UNITED STATES SECURITIES AND EXCHANGE COMMISSION |
WASHINGTON, D. C. 20549
FORM 10-K
(Mark One)
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2011
or
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________________ to _______________________
Commission File Number 0-26366
ROYAL BANCSHARES OF PENNSYLVANIA, INC.
(Exact name of registrant as specified in its charter)
| Pennsylvania | | 23-2812193 |
| (State of other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
| | | |
| 732 Montgomery Avenue, Narberth, Pennsylvania | | 19072 |
| (Address of principal executive offices) | | (Zip Code) |
(Issuer’s telephone number, including area code)
(Former name, former address and former year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
| Name of Each Exchange on Which Registered | | Title of Each Class |
| | | |
| The NASDAQ Stock Market, LLC | | Class A Common Stock ($2.00 par value) |
| | | |
| Securities registered pursuant to Section 12(g) of the Act: | | |
| | | |
| Name of Each Exchange on Which Registered | | Title of Each Class |
| | | |
| None | | Class B Common Stock ($0.10 par value) |
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
o Yes x No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act.
o Yes x No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 of 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding twelve months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
| Large accelerated filer o | Accelerated filer o | Non-accelerated filer o | Small reporting company x |
Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act) Yes o No x
The aggregate market value of the Registrant’s Common Stock held by non-affiliates is $7,934,523 based on the June 30, 2011 closing price of the Registrant’s Common Stock of $1.55 per share.
As of February 29, 2012, the Registrant had 10,864,008 and 2,080,574 shares outstanding of Class A and Class B common stock, respectively.
Documents Incorporated by Reference
Portions of the following documents are incorporated by reference: the definitive Proxy Statement of the Registrant relating to Registrant’s Annual meeting of Shareholders to be held on May 16, 2012—Part III.
Forward Looking Statements
From time to time, Royal Bancshares of Pennsylvania, Inc. (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, the Company 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 the Company’s 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: the nature, extent, and timing of governmental actions and reforms, including the rules of participation for the Troubled Asset Relief Program voluntary Capital Purchase Plan under the Emergency Economic Stabilization Act of 2008, which may be changed unilaterally and retroactively by legislative or regulatory actions; 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.
PART I
Royal Bancshares of Pennsylvania, Inc.
Royal Bancshares of Pennsylvania, Inc. (the “Company”), is a Pennsylvania business corporation and a bank holding company registered under the Federal Bank Holding Company Act of 1956, as amended (the “Holding Company Act”). The Company is supervised by the Board of Governors of the Federal Reserve System (“Federal Reserve Board”). The Company’s legal headquarters are located at 732 Montgomery Avenue, Narberth, Pennsylvania, 19072. On December 30, 2010, the Company completed the sale of all of the outstanding common stock of Royal Asian Bank (“Royal Asian”), a wholly-owned banking subsidiary of the Company, to an ownership group led by the President and Chief Executive Officer of Royal Asian.
The principal activities of the Company are supervising Royal Bank which engages in general banking business principally in Montgomery, Delaware, Chester, Bucks, Philadelphia and Berks counties in Pennsylvania, southern New Jersey, and Delaware. The Company also has a wholly owned non-bank subsidiary, Royal Investments of Delaware, Inc., which is engaged in investment activities. On November 21, 2007, the Company established Royal Captive Insurance Company, a wholly owned subsidiary. Royal Captive Insurance was formed to insure commercial property and provide comprehensive umbrella liability coverage for the Company and its affiliates. During the fourth quarter of 2010, Royal Captive Insurance was dissolved. The investments were sold for a gain of approximately $8,000, $2.0 million was paid to the Company as a dividend, and the remaining funds, in the approximate amount of $500,000, were transferred to the Company.
At December 31, 2011, the Company had consolidated total assets of approximately $848.4 million, total deposits of approximately $575.9 million and shareholders’ equity of approximately $75.9 million. The Company’s two Delaware trusts, Royal Bancshares Capital Trust I and Royal Bancshares Capital Trust II, are not consolidated per requirements under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 810, “Consolidation” (“ASC Topic 810”). The Company has two reportable operating segments, “Community Banking” and “Tax Liens”.
Regulatory Actions
FDIC and Department of Banking Orders
On July 15, 2009, Royal Bank agreed to enter into a Stipulation and Consent to the Issuance of an Order to Cease and Desist (the “Orders”) with each of the Federal Deposit Insurance Corporation (“FDIC”) and the Pennsylvania Department of Banking (the “Department”). The material terms of the Orders were identical and required Royal Bank among other items to maintain, after establishing an adequate allowance for loan and lease losses, a ratio of Tier 1 capital to total assets (“leverage ratio”) equal to or greater than 8% and a ratio of qualifying total capital to risk-weighted assets (“total risk-based capital ratio”) equal to or greater than 12%. The FDIC and the Department replaced the Orders in the fourth quarter of 2011 with an informal agreement, known as a memorandum of understanding. Included in the informal agreement is the continued requirement of maintaining a leverage ratio equal to or greater than 8% and a total risk-based capital ratio equal to or greater than 12%.
Federal Reserve Agreement
On March 17, 2010, the Company agreed to enter into a written agreement (“the Federal Reserve Agreement”) with the Federal Reserve Bank of Philadelphia (the “Reserve Bank”). The material terms of the Federal Reserve Agreement provide that: (i) the Company’s board of directors will take appropriate steps to fully utilize the Company’s financial and managerial resources to serve as a source of strength to its subsidiary banks; (ii) the Company’s board of directors will, within 60 days of the Federal Reserve Agreement, submit to the Reserve Bank a written plan to strengthen board oversight of the management and operations of the consolidated operation; (iii) the Company will not declare or pay any dividends without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System;
(iv) the Company and its non-bank subsidiaries will not make any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without the prior approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System; (v) the Company and its nonbank subsidiaries will not, directly or indirectly, incur, increase, or guarantee any debt without the prior written approval of the Reserve Bank; (vi) the Company will not, directly or indirectly, purchase or redeem any shares of its stock without the prior written approval of the Reserve Bank; (vii) the Company will, within 60 days of the Federal Reserve Agreement, submit to the Reserve Bank an acceptable written capital plan to maintain sufficient capital at the Company on a consolidated basis, which plan will at a minimum address: regulatory requirements for the Company and Royal Bank, the adequacy of Royal Bank’s capital taking into account the volume of classified credits, the allowance for loan and lease losses, current and projected asset growth, and projected retained earnings; the source and timing of additional funds necessary to fulfill the consolidated organization’s and Royal Bank’s future capital requirements; supervisory requests for additional capital at Royal Bank or the requirements of any supervisory action imposed on Royal Bank by federal or state regulators; and applicable legal requirements that the Company serve as a source of strength to Royal Bank; (viii) the Company will, within 60 days of the Federal Reserve Agreement, submit to the Reserve Bank cash flow projections for 2010 showing planned sources and uses of cash for debt service, operating expenses, and other purposes, and will submit similar cash flow projections for each subsequent calendar year at least one month prior to the beginning of such year; (ix) the Company will comply with applicable legal notice provisions in advance of appointing any new director or senior executive officer or changing the responsibilities of any senior executive officer such that the officer would assume a different senior executive officer position, and comply with restrictions on indemnification and severance payments imposed by the Federal Deposit Insurance Act; and (x) the Company’s board of directors will, within 45 days after the end of each quarter, submit progress reports to the Reserve Bank detailing the form and manner of all actions taken to secure compliance with the Agreement and the results thereof, together with a parent company-level balance sheet, income statement, and, as applicable, report of changes in shareholders’ equity.
The Federal Reserve Agreement will remain in effect and enforceable until stayed, modified, terminated or suspended by the Reserve Bank. The Company has submitted all progress reports and responses required under the Federal Reserve Agreement as of the date of this Report.
Royal Bank America
Royal Bank was incorporated in the Commonwealth of Pennsylvania on July 30, 1963, was chartered by the Department and commenced operation as a Pennsylvania state-chartered bank on October 22, 1963. Royal Bank is the successor of the Bank of King of Prussia, the principal ownership of which was acquired by the Tabas family in 1980. The deposits of Royal Bank are insured by the FDIC.
During the fourth quarter of 2006, Royal Bank formed a subsidiary, Royal Tax Lien Services, LLC, to purchase and service delinquent tax liens. Royal Bank owns 60% of the subsidiary.
On October 17, 2008, Royal Bank established RBA Property LLC, a wholly owned subsidiary. RBA Property was formed to hold other real estate owned acquired through foreclosure of collateral associated with non-performing loans.
On December 1, 2008, Royal Bank established Narberth Property Acquisition LLC, a wholly owned subsidiary. Narberth Property Acquisition was formed to hold other real estate owned acquired through foreclosure of collateral associated with non-performing loans.
On November 4, 2009, Royal Bank established Rio Marina LLC, a wholly owned subsidiary. Rio Marina LLC was formed to hold other real estate owned acquired through foreclosure of collateral associated with non-performing loans.
Royal Bank derives its income principally from interest charged on loans, interest earned on investment securities, and fees received in connection with the origination of loans and other services. Royal Bank’s principal expenses are interest expense on deposits and borrowings and operating expenses. Operating revenues, deposit growth, investment maturities, loan sales and the repayment of outstanding loans provide the majority of funds for activities.
Royal Bank conducts business operations as a commercial bank offering checking accounts, savings and time deposits, and loans, including residential mortgages, home equity and SBA loans. Royal Bank also offers safe deposit boxes, collections, internet banking and bill payment along with other customary bank services (excluding trust) to its customers. Drive-up, ATM, and night depository facilities are available. Services may be added or deleted from time to time. Royal Bank’s business and services are not subject to significant seasonal fluctuations. Royal Bank is a member of the Federal Reserve FedLine Wire Transfer System.
Service Area: Royal Bank’s primary service area includes Pennsylvania, primarily Montgomery, Chester, Bucks, Delaware, Berks and Philadelphia counties, and Gloucester County, New Jersey. This area includes residential areas and industrial and commercial businesses of the type usually found within a major metropolitan area. Royal Bank serves this area from fifteen branches located throughout Montgomery, Philadelphia, Delaware and Berks counties and Gloucester County, New Jersey. Royal Bank also considers New York, Maryland, and Delaware as a part of its service area for certain products and services. In the past, Royal Bank had frequently conducted business with clients located outside of its service area. Royal Bank has loans in twenty-four states via loan originations and/or participations with other lenders who have broad experience in those respective markets. Royal Bank’s headquarters are located at 732 Montgomery Avenue, Narberth, Pennsylvania 19072.
Competition: The financial services industry in our service area is extremely competitive. Competitors within our service area include banks and bank holding companies with greater resources. Many competitors have substantially higher legal lending limits.
In addition, savings banks, savings and loan associations, credit unions, money market and other mutual funds, brokerage firms, mortgage companies, leasing companies, finance companies and other financial services companies offer products and services similar to those offered by Royal Bank, on competitive terms.
Many bank holding companies have elected to become financial holding companies under the Gramm-Leach-Bliley Act of 1999, which give a broader range of products with which Royal Bank must compete. Management believes this statute further narrowed the differences and intensified competition among commercial banks, investment banks, insurance firms and other financial services companies. The Company has not elected financial holding company status.
Employees: Royal Bank employed approximately 152 persons on a full-time equivalent basis as of December 31, 2011.
Deposits: At December 31, 2011, total deposits of Royal Bank were distributed among demand deposits (10%), money market deposit, savings and NOW accounts (42%) and time deposits (48%). At year-end 2011, deposits decreased $115.0 million to $582.2 million, from year-end 2010, or 16.5%. Demand deposits increased $4.6 million and NOW and money market accounts increased $4.3 million while time deposits decreased $124.3 million primarily due to the redemption of brokered CDs. Included in Royal Bank’s deposits are approximately $6.3 million of intercompany deposits that are eliminated through consolidation.
Current market and regulatory trends in banking are changing the basic nature of the banking industry. Royal Bank intends to keep pace with the banking industry by being competitive with respect to interest rates and new types or classes of deposits insofar as it is practical to do so consistent with Royal Bank’s size, objective of profit maintenance and stable capital structure.
Lending: At December 31, 2011, Royal Bank had a total net loan portfolio of $397.7 million, representing 47% of total assets. The loan portfolio is categorized into commercial demand, commercial mortgages, residential mortgages (including home equity lines of credit), construction, real estate tax liens, asset based loans, small business leases and installment loans. At year-end 2011, loans decreased $78.0 million from year end 2010.
Royal Asian Bank
Royal Asian was incorporated in the Commonwealth of Pennsylvania on October 4, 2005, and was chartered by the Commonwealth of Pennsylvania Department of Banking and commenced operation as a Pennsylvania state-chartered bank on July 17, 2006. Royal Asian was an insured bank by the FDIC. Royal Asian derived its income principally from interest charged on loans and fees received in connection with other services. Royal Asian’s principal expenses were interest expense on deposits and operating expenses. Operating revenues, deposit growth, and the repayment of outstanding loans provided the majority of funds for activities. The sale of all of the outstanding common stock of Royal Asian owned by the Company was completed on December 30, 2010.
Non-Bank Subsidiaries
On June 30, 1995, the Company established a special purpose Delaware investment company, Royal Investment of Delaware (“RID”), as a wholly owned subsidiary. RID’s legal headquarters is 1105 N. Market Street, Suite 1300, Wilmington, Delaware 19899. RID buys, holds and sells investment securities. At December 31, 2011, total assets of RID were $30.0 million, of which $1.2 million was held in cash and cash equivalents and $6.0 million was held in investment securities. RID had net interest income of $673,000 and $779,000 for 2011 and 2010, respectively. Non-interest income, which is solely related to sales of investment securities, was $619,000 for 2011 compared to a loss of $158,000 for 2010.
RID’s net income for 2011 was $1.3 million compared to net income of $382,000 in 2010. Royal Bank has previously extended loans to RID, secured by securities and as per the provisions of Regulation W. During the third quarter of 2009, RID paid off the $9.4 million loan from Royal Bank. In addition, RID paid a $2.5 million dividend to Royal Bancshares in the third quarter of 2010 and a $10.0 million dividend to Royal Bancshares during the third quarter of 2009. The amounts above include the activity related to RID’s wholly owned subsidiary Royal Preferred LLC.
The Company, through its wholly owned subsidiary Royal Bank, holds a 60% ownership interest in Crusader Servicing Corporation (“CSC”). CSC’s legal headquarters is located at 732 Montgomery Avenue, Narberth, Pennsylvania 19072. CSC acquired, through auction, delinquent property tax liens in various jurisdictions, assuming a lien position that is generally superior to any mortgage liens on the property, and obtaining certain foreclosure rights as defined by local statute. In the first quarter of 2007, due to a change in CSC management, Royal Bank and other shareholders, constituting a majority of CSC shareholders, voted to liquidate CSC under an orderly, long term plan adopted by CSC management. At December 31, 2011, total assets of CSC were $9.0 million. Included in total assets is $1.0 million for the Strategic Municipal Investments (“SMI”) portfolio, which is comprised of residential, commercial, and land tax liens, primarily in Alabama. In 2005, the Company entered into a partnership with SMI, ultimately acquiring a 50% ownership interest in SMI. In connection with acquiring this ownership interest, CSC extended an $18 million line of credit to SMI, which was used by SMI to purchase tax lien portfolios at a discount. As a result of the deterioration in residential, commercial and land values principally in Alabama, management concluded that the loan was impaired based on an analysis of the portfolio in the fourth quarter of 2008. Through 2010, CSC charged-off $3.0 million related to this loan. Additional charge-offs of $587,000 related to SMI were recorded in 2011. The outstanding SMI loan balance was $1.0 million at December 31, 2011. In 2011, CSC’s net interest income declined $355,000 from $368,000 for 2010 to $13,000 due to the continued liquidation of the portfolio. The 2011 provision for lien losses was $619,000 compared to $59,000 for 2010. The provision is mainly related to the SMI impairments mentioned above. For 2011 and 2010 other income was $289,000 and $338,000, respectively. Other income is mostly comprised of gain on sale of real estate owned (“REO”) properties. Other expense was $285,000 and $512,000 for 2011 and 2010, respectively. CSC recorded a net loss of $361,000 in 2011 compared to net income of $81,000 in 2010. The 2011 loss was impacted by the increase in the provision for lien losses.
On June 23, 2003, the Company, through its wholly owned subsidiary Royal Bank, established Royal Investments America, LLC (“RIA”) as a wholly owned subsidiary. RIA’s legal headquarters is located at 732 Montgomery Avenue, Narberth, Pennsylvania 19072. RIA was formed to invest in equity real estate ventures subject to limitations imposed by regulation. At December 31, 2011, total assets of RIA were $5.9 million, which included $5.0 million in cash. During 2011, RIA had net income of $1.9 million compared to a net loss of $4.5 million for 2010. The net loss in 2010 was primarily a result of a $2.6 million impairment recorded on an equity real estate investment and a $2.5 million impairment recorded on a real estate joint venture.
On October 27, 2004, the Company formed two Delaware trust affiliates, Royal Bancshares Capital Trust I and Royal Bancshares Capital Trust II, in connection with the sale of an aggregate of $25.0 million of trust preferred securities.
On July 25, 2005, the Company, through its wholly owned subsidiary Royal Bank, formed Royal Bank America Leasing, LP (“Royal Leasing”). Royal Bank holds a 60% ownership interest in Royal Leasing. Royal Leasing’s legal headquarters is located at 550 Township Line Road, Blue Bell, Pennsylvania 19422. Royal Leasing was formed to originate small business leases. Royal Leasing originates small ticket leases through its internal sales staff and through independent brokers located throughout its business area. In general, Royal Leasing will portfolio individual small ticket leases in amounts of up to $250,000. Leases originated in amounts in excess of that are sold for a profit to other leasing companies. From time to time Royal Leasing will sell small lease portfolios to third-parties and will, on occasion, purchase lease portfolios from other originators. During 2011 and 2010, neither sales nor purchases of lease portfolios were material. At December 31, 2011, total assets of Royal Leasing were $36.5 million. For 2011, Royal Leasing had net interest income of $2.3 million compared to $2.5 million for 2010. For 2011 provision for lease losses was $504,000 compared to $834,000 for 2010. The decrease in the provision was primarily related to improvement in the credit quality of the leasing portfolio year over year. Other income increased $193,000 from $365,000 for 2010 to $558,000 for 2011. Other expense was $1.0 million and $803,000 for 2011 and 2010, respectively. The increase in other expense was related to an increase of $294,000 in distribution of management fees. Royal Leasing recorded net income of $479,000 for the year ended December 31, 2011 compared to a $547,000 for the year ended December 31, 2010.
On November 17, 2006, the Company, through its wholly owned subsidiary Royal Bank, formed Royal Tax Lien Services, LLC (“RTL”). Royal Bank holds a 60% ownership interest in RTL. Its legal headquarters is located at 732 Montgomery Avenue, Narberth, Pennsylvania 19072. RTL was formed to purchase and service delinquent tax certificates. RTL typically acquires delinquent property tax liens through public auctions in various jurisdictions, assuming a lien position that is generally superior to any mortgage liens that are on the property, and obtaining certain foreclosure rights as defined by local statute. At December 31, 2011, total assets of RTL of which the majority was held in tax liens were $61.8 million compared to $89.1 million at December 31, 2010. Tax certificates decline $19.2 million from $63.7 million at December 31, 2010 to $44.5 million at December 31, 2011. For 2011, RTL had net interest income of $4.8 million compared to $5.8 million for 2010 due to the reduction in average tax liens outstanding for RTL over the past year. Provision for lien losses was $464,000 compared to $70,000 for 2011 and 2010, respectively. Other expense was $1.2 million for both 2011 and 2010. Net income for 2011 declined $874,000 from $2.9 million for 2010 to $2.0 million for 2011.
On November 21, 2007, the Company established Royal Captive Insurance Company, a wholly owned subsidiary. Royal Captive Insurance was formed to insure commercial property and comprehensive umbrella liability for the Company and its affiliates. During the fourth quarter of 2010, Royal Captive Insurance was dissolved. The investments were sold for a gain of approximately $8,000, $2.0 million was paid to the Company as a dividend, and the remaining funds, in the approximate amount of $500,000, were transferred to the Company.
On June 16, 2006, the Company, through its wholly owned subsidiary RID, established Royal Preferred LLC as a wholly owned subsidiary. Royal Preferred LLC was formed to purchase a subordinated debenture from Royal Bank. At December 31, 2011, Royal Preferred LLC had total assets of approximately $21 million.
Website Access to Company Reports
We post publicly available reports required to be filed with the SEC on our website, www.royalbankamerica.com, as soon as reasonably practicable after filing such reports with the SEC. The required reports are available free of charge through our website. Information available on our website is not part or incorporated by reference into this Report or any other report filed by this Company with the SEC.
Products and Services with Reputation Risk
The Company offers a diverse range of financial and banking products and services. In the event one or more customers and/or governmental agencies become dissatisfied or object to any product or service offered by the Company or any of its subsidiaries, whether legally justified or not, negative publicity with respect to any such product or service could have a negative impact on the Company’s reputation. The discontinuance of any product or service, whether or not any customer or governmental agency has challenged any such product or service, could have a negative impact on the Company’s reputation.
Future Acquisitions
The Company’s acquisition strategy consists of identifying financial institutions, insurance agencies and other financial companies with business philosophies that are similar to our business philosophies, which operate in strong markets that are geographically compatible with our operations, and which can be acquired at an acceptable cost. In evaluating acquisition opportunities, we generally consider potential revenue enhancements and operating efficiencies, asset quality, interest rate risk, and management capabilities. The Company currently has no formal commitments with respect to future acquisitions.
Concentrations, Seasonality
The Company does not have any portion of its business dependent on a single or limited number of customers, the loss of which would have a material adverse effect on its business. No substantial portion of loans or investments is concentrated within a single industry or group of related industries, except a significant majority of loans are secured by real estate. The Company has seen a deterioration in economic conditions as it pertains to real estate loans. Construction and land, non-residential real estate, and commercial loans represent 43%, 40% and 9%, respectively of the $51.3 million in non-accrual loans held at December 31, 2011. The business of the Company and its subsidiaries is not seasonal in nature.
Environmental Compliance
The Company and its subsidiaries’ compliance with federal, state and local environment protection laws had no material effect on capital expenditures, earnings or their competitive position in 2011, and are not expected to have a material effect on such expenditures, earnings or competitive position in 2012.
Supervision and Regulation
Bank holding companies and banks operate in a highly regulated environment and are regularly examined by federal and state regulatory authorities. The following discussion concerns various federal and state laws and regulations and the potential impact of such laws and regulation on the Company and its subsidiaries. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory or regulatory provisions themselves. Proposals to change laws and regulations are frequently introduced in Congress, the state legislatures, and before the various bank regulatory agencies. The Company cannot determine the likelihood or timing of any such proposals or legislations or the impact they may have on the Company and its subsidiaries. A change in law, regulations or regulatory policy may have a material effect on the Company’s business.
Holding Company
The Company, as a Pennsylvania business corporation, is subject to the jurisdiction of the Securities and Exchange Commission (the “SEC”) and of state securities commissions for matters relating to the offering and sale of its securities. Accordingly, if the Company wishes to issue additional shares of its Common Stock, in order, for example, to raise capital or to grant stock options, the Company will have to comply with the registration requirements of the Securities Act of 1933 as amended, or find an applicable exemption from registration.
The Company is subject to the provisions of the Holding Company Act, and to supervision, regulation and examination by the Federal Reserve Board. The Holding Company Act requires the Company to secure the prior approval of the Federal Reserve Board before it owns or controls, directly or indirectly, more than 5% of the voting shares of any corporation, including another bank. In addition, the Holding Company Act prohibits the Company from acquiring more than 5% of the voting shares of, or interest in, or all or substantially all of the assets of, any bank located outside Pennsylvania, unless such an acquisition is specifically authorized by laws of the state in which such bank is located.
A bank holding company also is prohibited from engaging in or acquiring direct or indirect control of more than 5% of the voting shares of any such company engaged in non-banking activities unless the Federal Reserve Board, by order or regulation, has found such activities to be closely related to banking or managing or controlling banks as to be a proper incident thereto. In making this determination, the Federal Reserve Board considers whether the performance of these activities by a bank holding company would offer benefits to the public that outweigh possible adverse effects.
As a bank holding company, the Company is required to file an annual report with the Federal Reserve Board and any additional information that the Federal Reserve Board may require pursuant to the Holding Company Act. The Federal Reserve Board may also make examinations of the Holding Company and any or all of its subsidiaries. Further, under the Holding Company Act and the Federal Reserve Board’s regulations, a bank holding company and its subsidiaries are prohibited from engaging in certain tying arrangements in connection with any extension of credit or provision of credit of any property or services. The so called “anti-tying” provisions state generally that a bank may not extend credit, lease, sell property or furnish any service to a customer on the condition that the customer obtain additional credit or service from the banks, its bank holding company or any other subsidiary of its bank holding company, or on the condition that the customer not obtain other credit or services from a competitor of the banks, its bank holding company or any subsidiary of its bank holding company.
Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve Act and by state banking laws on any extensions of credit to the bank holding company or any of the holding company’s subsidiaries, on investments in the stock or other securities of the bank holding company and on taking of such stock or securities as collateral for loans to any borrower.
Under the Pennsylvania Banking Code of 1965, as amended, the (“Code”), the Company is permitted to control an unlimited number of banks. However, the Company would be required under the Holding Company Act to obtain the prior approval of the Federal Reserve Board before it could acquire all or substantially all of the assets of any bank, or acquiring ownership or control of any voting shares of any bank other than Royal Bank, if, after such acquisition, the registrant would own or control more than 5% of the voting shares of such bank.
A bank holding company located in Pennsylvania, another state, the District of Columbia or a territory or possession of the United States may control one or more banks, bank and trust companies, national banks, interstate banks and, with the prior written approval of the Department, may acquire control of a bank and trust company or a national bank located in Pennsylvania. A Pennsylvania-chartered institution may maintain a bank, branches in any other state, the District of Columbia, or a territory or possession of the United States upon the written approval of the Department.
Federal law also prohibits the acquisition of control of a bank holding company without prior notice to certain federal bank regulators. Control is defined for this purpose as the power, directly or indirectly, to direct the management or policies of a bank or bank holding company or to vote 25% or more of any class of voting securities of a bank or bank holding company.
Royal Bank
Royal Bank is subject to supervision, regulation and examination by the Department and by the FDIC. As previously mentioned under “Regulatory Actions”, in December 2011, the FDIC and the Department replaced the Orders to which Royal Bank was subject with a memorandum of understanding. The deposits of Royal Bank are insured by the FDIC. In addition, Royal Bank is subject to a variety of local, state and federal laws that affect its operation.
The Department and the FDIC routinely examine Pennsylvania state-chartered, non-member banks such as Royal Bank in areas such as reserves, loans, investments, management practices and other aspects of operations. These examinations are designed for the protection of depositors rather than the Company’s shareholders.
Federal and state banking laws and regulations govern, among other things, the scope of a bank’s business, the investments a bank may make, the reserves against deposits a bank must maintain, the types and terms of loans a bank may make and the collateral it may take, the activities of banks with respect to mergers and consolidations, and the establishment of branches. Pennsylvania law permits statewide branching.
Under the Federal Deposit Insurance Act (“FDIC Act”), the FDIC possesses the power to prohibit institutions regulated by it (such as Royal Bank) from engaging in any activity that would be an unsafe and unsound banking practice or in violation of applicable law. Moreover, the FDIC Act: (i) empowers the FDIC to issue cease-and-desist or civil money penalty orders against Royal Bank or its executive officers, directors and/or principal shareholders based on violations of law or unsafe and unsound banking practices; (ii) authorizes the FDIC to remove executive officers who have participated in such violations or unsound practices; (iii) restricts lending by Royal Bank to its executive officers, directors, principal shareholders or related interests thereof; and (iv) restricts management personnel of a bank from serving as directors or in other management positions with certain depository institutions whose assets exceed a specified amount or which have an office within a specified geographic area. Additionally, the FDIC Act provides that no person may acquire control of Royal Bank unless the FDIC has been given 60-days prior written notice and within that time has not disapproved the acquisition or extended the period for disapproval.
Under the Community Reinvestment Act (“CRA”), the FDIC uses a five-point rating scale to assign a numerical score for a bank’s performance in each of three areas: lending, service and investment. Under the CRA, the FDIC is required to: (i) assess the records of all financial institutions regulated by it to determine if these institutions are meeting the credit needs of the community (including low-and moderate-income neighborhoods) which they serve, and (ii) take this record into account in its evaluation of any application made by any such institutions for, among other things, approval of a branch or other deposit facility, office relocation, a merger or an acquisition of another bank. The CRA also requires the federal banking agencies to make public disclosures of their evaluation of each bank’s record of meeting the credit needs of its entire community, including low-and moderate-income neighborhoods. This evaluation will include a descriptive rate (“outstanding,” “satisfactory,” “needs to improve” or “substantial noncompliance”) and a statement describing the basis for the rating.
A subsidiary bank of a holding company is subject to certain restrictions imposed by the Federal Reserve Act, as amended, on any extensions of credit to the bank holding company or its subsidiaries, on investments in the stock or other securities of the bank holding company or its subsidiaries, and on taking such stock or securities as collateral for loans. The Federal Reserve Act, as amended and Federal Reserve Board regulations also place certain limitations and reporting requirements on extensions of credit by a bank to principal shareholders of its parent holding company, among others, and to related interests of such principal shareholders. In addition, such legislation and regulations may affect the terms upon which any person who becomes a principal shareholder of a holding company may obtain credit from banks with which the subsidiary bank maintains a correspondent relationship.
From time to time, various types of federal and state legislation have been proposed that could result in additional regulation of, and restrictions on, the business of Royal Bank. It cannot be predicted whether any such legislation will be adopted or how such legislation would affect the business of Royal Bank. As a consequence of the extensive regulation of commercial banking activities in the United States, Royal Bank’s business is particularly susceptible to being affected by federal legislation and regulations that may increase the costs of doing business.
Under the Bank Secrecy Act (“BSA”), banks and other financial institutions are required to report to the Internal Revenue Service currency transactions of more than $10,000 or multiple transactions in any one day of which the banks are aware that exceed $10,000 in the aggregate. Civil and criminal penalties are provided under the BSA for failure to file a required report, for failure to supply information required by the BSA or for filing a false or fraudulent report.
Federal Deposit Insurance Corporation Improvement Act of 1991
General: The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDIC Improvement Act”) includes several provisions that have a direct impact on Royal Bank. The most significant of these provisions are discussed below.
The FDIC is required to conduct periodic full-scope, on-site examinations of Royal Bank. In order to minimize losses to the deposit insurance funds, the FDIC Improvement Act establishes a format to monitor FDIC-insured institutions and to enable “prompt corrective action” by the appropriate federal supervisory agency if an institution begins to experience any difficulty. The FDIC Improvement Act establishes five “capital” categories. They are: (1) well capitalized, (2) adequately capitalized, (3) undercapitalized, (4) significantly undercapitalized, and (5) critically undercapitalized. The overall goal of these capital measures is to impose scrutiny and operational restrictions on banks as they descend the capital categories from well capitalized to critically undercapitalized.
Under current regulations, a “well-capitalized” institution is one that has at least a 10% total risk-based capital ratio, a 6% Tier 1 risk-based capital ratio, a 5% Tier 1 Leverage Ratio, and is not subject to any written order or final directive by the FDIC to meet and maintain a specific capital level. Under the informal agreement as described in “Regulatory Action” under “Item 1 – Business” of this Report, Royal Bank is required to maintain a minimum Tier 1 leverage ratio of 8% and a Total risk-based capital ratio of 12% during the term of the informal agreement. Royal Bank has met all of the capital ratio requirements under the informal agreement.
An “adequately capitalized” institution is one that meets the required minimum capital levels, but does not meet the definition of a “well-capitalized” institution. The existing capital rules generally require banks to maintain a Tier 1 Leverage Ratio of at least 4% and an 8% total risk-based capital ratio. Since the risk-based capital requirement is measured in the form of Tier 1 capital, this also will mean that a bank would need to maintain at least 4% Tier 1 risk-based capital ratio. An institution must meet each of the required minimum capital levels in order to be deemed “adequately capitalized.”
An “undercapitalized” institution is one that fails to meet one or more of the required minimum capital levels for an “adequately capitalized” institution. Under the FDIC Improvement Act, an “undercapitalized” institution must file a capital restoration plan and is automatically subject to restrictions on dividends, management fees and asset growth. In addition, the institution is prohibited from making acquisitions, opening new branches or engaging in new lines of business without the prior approval of its primary federal regulator. A number of other restrictions may be imposed.
A “critically undercapitalized” institution is one that has a tangible equity (Tier 1 capital) ratio of 2% or less. In addition to the same restrictions and prohibitions that apply to “undercapitalized” and “significantly undercapitalized” institutions, any institution that becomes “critically undercapitalized” is prohibited from taking the following actions without the prior written approval of its primary federal supervisory agency: engaging in any material transactions other than in the usual course of business; extending credit for highly leveraged transactions; amending its charter or bylaws; making any material changes in accounting methods; engaging in certain transactions with affiliates; paying excessive compensation or bonuses; and paying interest on liabilities exceeding the prevailing rates in the institution’s market area. In addition, a “critically undercapitalized” institution is prohibited from paying interest or principal on its subordinated debt and is subject to being placed in conservatorship or receivership if its tangible equity capital level is not increased within certain mandated time frames.
Real Estate Lending Guidelines: Pursuant to the FDIC Improvement Act, the FDIC has issued real estate lending guidelines that establish loan-to-value (“LTV”) ratios for different types of real estate loans. A LTV ratio is generally defined as the total loan amount divided by the appraised value of the property at the time the loan is originated. If a bank does not hold a first lien position, the total loan amount would be combined with the amount of all senior liens when calculating the ratio. In addition to establishing the LTV ratios, the FDIC’s real estate guidelines require all real estate loans to be based upon proper loan documentation and a recent independent appraisal of the property.
The FDIC’s guidelines establish the following limits for LTV ratios:
| Loan Category | | LTV limit | |
| | | | |
| Raw land | | | 65 | % |
| Land development | | | 65 | % |
| Construction: | | | | |
| Commercial, multifamily (includes condos and co-ops) and other nonresidential | | | 80 | % |
| Improved property | | | 85 | % |
| Owner occupied 1-4 family and home equity (without credit enhancements) | | | 90 | % |
The guidelines provide exceptions to the LTV ratios for government-backed loans; loans facilitating the sale of real estate acquired by the lending institution in the normal course of business; loans where Royal Bank’s decision to lend is not based on the offer of real estate as collateral and such collateral is taken only out of an abundance of caution; and loans renewed, refinanced, or restructured by the original lender to the same borrower, without the advancement of new money. The regulation also allows institutions to make a limited amount of real estate loans that do not conform to the proposed LTV ratios. Under this exception, Royal Bank would be allowed to make real estate loans that do not conform to the LTV ratio limits, up to an amount not to exceed 100% of their total capital.
Truth in Savings Act: The FDIC Improvement Act also contains the Truth in Savings Act. The purpose of this Act is to require the clear and uniform disclosure of the rates of interest that are payable on deposit accounts by Royal Bank and the fees that are assessable against deposit accounts, so that consumers can make a meaningful comparison between the competing claims of banks with regard to deposit accounts and products. This Act requires Royal Bank to include, in a clear and conspicuous manner, the following information with each periodic statement of a deposit account: (1) the annual percentage yield earned; (2) the amount of interest earned; (3) the amount of any fees and charges imposed; and (4) the number of days in the reporting period. This Act allows for civil lawsuits to be initiated by customers if Royal Bank violates any provision or regulation under this Act.
Gramm-Leach-Bliley Act of 1999
The Gramm-Leach-Bliley Act of 1999 (“GLBA”), also known as the Financial Services Modernization Act repeals the two anti-affiliation provisions of the Glass-Steagall Act. GLBA establishes a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers. It revises and expands the framework of the Holding Company Act to permit a holding company to engage in a full range of financial activities through a new entity known as a financial holding company. “Financial activities” is broadly defined to include not only banking, insurance and securities activities, but also merchant banking and additional activities that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to such financial activities, or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally.
In addition, GLBA provides a uniform framework for the functional regulation of the activities of banks, savings institutions and their holding companies; broadens the activities that may be conducted by national banks, banking subsidiaries of bank holding companies, and their financial subsidiaries; and adopts a number of provisions related to the capitalization, membership, corporate governance, and other measures designed to modernize the Federal Home Loan Bank system.
Privacy provision: GLBA provides an enhanced framework for protecting the privacy of consumer information. The FDIC and other banking regulatory agencies, as required under GLBA, have adopted rules limiting the ability of banks and other financial institutions to disclose nonpublic information about consumers to nonaffiliated third parties. Among other things, these provisions require banks and other financial institutions to have in place safeguards to ensure the security and confidentiality of customer records and information, to protect against anticipated threats or hazards to the security or integrity of such records, and to protect against unauthorized access to or use of such records that could result in substantial harm or inconvenience to a customer. GLBA also requires financial institutions to provide customers at the outset of the relationship and annually thereafter written disclosures concerning the institution’s privacy policies.
GLBA also expressly preserves the ability of a state bank to retain all existing subsidiaries. Because Pennsylvania permits commercial banks chartered by the state to engage in any activity permissible for national banks, Royal Bank will be permitted to form subsidiaries to engage in the activities authorized by GLBA to the same extent as a national bank. In order to form a financial subsidiary, Royal Bank must be well-capitalized, and would be subject to the same capital deduction, risk management and affiliate transaction rules as applicable to national banks.
To the extent that GLBA permits banks, securities firms, and insurance companies to affiliate, the financial services industry may experience further consolidation. GLBA is intended to grant to community banks certain powers as a matter of right that larger institutions have accumulated on an ad hoc basis. Nevertheless, this act may have the result of increasing the amount of competition that the Company and Royal Bank face from larger institutions and other types of companies offering financial products, many of which may have substantially more financial resources than the Company and Royal Bank.
USA Patriot Act of 2001
A major focus of governmental policy in recent years that impacts financial institutions has been combating money laundering and terrorist financing. The Patriot Act broadened anti-money laundering regulations to apply to additional types of financial institutions and strengthened the ability of the U. S. Government to help prevent and prosecute international money laundering and the financing of terrorism. The potential impact of the Patriot Act on financial institutions of all kinds is significant and wide ranging. The Patriot Act requires regulated financial institutions, among other things, to establish an anti-money laundering program that includes training and auditing components, to take additional precautions with non-U.S. owned accounts, and to comply with regulations related to verifying client identification at account opening. The Patriot Act also provides rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering. Failure of a financial institution to comply with the requirements of the Patriot Act could have serious legal and reputational consequences for the institution. The Company has implemented systems and procedures to meet the requirements of the regulation and will continue to revise and update policies, procedures and necessary controls to reflect changes required by the Patriot Act.
Sarbanes-Oxley Act of 2002
The primary aims of the Sarbanes-Oxley Act of 2002 (“SOX”) was to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. SOX addresses, among other matters, requirements for audit committee membership and responsibilities, requirements of management to evaluate the Company’s disclosure controls and procedures and its internal control over financial reporting, including certification of financial statements and the effectiveness of internal controls by the primary executive officer and primary financial officer; established standards for auditors and regulation of audits, including independence provisions that restrict non-audit services that accountants may provide to their audit clients; and expanded the disclosure requirements for our Company insiders; and increased various civil and criminal penalties for fraud and other violations of securities laws.
Emergency Economic Stabilization Act of 2008
The Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted on October 3, 2008. EESA was designed to enable the federal government, under terms and conditions developed by the Secretary of the Treasury, to insure troubled assets, including mortgage-backed securities, and collect premiums from participating financial institutions. EESA includes, among other provisions: (a) the $700 billion Troubled Asset Relief Program (“TARP”), under which the Secretary of the Treasury was authorized to purchase, insure, hold, and sell a wide variety of financial instruments, particularly those that are based on or related to residential or commercial mortgages originated or issued on or before March 14, 2008; and (b) an increase in the amount of deposit insurance provided by the FDIC.
Under the TARP, the United States Department of Treasury (“Treasury”) authorized a voluntary Capital Purchase Program (“CPP”) to purchase up to $250 billion of senior preferred shares of qualifying financial institutions that elected to participate by November 14, 2008. On February 20, 2009, the Company issued to Treasury, 30,407 shares of Series A Preferred Stock and a warrant to purchase 1,104,370 shares of Class A common stock for an aggregate purchase price of $30.4 million under the TARP CPP. (See “Note 14 – Shareholders’ Equity” of the Notes to Consolidated Financial Statements in Item 8 of this Report.) Companies participating in the TARP CPP were required to adopt certain standards relating to executive compensation. The terms of the TARP CPP also limit certain uses of capital by the issuer, including with respect to repurchases of securities and increases in dividends.
American Recovery and Reinvestment Act of 2009
On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (“ARRA”) was enacted. ARRA is intended to provide a stimulus to the U.S. economy in the wake of the economic downturn brought about by the subprime mortgage crisis and the resulting credit crunch. The bill included federal tax cuts, expansion of unemployment benefits and other social welfare provisions, and domestic spending in education, healthcare, and infrastructure, including the energy structure.
Under ARRA, an institution that received funds under TARP, such as the Company, is subject to certain restrictions and standards throughout the period in which any obligation arising under TARP remains outstanding (except for the time during which the federal government holds only warrants to purchase common stock of the issuer). The following summarizes the significant requirements of ARRA and applicable Treasury regulations:
| | § | Limits on compensation incentives for risks by senior executive officers; |
| | § | A requirement for recovery of any compensation paid based on inaccurate financial information; |
| | § | A prohibition on “golden parachute payments” to specified officers or employees, which term is generally defined as any payment for departure from a company for any reason; |
| | § | A prohibition on compensation plans that would encourage manipulation of reported earnings to enhance the compensation of employees; |
| | § | A prohibition on bonus, retention award, or incentive compensation to designated employees, except in the form of long-term restricted stock; |
| | § | A requirement that the board of directors adopt a luxury expenditures policy; |
| | § | A requirement that shareholders be permitted a separate nonbinding vote on executive compensation; |
| | § | A requirement that the chief executive officer and the chief financial officer provide a written certification of compliance with the standards, when established, to the SEC. |
Under ARRA, subject to consultation with the appropriate federal banking agency, Treasury is required to permit a recipient of TARP funds to repay any amounts previously provided to or invested in the recipient by Treasury without regard to whether the institution has replaced the funds from any other source or to any waiting period.
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) was enacted into law. The Dodd-Frank Act significantly changes regulation of financial institutions and the financial services industry, including: creating a Financial Services Oversight Council to identify emerging systemic risks and improve interagency cooperation; centralizing the responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau, which will be responsible for implementing, examining and enforcing compliance with federal consumer financial laws; permanently raising the current standard maximum deposit insurance amount to $250,000; establishing strengthened capital standards for banks, and disallowing trust preferred securities as qualifying as Tier 1 capital (subject to certain exceptions and grandfather provisions for existing trust preferred securities); amending the Truth in Lending Act with respect to mortgage originations and establishing new minimum mortgage underwriting standards; strengthening the SEC’s powers to regulate securities markets; granting the Federal Reserve Board the power to regulate debit card interchange fees; allowing the FDIC to raise the ratio of reserves to deposits from 1.15% to 1.35% for deposit insurance purposes by September 30, 2020 and to offset the effect of increased assessments on insured depository institutions with assets of less than $10 billion; allowing financial institutions to pay interest on business checking accounts; and implementing provisions that affect corporate governance and executive compensation at all publicly traded companies.
It is difficult to predict at this time the specific impact the Dodd-Frank Act and the yet to be written implementing rules and regulations will have on community banks. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such requirements will have on financial institutions’ operations is presently unclear. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage ratio requirements or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make necessary changes in order to comply with new statutory and regulatory requirements.
Regulation W
Transactions between a bank and its “affiliates” are quantitatively and qualitatively restricted under the Sections 23A and 23B of Federal Reserve Act. The FDIC Act applies Sections 23A and 23B to insured nonmember banks in the same manner and to the same extent as if they were members of the Federal Reserve System. The Federal Reserve Board has also recently issued Regulation W, which codifies prior regulations under Sections 23A and 23B of the Federal Reserve Act and interpretative guidance with respect to affiliate transactions. Regulation W incorporates the exemption from the affiliate transaction rules but expands the exemption to cover the purchase of any type of loan or extension of credit from an affiliate. Affiliates of a bank include, among other entities, the bank’s holding company and companies that are under common control with the bank. The Company is considered to be an affiliate of Royal Bank. In general, subject to certain specified exemptions, a bank or its subsidiaries are limited in their ability to engage in “covered transactions” with affiliates:
| | § | To an amount equal to 10% of Royal Bank’s capital and surplus, in the case of covered transactions with any one affiliate; and |
| | § | To an amount equal to 20% of Royal Bank’s capital and surplus, in the case of covered transactions with all affiliates. |
In addition, a bank and its subsidiaries may engage in covered transactions and other specified transactions only on terms and under circumstances that are substantially the same, or at least as favorable to the bank or its subsidiary, as those prevailing at the time for comparable transactions with nonaffiliated companies. A “covered transaction” includes:
| | § | A loan or extension of credit to an affiliate; |
| | § | A purchase of, or an investment in, securities issued by an affiliate; |
| | § | A purchase of assets from an affiliate, with some exceptions; |
| | § | The acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any party; and |
| | § | This issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate. |
In addition, under Regulation W:
| | § | A bank and its subsidiaries may not purchase a low-quality asset from an affiliate; |
| | § | Covered transactions and other specified transactions between a bank or its subsidiaries and an affiliate must be on terms and conditions that are consistent with safe and sound banking practices; and |
| | § | With some exceptions, each loan or extension of credit by a bank to an affiliate must be secured by collateral with a market value ranging from 100% to 130%, depending on the type of collateral, of the amount of the loan or extension of credit. |
Regulation W generally excludes all non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve Board decides to treat these subsidiaries as affiliates.
Concurrently with the adoption of Regulation W, the Federal Reserve Board has proposed a regulation which would further limit the amount of loans that could be purchased by a bank from an affiliate to not more than 100% of Royal Bank’s capital and surplus.
FDIC Insurance Assessments
The Federal Deposit Insurance Reform Act of 2005 (the “Reform Act”), which was signed into law in 2006, resulted in a number of changes to how banks are assessed deposit premiums. Under the new risk-related premium schedule established by the Reform Act, the FDIC assigns each depository institution to one of several supervisory groups based on both capital adequacy and the FDIC's judgment of the institution's strength in light of supervisory evaluations, including examination reports, statistical analyses and other information relevant to measuring the risk posed by the institution.
The Reform Act merged the former BIF and SAIF into a single Deposit Insurance Fund (“DIF”), increased deposit insurance coverage for IRAs to $250,000, provides for the future increase of deposit insurance on all other accounts (presently limited to $250,000 per account) by indexing the coverage to the rate of inflation, authorizes the FDIC to set the reserve ratio of the combined DIF at a level between 1.15% and 1.50%, and permits the FDIC to establish assessments to be paid by insured banks to maintain the minimum ratios. The required reserve ratio will depend upon the growth of insured deposits at all banks in the U.S., the number and size of any bank failures, and the FDIC’s assessment of the risk in the banking industry at any given time.
On October 14, 2008, the FDIC announced its temporary “Transaction Account Guarantee Program” (“TAGP”) which provides full coverage for non-interest bearing deposit accounts. Royal Bank was participating in the program which guaranteed all personal and business non-interest bearing checking accounts. This unlimited coverage expired on December 31, 2010. Under the Dodd Frank Act, the Dodd Frank Deposit Insurance Provision is providing temporary unlimited coverage for non-interest bearing deposit accounts from December 31, 2010 through December 31, 2012.
On February 27, 2009, the FDIC’s Board of Directors voted to amend the restoration plan for DIF. Failures of FDIC-insured institutions had caused the reserve ratio of DIF to decline from 1.19 percent as of March 30, 2008, to 0.76 percent as of September 30, 2008. Consequently, the 2009 DIF assessment rates reflected an increase of seven to nine basis points and range from $0.07 for those institutions with the least risk, up to $0.775 for every $100 of insured deposits for institutions deemed to have the highest risk. In May 2009, the Board imposed a five basis point emergency special assessment for every $100 of insured deposits on June 30, 2009. Royal Bank’s emergency special assessment was $601,000 and was collected on September 30, 2009. Additionally, in November 2009, the FDIC adopted a final rule imposing a 13-quarter prepayment of FDIC insurance premiums payable on December 30, 2009. The FDIC exempted Royal Bank from making this prepayment of approximately $11.8 million.
Beginning with the second quarter of 2011, as mandated by the recently enacted Dodd-Frank Act, the assessment base that the FDIC will use to calculate assessment premiums will be a bank’s average assets minus average tangible equity. As the asset base of the banking industry is larger than the deposit base, the range of base assessment rates will change to a low of 2.5 basis points to a high of 45 basis points, per $100 of assets; however, the dollar amount of the actual premiums is expected to be roughly the same.
The FDIC is required under the Dodd-Frank Act to establish assessment rates that will allow the Deposit Insurance Fund to achieve a reserve ratio of 1.35% of Insurance Fund insured deposits by September 2020. In attempting to achieve the mandated 1.35% ratio, the FDIC is required to implement assessment formulas that charge banks over $10 billion in asset size more than banks under that size. Those new formulas began in the second quarter of 2011, but did not affect Royal Bank. Under the Dodd-Frank Act, the FDIC is authorized to make reimbursements from the insurance fund to banks if the reserve ratio exceeds 1.50%, but the FDIC has adopted the “designated reserve ratio” of 2.0%. In lieu of reimbursements, the FDIC has set lower base assessment rates if the reserve ratio for the prior assessment period is equal to or exceeds 2.0%.
In addition to deposit insurance, Royal Bank is also subject to assessments to pay the interest on Financing Corporation bonds. The Financing Corporation was created by Congress to issue bonds to finance the resolution of failed thrift institutions. Commercial banks and thrifts are subject to the same assessment for Financing Corporation bonds. The FDIC sets the Financing Corporation assessment rate every quarter. For the first quarter of 2012, the Financing Corporation’s assessment for Royal Bank (and all other banks), is an annual rate of $.0066 for each $100 of deposits. The Financing Corporation bonds are expected to be paid off between 2017 and 2019.
Other Legislation/Regulatory Requirements
Capital Framework and Basel III
The Basel Committee on Banking Supervision and the Financial Stability Board, which was established by the Group of 20 (“G-20”) Finance Ministers and Central Bank Governors to take action to strengthen regulation and supervision of the financial system with greater international consistency, cooperation and transparency, have both committed to raise capital standards and liquidity buffers within the banking system. On September 12, 2010, the G-20 Governors and Heads of Supervision agreed to the phase-in of Basel III with full implementation by January 2015 of the following minimum capital requirements: minimum tier 1 equity ratio of 6% (subject to an additional capital conservation buffer of potentially of 2.5% and 5% with implementation by January 2019 imposed by regulatory agencies during periods of excess aggregate credit growth), and minimum total capital to risk-weighted assets of 8%, subject to new deductions and adjustments to Tier 1 common equity. Basel III also includes two newly required liquidity ratios. The G-20 endorsed Basel III on November 12, 2010. The U.S. financial regulatory agencies have indicated informally that they generally support Basel III and expect to draft final rules by the first quarter of 2012 with implementation and adoption of Basel III regulations later in 2012. Additionally, the Basel Committee is considering further amendments beyond the final framework that include more stringent capital requirements for “globally systemically important financial institutions”. The Company believes that our current capital levels already exceed the Basel III capital requirements.
In addition to the Federal Deposit Insurance Reform Act described above, the Financial Services Regulatory Relief Act of 2006 was also enacted. This legislation is a wide ranging law that affects many previously enacted financial regulatory laws. The overall intent of the law is to simplify regulatory procedures and requirements applicable to all banks, and to conform conflicting provisions. The Relief Act conforms a number of separate statutes to provide equal definitions and treatment for national banks, state banks, and for federal savings banks in a number of respects. The law streamlines certain reporting requirements, and provides for bank examinations on an 18 month schedule for smaller banks that qualify. The law also authorizes the Federal Reserve to pay interest to banks for the required deposit reserves maintained by banks at the Federal Reserve, but such interest would not begin to be paid until 2012. While this law has many facets that overall should benefit Royal Bank, the individual provisions of this law are not considered currently material to Royal Bank when considered alone.
Congress is currently considering major financial industry legislation, and the federal banking agencies routinely propose new regulations. The Company cannot predict how any new legislation, or new rules adopted by the federal banking agencies, may affect its business or the business of Royal Bank in the future.
The earnings of Royal Bank are affected by the policies of regulatory authorities including the Federal Reserve Board. An important function of the Federal Reserve System is to influence the money supply and interest rates. Among the instruments used to implement those objectives are open market operations in United States government securities, changes in reserve requirements against member bank deposits and limitations on interest rates that member banks may pay on time and savings deposits. These instruments are used in varying combinations to influence overall growth and distribution of bank loans and investments and deposits. Their use may also affect rates charged on loans or paid for deposits.
The policies and regulations of the Federal Reserve Board have had and will probably continue to have a significant effect on its reserve requirements, deposits, loans and investment growth, as well as the rate of interest earned and paid, and are expected to affect Royal Bank’s operations in the future. The effect of such policies and regulations upon the future business and earnings of Royal Bank cannot be predicted.
Effects of Inflation
Inflation can impact the country’s overall economy, which in turn can impact the business and revenues of the Company and its subsidiaries. Inflation has some impact on the Company’s operating costs. Unlike many industrial companies, however, substantially all of the Company’s assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on the Company’s performance than the general level of inflation. Over short periods of time, interest rates may not necessarily move in the same direction or in the same magnitude as prices of goods and services.
Available Information
Upon a shareholder’s written request, a copy of the Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, as required to be filed with the SEC pursuant to Exchange Act Rule 13a-1, may be obtained without charge from our Chief Executive Officer, Royal Bancshares of Pennsylvania, Inc. 732 Montgomery Avenue, Narberth, Pennsylvania 19072 or on our website www.royalbankamerica.com.
An investment in our common stock involves risks. Before making an investment decision, investors should carefully consider the risks described below in conjunction with the other information in this Report, including our consolidated financial statements and related notes. If any of the following risks or other risks, which have not been identified or which we may believe are immaterial or unlikely, actually occurs, our business, financial condition and results of operations could be harmed. In such a case, the trading price of our common stock could decline, and investors may lose all or part of their investment.
Risks Related to Our Business
Our business may be impacted by the existence of the informal agreement for Royal Bank and the Federal Reserve Agreement with the Federal Reserve Bank of Philadelphia.
Our success as a business is dependent upon pursuing various alternatives in not only achieving the growth and expansion of our banking franchise but also in managing our day to day operations. The existence of the informal agreement and the Federal Reserve Agreement limits and impacts our ability to pursue all previously available alternatives in the management of the Company. Our ability to retain existing retail and commercial customers as well as the ability to attract potentially new customers may be impacted by the existence of the informal agreement and the Federal Reserve Agreement. Our ability to obtain lines of credit, to receive attractive collateral treatment from funding sources, and to pursue all attractive funding alternatives in this current low interest rate environment could be potentially impacted and thereby limit liquidity alternatives. Royal Bank’s ability to pay dividends to the Company, which provides funding for cash dividends to the Company’s shareholders, is subject to prior written consent of the FDIC and Department. Moreover, the Company is prohibited from paying cash dividends without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System. Our ability to raise capital in the current economic environment could be potentially limited or impacted as a result of the informal agreement. Attracting new management talent is critical to the success of our business and could be potentially impacted due to the existence of the informal agreement and the Federal Reserve Agreement.
Our business is subject to the success of the local economies and real estate markets in which we operate.
Our success significantly depends on the growth in population, income levels, loans and deposits and on the continued stability in real estate values in our markets. If the communities in which we operate do not grow or if prevailing economic conditions locally or nationally are unfavorable, our business may be adversely affected. Adverse economic conditions in our specific market areas, specifically decreases in real estate property values due to the nature of our loan portfolio, over 80% of which is secured by real estate, could reduce our growth rate, affect the ability of customers to repay their loans and generally affect our financial condition and results of operations. The Company is less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of more diverse economies.
Our concentration of non-residential real estate and construction loans is subject to unique risks that could adversely affect our earnings.
Our non-residential real estate and construction and land development loan portfolio held for investment was $236.7 million at December 31, 2011 comprising 57% of total loans. Non-residential real estate and construction and development loans are often riskier and tend to have significantly larger balances than home equity loans or residential mortgage loans to individuals. While we believe that the commercial real estate concentration risk is mitigated by diversification among the types and characteristics of real estate collateral properties, sound underwriting practices, and ongoing portfolio monitoring and market analysis, the repayments of these loans usually depends on the successful operation of a business or the sale of the underlying property. As a result, these loans are more likely to be unfavorably affected by adverse conditions in the real estate market or the economy in general. The remaining loans in the portfolio are commercial or industrial loans. These loans are collateralized by various business assets the value of which may decline during adverse market and economic conditions. Adverse conditions in the real estate market and the economy may result in increasing levels of loan charge-offs and non-performing assets and the reduction of earnings. When we take collateral in foreclosures and similar proceedings, we are required to mark the related asset to the then fair market value of the collateral, which may ultimately result in a loss.
Further, under guidance adopted by the federal banking regulators, banks which have concentrations in construction, land development or commercial real estate loans (other than loans for majority owner occupied properties) would be expected to maintain higher levels of risk management and, potentially, higher levels of capital. It is possible that Royal Bank may be required to maintain higher levels of capital than it would be otherwise expected to maintain as a result of Royal Bank’s commercial real estate loans, which may require the Company to obtain additional capital sooner than it would otherwise seek it, which may reduce shareholder returns.
Our allowance for loan and lease losses may not be adequate to cover actual losses.
Like all financial institutions, we maintain an allowance for loan and lease losses to provide for loan and lease defaults and non-performance. Our allowance for loan and lease losses is based on our historical loss experience as well as an evaluation of the risks associated with our loan portfolio, including the size and composition of the loan portfolio, current economic conditions and geographic concentrations within the portfolio. Our allowance for loan and lease losses may not be adequate to cover actual loan and lease losses and future provisions for loan and lease losses could materially and adversely affect our financial results.
Our current level of non-performing loans and future growth may require us to raise additional capital but that capital may not be available.
We are required by regulatory authorities to maintain adequate capital levels to support our operations. We anticipate that our current capital will satisfy our regulatory requirements for the foreseeable future. However, in order to maintain our well-capitalized status and to support future growth we may need to raise capital. Our ability to raise additional capital will depend, in part, on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Under the informal agreement as described in “Regulatory Actions” under “Item 1 – Business” of this Report, Royal Bank is required to maintain a minimum Tier 1 leverage ratio of 8% and a Total risk-based capital ratio of 12% during the term of the informal agreement. In addition, on February 20, 2009, we issued 30,407 shares of Fixed Rate Cumulative Preferred Stock, Series A, to the United States Department of Treasury under its TARP Capital Purchase Program, The Series A Preferred Stock issued to Treasury has a liquidation preference of $1,000 per share and contains other provisions, including restrictions on the payment of dividends on common stock and on repurchases of any shares of preferred stock ranking equal to or junior to the Series A Preferred Stock or common stock while the Series A Preferred Stock is outstanding, which provisions may make it more difficult to raise additional capital on favorable terms while the Series A Preferred Stock is outstanding. Therefore, we may be unable to raise additional capital, or to raise capital on terms acceptable to us. If we cannot raise additional capital when required, our ability to further expand operations through both internal growth and acquisitions could be materially impaired. In addition, if we decide to raise additional capital, the existing shareholders are subject to dilution.
We may suffer losses in our loan portfolio despite our underwriting practices.
The Company seeks to mitigate the risks inherent in its loan portfolio by adhering to specific underwriting practices. These practices often include: analysis of a borrower’s credit history, financial statements, tax returns and cash flow projections; valuation of collateral based on reports of independent appraisers; and verification of liquid assets. Although we believe that our underwriting criteria are appropriate for the various kinds of loans we make, the Company may incur losses on loans that meet these criteria.
Holders of our Series A Preferred Stock have certain voting rights that may adversely affect our common shareholders, and the holders of the Series A Preferred Stock may have interests different from our common shareholders.
As a consequence of missing the sixth dividend payment in the fourth quarter of 2010, the Treasury had the right to appoint two directors to our board of directors until all accrued but unpaid dividends have been paid. The Treasury exercised its right and appointed two directors to the Company’s board of directors during 2011. Otherwise, except as required by law, holders of the Series A Preferred Stock have limited voting rights.
For as long as shares of the Series A Preferred Stock are outstanding, in addition to any other vote or consent of the shareholders required by law or our Articles of Incorporation, the vote or consent of holders of at least 66 2/3% of the shares of the Series A Preferred Stock outstanding is required for any authorization or issuance of shares ranking senior to the Series A Preferred Stock; any amendments to the rights of the Series A Preferred Stock so as to adversely affect the rights, privileges, or voting power of the Series A Preferred Stock; or initiation and completion of any merger, share exchange or similar transaction unless the shares of Series A Preferred Stock remain outstanding, or if we are not the surviving entity in such transaction, are converted into or exchanged for preference securities of the surviving entity and the shares of Series A Preferred Stock remaining outstanding or such preference securities have the rights, preferences, privileges and voting power of the Series A Preferred Stock.
The holders of our Series A Preferred Stock, including the Treasury, may have different interests from the holders of our common stock, and could vote to block the forgoing transactions, even when considered desirable by, or in the best interests of the holders of our common stock.
Our ability to pay dividends depends primarily on dividends from our banking subsidiary, which are subject to regulatory limits and we are subject to other dividend limitations.
We are a bank holding company and our operations are conducted by direct and indirect subsidiaries, each of which is a separate and distinct legal entity. Substantially all of our assets are held by our direct and indirect subsidiaries. Our ability to pay dividends depends on our receipt of dividends from our direct and indirect subsidiaries. Our banking subsidiary, Royal Bank is our primary source of dividends. Dividend payments from our banking subsidiary are subject to legal and regulatory limitations, generally based on net profits and retained earnings, imposed by the various banking regulatory agencies. The ability of Royal Bank to pay dividends is also subject to its profitability, financial condition, capital expenditures and other cash flow requirements. At December 31, 2011, as a result of significant losses within Royal Bank, the Company had negative retained earnings and therefore would not have been able to declare and pay any cash dividends. There is no assurance that our subsidiaries will be able to pay dividends in the future or that we will generate adequate cash flow to pay dividends in the future. Royal Bank must receive prior written approval from the FDIC and the Department before declaring and paying a dividend to the Company.
As a result of our participation in the Treasury’s TARP CPP on February 20, 2009, we are required to receive Treasury’s approval for any increases in the dividend above the amount of the last regular quarterly common stock dividend paid prior to October 14, 2008 ($0.15 per Class A share and $0.1725 per Class B share) and any repurchases of common stock. These restrictions on the payment of dividends and the repurchases of common stock will remain in effect until the earlier date of the third anniversary of the closing date of the preferred shares and the date of the redemption of the preferred shares. In addition, under the terms of the TARP CPP, we are not permitted to declare or pay cash dividends on, or redeem or otherwise acquire, stock that is junior to or on parity with the Series A Preferred Stock issued to Treasury at any time when we have not declared and paid full dividends on the Series A Preferred Stock. We suspended regular quarterly cash dividends on the Series A Preferred Stock in August 2009 and, accordingly, are not permitted at this time to pay dividends on our Class A or Class B Common Stock.
Under the terms of the Federal Reserve Agreement, we are prohibited from paying any dividends on shares of our stock without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System.
Failure to pay dividends on our stock could have a material adverse effect on the market price of our Class A Common Stock.
Competition from other financial institutions may adversely affect our profitability.
We face substantial competition in originating loans, both commercial and consumer. This competition comes principally from other banks, savings institutions, mortgage banking companies and other lenders. Many of our competitors enjoy advantages, including greater financial resources and higher lending limits, a wider geographic presence, more accessible branch office locations, the ability to offer a wider array of services or more favorable pricing alternatives, as well as lower origination and operating costs. This competition could reduce our net income by decreasing the number and size of loans that we originate and the interest rates we may charge on these loans.
In attracting business and consumer deposits, Royal Bank faces substantial competition from other insured depository institutions such as banks, savings institutions and credit unions, as well as institutions offering uninsured investment alternatives, including money market funds. Many of our competitors enjoy advantages, including greater financial resources, more aggressive marketing campaigns, better brand recognition and more branch locations. These competitors may offer higher interest rates than we do, which could decrease the deposits that we attract or require us to increase our rates to retain existing deposits or attract new deposits. Increased deposit competition could adversely affect our ability to generate the funds necessary for lending operations. As a result, we may need to seek other sources of funds that may be more expensive to obtain and could increase our cost of funds.
The Company’s banking and non-banking subsidiaries also compete with non-bank providers of financial services, such as brokerage firms, consumer finance companies, credit unions, insurance agencies, peer to peer lenders and governmental organizations which may offer more favorable terms. Some of our non-bank competitors are not subject to the same extensive regulations that govern our banking operations. As a result, such non-bank competitors may have advantages over the Company’s banking and non-banking subsidiaries in providing certain products and services. This competition may reduce or limit our margins on banking and non-banking services, reduce our market share, and adversely affect our earnings and financial condition.
Our ability to manage liquidity is always critical in our operation, but more so today given the uncertainty within the capital markets.
We monitor and manage our liquidity position on a regular basis to insure that adequate funds are in place to manage the day to day operations and to cover routine fluctuations in available funds. However, our funding decisions can be influenced by unplanned events. These unplanned events include, but are not limited to, the inability to fund asset growth, difficulty renewing or replacing funds that mature, the ability to maintain or draw down lines of credit with other financial institutions, significant customer withdrawals of deposits, and market disruptions. The Federal Home Loan Bank of Pittsburgh had imposed an over collateralized delivery requirement of 105% on Royal Bank. The available amount for future borrowings will be based on the amount of collateral to be pledged. We have a liquidity contingency plan in the event liquidity falls below an acceptable level, however in today’s economic environment, we are not certain that those sources of liquid funds will be available in the future when required. As a result, loan growth may be curtailed to maintain adequate liquidity, loans may need to be sold in the secondary market, investments may need to be sold or deposits may need to be raised at above market interest rates to maintain liquidity.
Negative publicity could damage our reputation and adversely impact our business and financial results.
Reputation risk, or the risk to the Company’s earnings and capital from negative publicity, is inherent in our business. Negative publicity can result from the Company’s actual or alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions, and actions taken by government regulators and community organizations in response to those activities. Negative publicity can adversely affect our ability to keep and attract customers and can expose the Company to litigation and regulatory action. Although the Company takes steps to minimize reputation risk in dealing with customers and other constituencies, the Company, as a larger diversified financial services company with a high industry profile, is inherently exposed to this risk.
Risks Related to Our Industry
Difficult market conditions and economic trends have adversely affected our industry and our business.
We are exposed to downturns in the U. S. housing market. Dramatic declines in the housing market over the past few years, with decreasing home prices and increasing delinquencies and foreclosures, have negatively impacted the credit performance of mortgage, consumer, commercial and construction loan portfolios resulting in significant write-downs of assets by many financial institutions. In addition, the values of real estate collateral supporting many loans have declined and may continue to decline. General downward economic trends, reduced availability of commercial credit and increasing unemployment may negatively impact the credit performance of commercial and consumer credit, resulting in additional write-downs. Concerns over the stability of the financial markets and the economy have resulted in decreased lending by financial institutions to their customers and to each other. This market turmoil and tightening of credit has led to increased commercial and consumer deficiencies, lack of customer confidence, increased market volatility and widespread reduction in general business activity. Financial institutions have also experienced decreased access to borrowings. While the economy and market conditions have improved, the current economic recovery has been much weaker than recent economic recoveries post recession and unemployment, despite recent improvement, remains high. The existing economic pressure on consumers and businesses and the lack of confidence in the financial markets may adversely affect our business, financial condition, results of operations and stock price. A worsening of current economic conditions would likely exacerbate the adverse effects of existing market conditions on us and others in the industry. In particular, we may face the following risks in connection with these events:
| | § | We expect to face increased regulation of our industry. Compliance with such regulation may increase our costs and limit our ability to pursue business opportunities. |
| | § | Our ability to assess the creditworthiness of customers and to estimate the losses inherent in our credit exposure is made more complex by these difficult market and economic conditions. |
| | § | We also may be required to pay even higher Federal Deposit Insurance Corporation premiums than the recently increased level, because financial institution failures resulting from the depressed market conditions have depleted and may continue to deplete the deposit insurance fund and reduce its ratio of reserves to insured deposits. |
| | § | Our ability to borrow from other financial institutions or the Federal Home Loan Bank on favorable terms or at all could be adversely affected by further disruptions in the capital markets or other events. |
| | § | We may experience increases in foreclosures, delinquencies and customer bankruptcies, as well as more restricted access to funds. |
Our business is subject to interest rate risk and variations in interest rates may negatively affect our financial performance.
Changes in the interest rate environment may reduce profits. The primary source of our income is the differential or “spread” between the interest earned on loans, securities and other interest-earning assets, and interest paid on deposits, borrowings and other interest-bearing liabilities. As prevailing interest rates change, net interest spreads are affected by the difference between the maturities and re-pricing characteristics of interest-earning assets and interest-bearing liabilities. In addition, loan volume and yields are affected by market interest rates on loans, and rising interest rates generally are associated with a lower volume of loan originations. An increase in the general level of interest rates may also adversely affect the ability of certain borrowers to pay the interest on and principal of their obligations. Accordingly, changes in levels of market interest rates could materially adversely affect our net interest spread, asset quality, loan origination volume and overall profitability.
Recent and future governmental regulation and legislation could limit our future growth.
As described under “Supervision and Regulation” the Company and our subsidiaries are subject to extensive state and federal regulation, supervision and legislation that govern almost all aspects of the operations of the Company and our subsidiaries. These laws may change from time to time and are primarily intended for the protection of consumers, depositors and the deposit insurance funds. Any changes to these laws may negatively affect our ability to expand our services and to increase the value of our business. While we cannot predict what effect any presently contemplated or future changes in the laws or regulations or their interpretations would have on the Company, these changes could be materially adverse to shareholders.
Changes in consumers’ use of banks and changes in consumers’ spending and saving habits could adversely affect the Company’s financial results.
Technology and other changes now allow many consumers to complete financial transactions without using banks. For example, consumers can pay bills and transfer funds directly without going through a bank. This “disintermediation” could result in the loss of fee income, as well as the loss of customer deposits and income generated from those deposits. In addition, changes in consumer spending and saving habits could adversely affect our operations, and we may be unable to timely develop competitive new products and services in response to these changes that are accepted by new and existing customers.
Acts or threats of terrorism and political or military actions taken by the United States or other governments could adversely affect general economic or industry conditions.
Geopolitical conditions may also affect our earnings. Acts or threats or terrorism and political or military actions taken by the United States or other governments in response to terrorism, or similar activity, could adversely affect general economic or industry conditions.
Other Risks
Our directors, executive officers and principal shareholders own a significant portion of our common stock and can influence shareholder decisions.
Our directors, executive officers and principal shareholders, as a group, beneficially owned approximately 57% of Class A common stock and 87% of Class B common stock as of February 29, 2012. As a result of their ownership, the directors, executive officers and principal shareholders will have the ability, by voting their shares in concert, to influence the outcome of any matter submitted to our shareholders for approval, including the election of directors. The directors and executive officers may vote to cause the Company to take actions with which the other shareholders do not agree or that are not beneficial to all shareholders.
| ITEM 1B. | UNRESOLVED STAFF COMMENTS |
None.
Royal Bank has fifteen banking offices, which are located in Pennsylvania and New Jersey.
15th Street Office | Bala Plaza Office (3) | Bridgeport Office (1) |
| 30 South Street | 231 St. Asaph's Road | 105 W. 4th Street |
| Philadelphia, PA 19102 | Bala Cynwyd, PA 19004 | Bridgeport, PA 19406 |
| | | |
| Castor Office (1) | Fairmount Office (1) | Grant Avenue Office (1) |
| 6331 Castor Avenue | 401 Fairmount Avenue | 1650 Grant Avenue |
| Philadelphia, PA 19149 | Philadelphia, PA 19123 | Philadelphia, PA 19115 |
| Henderson Road Office | Jenkintown Office (1) | King of Prussia Office (1) |
| Beidler and Henderson Roads | 600 Old York Road | 655 West DeKalb Pike |
| King of Prussia, PA 19406 | Jenkintown, PA 19046 | King of Prussia, PA 19406 |
| | | |
| Narberth Office (1) | Narberth Training Center (1)(2) | Phoenixville Office (1) |
| 732 Montgomery Avenue | 814 Montgomery Avenue | 808 Valley Forge Road |
| Narberth, PA 19072 | Narberth, PA 19072 | Phoenixville, PA 19460 |
| | | |
| Shillington Office | Trooper Office (1) | Turnersville Office |
| 516 East Lancaster Avenue | Trooper and Egypt Roads | 3501 Black Horse Pike |
| Shillington, PA 19607 | Trooper, PA 19401 | Turnersville, NJ 08012 |
| | | |
| Villanova Office | Walnut Street Office | Storage Facility (1) |
| 801 East Lancaster Avenue | 1230 Walnut Street | 3836 Spring Garden Street |
| Villanova, PA 19085 | Philadelphia, PA 19107 | Philadelphia, PA 19104 |
(1) Owned
(2) Used for employee training
(3) Loan production office
Royal Bank owns eleven of the above properties. The remaining seven properties are leased with expiration dates between 2012 and 2021. During 2011, Royal Bank made aggregate lease payments of approximately $815,000. The Company believes that all of its properties are sufficiently insured, maintained and are adequate for Royal Bank’s purposes.
| ITEM 3. | LEGAL PROCEEDINGS |
As described under “Item 1 – Business” of this Report, Royal Bank holds a 60% equity interest in each of Crusader Servicing Corporation (“CSC”) and Royal Tax Lien Services, LLC (“RTL”). CSC and RTL acquire, through public auction, delinquent tax liens in various jurisdictions thereby assuming a superior lien position to most other lien holders, including mortgage lien holders. On March 4, 2009, each of CSC and RTL received grand jury subpoenas issued by the U.S. District Court for New Jersey upon application of the Antitrust Division of the U.S. Department of Justice (“DOJ”). The subpoenas sought certain documents and information relating to an ongoing investigation being conducted by the DOJ relating to alleged bid-rigging at tax lien auctions in New Jersey. Royal Bank, CSC and RTL have produced to the DOJ documents responsive to the subpoenas and have been cooperating with the DOJ throughout the investigation. On February 23, 2012, the former President of CSC and RTL entered a plea of guilty to one count of bid-rigging at certain auctions for tax liens in New Jersey from 1998 until approximately the spring of 2009. The former President’s employment with CSC and RTL effectively terminated in November 2010. As previously disclosed, Royal Bank had been advised that neither CSC nor RTL were targets of the DOJ investigation, but they were subjects of the investigation. It is possible, particularly in light of the plea entered by the former President of CSC and RTL, that the outcome of the investigation could result in fines and penalties being assessed against both CSC and RTL, which could also result in reputational risk due to negative publicity. No proceedings have been instituted by the DOJ or any other governmental authority against CSC or RTL as of the date of this filing.
As a result of the plea agreements of the former President of CSC and RTL and others resulting from the DOJ investigation, on March 13, 2012, the former president of RTL and CSC, RTL, CSC, the Company and certain other parties were named as defendants in a putative class action lawsuit filed in the Superior Court of New Jersey, Chancery Division on behalf of a proposed class of taxpayers who became delinquent in paying their municipal tax obligations (Boyer v. Robert W. Stein, Crusader Servicing Corp. Royal Tax Lien Services LLC, Royal Bancshares of Pennsylvania, Inc., et al., Superior Court of New Jersey, Chancery Division, Docket No. C-14007/12). On March 28, 2012, CSC, RTL and the Company removed this case to the U.S. District Court for the District of New Jersey. The lawsuit alleges violations of the New Jersey Antitrust Act and unjust enrichment, and seeks treble damages, attorney fees and injunctive relief.
As of the date of this filing, the Company cannot reasonably estimate the possible loss or range of loss that may result from these actions or proceedings.
| ITEM 4. | MINE SAFETY DISCLOSURES |
Not applicable.
PART II
| ITEM 5. | MARKET FOR REGISTRANT’S COMMON EQUITY, AND RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES |
The Company’s Class A Common Stock commenced trading on the NASDAQ Global Market under the symbol RBPAA. There is no market for the Company’s Class B Common Stock. The Class B shares may not be transferred in any manner except to the holder’s immediate family. Class B shares may be converted to Class A shares at the rate of 1.15 to 1.
The following table shows the range of high and low closing prices for the Company’s stock as reported by NASDAQ.
| Closing Prices | |
| 2011 | | High | | | Low | |
| First Quarter | | $ | 1.92 | | | $ | 1.52 | |
| Second Quarter | | | 1.84 | | | | 1.28 | |
| Third Quarter | | | 1.45 | | | | 0.95 | |
| Fourth Quarter | | | 1.54 | | | | 0.82 | |
| 2010 | | High | | | Low | |
| First Quarter | | $ | 2.77 | | | $ | 1.24 | |
| Second Quarter | | | 4.17 | | | | 2.46 | |
| Third Quarter | | | 3.01 | | | | 1.74 | |
| Fourth Quarter | | | 2.04 | | | | 1.29 | |
The approximate number of recorded holders of the Company’s Class A and Class B Common Stock, as of February 29, 2012, is shown below:
| Title of Class | | Number of record holders | |
| Class A Common stock | | | 269 | |
| Class B Common stock | | | 135 | |
Dividends
Subject to certain limitations imposed by law or the Company’s articles of incorporation, the Board of Directors of the Company may declare a dividend on shares of Class A or Class B Common Stock.
Stock dividends: Future stock dividends, if any, will be at the discretion of the board of directors and will be dependent on the level of earnings and compliance with regulatory requirements. Stock dividends have not been declared since 2006.
Cash Dividends: In July 2008, the Company suspended cash dividends on its common stock to preserve capital and maintain liquidity in response to current financial and economic trends. The Company did not pay cash dividends on its common stock in 2011, 2010, and 2009.
Future dividends depend upon net income, capital requirements, and appropriate legal restrictions and other factors relevant at the time the Board of Directors of the Company considers dividend policy. Cash necessary to fund dividends available for dividend distributions to the shareholders of the Company must initially come primarily from dividends paid by its direct and indirect subsidiaries, including Royal Bank to the Company.
Under the Pennsylvania Business Corporation Law, the Company may pay dividends only if, after giving effect to the dividend payment, the total assets of the Company would exceed the total liabilities of the Company plus the amount necessary to satisfy preferential rights of holders of senior shareholders, and the Company is solvent and would not be rendered insolvent by the dividend payment. There are also restrictions set forth in the Pennsylvania Banking Code of 1965 (the “Code”) and in the Federal Deposit Insurance Act (“FDIA”) concerning the payment of dividends by the Company. Under the Code, no dividends may be paid except from “accumulated net earnings” (generally retained earnings). Under the FDIA, no dividend may be paid if a bank is in arrears in the payment of any insurance assessment due to the FDIC. In addition, dividends paid by Royal Bank to the Company would be prohibited if the effect thereof would cause Royal Bank’s capital to be reduced below applicable minimum capital requirements. Therefore, the restrictions on Royal Bank’s dividend payments are directly applicable to the Company. See “Note 14 – Shareholder’s Equity” of the Notes to Consolidated Financial Statements in Item 8 of this Report.
On August 13, 2009, the Company’s board of directors determined to suspend regular quarterly cash dividends on the $30.4 million in Series A Preferred Stock. The Company’s board of directors took this action in consultation with the Federal Reserve Bank of Philadelphia as required by regulatory policy guidance. The Company currently has sufficient capital and liquidity to pay the scheduled dividends on the preferred stock; however, this decision better supports the capital position of Royal Bank, a wholly owned subsidiary of the Company. As of December 31, 2011, the Series A Preferred stock dividend in arrears was $4.1 million and has not been recognized in the consolidated financial statements. As a consequence of missing the sixth dividend payment in the fourth quarter of 2010, the Treasury had the right to appoint two directors to our board of directors until all accrued but unpaid dividends have been paid. The Treasury exercised its right and appointed two directors to the Company’s board of directors during 2011.
At December 31, 2011, as a result of significant losses within Royal Bank and cash and stock dividends declared and paid in previous years, the Company had negative retained earnings and therefore would not have been able to declare and pay any cash dividends. Royal Bank must receive prior approval from the FDIC and the Department before declaring and paying a dividend to the Company. Under the Federal Reserve Agreement as described under “Regulatory Actions” in “Item 1 – Business” of this Report, the Company may not declare or pay any dividends without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System.
Additionally, as a result of the CPP completed between the Treasury and the Company on February 20, 2009, the Company is required to receive Treasury’s approval for any increases in the dividend above the amount of the last regular quarterly common stock dividend paid prior to October 14, 2008 and any repurchases of Company common stock. These restrictions on the payment of dividends and the repurchases of common stock by the Company became effective immediately upon closing and remain in effect until the earlier date of the third anniversary of the closing date of the preferred shares and the date of the redemption of the preferred shares.
COMMON STOCK PERFORMANCE GRAPH
The performance graph shows cumulative investment returns to shareholders based on the assumption that an investment of $100 was made on December 31, 2006, (with all dividends reinvested), in each of the following:
| | § | Royal Bancshares of Pennsylvania, Inc. Class A common stock; |
| | § | The stock of all United States companies trading on the NASDAQ Global Market; |
| | § | Common stock of 2011 Peer Group consists of twenty banks headquartered in the Mid-Atlantic region, trade on the major exchange and have total assets between $750 million and $1.5 billion. |
| | § | SNL Bank and Thrift Index |
| | | | | | Period Ending | | | | |
| Index | | 12/31/06 | | | 12/31/07 | | | 12/31/08 | | | 12/31/09 | | | 12/31/10 | | | 12/31/11 | |
| Royal Bancshares of Pennsylvania, Inc. | | | 100.00 | | | | 44.21 | | | | 13.75 | | | | 5.37 | | | | 5.78 | | | | 5.16 | |
| NASDAQ Composite | | | 100.00 | | | | 110.66 | | | | 66.42 | | | | 96.54 | | | | 114.06 | | | | 113.16 | |
| SNL Bank and Thrift | | | 100.00 | | | | 76.26 | | | | 43.85 | | | | 43.27 | | | | 48.30 | | | | 37.56 | |
| RBPAA Peer Group Index* | | | 100.00 | | | | 78.20 | | | | 59.81 | | | | 52.70 | | | | 59.80 | | | | 58.91 | |
*Royal Bancshares Peer Group consists of Eighteen banks headquartered in the Mid-Atlantic region, trade on the major exchanges, and have total assets between $750M and $1.5B.
| ITEM 6. | SELECTED FINANCIAL DATA |
The following selected consolidated financial and operating information for the Company should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and accompanying notes in Item 8 of this Report:
| Statement of Operations Data | | For the years ended December 31, | |
| (In thousands, except share data) | | 2011 | | | 2010 | | | 2009 | | | 2008 | | | 2007 | |
| Interest income | | $ | 39,377 | | | $ | 57,262 | | | $ | 66,043 | | | $ | 72,764 | | | $ | 86,736 | |
| Interest expense | | | 14,086 | | | | 25,994 | | | | 37,439 | | | | 38,109 | | | | 48,873 | |
| Net interest income | | | 25,291 | | | | 31,268 | | | | 28,604 | | | | 34,655 | | | | 37,863 | |
| Provision for loan and lease losses | | | 7,728 | | | | 22,140 | | | | 20,605 | | | | 21,841 | | | | 13,026 | |
| Net interest income after loan and lease losses | | | 17,563 | | | | 9,128 | | | | 7,999 | | | | 12,814 | | | | 24,837 | |
| Gains (loss) on investment securities | | | 1,782 | | | | 1,290 | | | | 1,892 | | | | (1,313 | ) | | | 5,358 | |
| Gains on sales related to real estate joint ventures | | | 1,750 | | | | - | | | | - | | | | 1,092 | | | | 350 | |
| Net gains on sales of other real estate owned | | | 1,638 | | | | 1,019 | | | | 294 | | | | 429 | | | | 1,111 | |
| Service charges and fees | | | 1,128 | | | | 1,266 | | | | 1,419 | | | | 1,186 | | | | 1,348 | |
| Income from bank owned life insurance | | | 391 | | | | 379 | | | | 1,099 | | | | 1,233 | | | | 875 | |
| Gains on sale of loans and leases | | | 337 | | | | 666 | | | | 914 | | | | 190 | | | | 404 | |
| Income related to real estate owned via equity investments | | | 478 | | | | 564 | | | | 1,302 | | | | 965 | | | | 1,384 | |
| Gain on sale of security claim | | | - | | | | 1,656 | | | | - | | | | - | | | | - | |
| Gain on sale of premises & equipment related to real estate owned via equity investments | | | - | | | | 667 | | | | 1,817 | | | | 1,679 | | | | 1,860 | |
| Gain on sale of premises & equipment | | | - | | | | - | | | | - | | | | 1,991 | | | | - | |
| Other income | | | 1,110 | | | | 737 | | | | 578 | | | | 148 | | | | 198 | |
| Total other than-temporary-impairment losses on investment securities | | | (1,796 | ) | | | (566 | ) | | | (13,431 | ) | | | (23,388 | ) | | | - | |
| Portion of loss recognized in other comprehensive loss | | | - | | | | 87 | | | | 2,390 | | | | - | | | | - | |
| Net impairment losses recognized in earnings | | | (1,796 | ) | | | (479 | ) | | | (11,041 | ) | | | (23,388 | ) | | | - | |
| Total other income (loss) | | | 6,818 | | | | 7,765 | | | | (1,726 | ) | | | (15,788 | ) | | | 12,888 | |
| Income (loss) before other expenses & income taxes | | | 24,381 | | | | 16,893 | | | | 6,273 | | | | (2,974 | ) | | | 37,725 | |
| Non-interest expense | | | | | | | | | | | | | | | | | | | | |
| Salaries and benefits | | | 10,920 | | | | 11,591 | | | | 12,235 | | | | 15,044 | | | | 12,215 | |
| Impairment related to OREO | | | 5,522 | | | | 7,374 | | | | 4,537 | | | | - | | | | - | |
| Impairment related to real estate owned via equity investments | | | - | | | | 2,600 | | | | - | | | | 1,500 | | | | 8,500 | |
| Expenses related to real estate owned via equity investments | | | - | | | | 529 | | | | 907 | | | | 966 | | | | 1,590 | |
| Impairment related to real estate joint venture | | | - | | | | 1,552 | | | | - | | | | - | | | | 5,927 | |
| Other | | | 15,627 | | | | 17,097 | | | | 19,977 | | | | 15,023 | | | | 11,800 | |
| Total other expense | | | 32,069 | | | | 40,743 | | | | 37,656 | | | | 32,533 | | | | 40,032 | |
| Loss before tax expense (benefit) | | | (7,688 | ) | | | (23,850 | ) | | | (31,383 | ) | | | (35,507 | ) | | | (2,307 | ) |
| Income tax expense (benefit) | | | - | | | | - | | | | 474 | | | | 2,643 | | | | (1,568 | ) |
| Net loss | | $ | (7,688 | ) | | $ | (23,850 | ) | | $ | (31,857 | ) | | $ | (38,150 | ) | | $ | (739 | ) |
| Less net income (loss) attributable to noncontrolling interest | | | 875 | | | | 243 | | | | 1,402 | | | | (68 | ) | | | (1,303 | ) |
| Net (loss) income attributable to Royal Bancshares | | | (8,563 | ) | | | (24,093 | ) | | | (33,259 | ) | | | (38,082 | ) | | | 564 | |
Less Series A Preferred stock accumulated dividend and accretion | | | (2,003 | ) | | | (1,970 | ) | | | (1,672 | ) | | | - | | | | - | |
| Net (loss) income available to common shareholders | | | (10,566 | ) | | | (26,063 | ) | | | (34,931 | ) | | | (38,082 | ) | | | 564 | |
| | | | | | | | | | | | | | | | | | | | | |
| Basic and diluted (loss) earnings per common share | | $ | (0.80 | ) | | $ | (1.97 | ) | | $ | (2.64 | ) | | $ | (2.86 | ) | | $ | 0.04 | |
| Balance Sheet Data | | For the years ended December 31, | |
| (In thousands) | | 2011 | | | 2010 | | | 2009 | | | 2008 | | | 2007 | |
| Total Assets | | | 848,449 | | | | 980,626 | | | | 1,292,726 | | | | 1,175,586 | | | | 1,278,475 | |
| Total average assets (2) | | | 906,502 | | | | 1,177,922 | | | | 1,295,126 | | | | 1,189,518 | | | | 1,314,361 | |
| Loans, net | | | 397,863 | | | | 475,725 | | | | 656,533 | | | | 671,814 | | | | 625,193 | |
| Total deposits | | | 575,916 | | | | 693,913 | | | | 881,755 | | | | 760,068 | | | | 770,152 | |
| Total average deposits | | | 621,709 | | | | 791,026 | | | | 857,742 | | | | 724,384 | | | | 869,884 | |
| Total borrowings (1) | | | 173,774 | | | | 180,723 | | | | 283,601 | | | | 313,805 | | | | 339,251 | |
| Total average borrowings (1) | | | 177,517 | | | | 256,688 | | | | 307,225 | | | | 307,597 | | | | 254,757 | |
| Total shareholders' equity (3) | | | 75,946 | | | | 84,093 | | | | 101,156 | | | | 79,687 | | | | 146,367 | |
| Total average shareholders' equity | | | 81,184 | | | | 103,895 | | | | 107,511 | | | | 131,155 | | | | 158,695 | |
| Return on average assets | | | (0.94 | %) | | | (2.04 | %) | | | (2.57 | %) | | | (3.20 | %) | | | 0.04 | % |
| Return on average equity | | | (10.55 | %) | | | (23.19 | %) | | | (30.94 | %) | | | (29.04 | %) | | | 0.36 | % |
| Average equity to average assets | | | 8.96 | % | | | 8.82 | % | | | 8.30 | % | | | 11.03 | % | | | 12.07 | % |
| Dividend payout ratio | | | 0.00 | % | | | 0.00 | % | | | 0.00 | % | | | (10.52 | %) | | | 2743.40 | % |
| (1) | Includes obligations through VIE equity investments and subordinated debt. |
| (2) | Includes premises and equipment of VIE. |
| (3) | Excludes noncontrolling interest |
| ITEM 7. | MANAGEMENT’S DISCUSSIONS AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The following discussion and analysis of financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements of the Company and the related Notes in Item 8 of this Report.
Critical Accounting Policies, Judgments and Estimates
The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and general practices within the financial services industry. Critical accounting policies, judgments and estimates relate to investment securities, loans, allowance for loan and lease losses and deferred tax assets. The policies which significantly affect the determination of the Company’s financial position, results of operations and cash flows are summarized in “Note 1 - Summary of Significant Accounting Polices” to the Consolidated Financial Statements and are discussed in the section captioned “Recent Accounting Pronouncements” of Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in Items 7 and 8 of this Report, each of which is incorporated herein by reference.
Investment Securities
Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each balance sheet date.
Investments in debt securities that the Company has the positive intent and ability to hold to maturity are classified as held to maturity securities and reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized holding gains and losses included in earnings. Debt and equity securities not classified as trading securities, nor as held to maturity securities are classified as available for sale securities and reported at fair value, with unrealized holding gains or losses, net of deferred income taxes, reported in the accumulated other comprehensive income component of shareholders’ equity. The Company did not hold trading securities at December 31, 2011 and 2010. Discounts and premiums are accreted/amortized to income by use of the level-yield method. Gain or loss on sales of securities available for sale is based on the specific identification method.
The Company evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis. The Company assesses whether OTTI is present when the fair value of a security is less than its amortized cost. All investment securities are evaluated for OTTI under FASB ASC Topic 320, “Investments-Debt & Equity Securities” (“ASC Topic 320”). The non-agency collateralized mortgage obligations that are rated below AA are evaluated under FASB ASC Topic 320 Subtopic 40, “Beneficial Interests in Securitized Financial Assets” under FASB ASC Topic 325, “Investments-Other”.
Under ASC Topic 320, OTTI is considered to have occurred with respect to debt securities (1) if an entity intends to sell the security; (2) if it is more likely than not an entity will be required to sell the security before recovery of its amortized cost basis; or (3) the present value of the expected cash flows is not sufficient to recover the entire amortized cost basis. In addition, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell or will more likely than not be required to sell the security. If an entity intends to sell the security or will be required to sell the security, the OTTI shall be recognized in earnings equal to the entire difference between the fair value and the amortized cost basis at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before the recovery of its amortized cost basis, the OTTI shall be separated into two amounts, the credit-related loss and the noncredit-related loss. The credit-related loss is based on the present value of the expected cash flows and is recognized in earnings.
For more information on the fair value of the Company’s investment securities and other financial instruments refer to “Note 3 - Investment Securities” and “Note 20 - Fair Values of Financial Instruments” to the Consolidated Financial Statements included in Item 8 of this Report.
Allowance for Loan and Lease Losses
The Company considers that the determination of the allowance for loan and lease losses (“allowance”) involves a higher degree of judgment and complexity than its other significant accounting policies. The allowance is calculated with the objective of maintaining a reserve level believed by management to be sufficient to absorb estimated credit losses. Management’s determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective as it requires material estimates, including, among others, expected default probabilities, loss given default, expected commitment usage, the amounts of timing of expected future cash flows on impaired loans, mortgages, and general amounts for historical loss experience. The process also considers economic conditions, uncertainties in estimating losses and inherent risks in the loan portfolio. All of these factors may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provisions for loan and lease losses may be required that would adversely impact earnings in future periods. See “Note 1 - Summary of Significant Accounting Policies” to the Consolidated Financial Statements included in Item 8 of this report.
Deferred Tax Assets
The Company recognizes deferred tax assets and liabilities for the future tax effects of temporary differences, net operating loss carry forwards and tax credits. Deferred tax assets are subject to management’s judgment based upon available evidence that future realization is more likely than not. If management determines that the Company may be unable to realize all or part of net deferred tax assets in the future, a direct charge to income tax expense may be required to reduce the recorded value of the net deferred tax asset to the expected realizable amount.
RECENT ACCOUNTING PRONOUNCEMENTS
See “Note 1 - Summary Of Significant Accounting Policies” to the Consolidated Financial Statements included in Item 8 of this Report.
Results of Operations
General: The Company’s 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. Net income is also affected by the provision for loan and lease 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.
Net Loss: The Company recorded a net loss of $8.6 million in 2011, which represented an improvement of $15.5 million, or 64.5%, from loss recorded in 2010 of $24.1 million. The improved results were primarily related to a reduction in the provision for loan and lease losses of $14.4 million and a decline of $8.7 million in total other expense. The favorable change in the provision resulted primarily from a decrease in the outstanding loan balances year over year as well as a decline in the level of non-performing loans. Loan balances, including loans held for sale, amounted to $410.4 million at year end 2011, which amounted to a decline of $94.9 million from balance at the end of 2010 due to charge-offs, loan sales, pay-downs, pay offs and transfers to other real estate owned (“OREO”). Other expenses of $32.1 million resulted in a year over year decline of $8.7 million, or 21.3%, and was attributed to an overall reduction of expenses related to the sale of Royal Asian at year end 2010, which amounted to $3.8 million; a reduction of $1.9 million in OREO impairment charges; lower FDIC and state assessments of $1.1 million associated with reduced deposit balances, mainly brokered CDs and deposits of Royal Asian; and the absence of impairment on real estate joint ventures which was $1.6 million in 2010 and the VIE related to real estate owned via equity investments being deconsolidated in 2011. The impairment related to the VIE in 2010 was $2.6 million.
Partially offsetting these favorable changes were a decline in both net interest income and other income year over year. Net interest income, which amounted to $25.3 million in 2011, decreased by $6.0 million, or 19.1%, from the prior year’s results of $31.3 million. The decline in loan balances negatively impacted net interest income during the past year. In addition, a reduction in the yields on loans and investments and a 2010 non-recurring adjustment amounting to $905,000 also contributed to the decline in net interest income. The nonrecurring adjustment was related to the correction of previously reversed interest income on a participation loan from a previous year. The overall decline in net interest income was partially mitigated by the continued reduction in interest expense related to lower interest rates principally associated with the re-pricing of maturing retail CDs and the redemption of brokered deposits and FHLB advances. Other income of $6.8 million in 2011 was $947,000 below the result for 2010 mainly due to impairment on investment securities of $1.8 million, resulting primarily from a complete write-down of one trust preferred security in the amount of $1.7 million.
Total non-performing loans at December 31, 2011 were $51.3 million and were comprised of $38.7 million in loans held for investment (“LHFI”) and $12.6 million in loans held for sale (“LHFS”), which amounted to an improvement of $14.5 million from the level at December 31, 2010 resulting from charge-offs, transfers to OREO and improved credit quality. Total non-performing loans at December 31, 2010 were $65.8 million and were comprised of $43.2 million in LHFI and $22.6 million in LHFS. Non-performing loans were $73.7 million at December 31, 2009. OREO at December 31, 2011, amounted to $21.0 million versus $29.2 million at year end 2010. As a consequence of the continued weak housing market and slow growth economy, the Company continued to experience a high level of non-performing assets despite the continued progress in reducing the level of those assets. Impaired and non-accrual loans and OREO assets are reviewed in the “Credit Quality” section of this report. Basic and diluted losses per common share were both $0.80 for 2011 compared to basic and diluted losses per common share of $1.97 in 2010.
The Company recorded a net loss of $24.1 million in 2010, which represented a $9.2 million improvement from 2009. The reduction in the net loss was primarily attributed to an increase in net interest income of $2.7 million, an improvement in other income of $9.5 million, which was mainly associated with a reduction of impairment losses on the investment portfolio, and a reduction in net income attributable to non-controlling interest of $1.2 million. Partially offsetting these favorable changes were an increase in the provision for loans and leases of $1.5 million and an increase in total other expense of $3.1 million. The increase in net interest income was primarily related to the re-pricing of maturing retail CDs and the redemption of higher costing brokered CDs and FHLB advances. The increased other income was associated mainly with a reduction in investment impairment and the sale of the Company’s collateral claim related to a pending lawsuit against Lehman Brothers Special Financing (“LBSF”) for $1.7 million. Investment impairment, which amounted to $479,000 during 2010 as compared to $11.0 million during 2009, improved due to the restructuring of the investment portfolio. During the fourth quarter of 2010 the Company sold its claim against LBSF for $1.7 million related to the collateral for an interest rate swap, which had previously been written off in 2008 in the amount of $5.0 million, due to the uncertainty surrounding the litigation and bankruptcy of Lehman Brothers Holdings, Inc., an affiliate of LBSF. The reduced net income attributable to non-controlling interest was principally due to the partner’s 50% share of the impairment related to real estate owned via equity investments of $1.3 million being included in the Company’s other expense and then eliminated through a credit to non-controlling interest in the Company’s consolidated statement of operations in 2010. The increase in other expense was mainly associated with increased OREO impairment charges of $2.8 million, impairment of $2.6 million related to real estate owned via equity investments and impairment of real estate joint ventures of $1.6 million. The real estate joint venture impairment was comprised of impairment on the entire investment of $2.5 million for an Ohio marina project due to a significant decline in the project’s value, which was partially offset by a recovery of $968,000 from a real estate joint venture investment that was written off in 2007.
Net Interest Income and Margin: Net interest income is the Company’s primary source of income. Its level is a function of the average balance of interest-earning assets, the average balance of interest-bearing liabilities, and the spread between the yield on assets and liabilities. In turn, these factors are influenced by the pricing and mix of the Company’s interest-earning assets and funding sources. Additionally, net interest income is affected by market and economic conditions, which influence rates on loan and deposit growth.
The Company utilizes the effective yield interest method for recognizing interest income as required by ASC Subtopic 20, “Nonrefundable Fees and Other Costs” (“ASC Subtopic 20”) under FASB ASC Topic 310, “Receivables” (“ASC Topic 310”). ASC Subtopic 20 also guides our accounting for nonrefundable fees and costs associated with lending activities such as discounts, premiums, and loan origination fees. In the case of loan restructurings, if the terms of the new loan resulting from a loan refinancing or restructuring other than a troubled debt restructuring are at least as favorable to the Company as the terms for comparable loans to other customers with similar collection risks who are not refinancing or restructuring a loan with the Company, the refinanced loan is accounted for as a new loan. This condition is met if the new loan’s effective yield is at least equal to the effective yield for such loans. Any unamortized net fees or costs and any prepayment penalties from the original loan shall be recognized in interest income when the new loan is granted.
Net interest income amounted to $25.3 million in 2011 as compared to $31.3 million in 2010, which resulted in a decline of $6.0 million, or 19.1%. The decrease was attributed mainly to a decline in interest-earning assets, both loans and investments, primarily attributable to the de-leveraging of the balance sheet, a decline on the yields of those interest-earning assets, again principally loans and investments, and a nonrecurring favorable adjustment of $905,000 for interest income in 2010. The decline was partially offset by a reduction of the average balances and the average rate paid on interest bearing liabilities associated with the redemption of brokered CDs and lower rates paid on maturing retail CDs. (See the “Average Balance” table included in this discussion.) Net interest income in 2010 of $31.3 million increased $2.7 million, or 9.3%, from the level recorded in 2009 of $28.6 million. The increase resulted from lower rates paid on maturing retail certificates of deposit, the redemption of brokered deposits and FHLB advances, and a nonrecurring adjustment of $905,000 in the second quarter of 2010 that was related to the correction of previously reversed interest income on a participation loan from a previous year. The favorable results were partially offset by a decline in the yield on average interest earning assets, primarily investment securities.
Interest income of $39.4 million in 2011 amounted to a reduction of $17.9 million, or 31.2%, from the level of $57.3 million in 2010. The decline was attributable to a lower yield on interest earning assets year over year for loans and investment securities, and a lower level of average interest earning assets again related to both loans and investment securities. The reduction in loan balances and investment securities was driven in part by the Company’s strategic capital initiative of de-leveraging the balance sheet. Interest income for loans declined by $13.0 million, or 30.5%, and was mainly attributed to the reduction of average total loans but was also related to a decline in the yield on the loan portfolio. Average balance of total loans amounted to $475.0 million during 2011 versus $643.5 million during 2010, which amounted to a decline of $168.5 million, or 26.2%, year over year. The reduction was comprised of charge-offs, pay downs, payoffs, the sale of Royal Asian Bank (“RAB”) at year end 2010 and transfers to OREO that was accompanied by minimal new loan growth. The sale of RAB accounted for almost 40% of the overall decline. The interest income on investment securities amounted to $9.6 million and declined $4.8 million, or 33.3%, resulting from a decline in average investment securities coupled with a decline in the yield on the investment securities. Average investment securities of $320.4 million in 2011 amounted to a decline of $61.4 million, or 16.1%, from the average in 2010.
The decline in the yield on average interest earning assets contributed to the decline in interest income year over year (4.76% in 2011 versus 5.29% in 2010). The 53 basis point reduction was comprised of a decline of 78 basis points on investment securities and a 39 basis point decrease in total loans. The decline in the yield on investment securities was mainly related to the replacement of sold investment securities and principal payments and prepayments on government agency investment securities with comparable investment securities at lower interest rates. The yield decrease on average total loans primarily resulted from the $905,000 favorable adjustment to interest income in 2010 as previously mentioned, the lower yields on new loans booked during the past year and a change in the composition of the loans within the portfolio during 2011. The loan composition change was related to a decrease in the percentage of tax liens, which have the highest yields within the loan portfolio. At year end 2011, the variable rate portfolio represented approximately 40% of total loans; however the Company has mitigated a portion of this negative impact through the utilization of rate floors in many of the commercial loan agreements that exceed the current prime rate.
Interest income for 2010 of $57.3 million amounted to a reduction of $8.8 million, or 13.3%, from the level recorded in 2009. The decrease was attributable to a lower yield on interest earning assets year over year, mainly associated with investment securities, and a lower level of average interest earning assets related almost entirely to loans and investment securities, which was driven in part by the Company’s strategic capital initiative of de-leveraging the balance sheet. Interest income for loans declined by $3.1 million, or 6.8%, and was mostly attributed to the reduction of average total loans, which was related to charge-offs, pay downs and payoffs, that was accompanied by minimal new loan growth. The decline was partially offset by an increase in the loan yield due to an increased concentration of higher yielding loans within the loan portfolio and the $905,000 adjustment previously mentioned. Average balance of total loans amounted to $643.5 million during 2010, which amounted to a decline of $72.1 million, or 10.1%, from the average level during 2009. The interest income on investment securities of $14.5 million declined $5.7 million, or 28.1%, due to a decline in average investment securities, and a decline in the yield due to an increased concentration in lower yielding, government agency securities. Average investment securities of $381.8 million in 2010 represented a decline of $45.0 million, or 10.5%, from the prior year’s average.
At December 31, 2011, non-performing loans to total loans amounted to 12.0%, whereas the same ratio at December 31, 2010, amounted 12.5%. The favorable change year over year was primarily associated with the decline in non-performing loans during 2011 and was partially offset by the decline in the loan portfolio during 2010. The total interest income lost as a result of non-performing loans during 2011 amounted to $5.1 million, which resulted in a decrease of $1.4 million, or 21.6%, from 2010.
For the full year ended December 31, 2011, interest expense amounted to $14.1 million, which resulted in a decline of $11.9 million, or 45.8%, from the level recorded in the previous year. The favorable change was attributed to a reduced level of average interest bearing liabilities year over year and a decline in the interest rates paid on those liabilities. Average interest bearing liabilities amounted to $742.0 million in 2011, which represented a decline of $243.3 million, or 24.7%, from the previous year and was primarily related to the previously noted de-leveraging strategy and compliance with the Orders. Average time deposits, which included brokered CDs, amounted to $327.6 million in 2011 and represented a decrease of $175.6 million, or 34.9%, from the average level of 2010 due mainly to the redemption of higher cost brokered CDs over the past two years. Average borrowings amounted to $151.7 million during 2011 and declined $77.8 million, or 33.9%, primarily due to the redemption of FHLB advances at the end of 2010.
Average rates paid on all major liability categories declined year over year due to the re-pricing of maturing retail certificates of deposit and the redemption of higher cost brokered CDs during the past two years; the redemption of higher cost FHLB advances during 2010; and the reduction of rates paid on NOW, money market accounts, and savings accounts primarily during 2011. The average interest rate paid on average interest-bearing liabilities in 2011 of 1.90% amounted to a reduction of 74 basis points from the prior year as the Company was able to take advantage of the current lower interest rate environment and the maturity of retail and brokered CDs as well as FHLB borrowings during the past two years. Significant declines in average interest rates paid on interest bearing liabilities year over year included certificates of deposits of 81 basis points and borrowings of 70 basis points.
Interest expense of $26.0 million for the full year 2010 declined $11.4 million, or 30.6%, from the level recorded in 2009. The improvement in interest expense was attributed to a reduced level of average interest bearing liabilities year over year and a decrease in the interest rates paid on those liabilities. Average interest bearing liabilities amounted to $985.2 million in 2010, which represented a decline of $117.2 million, or 10.6%, from the previous year. The change was primarily related to the redemption of higher cost brokered CDs and FHLB advances during the past year as part of the previously noted deleveraging strategy and compliance with the previous Orders.
The net interest margin for the full year 2011 amounted to 3.06%, which represented an increase of 17 basis points from 2010. The improved margin was attributed to lower interest rates for all major categories of interest bearing liabilities for the Company. The redemption of $83.2 million of higher cost brokered CDs, the retention of most of the $273 million maturing retail CDs at reduced rates of interest during 2011 and improved borrowings costs associated with the pay off of $57.5 million of FHLB advances at year end 2010 accounted for a majority of the improved net interest margin. The overall improvement was partially offset by a decline of 53 basis points on the yield on average interest earning assets, which resulted from a decline in yields on both loans and investment securities. The decline in the yield on investment securities was associated with a lower reinvestment rate on sold securities and payments and prepayments of cash-flowing agency investments due to the lower interest rates throughout 2011. The decline for loan yields was related to a reduction of higher yielding tax liens within the loan portfolio during 2011, the pay off of higher yielding loans, lower interest rates on new loans and a nonrecurring favorable adjustment of $905,000 that positively impacted the loan yield in 2010.
The net interest margin of 2.89% for the full year 2010 amounted to an increase of 50 basis points from the 2009 level of 2.39%. The improvement in the margin was primarily due to the ability to re-price the liability side of the balance sheet, which had lagged the re-pricing of the asset side in 2009, and to redeem higher cost funding sources throughout 2010. During 2010 the Company was able to re-price and retain almost all of the $230 million maturing retail CDs at reduced interest rates while also redeeming $118 million of higher cost brokered CDs and $98.8 million of higher cost FHLB advances. This positive trend was partially offset by a decline of 24 basis points in the yield on average interest earning assets mainly attributable to a decline in the yield on investment securities. The previously noted nonrecurring adjustment to net interest income of $905,000 contributed 8 basis points of the overall 50 basis point improvement in the net interest margin for 2010.
Average Balances
The following table represents the average daily balances of assets, liabilities and shareholders’ equity and the respective interest earned and paid on interest bearing assets and interest bearing liabilities, as well as average rates for the periods indicated:
| | | For the years ended December 31, | |
| | | 2011 | | | 2010 | | | 2009 | |
| (Dollars in thousands) | | Average Balance | | | Interest | | | Yield / Rate | | | Average Balance | | | Interest | | | Yield / Rate | | | Average Balance | | | Interest | | | Yield / Rate | |
| Assets | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest bearing deposits | | $ | 29,016 | | | $ | 78 | | | | 0.27 | % | | $ | 57,377 | | | $ | 154 | | | | 0.27 | % | | $ | 51,578 | | | $ | 164 | | | | 0.32 | % |
| Federal funds | | | 2,822 | | | | 3 | | | | 0.11 | % | | | 562 | | | | 1 | | | | 0.13 | % | | | 553 | | | | 1 | | | | 0.18 | % |
| Investment securities | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Held to maturity | | | - | | | | - | | | | 0.00 | % | | | - | | | | - | | | | 0.00 | % | | | - | | | | - | | | | 0.00 | % |
| Available for sale | | | 320,362 | | | | 9,645 | | | | 3.01 | % | | | 381,804 | | | | 14,464 | | | | 3.79 | % | | | 426,829 | | | | 20,121 | | | | 4.71 | % |
| Total investment securities | | | 320,362 | | | | 9,645 | | | | 3.01 | % | | | 381,804 | | | | 14,464 | | | | 3.79 | % | | | 426,829 | | | | 20,121 | | | | 4.71 | % |
| Loans & Leases | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Commercial demand loans | | | 219,554 | | | | 10,044 | | | | 4.57 | % | | | 307,515 | | | | 15,857 | | | | 5.16 | % | | | 384,831 | | | | 18,439 | | | | 4.79 | % |
| Real estate secured | | | 213,737 | | | | 16,268 | | | | 7.61 | % | | | 291,205 | | | | 23,195 | | | | 7.97 | % | | | 294,414 | | | | 24,285 | | | | 8.25 | % |
| Other loans and leases | | | 41,756 | | | | 3,339 | | | | 8.00 | % | | | 44,730 | | | | 3,591 | | | | 8.03 | % | | | 36,276 | | | | 3,032 | | | | 8.36 | % |
| Total loans | | | 475,047 | | | | 29,651 | | | | 6.24 | % | | | 643,450 | | | | 42,643 | | | | 6.63 | % | | | 715,521 | | | | 45,756 | | | | 6.39 | % |
| Total interest earnings assets | | | 827,247 | | | | 39,377 | | | | 4.76 | % | | | 1,083,193 | | | | 57,262 | | | | 5.29 | % | | | 1,194,481 | | | | 66,042 | | | | 5.53 | % |
| Non interest earnings assets | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Cash & due from banks | | | 11,725 | | | | | | | | | | | | 16,465 | | | | | | | | | | | | 11,752 | | | | | | | | | |
| Other assets | | | 87,729 | | | | | | | | | | | | 105,013 | | | | | | | | | | | | 115,173 | | | | | | | | | |
| Allowance for loan loss | | | (19,567 | ) | | | | | | | | | | | (25,919 | ) | | | | | | | | | | | (25,061 | ) | | | | | | | | |
| Unearned discount | | | (632 | ) | | | | | | | | | | | (830 | ) | | | | | | | | | | | (1,219 | ) | | | | | | | | |
| Total non-interest earning assets | | | 79,255 | | | | | | | | | | | | 94,729 | | | | | | | | | | | | 100,645 | | | | | | | | | |
| Total assets | | $ | 906,502 | | | | | | | | | | | $ | 1,177,922 | | | | | | | | | | | $ | 1,295,126 | | | | | | | | | |
| Liabilities & Shareholders' Equity | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Deposits | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Savings | | $ | 15,727 | | | $ | 86 | | | | 0.55 | % | | $ | 15,959 | | | $ | 90 | | | | 0.56 | % | | $ | 14,802 | | | $ | 83 | | | | 0.56 | % |
| NOW | | | 42,488 | | | | 236 | | | | 0.56 | % | | | 42,990 | | | | 395 | | | | 0.92 | % | | | 46,046 | | | | 478 | | | | 1.04 | % |
| Money market | | | 178,670 | | | | 1,722 | | | | 0.96 | % | | | 166,386 | | | | 1,754 | | | | 1.05 | % | | | 153,146 | | | | 2,797 | | | | 1.83 | % |
| Time deposits | | | 327,583 | | | | 6,906 | | | | 2.11 | % | | | 503,217 | | | | 14,683 | | | | 2.92 | % | | | 581,202 | | | | 21,984 | | | | 3.78 | % |
| Total interest bearing deposits | | | 564,468 | | | | 8,950 | | | | 1.59 | % | | | 728,552 | | | | 16,922 | | | | 2.32 | % | | | 795,196 | | | | 25,342 | | | | 3.19 | % |
| Borrowings | | | 151,743 | | | | 4,493 | | | | 2.96 | % | | | 229,515 | | | | 8,403 | | | | 3.66 | % | | | 271,000 | | | | 10,717 | | | | 3.95 | % |
| Obligation through VIE equity investments | | | - | | | | - | | | | 0.00 | % | | | 1,399 | | | | 22 | | | | 1.57 | % | | | 10,451 | | | | 243 | | | | 2.33 | % |
| Subordinated debt | | | 25,774 | | | | 643 | | | | 2.49 | % | | | 25,774 | | | | 647 | | | | 2.51 | % | | | 25,774 | | | | 1,136 | | | | 4.41 | % |
| Total interest bearing liabilities | | | 741,985 | | | | 14,086 | | | | 1.90 | % | | | 985,240 | | | | 25,994 | | | | 2.64 | % | | | 1,102,421 | | | | 37,438 | | | | 3.40 | % |
| Non interest bearing deposits | | | 57,241 | | | | | | | | | | | | 62,474 | | | | | | | | | | | | 62,546 | | | | | | | | | |
| Other liabilities | | | 26,092 | | | | | | | | | | | | 26,313 | | | | | | | | | | | | 22,648 | | | | | | | | | |
| Total liabilities | | | 825,318 | | | | | | | | | | | | 1,074,027 | | | | | | | | | | | | 1,187,615 | | | | | | | | | |
| Shareholders' equity | | | 81,184 | | | | | | | | | | | | 103,895 | | | | | | | | | | | | 107,511 | | | | | | | | | |
| Total liabilities and shareholders' equity | | $ | 906,502 | | | | | | | | | | | $ | 1,177,922 | | | | | | | | | | | $ | 1,295,126 | | | | | | | | | |
| Net interest income | | | | | | $ | 25,291 | | | | | | | | | | | $ | 31,268 | | | | | | | | | | | $ | 28,604 | | | | | |
| Net interest margin | | | | | | | | | | | 3.06 | % | | | | | | | | | | | 2.89 | % | | | | | | | | | | | 2.39 | % |
| (1) | Non-accrual loans have been included in the appropriate average loan balance category, but interest on these loans has not been included. |
| (2) | Portions of interest related to obligations through VIE are capitalized on the VIE’s books. |
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 years ended December 31, 2011 and 2010, as compared to respective previous periods, into amounts attributable to both rate and volume variances.
| | | 2011 versus 2010 | | | 2010 versus 2009 | |
| | | Changes due to: | | | Changes due to: | |
| (In thousands) | | Volume | | | Rate | | | Total | | | Volume | | | Rate | | | Total | |
| Interest income | | | | | | | | | | | | | | | | | | |
| Short term earning assets | | | | | | | | | | | | | | | | | | |
| Interest bearing deposits in banks | | $ | (76 | ) | | $ | - | | | $ | (76 | ) | | $ | 16 | | | $ | (26 | ) | | $ | (10 | ) |
| Federal funds sold | | | 2 | | | | - | | | | 2 | | | | - | | | | - | | | | - | |
| Total short term earning assets | | | (74 | ) | | | - | | | | (74 | ) | | | 16 | | | | (26 | ) | | | (10 | ) |
| Investments securities | | | | | | | | | | | | | | | | | | | | | | | | |
| Held to maturity | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | |
| Available for sale | | | (2,260 | ) | | | (2,559 | ) | | | (4,819 | ) | | | (1,730 | ) | | | (3,927 | ) | | | (5,657 | ) |
| Total Investments securities | | | (2,260 | ) | | | (2,559 | ) | | | (4,819 | ) | | | (1,730 | ) | | | (3,927 | ) | | | (5,657 | ) |
| Loans | | | | | | | | | | | | | | | | | | | | | | | | |
| Commercial demand loans | | | (3,768 | ) | | | (1,704 | ) | | | (5,472 | ) | | | (3,536 | ) | | | 1,180 | | | | (2,356 | ) |
| Commercial mortgages | | | (3,810 | ) | | | (342 | ) | | | (4,152 | ) | | | (156 | ) | | | (724 | ) | | | (880 | ) |
| Residential and home equity loans | | | (56 | ) | | | (11 | ) | | | (67 | ) | | | (95 | ) | | | (103 | ) | | | (198 | ) |
| Lease receivables | | | (200 | ) | | | (21 | ) | | | (221 | ) | | | 693 | | | | (135 | ) | | | 558 | |
| Real estate tax liens | | | (1,541 | ) | | | (1,140 | ) | | | (2,681 | ) | | | 127 | | | | (160 | ) | | | (33 | ) |
| Other loans | | | (30 | ) | | | - | | | | (30 | ) | | | 5 | | | | (5 | ) | | | - | |
| Loan fees | | | (369 | ) | | | - | | | | (369 | ) | | | (205 | ) | | | - | | | | (205 | ) |
| Total loans | | | (9,774 | ) | | | (3,218 | ) | | | (12,992 | ) | | | (3,167 | ) | | | 53 | | | | (3,114 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total decrease in interest income | | $ | (12,108 | ) | | $ | (5,777 | ) | | $ | (17,885 | ) | | $ | (4,881 | ) | | $ | (3,900 | ) | | $ | (8,781 | ) |
| Interest expense | | | | | | | | | | | | | | | | | | | | | | | | |
| Deposits | | | | | | | | | | | | | | | | | | | | | | | | |
| NOW and money market | | $ | 117 | | | $ | (307 | ) | | $ | (190 | ) | | $ | 160 | | | $ | (1,286 | ) | | $ | (1,126 | ) |
| Savings | | | (1 | ) | | | (3 | ) | | | (4 | ) | | | 6 | | | | 1 | | | | 7 | |
| Time deposits | | | (4,336 | ) | | | (3,442 | ) | | | (7,778 | ) | | | (2,699 | ) | | | (4,602 | ) | | | (7,301 | ) |
| Total deposits | | | (4,220 | ) | | | (3,752 | ) | | | (7,972 | ) | | | (2,533 | ) | | | (5,887 | ) | | | (8,420 | ) |
| Borrowings | | | | | | | | | | | | | | | | | | | | | | | | |
| Borrowings | | | (2,498 | ) | | | (1,412 | ) | | | (3,910 | ) | | | (1,558 | ) | | | (757 | ) | | | (2,315 | ) |
| Trust preferred | | | - | | | | (4 | ) | | | (4 | ) | | | - | | | | (489 | ) | | | (489 | ) |
| Total Borrowings | | | (2,498 | ) | | | (1,416 | ) | | | (3,914 | ) | | | (1,558 | ) | | | (1,246 | ) | | | (2,804 | ) |
| Total decrease in interest expense | | | (6,718 | ) | | | (5,168 | ) | | | (11,886 | ) | | | (4,091 | ) | | | (7,133 | ) | | | (11,224 | ) |
| Total (decrease) increase in net interest income | | $ | (5,390 | ) | | $ | (609 | ) | | $ | (5,999 | ) | | $ | (790 | ) | | $ | 3,233 | | | $ | 2,443 | |
Provision for Loan and Lease Losses
The provision for loan and lease losses was $7.7 million in 2011 compared to $22.1 million in 2010. During 2011 loan balances declined $82.6 million, which includes net charge-offs of $12.5 million. This lower level of loan and lease balances requires a lower allowance which enabled the provision to decline.
The provision for loan and lease losses was $22.1 million in 2010. Included in the 2010 provision was $11.4 million in charge-offs on loans transferred to loans held for sale. The Company recorded $30.4 million in net charge-offs in 2010.
The provision for loan and lease losses was $20.6 million in 2009. Included in the 2009 provision was $11.0 million in specific reserves for individual loans that became impaired during 2009. The Company recorded $19.2 million in net charge-offs in 2009.
Total Other Income
Other income includes service charges on depositors’ accounts, safe deposit rentals and various services such issuing money orders and traveler’s checks. In addition, other forms of non-interest income are derived from changes in the cash value of bank owned life insurance (“BOLI”), income related to income producing properties within other real estate owned and income relating to real estate owned via equity investment. Most components of other income are a modest and stable source of income, with exceptions of one-time gains and losses from the sale of investment securities, other real estate owned, and real estate owned via equity investments. From period to period these sources of income may vary considerably. Service charges on depositors’ accounts, safe deposit rentals and other fees are periodically reviewed by management to remain competitive with other local banks.
Total other income in 2011 amounted to $6.8 million resulting in a decline of $947,000, or 12.2%, from the previous year, which was primarily attributable to an increase of $1.3 million in OTTI charges on AFS securities ($1.8 million in 2011 versus $479,000 in 2010). This was mainly associated with the impairment of one trust preferred security within the Company’s investment portfolio which was completely written off in 2011. Other unfavorable fluctuations year over year in other income amounted to a $329,000 decrease in gain on the sales of loans and leases ($337,000 in 2011 compared to $666,000 in 2010), and decreases in both income related to real estate owned via equity investments and gains on the sale of premises and equipment related to real estate owned via equity investments of $86,000 and $667,000, respectively. The decline in income related to real estate owned via equity investments and gains on the sale of premises and equipment related to real estate owned via equity investment is attributable to the deconsolidation of the VIE as a result of the substantial completion of the real estate partnership project. As a result of deconsolidation, income of $278,000 is reflected in income related to real estate owned via equity investments.
Partially offsetting these decreases was a $619,000 increase in net gains on the sale of other real estate owned ($1.6 million in 2011 versus $1.0 million in 2010), a $492,000 increase in net gains on the sale of available for sale investment securities ($1.8 million in 2011 versus $1.3 million in 2010), a $1.8 million increase in income from real estate joint ventures related to a partial recovery of a fully impaired real estate joint venture and an increase in other income of $373,000. The improvement in other income was mostly attributed to rental income associated with two OREO properties acquired through foreclosures.
Total other income of $7.8 million in 2010 amounted to an improvement of $9.5 million from 2009 due primarily to a reduction of $10.6 million in net impairment losses on AFS investment securities, a one-time gain of $1.7 million on the sale of the Company’s LBSF claim and increased gains of $725,000 on the sale of other real estate, primarily related to the favorable disposition in 2010 of two properties acquired through foreclosure. The 2010 impairment losses were isolated to two real estate investments that amounted to $479,000 and reflected the restructuring of the investment portfolio during the previous year while 2009 impairment losses totaled $11.0 million. The sale of the LBSF claim resulted in a gain of a previous impairment charge of $5.0 million in 2008 for the value of a CMO pledged as collateral for an interest rate swap with LBSF as previously mentioned under the caption “Net Loss” in the “Results of Operations”.
Offsetting these favorable year over year results were a reduction of $720,000 in BOLI income, a reduction of $602,000 in investment security gains ($1.3 million in 2010 versus $1.9 million in 2009), a decline in service fees of $153,000, a decline of $404,000 in gains on the sale of loans and leases, mainly related to fewer SBA loan sales. Additionally, lower other income was associated with reduced gains of $1.2 million on the sale of premises and equipment related to real estate owned via equity investments ($667,000 versus $1.8 million) and a decrease of $738,000 in income related to real estate owned via equity investments. The decline in BOLI income was due to the sale of approximately $23 million of BOLI insurance in 2009. The reduction of income related to real estate owned via equity investments and gains on the sale of premises and equipment related to real estate owned via equity investments was primarily attributed to a slowdown in unit sales for the real estate partnership project due to the expiration of the new home buyers’ tax credit at the end of the second quarter.
Total Other Expense
For the period ended December 31, 2011 non-interest expense of $32.1 million amounted to a decrease of $8.7 million, or 21.3%, from the results in 2010. The improvement in expenses was primarily attributable to a decrease of $3.5 million related to the sale of Royal Asian at the end of 2010 that impacted most expense categories, a $1.9 million decrease in OREO impairments, a $2.6 million decrease in impairments on real estate owned via equity investments, a $1.6 million decrease in impairments of real estate joint ventures, and an $1.1 million decrease in FDIC Insurance and Pennsylvania Department of Banking assessments, mainly a result of a reduction in deposits, most notably brokered CDs and Royal Asian deposits. The VIE was deconsolidated in 2011. During 2010 impairments of real estate joint ventures was the net impact of a $2.6 million impairment, which was the entire amount of an investment in which the Company had a subordinate debt position, due to the reduction in the collateral value as a consequence of a significant decline in the cash flows generated from the property and a recovery of $968,000 from another investment in a real estate joint venture that was written off in 2007.
Salaries and benefits of $10.9 million in 2011, which declined $671,000, or 5.8%, also contributed to the favorable results for other expense. The improvement was comprised of a reduction associated with the sale of Royal Asian amounting to $1.1 million and a partially offsetting increase of $417,000 mainly related to annual merit raises for most employees, the reinstatement of the 401K match and increased benefit costs. The $888,000 decline in occupancy and equipment expense in 2011 was primarily associated with the reduction of expenses related to the Royal Asian retail branch network. While professional and legal fees of $4.1 million in 2011 and OREO and loan collection expenses of $2.6 million in the current year were relatively flat year over year, they represent significant increases from historical levels due to credit quality issues, which have improved but remain elevated. Other operating expense is comprised of data processing, postage, telephone, travel and entertainment, advertising, printing and supplies, dues and subscriptions and other miscellaneous expense.
Total other expense amounted to $40.7 million in 2010, which represented an increase of $3.1 million, or 8.2%, above the level of 2009. The increase was principally related to an increase in OREO impairment charges of $2.8 million, impairment of $2.6 million related to real estate owned via equity investments and impairment of $1.6 million in real estate joint ventures. The impairment of real estate owned via equity investments was due to lower projected operating cash flows resulting from a significant decline in unit sales, which was primarily related to the expiration of the new home buyers’ tax credit. During 2010, the Company recorded a $2.5 million impairment of real estate joint ventures, which amounted to the entire amount of the investment in which the Company had a subordinate debt position due to the reduction in the collateral value as a consequence of a significant decline in the cash flows generated from the property. The entire amount of the partnership’s impairment, including the partner’s share, is posted as a charge to expense and included in the Company’s other expense. The partner’s share of the losses is then eliminated through a credit to non-controlling interest on the Company’s consolidated statement of operations. Partially offsetting this impairment loss was a recovery of $968,000 from an investment in a real estate joint venture that was written off in 2007 resulting in a $1.6 million net impairment expense for real estate joint ventures in 2010.
Offsetting these expense increases during 2010 was a reduction of $644,000 in employee salaries and benefits due to reduced headcount and the closing of the Blue Bell loan production office in 2009; a decline of $754,000 in FDIC and state assessment expense due to lower deposit balances in 2010 and a change in the accounting method from a prepaid basis to an accrual method in 2009; reduced OREO and loan collection expense of $682,000 mainly attributed to the successful auction of an OREO property in 2010 and the resulting recovery of expenses; and a decrease in directors’ fees of $321,000 due mainly to a reduction in the number of directors and the elimination of inside directors’ fees. Additionally, reductions were experienced in occupancy and equipment, stock option expense, professional and legal fees, expenses related to real estate owned via equity investments, and other operating expense, which collectively represented an expense decrease of $1.5 million.
Accounting for Income Tax Expense
In 2011 and 2010, the Company recorded no tax expense. The Company did not record a tax benefit despite the net loss for 2011 and 2010 since it concluded at December 31, 2011 and 2010 that it was more likely than not that the Company would not generate sufficient taxable income to realize all of the deferred tax assets. In 2009, a tax expense of $474,000 was recorded which was entirely related to a 10% excise tax on the surrender of approximately $23.0 million in BOLI.
As of December 31, 2011 and December 31, 2010, management concluded that it was more likely than not that the Company would not generate sufficient future taxable income to realize all of the deferred tax assets. Management’s conclusion was based on consideration of the relative weight of the available evidence and the uncertainty of future market conditions on results of operations. The Company recorded a non-cash charge of $15.5 million in the consolidated statements of operations in the period ended December 31, 2008 related to the establishment of a valuation allowance for the deferred tax asset for the portion of the future tax benefit that more likely than not will not be utilized in the future. During 2009, 2010 and 2011, the Company established additional valuation allowances of $10.2 million, $7.7 million, and $3.0 million, respectively, which was a result of the net operating losses for each year and the portion of the future tax benefit that more likely than not will not be utilized in the future. The additional valuation allowance did not impact the net loss as no tax benefit was recorded during 2011. As of December 31, 2011 the valuation allowance for deferred tax assets totaled $36.4 million.
The Company’s effective tax rate is the provision for federal income taxes, excluding the tax effect of extraordinary items, expressed as a percentage of income or loss before federal income taxes. The effective tax rate for the twelve months ended December 31, 2011 and 2010 was 0%. In general our effective tax rate is different from the federal statutory rate of 35% primarily due to the benefits related to certain insurance that is non-taxable and the establishment of a valuation allowance which was $36.4 million as of December 31, 2011.
Results of Operations by Business Segments
Under FASB ASC Topic 280, “Segment Reporting” (“ASC Topic 280”), management of the Company has identified two reportable operating segments, “Community Banking” and “Tax Liens”. In previous years, the Company reflected “Equity Investments” and “Leasing” as operating segments. Management has determined that the operating results and assets related to Equity Investments and Leasing should be reflected under the Community Banking segment. The determination related to Equity Investments was based on the deconsolidation of the VIE as a result of the substantial completion of the project and minimal assets remaining. The determination related to Leasing was based on not meeting the quantitative thresholds for requiring disclosure.
| | § | Community Bank segment: At December 31, 2011, the Community Bank segment had total assets of $777.6 million, a decrease of $102.5 million or 11.6% from $880.0 million at December 31, 2010. Total deposits declined $118.0 million or 17.0% from $693.9 million at December 31, 2010 to $575.9 million at December 31, 2011. Net interest income for 2011 was $20.3 million compared to $24.4 million for 2010 representing a decrease of $4.2 million, or 17.1%. The decrease in net interest income was primarily related to a reduction in the average balance of loans which have a higher yield than investments. In addition, the yield earned on the investment securities declined in 2011 as a result of the market rates being significantly lower in 2011. The interest rates paid on deposits declined in 2011 largely due to the maturities of brokered and retail certificates of deposits. The loan loss provision was $6.6 million for 2011 compared to $22.0 million for 2010 primarily as a result of the reduction of non-performing loans. For 2011, total other income was $6.3 million compared to a total other income of $7.4 million for 2010. The decline is mostly attributed to a $1.3 million increase in impairment charges recorded on the available-for-sale investment portfolio in 2011 compared to 2010. In 2011, total other expense was $30.4 million, a decrease of $8.4 million, or 21.6%, from $38.8 million in 2010. The decrease is mostly associated with decreases in OREO impairment charges of $1.9 million, impairment in real estate joint ventures of $1.6 million and a decline in the FDIC assessment of $1.1 million. The net loss for 2011 was $9.6 million compared to a net loss of $25.9 million for 2010, which represents an improvement of $16.3 million, or 63.0%. |
| | § | Tax Lien segment: At December 31, 2011, the Tax Lien segment had total assets of $70.9 million compared to $100.6 million at December 31, 2010 representing a decrease of $29.7 million, or 30%. Net interest income decreased $1.7 million, or 26%, from $6.5 million in 2010 to $4.8 million in 2011. The provision for losses increased from $129,000 in 2010 to $1.1 million in 2011. The 2011 provision was mostly related to charge-offs on a non-accrual loan with a tax lien portfolio located in Alabama. Total other income was $548,000 in 2011 compared to $389,000 in 2010. Total other income is derived mostly from the gains on sale of OREO property. Total other expense decreased $203,000 from $1.7 million for 2010 to $1.5 million for 2011. The decrease in other total expense was related to a decline in management fees. Net income was $1.0 million in 2011 compared to $1.8 million for 2010. |
Financial Condition
Total assets decreased $132.2 million, or 13.5%, to $848.4 million at December 31, 2011 from $980.6 million at year-end 2010.
Cash and Cash Equivalents: Cash and cash equivalents consist of cash on hand, and cash in interest bearing and non-interest bearing accounts in banks, in addition to federal funds sold. Cash and cash equivalents decreased $27.2 million from $51.7 million at December 31, 2010 to $24.5 million at December 31, 2011. The average balance of cash and cash equivalents was approximately $43.6 million for 2011 versus $74.4 million for 2010. The high level of cash for 2010 was primarily related to maintaining strong liquidity during this current economic environment. The majority of this average balance was held in interest-bearing accounts with other financial institutions which were paying a higher interest rate than federal funds. The excess cash is invested daily in overnight and federal funds. The average balance of these funds that earn interest was $29.0 million in 2011.
Investment Securities Available for Sale (“AFS”): AFS investment securities represented 39% of average interest earning assets during 2011 and consisted of government secured agency bonds, government secured mortgage-backed securities, collateralized mortgage obligations (“CMOs”), capital trust security issues of regional banks, domestic corporate debt and third party managed equity funds. At December 31, 2011, AFS investment securities were $329.0 million as compared to $315.6 million at December 31, 2010, an increase of $13.4 million. The increase was primarily due to the purchase of liquid, cash-flowing mortgage backed securities and U. S. government agency CMOs. The purchase of these investments was partially offset by the sale of debt securities and government agencies to reduce credit risk and extension risk within the investment portfolio.
Loans: The Company’s primary earning assets are loans, representing approximately 57% of average earning assets during 2011. The loan portfolio consists primarily of business demand loans and commercial mortgages secured by real estate, real estate tax liens, lease receivables, and to a significantly lesser extent, residential loans comprised of one to four family residential and home equity loans. During 2011, total loans held for investment decreased $82.6 million to $414.2 million at December 31, 2011 from $496.8 million at December 31, 2010. The decline was primarily due to net pay downs or payoffs, loan charge-offs of $13.2 million, transfers to OREO of approximately $6.4 million in non-performing construction and land development, non-residential, and residential real estate loans, and transfers to LHFS of $2.9 million.
Non-residential real estate, construction loans and land development make up a significant portion of our loan portfolio and represented 57% of total loans at December 31, 2011 compared to 55% of total loans at December 31, 2010. Management believes our current loan loss reserve is adequate at December 31, 2011 to cover losses arising from these loan categories as well as all others within the portfolio. We continue to monitor these loans, with emphasis on construction, land development and non-residential real estate loans, due to the continuing deterioration in market conditions to evaluate the impact these loans will have on our loan loss reserve.
Allowance for loan and lease losses: The Company’s loan and lease portfolio (the “credit portfolio”) is subject to varying degrees of credit risk. The Company maintains an allowance to absorb losses in the loan and lease portfolio. The allowance is based on the review and evaluation of the loan and lease portfolio, along with ongoing, quarterly assessments of the probable losses inherent in that portfolio. The allowance represents an estimation made pursuant to FASB ASC Topic 450, “Contingencies” (“ASC Topic 450”) or FASB ASC Topic 310, “Receivables” (“ASC Topic 310”). The adequacy of the allowance is determined through evaluation of the credit portfolio, and involves consideration of a number of factors, as outlined below, to establish a prudent level. Determination of the allowance is inherently subjective and requires significant estimates, including estimated losses on pools of homogeneous loans and leases based on historical loss experience and consideration of current economic trends, which may be susceptible to significant change. Loans and leases deemed uncollectible are charged against the allowance, while recoveries are credited to the allowance. Management adjusts the level of the allowance through the provision for loan and lease losses, which is recorded as a current period expense. The Company’s systematic methodology for assessing the appropriateness of the allowance includes: (1) general reserves reflecting historical loss rates by loan type, (2) specific reserves for risk-rated credits based on probable losses on an individual or portfolio basis and (3) qualitative reserves based upon current economic conditions and other risk factors.
The loan portfolio is stratified into loan segments that have similar risk characteristics. The general allowance is based upon historical loss rates using a three-year rolling average of the historical loss experienced within each loan segment. The qualitative factors used to adjust the historical loss experience address various risk characteristics of the Company’s loan and lease portfolio include evaluating: (1) trends in delinquencies and other non-performing loans, (2) changes in the risk profile related to large loans in the portfolio, (3) changes in the growth trends of categories of loans comprising the loan and lease portfolio, (4) concentrations of loans and leases to specific industry segments, and (5) changes in economic conditions on both a local and national level, (6) quality of loan review and board oversight, (7) changes in lending policies and procedures, and (8) changes in lending staff. Each factor is assigned a value to reflect improving, stable or declining conditions based on management’s best judgment using relevant information available at the time of the evaluation. Adjustments to the factors are supported through documentation of changes in conditions in a report accompanying the allowance calculation.
The specific reserves are determined utilizing standards required under ASC Topic 310. A loan is considered impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. Non-accrual loans and loans restructured under a troubled debt restructuring are evaluated for impairment on an individual basis considering all known relevant factors that may affect loan collectability such as the borrower’s overall financial condition, resources and payment record, support available from financial guarantors and the sufficiency of current collateral values (current appraisals or rent rolls for income producing properties), and risks inherent in different kinds of lending (such as source of repayment, quality of borrower and concentration of credit quality). Non-accrual loans that experience insignificant payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and industrial loans, commercial real estate loans and commercial construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent. An allowance for loan losses is established for an impaired loan if its carrying value exceeds its estimated fair value. The estimated fair values of substantially all of the Company’s impaired loans are measured based on the estimated fair value of the loan’s collateral. The Company obtains third-party appraisals on the fair value of real estate collateral. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property. For commercial and industrial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Once a loan is determined to be impaired it will be deducted from the portfolio and the net remaining balance will be used in the general and qualitative analysis.
Analysis of the Allowance for Loan and Lease Losses:
| | | For the years ended December 31, | |
| (In thousands) | | 2011 | | | 2010 | | | 2009 | | | 2008 | | | 2007 | |
| Total Loans | | $ | 414,243 | | | $ | 496,854 | | | $ | 686,864 | | | $ | 700,722 | | | $ | 644,475 | |
| Daily average loan balance | | $ | 475,047 | | | $ | 643,450 | | | $ | 715,521 | | | $ | 676,761 | | | $ | 636,612 | |
| Allowance for loan and lease losses: | | | | | | | | | | | | | | | | | | | | |
| Balance at the beginning of the year | | $ | 21,129 | | | $ | 30,331 | | | $ | 28,908 | | | $ | 19,282 | | | $ | 11,455 | |
| Charge-offs by loan type: | | | | | | | | | | | | | | | | | | | | |
| Real Estate – non-residential | | | 1,685 | | | | 7,352 | | | | 7,404 | | | | 1,330 | | | | 294 | |
| Real Estate – non-residential-mezzanine | | | - | | | | - | | | | 1,132 | | | | 1,675 | | | | - | |
| Construction and land development | | | 5,755 | | | | 13,413 | | | | 6,231 | | | | 3,852 | | | | 2,408 | |
| Construction and land develop-mezzanine | | | - | | | | - | | | | 2,756 | | | | 1,540 | | | | 1,579 | |
| Commercial and industrial | | | 2,901 | | | | 5,930 | | | | 258 | | | | 1,009 | | | | 704 | |
| Real Estate – multi-family | | | 328 | | | | 787 | | | | - | | | | - | | | | - | |
| Real Estate – residential | | | 635 | | | | 731 | | | | 1,361 | | | | 37 | | | | 195 | |
| Real Estate - residential-mezzanine | | | - | | | | 2,480 | | | | - | | | | 2,220 | | | | - | |
| Leases | | | 868 | | | | 972 | | | | 676 | | | | 642 | | | | 286 | |
| Tax certificates | | | 1,039 | | | | 49 | | | | - | | | | 22 | | | | - | |
| Total charge-offs | | | 13,211 | | | | 31,714 | | | | 19,818 | | | | 12,327 | | | | 5,466 | |
| Recoveries by loan type: | | | | | | | | | | | | | | | | | | | | |
| Real Estate – non-residential | | | 357 | | | | 684 | | | | 431 | | | | - | | | | 4 | |
| Construction and land development | | | 196 | | | | 116 | | | | - | | | | - | | | | 34 | |
| Commercial and industrial | | | 22 | | | | 81 | | | | 15 | | | | 106 | | | | 201 | |
| Real Estate – multi-family | | | - | | | | 18 | | | | - | | | | - | | | | - | |
| Real Estate – residential | | | 153 | | | | 313 | | | | 190 | | | | 6 | | | | 28 | |
| Leases | | | 6 | | | | 51 | | | | - | | | | - | | | | - | |
| Other | | | - | | | | 37 | | | | - | | | | - | | | | - | |
| Total recoveries | | | 734 | | | | 1,300 | | | | 636 | | | | 112 | | | | 267 | |
| Net loan charge-offs | | | (12,477 | ) | | | (30,414 | ) | | | (19,182 | ) | | | (12,215 | ) | | | (5,199 | ) |
| Provision for loan and lease losses | | | 7,728 | | | | 22,140 | | | | 20,605 | | | | 21,841 | | | | 13,026 | |
| Allowance related to disposed assets | | | - | | | | (928 | ) | | | - | | | | - | | | | - | |
| Balance at end of year | | $ | 16,380 | | | $ | 21,129 | | | $ | 30,331 | | | $ | 28,908 | | | $ | 19,282 | |
| Net charge-offs to average loans | | | (2.63 | %) | | | (4.73 | %) | | | (2.68 | %) | | | (1.80 | %) | | | (0.82 | %) |
| Allowance to total loans at year-end | | | 3.95 | % | | | 4.25 | % | | | 4.42 | % | | | 4.13 | % | | | 2.99 | % |
Analysis of the Allowance for Loan and Lease Losses by Loan Type:
| | | As of December 31, | |
| | | 2011 | | | 2010 | | | 2009 | | | 2008 | | | 2007 | |
| (In thousands, except percentages) | | Reserve Amount | | | Percent of outstanding loans in each category to total loans | | | Reserve Amount | | | Percent of outstanding loans in each category to total loans | | | Reserve Amount | | | Percent of outstanding loans in each category to total loans | | | Reserve Amount | | | Percent of outstanding loans in each category to total loans | | | Reserve Amount | | | Percent of outstanding loans in each category to total loans | |
| Commercial and industrial | | $ | 2,331 | | | | 13.0 | % | | $ | 3,797 | | | | 14.9 | % | | $ | 6,542 | | | | 14.9 | % | | $ | 2,403 | | | | 12.3 | % | | $ | 2,124 | | | | 12.0 | % |
| Construction | | | 417 | | | | 3.4 | % | | | 1,117 | | | | 5.8 | % | | | 4,713 | | | | 5.8 | % | | | 11,548 | | | | 23.8 | % | | | 7,674 | | | | 14.4 | % |
Land development (1) | | | 2,106 | | | | 9.7 | % | | | 2,859 | | | | 10.2 | % | | | 3,182 | | | | 10.2 | % | | | 2,359 | | | | 10.6 | % | | | - | | | | 12.2 | % |
Construction and land development - mezzanine | | | - | | | | 0.0 | % | | | - | | | | 0.0 | % | | | - | | | | 0.0 | % | | | 1,415 | | | | 0.3 | % | | | 2,493 | | | | 1.0 | % |
| Real Estate - residential | | | 1,188 | | | | 6.4 | % | | | 1,106 | | | | 5.9 | % | | | 2,762 | | | | 5.9 | % | | | 747 | | | | 3.9 | % | | | 1,014 | | | | 6.5 | % |
| Real Estate - residential - mezzanine | | | - | | | | 0.0 | % | | | - | | | | 0.0 | % | | | 1,000 | | | | 0.0 | % | | | - | | | | 0.0 | % | | | - | | | | 0.0 | % |
| Real Estate - non-residential | | | 7,744 | | | | 44.0 | % | | | 9,534 | | | | 39.0 | % | | | 9,824 | | | | 39.0 | % | | | 5,172 | | | | 33.4 | % | | | 4,746 | | | | 40.5 | % |
| Real Estate - non-residential -mezzanine | | | - | | | | 0.0 | % | | | - | | | | 0.0 | % | | | - | | | | 0.0 | % | | | 1,188 | | | | 0.6 | % | | | 204 | | | | 1.4 | % |
| Real Estate - multi-family | | | 531 | | | | 2.8 | % | | | 652 | | | | 2.1 | % | | | 215 | | | | 2.1 | % | | | 133 | | | | 2.0 | % | | | 59 | | | | 1.1 | % |
| Real Estate - multi-family - mezzanine | | | - | | | | 0.0 | % | | | - | | | | 0.0 | % | | | - | | | | 0.0 | % | | | - | | | | 0.0 | % | | | 6 | | | | 0.5 | % |
| Tax certificates | | | 425 | | | | 11.8 | % | | | 380 | | | | 14.2 | % | | | 290 | | | | 14.2 | % | | | 2,735 | | | | 9.1 | % | | | 185 | | | | 7.1 | % |
| Lease financing | | | 1,311 | | | | 8.7 | % | | | 1,670 | | | | 7.8 | % | | | 1,757 | | | | 7.8 | % | | | 1,183 | | | | 3.7 | % | | | 763 | | | | 3.1 | % |
| Other | | | 20 | | | | 0.2 | % | | | 12 | | | | 0.2 | % | | | 25 | | | | 0.2 | % | | | 15 | | | | 0.2 | % | | | 14 | | | | 0.2 | % |
| Unallocated | | | 307 | | | | 0.0 | % | | | 2 | | | | 0.0 | % | | | 21 | | | | 0.0 | % | | | 10 | | | | 0.0 | % | | | - | | | | 0.0 | % |
| Total | | $ | 16,380 | | | | 100.0 | % | | $ | 21,129 | | | | 100.0 | % | | $ | 30,331 | | | | 100.0 | % | | $ | 28,908 | | | | 100.0 | % | | $ | 19,282 | | | | 100.0 | % |
| (1) | Beginning in 2008, the Company began segregating land development loans from the rest of the loan portfolio. |
The amount of the allowance is reviewed and approved by the Chief Operating Officer (“COO”), Chief Financial Officer (“CFO”) and the Chief Accounting Officer (“CAO”) on at least a quarterly basis. The provision for loan and lease losses was $7.7 million in 2011 compared to $22.1 million in 2010. Included in the 2010 provision was $11.4 million in charge-offs on loans transferred to LHFS. The historical loss calculation of the allowance for loan and lease losses has been specifically impacted by the recent charge-off history of the Company. The deterioration of the real estate market these past few years had significantly impacted construction and real estate loans throughout the banking industry. Construction and land, non-residential real estate, and commercial loans represent 43%, 40% and 9%, respectively of the $51.3 million in non-accrual loans held at December 31, 2011. Total charge-offs recorded in 2011 related to construction and land development loans and non-residential real estate loans were $7.4 million, or 56%, of total charge-offs in 2011.
The provision for loan and lease losses was $22.1 million in 2010 compared to $20.6 million in 2009. Included in the 2010 provision was $11.4 million in charge-offs on loans transferred to LHFS. Construction and land, non-residential real estate, and commercial loans represent 50%, 28% and 9%, respectively of the $65.8 million in non-accrual loans held at December 31, 2010. Total charge-offs recorded in 2010 related to construction and land development loans and non-residential real estate loans were $20.8 million, or 66%, of total charge-offs in 2010.
The provision for loan and lease losses was $20.6 million in 2009 compared to $21.8 million in 2008. The 2009 provision was the result of $11.0 million in required specific reserves based on the Company’s impairment analysis in accordance with ASC Topic 310 and net charge-offs of $19.2 million recorded in 2009. The remaining 2009 provision was based on the formula allowance reflecting historical losses. Construction and land loans, non-residential and residential real estate loans represent 33%, 27% and 20%, respectively of the $73.7 million in non-accrual loans at December 31, 2009. Total charge-offs recorded in 2009 related to construction and land development loans and non-residential real estate loans were $17.5 million, or 88%, of total charge-offs in 2009.
Management believes that the allowance for loan and lease losses at December 31, 2011 is adequate. However, its determination requires significant judgment, and estimates of probable losses inherent in the credit portfolio can vary significantly from the amounts actually observed. While management uses available information to recognize probable losses, future changes to the allowance may be necessary based on changes in the credits comprising the portfolio and changes in the financial condition of borrowers, such as may result from changes in economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the credit portfolio and the allowance. Such review may result in additional provisions based on their judgment of information available at the time of each examination.
Deposits: The Company’s deposits are an important source of funding. Total deposits of $575.9 million at December 31, 2011 decreased $118.0 million, or 17.0%, from $693.9 million at December 31, 2010. Brokered deposits declined $83.2 million, or 93%, from $89.0 million at December 31, 2010 to $5.8 million at December 31, 2011 as the Company redeemed all maturing brokered deposits as required under the previous Orders. Time deposit accounts of $273.3 million at December 31, 2011 decreased $41.0 million, or 13%, from $314.3 million at December 31, 2010 primarily as a result of the Company electing to partially run off the higher cost deposits.
FHLB Borrowings: Borrowings consist of long-term borrowings (advances) and short-term borrowings (overnight borrowings, advances). Total FHLB borrowings, which include $22.0 million in overnight borrowings, declined from $110.7 million at year end 2010 to $104.2 million at December 31, 2011 due to scheduled pay downs on one amortizing advance. Due to long term advances of $32.2 million being reclassified to short term borrowings at December 31, 2011, short term borrowings amounted to $54.2 million at December 31, 2011 versus $22.0 million at December 31, 2010 while long term advances for the periods ending December 31, 2011 and 2010 were $50.0 million and $88.7 million, respectively.
Other Borrowings: During 2004, the Company completed a private placement of trust preferred securities in the aggregate amount of $25.0 million for a term of 30 years with a call feature of 5 years. These securities were eligible to be called in October 2009 by the Company. The maturity date of these securities is October 2034. On August 13, 2009, the Company’s Board of Directors determined to suspend interest payments on the trust preferred securities. The Company’s Board of Directors took this action in consultation with the Federal Reserve Bank of Philadelphia as required by recent regulatory policy guidance. The Company currently has sufficient capital and liquidity to pay the scheduled interest payments; however, the Company believes this decision better supports the capital position of Royal Bank, a wholly owned subsidiary of the Company. As of December 31, 2011 the trust preferred interest payment in arrears was $1.8 million and has been recorded in interest expense and accrued interest payable.
At December 31, 2011, the Company has an amortizing loan outstanding with PNC Bank in the amount of $3.8 million. The Company also has $40.0 million in repurchase agreements with PNC. These repurchase agreements are callable quarterly and have a final maturity date of January 7, 2018.
Other Liabilities: At December 31, 2011, other liabilities of $19.4 million increased $1.5 million from December 31, 2010. This was principally due to an increase of $2.4 million related to unfunded pension plan obligations, which was partially offset by a $1.9 million decrease in other liabilities as a result of the deconsolidation of the variable interest entity.
Shareholders’ Equity: Shareholders’ equity decreased $8.4 million, or 9.7%, in 2011 to $75.9 million primarily due net losses of $8.6 million and a $1.1 million decrease in accumulated other comprehensive income due to declines in valuations in the bond markets that negatively impacted the investment portfolio. Noncontrolling interest increased $1.5 million from $3.4 million at December 31, 2010 to $4.9 million at December 31, 2011.
Asset Liability Management
The primary functions of asset-liability management are to ensure adequate liquidity and maintain an appropriate balance between interest earning assets and interest bearing liabilities. This process is overseen by the Asset-Liability Committee (“ALCO”) which monitors and controls, among other variables, the liquidity, balance sheet structure and interest rate risk of the consolidated company within policy parameters established and outlined in the ALCO Policy which are reviewed by the Board of Directors at least annually. Additionally, the ALCO committee meets periodically and reports on liquidity, interest rate sensitivity and projects financial performance in various interest rate scenarios.
Liquidity: Liquidity is the ability of the financial institution to ensure that adequate funds will be available to meet its financial commitments as they become due. In managing its liquidity position, the financial institution evaluates all sources of funds, the largest of which is deposits. Also taken into consideration is the repayment of loans. These sources provide the financial institution with alternatives to meet its short-term liquidity needs. Longer-term liquidity needs may be met by issuing longer-term deposits and by raising additional capital.
The Company generally targets liquidity ratios equal to or greater than 12% and 10% of total deposits and total liabilities, respectively. The liquidity ratios are specifically defined as the ratio of net cash, available FHLB and other lines of credit, and unpledged marketable securities relative to both total deposits and total liabilities. At December 31, 2011, liquidity as a percent of deposits was 34% and liquidity as a percent of total liabilities was 26%. At December 31, 2010, liquidity as a percent of deposits was 31% and liquidity as a percent of total liabilities was 24%. Management believes that the Company’s liquidity position continues to be adequate and meets or exceeds the liquidity target set forth in the Asset/Liability Management Policy. Management believes that due to its financial position, it will be able to raise deposits as needed to meet liquidity demands. However, any financial institution could have unmet liquidity demands at any time.
Our funding decisions can be influenced by unplanned events, which include, but are not limited to, the inability to fund asset growth, difficulty renewing or replacing funds that mature, the ability to maintain or draw down lines of credit with other financial institutions, significant customer withdrawals of deposits, and market disruptions. Royal Bank is in an overcollateralization status with the FHLB, with a 105% pledged collateral requirement, The available amount for future borrowings will be based on the amount of collateral to be pledged. The Company has a liquidity contingency plan in the event liquidity falls below an acceptable level, however in today’s economic environment, events could arise that may render sources of liquid funds unavailable in the future when required. The Company’s liquidity committee meets monthly to increase the oversight role of liquidity management during this challenging economic environment.
Contractual Obligations and Other Commitments: The following table sets forth contractual obligations and other commitments representing required and potential cash outflows as of December 31, 2011.
| | | As of December 31, 2011 | |
| (In thousands) | | Total | | | Less than one year | | | One to three years | | | Four to five years | | | More than five years | |
| FHLB advances | | $ | 104,218 | | | $ | 54,218 | | | $ | 50,000 | | | $ | - | | | $ | - | |
| Operating leases | | | 2,376 | | | | 693 | | | | 901 | | | | 403 | | | | 379 | |
| PNC Bank | | | 43,782 | | | | - | | | | - | | | | 3,782 | | | | 40,000 | |
| Benefit obligations | | | 9,629 | | | | 652 | | | | 1,342 | | | | 2,049 | | | | 5,586 | |
| Standby letters of credit | | | 2,594 | | | | 2,594 | | | | - | | | | - | | | | - | |
| Subordinated debt | | | 25,774 | | | | - | | | | - | | | | - | | | | 25,774 | |
| Non-interest bearing deposits | | | 54,534 | | | | 54,534 | | | | - | | | | - | | | | - | |
| Interest bearing deposits | | | 242,265 | | | | 105,998 | | | | 136,267 | | | | - | | | | - | |
| Time deposits | | | 279,117 | | | | 136,573 | | | | 112,389 | | | | 14,229 | | | | 15,926 | |
| Total | | $ | 764,289 | | | $ | 355,262 | | | $ | 300,899 | | | $ | 20,463 | | | $ | 87,665 | |
Interest-Rate Sensitivity: Interest rate sensitivity is a function of the re-pricing characteristics of the Company’s assets and liabilities. These include the volume of assets and liabilities re-pricing, the timing of re-pricing, and the interest rate sensitivity gaps which are a continual challenge in a changing rate environment. 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. The interest rate sensitivity report examines the positioning of the interest rate risk exposure in a changing interest rate environment. Ideally, the rate sensitive assets and liabilities will be maintained in a matched position to minimize interest rate risk.
The interest rate sensitivity analysis is an important management tool; however, it does have some inherent shortcomings. It is a “static” analysis. Although certain assets and liabilities may have similar maturities or re-pricing, they may react in different degrees to changes in market interest rates. Additionally, re-pricing characteristics of certain assets and liabilities may vary substantially within a given period.
The following table summarizes re-pricing intervals for interest earning assets and interest bearing liabilities as of December 31, 2011, and the difference or “gap” between them on an actual and cumulative basis for the periods indicated. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. During a period of falling interest rates, a positive gap would tend to adversely affect net interest income, while a negative gap would tend to result in an increase in net interest income. During a period of rising interest rates, a positive gap would tend to result in an increase in net interest income while a negative gap would tend to affect net interest income adversely. At December 31, 2011, the Company is in an asset sensitive position of $62.2 million, which indicates that within one year the re-pricing of assets is sooner than the re-pricing of liabilities.
| | | As of December 31, 2011 | |
| (In millions) | | 0 – 90 days | | | 91 – 365 days | | | One to five years | | | Over five years | | | Non-rate sensitive | | | Total | |
| Assets (1) | | | | | | | | | | | | | | | | | | |
| Interest-bearing deposits in banks | | $ | 10.1 | | | $ | - | | | $ | - | | | $ | - | | | $ | 14.4 | | | $ | 24.5 | |
| Federal funds sold | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | |
| Investment securities | | | 38.2 | | | | 74.3 | | | | 154.1 | | | | 56.8 | | | | 5.6 | | | | 329.0 | |
| Loans: (2) | | | | | | | | | | | | | | | | | | | | | | | | |
| Fixed rate | | | 18.3 | | | | 55.0 | | | | 165.4 | | | | 19.5 | | | | (16.4 | ) | | | 241.8 | |
| Variable rate | | | 135.1 | | | | 33.6 | | | | - | | | | - | | | | - | | | | 168.7 | |
| Total loans | | | 153.4 | | | | 88.6 | | | | 165.4 | | | | 19.5 | | | | (16.4 | ) | | | 410.5 | |
| Other assets (3) | | | - | | | | 24.0 | | | | - | | | | - | | | | 60.4 | | | | 84.4 | |
| Total Assets | | $ | 201.7 | | | $ | 186.9 | | | $ | 319.5 | | | $ | 76.3 | | | $ | 64.0 | | | $ | 848.4 | |
| Liabilities & Capital | | | | | | | | | | | | | | | | | | | | | | | | |
| Deposits: | | | | | | | | | | | | | | | | | | | | | | | | |
| Non interest bearing deposits | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | 54.5 | | | $ | 54.5 | |
| Interest bearing deposits | | | 26.5 | | | | 79.5 | | | | 136.3 | | | | - | | | | - | | | | 242.3 | |
| Certificate of deposits | | | 42.2 | | | | 94.4 | | | | 126.6 | | | | 15.9 | | | | - | | | | 279.1 | |
| Total deposits | | | 68.7 | | | | 173.9 | | | | 262.9 | | | | 15.9 | | | | 54.5 | | | | 575.9 | |
| Borrowings (1) | | | 83.2 | | | | 0.6 | | | | 50.0 | | | | 40.0 | | | | - | | | | 173.8 | |
| Other liabilities | | | - | | | | - | | | | - | | | | - | | | | 22.8 | | | | 22.8 | |
| Capital | | | - | | | | - | | | | - | | | | - | | | | 75.9 | | | | 75.9 | |
| Total liabilities & capital | | $ | 151.9 | | | $ | 174.5 | | | $ | 312.9 | | | $ | 55.9 | | | $ | 153.2 | | | $ | 848.4 | |
| Net interest rate GAP | | $ | 49.8 | | | $ | 12.4 | | | $ | 6.6 | | | $ | 20.4 | | | $ | (89.2 | ) | | | | |
| Cumulative interest rate GAP | | $ | 49.8 | | | $ | 62.2 | | | $ | 68.8 | | | $ | 89.2 | | | | | | | | | |
| GAP to total assets | | | 6 | % | | | 1 | % | | | | | | | | | | | | | | | | |
| GAP to total equity | | | 66 | % | | | 16 | % | | | | | | | | | | | | | | | | |
| Cumulative GAP to total assets | | | 6 | % | | | 7 | % | | | | | | | | | | | | | | | | |
| Cumulative GAP to total equity | | | 66 | % | | | 82 | % | | | | | | | | | | | | | | | | |
| (1) | Interest earning assets are included in the period in which the balances are expected to be repaid and/or re-priced as a result of anticipated prepayments, scheduled rate adjustments, and contractual maturities. |
| (2) | Reflects principal maturing within the specified periods for fixed and re-pricing for variable rate loans; includes non-performing loans. |
The method of analysis of interest rate sensitivity in the table above has a number of limitations. Certain assets and liabilities may react differently to changes in interest rates even though they re-price or mature in the same time periods. The interest rates on certain assets and liabilities may change at different times than changes in market interest rates, with some changes in advance of changes in market rates and some lagging behind changes in market rates. Also, certain assets have provisions, which limit changes in interest rates each time the interest rate changes and for the entire term of the loan. Additionally, prepayments and withdrawals experienced in the event of a change in interest rates may deviate significantly from those assumed in the interest rate sensitivity table. Additionally, the ability of some borrowers to service their debt may decrease in the event of an interest rate increase.
Interest Rate Swaps: For asset/liability management purposes, the Company has used interest rate swaps which are agreements between the Company and another party (known as 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 had utilized 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 represent a series of interest flows exchanged over a prescribed period.
As a consequence of the 2008 Lehman Brothers Holdings, Inc. (“Lehman”) bankruptcy filing, the swap agreements and cash flow hedge that existed at the time of the bankruptcy filing were terminated. The Company had an agency mortgage-backed security (approximately $5.0 million) that was pledged as collateral at Lehman for our swap agreements. In October 2008, the Company sued Lehman Brothers Special Financing, Inc. (“LBSF”) to recover possession of its collateral. Because of the uncertainty surrounding the litigation and the Lehman bankruptcy, the Company classified the collateral as other-than-temporarily impaired for the entire amount as of December 31, 2008. In the fourth quarter of 2010, the Company sold its claim and recorded a gain of $1.7 million. The Company did not have any interest rate swaps agreements at December 31, 2011 and 2010.
Capital Adequacy
In connection with a prior bank regulatory examination, the FDIC concluded, based upon its interpretation of the Consolidated Reports of Condition and Income (the “Call Report”) instructions and under regulatory accounting principles (“RAP”), that income from Royal Bank’s tax lien business should be recognized on a cash basis, not an accrual basis. Royal Bank’s current accrual method is in accordance with U.S. GAAP. Royal Bank disagrees with the FDIC’s conclusion and filed the Call Report for December 31, 2011 and the previous five quarters in accordance with U.S. GAAP. The change in the method of revenue recognition for the tax lien business for regulatory accounting purposes affects Royal Bank’s capital ratios as shown below. Royal Bank is in discussions with the FDIC to resolve the matter.
The table below sets forth Royal Bank’s capital ratios under RAP, based on the FDIC’s interpretation of the Call Report instructions:
| | | As of December 31, | |
| | | 2011 | | | 2010 | | | 2009 | |
| Royal Bank | | | | | | | | | |
| Leverage ratio | | | 9.09 | % | | | 8.03 | % | | | 8.09 | % |
| Risk based capital ratio: | | | | | | | | | | | | |
| Tier 1 | | | 13.77 | % | | | 12.49 | % | | | 12.09 | % |
| Total | | | 15.04 | % | | | 13.76 | % | | | 13.37 | % |
The tables below reflect the adjustments to the net loss as well as the capital ratios under U.S. GAAP:
| | | For the year ended | |
| (In thousands) | | December 31, 2011 | |
| RAP net loss | | $ | (15,626 | ) |
| Tax lien adjustment, net of noncontrolling interest | | | 7,738 | |
| U.S. GAAP net loss | | $ | (7,888 | ) |
| | | As reported | | | As adjusted | |
| | | under RAP | | | for U.S. GAAP | |
| Total capital (to risk-weighted assets) | | | 15.04 | % | | | 17.02 | % |
| Tier I capital (to risk-weighted assets) | | | 13.77 | % | | | 15.75 | % |
| Tier I capital (to average assets, leverage) | | | 9.09 | % | | | 10.48 | % |
The tables below reflect the Company’s capital ratios and the Company’s performance ratios:
| | | For the years ended December 31, | |
| | | 2011 | | | 2010 | | | 2009 | |
| Company | | | | | | | | | |
| Leverage ratio | | | 11.64 | % | | | 9.68 | % | | | 9.78 | % |
| Risk based capital ratio: | | | | | | | | | | | | |
| Tier 1 | | | 17.55 | % | | | 15.93 | % | | | 14.18 | % |
| Total | | | 18.82 | % | | | 17.21 | % | | | 15.45 | % |
| Capital performance | | | | | | | | | | | | |
| Return on average assets | | | (0.94 | %) | | | (2.04 | %) | | | (2.57 | %) |
| Return on average equity | | | (10.55 | %) | | | (23.19 | %) | | | (30.94 | %) |
The Company has filed the Consolidated Financial Statements for Bank Holding Companies-FR Y-9C (“FR Y-9C”) for the most recent six quarters consistent with GAAP and the FR Y-9C instructions. In the event that a similar adjustment for RAP purposes would be required by the Federal Reserve on the holding company level, the adjusted ratios are shown in the table below.
| | | For the year ended | |
| (In thousands) | | December 31, 2011 | |
| U.S. GAAP net loss | | $ | (8,563 | ) |
| Tax lien adjustment, net of noncontrolling interest | | | (7,738 | ) |
| RAP net loss | | $ | (16,301 | ) |
| | | As reported | | | As adjusted | |
| | | under US GAAP | | | for RAP | |
| Total capital (to risk-weighted assets) | | | 18.82 | % | | | 16.90 | % |
| Tier I capital (to risk-weighted assets) | | | 17.55 | % | | | 15.63 | % |
| Tier I capital (to average assets, leverage) | | | 11.64 | % | | | 10.29 | % |
The capital ratios set forth above 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 the banking regulators. At December 31, 2011, the Company was required to have minimum Tier 1 and total capital ratios of 4.0% and 8.0%, respectively, and a minimum Tier 1 leverage ratio of 4.0%. At December 31, 2011, the Company met the regulatory minimum capital requirements, and management believes that, under current regulations, the Company will continue to meet its minimum capital requirements in the foreseeable future. As described in “Regulatory Action” under “Item 1 – Business” in this Report, Royal Bank is required to maintain a minimum Tier 1 leverage ratio of 8% and a Total risk-based capital ratio of 12% as part of an informal agreement. Royal Bank met those requirements at December 31, 2011. See “Note 15 – Regulatory Capital Requirements” of the Notes to Consolidated Financial Statements in Item 8 of this Report. Royal Bank met the criteria for a well capitalized institution which is a leverage ratio of 5%, a Tier 1 ratio of 8%, and a total capital ratio of 10%.
On February 20, 2009, as part of the Capital Purchase Program (“CPP”) established by the United States Department of Treasury (“Treasury”), the Company issued to Treasury 30,407 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, without par value per share (the “Series A Preferred Stock”), and a liquidation preference of $1,000 per share. In conjunction with the purchase of the Series A Preferred Stock, Treasury received a warrant to purchase 1,104,370 shares of the Company’s Class A common stock. The aggregate purchase price for the Series A Preferred Stock and Warrant was $30.4 million in cash. The Series A Preferred Stock qualifies as Tier 1 capital and pays cumulative dividends at a rate of 5% per annum for the first five years, and 9% per annum thereafter. The Series A Preferred Stock may generally be redeemed by the Company at any time following consultation with its primary banking regulators. The warrant issued to Treasury has a 10-year term and is immediately exercisable upon its issuance, with an exercise price, subject to anti-dilution adjustments, equal to $4.13 per share of the common stock.
Management Options to Purchase Securities
The 2007 Long-Term Incentive Plan was approved by shareholders at the 2007 Annual Meeting. All employees and non-employee directors of the Company and its designated subsidiaries are eligible participants. The plan includes 1,000,000 shares of Class A common stock (of which 250,000 shares may be issued as restricted stock), subject to customary anti-dilution adjustments, or approximately 9.0% of total outstanding shares of the Class A common stock. As of December 31, 2011, 191,072 shares from this plan have been 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. At December 31, 2011, 116,440 of the options that have been granted are outstanding, of which 84,332 are exercisable. The restricted stock is granted with an estimated fair value equal to the market value of the Company closing stock price on the date of the grant. Restricted stock will vest three years from the grant date, if the Company achieves specific goals set by the Compensation Committee and approved by the Board of Directors. These goals include a three year average return on assets compared to peers, a three year average return on equity compared to peers and a minimum return on both assets and equity over the three year period.
In May 2001, the directors of the Company approved the amended Royal Bancshares of Pennsylvania Non-qualified Stock Option and Appreciation Right Plan (the “Plan”). The shareholders in connection with the formation of the Holding Company re-approved the Plan. The Plan is an incentive program under which Bank officers and other key employees may be awarded additional compensation in the form of options to purchase up to 1,800,000 shares of the Company’s Class A common stock (but not in excess of 19% of outstanding shares). In May 2006, the shareholders approved an increase of the number of shares of Class A Common Stock available for issuance under the Plan by 150,000 to 1,800,000 and extended the plan for an additional year 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. At December 31, 2011, 335,919 of the options that have been granted are outstanding and exercisable. The ability to grant new options under this plan has expired.
In May 2001, the directors of the Company approved an amended non-qualified Outside Directors’ Stock Option Plan. The shareholders in connection with the formation of the Holding Company re-approved this Plan. Under the terms of the 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 is exercisable one year from the grant date. The options are granted at the fair market value at the date of the grant. At December 31, 2011, 68,620 of the options that have been granted are outstanding and exercisable. The ability to grant new options under this plan has expired.
Loans
The Company grants commercial and real estate loans, including construction and land development primarily in the greater Philadelphia metropolitan area as well as selected locations throughout the Mid-Atlantic region. The Company also has participated with other financial institutions in selected construction and land development loans outside these geographic areas. The Company has a concentration of credit risk in commercial real estate, construction and land development loans at December 31, 2011. A substantial portion of its debtors’ ability to honor these contracts is dependent upon the housing sector specifically and the economy in general.
The Company classifies its leases as finance leases, in accordance to FASB ASC Topic 840, “Leases”. The difference between the Company’s gross investment in the lease and the cost or carrying amount of the leased property, if different, is recorded as unearned income, which is amortized to income over the lease term by the interest method.
The Company granted loans to the officers and directors of the Company and to their associates. In accordance with Regulation O related party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than normal risk of collectability. The aggregate dollar amount of these loans was $8.8 million and $3.9 million at December 31, 2011 and 2010. During 2011, three new related party loans totaling $5.8 million were approved and three were paid off. Total payments received on related party loans in 2011 were $915,000.
The following table reflects the composition of the loan portfolio and the percent of gross loans outstanding represented by each category at the dates indicated.
| | | As of December 31, | |
| (Dollars in thousands) | | 2011 | | | 2010 | | | 2009 | | | 2008 | | | 2007 | |
| Commercial and industrial | | $ | 54,136 | | | | 13.0 | % | | $ | 74,027 | | | | 14.9 | % | | $ | 104,063 | | | | 15.1 | % | | $ | 86,278 | | | | 12.3 | % | | $ | 77,856 | | | | 12.1 | % |
| Construction | | | 14,066 | | | | 3.4 | % | | | 29,044 | | | | 5.8 | % | | | 52,196 | | | | 7.6 | % | | | 167,204 | | | | 23.8 | % | | | 92,779 | | | | 14.4 | % |
| Construction and land development - mezzanine | | | - | | | | 0.0 | % | | | - | | | | 0.0 | % | | | - | | | | 0.0 | % | | | 2,421 | | | | 0.3 | % | | | 6,443 | | | | 1.0 | % |
| Land development | | | 40,054 | | | | 9.7 | % | | | 50,594 | | | | 10.2 | % | | | 66,878 | | | | 9.7 | % | | | 74,168 | | | | 10.6 | % | | | 78,874 | | | | 12.2 | % |
| Real Estate - residential | | | 26,637 | | | | 6.4 | % | | | 29,299 | | | | 5.9 | % | | | 48,498 | | | | 7.1 | % | | | 27,480 | | | | 3.9 | % | | | 42,286 | | | | 6.5 | % |
| Real Estate - non-residential | | | 182,579 | | | | 44.0 | % | | | 194,203 | | | | 39.0 | % | | | 277,234 | | | | 40.3 | % | | | 234,573 | | | | 33.4 | % | | | 261,350 | | | | 40.5 | % |
| Real Estate - non-residential - mezzanine | | | - | | | | 0.0 | % | | | - | | | | 0.0 | % | | | - | | | | 0.0 | % | | | 4,111 | | | | 0.6 | % | | | 8,749 | | | | 1.4 | % |
| Real Estate - multi-family | | | 11,622 | | | | 2.8 | % | | | 10,277 | | | | 2.1 | % | | | 22,017 | | | | 3.2 | % | | | 14,059 | | | | 2.0 | % | | | 6,887 | | | | 1.1 | % |
| Real Estate - residential - mezzanine | | | - | | | | 0.0 | % | | | - | | | | 0.0 | % | | | 2,480 | | | | 0.4 | % | | | 335 | | | | 0.0 | % | | | 3,504 | | | | 0.5 | % |
| Tax certificates | | | 48,809 | | | | 11.8 | % | | | 70,443 | | | | 14.2 | % | | | 73,106 | | | | 10.6 | % | | | 64,168 | | | | 9.1 | % | | | 46,090 | | | | 7.1 | % |
| Lease financing | | | 36,014 | | | | 8.7 | % | | | 38,725 | | | | 7.8 | % | | | 39,097 | | | | 5.7 | % | | | 26,123 | | | | 3.7 | % | | | 19,778 | | | | 3.1 | % |
| Other | | | 949 | | | | 0.2 | % | | | 793 | | | | 0.2 | % | | | 2,173 | | | | 0.3 | % | | | 1,243 | | | | 0.2 | % | | | 1,424 | | | | 0.2 | % |
| Total gross loans and leases | | $ | 414,866 | | | | 100 | % | | $ | 497,405 | | | | 100 | % | | $ | 687,742 | | | | 100 | % | | $ | 702,163 | | | | 100 | % | | $ | 646,020 | | | | 100 | % |
| Unearned income | | | (623 | ) | | | | | | | (551 | ) | | | | | | | (878 | ) | | | | | | | (1,441 | ) | | | | | | | (1,545 | ) | | | | |
| | | $ | 414,243 | | | | | | | $ | 496,854 | | | | | | | $ | 686,864 | | | | | | | $ | 700,722 | | | | | | | $ | 644,475 | | | | | |
| Allowance for loan and lease losses | | | (16,380 | ) | | | | | | | (21,129 | ) | | | | | | | (30,331 | ) | | | | | | | (28,908 | ) | | | | | | | (19,282 | ) | | | | |
| Total net loans and leases | | $ | 397,863 | | | | | | | $ | 475,725 | | | | | | | $ | 656,533 | | | | | | | $ | 671,814 | | | | | | | $ | 625,193 | | | | | |
Credit Quality
The following table presents the principal amounts of non-accrual loans held for investment and other real estate:
| | | As of December 31, | |
| (Dollars in thousands) | | 2011 | | | 2010 | | | 2009 | | | 2008 | | | 2007 | |
| Non-accrual loans (1) | | $ | 38,755 | | | $ | 43,162 | | | $ | 73,679 | | | $ | 85,830 | | | $ | 25,401 | |
| Other real estate owned | | | 21,016 | | | | 29,244 | | | | 30,317 | | | | 10,346 | | | | 1,048 | |
| Total non-performing assets | | $ | 59,771 | | | $ | 72,406 | | | $ | 103,996 | | | $ | 96,176 | | | $ | 26,449 | |
| Non-performing assets to total assets | | | 7.04 | % | | | 7.38 | % | | | 8.04 | % | | | 8.18 | % | | | 2.07 | % |
| Non-performing loans to total loans | | | 9.36 | % | | | 8.69 | % | | | 10.73 | % | | | 12.25 | % | | | 3.94 | % |
| Allowance for loan loss to non-accrual loans | | | 42.27 | % | | | 48.95 | % | | | 41.17 | % | | | 33.68 | % | | | 75.91 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Total Loans | | | 414,243 | | | | 496,854 | | | | 686,864 | | | | | | | | | |
| Total Assets | | | 848,449 | | | | 980,626 | | | | 1,292,726 | | | | | | | | | |
| Allowance for loan and lease losses | | | 16,380 | | | | 21,129 | | | | 30,331 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| ALLL / Loans & Leases | | | 3.95 | % | | | 4.25 | % | | | 4.42 | % | | | | | | | | |
| (1) | Generally, a loan is placed in non-accrual 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. |
Non-accrual loan activity for each of the four quarters in 2011 is set forth below:
| | | | | | 1st Quarter Activity | | | | |
| (In thousands) | | Balance at January 1, 2011 | | | Additions | | | Payments and other decreases | | | Charge-offs | | | Transfer to OREO | | | Balance at March 31, 2011 | |
| Non-accrual loans held for investment | | | | | | | | | | | | | | | | |
| Construction and land development | | $ | 19,758 | | | $ | 5,268 | | | $ | (4,321 | ) | | $ | - | | | $ | - | | | $ | 20,705 | |
| Non-residential real estate | | | 10,060 | | | | - | | | | (197 | ) | | | - | | | | - | | | | 9,863 | |
| Commercial & industrial | | | 5,958 | | | | 656 | | | | (1,079 | ) | | | - | | | | - | | | | 5,535 | |
| Residential real estate | | | 2,399 | | | | 350 | | | | (211 | ) | | | - | | | | - | | | | 2,538 | |
| Multi-family | | | 2,453 | | | | - | | | | (38 | ) | | | - | | | | - | | | | 2,415 | |
| Leasing | | | 732 | | | | 115 | | | | - | | | | (176 | ) | | | - | | | | 671 | |
| Tax certificates | | | 1,802 | | | | 1 | | | | (12 | ) | | | (1 | ) | | | - | | | | 1,790 | |
| Total non-accrual LHFI | | $ | 43,162 | | | $ | 6,390 | | | $ | (5,858 | ) | | $ | (177 | ) | | $ | - | | | $ | 43,517 | |
| Non-accrual loans held for sale | | | | | | | | | | | | | | | | | | | |
| Construction and land development | | $ | 13,371 | | | $ | 400 | | | $ | (51 | ) | | $ | - | | | $ | - | | | $ | 13,720 | |
| Non-residential real estate | | | 8,638 | | | | 686 | | | | (4 | ) | | | - | | | | (2,581 | ) | | | 6,739 | |
| Residential real estate | | | 634 | | | | 438 | | | | - | | | | - | | | | - | | | | 1,072 | |
| Multi-family | | | - | | | | 51 | | | | - | | | | - | | | | - | | | | 51 | |
| Total non-accrual LHFS | | $ | 22,643 | | | $ | 1,575 | | | $ | (55 | ) | | $ | - | | | $ | (2,581 | ) | | $ | 21,582 | |
| Total non-accrual loans | | $ | 65,805 | | | $ | 7,965 | | | $ | (5,913 | ) | | $ | (177 | ) | | $ | (2,581 | ) | | $ | 65,099 | |
| | | | | | 2nd Quarter Activity | |
| (In thousands) | | Balance at April 1, 2011 | | | Additions | | | Payments and other decreases | | | Charge-offs/ Impairment* | | | Transfer to OREO | | | Balance at June 30, 2011 | |
| Non-accrual loans held for investment | | | | | | | | | | | | | | | |
| Construction and land development | | $ | 20,705 | | | $ | - | | | $ | (305 | ) | | $ | (3,649 | ) | | $ | (375 | ) | | $ | 16,376 | |
| Non-residential real estate | | | 9,863 | | | | 5,549 | | | | (4,051 | ) | | | (1,685 | ) | | | - | | | | 9,676 | |
| Commercial & industrial | | | 5,535 | | | | 8,694 | | | | (120 | ) | | | (552 | ) | | | - | | | | 13,557 | |
| Residential real estate | | | 2,538 | | | | 110 | | | | (467 | ) | | | (507 | ) | | | (279 | ) | | | 1,395 | |
| Multi-family | | | 2,415 | | | | - | | | | - | | | | (329 | ) | | | (310 | ) | | | 1,776 | |
| Leasing | | | 671 | | | | 269 | | | | - | | | | (133 | ) | | | - | | | | 807 | |
| Tax certificates | | | 1,790 | | | | 41 | | | | (81 | ) | | | (41 | ) | | | - | | | | 1,709 | |
| Total non-accrual LHFI | | $ | 43,517 | | | $ | 14,663 | | | $ | (5,024 | ) | | $ | (6,896 | ) | | $ | (964 | ) | | $ | 45,296 | |
| Non-accrual loans held for sale | | | | | | | | | | | | | | | | | | | |
| Construction and land development | | $ | 13,720 | | | $ | - | | | $ | (814 | ) | | $ | (303 | ) | | $ | - | | | $ | 12,603 | |
| Non-residential real estate | | | 6,739 | | | | - | | | | (2,155 | ) | | | - | | | | - | | | | 4,584 | |
| Residential real estate | | | 1,072 | | | | - | | | | (826 | ) | | | - | | | | - | | | | 246 | |
| Multi-family | | | 51 | | | | - | | | | (51 | ) | | | - | | | | - | | | | - | |
| Total non-accrual LHFS | | $ | 21,582 | | | $ | - | | | $ | (3,846 | ) | | $ | (303 | ) | | $ | - | | | $ | 17,433 | |
| Total non-accrual loans | | $ | 65,099 | | | $ | 14,663 | | | $ | (8,870 | ) | | $ | (7,199 | ) | | $ | (964 | ) | | $ | 62,729 | |
| | | | | | 3rd Quarter Activity | |
| (In thousands) | | Balance at July 1, 2011 | | | Additions | | | Payments and other decreases | | | Charge-offs | | | Transfer to OREO | | | Balance at September 30, 2011 | |
| Non-accrual loans held for investment | | | | | | | | | | | | | | | | |
| Construction and land development | | $ | 16,376 | | | $ | - | | | $ | (2,811 | ) | | $ | (1,471 | ) | | $ | (348 | ) | | $ | 11,746 | |
| Non-residential real estate | | | 9,676 | | | | - | | | | - | | | | - | | | | - | | | | 9,676 | |
| Commercial & industrial | | | 13,557 | | | | 220 | | | | (1,018 | ) | | | (114 | ) | | | - | | | | 12,645 | |
| Residential real estate | | | 1,395 | | | | 81 | | | | - | | | | (43 | ) | | | - | | | | 1,433 | |
| Multi-family | | | 1,776 | | | | - | | | | (59 | ) | | | - | | | | - | | | | 1,717 | |
| Leasing | | | 807 | | | | - | | | | (30 | ) | | | (326 | ) | | | - | | | | 451 | |
| Tax certificates | | | 1,709 | | | | 124 | | | | - | | | | (446 | ) | | | - | | | | 1,387 | |
| Total non-accrual LHFI | | $ | 45,296 | | | $ | 425 | | | $ | (3,918 | ) | | $ | (2,400 | ) | | $ | (348 | ) | | $ | 39,055 | |
| Non-accrual loans held for sale | | | | | | | | | | | | | | | | | | | | |
| Construction and land development | | $ | 12,603 | | | $ | - | | | $ | (410 | ) | | $ | - | | | $ | - | | | $ | 12,193 | |
| Non-residential real estate | | | 4,584 | | | | 3,032 | | | | (929 | ) | | | - | | | | - | | | | 6,687 | |
| Residential real estate | | | 246 | | | | - | | | | (6 | ) | | | - | | | | - | | | | 240 | |
| Total non-accrual LHFS | | $ | 17,433 | | | $ | 3,032 | | | $ | (1,345 | ) | | $ | - | | | $ | - | | | $ | 19,120 | |
| Total non-accrual loans | | $ | 62,729 | | | $ | 3,457 | | | $ | (5,263 | ) | | $ | (2,400 | ) | | $ | (348 | ) | | $ | 58,175 | |
| | | | | | 4th Quarter Activity | |
| (In thousands) | | Balance at October 1, 2011 | | | Additions | | | Payments and other decreases | | | Charge-offs/ Impairment* | | | Transfer to OREO | | | Net transfers between LHFI & LHFS | | | Balance at December 31, 2011 | |
| Non-accrual loans held for investment | | | | | | | | | | | | | | | | | | | |
| Construction and land development | | $ | 11,746 | | | $ | 668 | | | $ | (40 | ) | | $ | (635 | ) | | $ | - | | | $ | 1,275 | | | $ | 13,014 | |
| Non-residential real estate | | | 9,676 | | | | 4,060 | | | | - | | | | - | | | | - | | | | 2,935 | | | | 16,671 | |
| Commercial & industrial | | | 12,645 | | | | 2,578 | | | | (8,268 | ) | | | (2,235 | ) | | | - | | | | - | | | | 4,720 | |
| Residential real estate | | | 1,433 | | | | 19 | | | | (95 | ) | | | (85 | ) | | | (333 | ) | | | 200 | | | | 1,139 | |
| Multi-family | | | 1,717 | | | | - | | | | (14 | ) | | | - | | | | - | | | | - | | | | 1,703 | |
| Leasing | | | 451 | | | | 266 | | | | - | | | | (232 | ) | | | - | | | | - | | | | 485 | |
| Tax certificates | | | 1,387 | | | | 291 | | | | (105 | ) | | | (550 | ) | | | - | | | | - | | | | 1,023 | |
| Total non-accrual LHFI | | $ | 39,055 | | | $ | 7,882 | | | $ | (8,522 | ) | | $ | (3,737 | ) | | $ | (333 | ) | | $ | 4,410 | | | $ | 38,755 | |
| Non-accrual loans held for sale | | | | | | | | | | | | | | | | | | | | | | | |
| Construction and land development | | $ | 12,193 | | | $ | - | | | $ | (1,981 | ) | | $ | (36 | ) | | $ | - | | | $ | (1,275 | ) | | $ | 8,901 | |
| Non-residential real estate | | | 6,687 | | | | - | | | | (97 | ) | | | (21 | ) | | | - | | | | (2,935 | ) | | | 3,634 | |
| Residential real estate | | | 240 | | | | (6 | ) | | | - | | | | - | | | | - | | | | (200 | ) | | | 34 | |
| Total non-accrual LHFS | | $ | 19,120 | | | $ | (6 | ) | | $ | (2,078 | ) | | $ | (57 | ) | | $ | - | | | $ | (4,410 | ) | | $ | 12,569 | |
| Total non-accrual loans | | $ | 58,175 | | | $ | 7,876 | | | $ | (10,600 | ) | | $ | (3,794 | ) | | $ | (333 | ) | | $ | - | | | $ | 51,324 | |
*Charge-offs on LHFI were recorded in the allowance while impairment on LHFS was recorded in other expenses.
Total non-accrual loans at December 31, 2011 were $51.3 million and were comprised of $38.7 million in LHFI and $12.6 million in LHFS. Non-accrual loans were $65.8 million and were comprised of $43.2 million in LHFI and $22.6 million in LHFS at December 31, 2010. The $14.5 million decline in total non-accrual loans was the result of a $30.7 million reduction in existing non-accrual loan balances through payments or loans becoming current and placed back on accrual, $13.6 million in charge-offs and write downs related to impairment analysis and transfers to OREO, and $4.2 million transferred to other real estate owned which collectively were offset by $34.0 million in additions.
The following is a detail listing of the significant additions to non-accrual loans during 2011:
First Quarter 2011 new non-accrual loan:
| | | A $5.3 million participation in a $249.0 million loan to build a 250 unit condo hotel plus 18 condo units in Florida became non-accrual in the first quarter of 2011. The construction has been completed and the property is generating income and is currently being managed primarily as a hotel rather than a condo hotel. However it is insufficient to pay down the debt since the individual units have been equipped with amenities and furnishings found in a condo hotel (similar to a luxury timeshare) but not normally included in hotel rooms. In addition the guarantors claim they do not have sufficient financial standing to support the existing debt level. A current appraisal indicated impairment in accordance with ASC Topic 310. During 2011, the Company recorded total charge-offs through the allowance of $2.0 million. |
Second Quarter 2011 new non-accrual loans:
| | · | An $8.1 million acquisition and development loan that is part of a loan participation to build a timeshare building in Las Vegas, Nevada became non-accrual during the second quarter of 2011. The hotel has been completed with the exception of 21 Penthouse suites which are built to suit once sold. The timeshare units are currently being used as hotel rooms as the ability for the borrower to place the time share receivables in this market is not currently possible. The borrower was also working through credit lines that are fully funded due to the lack of the securitization ability in this economy. The most recent appraisal, which was discounted by Management to reflect current values, did not indicate impairment in accordance with ASC Topic 310. During the fourth quarter the lead lender negotiated the sale of the loan. The Company’s share of the sales proceeds paid the note down to a $0 balance. |
| | · | A $5.5 million commercial real estate loan became non-accrual during the second quarter of 2011 as a result of the borrower’s inability to meet a scheduled principal reduction payment. The loan was to refinance an existing mortgage on and renovations to a 3-story limited service hotel facility with 76 guestrooms located in New Jersey. The most recent appraisal did not indicate an impairment amount in accordance with ASC Topic 310. |
Third Quarter 2011 new non-accrual loan:
| | · | A $3.0 million commercial real estate loan held for sale for the purpose of constructing a golf course and club house in Delaware became non-accrual during the third quarter of 2011. The loan was modified under a troubled debt restructuring and transferred to LHFI. There is collateral in addition to the golf course for the loan. The most recent appraisals did not indicate an impairment amount in accordance with ASC Topic 310. |
Fourth Quarter 2011 new non-accrual loans:
| | · | A $4.1 million commercial real estate loan became non-accrual during the fourth quarter of 2011 as a result of the borrower’s inability to meet a scheduled principal reduction payment. The loan was for the purchase and renovation of two buildings in Philadelphia, Pennsylvania. At least one guarantor does have the financial capacity to support the debt. The most recent appraisals did not indicate an impairment amount in accordance with ASC Topic 310. |
| | · | A $2.5 million commercial loan related to one borrower extending loans to third-party buyers of single family residences in need of rehab work became non-accrual during the fourth quarter of 2011. The loan matured and the borrower was unable to retire the loan. The Company is in the process of taking over management of this portfolio and with the borrower’s assistance is working out the portfolio’s underlying assets. The current independent valuations indicated impairment in accordance with ASC Topic 310. As a result of the impairment analysis, the Company recorded a charge-off through the allowance of $647,000 during the fourth quarter of 2011. |
Impaired Loans
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 Company does not accrue interest income on impaired non-accrual loans. Excess proceeds received over the principal amounts due on impaired non-accrual loans are recognized as income on a cash basis. The Company recognizes income under the accrual 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 following is a summary of information pertaining to impaired loans and leases:
| | | As of December 31, | |
| (In thousands) | | 2011 | | | 2010 | |
| Impaired LHFI with a valuation allowance | | $ | 1,068 | | | $ | 9,620 | |
Impaired LHFI without a valuation allowance (1) | | | 45,009 | | | | 32,805 | |
| Impaired LHFS | | | 12,569 | | | | 22,643 | |
| Total impaired loans and leases | | $ | 58,646 | | | $ | 65,068 | |
| Valuation allowance related to impaired LHFI | | $ | 138 | | | $ | 1,907 | |
| | (1) | The carrying value of the impaired LHFI without a valuation allowance reflects $17.5 million in charge-offs. |
| | | For the years ended December 31, | |
| (In thousands) | | 2011 | | | 2010 | | | 2009 | |
| Average investment in impaired loans and leases | | $ | 62,936 | | | $ | 78,225 | | | $ | 79,754 | |
| Interest income recognized on impaired loans and leases | | $ | 202 | | | $ | 335 | | | $ | 242 | |
| Interest income recognized on a cash basis on impaired loans and leases | | $ | 202 | | | $ | 335 | | | $ | 242 | |
Total cash collected on impaired loans and leases during 2011, 2010, and 2009 was $29.9 million, $21.7 million, and $21.6 million, respectively, of which $29.7 million, $21.4 million, and $21.3 million was credited to the principal balance outstanding on such loans, respectively.
Troubled Debt Restructurings
A loan modification is deemed a troubled debt restructuring (“TDR”) when two conditions are met: 1) the borrower is experiencing financial difficulty and 2) a concession is made by the Company that would not otherwise be considered for a borrower or collateral with similar credit risk characteristics. During the third quarter of 2011, the Company adopted ASU 2011-02, “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring” (“ASU 2011-02”) which amended guidance related to identifying and reporting TDRs. If in modifying a loan the Company, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession it would not normally consider then the loan modification is classified as a TDR. All loans classified as TDRs are considered to be impaired. TDRs are returned to an accrual status when the loan is brought current, has performed in accordance with the contractual restructured terms for a reasonable period of time (generally six months) and the ultimate collectibility of the total contractual restructured principal and interest is no longer in doubt. As required under ASU 2011-02, the Company reassessed all loan modifications that occurred after December 31, 2010 for identification as TDRs. At December 31, 2011, the Company had twelve TDRs, of which seven are on non-accrual status, with a total carrying value of $14.2 million. At the time of the modifications eight of the loans were already classified as impaired loans. The Company had one TDR at December 31, 2010 which was classified as a multi-family real estate non-accrual loan in the amount of $1.8 million. The Company’s policy for TDRs is to recognize income on currently performing restructured loans under the accrual method.
The following table details the Company’s TDRs that are on an accrual status and a non-accrual status at December 31, 2011.
| | | As of December 31, 2011 | |
| (In thousands) | | Number of' loans | | | Accrual Status | | | Non- Accrual Status | | | Total TDRs | |
| Construction and land development | | | 5 | | | $ | 4,354 | | | $ | 1,587 | | | $ | 5,941 | |
| Non-residential real estate | | | 3 | | | | 640 | | | | 2,995 | | | | 3,635 | |
| Commercial & industrial | | | 1 | | | | 2,744 | | | | - | | | | 2,744 | |
| Residential real estate | | | 2 | | | | - | | | | 180 | | | | 180 | |
| Multi-family | | | 1 | | | | - | | | | 1,703 | | | | 1,703 | |
| Total | | | 12 | | | $ | 7,738 | | | $ | 6,465 | | | $ | 14,203 | |
The following table presents newly restructured loans that occurred during the year ended December 31, 2011.
| | | Modifications by type for the year ended December 31, 2011 | |
| (Dollars in thousands) | | Number of loans | | | Rate | | | Term | | | Payment | | | Combination | | | Total | | | Pre-Modification Outstanding Recorded Investment | | | Post-Modification Outstanding Recorded Investment | |
| Construction and land development | | | 5 | | | $ | - | | | $ | 2,374 | | | $ | - | | | $ | 3,567 | | | $ | 5,941 | | | $ | 8,219 | | | $ | 6,693 | |
| Non-residential real estate | | | 3 | | | | - | | | | 2,935 | | | | 60 | | | | 640 | | | | 3,635 | | | | 3,803 | | | | 3,803 | |
| Commercial & industrial | | | 1 | | | | - | | | | - | | | | - | | | | 2,744 | | | | 2,744 | | | | 2,774 | | | | 2,774 | |
| Residential real estate | | | 2 | | | | 139 | | | | - | | | | 41 | | | | - | | | | 180 | | | | 194 | | | | 194 | |
| Total | | | 11 | | | $ | 139 | | | $ | 5,309 | | | $ | 101 | | | $ | 6,951 | | | $ | 12,500 | | | $ | 14,990 | | | $ | 13,464 | |
At December 31, 2011, the Company had two non-residential real estate TDRs with a payment default occurring within 12 months of the restructure date, and the payment default occurring during the three and twelve months ended December 31, 2011. The carrying amount of the TDRs in default was $3.0 million at December 31, 2011.
Potential Problem Loans
Potential problem loans are loans not currently classified as non-performing loans, but for which management has doubts as to the borrowers’ ability to comply with present repayment terms. The loans are usually delinquent more than 30 days but less than 90 days. Potential problem loans amounted to approximately $4.2 million and $20.5 million at December 31, 2011 and December 31, 2010, respectively.
Other Real Estate Owned (“OREO”):
OREO declined $8.2 million from $29.2 million at December 31, 2010 to $21.0 million at December 31, 2011. Set forth below is a table which details the changes in OREO from December 31, 2010 to December 31, 2011.
| | | For the year ended December 31, 2011 | |
| (In thousands) | | First Quarter | | | Second Quarter | | | Third Quarter | | | Fourth Quarter | |
| Beginning balance | | $ | 29,244 | | | $ | 30,681 | | | $ | 25,448 | | | $ | 21,921 | |
| Net proceeds from sales | | | (1,594 | ) | | | (4,320 | ) | | | (3,364 | ) | | | (972 | ) |
| Net gain on sales | | | 394 | | | | 900 | | | | 206 | | | | 138 | |
| Assets acquired on non-accrual loans | | | 3,030 | | | | 1,469 | | | | 1,124 | | | | 818 | |
| Other | | | - | | | | (535 | ) | | | - | | | | - | |
| Impairment charge | | | (393 | ) | | | (2,747 | ) | | | (1,493 | ) | | | (889 | ) |
| Ending balance | | $ | 30,681 | | | $ | 25,448 | | | $ | 21,921 | | | $ | 21,016 | |
During the fourth quarter of 2011, the Company sold collateral related to four loans. The Company received net proceeds of $312,000 and recorded a loss of $61,000 as a result of these sales. Additionally the Company sold six properties acquired through the tax lien portfolio. The Company received proceeds of $660,000 and recorded a net gain of $199,000 as a result of these sales. During the fourth quarter, the Company foreclosed on the collateral for one single-family residential loan and transferred $333,000 to OREO. In addition the Company acquired collateral related to the tax lien portfolio and transferred $485,000 to OREO. During the fourth quarter of 2011, the Company recorded $860,000 in impairment charges on OREO properties that included one apartment building, five single-family homes, nine residential lots, and 13 residential rental properties. The impairment charges were the result of impairment analyses using updated appraisals and current sales. The Company recorded impairment charges of $29,000 related to properties acquired through the tax lien portfolio.
During the third quarter of 2011, the Company sold collateral related to an apartment building in Pennsylvania foreclosed on in the second quarter of 2009. The Company received net proceeds of $2.8 million and recorded a gain of $253,000 as a result of this sale. In addition the Company sold collateral related to four loans. The Company received net proceeds of $284,000 and recorded a loss of $47,000 as a result of these sales. In addition to the sales mentioned above the Company sold six properties acquired through the tax lien portfolio. The Company received proceeds of $246,000 as a result of these sales. During the third quarter of 2011, the Company foreclosed on five residential properties related to two lending relationships. The Company transferred $348,000 to OREO after recording a $74,000 charge-off to the allowance. In addition the Company acquired collateral related to the tax lien portfolio and transferred $776,000 to OREO. During the third quarter of 2011, the Company recorded $1.4 million in impairment charges on five OREO properties as the result of impairment analyses using updated appraisals. The Company recorded impairment charges of $58,000 related to properties acquired through the tax lien portfolio.
During the second quarter of 2011, the Company sold collateral related to three loans. The Company received net proceeds of $3.7 million and recorded a gain of $912,000 as a result of these sales. Also during the second quarter, the collateral for a loan in which the Company was a participant was sold. The Company was entitled to 14.4% of the net sales proceeds. The Company received net proceeds of $424,000 related to the sale with the remaining proceeds of $535,000 held in escrow. In addition to the sales mentioned above the Company sold six properties acquired through the tax lien portfolio. The Company received proceeds of $195,000 and recorded losses of $12,000 as a result of these sales. During the second quarter of 2011, the Company foreclosed on 19 properties which were predominantly residential rental properties related to two lending relationships. The Company transferred $589,000 to OREO after recording an $835,000 charge-off to the allowance, for which $245,000 had previously been reserved, in the allowance in accordance with ASC Topic 310. The collateral for a loan in which the Company participates was acquired by the lead bank. The Company is entitled to 23.2% of the collateral value, which is farmland. The Company transferred $375,000 to OREO after recording a $79,000 charge-off in the allowance in accordance with ASC Topic 310. In addition the Company acquired collateral related to the tax lien portfolio and transferred $505,000 to OREO.
During the second quarter of 2011, the Company entered into a sales agreement on a rental community consisting of 102 dwelling units for which the Company received a deed in lieu of foreclosure in the second quarter of 2010. The Company recorded a $2.2 million impairment charge based on the expected net proceeds of the sale. Additional impairment was recorded on two commercial building lots in Maryland that were transferred to OREO during the third quarter of 2010. After performing an impairment analysis using an updated appraisal on the two lots, the Company recorded a $355,000 impairment charge. The Company recorded impairment charges of $156,000 related to properties acquired through the tax lien portfolio.
During the first quarter of 2011, the Company sold portions of collateral related to two loans. The Company received net proceeds of $620,000 and recorded a net loss of $43,000. As a result of the sales of three single family homes related to one loan, the Company recorded an impairment charge of $100,000 on the remaining collateral. In addition to the sales mentioned above the Company sold five properties acquired through the tax lien portfolio. The Company received proceeds of $974,000 and recorded gains of $437,000 as a result of these sales. During the first quarter of 2011, the Company entered into sales agreements on two properties and recorded impairment charges of $293,000 based on the expected net proceeds. The Company acquired the collateral for one loan held for sale and transferred the fair value of $2.5 million to OREO in the first quarter of 2011. In addition the Company acquired collateral related to the tax lien portfolio and transferred $540,000 to OREO.
The Company is working to satisfactorily sell the remaining OREO properties using existing relationships and possible future auctions. However the Company recognizes that due to the continued weak housing and commercial real estate markets the successful disposition of the properties will likely take considerable time.
Loans and Lease Financing Receivables
The following table summarizes the loan portfolio by loan category and amount that corresponds to the appropriate regulatory definitions.
| | | As of December 31, | |
| (In thousands) | | 2010 | | | 2010 | | | 2009 | |
| Loans secured by real estate: | | | | | | | | | |
| Construction | | $ | 14,066 | | | $ | 29,044 | | | $ | 52,196 | |
| Land development | | | 40,054 | | | | 50,594 | | | | 66,878 | |
| Secured by 1-4 family residential properties: | | | | | | | | | | | | |
| Revolving, open-end loans secured by 1-4 family residential properties and extended under lines of credit | | | 1,165 | | | | 1,252 | | | | 1,272 | |
| All other loans secured by 1-4 family residential properties: | | | | | | | | | | | | |
| Secured by first liens | | | 23,521 | | | | 26,166 | | | | 44,053 | |
| Secured by junior liens | | | 1,951 | | | | 1,881 | | | | 3,173 | |
| Secured by junior liens - mezzaninie | | | - | | | | - | | | | 2,480 | |
| Secured by multi family (5 or more) residential properties | | | 11,622 | | | | 10,277 | | | | 22,017 | |
| Secured by non-farm nonresidential properties | | | 182,579 | | | | 194,203 | | | | 277,234 | |
| Tax certificates | | | 48,809 | | | | 70,443 | | | | 73,106 | |
| Commercial and industrial loans | | | 54,136 | | | | 74,027 | | | | 104,063 | |
| Loans to individuals for household, family, and other personal expenditures | | | 861 | | | | 768 | | | | 1,514 | |
| Lease financing receivables (net of unearned income) | | | 36,014 | | | | 38,725 | | | | 39,097 | |
| All other loans | | | 88 | | | | 25 | | | | 659 | |
| Less: Net deferred loan fees | | | (623 | ) | | | (551 | ) | | | (878 | ) |
| Total loans and leases, net of unearned income | | $ | 414,243 | | | $ | 496,854 | | | $ | 686,864 | |
Credit Classification Process
The loan review function is outsourced to a third party vendor which applies the Company’s loan rating system to specific credits. The Company uses a nine point grading risk classification system commonly used in the financial services industry. The first four classifications are rated Pass. The riskier classifications include Watch, Special Mention, Substandard, Doubtful and Loss. Upon completion of a loan review, a copy of any review receiving an adverse classification by the reviewer is presented to the Loan Review Committee for discussion. Minutes outlining in detail the Committee’s findings and recommendations are issued after each meeting for follow-up by individual loan officers. The Committee is comprised of the voting members of the Officers’ Loan Committee. The CCO is the primary bank officer dealing with the third party vendor during the reviews.
All loans are subject to initial loan review. Additional review is undertaken with respect to loans providing potentially greater exposure. This is accomplished by:
| | · | 100% of construction loans regardless of loan size; |
| | · | 100% of loans/relationships with balances of $1 million or greater; |
| | · | 50% of loans with balances from $500,000 up to $1 million; |
| | · | 25% of loans with balances from $250,000 to $499,999; |
| | · | 5% of loans with balances up to $250,000; and |
| | · | Loans requested specifically by the Company’s management |
Loans on the Company’s Special Assets Committee list are also subject to loan review even though they are receiving the daily attention of an assigned officer and monthly attention of the Special Assets Committee. A watch list is maintained and reviewed at each meeting of the Loan Review Committee. Loans are added to the watch list, even though the loans may be current or less than 30 days delinquent if they exhibit elements of substandard creditworthiness. The watch list contains a statement for each loan as to why it merits special attention, and this list is distributed to the Board of Directors on a monthly basis. Loans may be removed from the watch list if the Loan Review Committee determines that exception items have been resolved or creditworthiness has improved. Additionally, if loans become serious collection matters and are listed on the Company’s monthly delinquent loan or Special Assets Committee lists, they may be removed from the watch list. During the third quarter of 2009, as a result of the level of classified assets within the loan portfolio, the Company established the CCIC Committee (Classified, Charge-off and Impairment Committee) to formalize the process and documentation required to classify, remove from classification, impair or charge-off a loan. The Committee, which is comprised of the President, Vice Chairman, Chief Financial Officer, Chief Credit Officer, Chief Lending Officer and Chief Risk Officer, meets as required and provides regular updated reports to the Board of Directors.
All loans, at the time of presentation to the appropriate loan committee, are given an initial loan “risk” rating by the CCO. From time to time, and at the general direction of any of the various loan committees, the ratings may be changed based on the findings of that committee. Items considered in assigning ratings include the financial strength of the borrower and/or guarantors, the type of collateral, the collateral lien position, the type of loan and loan structure, any potential risk inherent in the specific loan type, higher than normal monitoring of the loan or any other factor deemed appropriate by any of the various committees for changing the rating of the loan. Any such change in rating is reflected in the minutes of that committee.
Investment Securities
The following tables present the consolidated amortized cost and approximate fair value at December 31, 2011, 2010 and 2009, respectively, for each major category of the Company’s AFS investment securities portfolio.
| As of December 31, 2011 | | | | | Included in Accumulated Other Comprehensive Income (AOCI) | | | | |
| | | | | | | | | Gross unrealized losses | | | | |
| (In thousands) | | Amortized cost | | | Gross unrealized gains | | | Non-OTTI in AOCI | | | Non-credit related OTTI in AOCI | | | Fair value | |
| Investment securities available-for-sale | | | | | | | | | | | | | | | |
| Mortgage-backed securities-residential | | $ | 16,763 | | | $ | 309 | | | $ | (67 | ) | | $ | - | | | $ | 17,005 | |
| U.S. government agencies | | | 35,966 | | | | 122 | | | | (4 | ) | | | - | | | | 36,084 | |
| Common stocks | | | 130 | | | | 118 | | | | - | | | | - | | | | 248 | |
| Collateralized mortgage obligations: | | | | | | | | | | | | | | | | | | | | |
| Issued or guaranteed by U.S. government agencies | | | 231,262 | | | | 3,315 | | | | (543 | ) | | | - | | | | 234,034 | |
| Non-agency | | | 4,739 | | | | 94 | | | | (1 | ) | | | - | | | | 4,832 | |
| Corporate bonds | | | 13,342 | | | | 104 | | | | (471 | ) | | | - | | | | 12,975 | |
| Municipal bonds | | | 985 | | | | - | | | | (20 | ) | | | - | | | | 965 | |
| Trust preferred securities | | | 13,665 | | | | 2,280 | | | | - | | | | - | | | | 15,945 | |
| Other securities | | | 6,586 | | | | 347 | | | | (15 | ) | | | - | | | | 6,918 | |
| Total available-for-sale investment securities | | $ | 323,438 | | | $ | 6,689 | | | $ | (1,121 | ) | | $ | - | | | $ | 329,006 | |
| As of December 31, 2010 | | | | | Included in Accumulated Other Comprehensive Income (AOCI) | | | | |
| | | | | | | | | Gross Unrealized Losses | | | | |
| (In thousands) | | Amortized cost | | | Gross unrealized gains | | | Non-OTTI in AOCI | | | Non-credit related OTTI in AOCI | | | Fair value | |
| Investment securities available-for-sale | | | | | | | | | | | | | | | |
| Mortgage-backed securities-residential | | $ | 8,492 | | | $ | 348 | | | $ | - | | | $ | - | | | $ | 8,840 | |
| U.S. government agencies | | | 30,492 | | | | - | | | | (755 | ) | | | - | | | | 29,737 | |
| Common stocks | | | 381 | | | | 152 | | | | (50 | ) | | | - | | | | 483 | |
| Collateralized mortgage obligations: | | | | | | | | | | | | | | | | | | | | |
| Issued or guaranteed by U.S. government agencies | | | 231,717 | | | | 3,640 | | | | (704 | ) | | | - | | | | 234,653 | |
| Non-agency | | | 7,026 | | | | 114 | | | | (3 | ) | | | - | | | | 7,137 | |
| Corporate bonds | | | 9,483 | | | | - | | | | (197 | ) | | | - | | | | 9,286 | |
| Trust preferred securities | | | 16,566 | | | | 2,135 | | | | - | | | | (87 | ) | | | 18,614 | |
| Other securities | | | 6,436 | | | | 431 | | | | - | | | | - | | | | 6,867 | |
| Total available-for-sale investment securities | | $ | 310,593 | | | $ | 6,820 | | | $ | (1,709 | ) | | $ | (87 | ) | | $ | 315,617 | |
| As of December 31, 2009 | | | | | Included in Accumulated Other Comprehensive Loss (AOCL) | | | | |
| | | | | | | | | Gross Unrealized Losses | | | | |
| (In thousands) | | Amortized cost | | | Gross unrealized gains | | | Non-OTTI in AOCL | | | Non-credit related OTTI in AOCL | | | Fair value | |
| Investment securities available-for-sale | | | | | | | | | | | | | | | |
| Mortgage-backed securities-residential | | $ | 21,393 | | | $ | 234 | | | $ | (26 | ) | | $ | - | | | $ | 21,601 | |
| U.S. government agencies | | | 1,150 | | | | 3 | | | | (2 | ) | | | - | | | | 1,151 | |
| Preferred stocks | | | 2,500 | | | | - | | | | (270 | ) | | | - | | | | 2,230 | |
| Common stocks | | | 381 | | | | 71 | | | | (8 | ) | | | - | | | | 444 | |
| Collateralized mortgage obligations: | | | | | | | | | | | | | | | | | | | | |
| Issued or guaranteed by U.S. government agencies | | | 316,911 | | | | 2,871 | | | | (1,281 | ) | | | - | | | | 318,501 | |
| Non-agency | | | 23,010 | | | | 145 | | | | (875 | ) | | | (1,082 | ) | | | 21,198 | |
| Collateralized debt obligations | | | 24,825 | | | | - | | | | - | | | | - | | | | 24,825 | |
| Corporate bonds | | | 7,911 | | | | 9 | | | | (423 | ) | | | (630 | ) | | | 6,867 | |
| Trust preferred securities | | | 32,926 | | | | 2,064 | | | | (177 | ) | | | (678 | ) | | | 34,135 | |
| Other securities | | | 6,354 | | | | 8 | | | | (133 | ) | | | - | | | | 6,229 | |
| Total available-for-sale investment securities | | $ | 437,361 | | | $ | 5,405 | | | $ | (3,195 | ) | | $ | (2,390 | ) | | $ | 437,181 | |
The contractual maturity distribution and weighted average rate of the Company’s AFS debt securities at December 31, 2011 are presented in the following table. Mortgage-backed securities and collateralized mortgage obligations are presented within the category that represents the total weighted average expected maturity.
| | | As of December 31, 2011 | |
| | | | | | | | | After one year, but | | | After five years, but | | | | | | | | | | |
| | | Within one year | | | within five years | | | within ten years | | | After ten years | | | Total | |
| (In thousands, except percentages) | | Amount | | | Rate | | | Amount | | | Rate | | | Amount | | | Rate | | | Amount | | | Rate | | | Amount | | | Rate | |
| Mortgage-backed securities-residential | | $ | - | | | | - | | | $ | 16,990 | | | | 3.94 | % | | $ | 15 | | | | 2.32 | % | | $ | - | | | | - | | | $ | 17,005 | | | | 3.94 | % |
| U.S. government agencies | | | 5,003 | | | | 2.25 | % | | | 4,049 | | | | 1.25 | % | | | 4,008 | | | | 2.00 | % | | | 23,024 | | | | 2.09 | % | | | 36,084 | | | | 2.01 | % |
| Collateralized mortgage obligations: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Issued or guaranteed by U.S. government agencies | | | 10,314 | | | | 5.39 | % | | | 223,720 | | | | 4.22 | % | | | - | | | | - | | | | - | | | | - | | | | 234,034 | | | | 4.27 | % |
| Non-agency | | | - | | | | - | | | | 3,658 | | | | 5.45 | % | | | 1,174 | | | | 0.71 | % | | | - | | | | - | | | | 4,832 | | | | 4.29 | % |
| Corporate bonds | | | - | | | | - | | | | 7,495 | | | | 2.42 | % | | | 2,613 | | | | 2.77 | % | | | 2,867 | | | | 4.33 | % | | | 12,975 | | | | 2.95 | % |
| Municipal bonds | | | - | | | | - | | | | - | | | | - | | | | 965 | | | | 7.00 | % | | | - | | | | - | | | | 965 | | | | 7.00 | % |
| Trust preferred securities | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | 15,945 | | | | 10.35 | % | | | 15,945 | | | | 10.35 | % |
| Total AFS debt securities | | $ | 15,317 | | | | 4.36 | % | | $ | 255,912 | | | | 4.12 | % | | $ | 8,775 | | | | 2.63 | % | | $ | 41,836 | | | | 5.11 | % | | $ | 321,840 | | | | 4.21 | % |
The Company assesses whether OTTI is present when the fair value of a security is less than its amortized cost. All investment securities are evaluated for OTTI under FASB ASC Topic 320, “Investments-Debt & Equity Securities” (“ASC Topic 320”). The non-agency collateralized mortgage obligations that are rated below AA are evaluated under FASB ASC Topic 320 Subtopic 40, “Beneficial Interests in Securitized Financial Assets” under FASB ASC Topic 325, “Investments-Other”. In determining whether OTTI exists, management considers numerous factors, including but not limited to: (1) the length of time and the extent to which the fair value is less than the amortized cost, (2) the Company’s intent to hold or sell the security, (3) the financial condition and results of the issuer including changes in capital, (4) the credit rating of the issuer, (5) analysts earnings estimate, (6) industry trends specific to the security, and (7) timing of debt maturity and status of debt payments. If the Company intends to sell a security or will be required to sell a security, the OTTI is recognized in earnings equal to the entire difference between the fair value and the amortized cost basis at the balance sheet date. If the Company does not intend to sell a security and it is not more likely than not that the entity will be required to sell a security before the recovery of its amortized cost basis, the OTTI is separated into two amounts, the credit related loss and the loss related to other factors. The credit related loss is based on the present value of the expected cash flows and is recognized in earnings. The noncredit-related loss is based on other factors such as illiquidity and is recognized in other comprehensive income.
At December 31, 2011 investment securities were $329.0 million with a net unrealized gain of $5.6 million compared to $315.6 million with a net unrealized gain of $5.0 million at December 31, 2010. The improvement in gross unrealized losses of $675,000 is related to the overall improvement in the fair values of the securities in the Company’s investment portfolio offset by $1.8 million in impairment charges, which includes $1.7 million on one trust preferred security. Refer to “Note 3- Investment Securities” to the Consolidated Financial Statements in Item 8 for more information.
Deposits
The average balance of the Company’s deposits by major classifications for each of the last three years is presented in the following table.
| | | As of December 31, | |
| | | 2011 | | | 2010 | | | 2009 | |
| (In thousands, except percentages) | | Average Balance | | | Rate | | | Average Balance | | | Rate | | | Average Balance | | | Rate | |
| Demand deposits | | | | | | | | | | | | | | | | | | |
| Non interest bearing | | $ | 57,241 | | | | - | | | $ | 62,474 | | | | - | | | $ | 62,546 | | | | - | |
| Interest bearing (NOW) | | | 42,488 | | | | 0.56 | % | | | 42,990 | | | | 0.92 | % | | | 46,046 | | | | 1.04 | % |
| Money market deposits | | | 178,670 | | | | 0.96 | % | | | 166,386 | | | | 1.05 | % | | | 153,146 | | | | 1.83 | % |
| Savings deposits | | | 15,727 | | | | 0.55 | % | | | 15,959 | | | | 0.56 | % | | | 14,802 | | | | 0.56 | % |
| Certificate of deposit | | | 327,583 | | | | 2.11 | % | | | 503,217 | | | | 2.92 | % | | | 581,202 | | | | 3.78 | % |
| Total deposits | | $ | 621,709 | | | | | | | $ | 791,026 | | | | | | | $ | 857,742 | | | | | |
The remaining maturity of Certificates of Deposit of $100,000 or greater:
| | | As of December 31, | |
| (In thousands) | | 2011 | | | 2010 | |
| Three months or less | | $ | 13,298 | | | $ | 9,483 | |
| Over three months through twelve months | | | 29,477 | | | | 52,969 | |
| Over twelve months through five years | | | 46,332 | | | | 38,265 | |
| Over five years | | | 6,227 | | | | 5,071 | |
| Total | | $ | 95,334 | | | $ | 105,788 | |
Short and Long Term Borrowings
| | | As of December 31, | |
| (In thousands) | | 2011 | | | 2010 | | | 2009 | | | 2008 | | | 2007 | |
| Short term borrowings | | $ | 54,218 | | | $ | 22,000 | | | $ | 114,500 | | | $ | 37,000 | | | $ | 102,000 | |
| Long term borrowings | | | | | | | | | | | | | | | | | | | | |
| Other borrowings | | | 43,782 | | | | 44,230 | | | | 44,674 | | | | 45,112 | | | | 5,411 | |
| Obligations through RE owned via equity invest(1) | | | - | | | | - | | | | 3,652 | | | | 12,350 | | | | 18,566 | |
| Subordinated debt | | | 25,774 | | | | 25,774 | | | | 25,774 | | | | 25,774 | | | | 25,774 | |
| FHLB advances | | | 50,000 | | | | 88,719 | | | | 95,001 | | | | 193,569 | | | | 187,500 | |
| Total borrowings | | $ | 173,774 | | | $ | 180,723 | | | $ | 283,601 | | | $ | 313,805 | | | $ | 339,251 | |
| (1) | This obligation is consolidated from requirements under ASC Topic 810 of which $0 was guaranteed by the Company. |
At December 31, 2011 advances totaling $32.2 million were reclassified from FHLB advances to short term borrowings due to their final maturity date in 2012.
| ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK |
A simulation model is used to estimate the impact of various changes, both upward and downward, in market interest rates and volumes of assets and liabilities on the net income. This model produces an interest rate exposure report that forecast changes in the market value of portfolio equity under alternative interest rate environment. The market value of portfolio is defined as the present value of existing assets and liabilities. The calculated estimates of changes in the market value of portfolio value for Royal Bank are as follows:
| (In thousands, except percentages) | | As of December 31, 2011 | |
| Changes in Rates | | Market Value of Portfolio Equity | | | Percent of Change | | | Policy Limits | |
| + 400 basis points | | $ | 53,198 | | | | (34.5 | %) | | | +/- 45 | % |
| + 300 basis points | | | 65,016 | | | | (20.0 | %) | | | +/- 35 | % |
| + 200 basis points | | | 77,412 | | | | (4.7 | %) | | | +/- 25 | % |
| + 100 basis points | | | 83,602 | | | | 2.9 | % | | | +/- 15 | % |
| Flat rate | | | 81,225 | | | | 0.0 | % | | | N/A | |
| - 100 basis points | | | 76,018 | | | | (6.4 | %) | | | +/- 15 | % |
| - 200 basis points | | | 69,593 | | | | (14.3 | %) | | | +/- 25 | % |
The assumptions used in evaluating the vulnerability of earnings and capital to changes in interest rates are based on management’s considerations of past experience, current position and anticipated future economic conditions. The interest rate sensitivity of assets and liabilities as well as the estimated effect of changes in interest rates on the market value of portfolio equity could vary substantially if different assumptions are used or actual experience differs from what the calculations may be based.
| ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders
Royal Bancshares of Pennsylvania, Inc.
We have audited the accompanying consolidated balance sheets of Royal Bancshares of Pennsylvania, Inc. and subsidiaries as of December 31, 2011 and 2010, and the related consolidated statements of operations, changes in shareholders’ equity and comprehensive loss, and cash flows for each of the years in the three-year period ended December 31, 2011. These financial statements are the responsibility of Royal Bancshares of Pennsylvania, Inc.’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Royal Bancshares of Pennsylvania, Inc. and subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America.
/s/ ParenteBeard LLC
ParenteBeard LLC
Philadelphia, Pennsylvania
March 30, 2012
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
| | | December 31, | |
| ASSETS | | 2011 | | | 2010 | |
| | | (In thousands, except share data) | |
| Cash and due from banks | | $ | 10,128 | | | $ | 26,811 | |
| Interest bearing deposits | | | 14,378 | | | | 24,922 | |
| Total cash and cash equivalents | | | 24,506 | | | | 51,733 | |
| Investment securities available-for-sale ("AFS”), at fair value | | | 329,006 | | | | 315,617 | |
| Other investment, at cost | | | 1,538 | | | | 1,538 | |
| Federal Home Loan Bank ("FHLB") stock, at cost | | | 8,474 | | | | 10,405 | |
| Loans and leases held for sale, at lower of cost or fair market value | | | 12,569 | | | | 29,621 | |
| Loans and leases | | | 414,243 | | | | 496,854 | |
| Less allowance for loan and lease losses | | | 16,380 | | | | 21,129 | |
| Net loans and leases | | | 397,863 | | | | 475,725 | |
| Bank owned life insurance | | | 14,032 | | | | 8,642 | |
| Real estate owned via equity investment | | | - | | | | 6,794 | |
| Accrued interest receivable | | | 15,463 | | | | 16,864 | |
| Other real estate owned ("OREO"), net | | | 21,016 | | | | 29,244 | |
| Premises and equipment, net | | | 5,394 | | | | 5,735 | |
| Other assets | | | 18,587 | | | | 28,708 | |
| Total assets | | $ | 848,448 | | | $ | 980,626 | |
| LIABILITIES AND SHAREHOLDERS’ EQUITY | | | | | | | | |
| Liabilities | | | | | | | | |
| Deposits | | | | | | | | |
| Non-interest bearing | | $ | 54,534 | | | $ | 52,872 | |
| Interest bearing | | | 521,382 | | | | 641,041 | |
| Total deposits | | | 575,916 | | | | 693,913 | |
| Accrued interest payable | | | 3,450 | | | | 3,983 | |
| Short-term borrowings | | | 54,218 | | | | 22,000 | |
| Long-term borrowings | | | 93,782 | | | | 132,949 | |
| Subordinated debentures | | | 25,774 | | | | 25,774 | |
| Other liabilities | | | 19,363 | | | | 17,914 | |
| Total liabilities | | | 772,503 | | | | 896,533 | |
| Shareholders’ equity | | | | | | | | |
| Royal Bancshares of Pennsylvania, Inc. equity: | | | | | | | | |
| Preferred stock, Series A perpetual, $1,000 liquidation value, 500,000 shares authorized, 30,407 shares issued and outstanding at December 31, 2011 and 2010 | | | 28,878 | | | | 28,395 | |
| Class A common stock, par value $2.00 per share, authorized 18,000,000 shares; issued, 11,361,580 and 11,355,466 at December 31, 2011 and December 31, 2010, respectively | | | 22,723 | | | | 22,711 | |
| Class B common stock, par value $0.10 per share; authorized 3,000,000 shares; issued, 2,081,371 and 2,086,689 at December 31, 2011 and December 31, 2010, respectively | | | 208 | | | | 209 | |
| Additional paid in capital | | | 126,245 | | | | 126,152 | |
| Accumulated deficit | | | (100,803 | ) | | | (91,746 | ) |
| Accumulated other comprehensive income | | | 800 | | | | 1,942 | |
| Treasury stock - at cost, shares of Class A, 498,488 at December 31, 2011 and 2010 | | | (6,971 | ) | | | (6,971 | ) |
| Total Royal Bancshares of Pennsylvania, Inc. shareholders’ equity | | | 71,080 | | | | 80,692 | |
| Noncontrolling interest | | | 4,865 | | | | 3,401 | |
| Total shareholders’ equity | | | 75,945 | | | | 84,093 | |
| Total liabilities and shareholders’ equity | | $ | 848,448 | | | $ | 980,626 | |
The accompanying notes are an integral part of these consolidated financial statements.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
| | | For the years ended December 31, | |
| | | 2011 | | | 2010 | | | 2009 | |
| | | (In thousands, except per share data) | |
| Interest income | | | | | | | | | |
| Loans and leases, including fees | | $ | 29,651 | | | $ | 42,643 | | | $ | 45,757 | |
| Investment securities available for sale: | | | | | | | | | | | | |
| Taxable interest | | | 9,645 | | | | 14,464 | | | | 20,102 | |
| Tax exempt interest | | | - | | | | - | | | | 19 | |
| Deposits in banks | | | 78 | | | | 154 | | | | 164 | |
| Federal funds sold | | | 3 | | | | 1 | | | | 1 | |
| Total Interest Income | | | 39,377 | | | | 57,262 | | | | 66,043 | |
| Interest expense | | | | | | | | | | | | |
| Deposits | | | 8,950 | | | | 16,922 | | | | 25,342 | |
| Short-term borrowings | | | 149 | | | | 3,835 | | | | 169 | |
| Long-term borrowings | | | 4,987 | | | | 5,215 | | | | 11,685 | |
| Obligations related to real estate owned via equity investments | | | - | | | | 22 | | | | 243 | |
| Total Interest Expense | | | 14,086 | | | | 25,994 | | | | 37,439 | |
| Net Interest Income | | | 25,291 | | | | 31,268 | | | | 28,604 | |
| Provision for loan and lease losses | | | 7,728 | | | | 22,140 | | | | 20,605 | |
| Net Interest Income after Provision for Loan and Lease Losses | | | 17,563 | | | | 9,128 | | | | 7,999 | |
| Other income (loss) | | | | | | | | | | | | |
| Net gains on the sale of AFS investment securities | | | 1,782 | | | | 1,290 | | | | 1,892 | |
| Income from real estate joint ventures | | | 1,750 | | | | - | | | | - | |
| Net gains on sales of other real estate owned | | | 1,638 | | | | 1,019 | | | | 294 | |
| Service charges and fees | | | 1,128 | | | | 1,266 | | | | 1,419 | |
| Income from bank owned life insurance | | | 391 | | | | 379 | | | | 1,099 | |
| Gains on sales of loans and leases | | | 337 | | | | 666 | | | | 914 | |
| Income related to real estate owned via equity investments | | | 478 | | | | 564 | | | | 1,302 | |
| Gain on sale of security claim | | | - | | | | 1,656 | | | | - | |
| Gains on sale of premises and equipment related to real estate owned via equity investments | | | - | | | | 667 | | | | 1,817 | |
| Other income | | | 1,110 | | | | 737 | | | | 578 | |
| Total other-than-temporary impairment losses on investment securities | | | (1,796 | ) | | | (566 | ) | | | (13,431 | ) |
| Less portion of loss recognized in other comprehensive loss | | | - | | | | (87 | ) | | | (2,390 | ) |
| Net impairment losses recognized in earnings | | | (1,796 | ) | | | (479 | ) | | | (11,041 | ) |
| Total Other Income (Loss) | | | 6,818 | | | | 7,765 | | | | (1,726 | ) |
| Other expenses | | | | | | | | | | | | |
| Employee salaries and benefits | | | 10,920 | | | | 11,591 | | | | 12,235 | |
| OREO impairment charge | | | 5,522 | | | | 7,374 | | | | 4,537 | |
| Professional and legal fees | | | 4,137 | | | | 4,237 | | | | 4,367 | |
| OREO and loan collection expenses | | | 2,625 | | | | 2,536 | | | | 3,218 | |
| Occupancy and equipment | | | 2,328 | | | | 3,216 | | | | 3,381 | |
| FDIC and state assessments | | | 1,990 | | | | 3,047 | | | | 3,801 | |
| Pennsylvania shares tax | | | 1,123 | | | | 1,320 | | | | 1,299 | |
| Impairment of loans held for sale | | | 340 | | | | - | | | | - | |
| Directors fees | | | 339 | | | | 355 | | | | 676 | |
| Stock option expense | | | 93 | | | | 35 | | | | 226 | |
| Impairment related to real estate owned via equity investments | | | - | | | | 2,600 | | | | - | |
| Impairment of real estate joint ventures | | | - | | | | 1,552 | | | | - | |
| Expenses related to real estate owned via equity investments | | | - | | | | 529 | | | | 907 | |
| Other operating expenses | | | 2,652 | | | | 2,351 | | | | 3,009 | |
| Total Other Expenses | | | 32,069 | | | | 40,743 | | | | 37,656 | |
| Loss Before Income Taxes | | | (7,688 | ) | | | (23,850 | ) | | | (31,383 | ) |
| Income tax expense | | | - | | | | - | | | | 474 | |
| Net Loss | | $ | (7,688 | ) | | $ | (23,850 | ) | | $ | (31,857 | ) |
| Less net income attributable to noncontrolling interest | | | 875 | | | | 243 | | | | 1,402 | |
| Net Loss Attributable to Royal Bancshares of Pennsylvania, Inc. | | $ | (8,563 | ) | | $ | (24,093 | ) | | $ | (33,259 | ) |
| Less Preferred stock Series A accumulated dividend and accretion | | $ | 2,003 | | | $ | 1,970 | | | $ | 1,672 | |
| Net Loss to Common Shareholders | | $ | (10,566 | ) | | $ | (26,063 | ) | | $ | (34,931 | ) |
| Per common share data | | | | | | | | | | | | |
| Net loss per share – basic and diluted | | $ | (0.80 | ) | | $ | (1.97 | ) | | $ | (2.64 | ) |
The accompanying notes are an integral part of these consolidated financial statements.
ROYAL BANCSHARES OF PENNSYLVANIA INC. AND SUBSIDIARIES
Consolidated Statement of Changes in Shareholders' Equity and Comprehensive Loss
For the year ended December 31, 2011
| | | Preferred stock | | | Class A common stock | | | Class B common stock | | | Additional paid in | | | Accumulated | | | Accumulated other comprehensive | | | Treasury | | | Noncontrolling | | | Total Shareholders' | |
| (In thousands, except preferred share data) | | Series A | | | Shares | | | Amount | | | Shares | | | Amount | | | capital | | | deficit | | | income | | | stock | | | Interest | | | Equity | |
| Balance January 1, 2011 | | $ | 28,395 | | | | 11,355 | | | $ | 22,711 | | | | 2,087 | | | $ | 209 | | | $ | 126,152 | | | $ | (91,746 | ) | | $ | 1,942 | | | $ | (6,971 | ) | | $ | 3,401 | | | $ | 84,093 | |
| Comprehensive loss | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net (loss) income | | | | | | | | | | | | | | | | | | | | | | | | | | | (8,563 | ) | | | | | | | | | | | 875 | | | | (7,688 | ) |
| Transfer of noncontrolling interest related to Variable Interest Entity | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 589 | | | | 589 | |
| Other comprehensive loss, net of reclassifications and taxes | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | (1,142 | ) | | | | | | | | | | | (1,142 | ) |
| Total comprehensive loss | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | $ | (8,241 | ) |
| Common stock conversion from Class B to Class A | | | | | | | 7 | | | | 12 | | | | (6 | ) | | | (1 | ) | | | | | | | (11 | ) | | | | | | | | | | | | | | | - | |
| Accretion of discount on preferred stock | | | 483 | | | | | | | | | | | | | | | | | | | | | | | | (483 | ) | | | | | | | | | | | | | | | - | |
| Stock option expense | | | | | | | | | | | | | | | | | | | | | | | 93 | | | | | | | | | | | | | | | | | | | | 93 | |
| Balance December 31, 2011 | | $ | 28,878 | | | | 11,362 | | | $ | 22,723 | | | | 2,081 | | | $ | 208 | | | $ | 126,245 | | | $ | (100,803 | ) | | $ | 800 | | | $ | (6,971 | ) | | $ | 4,865 | | | $ | 75,945 | |
The accompanying notes are an integral part of these consolidated financial statements.
ROYAL BANCSHARES OF PENNSYLVANIA INC. AND SUBSIDIARIES
Consolidated Statement of Changes in Shareholders' Equity and Comprehensive Loss
For the year ended December 31, 2010
| | | Preferred stock | | | Class A common stock | | | Class B common stock | | | Additional paid in | | | Accumulated | | | Accumulated other comprehensive | | | Treasury | | | Noncontrolling | | | Total Shareholders' | |
| (In thousands, except preferred share data) | | Series A | | | Shares | | | Amount | | | Shares | | | Amount | | | capital | | | deficit | | | income | | | stock | | | Interest | | | Equity | |
| Balance January 1, 2010 | | $ | 27,945 | | | | 11,352 | | | $ | 22,705 | | | | 2,089 | | | $ | 209 | | | $ | 126,117 | | | $ | (67,197 | ) | | $ | (1,652 | ) | | $ | (6,971 | ) | | $ | 3,158 | | | $ | 104,314 | |
| Comprehensive loss | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net (loss) income | | | | | | | | | | | | | | | | | | | | | | | | | | | (24,093 | ) | | | | | | | | | | | 243 | | | | (23,850 | ) |
| Other comprehensive income, net of reclassifications and taxes | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 3,594 | | | | | | | | | | | | 3,594 | |
| Total comprehensive loss | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | $ | (20,256 | ) |
| Common stock conversion from Class B to Class A | | | | | | | 3 | | | | 6 | | | | (2 | ) | | | - | | | | | | | | (6 | ) | | | | | | | | | | | | | | | - | |
| Accretion of discount on preferred stock | | | 450 | | | | | | | | | | | | | | | | | | | | | | | | (450 | ) | | | | | | | | | | | | | | | - | |
| Stock option expense | | | | | | | | | | | | | | | | | | | | | | | 35 | | | | | | | | | | | | | | | | | | | | 35 | |
| Balance December 31, 2010 | | $ | 28,395 | | | | 11,355 | | | $ | 22,711 | | | | 2,087 | | | $ | 209 | | | $ | 126,152 | | | $ | (91,746 | ) | | $ | 1,942 | | | $ | (6,971 | ) | | $ | 3,401 | | | $ | 84,093 | |
The accompanying notes are an integral part of these consolidated financial statements.
ROYAL BANCSHARES OF PENNSYLVANIA INC. AND SUBSIDIARIES
Consolidated Statement of Changes in Shareholders' Equity and Comprehensive Loss
For the year ended December 31, 2009
| | | Preferred stock | | | Class A common stock | | | Class B common stock | | | Additional paid in | | | Accumulated | | | Accumulated other comprehensive | | | Treasury | | | Noncontrolling | | | Total Shareholders' | |
| (In thousands, except preferred share data) | | Series A | | | Shares | | | Amount | | | Shares | | | Amount | | | capital | | | deficit | | | loss | | | stock | | | Interest | | | Equity | |
| Balance January 1, 2009 | | $ | - | | | | 11,345 | | | $ | 22,690 | | | | 2,096 | | | $ | 210 | | | $ | 123,425 | | | $ | (33,561 | ) | | $ | (26,106 | ) | | $ | (6,971 | ) | | $ | 1,898 | | | $ | 81,585 | |
| Comprehensive loss | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net (loss) income | | | | | | | | | | | | | | | | | | | | | | | | | | | (33,259 | ) | | | | | | | | | | | 1,402 | | | | (31,857 | ) |
| Transfer of noncontrolling interest related to RBA Capital | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | (142 | ) | | | (142 | ) |
| Other comprehensive income, net of reclassifications and taxes | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 24,454 | | | | | | | | | | | | 24,454 | |
| Total comprehensive loss | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | $ | (7,545 | ) |
| Common stock conversion from Class B to Class A | | | | | | | 7 | | | | 15 | | | | (7 | ) | | | (1 | ) | | | | | | | (14 | ) | | | | | | | | | | | | | | | - | |
| Dividends paid on preferred stock | | | | | | | | | | | | | | | | | | | | | | | (359 | ) | | | | | | | | | | | | | | | | | | | (359 | ) |
| Issuance of Series A perpetual preferred stock (30,407 shares) and warrants to purchase common stock (1,140,307 shares) | | | 27,582 | | | | | | | | | | | | | | | | | | | | 2,825 | | | | | | | | | | | | | | | | | | | | 30,407 | |
| Accretion of discount on preferred stock | | | 363 | | | | | | | | | | | | | | | | | | | | | | | | (363 | ) | | | | | | | | | | | | | | | - | |
| Stock option expense | | | | | | | | | | | | | | | | | | | | | | | 226 | | | | | | | | | | | | | | | | | | | | 226 | |
| Balance December 31, 2009 | | $ | 27,945 | | | | 11,352 | | | $ | 22,705 | | | | 2,089 | | | $ | 209 | | | $ | 126,117 | | | $ | (67,197 | ) | | $ | (1,652 | ) | | $ | (6,971 | ) | | $ | 3,158 | | | $ | 104,314 | |
The accompanying notes are an integral part of these consolidated financial statements.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
| | | For the years ended December 31, | |
| (In thousands) | | 2011 | | | 2010 | | | 2009 | |
| Cash flows from operating activities | | | | | | | | | |
| Net loss | | $ | (8,563 | ) | | $ | (24,093 | ) | | $ | (33,259 | ) |
| Adjustments to reconcile net loss to net cash provided by operating activities: | | | | | | | | | | | | |
| Depreciation and amortization | | | 486 | | | | 686 | | | | 907 | |
| Stock compensation expense | | | 93 | | | | 35 | | | | 226 | |
| Impairment charge for other real estate owned | | | 5,522 | | | | 7,374 | | | | 4,537 | |
| Impairment charge on loans held for sale | | | 340 | | | | - | | | | - | |
| Impairment charge on real estate owned via equity investment | | | - | | | | 2,600 | | | | - | |
| Impairment of available-for-sale ("AFS") investment securities | | | 1,796 | | | | 479 | | | | 11,041 | |
| Impairment of real estate joint venture | | | - | | | | 1,552 | | | | - | |
| Provision for loan and lease losses | | | 7,728 | | | | 22,140 | | | | 20,605 | |
| Proceeds from sales of loans and leases | | | 3,234 | | | | 4,145 | | | | 10,844 | |
| Net amortization of investment securities | | | 3,046 | | | | 2,862 | | | | 1,735 | |
| Net accretion on loans | | | (281 | ) | | | (418 | ) | | | (1,217 | ) |
| Benefit for deferred income taxes | | | - | | | | - | | | | (174 | ) |
| Net gains on sales of other real estate owned | | | (1,638 | ) | | | (1,019 | ) | | | (294 | ) |
| Gains on sales of loans and leases | | | (337 | ) | | | (666 | ) | | | (914 | ) |
| Gains on sales of security claim | | | - | | | | (1,656 | ) | | | - | |
| Net gains on sales of investment securities | | | (1,782 | ) | | | (1,290 | ) | | | (1,892 | ) |
| Gains from sale of premises of real estate owned via equity investment | | | - | | | | (667 | ) | | | (1,817 | ) |
| Income from equity investments | | | (200 | ) | | | (210 | ) | | | (200 | ) |
| Income from real estate joint venture | | | (1,750 | ) | | | - | | | | - | |
| Income from bank owned life insurance | | | (391 | ) | | | (379 | ) | | | (1,099 | ) |
| Changes in assets and liabilities: | | | | | | | | | | | | |
| Decrease (increase) in accrued interest receivable | | | 1,401 | | | | (1,922 | ) | | | (1,362 | ) |
| Decrease (increase) in other assets | | | 10,172 | | | | 29,646 | | | | (5,225 | ) |
| (Decrease) increase in accrued interest payable | | | (533 | ) | | | (2,167 | ) | | | 48 | |
| Increase in other liabilities | | | 1,449 | | | | 1,669 | | | | 5,292 | |
| Net cash provided by operating activities | | | 19,792 | | | | 38,701 | | | | 7,782 | |
| Cash flows from investing activities | | | | | | | | | | | | |
| Proceeds from calls/maturities of AFS investment securities | | | 80,067 | | | | 118,056 | | | | 148,268 | |
| Proceeds from sales of AFS investment securities | | | 113,029 | | | | 181,334 | | | | 184,226 | |
| Purchase of AFS investment securities | | | (209,002 | ) | | | (174,167 | ) | | | (398,312 | ) |
| Redemption of Federal Home Loan Bank stock | | | 1,931 | | | | 547 | | | | - | |
| Net decrease (increase) in loans | | | 84,959 | | | | 109,221 | | | | (49,260 | ) |
| Capital improvements to foreclosed assets | | | - | | | | (1,242 | ) | | | (2,431 | ) |
| Proceeds from sale of foreclosed assets | | | 11,888 | | | | 13,319 | | | | 7,877 | |
| Net cash received in connection with the sale of Royal Asian Bank | | | - | | | | 224 | | | | - | |
| Purchase of premises and equipment | | | (145 | ) | | | (115 | ) | | | (287 | ) |
| Purchase of life insurance | | | (5,000 | ) | | | - | | | | - | |
| Proceeds from surrender of life insurance | | | - | | | | - | | | | 22,628 | |
| Net proceeds from sale of premises of real estate owned via equity investments | | | 6,794 | | | | 6,682 | | | | 11,354 | |
| Distribution from investments in real estate | | | 200 | | | | 210 | | | | 200 | |
| Net decrease in real estate owned via equity investments | | | (6,794 | ) | | | (8,615 | ) | | | (9,537 | ) |
| Net cash provided by (used in) investing activities | | | 77,927 | | | | 245,454 | | | | (85,274 | ) |
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Continued)
| | | For the years ended December 31, | |
| | | 2011 | | | 2010 | | | 2009 | |
| Cash flows from financing activities: | | | | | | | | | |
| Increase (decrease) in demand and NOW accounts | | | 3,950 | | | | (14,660 | ) | | | 9,099 | |
| Increase in money market and savings accounts | | | 2,309 | | | | 12,555 | | | | 23,620 | |
| (Decrease) increase in certificates of deposit | | | (124,256 | ) | | | (185,737 | ) | | | 88,968 | |
| Repayments in short-term borrowings | | | - | | | | (92,500 | ) | | | - | |
| Repayments of long-term borrowings | | | (6,949 | ) | | | (6,726 | ) | | | (21,506 | ) |
| Repayment of mortgage debt of real estate owned via equity investments | | | - | | | | (3,652 | ) | | | (8,698 | ) |
| Proceeds from the issuance of preferred stock | | | - | | | | - | | | | 30,407 | |
| Cash dividends paid | | | - | | | | - | | | | (359 | ) |
| Net cash (used in) provided by financing activities | | | (124,946 | ) | | | (290,720 | ) | | | 121,531 | |
| Net (decrease) increase in cash and cash equivalents | | | (27,227 | ) | | | (6,565 | ) | | | 44,039 | |
| Cash and cash equivalents at beginning of period | | | 51,733 | | | | 58,298 | | | | 14,259 | |
Cash and cash equivalents at end of period | | $ | 24,506 | | | $ | 51,733 | | | $ | 58,298 | |
| Supplemental Disclosure | | | | | | | | | | | | |
| Interest | | $ | 14,619 | | | $ | 28,161 | | | $ | 37,391 | |
| Income taxes | | $ | - | | | $ | - | | | $ | - | |
| Transfers to other real estate owned | | $ | 6,441 | | | $ | 18,797 | | | $ | 29,660 | |
The accompanying notes are an integral part of these consolidated financial statements.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
1. Basis of Financial Statement Presentation
Nature of Operations
Royal Bancshares of Pennsylvania, Inc. (the “Company”), through its wholly-owned subsidiary Royal Bank America (“Royal Bank”) offers a full range of banking services to individual and corporate customers primarily located in the Mid-Atlantic states. Royal Bank competes with other banking and financial institutions in certain markets, including financial institutions with resources substantially greater than its own. Commercial banks, savings banks, savings and loan associations, credit unions and brokerage firms actively compete for savings and time deposits and for various types of loans. Such institutions, as well as consumer finance and insurance companies, may be considered competitors of Royal Bank with respect to one or more of the services it renders.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Royal Investments of Delaware, Inc., Royal Captive Insurance Company, Royal Preferred, LLC, and Royal Bank, including Royal Bank’s subsidiaries, Royal Real Estate of Pennsylvania, Inc., Royal Investment America, LLC, RBA Property LLC, Narberth Property Acquisition LLC, and Rio Marina LLC. In addition the following are owned 60% by Royal Bank: Royal Bank America Leasing, LP, Crusader Servicing Corporation (“CSC”) and Royal Tax Lien Services (“RTL”), LLC. During the fourth quarter of 2010, the Company’s wholly-owned subsidiary, Royal Captive Insurance, was dissolved. On December 30, 2010, the Company completed the sale of all of the outstanding common stock of Royal Asian Bank (“Royal Asian”), a wholly-owned subsidiary, to an investor group. Royal Asian’s net loss of $ 953,000 through December 29, 2010 is consolidated into the Company’s consolidated financial statements. Both of the Company’s Trusts are not consolidated as further discussed below in “Variable Interest Entities”. All significant intercompany transactions and balances have been eliminated.
Use of Estimates
In preparing the consolidated financial statements in accordance with United States generally accepted accounting principles (“U.S. GAAP”), management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenditures for the period. Therefore, actual results could differ significantly from those estimates.
The principal estimates that are particularly susceptible to significant change in the near term relate to the allowance for loan and lease losses, loans held for sale, the valuation of other real estate owned, the valuation of deferred tax assets, real estate owned via equity investments, investment in real estate joint ventures, and other-than-temporary impairment losses on investment securities. In connection with the allowance for loan and lease losses estimate, when circumstances warrant, management obtains independent appraisals for significant properties. However, future changes in real estate market conditions and the economy could affect the Company’s allowance for loan and lease losses. In addition, regulatory agencies, as an integral part of their examination process, periodically review the credit portfolio and the allowance. Such review may result in additional provisions based on their judgment of information available at the time of each examination.
Significant Concentration of Credit Risk
Most of the Company’s activities are with customers located within the Mid-Atlantic region of the country. “Note 3 – Investment Securities” to the Consolidated Financial Statements discusses the types of securities in which the Company invests. “Note 4 – Loans and Leases” to the Consolidated Financial Statements discusses the types of lending in which the Company engages. The Company does not have any portion of its business dependent on a single or limited number of customers, the loss of which would have a material adverse effect on its business. The Company has 87% of its investment portfolio in securities issued by government sponsored entities. The Company’s tax lien portfolio has a geographic concentration in the State of New Jersey.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
No substantial portion of loans is concentrated within a single industry or group of related industries, except a significant majority of loans are secured by real estate. There are numerous risks associated with commercial and consumer lending that could impact the borrower’s ability to repay on a timely basis. They include, but are not limited to: the owner’s business expertise, changes in local, national, and in some cases international economies, competition, governmental regulation, and the general financial stability of the borrowing entity. The Company has seen a deterioration in economic conditions as it pertains to real estate loans. Construction and land loans, non-residential real estate, and commercial loans represent 43% 40%, and 9%, respectively, of the total $51.3 million in non-accrual loans at December 31, 2011.
The Company attempts to mitigate these risks by making an analysis of the borrower’s business and industry history, its financial position, as well as that of the business owner. The Company will also require the borrower to provide financial information on the operation of the business periodically over the life of the loan. In addition, most commercial loans are secured by assets of the business or those of the business owner, which can be liquidated if the borrower defaults, along with the personal surety of the business owner.
Variable Interest Entities (“VIE”)
Real estate owned via equity investments: The Company, together with third party real estate development companies, forms variable interest entities (“VIEs”) to construct various real estate development projects. These VIEs account for acquisition, development and construction costs of the real estate development projects in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standard Codification (“ASC”) Topic 970, “Real Estate-General”, and account for capitalized interest on those projects in accordance with FASB ASC Topic 835, “Interest”. Due to the present economic conditions, management has made a decision to curtail new equity investments.
In accordance with FASB ASC Topic 976, “Real Estate-Retail Land” the full accrual method is used to recognize profit on real estate sales. Profits on the sales of this real estate are recorded when cash in excess of the amount of the original investment is received, and calculation of same is made in accordance with the terms of the partnership agreement, the Company is no longer obligated to perform significant activities after the sale to earn profits, there is no continuing involvement with the property and; finally, the usual risks and rewards of ownership in the transaction had passed to the acquirer.
During the fourth quarter of 2011, the Company deconsolidated the remaining VIE as a result of the substantial completion of the project and the sales of the remaining units that were associated with the VIE. The activity associated with this VIE for 2011 is reflected as other income in the amount of $278,000 on the Consolidated Statement of Operations. As of December 31, 2011, the Company no longer has any VIE’s that are consolidated into the Company’s financial statements. At December 31, 2010, the Company had one VIE consolidated into the Company’s financial statements which met the requirements for consolidation under FASB ASC Topic 810, “Consolidation” (“ASC Topic 810”) based on Royal Investments America being the primary financial beneficiary.
Consolidation of this VIE was determined based on the amount invested by Royal Investments America compared to the Company’s partners. In September 2005, the Company, together with a real estate development company, formed a limited partnership. Royal Investments America is a limited partner in the partnership (the “Partnership”). The Partnership was formed to convert an apartment complex into condominiums. The development company is the general partner of the Partnership. The Company invested 66% of the initial capital contribution, or $2.5 million, with the development company investing the remaining equity of $1.3 million. The Company was entitled to earn a preferred return on the $2.5 million capital contribution. In addition, the Company made two mezzanine loans totaling $9.2 million at market terms and interest rates.
In accordance with FASB ASC Topic 360, “Property, Plant and Equipment” the Partnership assesses the recoverability of fixed assets based on estimated future operating cash flows. The Company had recognized $12.6 million in impairment charges related to this asset through December 31, 2010. The measurement and recognition of the impairment was based on estimated future discounted operating cash flows.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
At December 31, 2011, the VIE was deconsolidated as a result of the substantial completion of the project and the sales of the remaining units. At December 31, 2010, the Partnership had total assets of $9.0 million of which $6.8 million is real estate as reflected on the consolidated balance sheet and total borrowings of $9.6 million, which related to the Company’s loans. The Company has made an investment of $14.1 million in this Partnership ($2.5 million capital contribution and $11.6 million of loans). The impairments mentioned above along with the repayment of advances that started in June 2010 have contributed to an overall reduction in the Company’s investment. At December 31, 2011, the carrying amount of the investment in and receivables due from the Partnership totaled $325,000.
Trust Preferred Securities: Royal Bancshares Capital Trust I/II (“Trusts”) issued mandatory redeemable preferred stock to investors and loaned the proceeds to the Company. The Trusts hold, as their sole asset, subordinated debentures issued by the Company in 2004. The Company does not consolidate the Trusts as ASC Topic 810 precludes consideration of the call option embedded in the preferred stock when determining if the Company 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 accrued on the Company’s common stock investments is included in other income. 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 ASC Topic 810. 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 final adoption of the rule was effective on March 31, 2011 and did not have a material impact on the Company’s capital ratios. Refer to “Note 10 – Borrowings and Subordinated Debentures” to the Consolidated Financial Statements for more information.
U.S. GAAP RAP Difference
In connection with a prior bank regulatory examination, the Federal Deposit Insurance Company (“FDIC”) concluded, based upon its interpretation of the Consolidated Reports of Condition and Income (the “Call Report”) instructions and under regulatory accounting principles (“RAP”), that income from Royal Bank’s tax lien business should be recognized on a cash basis, not an accrual basis. Royal Bank’s current accrual method is in accordance with U.S. GAAP. Royal Bank disagrees with the FDIC’s conclusion and filed the Call Report for December 31, 2011 and the previous five quarters in accordance with U.S. GAAP. However, the change in the manner of revenue recognition for the tax lien business for regulatory accounting purposes affects Royal Bank’s and the Company’s capital ratios as disclosed in “Note 2 - Regulatory Matters and Significant Risks And Uncertainties” and “Note 15 - Regulatory Capital Requirements” to the Consolidated Financial Statements. Royal Bank is in discussions with the FDIC to resolve the matter.
Reclassifications
Certain items in the 2010 and 2009 consolidated financial statements and accompanying notes have been reclassified to conform to the current year’s presentation format. There was no effect on net loss for the periods presented herein as a result of reclassification.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, interest-bearing deposits and federal funds sold. Generally, federal funds are purchased and sold for one-day periods.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
Investment Securities
Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each balance sheet date. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are classified as held to maturity securities and reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized holding gains and losses included in earnings. Debt and equity securities not classified as trading securities, nor as held to maturity securities are classified as available for sale securities and reported at fair value, with unrealized holding gains or losses, net of deferred income taxes (when applicable), reported in the accumulated other comprehensive income component of shareholders’ equity. The Company did not hold trading securities nor had securities classified as held to maturity at December 31, 2011 and 2010. Discounts and premiums are accreted/amortized to income by use of the level-yield method. Gain or loss on sales of securities available for sale is based on the specific identification method.
The Company evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis. The Company assesses whether OTTI is present when the fair value of a security is less than its amortized cost. All investment securities are evaluated for OTTI under FASB ASC Topic 320, “Investments-Debt & Equity Securities” (“ASC Topic 320”). The non-agency collateralized mortgage obligations that are rated below AA are evaluated under FASB ASC Topic 320 Subtopic 40, “Beneficial Interests in Securitized Financial Assets” or under FASB ASC Topic 325, “Investments-Other”. In determining whether OTTI exists, management considers numerous factors, including but not limited to: (1) the length of time and the extent to which the fair value is less than the amortized cost, (2) the Company’s intent to hold or sell the security, (3) the financial condition and results of the issuer including changes in capital, (4) the credit rating of the issuer, (5) analysts earnings estimate, (6) industry trends specific to the security, and (7) timing of debt maturity and status of debt payments.
Under ASC Topic 320, OTTI is considered to have occurred with respect to debt securities (1) if an entity intends to sell the security; (2) if it is more likely than not an entity will be required to sell the security before recovery of its amortized cost basis; or (3) the present value of the expected cash flows is not sufficient to recover the entire amortized cost basis. In addition, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell or will more likely than not be required to sell the security. If an entity intends to sell the security or will be required to sell the security, the OTTI shall be recognized in earnings equal to the entire difference between the fair value and the amortized cost basis at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before the recovery of its amortized cost basis, the OTTI shall be separated into two amounts, the credit-related loss and the noncredit-related loss. The credit-related loss is based on the present value of the expected cash flows and is recognized in earnings. The noncredit-related loss is based on other factors such as illiquidity and is recognized in other comprehensive income.
Other Investment
This investment includes the Solomon Hess SBA Loan Fund, which the Company invested in to partially satisfy its community reinvestment requirement. Shares in this fund are not publicly traded and therefore have no readily determinable fair market value. An investor can have their investment in the Fund redeemed for the balance of their capital account at any quarter end with 60 days notice to the Fund. The investment in this Fund is recorded at cost.
Federal Home Loan Bank Stock
As a member of the Federal Home Loan Bank of Pittsburgh (“FHLB”), the Company is required to purchase and hold stock in the FHLB to satisfy membership and borrowing requirements. The stock can only be sold to the FHLB or to another member institution, and all sales of FHLB stock must be at par. As a result of these restrictions, there is no active market for the FHLB stock. As of December 31, 2011 and 2010, FHLB stock totaled $8.5 million and $10.4 million, respectively.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
In December 2008, the FHLB voluntarily suspended dividend payments on its stock, as well as the repurchase of excess stock from members. The FHLB cited a significant reduction in the level of core earnings resulting from lower short-term interest rates, the increased cost of liquidity, and constrained access to the debt markets at attractive rates and maturities as the main reasons for the decision to suspend dividends and the repurchase of excess capital stock. In the fourth quarter of 2010 the FHLB began partially repurchasing excess capital stock. During 2011 and 2010 the FHLB repurchased $1.9 million and $500,000; respectively, in FHLB capital stock from the Company.
FHLB stock is held as a long-term investment and its value is determined based on the ultimate recoverability of the par value. The Company evaluates impairment quarterly. The decision of whether impairment exists is a matter of judgment that reflects management’s view of the FHLB’s long-term performance, which includes factors such as the following: (1) its operating performance, (2) the severity and duration of declines in the fair value of its net assets related to its capital stock amount, (3) its liquidity position, and (4) the impact of legislative and regulatory changes on the FHLB. On February 22, 2012, the FHLB filed an 8-K to report their results for the year ended December 31, 2011. For the year ended December 31, 2011, the FHLB had net income of $38.0 million compared to net income of $8.3 million for the year ended December 31, 2010. The improvement in their results was related to lower credit-related losses on their mortgage-backed securities portfolio which was partially offset by lower net interest income. At December 31, 2011, GAAP capital was $3.7 billion as compared to a $4.2 billion at December 31, 2010. The FHLB was in compliance with its risk-based, total and leverage capital requirements at December 31, 2011. The FHLB declared a small dividend to be paid during the first quarter of 2012. The dividend will be calculated on the stockholders’ average balances for the fourth quarter of 2011. The FHLB also announced another partial repurchase of excess stock and completed the transaction in the first quarter of 2012. The FHLB has the capacity to issue additional debt if necessary to raise cash. If needed, the FHLB also has the ability to secure funding available to GSEs (government-sponsored entities) through the U.S. Treasury. Based on the capital adequacy and the liquidity position of the FHLB, management believes that the par value of its investment in FHLB stock will be recovered. Accordingly, there is no other-than-temporary impairment related to the carrying amount of the Company’s FHLB stock as of December 31, 2011.
Loans Held for Sale
At December 31, 2011, the Company’s loans held for sale (“LHFS”) were comprised of $12.6 million in non-accrual construction and land development loans and commercial and residential real estate loans. These loans were transferred from loans held for investment (“LHFI”) to LHFS at the lower of cost or fair market value using expected net sales proceeds. At the time of transfer to LHFS, credit losses of $110,000 and $11.4 million were charged against the allowance for loan and lease losses during 2011 and 2010, respectively. Generally any subsequent credit losses on LHFS are recorded as a component of non-interest expense. Additional impairment on LHFS of $340,000 was recorded in 2011. During the fourth quarter of 2011, the Company transferred $4.8 million in non-accrual LHFS back to LHFI. At December 31, 2010 LHFS were $29.6 million and included $22.6 million in non-accrual loans and $7.0 million in classified construction and land development loans and commercial and residential real estate loans.
Loans and Leases
Loans and leases are classified as LHFI when management has the intent and ability to hold the loan or lease for the foreseeable future or until maturity or payoff. LHFI are stated at their outstanding unpaid principal balances, net of an allowance for loan and leases losses and any deferred fees or costs. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the yield (interest income) of the related loans. The Company is generally amortizing these amounts over the contractual life of the loan. The Company grants commercial and real estate loans, including construction and land development loans primarily in the greater Philadelphia metropolitan area as well as selected locations throughout the mid-Atlantic region. The Company also has participated with other financial institutions in selected construction and land development loans outside our geographic area. The Company has a concentration of credit risk in commercial real estate, construction and land development loans at December 31, 2011. A substantial portion of its debtors’ ability to honor their contracts is dependent upon the housing sector specifically and the economy in general.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
The Company classifies its leases as finance leases, in accordance with FASB ASC Topic 840, “Leases”. The difference between the Company’s gross investment in the lease and the cost or carrying amount of the leased property, if different, is recorded as unearned income, which is amortized to income over the lease term by the interest method.
For all classes of loans receivable, the accrual of interest is discontinued on a loan when management believes that the borrower’s financial condition is such that collection of principal and interest is doubtful or when a loan becomes 90 days past due. When a loan is placed on non-accrual all unpaid interest is reversed from interest income. Interest payments received on impaired nonaccrual loans are normally applied against principal. Excess proceeds received over the principal amounts due on impaired loans are recognized as income on a cash basis. Generally, loans are restored to accrual status when the loan is brought current, has performed in accordance with the contractual terms for a reasonable period of time (generally six months) and the ultimate collectibility of the total contractual principal and interest is no longer in doubt. The past due status of all classes of loans receivable is determined based on contractual due dates for loan payments.
A loan modification is deemed a troubled debt restructuring (“TDR”) when two conditions are met: 1) the borrower is experiencing financial difficulty and 2) a concession is made by the Company that would not otherwise be considered for a borrower or collateral with similar credit risk characteristics. During the third quarter of 2011, the Company adopted ASU 2011-02, “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring” (“ASU 2011-02”) which amended guidance related to identifying and reporting TDRs. If in modifying a loan the Company, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession it would not normally consider then the loan modification is classified as a TDR. All loans classified as TDRs are considered to be impaired. TDRs are returned to an accrual status when the loan is brought current, has performed in accordance with the contractual restructured terms for a reasonable period of time (generally six months) and the ultimate collectibility of the total contractual restructured principal and interest is no longer in doubt. As required under ASU 2011-02, the Company reassessed all loan modifications that occurred after December 31, 2010 for identification as TDRs. At December 31, 2011, the Company had twelve TDRs, of which seven are on non-accrual status, with a total carrying value of $14.2 million. At the time of the modifications, eight of the loans were already classified as impaired loans. The Company had one TDR at December 31, 2010 which was classified as a multi-family real estate non-accrual loan in the amount of $1.8 million. The Company’s policy for TDRs is to recognize income on currently performing restructured loans under the accrual method.
The Company accounts for guarantees in accordance with FASB ASC Topic 460 “Guarantees” (“ASC Topic 460”). ASC Topic 460 requires a guarantor entity, at the inception of a guarantee covered by the measurement provisions of the interpretation, to record a liability for the fair value of the obligation undertaken in issuing the guarantee. The Company has financial and performance letters of credit. Financial letters of credit require a company to make a payment if the customer’s condition deteriorates, as defined in agreements. Performance letters of credits require the Company to make payments if the customer fails to perform certain non-financial contractual obligations.
Allowance for Loan and Lease Losses
The Company’s loan and lease portfolio (the “credit portfolio”) is subject to varying degrees of credit risk. The Company maintains an allowance for loan and lease losses (the “allowance”) to absorb losses in the loan and lease portfolio. The allowance is based on the review and evaluation of the loan and lease portfolio, along with ongoing, quarterly assessments of the probable losses inherent in that portfolio. The allowance represents an estimation made pursuant to FASB ASC Topic 450, “Contingencies” (“ASC Topic 450”) or FASB ASC Topic 310, “Receivables” (“ASC Topic 310”). The adequacy of the allowance is determined through evaluation of the credit portfolio, and involves consideration of a number of factors, as outlined below, to establish a prudent level.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
Determination of the allowance is inherently subjective and requires significant estimates, including estimated losses on pools of homogeneous loans and leases based on historical loss experience and consideration of current economic trends, which may be susceptible to significant change as more information becomes available. Loans and leases deemed uncollectible are charged against the allowance, while recoveries are credited to the allowance. Management adjusts the level of the allowance through the provision for loan and lease losses, which is recorded as a current period expense. The Company’s systematic methodology for assessing the appropriateness of the allowance includes: (1) general reserves reflecting historical loss rates by loan type, (2) specific reserves for risk-rated credits based on probable losses on an individual or portfolio basis and (3) qualitative reserves based upon current economic conditions and other risk factors.
The loan portfolio is stratified into loan segments that have similar risk characteristics. The general allowance is based upon historical loss rates using a three-year rolling average of the historical loss experienced within each loan segment. The qualitative factors used to adjust the historical loss experience address various risk characteristics of the Company’s loan and lease portfolio include evaluating: (1) trends in delinquencies and other non-performing loans, (2) changes in the risk profile related to large loans in the portfolio, (3) changes in the growth trends of categories of loans comprising the loan and lease portfolio, (4) concentrations of loans and leases to specific industry segments, (5) changes in economic conditions on both a local and national level, (6) quality of loan review and board oversight, (7) changes in lending policies and procedures, and (8) changes in lending staff. Each factor is assigned a value to reflect improving, stable or declining conditions based on management’s best judgment using relevant information available at the time of the evaluation. Adjustments to the factors are supported through documentation of changes in conditions in a report accompanying the allowance for loan loss calculation.
The specific reserves are determined utilizing standards required under ASC Topic 310. A loan is considered impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. Non-accrual loans are evaluated for impairment on an individual basis considering all known relevant factors that may affect loan collectability such as the borrower’s overall financial condition, resources and payment record, support available from financial guarantors and the sufficiency of current collateral values (current appraisals or rent rolls for income producing properties), and risks inherent in different kinds of lending (such as source of repayment, quality of borrower and concentration of credit quality). Non-accrual loans that experience insignificant payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and industrial loans, commercial real estate loans and commercial construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent. An allowance for loan losses is established for an impaired loan if its carrying value exceeds its estimated fair value. The estimated fair values of substantially all of the Company’s impaired loans are measured based on the estimated fair value of the loan’s collateral. The Company obtains third-party appraisals on the fair value of real estate collateral. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property. For commercial and industrial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Once a loan is determined to be impaired it will be deducted from the portfolio and the net remaining balance will be used in the general and qualitative analysis.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
The allowance calculation methodology includes further segregation of loan classes into risk rating categories. The borrower’s overall financial condition, repayment sources, guarantors and value of collateral, if appropriate, are evaluated annually for commercial loans or when credit deficiencies arise, such as delinquent loan payments, for commercial and consumer loans. Credit quality risk ratings include regulatory classifications of special mention, substandard, doubtful and loss. Loans classified as special mention have potential weaknesses that deserve management’s close attention. If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects. Loans classified as substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They include loans that are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as doubtful have all the weaknesses inherent in loans classified substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans classified as a loss are considered uncollectible and are charged to the allowance for loan losses. Loans not classified are rated pass.
In addition, Federal regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses and may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management. Based on management’s comprehensive analysis of the loan portfolio, management believes the current level of the allowance is adequate at December 31, 2011. However, its determination requires significant judgment, and estimates of probable losses inherent in the credit portfolio can vary significantly from the amounts actually observed. While management uses available information to recognize probable losses, future changes to the allowance may be necessary based on changes in the credits comprising the portfolio and changes in the financial condition of borrowers, such as may result from changes in economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the credit portfolio and the allowance. Such review may result in additional provisions based on their judgment of information available at the time of each examination.
Other Real Estate Owned
Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in other expenses.
Premises and Equipment
Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation, which is computed principally on accelerated methods over the estimated useful lives of the assets. Leasehold improvements are amortized on the accelerated methods over the shorter of the estimated useful lives of the improvements or the terms of the related leases. Expected term includes lease options periods to the extent that the exercise of such options is reasonably assured.
Interest Rate Swaps
For asset/liability management purposes, the Company had used interest rate swaps which are agreements between the Company and another party (known as 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.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
The Company had utilized 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 represent a series of interest flows and are exchanged over a prescribed period.
As a consequence of the 2008 Lehman Brothers Holdings, Inc. (“Lehman”) bankruptcy filing, the swap agreements and cash flow hedge that existed at the time of the bankruptcy filing were terminated. The Company had an agency mortgage-backed security (approximately $5.0 million) that was pledged as collateral at Lehman for our swap agreements. In October 2008, the Company sued Lehman Brothers Special Financing, Inc. (“LBSF”) to recover possession of its collateral. Because of the uncertainty surrounding the litigation and the Lehman bankruptcy, the Company classified the collateral as other-than-temporarily impaired for the entire amount as of December 31, 2008. In the fourth quarter of 2010, the Company sold its claim and recorded a gain of $1.7 million. The Company did not have any interest rate swaps agreements at December 31, 2011 and 2010.
Investments in Real Estate Joint Ventures
During 2011, the Company recorded income from real estate joint ventures of $1.8 million. This income related to a payment received from a guarantor on an investment which had been fully written down in 2007. During 2010, the Company had one investment in a real estate joint venture and accounted for it in accordance with ASC Topic 310 and FASB ASC Topic 976, “Real Estate-Retail Land” (“ASC Topic 976”) because the Company was not a party to an operating agreement and had no legal ownership of the entity that owns the real estate. The real estate joint venture was an investment in an Ohio marina project in which the Company had a subordinate debt position. During the second quarter of 2010, the Company fully impaired the investment and recorded a $2.5 million charge to earnings. The impairment was the result of a lower collateral value due to the significant reduction in the cash flows being generated from the property. During the third quarter of 2010, the first mortgage lender foreclosed on the property. Partially offsetting the $2.5 million impairment charge was a $968,000 recovery on another investment in a real estate in joint venture which had been written down in 2007. The Company no longer holds any investments in real estate joint ventures.
Bank-Owned Life Insurance
Royal Bank has purchased life insurance policies on certain executives. These policies are reflected on the consolidated balance sheets at their cash surrender value, or the amount that can be realized. During the fourth quarter of 2011, Royal Bank purchased an additional $5.0 million of bank owned life insurance. Income from these policies and changes in the cash surrender value are recorded in other income.
Transfer of Financial Assets
The Company accounts for the transfer of financial assets in accordance with FASB ASC Topic 860, “Transfers and Servicing” (“ASC Topic 860”). ASC Topic 860 revises the standards for accounting for the securitizations and other transfers of financial assets and collateral.
Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred asset through an agreement to repurchase them before maturity.
Advertising Costs
Advertising costs are expensed as incurred. The Company’s advertising costs were $116,000, $109,000, and $184,000 for 2011, 2010, and 2009, respectively.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
Benefit Plans
The Company has a noncontributory nonqualified, defined benefit pension plan covering certain eligible employees. The plan provides retirement benefits under pension trust agreements. 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 pension expense consists of service costs and interest costs. The Company accrues pension costs as incurred.
The Company has a capital accumulation and salary reduction plan under Section 401(k) of the Internal Revenue Code of 1986, as amended. Under the plan, all employees are eligible to contribute up to the maximum allowed by IRS regulation, with the Company matching 100% of any contribution between 1% and 5% subject to a $2,500 per employee annual limit. During 2010 and 2009, no matching contribution was made as a result of a management decision to reduce costs. During 2011 the Company partially reinstated the matching contribution and contributed $128,000 to the plan.
Stock Compensation
FASB ASC Topic 718, “Compensation-Stock Compensation” (“ASC Topic 718”) requires that the compensation cost relating to share-based payment transactions be recognized in consolidated financial statements. The costs are measured based on the fair value of the equity or liability instruments issued. ASC Topic 718 covers a wide range of share-based compensation arrangements including stock options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. The effect of ASC Topic 718 is to require entities to measure the cost of employee services received in exchange for stock options based on the grant-date fair value of the award, and to recognize the cost over the period the employee is required to provide services for the award. ASC Topic 718 permits entities to use any option-pricing model that meets the fair value objective in the Statement. The Company recorded compensation expense relating to stock options and restricted stock of $93,000, $35,000 and $226,000 during 2011, 2010 and 2009, respectively.
At December 31, 2011, the Company had a director stock-based, an employee stock-based, and a long term incentive compensation plans, which are more fully described in “Note 17 – Stock Compensation Plans” to the Consolidated Financial Statements.
Income Taxes
The Company accounts for income taxes in accordance with income tax accounting guidance (FASB ASC Topic 740, Income Taxes), which includes guidance related to accounting for uncertainty in income taxes, which sets out a consistent framework to determine the appropriate level of tax reserves to maintain for uncertain tax positions. The Company had no material unrecognized tax benefits or accrued interest and penalties as of December 31, 2011 and 2010. The Company’s policy is to account for interest as a component of interest expense and penalties as a component of other expense.
The Company and its subsidiaries file a consolidated federal income tax return. Income taxes are allocated to the Company and its subsidiaries based on the contribution of their income or use of their loss in the consolidated return. Separate state income tax returns are filed by the Company and its subsidiaries. The Company is no longer subject to examination by taxing authorities for the years before January 1, 2005.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
Federal and state income taxes have been provided on the basis of reported income or loss. The amounts reflected on the tax returns differ from these provisions due principally to temporary differences in the reporting of certain items for financial reporting and income tax reporting purposes. The tax effect of these temporary differences is accounted for as deferred taxes applicable to future periods. Deferred income tax expense or benefit is determined by recognizing deferred tax assets and liabilities for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred assets and liabilities of a change in tax rates is recognized in earnings in the period that includes the enactment date. The realization of deferred tax assets is assessed and a valuation allowance provided for the full amount which is not more likely than not to be realized.
Treasury Stock
Shares of common stock repurchased are recorded at treasury stock cost.
Earnings (Losses) Per Share Information
Basic per share data excludes dilution and is computed by dividing income (loss) available to common shareholders by the weighted average common shares outstanding during the period. Diluted per share data 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.
The Class B shares of the Company may be converted to Class A shares at the rate of 1.15 to 1.
Comprehensive Income (Loss)
The Company reports comprehensive income (loss) in accordance with FASB ASC Topic 220, “Comprehensive Income” (“ASC Topic 220”), which requires the reporting of all changes in equity during the reporting period except investments from and distributions to shareholders. Net income (loss) is a component of comprehensive income (loss) with all other components referred to in the aggregate as other comprehensive income. Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on available for sale investment securities, non-credit related losses on other-than-temporarily impaired investment securities, and adjustment to net periodic pension cost which are also recognized as separate components of equity.
Fair Value of Financial Instruments
For information on the fair value of the Company’s financial instruments refer to “Note 20 - Fair Value of Financial Instruments” to the Consolidated Financial Statements.
Restrictions on Cash and Amounts Due From Banks
Royal Bank is required to maintain average balances on hand with the Federal Reserve Bank. At December 31, 2011 and 2010, these reserve balances amounted to $100,000.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
2. Recent Accounting Pronouncements
In January 2010, the FASB issued Accounting Standard Update (“ASU”) No. 2010-06, “Improving Disclosures about Fair Value Measurements” (“ASU 2010-06”), which updates ASC Topic 820 “Fair Value Measurements and Disclosures”. ASU 2010-06 is intended to provide a greater level of disaggregated information and more robust disclosures about valuation techniques and inputs to fair value measurements. A reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers. Additionally, a reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. Those disclosures are required for fair value measurements that fall in either Level 2 or Level 3. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009. The disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements were effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of ASU 2010-06 did not have a significant impact on the Company’s consolidated financial statements.
In July 2010, the FASB issued ASU No. 2010-20, “Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses” (“ASU 2010-20”), which is intended to help investors assess the credit risk of a company’s receivables portfolio and the adequacy of its allowance for credit losses held against the portfolios by expanding credit risk disclosures. (“ASU 2010-20”) requires more information about the credit quality of financing receivables in the disclosures to financial statements, such as aging information and credit quality indicators. Both new and existing disclosures must be disaggregated by portfolio segment or class. The disaggregation of information is based on how a company develops its allowance for credit losses and how it manages its credit exposure. The disclosure requirements as of December 31, 2010 are included in “Note 4 - Loans and Leases” and “Note 5 – Allowance for Loan and Lease Losses” to the Consolidated Financial Statements. The disclosures about activity that occurs during a reporting period were effective in the interim reporting period ending March 31, 2011.
In April 2011, the FASB issued ASU 2011-02, “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring” (“ASU 2011-02”) which is intended to amend guidance related to TDRs. ASU 2011-02 provides additional guidance to assist creditors in concluding whether the restructuring has granted a concession to the borrower and that the borrower is experiencing financial difficulties. ASU 2011-02 was effective for public entities for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. The adoption of ASU 2011-02 did not have a significant impact on the Company’s consolidated financial statements.
In May 2011, the FASB issued ASU 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” (“ASU 2011-04”) which generally clarifies guidance in ASC Topic 820 “Fair Value Measurements and Disclosures”. The amendments in ASU 2011-004 explain how to measure fair value and change the wording used to describe the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. ASU 2011-04 does not require additional fair value measurements and is not intended to establish valuation standards or affect valuation practices outside of financial reporting. For public entities, ASU 2011-04 is effective for the first interim or annual period beginning after December 15, 2011. The adoption of ASU 2011-04 is not expected to have a significant impact on the Company’s consolidated financial statements.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Continued
In June 2011, the FASB issued ASU 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”) which amends ASC Topic 220 “Comprehensive Income”. To increase the prominence of items reported in other comprehensive income and to facilitate convergence of U.S. GAAP and International Financial Reporting Standards (“IFRS”), the FASB decided to eliminate the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity, among other amendments in ASU 2011-05. The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income. For public entities, ASU 2011-05 is effective for the first interim or annual period beginning after December 15, 2011. The adoption of ASU 2011-05 is not expected to have a significant impact on the Company’s consolidated financial statements.
In December 2011, the FASB issued ASU 2011-11, “Disclosures about Offsetting Assets and Liabilities” (“ASU 2011-11”) which amends ASC Topic 210 “Balance Sheet”. Because of the significant differences in requirements under U.S. GAAP and IFRS, FASB and the International Accounting Standards Board (“IASB”) are issuing joint requirements that will enhance current disclosures. Entities are required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. This scope would include derivatives, sale and repurchase agreements and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. The objective of this disclosure is to facilitate comparison between those entities that prepare their financial statements on the basis of U.S. GAAP and those entities that prepare their financial statements on the basis of IFRS. ASU 2011-11 is effective for annual periods beginning on or after January 1, 2013 and interim periods within those annual periods. An entity should provide the disclosures required by these amendments retrospectively for all comparative periods presented. The adoption of ASU 2011-11 is not expected to have a significant impact on the Company’s consolidated financial statements.
In December 2011, the FASB issues ASU 2011-12, “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05”. The amendments in ASU 2011-12 effectively defer only those changes in ASU 2011-05 that relate to the presentation of reclassification adjustments out of accumulated other comprehensive income. The amendments will be temporary to allow the Board time to redeliberate the presentation requirements for reclassifications out of accumulated other comprehensive income for annual and interim financial statements for public, private, and non-profit entities. All other requirements in ASU 2011-05 are not affected by ASU 2011-12, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements.
NOTE 2 – REGULATORY MATTERS and SIGNIFICANT RISKS and UNCERTAINTIES
FDIC and Department of Banking Orders
On July 15, 2009, Royal Bank agreed to enter into a Stipulation and Consent to the Issuance of an Order to Cease and Desist (the “Orders”) with each of the Federal Deposit Insurance Corporation (“FDIC”) and the Pennsylvania Department of Banking (the “Department”). The material terms of the Orders were identical and required Royal Bank among other items to maintain, after establishing an adequate allowance for loan and lease losses, a ratio of Tier 1 capital to total assets (“leverage ratio”) equal to or greater than 8% and a ratio of qualifying total capital to risk-weighted assets (“total risk-based capital ratio”) equal to or greater than 12%. The FDIC and the Department replaced the Orders in the fourth quarter of 2011 with an informal agreement, known as a memorandum of understanding (“MOU”). Included in the MOU is the continued requirement of maintaining a leverage ratio equal to or greater than 8% and a total risk-based capital ratio equal to or greater than 12%.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 2 – REGULATORY MATTERS and SIGNIFICANT RISKS and UNCERTAINTIES- Continued
Federal Reserve Agreement
On March 17, 2010, the Company agreed to enter into the Federal Reserve Agreement with the Reserve Bank. The material terms of the Federal Reserve Agreement provide that: (i) the Company’s board of directors will take appropriate steps to fully utilize the Company’s financial and managerial resources to serve as a source of strength to its subsidiary banks; (ii) the Company’s board of directors will, within 60 days of the Federal Reserve Agreement, submit to the Reserve Bank a written plan to strengthen board oversight of the management and operations of the consolidated operation; (iii) the Company will not declare or pay any dividends without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System; (iv) the Company and its non-bank subsidiaries will not make any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without the prior approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System; (v) the Company and its nonbank subsidiaries will not, directly or indirectly, incur, increase, or guarantee any debt without the prior written approval of the Reserve Bank; (vi) the Company will not, directly or indirectly, purchase or redeem any shares of its stock without the prior written approval of the Reserve Bank; (vii) the Company will, within 60 days of the Federal Reserve Agreement, submit to the Reserve Bank an acceptable written capital plan to maintain sufficient capital at the Company on a consolidated basis, which plan will at a minimum address: regulatory requirements for the Company and the Banks, the adequacy of the Banks’ capital taking into account the volume of classified credits, the allowance for loan and lease losses, current and projected asset growth, and projected retained earnings; the source and timing of additional funds necessary to fulfill the consolidated organization’s and the Banks’ future capital requirements; supervisory requests for additional capital at the Banks or the requirements of any supervisory action imposed on the Banks by federal or state regulators; and applicable legal requirements that the Company serve as a source of strength to the Banks; (viii) the Company will, within 60 days of the Federal Reserve Agreement, submit to the Reserve Bank cash flow projections for 2010 showing planned sources and uses of cash for debt service, operating expenses, and other purposes, and will submit similar cash flow projections for each subsequent calendar year at least one month prior to the beginning of such year; (ix) the Company will comply with applicable legal notice provisions in advance of appointing any new director or senior executive officer or changing the responsibilities of any senior executive officer such that the officer would assume a different senior executive officer position, and comply with restrictions on indemnification and severance payments imposed by the Federal Deposit Insurance Act; and (x) the Company’s board of directors will, within 45 days after the end of each quarter, submit progress reports to the Reserve Bank detailing the form and manner of all actions taken to secure compliance with the Agreement and the results thereof, together with a parent company-level balance sheet, income statement, and, as applicable, report of changes in shareholders’ equity.
The Federal Reserve Agreement will remain in effect and enforceable until stayed, modified, terminated or suspended by the Reserve Bank. Royal Bancshares has submitted all progress reports and responses required under the Federal Reserve Agreement as of the date of this Report.
Our success as a Company is dependent upon pursuing various alternatives in not only achieving the growth and expansion of our banking franchise but also in managing our day to day operations. The existence of the MOU and the Federal Reserve Agreement may limit or impact our ability to pursue all previously available alternatives in the management of the Company. Our ability to retain existing retail and commercial customers as well as the ability to attract potentially new customers may be impacted by the existence of the MOU and the Federal Reserve Agreement. The Company has been successful in commercial real estate lending; however, our ability to expand into potentially attractive commercial real estate or construction loans at this time is limited. The Company’s ability to raise capital in the current economic environment could be potentially limited or impacted as a result of the MOU and the Federal Reserve Agreement. Attracting new management talent is critical to the success of our business and could be potentially impacted due to the existence of the MOU and the Federal Reserve Agreement.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 2 – REGULATORY MATTERS and SIGNIFICANT RISKS and UNCERTAINTIES - Continued
Continued Losses
Over the past four years, the Company has recorded significant losses totaling $104.0 million which were primarily related to charge-offs on the loan and lease portfolio, impairment charges on investment securities, impairment charges on OREO, credit related expenses and the establishment of a deferred tax valuation allowance. The loss of earnings in 2011 amounted to $8.6 million, which represented a significant improvement of $15.5 million, or 64.5%, from the loss recorded in 2010. The year-over-year decrease in losses was mainly related to improved credit quality within the loan portfolio and the corresponding reduction in the provision for loan losses. Loan charge-offs and investment impairment charges that contributed to the losses in earnings are discussed below under “Credit Quality”. In addition to reducing the total shareholders’ equity, the continued losses and negative retained earnings impacts the Company’s ability to pay cash dividends to its shareholders now and in future years. The Company’s deferred tax valuation allowance amounted to $36.4 million at the end of 2011. The deferred tax valuation allowance is a result of management’s conclusion that it was more likely than not that the Company would not generate sufficient future taxable income to realize all of the deferred tax assets.
Due to the losses mentioned above that were primarily credit related, the Company has experienced an increase in other operating expenses over the past four years. These increased expenses include OREO impairment charges, OREO expenses, and legal and other expenses related to credit quality. Impairment associated with OREO, real estate joint ventures and real estate owned via equity investments has declined significantly during 2011. In addition the FDIC and state assessments have declined almost 50% from 2009 due to the redemption of brokered CDs and the sale of Royal Asian.
Credit Quality
Adverse economic conditions in our specific market areas and decreases in real estate property values due to the nature of our loan portfolio in particular have affected the ability of customers to repay their loans and generally impact our financial condition and results of operations. The financial services and real estate industries were hit particularly hard during the “Great Recession” and as a result the Company’s loan and investment portfolios were directly affected. The Company’s commercial real estate loans, including construction and land development loans, have seen a decline in the collateral values, and a reduction in the borrowers’ ability to meet the payment terms of their loans due to reduced cash flow. Further declines in collateral values and borrowers’ liquidity with sustained unemployment at current levels may lead to additional increases in foreclosures, delinquencies and customer bankruptcies. The Company is less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of more diverse economies.
The Company had non-performing loans and recorded charge-offs of $51.3 million and $13.2 million at December 31, 2011, $65.8 million and $31.7 million at December 31, 2010, and $73.7 million and $19.8 million at December 31, 2009, respectively. OREO balances were $21.0 million, $29.2 million, and $30.3 million at December 31, 2011, 2010, and 2009, respectively.
Royal Bank was successful in reducing net classified loans, which includes LHFS, and OREO from $149.6 million at June 30, 2009 to $74.2 million at December 31, 2011. Royal Bank’s delinquent loans held for investment (30 to 90 days) amounted to $36.3 million at June 30, 2009 versus $4.2 million at December 31, 2011. No material advances were made on any classified or delinquent loan unless approved by the board of directors and determined to be in Royal Bank’s best interest. Royal Bank’s non-performing loans held for investment were $80.8 million and $38.7 million at June 30, 2009 and December 31, 2011, respectively. Total non-performing loans at December 31, 2011 were $51.3 million and include $12.6 million in LHFS. The Company has restructured the investment portfolio to reduce credit risk by selling corporate debt securities and equity securities and replacing their maturities with U.S. government issued or sponsored securities. Other-than-temporary-impairment losses were $1.8 million, $479,000, and $11.0 million at December 31, 2011, 2010, and 2009, respectively.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 2 – REGULATORY MATTERS and SIGNIFICANT RISKS and UNCERTAINTIES - Continued
Commercial Real Estate Concentrations
As mentioned previously the adverse economic conditions have primarily impacted the real estate secured loan portfolio. Non-residential real estate and construction and development loans are often riskier and tend to have significantly larger balances than home equity loans or residential mortgage loans to individuals. While the Company believes that the commercial real estate concentration risk is mitigated by diversification among the types and characteristics of real estate collateral properties, sound underwriting practices, and ongoing portfolio monitoring and market analysis, the repayments of these loans usually depends on the successful operation of a business or the sale of the underlying property. As a result, these loans are more likely to be unfavorably affected by adverse conditions in the real estate market or the economy in general, which may result in increasing levels of loan charge-offs and non-performing assets and the reduction of earnings. When we take collateral in foreclosures and similar proceedings, we are required to mark the related asset to the then fair market value of the collateral, which may ultimately result in a loss. It is possible that Royal Bank may be required to maintain higher levels of capital than it would be otherwise be expected to maintain as a result of the Bank’s commercial real estate loans, which may require the Company to obtain additional capital.
Non-residential real estate and construction and land development loans held for investment were $236.7 million at December 31, 2011 comprising 57% of total loans compared to $284.1 million or 57% of total loans at December 31, 2010. Royal Bank was successful in reducing the CRE concentration, which includes loans held for sale from $289.1 million at June 30, 2009 to $178.8 million at December 31, 2011, which amounted to 187.3% of total capital and 202.4% of Tier 1 capital. At December 31, 2011, total construction/land loans (“CL loans”) including loans held for sale amounted to $63.4 million, or 66.5%, of total capital and 71.8% of Tier 1 capital. Based on capital levels calculated under U.S. GAAP, as shown above, Royal Bank no longer has a concentration of commercial real estate loans as defined in the joint agency “Guidance on Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices” issued on December 12, 2006 (“Guidance”). Based on capital levels calculated under RAP (see discussions under “GAAP RAP Difference” under “Note 1 -Significant Accounting Policies” and “Note 15 – Regulatory Capital Requirements” to the Consolidated Financial Statements), CRE loans and CL loans as a percentage of total capital and Tier 1 capital, respectively, are 217.0%, 237.1%, 77.0% and 84.1%. Under RAP, Royal Bank no longer has a concentration of commercial real estate loans as defined in the Guidance. Included in the figures above are loans held for sale as of December 31, 2011.
Liquidity and Funds Management
Royal Bank has limited capacity to borrow additional funds in the event it is needed for liquidity purposes. However, Royal Bank has continued to maintain liquidity measures that are well in excess of the target levels. As discussed in “Note 10 – Borrowings and Subordinated Debentures” to the Consolidated Financial Statement, Royal Bank has an over collateralized delivery requirement of 105% with the FHLB as a result of the level of non-performing assets and the losses that have been experienced over the past four years. The ability to borrow additional funds is based on the amount of collateral that is available to be pledged. As of December 31, 2011, Royal Bank had approximately $3 million of available borrowing capacity at the FHLB as a result of excess collateral that has been pledged. In addition at December 31, 2011, Royal Bank had $132.4 million in unpledged agency securities that were available to be pledged as collateral if needed and $24.5 million in cash on hand. Royal Bank also has limited availability to borrow from the Federal Reserve Discount Window, which was approximately $7 million at December 31, 2011, and was based on collateral pledged.
At December 31, 2011, the liquidity to deposits ratio was 31.8% compared to Royal Bank’s 12% policy target and the liquidity to total liabilities ratio was 23.9% compared to Royal Bank’s 10% policy target. Brokered CDs declined $221.1 million from $226.9 million at June 30, 2009 to $5.8 million at December 31, 2011. Borrowings declined $135.9 million from $283.9 million at June 30, 2009 to $148.0 million at December 31, 2011.
The Company also has unfunded pension plan obligations of $14.9 million as of December 31, 2011 which potentially could impact liquidity. The Company plans to fund the pension plan obligations through existing Company owned life insurance policies.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 2 – REGULATORY MATTERS and SIGNIFICANT RISKS and UNCERTAINTIES - Continued
Dividend and Interest Restrictions
Due to the MOU and the Federal Reserve Agreement, our ability to obtain lines of credit, to receive attractive collateral treatment from funding sources, and to pursue all attractive funding alternatives in this current low interest rate environment could be impacted and thereby limit liquidity alternatives. On August 13, 2009, the Company’s board of directors determined to suspend regular quarterly cash dividends on the $30.4 million in Series A Preferred Stock and to suspend interest payments on the $25.8 million in trust preferred securities. As of December 31, 2011, the Series A Preferred stock dividend in arrears is $4.1 million, which has not been recognized in the consolidated financial statements. As of December 31, 2011 the trust preferred interest payment in arrears was $1.8 million and has been recorded in interest expense and accrued interest payable. The Company believes the decision to suspend the preferred cash dividends and the trust preferred interest payments will better support the capital position of Royal Bank. As a result of the Company missing the sixth quarterly dividend payment due on November 16, 2010, the Treasury exercised its rights under the Capital Purchase Program and appointed two directors to our board of directors in 2011 until all accrued but unpaid dividends have been paid in full by the Company.
At December 31, 2011, as a result of significant losses within Royal Bank, the Company had negative retained earnings and therefore would not have been able to declare and pay any cash dividends. Royal Bank must receive prior approval from the FDIC and the Department before declaring and paying a dividend to the Company. Under the Federal Reserve Agreement the Company may not declare or pay any dividends without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System.
Capital Adequacy
In connection with a prior bank regulatory examination, the FDIC concluded, based upon its interpretation of the Consolidated Reports of Condition and Income (the “Call Report”) instructions and under regulatory accounting principles (“RAP”), that income from Royal Bank’s tax lien business should be recognized on a cash basis, not an accrual basis. Royal Bank’s current accrual method is in accordance with U.S. GAAP. Royal Bank disagrees with the FDIC’s conclusion and filed the Call Report for December 31, 2011 and the previous five quarters in accordance with U.S. GAAP. However, the change in the manner of revenue recognition for the tax lien business for regulatory accounting purposes affects Royal Bank’s and potentially the Company’s capital ratios as disclosed in “Note 15 - Regulatory Capital Requirements” to the Consolidated Financial Statements. Royal Bank is in discussions with the FDIC to resolve the matter.
Under the MOU, Royal Bank must maintain a minimum total risk-based capital ratio and a minimum Tier 1 leverage ratio of 12% and 8%, respectively. At December 31, 2011, based on capital levels calculated under RAP, Royal Bank’s total risk-based capital and Tier 1 leverage ratios were 15.04% and 9.09%, respectively.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 2 – REGULATORY MATTERS and SIGNIFICANT RISKS and UNCERTAINTIES - Continued
Department of Justice Investigation (“DOJ”)
As described under “Item 1 – Business” of this Report, Royal Bank holds a 60% equity interest in each of Crusader Servicing Corporation (“CSC”) and Royal Tax Lien Services, LLC (“RTL”). CSC and RTL acquire, through public auction, delinquent tax liens in various jurisdictions thereby assuming a superior lien position to most other lien holders, including mortgage lien holders. On March 4, 2009, each of CSC and RTL received grand jury subpoenas issued by the U.S. District Court for New Jersey upon application of the Antitrust Division of the U.S. Department of Justice (“DOJ”). The subpoenas sought certain documents and information relating to an ongoing investigation being conducted by the DOJ relating to alleged bid-rigging at tax lien auctions in New Jersey. Royal Bank, CSC and RTL have produced to the DOJ documents responsive to the subpoenas and have been cooperating with the DOJ throughout the investigation. On February 23, 2012, the former President of CSC and RTL entered a plea of guilty to one count of bid-rigging at certain auctions for tax liens in New Jersey from 1998 until approximately the spring of 2009. The former President’s employment with CSC and RTL effectively terminated in November 2010. As previously disclosed, Royal Bank had been advised that neither CSC nor RTL were targets of the DOJ investigation, but they were subjects of the investigation. It is possible, particularly in light of the plea entered by the former President of CSC and RTL, that the outcome of the investigation could result in fines and penalties being assessed against both CSC and RTL, which could also result in reputational risk due to negative publicity. No proceedings have been instituted by the DOJ or any other governmental authority against CSC or RTL as of the date of this filing.
As a result of the plea agreements of the former President of CSC and RTL and others resulting from the DOJ investigation, on March 13, 2012, the former president of RTL and CSC, RTL, CSC, the Company and certain other parties were named as defendants in a putative class action lawsuit filed in the Superior Court of New Jersey, Chancery Division on behalf of a proposed class of taxpayers who became delinquent in paying their municipal tax obligations (Boyer v. Robert W. Stein, Crusader Servicing Corp. Royal Tax Lien Services LLC, Royal Bancshares of Pennsylvania, Inc., et al., Superior Court of New Jersey, Chancery Division, Docket No. C-14007/12). On March 28, 2012, CSC, RTL and the Company removed this case to the U.S. District Court for the District of New Jersey. The lawsuit alleges violations of the New Jersey Antitrust Act and unjust enrichment, and seeks treble damages, attorney fees and injunctive relief.
As of the date of this filing, the Company cannot reasonably estimate the possible loss or range of loss that may result from these actions or proceedings.
Management Plans
In addition to increased board oversight and the creation of a Regulatory Compliance Committee in response to the previous Orders, the Company has enhanced the board through the addition of experienced directors with diverse backgrounds. The new members are comprised of the following: the CEO of a public company who has legal and consulting experience, a former banking regulator with consulting experience, a former CEO of a much larger financial institution who has bank turnaround experience, a former President of a larger financial institution (Treasury appointee), a former executive within the financial services industry (Treasury appointee) and a former senior partner of a public accounting firm.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 2 – REGULATORY MATTERS and SIGNIFICANT RISKS and UNCERTAINTIES - Continued
The Company implemented a strategy to mitigate the negative impact to the capital ratios associated with losses in earnings through the reduction of the balance sheet (deleveraging), which was accomplished primarily through the redemption of brokered deposits and FHLB borrowings by reducing the balances of cash, investment securities and loans. This strategy of reducing the size of the balance sheet has provided greater use of the existing capital despite the continued losses of income by maintaining that capital ratio as a percentage of the remaining reduced level of assets in order to achieve capital ratios at required regulatory levels. The board and management remain committed to meeting the capital level requirements for Royal Bank as set forth in the previous Orders and current MOU and have therefore developed a contingency plan to maintain capital ratios at required levels. The contingency plan expands the deleveraging beyond the redemption of brokered CDs and FHLB advances and considers additional measures, if required, to insure that capital ratios continue to meet the current requirements of the MOU. These additional measures include the following: consider selling selected branches with high concentrations of retail CDs, consider selling specific segments of the loan portfolio, consider a shareholder rights offering, and consider reducing the level of investment securities by allowing maturing CDs to selectively runoff. It is extremely unlikely that all of the above alternatives would be initiated.
The deleveraging of the balance sheet over the past 30 months resulted from paying off FHLB advances and redeeming brokered CDs totaling $344.4 million within Royal Bank. As part of the restructuring of the investment portfolio, the Company also reduced the investment portfolio by approximately $110 million in the past two years, primarily during 2010, which was almost entirely within Royal Bank. In addition, during the past two years loans have declined by approximately $262 million due to pay downs of principal, payoffs, charge-offs, transfers to OREO and sale of Royal Asian.
The Company’s strategic plan includes compliance with the MOU and the Federal Reserve Agreement discussed above, reducing the level of classified loans within the loan portfolio and improving the overall level of credit quality, maintaining reduced credit risk within the investment portfolio and returning to profitability. In concert with these efforts, the Company has started to transition more toward a community bank focus within its geographic footprint and adjacent markets. This will be achieved through the continued diversification of the loan portfolio, increased emphasis on the growth of core deposits, the utilization of enterprise risk management for reviewing strategic initiatives and maintenance of improved underwriting standards. The strategic plan provides a framework for maintaining required capital ratios while also continuing the reduction of the risk profile of the Company and Royal Bank. During the past two years the Company has made significant progress in reducing losses in earnings, improving capital ratios, improving credit quality, reducing the CRE concentration, strengthening the board of directors and maintaining strong liquidity.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 3 - INVESTMENT SECURITIES
The amortized cost, gross unrealized gains and losses, and fair value of the Company’s available-for-sale investment securities are summarized as follows:
| As of December 31, 2011 | | | | | Included in Accumulated Other Comprehensive Income (AOCI) | | | | |
| | | | | | | | | Gross unrealized losses | | | | |
| (In thousands) | | Amortized cost | | | Gross unrealized gains | | | Non-OTTI in AOCI | | | Non-credit related OTTI in AOCI | | | Fair value | |
| Investment securities available-for-sale | | | | | | | | | | | | | | | |
| Mortgage-backed securities-residential | | $ | 16,763 | | | $ | 309 | | | $ | (67 | ) | | $ | - | | | $ | 17,005 | |
| U.S. government agencies | | | 35,966 | | | | 122 | | | | (4 | ) | | | - | | | | 36,084 | |
| Common stocks | | | 130 | | | | 118 | | | | - | | | | - | | | | 248 | |
| Collateralized mortgage obligations: | | | | | | | | | | | | | | | | | | | | |
| Issued or guaranteed by U.S. government agencies | | | 231,262 | | | | 3,315 | | | | (543 | ) | | | - | | | | 234,034 | |
| Non-agency | | | 4,739 | | | | 94 | | | | (1 | ) | | | - | | | | 4,832 | |
| Corporate bonds | | | 13,342 | | | | 104 | | | | (471 | ) | | | - | | | | 12,975 | |
| Municipal bonds | | | 985 | | | | - | | | | (20 | ) | | | | | | | 965 | |
| Trust preferred securities | | | 13,665 | | | | 2,280 | | | | - | | | | - | | | | 15,945 | |
| Other securities | | | 6,586 | | | | 347 | | | | (15 | ) | | | - | | | | 6,918 | |
| Total available for sale | | $ | 323,438 | | | $ | 6,689 | | | $ | (1,121 | ) | | $ | - | | | $ | 329,006 | |
| As of December 31, 2010 | | | | | Included in Accumulated Other Comprehensive Income (AOCI) | | | | |
| | | | | | | | | Gross unrealized losses | | | | |
| (In thousands) | | Amortized cost | | | Gross unrealized gains | | | Non-OTTI in AOCL | | | Non-credit related OTTI in AOCI | | | Fair value | |
| Investment securities available-for-sale | | | | | | | | | | | | | | | |
| Mortgage-backed securities-residential | | $ | 8,492 | | | $ | 348 | | | $ | - | | | $ | - | | | $ | 8,840 | |
| U.S. government agencies | | | 30,492 | | | | - | | | | (755 | ) | | | - | | | | 29,737 | |
| Common stocks | | | 381 | | | | 152 | | | | (50 | ) | | | - | | | | 483 | |
| Collateralized mortgage obligations: | | | | | | | | | | | | | | | | | | | | |
| Issued or guaranteed by U.S. government agencies | | | 231,717 | | | | 3,640 | | | | (704 | ) | | | - | | | | 234,653 | |
| Non-agency | | | 7,026 | | | | 114 | | | | (3 | ) | | | - | | | | 7,137 | |
| Corporate bonds | | | 9,483 | | | | - | | | | (197 | ) | | | - | | | | 9,286 | |
| Trust preferred securities | | | 16,566 | | | | 2,135 | | | | - | | | | (87 | ) | | | 18,614 | |
| Other securities | | | 6,436 | | | | 431 | | | | - | | | | - | | | | 6,867 | |
| Total available for sale | | $ | 310,593 | | | $ | 6,820 | | | $ | (1,709 | ) | | $ | (87 | ) | | $ | 315,617 | |
The investment portfolio grew $13.4 million from $315.6 million at December 31, 2010 to $329.0 million at December 31, 2011. The increase was primarily due to the reinvestment of cash flows from the loan and lease portfolio into government sponsored agency mortgage-backed securities and debt securities.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 3 - INVESTMENT SECURITIES – Continued
The amortized cost and fair value of investment securities at December 31, 2011, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
| | | As of December 31, 2011 | |
| (In thousands) | | Amortized cost | | | Fair value | |
| Within 1 year | | $ | 4,988 | | | $ | 5,003 | |
| After 1 but within 5 years | | | 11,496 | | | | 11,544 | |
| After 5 but within 10 years | | | 7,828 | | | | 7,586 | |
| After 10 years | | | 39,646 | | | | 41,836 | |
| Mortgage-backed securities-residential | | | 16,763 | | | | 17,005 | |
| Collateralized mortgage obligations: | | | | | | | | |
| Issued or guaranteed by U.S. government agencies | | | 231,262 | | | | 234,034 | |
| Non-agency | | | 4,739 | | | | 4,832 | |
| Total available for sale debt securities | | | 316,722 | | | | 321,840 | |
| No contractual maturity | | | 6,716 | | | | 7,166 | |
| Total available for sale securities | | $ | 323,438 | | | $ | 329,006 | |
Proceeds from the sales of investments available for sale during 2011, 2010 and 2009 were $113.0 million, $181.3 million, and $184.2 million, respectively. The following table summarizes gross realized gains and losses realized on the sale of securities recognized in earnings in the periods indicated:
| | | For the years ended December 31, | |
| (In thousands) | | 2011 | | | 2010 | | | 2009 | |
| Gross realized gains | | $ | 2,584 | | | $ | 1,938 | | | $ | 4,077 | |
| Gross realized losses | | | (802 | ) | | | (648 | ) | | | (2,185 | ) |
| Net realized gains (losses) | | $ | 1,782 | | | $ | 1,290 | | | $ | 1,892 | |
As of December 31, 2011, investment securities with a market value of $93.7 million were pledged as collateral to secure advances with the FHLB.
The Company evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis. The Company assesses whether OTTI is present when the fair value of a security is less than its amortized cost. All investment securities are evaluated for OTTI under FASB ASC Topic 320, “Investments-Debt & Equity Securities” (“ASC Topic 320”). The non-agency collateralized mortgage obligations that are rated below AA are evaluated under FASB ASC Topic 320 Subtopic 40, “Beneficial Interests in Securitized Financial Assets” or under FASB ASC Topic 325, “Investments-Other”. In determining whether OTTI exists, management considers numerous factors, including but not limited to: (1) the length of time and the extent to which the fair value is less than the amortized cost, (2) the Company’s intent to hold or sell the security, (3) the financial condition and results of the issuer including changes in capital, (4) the credit rating of the issuer, (5) analysts earnings estimate, (6) industry trends specific to the security, and (7) timing of debt maturity and status of debt payments.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 3 - INVESTMENT SECURITIES – Continued
Under ASC Topic 320, OTTI is considered to have occurred with respect to debt securities (1) if an entity intends to sell the security; (2) if it is more likely than not an entity will be required to sell the security before recovery of its amortized cost basis; or (3) the present value of the expected cash flows is not sufficient to recover the entire amortized cost basis. In addition, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell or will more likely than not be required to sell the security. If an entity intends to sell the security or will be required to sell the security, the OTTI shall be recognized in earnings equal to the entire difference between the fair value and the amortized cost basis at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before the recovery of its amortized cost basis, the OTTI shall be separated into two amounts, the credit-related loss and the noncredit-related loss. The credit-related loss is based on the present value of the expected cash flows and is recognized in earnings. The noncredit-related loss is based on other factors such as illiquidity and is recognized in other comprehensive income.
The tables below indicate the length of time individual securities have been in a continuous unrealized loss position at December 31, 2011:
| As of December 31, 2011 | | Less than 12 months | | | 12 months or longer | | | Total | |
| (In thousands) | | Fair value | | | Gross unrealized losses | | | Number of positions | | | Fair value | | | Gross unrealized losses | | | Number of positions | | | Fair value | | | Gross unrealized losses | | | Number of positions | |
| Investment securities available for sale | | | | | | | | | | | | | | | | | | | | | | |
| Mortgage-backed securities-residential | | $ | 9,588 | | | $ | (67 | ) | | | 2 | | | $ | - | | | $ | - | | | | - | | | $ | 9,588 | | | $ | (67 | ) | | | 2 | |
| U.S. government agencies | | | 2,999 | | | | (1 | ) | | | 1 | | | | 3,996 | | | $ | (3 | ) | | | 1 | | | | 6,995 | | | | (4 | ) | | | 2 | |
| Collateralized mortgage obligations: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Issued or guaranteed by U.S. government agencies | | | 35,511 | | | | (374 | ) | | | 8 | | | | 10,149 | | | | (169 | ) | | | 3 | | | | 45,660 | | | | (543 | ) | | | 11 | |
| Non-agency | | | - | | | | - | | | | - | | | | 669 | | | | (1 | ) | | | 1 | | | | 669 | | | | (1 | ) | | | 1 | |
| Corporate bonds | | | 3,804 | | | | (197 | ) | | | 5 | | | | 3,751 | | | | (274 | ) | | | 4 | | | | 7,555 | | | | (471 | ) | | | 9 | |
| Municipal bonds | | | 965 | | | | (20 | ) | | | 1 | | | | - | | | | - | | | | - | | | | 965 | | | | (20 | ) | | | 1 | |
| Other securities | | | 502 | | | | (15 | ) | | | 1 | | | | - | | | | - | | | | - | | | | 502 | | | | (15 | ) | | | 1 | |
| Total available for sale | | $ | 53,369 | | | $ | (674 | ) | | | 18 | | | $ | 18,565 | | | $ | (447 | ) | | | 9 | | | $ | 71,934 | | | $ | (1,121 | ) | | | 27 | |
The AFS portfolio had gross unrealized losses of $1.1 million at December 31, 2011, which improved from gross unrealized losses of $1.8 million at December 31, 2010. The slight improvement in gross unrealized losses of $675,000 is related to the overall improvement in the fair values of the securities in the Company’s investment portfolio offset by $1.8 million in impairment charges, which includes $1.7 million on one trust preferred security. In determining the Company’s intent not to sell and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, management considers the following factors: current liquidity and availability of other non-pledged assets that permits the investment to be held for an extended period of time but not necessarily until maturity, capital planning, and any specific investment committee goals or guidelines related to the disposition of specific investments.
Common stocks: As of December 31, 2011, the Company had three common stocks of financial institutions with a total fair value of $248,000 and an unrealized gain of $118,000. During 2011 the Company sold six investments in common stocks and recorded a gain of $106,000.
For all debt security types discussed below the fair value is based on prices provided by brokers and safekeeping custodians with the exception of trust preferred securities which is described below.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 3 - INVESTMENT SECURITIES – Continued
Mortgage-backed securities issued by U.S. government agencies and U.S. government sponsored enterprises: As of December 31, 2011, the Company had two mortgage-backed securities with a fair value of $9.6 million and gross unrealized losses of $67,000, or 0.7% of their aggregate cost. The two mortgage-backed securities had been in an unrealized loss position for less than six months. The unrealized loss is attributable to a combination of factors, including relative changes in interest rates since the time of purchase. The contractual cash flows for these securities are guaranteed by U.S. government agencies and U.S. government-sponsored enterprises. Based on its assessment of these factors, management believes that the unrealized losses on these debt securities are a function of changes in investment spreads and interest rate movements and not changes in credit quality. Management expects to recover the entire amortized cost basis of these securities. The Company does not intend to sell these securities before recovery of their cost basis and will not more likely than not be required to sell these securities before recovery of their cost basis. Therefore, management has determined that these securities are not other-than-temporarily impaired at December 31, 2011.
U.S. government-sponsored agencies (“U.S. Agencies”): As of December 31, 2011, the Company had two U.S. Agencies with a fair value of $7.0 million and gross unrealized losses of $4,000, or less than 0.1%, of their aggregate cost. One of these U.S. Agencies has been in an unrealized loss position for less than one year and the other one for more than one year. Management believes that the unrealized losses on these debt securities are a function of changes in investment spreads. Management expects to recover the entire amortized cost basis of these securities. The Company does not intend to sell these securities before recovery of their cost basis and will not more likely than not be required to sell these securities before recovery of their cost basis. Therefore, management has determined that these securities are not other-than-temporarily impaired at December 31, 2011.
U.S. government issued or sponsored collateralized mortgage obligations (“Agency CMOs”): As of December 31, 2011, the Company had eleven Agency CMOs with a fair value of $45.7 million and gross unrealized losses of $543,000, or 1.2% of their aggregate cost. Three of the Agency CMOs had been in an unrealized loss position for more than one year and the remaining eight have been in an unrealized loss position for six months or less. The unrealized loss is attributable to a combination of factors, including relative changes in interest rates since the time of purchase. The contractual cash flows for these securities are guaranteed by U.S. government agencies and U.S. government-sponsored enterprises. Based on its assessment of these factors, management believes that the unrealized losses on these debt securities are a function of changes in investment spreads and interest rate movements and not changes in credit quality. Management expects to recover the entire amortized cost basis of these securities. The Company does not intend to sell these securities before recovery of their cost basis and will not more likely than not be required to sell these securities before recovery of their cost basis. Therefore, management has determined that these securities are not other-than-temporarily impaired at December 31, 2011.
Non-agency collateralized mortgage obligations (“Non-agency CMOs”): As of December 31, 2011, the Company had one non-agency CMO with a fair value of $669,000 with a gross unrealized loss of $1,000, or 0.2% of the aggregate cost. The non-agency CMO bond has been in an unrealized loss position for more than twelve months. The Company evaluated the impairment to determine if it could expect to recover the entire amortized cost basis of the non-agency CMO bond by considering numerous factors including credit default rates, conditional prepayment rates, current and expected loss severities, delinquency rates, and geographic concentrations. The bond is rated AAA. The Company does not intend to sell the non-agency CMO and it is not more likely than not that the Company will be required to sell the investment before recovery of the amortized cost basis. Therefore, the Company does not consider the bond to be other-than–temporarily impaired as of December 31, 2011.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 3 - INVESTMENT SECURITIES – Continued
Corporate bonds: As of December 31, 2011, the Company had nine corporate bonds with a fair value of $7.6 million and gross unrealized losses of $471,000, or 5.9% of the aggregate cost. Four of the corporate bonds had been in an unrealized loss position for more than one year and the remaining five have been in an unrealized loss position for three months. All nine bonds are above investment grade. The Company’s unrealized losses in investments in corporate bonds represent interest rate risk and not credit risk of the underlying issuers. As previously mentioned management also considered (1) the length of time and the extent to which the fair value is less than the amortized cost, (2) the Company’s intent to hold or sell the security, (3) the financial condition and results of the issuer including changes in capital, (4) the credit rating of the issuer, (5) analysts earnings estimate, (6) industry trends specific to the security, and (7) timing of debt maturity and status of debt payments. Management utilized discounted cash flow analysis based upon the credit ratings of the securities, liquidity risk premiums, and the recent corporate spreads for similar securities as required under ASC Topic 320 to determine the credit risk component of the corporate bonds. Based on these analyses, there was no credit-related loss on the bonds. Because the Company does not intend to sell the corporate bonds and it is not more likely than not that the Company will be required to sell the bonds before recovery of their amortized cost basis, which may be maturity, the Company does not consider the nine bonds to be other-than-temporarily impaired at December 31, 2011.
Municipal bonds: As of December 31, 2011, the Company had one municipal bond issued by the City of Chicago with a fair value of $965,000 with a gross unrealized loss of $20,000, or 2.0% of the aggregate cost. The municipal bond has been in an unrealized loss position for less than three months and is investment grade. The unrealized loss is attributable to a combination of factors, including Chicago’s financial situation. During the fourth quarter, the three major ratings agencies gave Chicago’s credit a stable outlook. Because the Company does not intend to sell the bonds and it is not more likely than not that the Company will be required to sell the bond before recovery of its amortized cost basis, which may be maturity, the Company does not consider the bond to be other-than-temporarily impaired at December 31, 2011.
Trust preferred securities: As of December 31, 2011, the Company had six trust preferred securities issued by four individual name companies (reflecting, where applicable the impact of mergers and acquisitions of issuers subsequent to original purchase) in the financial services/banking industry. The valuations of trust preferred securities were based upon the fair market values of active trades for one of the securities and ASC Topic 320 using cash flow analysis for the remaining five securities. Contractual cash flows and a market rate of return were used to derive fair value for each of these securities. Factors that affected the market rate of return included (1) any uncertainty about the amount and timing of the cash flows, (2) the credit risk, (3) liquidity of the instrument, and (4) observable yields from trading data and bid/ask indications. Credit risk spreads and liquidity premiums were analyzed to derive the appropriate discount rate. During 2011, the Company recorded an impairment charge to earnings of $1.7 million on one trust preferred security which was equal to the amortized cost. This trust preferred security had been in an unrealized loss position for longer than twelve months, is not rated, and was issued by a non-public company. The impairment reflects the credit concerns related to the financial institution that issued this long term financial obligation. Management does not believe the Company will recover the entire amortized cost of this security due to the issuer’s financial losses and reductions of capital.
Other securities: As of December 31, 2011, the Company had seven investments in real estate funds. As of December 31, 2011, one of the private equity real estate funds had a fair value of $502,000 and an unrealized loss of $15,000 or 2.9% of the aggregate cost. During the first quarter of 2010, management concluded that the fund was other-than-temporarily impaired and recorded an impairment charge of $63,000. After reviewing the fund’s financials, asset values, and its near-term projections, management concluded that there was no additional impairment in 2011.
The Company will continue to monitor all of the above investments to determine if the discounted cash flow analysis, continued negative trends, market valuations or credit defaults result in impairment that is other than temporary.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 3 - INVESTMENT SECURITIES – Continued
The following table presents a roll-forward of the balance of credit-related impairment losses on debt securities held at December 31, 2011 and 2010 for which a portion of an other-than-temporary impairment was recognized in other comprehensive income:
| (In thousands) | | 2011 | | | 2010 | |
| Balance at January 1, | | $ | 924 | | | $ | 1,896 | |
| Reductions for securities sold during the period (realized) | | | - | | | | (859 | ) |
| Reductions for securities for which the amount previously recognized in other comprehensive income was recognized in earnings because the Company does not expect to recover the entire amortized cost | | | (751 | ) | | | - | |
| Reductions for securities for which the amount previously recognized in other comprehensive income was recognized in earnings because the Company intends to sell the security | | | - | | | | (113 | ) |
| Balance at December 31, | | $ | 173 | | | $ | 924 | |
The following table summarizes other-than-temporary impairment losses on securities recognized in earnings in the periods indicated:
| | | For the years ended December 31, | |
| (In thousands) | | 2011 | | | 2010 | | | 2009 | |
| Non-agency collateralized mortgage obligations | | $ | - | | | $ | - | | | $ | 459 | |
| Corporate bonds | | | - | | | | 58 | | | | 1,353 | |
| Trust preferred securities | | | 1,749 | | | | 193 | | | | 3,009 | |
| Common stocks | | | 47 | | | | - | | | | 4,334 | |
| Preferred stocks | | | - | | | | 165 | | | | 1,117 | |
| Other securities | | | - | | | | 63 | | | | 769 | |
| Total OTTI recognized in earnings | | $ | 1,796 | | | $ | 479 | | | $ | 11,041 | |
The tables below indicate the length of time individual securities have been in a continuous unrealized loss position at December 31, 2010:
| As of December 31, 2010 | | Less than 12 months | | | 12 months or longer | | | Total | |
| (In thousands) | | Fair value | | | Gross Unrealized losses | | | Number of positions | | | Fair value | | | Gross Unrealized losses | | | Number of positions | | | Fair value | | | Gross Unrealized losses | | | Number of positions | |
| Investment securities available for sale | | | | | | | | | | | | | | | | | | | | | |
| U.S. government agencies | | $ | 29,737 | | | $ | (755 | ) | | | 8 | | | $ | - | | | $ | - | | | | - | | | $ | 29,737 | | | $ | (755 | ) | | | 8 | |
| Common stocks | | | 96 | | | | (50 | ) | | | 2 | | | | - | | | | - | | | | - | | | | 96 | | | | (50 | ) | | | 2 | |
| Collateralized mortgage obligations: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Issued or guaranteed by U.S. government agencies | | | 73,169 | | | | (687 | ) | | | 19 | | | | 4,429 | | | | (17 | ) | | | 1 | | | | 77,598 | | | | (704 | ) | | | 20 | |
| Non-agency | | | 918 | | | | (3 | ) | | | 1 | | | | - | | | | - | | | | - | | | | 918 | | | | (3 | ) | | | 1 | |
| Corporate bonds | | | 8,986 | | | | (197 | ) | | | 9 | | | | - | | | | - | | | | - | | | | 8,986 | | | | (197 | ) | | | 9 | |
| Trust preferred securities | | | - | | | | - | | | | - | | | | 1,662 | | | | (87 | ) | | | 1 | | | | 1,662 | | | | (87 | ) | | | 1 | |
| Total available for sale | | $ | 112,906 | | | $ | (1,692 | ) | | | 39 | | | $ | 6,091 | | | $ | (104 | ) | | | 2 | | | $ | 118,997 | | | $ | (1,796 | ) | | | 41 | |
During 2010, the Company recorded a total impairment charge to earnings of $479,000 related to preferred stocks, trust preferred securities, corporate bonds, and real estate investment funds. Management concluded that these investments were OTTI.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 4 – LOANS AND LEASES
Major classifications of LHFI are as follows:
| | | As of December 31, | |
| (In thousands) | | 2011 | | | 2010 | |
| Loans secured by real estate: | | | | | | |
| Construction | | $ | 14,066 | | | $ | 29,044 | |
| Land development | | | 40,054 | | | | 50,594 | |
| Secured by 1-4 family residential real estate: | | | | | | | | |
| Revolving, open-end loans secured by residential real estate and extended under lines of credit | | | 1,165 | | | | 1,252 | |
| All other loans secured by 1-4 family residential real estate: | | | | | | | | |
| Secured by first liens | | | 23,521 | | | | 26,166 | |
| Secured by junior liens | | | 1,951 | | | | 1,881 | |
| Secured by multi family (5 or more) residential real estate | | | 11,622 | | | | 10,277 | |
| Secured by non-farm nonresidential real estate | | | 182,579 | | | | 194,203 | |
| Tax certificates | | | 48,809 | | | | 70,443 | |
| Commercial and industrial loans | | | 54,136 | | | | 74,027 | |
| Loans to individuals for household, family, and other personal expenditures | | | 861 | | | | 768 | |
| Lease financing receivables (net of unearned income) | | | 36,014 | | | | 38,725 | |
| All other loans | | | 88 | | | | 25 | |
| Less: Deferred loan fees | | | (623 | ) | | | (551 | ) |
| Total LHFI, net of unearned income | | $ | 414,243 | | | $ | 496,854 | |
The Company granted loans to the officers and directors of the Company and to their associates. In accordance with Regulation O, related party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than normal risk of collectability. The aggregate dollar amount of these loans and commitments was $8.8 million and $3.9 million at December 31, 2011 and 2010. During 2011 three new related party loans totaling $5.8 million were approved and three were paid off. Total payments received on related party loans in 2011 were $915,000.
The Company classifies its leases as finance leases, in accordance with FASB ASC Topic 840, “Leases”. The difference between the Company’s gross investment in the lease and the cost or carrying amount of the leased property, if different, is recorded as unearned income, which is amortized to income over the lease term by the interest method.
The Company grants commercial and real estate loans, including construction and land development primarily in the greater Philadelphia metropolitan area as well as selected locations throughout the mid-Atlantic region. The Company also has participated with other financial institutions in selected construction and land development loans outside these geographic areas. The Company has a concentration of credit risk in commercial real estate and construction and land development loans at December 31, 2011. A substantial portion of its debtors’ ability to honor these contracts is dependent upon the housing sector specifically and the economy in general.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 4 – LOANS AND LEASES – Continued
The Company uses a nine point grading risk classification system commonly used in the financial services industry as the credit quality indicator. The first four classifications are rated Pass. The riskier classifications include Watch, Special Mention, Substandard, Doubtful and Loss. The risk rating is related to the underlying credit quality and probability of default. These risk ratings are used to calculate the historical loss component of the allowance.
| | · | Pass: includes credits that demonstrate a low probability of default; |
| | · | Watch: a warning classification which includes credits that are beginning to demonstrate above average risk through declining earnings, strained cash flows, increased leverage and/or weakening market fundamentals; |
| | · | Special mention: includes credits that have potential weaknesses that if left uncorrected could weaken the credit or result in inadequate protection of the Company’s position at some future date. While potentially weak, credits in this classification are marginally acceptable and loss of principal or interest is not anticipated; |
| | · | Substandard accrual: includes credits that exhibit a well-defined weakness which currently jeopardizes the repayment of debt and liquidation of collateral even though they are currently performing. These credits are characterized by the distinct possibility that the Company may incur a loss in the future if these weaknesses are not corrected; |
| | · | Non-accrual (substandard non-accrual, doubtful, loss): includes credits that demonstrate serious problems to the point that it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. |
All loans, at the time of presentation to the appropriate loan committee, are given an initial loan “risk” rating by the CCO. From time to time, and at the general direction of any of the various loan committees, the ratings may be changed based on the findings of that committee. Items considered in assigning ratings include the financial strength of the borrower and/or guarantors, the type of collateral, the collateral lien position, the type of loan and loan structure, any potential risk inherent in the specific loan type, higher than normal monitoring of the loan or any other factor deemed appropriate by any of the various committees for changing the rating of the loan. Any such change in rating is reflected in the minutes of that committee.
The following tables present risk ratings for each loan portfolio segment at December 31, 2011 and 2010, excluding LHFS.
| As of December 31, 2011 | | | | | | | | Special | | | | | | | | | | |
| (In thousands) | | Pass | | | Watch | | | Mention | | | Substandard | | | Non-accrual | | | Total | |
| Construction and land development | | $ | 1,303 | | | $ | 17,493 | | | $ | 19,936 | | | $ | 2,374 | | | $ | 13,014 | | | $ | 54,120 | |
| Non-residential real estate | | | 87,308 | | | | 64,878 | | | | 13,722 | | | | - | | | | 16,671 | | | | 182,579 | |
| Commercial & industrial | | | 19,073 | | | | 12,101 | | | | 18,242 | | | | - | | | | 4,720 | | | | 54,136 | |
| Residential real estate | | | 15,335 | | | | 9,092 | | | | 1,071 | | | | - | | | | 1,139 | | | | 26,637 | |
| Multi-family | | | 4,962 | | | | 3,907 | | | | 1,050 | | | | - | | | | 1,703 | | | | 11,622 | |
| Leasing | | | 35,355 | | | | 147 | | | | 27 | | | | - | | | | 485 | | | | 36,014 | |
| Tax certificates | | | 47,786 | | | | - | | | | - | | | | - | | | | 1,023 | | | | 48,809 | |
| Consumer | | | 847 | | | | 102 | | | | - | | | | - | | | | - | | | | 949 | |
| Subtotal LHFI | | | 211,969 | | | | 107,720 | | | | 54,048 | | | | 2,374 | | | | 38,755 | | | | 414,866 | |
| Less: Deferred loan fees | | | | | | | | | | | | | | | | | | | | | | | (623 | ) |
| Total LHFI | | | | | | | | | | | | | | | | | | | | | | $ | 414,243 | |
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 4 – LOANS AND LEASES – Continued
| As of December 31, 2010 | | | | | | | | Special | | | | | | | | | | |
| (In thousands) | | Pass | | | Watch | | | Mention | | | Substandard | | | Non-accrual | | | Total | |
| Construction and land development | | $ | 7,913 | | | $ | 24,056 | | | $ | 27,911 | | | $ | - | | | $ | 19,758 | | | $ | 79,638 | |
| Non-residential real estate | | | 97,142 | | | | 49,278 | | | | 37,723 | | | | - | | | | 10,060 | | | | 194,203 | |
| Commercial & industrial | | | 27,864 | | | | 6,488 | | | | 25,400 | | | | 8,317 | | | | 5,958 | | | | 74,027 | |
| Residential real estate | | | 19,272 | | | | 7,430 | | | | 198 | | | | - | | | | 2,399 | | | | 29,299 | |
| Multi-family | | | 2,804 | | | | 4,117 | | | | 903 | | | | - | | | | 2,453 | | | | 10,277 | |
| Leasing | | | 37,731 | | | | 252 | | | | 10 | | | | - | | | | 732 | | | | 38,725 | |
| Tax certificates | | | 68,641 | | | | - | | | | - | | | | - | | | | 1,802 | | | | 70,443 | |
| Consumer | | | 768 | | | | 25 | | | | - | | | | - | | | | - | | | | 793 | |
| Subtotal LHFI | | | 262,135 | | | | 91,646 | | | | 92,145 | | | | 8,317 | | | | 43,162 | | | | 497,405 | |
| Less: Deferred loan fees | | | | | | | | | | | | | | | | | | | | | | | (551 | ) |
| Total LHFI | | | | | | | | | | | | | | | | | | | | | | $ | 496,854 | |
The following tables are an aging analysis of past due payments for each loan portfolio segment at December 31, 2011 and 2010, excluding LHFS.
| As of December 31, 2011 | | 30-59 Days | | | 60-89 Days | | | Accruing | | | Total | | | | | | | |
| (In thousands) | | Past Due | | | Past Due | | | 90+ Days | | | Non-accrual | | | Current | | | Total | |
| Construction and land development | | $ | - | | | $ | - | | | $ | - | | | $ | 13,014 | | | $ | 41,106 | | | $ | 54,120 | |
| Non-residential real estate | | | 2,837 | | | | 100 | | | | - | | | | 16,671 | | | | 162,971 | | | | 182,579 | |
| Commercial & industrial | | | 148 | | | | - | | | | - | | | | 4,720 | | | | 49,268 | | | | 54,136 | |
| Residential real estate | | | 527 | | | | 382 | | | | - | | | | 1,139 | | | | 24,589 | | | | 26,637 | |
| Multi-family | | | - | | | | - | | | | - | | | | 1,703 | | | | 9,919 | | | | 11,622 | |
| Leasing | | | 147 | | | | 28 | | | | - | | | | 485 | | | | 35,354 | | | | 36,014 | |
| Tax certificates | | | - | | | | - | | | | - | | | | 1,023 | | | | 47,786 | | | | 48,809 | |
| Consumer | | | - | | | | - | | | | - | | | | - | | | | 949 | | | | 949 | |
| Subtotal LHFI | | | 3,659 | | | | 510 | | | | - | | | | 38,755 | | | | 371,942 | | | | 414,866 | |
| Less: Deferred loan fees | | | | | | | | | | | | | | | | | | | | | | | (623 | ) |
| Total LHFI | | | | | | | | | | | | | | | | | | | | | | $ | 414,243 | |
| As of December 31, 2010 | | 30-59 Days | | | 60-89 Days | | | Accruing | | | Total | | | | | | | |
| (In thousands) | | Past Due | | | Past Due | | | 90+ Days | | | Non-accrual | | | Current | | | Total | |
| Construction and land development | | $ | - | | | $ | - | | | $ | - | | | $ | 19,758 | | | $ | 59,880 | | | $ | 79,638 | |
| Non-residential real estate | | | 9,469 | | | | - | | | | - | | | | 10,060 | | | | 174,674 | | | | 194,203 | |
| Commercial & industrial | | | 146 | | | | 659 | | | | - | | | | 5,958 | | | | 67,264 | | | | 74,027 | |
| Residential real estate | | | 1,341 | | | | 341 | | | | - | | | | 2,399 | | | | 25,218 | | | | 29,299 | |
| Multi-family | | | - | | | | - | | | | - | | | | 2,453 | | | | 7,824 | | | | 10,277 | |
| Leasing | | | 252 | | | | 10 | | | | - | | | | 732 | | | | 37,731 | | | | 38,725 | |
| Tax certificates | | | - | | | | - | | | | - | | | | 1,802 | | | | 68,641 | | | | 70,443 | |
| Consumer | | | 18 | | | | - | | | | - | | | | - | | | | 775 | | | | 793 | |
| Subtotal LHFI | | | 11,226 | | | | 1,010 | | | | - | | | | 43,162 | | | | 442,007 | | | | 497,405 | |
| Less: Deferred loan fees | | | | | | | | | | | | | | | | | | | | | | | (551 | ) |
| Total LHFI | | | | | | | | | | | | | | | | | | | | | | $ | 496,854 | |
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 4 – LOANS AND LEASES – Continued
The following table details the composition of the non-accrual loans.
| | | As of December 31, 2011 | | | As of December 31, 2010 | |
| (In thousands) | | Loan balance | | | Specific reserves | | | Loan balance | | | Specific reserves | |
| Non-accrual loans held for investment | | | | | | | | | | | | |
| Construction and land development | | $ | 13,014 | | | $ | - | | | $ | 19,758 | | | $ | - | |
| Non-residential real estate | | | 16,671 | | | | - | | | | 10,060 | | | | 1,363 | |
| Commercial & industrial | | | 4,720 | | | | - | | | | 5,958 | | | | - | |
| Residential real estate | | | 1,139 | | | | 24 | | | | 2,399 | | | | 74 | |
| Multi-family | | | 1,703 | | | | - | | | | 2,453 | | | | 245 | |
| Leasing | | | 485 | | | | 114 | | | | 732 | | | | 194 | |
| Tax certificates | | | 1,023 | | | | - | | | | 1,802 | | | | 31 | |
| Total non-accrual LHFI | | $ | 38,755 | | | $ | 138 | | | $ | 43,162 | | | $ | 1,907 | |
| Non-accrual loans held for sale | | | | | | | | | | | | | | | | |
| Construction and land development | | $ | 8,901 | | | $ | - | | | $ | 13,371 | | | $ | - | |
| Non-residential real estate | | | 3,634 | | | | - | | | | 8,638 | | | | - | |
| Residential real estate | | | 34 | | | | - | | | | 634 | | | | - | |
| Total non-accrual LHFS | | $ | 12,569 | | | | - | | | $ | 22,643 | | | | - | |
| Total non-accrual loans | | $ | 51,324 | | | $ | 138 | | | $ | 65,805 | | | $ | 1,907 | |
Total non-accrual loans at December 31, 2011 were $51.3 million and were comprised of $38.7 million in LHFI and $12.6 million in LHFS. Non-accrual loans were $65.8 million and were comprised of $43.2 million in LHFI and $22.6 million in LHFS at December 31, 2010. The $14.5 million decline in total non-accrual loans was the result of a $30.7 million reduction in existing non-accrual loan balances through payments or loans becoming current and placed back on accrual, $13.6 million in charge-offs and write downs related to impairment analysis and transfers to OREO of $4.2 million which collectively were offset by $34.0 million in additions. Construction and land loans, non-residential real estate and commercial loans represent 43%, 40% and 9%, respectively of the $51.3 million in non-accrual loans at December 31, 2011. If interest had been accrued, such income would have been approximately $5.1 million, $6.5 million, and $6.2 million, for the years ended December 31, 2011, 2010, and 2009, respectively. At December 31, 2011, the Company had no loans past due 90 days or more on which interest continues to accrue.
Impaired Loans
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 Company does not accrue interest income on impaired non-accrual loans. Excess proceeds received over the principal amounts due on impaired non-accrual loans are recognized as income on a cash basis.
Total cash collected on impaired loans and leases during 2011, 2010, and 2009 was $29.9 million, $21.7 million, and $21.6 million, respectively, of which $29.7 million, $21.4 million, and $21.3 million was credited to the principal balance outstanding on such loans, respectively.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 4 – LOANS AND LEASES – Continued
The following is a summary of information pertaining to impaired loans:
| | | As of December 31, | |
| (In thousands) | | 2011 | | | 2010 | |
| Impaired LHFI with a valuation allowance | | $ | 1,068 | | | $ | 9,620 | |
| Impaired LHFI without a valuation allowance | | | 45,009 | | | | 32,805 | |
| Impaired LHFS | | | 12,569 | | | | 22,643 | |
| Total impaired loans and leases | | $ | 58,646 | | | $ | 65,068 | |
| Valuation allowance related to impaired LHFI | | $ | 138 | | | $ | 1,907 | |
| | | For the years ended December 31, | |
| (In thousands) | | 2011 | | | 2010 | | | 2009 | |
| Average investment in impaired loans and leases | | $ | 62,936 | | | $ | 78,225 | | | $ | 79,754 | |
| Interest income recognized on impaired loans and leases | | $ | 202 | | | $ | 335 | | | $ | 242 | |
| Interest income recognized on a cash basis on impaired loans and leases | | $ | 202 | | | $ | 335 | | | $ | 242 | |
Troubled Debt Restructurings
A loan modification is deemed a troubled debt restructuring (“TDR”) when two conditions are met: 1) the borrower is experiencing financial difficulty and 2) a concession is made by the Company that would not otherwise be considered for a borrower or collateral with similar credit risk characteristics. During the third quarter of 2011, the Company adopted ASU 2011-02, “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring” (“ASU 2011-02”) which amended guidance related to identifying and reporting TDRs. If in modifying a loan the Company, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession it would not normally consider then the loan modification is classified as a TDR. All loans classified as TDRs are considered to be impaired. TDRs are returned to an accrual status when the loan is brought current, has performed in accordance with the contractual restructured terms for a reasonable period of time (generally six months) and the ultimate collectibility of the total contractual restructured principal and interest is no longer in doubt. As required under ASU 2011-02, the Company reassessed all loan modifications that occurred after December 31, 2010 for identification as TDRs. At December 31, 2011, the Company had twelve TDRs, of which seven are on non-accrual status, with a total carrying value of $14.2 million. At the time of the modifications, eight of the loans were already classified as impaired loans. The Company had one TDR at December 31, 2010 which was classified as a multi-family real estate non-accrual loan in the amount of $1.8 million. The Company’s policy for TDRs is to recognize income on currently performing restructured loans under the accrual method.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 4 – LOANS AND LEASES – Continued
The following table details the Company’s TDRs that are on an accrual status and a non-accrual status at December 31, 2011.
| | | As of December 31, 2011 | |
| (In thousands) | | Number of loans | | | Accrual Status | | | Non- Accrual Status | | | Total TDRs | |
| Construction and land development | | | 5 | | | $ | 4,354 | | | $ | 1,587 | | | $ | 5,941 | |
| Non-residential real estate | | | 3 | | | | 640 | | | | 2,995 | | | | 3,635 | |
| Commercial & industrial | | | 1 | | | | 2,744 | | | | - | | | | 2,744 | |
| Residential real estate | | | 2 | | | | - | | | | 180 | | | | 180 | |
| Multi-family | | | 1 | | | | - | | | | 1,703 | | | | 1,703 | |
| Total | | | 12 | | | $ | 7,738 | | | $ | 6,465 | | | $ | 14,203 | |
The following table presents newly restructured loans that occurred during the year ended December 31, 2011.
| | | Modifications by type for the year ended December 31, 2011 | |
| (Dollars in thousands) | | Number of loans | | | Rate | | | Term | | | Payment | | | Combination | | | Total | | | Pre-Modification Outstanding Recorded Investment | | | Post-Modification Outstanding Recorded Investment | |
| Construction and land development | | | 5 | | | $ | - | | | $ | 2,374 | | | $ | - | | | $ | 3,567 | | | $ | 5,941 | | | $ | 8,219 | | | $ | 6,693 | |
| Non-residential real estate | | | 3 | | | | - | | | | 2,935 | | | | 60 | | | | 640 | | | | 3,635 | | | | 3,803 | | | | 3,803 | |
| Commercial & industrial | | | 1 | | | | - | | | | - | | | | - | | | | 2,744 | | | | 2,744 | | | | 2,774 | | | | 2,774 | |
| Residential real estate | | | 2 | | | | 139 | | | | - | | | | 41 | | | | - | | | | 180 | | | | 194 | | | | 194 | |
| Total | | | 11 | | | $ | 139 | | | $ | 5,309 | | | $ | 101 | | | $ | 6,951 | | | $ | 12,500 | | | $ | 14,990 | | | $ | 13,464 | |
At December 31, 2011, the Company had two non-residential real estate TDRs with a payment default occurring within 12 months of the restructure date, and the payment default occurring during the three and twelve months ended December 31, 2011. The carrying amount of the TDRs in default was $3.0 million at December 31, 2011.
NOTE 5 – ALLOWANCE FOR LOAN AND LEASE LOSSES
Changes in the allowance for loan and lease losses were as follows:
| | | For the years ended December 31, | |
| (In thousands) | | 2011 | | | 2010 | | | 2009 | |
| Balance at the beginning of the year | | $ | 21,129 | | | $ | 30,331 | | | $ | 28,908 | |
| Charge-offs | | | (13,211 | ) | | | (31,714 | ) | | | (19,818 | ) |
| Recoveries | | | 734 | | | | 1,300 | | | | 636 | |
| Net charge-offs | | | (12,477 | ) | | | (30,414 | ) | | | (19,182 | ) |
| Reduction due to Royal Asian sale | | | - | | | | (928 | ) | | | - | |
| Provision for loan losses and leases | | | 7,728 | | | | 22,140 | | | | 20,605 | |
| Balance at the end of year | | $ | 16,380 | | | $ | 21,129 | | | $ | 30,331 | |
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 5 – ALLOWANCE FOR LOAN AND LEASE LOSSES - Continued
The following table presents the detail of the allowance and the loan portfolio disaggregated by loan portfolio segment as of December 31, 2011 and 2010.
Allowance for Loan and Leases Losses and Loans Held for Investment
For the year ended December 31, 2011
| (In thousands) | | Non- residential real estate | | | Construction and land development | | | Commercial & industrial | | | Multi- family | | | Residential | | | Consumer | | | Leasing | | | Tax certificates | | | Unallocated | | | Total | |
| Allowance for Loan and Leases Losses | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Beginning balance | | $ | 9,534 | | | $ | 3,976 | | | $ | 3,797 | | | $ | 652 | | | $ | 1,106 | | | $ | 12 | | | $ | 1,670 | | | $ | 380 | | | $ | 2 | | | $ | 21,129 | |
| Charge-offs | | | (1,685 | ) | | | (5,755 | ) | | | (2,901 | ) | | | (328 | ) | | | (635 | ) | | | - | | | | (868 | ) | | | (1,039 | ) | | | - | | | | (13,211 | ) |
| Recoveries | | | 357 | | | | 196 | | | | 22 | | | | - | | | | 153 | | | | - | | | | 6 | | | | - | | | | - | | | | 734 | |
| Provision | | | (462 | ) | | | 4,106 | | | | 1,413 | | | | 207 | | | | 564 | | | | 8 | | | | 503 | | | | 1,084 | | | | 305 | | | | 7,728 | |
| Ending balance | | $ | 7,744 | | | $ | 2,523 | | | $ | 2,331 | | | $ | 531 | | | $ | 1,188 | | | $ | 20 | | | $ | 1,311 | | | $ | 425 | | | $ | 307 | | | $ | 16,380 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ending balance: related to loans individually evaluated for impairment | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | 24 | | | $ | - | | | $ | 114 | | | $ | - | | | $ | - | | | $ | 138 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ending balance: related to loans collectively evaluated for impairment | | $ | 7,744 | | | $ | 2,523 | | | $ | 2,331 | | | $ | 531 | | | $ | 1,164 | | | $ | 20 | | | $ | 1,197 | | | $ | 425 | | | $ | 307 | | | $ | 16,242 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| LHFI | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ending balance | | $ | 182,579 | | | $ | 54,120 | | | $ | 54,136 | | | $ | 11,622 | | | $ | 26,637 | | | $ | 949 | | | $ | 36,014 | | | $ | 48,809 | | | $ | - | | | $ | 414,866 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ending balance: individually evaluated for impairment | | $ | 17,311 | | | $ | 17,368 | | | $ | 7,267 | | | $ | 1,703 | | | $ | 1,139 | | | $ | - | | | $ | 266 | | | $ | 1,023 | | | $ | - | | | $ | 46,077 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ending balance: collectively evaluated for impairment | | $ | 165,268 | | | $ | 36,752 | | | $ | 46,869 | | | $ | 9,919 | | | $ | 25,498 | | | $ | 949 | | | $ | 35,748 | | | $ | 47,786 | | | $ | - | | | $ | 368,789 | |
Allowance for Loan and Leases Losses and Loans Held for Investment
For the year ended December 31, 2010
| (In thousands) | | Non- residential real estate | | | Construction and land development | | | Commercial & industrial | | | Multi- family | | | Residential | | | Consumer | | | Leasing | | | Tax certificates | | | Unallocated | | | Total | |
| Allowance for Loan and Leases Losses | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Beginning balance | | $ | 10,039 | | | $ | 7,895 | | | $ | 6,542 | | | $ | - | | | $ | 3,762 | | | $ | 25 | | | $ | 1,757 | | | $ | 290 | | | $ | 21 | | | $ | 30,331 | |
| Charge-offs | | | (7,352 | ) | | | (13,413 | ) | | | (5,930 | ) | | | (787 | ) | | | (3,211 | ) | | | - | | | | (972 | ) | | | (49 | ) | | | - | | | | (31,714 | ) |
| Recoveries | | | 684 | | | | 116 | | | | 81 | | | | 18 | | | | 313 | | | | 37 | | | | 51 | | | | - | | | | - | | | | 1,300 | |
| Provision | | | 6,796 | | | | 9,508 | | | | 3,223 | | | | 1,421 | | | | 285 | | | | (47 | ) | | | 834 | | | | 139 | | | | (19 | ) | | | 22,140 | |
| Reduction due to Royal Asian sale | | | (633 | ) | | | (130 | ) | | | (119 | ) | | | - | | | | (43 | ) | | | (3 | ) | | | - | | | | - | | | | - | | | | (928 | ) |
| Ending balance | | $ | 9,534 | | | $ | 3,976 | | | $ | 3,797 | | | $ | 652 | | | $ | 1,106 | | | $ | 12 | | | $ | 1,670 | | | $ | 380 | | | $ | 2 | | | $ | 21,129 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ending balance: related to loans individually evaluated for impairment | | $ | 1,363 | | | $ | - | | | $ | - | | | $ | 245 | | | $ | 74 | | | $ | - | | | $ | 194 | | | $ | 31 | | | $ | - | | | $ | 1,907 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ending balance: related to loans collectively evaluated for impairment | | $ | 8,171 | | | $ | 3,976 | | | $ | 3,797 | | | $ | 407 | | | $ | 1,032 | | | $ | 12 | | | $ | 1,476 | | | $ | 349 | | | $ | 2 | | | $ | 19,222 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| LHFI | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ending balance | | $ | 194,203 | | | $ | 79,638 | | | $ | 74,027 | | | $ | 10,277 | | | $ | 29,299 | | | $ | 793 | | | $ | 38,725 | | | $ | 70,443 | | | $ | - | | | $ | 497,405 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ending balance: individually evaluated for impairment | | $ | 10,060 | | | $ | 19,758 | | | $ | 5,858 | | | $ | 2,453 | | | $ | 2,159 | | | $ | - | | | $ | 335 | | | $ | 1,802 | | | $ | - | | | $ | 42,425 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Ending balance: collectively evaluated for impairment | | $ | 184,143 | | | $ | 59,880 | | | $ | 68,169 | | | $ | 7,824 | | | $ | 27,140 | | | $ | 793 | | | $ | 38,390 | | | $ | 68,641 | | | $ | - | | | $ | 454,980 | |
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 5 – ALLOWANCE FOR LOAN AND LEASE LOSSES - Continued
The following table details the loans that were evaluated for impairment by loan segment.
| | | As of December 31, 2011 | |
| (In thousands) | | Unpaid principal balance | | | Recorded investment | | | Related allowance | | | Average recorded investment | | | Interest income recognized | |
| With no related allowance recorded: | | | | | | | | | | | | | | | |
| Construction and land development | | $ | 24,183 | | | $ | 17,368 | | | $ | - | | | $ | 13,331 | | | $ | 84 | |
| Non-residential real estate | | | 19,513 | | | | 17,311 | | | | - | | | | 7,732 | | | | 33 | |
| Commercial & industrial | | | 14,368 | | | | 7,267 | | | | - | | | | 8,257 | | | | 77 | |
| Residential real estate | | | 3,645 | | | | 337 | | | | - | | | | 950 | | | | - | |
| Multi-family | | | 1,888 | | | | 1,703 | | | | - | | | | 1,760 | | | | - | |
| Tax certificates | | | 4,658 | | | | 1,023 | | | | - | | | | 171 | | | | - | |
| Total: | | $ | 68,255 | | | $ | 45,009 | | | $ | - | | | $ | 32,201 | | | $ | 194 | |
| With an allowance recorded: | | | | | | | | | | | | | | | | | | | | |
| Construction and land development | | $ | - | | | $ | - | | | $ | - | | | $ | 4,514 | | | $ | - | |
| Non-residential real estate | | | - | | | | - | | | | - | | | | 2,642 | | | | - | |
| Commercial & industrial | | | - | | | | - | | | | - | | | | 1,394 | | | | - | |
| Residential real estate | | | 1,048 | | | | 778 | | | | 24 | | | | 915 | | | | 1 | |
| Multi-family | | | - | | | | - | | | | - | | | | 245 | | | | - | |
| Leasing | | | 266 | | | | 152 | | | | 114 | | | | 348 | | | | - | |
| Tax certificates | | | - | | | | - | | | | - | | | | 1,423 | | | | - | |
| Total: | | $ | 1,314 | | | $ | 930 | | | $ | 138 | | | $ | 11,481 | | | $ | 1 | |
| | | As of December 31, 2010 | |
| (In thousands) | | Unpaid principal balance | | | Recorded investment | | | Related allowance | | | Average recorded investment | | | Interest income recognized | |
| With no related allowance recorded: | | | | | | | | | | | | | | | |
| Construction and land development | | $ | 25,312 | | | $ | 19,758 | | | $ | - | | | $ | 28,105 | | | $ | 202 | |
| Non-residential real estate | | | 4,511 | | | | 4,255 | | | | - | | | | 13,650 | | | | 42 | |
| Commercial & industrial | | | 10,217 | | | | 5,858 | | | | - | | | | 5,236 | | | | 2 | |
| Residential real estate | | | 1,172 | | | | 1,119 | | | | - | | | | 3,243 | | | | 76 | |
| Multi-family | | | 1,935 | | | | 1,815 | | | | - | | | | 458 | | | | - | |
| Tax certificates | | | - | | | | - | | | | - | | | | 996 | | | | - | |
| Total: | | $ | 43,147 | | | $ | 32,805 | | | $ | - | | | $ | 51,688 | | | $ | 322 | |
| With an allowance recorded: | | | | | | | | | | | | | | | | | | | | |
| Construction and land development | | $ | - | | | $ | - | | | $ | - | | | $ | 13,512 | | | $ | 13 | |
| Non-residential real estate | | | 5,805 | | | | 4,442 | | | | 1,363 | | | | 5,057 | | | | - | |
| Commercial & industrial | | | - | | | | - | | | | - | | | | 1,782 | | | | - | |
| Residential real estate | | | 1,239 | | | | 966 | | | | 74 | | | | 1,153 | | | | - | |
| Multi-family | | | 638 | | | | 393 | | | | 245 | | | | 3,469 | | | | - | |
| Leasing | | | 335 | | | | 141 | | | | 194 | | | | 538 | | | | - | |
| Tax certificates | | | 4,850 | | | | 1,771 | | | | 31 | | | | 1,026 | | | | - | |
| Total: | | $ | 12,867 | | | $ | 7,713 | | | $ | 1,907 | | | $ | 26,537 | | | $ | 13 | |
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 6 – OTHER REAL ESTATE OWNED
OREO declined $8.2 million from $29.2 million at December 31, 2010 to $21.0 million at December 31, 2011. Set forth below is a table which details the changes in OREO from December 31, 2010 to December 31, 2011.
| | | For the year ended December 31, 2011 | |
| (In thousands) | | First Quarter | | | Second Quarter | | | Third Quarter | | | Fourth Quarter | |
| Beginning balance | | $ | 29,244 | | | $ | 30,681 | | | $ | 25,448 | | | $ | 21,921 | |
| Net proceeds from sales | | | (1,594 | ) | | | (4,320 | ) | | | (3,364 | ) | | | (972 | ) |
| Net gain on sales | | | 394 | | | | 900 | | | | 206 | | | | 138 | |
| Assets acquired on non-accrual loans | | | 3,030 | | | | 1,469 | | | | 1,124 | | | | 818 | |
| Other | | | - | | | | (535 | ) | | | - | | | | - | |
| Impairment charge | | | (393 | ) | | | (2,747 | ) | | | (1,493 | ) | | | (889 | ) |
| Ending balance | | $ | 30,681 | | | $ | 25,448 | | | $ | 21,921 | | | $ | 21,016 | |
During the fourth quarter of 2011, the Company sold collateral related to four loans. The Company received net proceeds of $312,000 and recorded a loss of $61,000 as a result of these sales. Additionally the Company sold six properties acquired through the tax lien portfolio. The Company received proceeds of $660,000 and recorded a net gain of $199,000 as a result of these sales. During the fourth quarter, the Company foreclosed on the collateral for one single-family residential loan and transferred $333,000 to OREO. In addition the Company acquired collateral related to the tax lien portfolio and transferred $485,000 to OREO. During the fourth quarter of 2011, the Company recorded $860,000 in impairment charges on OREO properties that included one apartment building, five single-family homes, nine residential lots, and 13 residential rental properties. The impairment charges were the result of impairment analyses using updated appraisals and current sales. The Company recorded impairment charges of $29,000 related to properties acquired through the tax lien portfolio.
During the third quarter of 2011, the Company sold collateral related to an apartment building in Pennsylvania foreclosed on in the second quarter of 2009. The Company received net proceeds of $2.8 million and recorded a gain of $253,000 as a result of this sale. In addition the Company sold collateral related to four loans. The Company received net proceeds of $284,000 and recorded a loss of $47,000 as a result of these sales. In addition to the sales mentioned above the Company sold six properties acquired through the tax lien portfolio. The Company received proceeds of $246,000 as a result of these sales. During the third quarter of 2011, the Company foreclosed on five residential properties related to two lending relationships. The Company transferred $348,000 to OREO after recording a $74,000 charge-off to the allowance. In addition the Company acquired collateral related to the tax lien portfolio and transferred $776,000 to OREO. During the third quarter of 2011, the Company recorded $1.4 million in impairment charges on five OREO properties as the result of impairment analyses using updated appraisals. The Company recorded impairment charges of $58,000 related to properties acquired through the tax lien portfolio.
During the second quarter of 2011, the Company sold collateral related to three loans. The Company received net proceeds of $3.7 million and recorded a gain of $912,000 as a result of these sales. Also during the second quarter, the collateral for a loan in which the Company was a participant was sold. The Company was entitled to 14.4% of the net sales proceeds. The Company received net proceeds of $424,000 related to the sale with the remaining proceeds of $535,000 held in escrow. In addition to the sales mentioned above the Company sold six properties acquired through the tax lien portfolio. The Company received proceeds of $195,000 and recorded losses of $12,000 as a result of these sales. During the second quarter of 2011, the Company foreclosed on 19 properties which were predominantly residential rental properties related to two lending relationships. The Company transferred $589,000 to OREO after recording an $835,000 charge-off to the allowance, for which $245,000 had previously been reserved, in the allowance in accordance with ASC Topic 310. The collateral for a loan in which the Company participates was acquired by the lead bank. The Company is entitled to 23.2% of the collateral value, which is farmland. The Company transferred $375,000 to OREO after recording a $79,000 charge-off in the allowance in accordance with ASC Topic 310. In addition the Company acquired collateral related to the tax lien portfolio and transferred $505,000 to OREO.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 6 – OTHER REAL ESTATE OWNED - Continued
During the second quarter of 2011, the Company entered into a sales agreement on a rental community consisting of 102 dwelling units for which the Company received a deed in lieu of foreclosure in the second quarter of 2010. The Company recorded a $2.2 million impairment charge based on the expected net proceeds of the sale. Additional impairment was recorded on two commercial building lots in Maryland that were transferred to OREO during the third quarter of 2010. After performing an impairment analysis using an updated appraisal on the two lots, the Company recorded a $355,000 impairment charge. The Company recorded impairment charges of $156,000 related to properties acquired through the tax lien portfolio.
During the first quarter of 2011, the Company sold portions of collateral related to two loans. The Company received net proceeds of $620,000 and recorded a net loss of $43,000. As a result of the sales of three single family homes related to one loan, the Company recorded an impairment charge of $100,000 on the remaining collateral. In addition to the sales mentioned above the Company sold five properties acquired through the tax lien portfolio. The Company received proceeds of $974,000 and recorded gains of $437,000 as a result of these sales. During the first quarter of 2011, the Company entered into sales agreements on two properties and recorded impairment charges of $293,000 based on the expected net proceeds. The Company acquired the collateral for one loan held for sale and transferred the fair value of $2.5 million to OREO in the first quarter of 2011. In addition the Company acquired collateral related to the tax lien portfolio and transferred $540,000 to OREO.
The Company is working to satisfactorily sell the remaining OREO properties using existing relationships and possible future auctions. However the Company recognizes that due to the continued weak housing and commercial real estate markets the successful disposition of the properties will likely take considerable time.
NOTE 7 - PREMISES AND EQUIPMENT
| | | | As of December 31, | |
| (In thousands) | Estimated Useful Lives | | 2011 | | | 2010 | |
| Land | | | $ | 2,396 | | | $ | 2,396 | |
| Buildings and leasehold improvements | 5 - 39 years | | | 7,534 | | | | 7,519 | |
| Furniture, fixtures and equipment | 3 - 7 years | | | 6,440 | | | | 6,310 | |
| | | | | 16,370 | | | | 16,225 | |
| Less accumulated depreciation and amortization | | | | (10,976 | ) | | | (10,490 | ) |
| Premises and equipment, net | | | $ | 5,394 | | | $ | 5,735 | |
Depreciation and amortization expense, related to premises and equipment, was approximately $486,000, $686,000, and $907,000, for the years ended 2011, 2010, and 2009, respectively. Depreciation and amortization related to real estate owned via equity investments is not included in the above table.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 8 - LEASE COMMITMENTS
The Company leases various premises under non-cancelable operating lease agreements, which expire through 2021 and require minimum annual rentals. The approximate minimum rental commitments under the leases are as follows for the year ended December 31, 2011:
| | | As of | |
| (In thousands) | | December 31, 2011 | |
| 2012 | | $ | 693 | |
| 2013 | | | 606 | |
| 2014 | | | 295 | |
| 2015 | | | 199 | |
| 2016 | | | 204 | |
| Thereafter | | | 379 | |
| Total lease commitments | | $ | 2,376 | |
The leases contain options to extend for periods from one to ten years. The cost of such lease extensions is not included in the above table. Rental expense for all leases was approximately $815,000, $1.3 million, and $1.2 million for the years ended December 31, 2011, 2010 and 2009, respectively. The decline in rental expense was related to the sale of Royal Asian in December 2010.
NOTE 9 – DEPOSITS
Deposits are summarized as follows:
| | | As of December 31, | |
| (In thousands) | | 2011 | | | 2010 | |
| Demand | | $ | 54,534 | | | $ | 52,872 | |
| NOW | | | 43,172 | | | | 40,884 | |
| Money Market | | | 182,830 | | | | 180,862 | |
| Savings | | | 16,263 | | | | 15,922 | |
| Time deposits (over $100) | | | 95,334 | | | | 105,788 | |
| Time deposits (under $100) | | | 177,960 | | | | 208,534 | |
| Brokered deposits | | | 5,823 | | | | 89,051 | |
| Total deposits | | $ | 575,916 | | | $ | 693,913 | |
Maturities of time deposits for the next five years and thereafter are as follows:
| | | As of | |
| (In thousands) | | December 31, 2011 | |
| 2012 | | $ | 136,573 | |
| 2013 | | | 88,579 | |
| 2014 | | | 23,810 | |
| 2015 | | | 7,944 | |
| 2016 | | | 6,285 | |
| Thereafter | | | 15,926 | |
| Total certificates of deposit | | $ | 279,117 | |
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 10 – BORROWINGS AND SUBORDINATED DEBENTURES
1. Advances from the Federal Home Loan Bank
Royal Bank has a $150 million line of credit with the FHLB of which $22.0 million was outstanding as of December 31, 2011. At December 31, 2011, advances from the FHLB totaling $104.2 million, which includes the $22.0 million mentioned above, will mature within one day to two years. The FHLB advances had a weighted average interest rate of 2.66%. The advances and the line of credit are collateralized by FHLB stock, government agencies and mortgage-backed securities, residential loans, and commercial real estate loans. As of December 31, 2011, investment securities with a market value of $93.7 million and loans with a book value of $77.6 million were pledged as collateral to the FHLB. The average balance of advances with the FHLB during 2011 was $107.7 million.
The available borrowing capacity is based on qualified collateral. During the first quarter of 2010, Royal Bank was notified by the FHLB that they were being placed on an over collateralized delivery requirement of 105%. The FHLB’s decision was based primarily upon the level of Royal Bank’s non-performing assets and net loss. The available amount for future borrowings will be based on the amount of collateral to be pledged.
At December 31, 2010, advances from FHLB totaled $110.7 million with maturities within one day to three years. These advances had a weighted average interest rate of 2.78%. The average balance of advances with the FHLB during 2010 was $185.1 million.
Presented below are the Company’s FHLB borrowings allocated by the year in which they mature with their corresponding weighted average rates:
| | | As of December 31, | |
| (Dollars in thousands) | | 2011 | | | 2010 | |
| | | Amount | | | Rate | | | Amount | | | Rate | |
| Advances maturing in | | | | | | | | | | | | |
| 2011 | | $ | - | | | | - | | | $ | 22,000 | | | | 0.72 | % |
| 2012 | | | 52,000 | | | | 2.64 | % | | | 30,000 | | | | 4.32 | % |
| 2013 | | | 50,000 | | | | 2.64 | % | | | 50,000 | | | | 2.64 | % |
| Amortizing advance, due April 2012, requiring monthly principal and interest of $558,400 | | | 2,218 | | | | 3.46 | % | | | 8,719 | | | | 3.46 | % |
| Total FHLB borrowings | | $ | 104,218 | | | | | | | $ | 110,719 | | | | | |
2. Other borrowings
The Company has a note payable with PNC Bank (“PNC”) at December 31, 2011 in the amount of $3.8 million with a maturity date of August 25, 2016. The note payable balance at December 31, 2010 was $4.2 million. The interest rate is a variable rate using rate index of one month LIBOR + 15 basis points and adjusts monthly. The interest rate at December 31, 2011 and 2010 was 0.44% and 0.40%, respectively.
At December 31, 2011 and 2010, the Company had additional borrowings of $40 million from PNC which will mature on January 7, 2018. These borrowings are secured by government agencies and mortgaged-backed securities. These borrowings have a weighted average interest rate of 3.65%. As of December 31, 2011, investment securities with a market value of $52.9 million were pledged as collateral to secure all borrowings with PNC.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 10 – BORROWINGS AND SUBORDINATED DEBENTURES - Continued
3. Subordinated debentures
The Company has outstanding $25.0 million of Trust Preferred Securities issued through two Delaware trust affiliates, Royal Bancshares Capital Trust I (“Trust I”) and Royal Bancshares Capital Trust II (“Trust II”) (collectively, the “Trusts”). The Company issued an aggregate principal amount of $12.9 million of floating rate junior subordinated debt securities to Trust I, which debt securities bear an interest rate of 2.70% at December 31, 2011, and reset quarterly at 3-month LIBOR plus 2.15%. The Company also issued an aggregate principal amount of $12.9 million of fixed/floating rate junior subordinated deferrable interest to Trust II, which debt securities had an initial interest rate of 5.80% until December 2009 and now resets quarterly at 3-month LIBOR plus 2.15%. The interest rate at December 31, 2011 was 2.70%.
Each of Trust I and Trust II issued an aggregate principal amount of $12.5 million of capital securities bearing fixed and/or fixed/floating interest rates corresponding to the debt securities held by each trust to an unaffiliated investment vehicle and an aggregate principal amount of $387,000 of common securities bearing fixed and/or fixed/floating interest rates corresponding to the debt securities held by each trust to the Company. The Company has fully and unconditionally guaranteed all of the obligations of the Trusts, including any distributions and payments on liquidation or redemption of the capital securities.
On August 13, 2009, the Company’s Board of Directors determined to suspend interest payments on the trust preferred securities. The Company’s Board of Directors took this action in consultation with the Federal Reserve Bank of Philadelphia as required by recent regulatory policy guidance. The Company currently has sufficient capital and liquidity to pay the scheduled interest payments; however, the Company believes this decision will better support the capital position of Royal Bank. As of December 31, 2011 the trust preferred interest payment in arrears was $1.8 million and has been recorded in interest expense and accrued interest payable.
NOTE 11 - INCOME TAXES
The components of the income tax expense included in the consolidated statements of operations are as follows:
| | | For the years ended December 31, | |
| (In thousands) | | 2011 | | | 2010 | | | 2009 | |
| Income tax expense | | | | | | | | | |
| Current | | $ | - | | | $ | - | | | $ | 648 | |
| Deferred | | | - | | | | - | | | | (174 | ) |
| Income tax expense | | $ | - | | | $ | - | | | $ | 474 | |
The difference between the applicable income tax expense and the amount computed by applying the statutory federal income tax rate of 35% in 2011, 2010, and 2009 is as follows:
| | | For the years ended December 31, | |
| (In thousands) | | 2011 | | | 2010 | | | 2009 | |
| Computed tax benefit at statutory rate | | $ | (2,997 | ) | | $ | (8,432 | ) | | $ | (11,474 | ) |
| Tax-exempt income | | | (2 | ) | | | (28 | ) | | | (120 | ) |
| Nondeductible expense | | | 29 | | | | 29 | | | | 58 | |
| Bank owned life insurance | | | (137 | ) | | | (133 | ) | | | 1,306 | |
| Bank owned life insurance excise penalty | | | - | | | | - | | | | 474 | |
| Increase in valuation allowance | | | 3,107 | | | | 8,564 | | | | 10,230 | |
| Applicable income tax expense | | $ | - | | | $ | - | | | $ | 474 | |
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 11 - INCOME TAXES - Continued
Deferred tax assets and liabilities consist of the following:
| | | As of December 31, | |
| (In thousands) | | 2011 | | | 2010 | |
| Deferred tax assets | | | | | | |
| Allowance for loan and lease losses | | $ | 5,998 | | | $ | 7,395 | |
| Tax net loss carryforward | | | 10,046 | | | | 9,984 | |
| Asset valuation reserves | | | 431 | | | | 431 | |
| Security writedowns | | | 1,929 | | | | 1,943 | |
| OREO writedowns | | | 7,462 | | | | 5,564 | |
| Investment in partnerships | | | 3,761 | | | | 2,398 | |
| Accrued pension liability | | | 5,453 | | | | 4,588 | |
| Accrued stock-based compensation | | | 812 | | | | 780 | |
| Net operating loss carryovers from Knoblauch State Bank | | | 1,232 | | | | 1,232 | |
| Non-accrual interest | | | 678 | | | | 2,029 | |
| Capital loss carryover | | | 1,589 | | | | - | |
| Other | | | 8 | | | | 8 | |
| Deferred tax assets before valuation allowance | | | 39,399 | | | | 36,352 | |
| Less valuation allowance | | | (36,233 | ) | | | (33,479 | ) |
| | | | | | | | | |
| Less valuation allowance for accumulated other comprehensive income items | | | (134 | ) | | | - | |
| Total deferred tax assets | | | 3,032 | | | | 2,873 | |
| Deferred tax liabilities | | | | | | | | |
| Penalties on delinquent tax certificates | | | 398 | | | | 596 | |
| Unrealized gains on investment securities available for sale | | | 1,337 | | | | 1,228 | |
| Accretion on investments | | | 650 | | | | 127 | |
| Prepaid deductions | | | 270 | | | | 545 | |
| Other | | | (37 | ) | | | (37 | ) |
| Total deferred tax liabilities | | | 2,618 | | | | 2,459 | |
| Net deferred tax assets, included in other assets | | $ | 414 | | | $ | 414 | |
As of December 31, 2011 the Company had net operating income tax loss carryforwards of approximately $28.7 million which are available to be carried forward to future tax years. These loss carryforwards will expire in 2031 if not utilized.
The Company has approximately $22.0 million of net operating loss carryovers from the acquisition of Knoblauch State Bank (“KSB”) of which $3.5 million was available to be utilized as of December 31, 2011. The utilization of these losses is subject to limitation under Section 382 of the Internal Revenue Code.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 11 - INCOME TAXES - Continued
The Company recognizes deferred tax assets and liabilities for the future tax consequences related to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for tax credits. The deferred tax assets, net of valuation allowances, totaled $414,000 at December 31, 2011 and 2010. Management evaluated the deferred tax assets for recoverability using a consistent approach which considers the relative impact of negative and positive evidence, including historical profitability and projections of future reversals of temporary differences and future taxable income. The Company is required to establish a valuation allowance for deferred tax assets and record a charge to income or shareholders' equity if management determines, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. In evaluating the need for a valuation allowance, the Company estimates future taxable income based on management approved business plans and ongoing tax planning strategies. This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws or variances between projected operating performance, actual results and other factors.
As of December 31, 2011, the Company was in a cumulative book taxable loss position for the three-year period ended December 31, 2011. For purposes of establishing a deferred tax asset valuation allowance, this cumulative book taxable loss position is considered significant objective evidence that the Company may not be able to realize some portion of the deferred tax assets in the future. The cumulative book taxable loss position was caused by the negative impact on results from the banking operations, investment impairments and loan and lease losses over the past three years. These conditions deteriorated dramatically during the three month period ended December 31, 2008 and continued throughout 2009, 2010 and 2011, causing a significant increase in the pre-tax losses due in part to much higher credit losses, and downward revisions to projections of future results.
As of December 31, 2011, 2010 and 2009, management concluded that it was more likely than not that the Company would not generate sufficient future taxable income to realize all of the deferred tax assets. Management’s conclusion was based on consideration of the relative weight of the available evidence and the uncertainty of future market conditions on results of operations. As a result, the Company recorded a non-cash charge of $15.5 million in the consolidated statements of operations in the period ended December 31, 2008 related to the establishment of a valuation allowance for the deferred tax asset for the portion of the future tax benefit that more likely than not will not be utilized in the future. During 2009, 2010 and 2011, the Company established additional valuation allowances of $10.2 million, $7.7 million, and $3.0 million, respectively, which was a result of the net operating losses for each year and the portion of the future tax benefit that more likely than not will not be utilized in the future. The additional valuation allowance did not impact the net loss as no tax benefit was recorded during 2011 or 2010. As of December 31, 2011 the valuation allowance for deferred tax assets totaled $36.4 million. The net deferred tax asset of $414,000 relates to projected reversals of temporary differences in 2012 that are projected to be carried back to a prior year.
The Company is subject to income taxes in the U. S. and various state and local jurisdictions. As of December 31, 2011, tax years 2005 through 2011 are subject to examination by various taxing authorities. Tax regulations are subject to interpretation of the related tax laws and regulations and require significant judgment to apply.
NOTE 12 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF CREDIT RISK
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they become payable. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 12 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF CREDIT RISK-Continued
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:
| | | As of December 31, | |
| (In thousands) | | 2011 | | | 2010 | |
| Financial instruments whose contract amounts represent credit risk | | | | | | |
| Open-end lines of credit | | $ | 13,600 | | | $ | 30,560 | |
| Commitments to extend credit | | | 7,073 | | | | - | |
| Standby letters of credit and financial guarantees written | | | 2,594 | | | | 2,755 | |
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, and others are for staged construction, the total commitment amounts do not necessarily represent immediate cash requirements.
The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation. Collateral held varies but may include personal or commercial real estate, accounts receivable, inventory or equipment.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. Most guarantees extend for one year and expire in decreasing amounts through April 2013. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds personal or commercial real estate, accounts receivable, inventory or equipment as collateral supporting those commitments for which collateral is deemed necessary. The extent of collateral held for those commitments is approximately 75%.
NOTE 13 – LEGAL CONTINGENCIES
As described under “Item 1 – Business” of this Report, Royal Bank holds a 60% equity interest in each of Crusader Servicing Corporation (“CSC”) and Royal Tax Lien Services, LLC (“RTL”). CSC and RTL acquire, through public auction, delinquent tax liens in various jurisdictions thereby assuming a superior lien position to most other lien holders, including mortgage lien holders. On March 4, 2009, each of CSC and RTL received grand jury subpoenas issued by the U.S. District Court for New Jersey upon application of the Antitrust Division of the U.S. Department of Justice (“DOJ”). The subpoenas sought certain documents and information relating to an ongoing investigation being conducted by the DOJ relating to alleged bid-rigging at tax lien auctions in New Jersey. Royal Bank, CSC and RTL have produced to the DOJ documents responsive to the subpoenas and have been cooperating with the DOJ throughout the investigation. On February 23, 2012, the former President of CSC and RTL entered a plea of guilty to one count of bid-rigging at certain auctions for tax liens in New Jersey from 1998 until approximately the spring of 2009. The former President’s employment with CSC and RTL effectively terminated in November 2010. As previously disclosed, Royal Bank had been advised that neither CSC nor RTL were targets of the DOJ investigation, but they were subjects of the investigation. It is possible, particularly in light of the plea entered by the former President of CSC and RTL, that the outcome of the investigation could result in fines and penalties being assessed against both CSC and RTL, which could also result in reputational risk due to negative publicity. No proceedings have been instituted by the DOJ or any other governmental authority against CSC or RTL as of the date of this filing.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 13 – LEGAL CONTINGENCIES-Continued
As a result of the plea agreements of the former President of CSC and RTL and others resulting from the DOJ investigation, on March 13, 2012, the former president of RTL and CSC, RTL, CSC, the Company and certain other parties were named as defendants in a putative class action lawsuit filed in the Superior Court of New Jersey, Chancery Division on behalf of a proposed class of taxpayers who became delinquent in paying their municipal tax obligations (Boyer v. Robert W. Stein, Crusader Servicing Corp. Royal Tax Lien Services LLC, Royal Bancshares of Pennsylvania, Inc., et al., Superior Court of New Jersey, Chancery Division, Docket No. C-14007/12). On March 28, 2012, CSC, RTL and the Company removed this case to the U.S. District Court for the District of New Jersey. The lawsuit alleges violations of the New Jersey Antitrust Act and unjust enrichment, and seeks treble damages, attorney fees and injunctive relief.
As of the date of this filing, the Company cannot reasonably estimate the possible loss or range of loss that may result from these actions or proceedings.
NOTE 14 – SHAREHOLDERS’ EQUITY
1. Preferred Stock
On February 20, 2009, as part of the Capital Purchase Program (“CPP”) established by the United States Department of Treasury (“Treasury”), the Company issued to Treasury 30,407 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, without par value per share (the “Series A Preferred Stock”), and a liquidation preference of $1,000 per share. In conjunction with the purchase of the Series A Preferred Stock, Treasury received a warrant to purchase 1,104,370 shares of the Company’s Class A common stock. The aggregate purchase price for the Series A Preferred Stock and warrant was $30.4 million in cash. The Series A Preferred Stock qualifies as Tier 1 capital and pays cumulative dividends at a rate of 5% per annum for the first five years, and 9% per annum thereafter. The Series A Preferred Stock may generally be redeemed by the Company at any time following consultation with its primary banking regulators. The warrant issued to Treasury has a 10-year term and is immediately exercisable upon its issuance, with an exercise price, subject to anti-dilution adjustments, equal to $4.13 per share of the common stock. The Company’s utilized the extra capital provided by the CPP funds to support its efforts to prudently and transparently provide lending and liquidity while also balancing the goal to remain well-capitalized.
2. Common Stock
The Company’s Class A common stock trades on the NASDAQ Global Market under the symbol RBPAA. There is no market for the Company’s Class B common stock. The Class B shares may not be transferred in any manner except to the holder’s immediate family. Class B shares may be converted to Class A shares at the rate of 1.15 to 1. Class B common stock is entitled to one vote for each Class A share and ten votes for each Class B share held. Holders of either class of common stock are entitled to conversion equivalent per share dividends when declared.
3. Payment of Dividends
Under the Pennsylvania Business Corporation Law, the Company may pay dividends only if, after giving effect to the dividend payment, the total assets of the Company would exceed the total liabilities of the Company plus the amount necessary to satisfy preferential rights of holders of senior shareholders, and the Company is solvent and would not be rendered insolvent by the dividend payment. There are also restrictions set forth in the Pennsylvania Banking Code of 1965 (the “Code”) and in the Federal Deposit Insurance Act (“FDIA”) concerning the payment of dividends by the Company. Under the Code, no dividends may be paid except from “accumulated net earnings” (generally retained earnings). Under the FDIA, no dividend may be paid if a bank is in arrears in the payment of any insurance assessment due to the FDIC. In addition, dividends paid by Royal Bank to the Company would be prohibited if the effect thereof would cause Royal Bank’s capital to be reduced below applicable minimum capital requirements.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 14 – SHAREHOLDERS’ EQUITY-Continued
On August 13, 2009, the Company’s board of directors determined to suspend regular quarterly cash dividends on the $30.4 million in Series A Preferred Stock. The Company’s board of directors took this action in consultation with the Federal Reserve Bank of Philadelphia as required by regulatory policy guidance. The Company currently has sufficient capital and liquidity to pay the scheduled dividends on the preferred stock; however, this decision better supports the capital position of Royal Bank, a wholly owned subsidiary of the Company. As of December 31, 2011, the Series A Preferred stock dividend in arrears was $4.1 million and has not been recognized in the consolidated financial statements. As a consequence of missing the sixth dividend payment in the fourth quarter of 2010, the Treasury had the right to appoint two directors to our board of directors until all accrued but unpaid dividends have been paid. The Treasury exercised its right and appointed two directors to the Company’s board of directors during 2011.
At December 31, 2011, as a result of significant losses within Royal Bank and cash and stock dividends declared and paid in previous years, the Company had negative retained earnings and therefore would not have been able to declare and pay any cash dividends. Royal Bank must receive prior approval from the FDIC and the Department before declaring and paying a dividend to the Company. Under the Federal Reserve Agreement as described in “Note 2 – Regulatory Matters and Significant Risks or Uncertainties” to the Consolidated Financial Statements, the Company may not declare or pay any dividends without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System.
Additionally, as a result of the CPP completed between the Treasury and the Company on February 20, 2009, the Company is required to receive Treasury’s approval for any increases in the dividend above the amount of the last regular quarterly common stock dividend paid prior to October 14, 2008 and any repurchases of Company common stock. These restrictions on the payment of dividends and the repurchases of common stock by the Company became effective immediately upon closing and remain in effect until the earlier date of the third anniversary of the closing date of the preferred shares and the date of the redemption of the preferred shares. In addition, under the terms of the CPP, the Company is not permitted to declare or pay cash dividends on, or redeem or otherwise acquire, stock that is junior to or on parity with the Series A Preferred Stock issued to Treasury at any time when the Company has not declared and paid full dividends on the Series A Preferred Stock.
NOTE 15 – REGULATORY CAPITAL REQUIREMENTS
The Company and Royal Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s and Royal Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. At December 31, 2011, the Company and Royal Bank met all capital adequacy requirements to which it is subject.
Under the informal agreement referenced in “Note 2 – Regulatory Matters and Significant Risks And Uncertainties” to the Consolidated Financial Statements, Royal Bank is required to maintain a minimum Tier 1 leverage ratio of 8% and a Total risk-based capital ratio of 12% during the term of the agreement. Royal Bank met these requirements as of December 31, 2011. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the table. As of December 31, 2011, Royal Bank met the criteria for a well capitalized institution.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 15 – REGULATORY CAPITAL REQUIREMENTS - Continued
In connection with a prior bank regulatory examination, the FDIC concluded, based upon its interpretation of the Consolidated Reports of Condition and Income (the “Call Report”) instructions and under regulatory accounting principles (“RAP”), that income from Royal Bank’s tax lien business should be recognized on a cash basis, not an accrual basis. Royal Bank’s current accrual method is in accordance with U.S. GAAP. Royal Bank disagrees with the FDIC’s conclusion and filed the Call Report for December 31, 2011 and the previous five quarters in accordance with U.S. GAAP. However, a change in the manner of revenue recognition for the tax lien business for regulatory accounting purposes affects Royal Bank’s and the Company’s capital ratios as shown below. Royal Bank is in discussions with the FDIC and expects resolve the matter in 2012.
The table below sets forth Royal Bank’s capital ratios under RAP based on the FDIC’s interpretation of the Call Report instructions:
| | | | | | | | | | | | | | | To be well capitalized | |
| | | | | | | | | For capital | | | capitalized under prompt | |
| | | Actual | | | adequacy purposes | | | corrective action provision | |
| (Dollars in thousands) | | Amount | | | Ratio | | | Amount | | | Ratio | | | Amount | | | Ratio | |
| Total capital (to risk-weighted assets) | | | | | | | | | | | | | | | | | | |
| At December 31, 2011 | | $ | 82,375 | | | | 15.04 | % | | $ | 43,803 | | | | 8.00 | % | | $ | 54,754 | | | | 10.00 | % |
| At December 31, 2010 | | $ | 89,547 | | | | 13.76 | % | | $ | 52,057 | | | | 8.00 | % | | $ | 65,071 | | | | 10.00 | % |
| Tier I capital (to risk-weighted assets) | | | | | | | | | | | | | | | | | | | | | | | | |
| At December 31, 2011 | | $ | 75,413 | | | | 13.77 | % | | $ | 21,902 | | | | 4.00 | % | | $ | 32,852 | | | | 6.00 | % |
| At December 31, 2010 | | $ | 81,253 | | | | 12.49 | % | | $ | 26,029 | | | | 4.00 | % | | $ | 39,043 | | | | 6.00 | % |
| Tier I capital (to average assets, leverage) | | | | | | | | | | | | | | | | | | | | | | | | |
| At December 31, 2011 | | $ | 75,413 | | | | 9.09 | % | | $ | 33,189 | | | | 4.00 | % | | $ | 41,486 | | | | 5.00 | % |
| At December 31, 2010 | | $ | 81,253 | | | | 8.03 | % | | $ | 40,493 | | | | 4.00 | % | | $ | 50,616 | | | | 5.00 | % |
The tables below reflect the adjustments to the net loss as well as the capital ratios for Royal Bank under U.S. GAAP:
| | | For the years ended December 31, | |
| (In thousands) | | 2011 | | | 2010 | |
| RAP net loss | | $ | (15,626 | ) | | $ | (30,011 | ) |
| Tax lien adjustment, net of noncontrolling interest | | | 7,738 | | | | 8,126 | |
| U.S. GAAP net loss | | $ | (7,888 | ) | | $ | (21,885 | ) |
| | | At December 31, 2011 | | | At December 31, 2010 | |
| | | As reported | | | As adjusted | | | As reported | | | As adjusted | |
| | | under RAP | | | for U.S. GAAP | | | under RAP | | | for U.S. GAAP | |
| Total capital (to risk-weighted assets) | | | 15.04 | % | | | 17.02 | % | | | 13.76 | % | | | 15.54 | % |
| Tier I capital (to risk-weighted assets) | | | 13.77 | % | | | 15.75 | % | | | 12.49 | % | | | 14.27 | % |
| Tier I capital (to average assets, leverage) | | | 9.09 | % | | | 10.48 | % | | | 8.03 | % | | | 9.24 | % |
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 15 – REGULATORY CAPITAL REQUIREMENTS - Continued
The tables below reflect the Company’s capital ratios:
| | | | | | | | | | | | | | | To be well capitalized | |
| | | | | | | | | For capital | | | capitalized under prompt | |
| | | Actual | | | adequacy purposes | | | corrective action provision | |
| (Dollars in thousands) | | Amount | | | Ratio | | | Amount | | | Ratio | | | Amount | | | Ratio | |
| Total capital (to risk-weighted assets) | | | | | | | | | | | | | | | | | | |
| At December 31, 2011 | | $ | 106,745 | | | | 18.82 | % | | $ | 45,386 | | | | 8.00 | % | | | N/A | | | | N/A | |
| At December 31, 2010 | | $ | 115,227 | | | | 17.21 | % | | $ | 53,570 | | | | 8.00 | % | | | N/A | | | | N/A | |
| Tier I capital (to risk-weighted assets) | | | | | | | | | | | | | | | | | | | | | | | | |
| At December 31, 2011 | | $ | 99,539 | | | | 17.55 | % | | $ | 22,693 | | | | 4.00 | % | | | N/A | | | | N/A | |
| At December 31, 2010 | | $ | 106,699 | | | | 15.93 | % | | $ | 26,785 | | | | 4.00 | % | | | N/A | | | | N/A | |
| Tier I Capital (to average assets, leverage) | | | | | | | | | | | | | | | | | | | | | | | | |
| At December 31, 2011 | | $ | 99,539 | | | | 11.64 | % | | $ | 34,209 | | | | 4.00 | % | | | N/A | | | | N/A | |
| At December 31, 2010 | | $ | 106,699 | | | | 9.68 | % | | $ | 44,075 | | | | 4.00 | % | | | N/A | | | | N/A | |
The Company has filed the Consolidated Financial Statements for Bank Holding Companies-FR Y-9C (“FR Y-9C”) for the most recent six quarters consistent with GAAP and the FR Y-9C instructions. In the event that a similar adjustment for RAP purposes would be required by the Federal Reserve on the holding company level, the adjusted ratios are shown in the table below.
| | | For the years ended December 31, | |
| (In thousands) | | 2011 | | | 2010 | |
| U.S. GAAP net loss | | $ | (8,563 | ) | | $ | (24,093 | ) |
| Tax lien adjustment, net of noncontrolling interest | | | (7,738 | ) | | | (8,126 | ) |
| RAP net loss | | $ | (16,301 | ) | | $ | (32,219 | ) |
| | | At December 31, 2011 | | | At December 31, 2010 | |
| | | As reported | | | As adjusted | | | As reported | | | As adjusted | |
| | | under U.S. GAAP | | | for RAP | | | under U.S. GAAP | | | for RAP | |
| Total capital (to risk-weighted assets) | | | 18.82 | % | | | 16.90 | % | | | 17.21 | % | | | 15.48 | % |
| Tier I capital (to risk-weighted assets) | | | 17.55 | % | | | 15.63 | % | | | 15.93 | % | | | 14.20 | % |
| Tier I capital (to average assets, leverage) | | | 11.64 | % | | | 10.29 | % | | | 9.68 | % | | | 8.56 | % |
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
The Company has a noncontributory nonqualified defined benefit pension plan covering certain eligible employees. The Company-sponsored pension plan provides retirement benefits under pension trust agreements. 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. The Company accounts for its pension in accordance with FASB ASC Topic 715 “Compensation-Retirement Benefits” (“ASC Topic 715”). ASC Topic 715 requires the recognition of a plan’s over-funded or under-funded status as an asset or liability with an offsetting adjustment to Accumulated OCI. ASC Topic 715 requires the determination of the fair values of plans assets at a company’s year-end and recognition of actuarial gains and losses, prior service costs or credits, and transition assets or obligations as a component of Accumulated OCI. These amounts will be subsequently recognized as components of net periodic benefits cost. Further, actuarial gains and losses that arise in subsequent periods that are not initially recognized as a component of net periodic benefit cost will be recognized as a component of Accumulated OCI. Those amounts will subsequently be recognized as a component of net periodic benefit cost as they are amortized during future periods.
The following table sets forth the plan’s funded status and amounts recognized in the Company’s consolidated balance sheets:
| | | For the years ended December 31, | |
| (In thousands) | | 2011 | | | 2010 | |
| Change in benefit obligation | | | | | | |
| Benefit obligation at beginning of year | | $ | 12,526 | | | $ | 11,549 | |
| Service cost | | | 306 | | | | 301 | |
| Interest cost | | | 615 | | | | 622 | |
| Benefits paid | | | (531 | ) | | | (484 | ) |
| Actuarial loss | | | 2,026 | | | | 538 | |
| Benefits obligation at end of year | | $ | 14,942 | | | $ | 12,526 | |
| Unrecognized prior service cost | | | 359 | | | | 449 | |
| Unrecognized actuarial loss | | | 3,845 | | | | 1,962 | |
| | | $ | 4,204 | | | $ | 2,411 | |
The accumulated benefit obligation at December 31, 2011 and 2010 was $14.1 million and $12.7 million, respectively.
The table below reflects the assumptions used to determine the benefit obligations:
| | | For the years ended December 31, | |
| | | 2011 | | | 2010 | |
| Discount rate | | | 4.00 | % | | | 5.00 | % |
| Rate of compensation increase | | | 4.00 | % | | | 4.00 | % |
The table below reflects the assumptions used to determine the net periodic pension cost:
| | | For the years ended December 31, | |
| | | 2011 | | | 2010 | | | 2009 | |
| Discount rate | | | 5.00 | % | | | 5.50 | % | | | 5.50 | % |
| Rate of compensation increase | | | 4.00 | % | | | 4.00 | % | | | 4.00 | % |
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 16 - PENSION PLANS - Continued
Net pension cost included the following components:
| | | For the years ended December 31, | |
| (In thousands) | | 2011 | | | 2010 | | | 2009 | |
| Service cost | | $ | 306 | | | $ | 301 | | | $ | 505 | |
| Interest cost | | | 615 | | | | 622 | | | | 563 | |
| Amortization prior service cost | | | 90 | | | | 90 | | | | 90 | |
| Amortization net actuarial loss | | | 141 | | | | 54 | | | | 27 | |
| Net periodic benefit cost | | $ | 1,152 | | | $ | 1,067 | | | $ | 1,185 | |
Benefit payments to be made from the Non-qualified Pension Plan are as follows:
| | | As of December 31, 2011 | |
| | | Non-Qualified | |
| (In thousands) | | Pension Plans | |
| 2012 | | $ | 652 | |
| 2013 | | | 671 | |
| 2014 | | | 671 | |
| 2015 | | | 974 | |
| 2016 | | | 1,075 | |
| Next five years thereafter | | | 5,586 | |
Benefit payments are expected to be made from insurance policies owned by the Company. The cash surrender value for these policies was approximately $2.6 million and $2.4 million as of December 31, 2011 and 2010, respectively.
Defined Contribution Plan
The Company has a capital accumulation and salary reduction plan under Section 401(k) of the Internal Revenue Code of 1986, as amended. Under the plan, all employees are eligible to contribute up to the maximum allowed by IRS regulation, with the Company matching 100% of any contribution between 1% and 5% subject to a $2,500 per employee annual limit. During 2010 and 2009, no matching contribution was made as a result of a management decision to reduce costs. During 2011 the Company partially reinstated the matching contribution and contributed $128,000 to the plan.
NOTE 17 - STOCK COMPENSATION PLANS
Under the Company’s Director’s and Employee’s Stock Option Plan, the Company may grant options to its directors, officers and employees for up to 2.1 million shares of common stock. Non-qualified stock options may be granted under the Plan. The exercise price of each option equals the market price of the Company’s stock on the date of grant and an option’s maximum term is ten years. Vesting periods range from one to five years from the date of grant. The Company recognized compensation expense for stock options and restricted stock in the amounts of $93,000, $35,000 and $226,000 for December 31, 2011, 2010 and 2009, respectively. The Company did not grant any options to purchase common stock in 2011.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 17 - STOCK COMPENSATION PLANS – Continued
1. Outside Directors’ Stock Option Plan
The Company adopted a non-qualified outside Directors’ Stock Option Plan (the “Directors’ Plan”). Under the terms of the Directors’ Plan, 250,000 shares of Class A stock were authorized for grants. Each director was entitled to a grant of an option to purchase 1,500 shares of stock annually. The options were granted at the fair market value at the date of the grant. The options are exercisable one year after the date of grant date and must be exercised within ten years of the grant.
A summary of the status of the Directors’ Plan is presented below:
| | | 2011 | | | 2010 | | | 2009 | |
| | | | | | Weighted | | | Weighted | | | (1) | | | | | | Weighted | | | | | | Weighted | |
| | | | | | Average | | | Average | | | Average | | | | | | Average | | | | | | Average | |
| | | | | | Exercise | | | Remaining | | | Intrinsic | | | | | | Exercise | | | | | | Exercise | |
| | | Options | | | Price | | | Term (yrs) | | | Value | | | Options | | | Price | | | Options | | | Price | |
| Options outstanding at beginning of year | | | 74,086 | | | $ | 20.02 | | | | 2.8 | | | | | | | | 90,197 | | | $ | 19.15 | | | | 95,950 | | | $ | 18.82 | |
| Exercised | | | - | | | | - | | | | | | | | | | | | - | | | | - | | | | - | | | | - | |
| Forfeited | | | - | | | | - | | | | | | | | | | | | (5,742 | ) | | | 11.72 | | | | (1,575 | ) | | | 21.78 | |
| Expired | | | (5,466 | ) | | | 11.90 | | | | | | | | | | | | (10,369 | ) | | | 17.09 | | | | (4,178 | ) | | | 10.57 | |
| Options outstanding at the end of the year | | | 68,620 | | | $ | 20.66 | | | | 2.0 | | | $ | - | | | | 74,086 | | | $ | 20.02 | | | | 90,197 | | | $ | 19.15 | |
| Options exercisable at the end of the year | | | 68,620 | | | $ | 20.66 | | | | 2.0 | | | $ | - | | | | 74,086 | | | $ | 20.02 | | | | 90,197 | | | $ | 19.15 | |
(1) The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had they exercised their options on December 31, 2011. The intrinsic value varies based on the changes in the market value in the Company’s stock. Because the exercise price exceeded the market value of the options, the average intrinsic value was $0 at December 31, 2011.
Information pertaining to options outstanding at December 31, 2011 is as follows:
| | | | Options outstanding | |
| | | | | | | Weighted | | | Weighted | |
| | | | | | | Average | | | Average | |
| Range of | | | Number | | | Exercise | | | Remaining | |
| exercise prices | | | Outstanding | | | Price | | | Term (yrs) | |
| $ | 17.00 - $20.00 | | | | 23,674 | | | $ | 18.11 | | | | 1.0 | |
| $ | 21.00 - $23.00 | | | | 44,946 | | | | 22.01 | | | | 2.5 | |
| | | | | | 68,620 | | | $ | 20.66 | | | | 2.0 | |
As of December 31, 2011 all outstanding shares are fully vested (exercisable). The ability to grant new options under this plan has expired.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 17 - STOCK COMPENSATION PLANS - Continued
2. Employee Stock Option and Appreciation Right Plan
The Company 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 1.8 million shares of the Company’s 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 were exercisable at 20% per year beginning one year after the date of grant and must be exercised within ten years of the grant.
A summary of the status of the Plan is presented below:
| | | 2011 | | | 2010 | | | 2009 | |
| | | | | | Weighted | | | Weighted | | | (1) | | | | | | Weighted | | | | | | Weighted | |
| | | | | | Average | | | Average | | | Average | | | | | | Average | | | | | | Average | |
| | | | | | Exercise | | | Remaining | | | Intrinsic | | | | | | Exercise | | | | | | Exercise | |
| | | Options | | | Price | | | Term (yrs) | | | Value | | | Options | | | Price | | | Options | | | Price | |
| Options outstanding at beginning of year | | | 385,005 | | | $ | 20.30 | | | | 3.3 | | | | | | | | 401,626 | | | $ | 20.09 | | | | 685,873 | | | $ | 19.72 | |
| Exercised | | | - | | | | - | | | | | | | | | | | | - | | | | - | | | | - | | | | - | |
| Forfeited | | | (18,168 | ) | | | 21.50 | | | | | | | | | | | | (16,621 | ) | | | 15.10 | | | | (263,866 | ) | | | 19.44 | |
| Expired | | | (30,918 | ) | | | 11.90 | | | | | | | | | | | | - | | | | - | | | | (20,381 | ) | | | 16.28 | |
| Options outstanding at the end of the year | | | 335,919 | | | $ | 21.01 | | | | 2.6 | | | $ | - | | | | 385,005 | | | $ | 20.30 | | | | 401,626 | | | $ | 20.09 | |
| Options exercisable at the end of the year | | | 335,919 | | | $ | 21.01 | | | | 2.6 | | | $ | - | | | | 369,448 | | | $ | 20.24 | | | | 357,737 | | | $ | 19.88 | |
(1) The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had they exercised their options on December 31, 2011. The intrinsic value varies based on the changes in the market value in the Company’s stock. Because the exercise price exceeded the market value of the options, the average intrinsic value was $0 at December 31, 2011.
Information pertaining to options outstanding at December 31, 2011 is as follows:
| | | | Options outstanding | | | Options exercisable | |
| | | | | | | Weighted | | | Weighted | | | | | | Weighted | |
| | | | | | | Average | | | Average | | | | | | Average | |
| Range of | | | Number | | | Exercise | | | Remaining | | | Number | | | Exercise | |
| exercise prices | | | Outstanding | | | Price | | | Term (yrs) | | | Outstanding | | | Price | |
| $ | 17.00 - $20.00 | | | | 90,070 | | | $ | 18.09 | | | | 0.8 | | | | 90,070 | | | $ | 18.09 | |
| $ | 21.00 - $23.00 | | | | 245,849 | | | | 22.08 | | | | 3.2 | | | | 245,849 | | | | 22.08 | |
| | | | | | 335,919 | | | $ | 21.01 | | | | 2.6 | | | | 335,919 | | | $ | 21.01 | |
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 17 - STOCK COMPENSATION PLANS - Continued
The following table provides detail for non-vested shares under the Employees’ Plan as of December 31, 2011:
| | | | | | Weighted | |
| | | | | | Average | |
| | | Number | | | Exercise | |
| | | of shares | | | Price | |
| Non-vested options December 31, 2010 | | | 15,557 | | | $ | 21.78 | |
| Forfeited | | | (167 | ) | | | 21.78 | |
| Vested | | | (15,390 | ) | | | 21.78 | |
| Non-vested options December 31, 2011 | | | - | | | $ | - | |
As of December 31, 2011 all outstanding shares are fully vested (exercisable). The ability to grant new options under this plan has expired.
3. Long-Term Incentive Plan
The 2007 Long-Term Incentive Plan was approved by Shareholders at the May 16, 2007 Annual Meeting. The plan consists of both a restricted and an unrestricted stock option plan. All employees and non-employee directors of the Company and its designated subsidiaries are eligible participants. The plan includes one million shares of Class A common stock, subject to customary anti-dilution adjustments, or approximately 9.0% of the total outstanding shares of the Class A common stock.
As of December 31, 2011, 172,390 shares from the unrestricted plan have been granted. The option price is equal to the fair market value at the date of the grant. The employee 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 date. Directors’ options are exercisable on the one year anniversary of the date of grant and must be exercised within ten years of the grant date.
A summary of the status of the unrestricted portion of the Plan is presented below:
| | | 2011 | | | 2010 | | | 2009 | |
| | | | | | Weighted | | | Weighted | | | (1) | | | | | | Weighted | | | | | | Weighted | |
| | | | | | Average | | | Average | | | Average | | | | | | Average | | | | | | Average | |
| | | | | | Exercise | | | Remaining | | | Intrinsic | | | | | | Exercise | | | | | | Exercise | |
| | | Options | | | Price | | | Term (yrs) | | | Value | | | Options | | | Price | | | Options | | | Price | |
| Options outstanding at beginning of year | | | 121,862 | | | $ | 9.76 | | | | 7.3 | | | | | | | | 135,312 | | | $ | 10.19 | | | | 161,901 | | | $ | 10.89 | |
| Granted | | | - | | | | - | | | | | | | | | | | | - | | | | - | | | | - | | | | - | |
| Exercised | | | - | | | | - | | | | | | | | | | | | - | | | | - | | | | - | | | | - | |
| Forfeited | | | (5,422 | ) | | | 10.45 | | | | | | | | | | | | (13,450 | ) | | | 12.33 | | | | (26,102 | ) | | | 14.38 | |
| Expired | | | - | | | | - | | | | | | | | | | | | - | | | | - | | | | (487 | ) | | | 20.08 | |
| Options outstanding at the end of the year | | | 116,440 | | | $ | 9.73 | | | | 6.4 | | | $ | - | | | | 121,862 | | | $ | 9.76 | | | | 135,312 | | | $ | 10.19 | |
| Options exercisable at the end of the year | | | 84,332 | | | $ | 10.73 | | | | 6.3 | | | $ | - | | | | 68,877 | | | $ | 11.35 | | | | 62,295 | | | $ | 12.78 | |
(1) The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had they exercised their options on December 31, 2011. The intrinsic value varies based on the changes in the market value in the Company’s stock. Because the exercise price exceeded the market value of the options, the average intrinsic value was $0 at December 31, 2011.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 17 - STOCK COMPENSATION PLANS – Continued
Information pertaining to options outstanding at December 31, 2011 is as follows:
| | | | Options outstanding | | | Options exercisable | |
| | | | | | | Weighted | | | Weighted | | | | | | Weighted | |
| | | | | | | Average | | | Average | | | | | | Average | |
| Range of | | | Number | | | Exercise | | | Remaining | | | Number | | | Exercise | |
| exercise prices | | | Outstanding | | | Price | | | Term (yrs) | | | Outstanding | | | Price | |
| $ | 4.50 | | | | 77,350 | | | $ | 4.50 | | | | 6.8 | | | | 50,610 | | | $ | 4.50 | |
| $ | 20.08 | | | | 39,090 | | | | 20.08 | | | | 5.6 | | | | 33,722 | | | | 20.08 | |
| | | | | | 116,440 | | | $ | 9.73 | | | | 6.4 | | | | 84,332 | | | $ | 10.73 | |
The following table provides detail for non-vested shares under the Long-Term Incentive Plan as of December 31, 2011:
| | | | | | Weighted | |
| | | | | | Average | |
| | | Number | | | Exercise | |
| | | of shares | | | Price | |
| Non-vested options December 31, 2010 | | | 52,985 | | | $ | 7.69 | |
| Granted | | | - | | | | - | |
| Forfeited | | | (2,010 | ) | | | - | |
| Vested | | | (18,867 | ) | | | - | |
| Non-vested options December 31, 2011 | | | 32,108 | | | $ | 7.10 | |
There were a total of 32,108 unvested options at December 31, 2011, with a fair value of $87,000 and approximately $66,000 remained to be recognized in expense over a weighted-average period of 1.5 years.
Under the aforementioned Long-Term Incentive Plan, approved by shareholders in May 2007, the Company is authorized to grant share-based incentive compensation awards for corporate performance to employees. These awards may be granted in form of shares of the Company’s common stock, performance-restricted restricted stock.
The vesting of awards is contingent upon meeting certain return on asset and return on equity goals. These goals include a three year average return on assets compared to peers, a three year average return on equity compared to peers and a minimum return on both assets and equity over the three year period. The awards are not permitted to be transferred during the restricted time period of three years from the date of the award and are subject to forfeiture to the extent that the performance restrictions are not satisfied. Awards are also forfeited if the employee terminates his or her service prior to the end of the restricted time period, unless such termination is in accordance with the Company’s mandatory retirement age. Vested awards are converted to shares of the Company’s common stock at the end of the restricted time period.
The fair market value of each employee based award is estimated based on the fair market value of the Company’s common stock on the date of the grant and probable performance goals to be achieved and estimated forfeitures. If such goals are not met, no compensation cost would be recognized and any recognized compensation cost would be reversed. All shares of restricted stock were forfeited in the first quarter of 2010 due to the Company’s losses in 2009 and 2008.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 18 - EARNINGS PER COMMON SHARE
Basic and diluted EPS are calculated as follows:
| | | For the year ended December 31, 2011 | |
| | | Loss | | | Average shares | | | Per share | |
| (In thousands, except for per share data) | | (numerator) | | | (denominator) | | | Amount | |
| Basic and Diluted EPS | | | | | | | | | |
| Loss available to common shareholders | | $ | (10,566 | ) | | | 13,256 | | | $ | (0.80 | ) |
At December 31, 2011, 557,665 options to purchase shares of common stock and restricted stock awards were anti-dilutive in the computation of diluted EPS, as exercise price exceeded average market price and as a result of the net loss for the year. Additionally 30,407 warrants were also anti-dilutive.
| | | For the year ended December 31, 2010 | |
| | | Loss | | | Average shares | | | Per share | |
| (In thousands, except for per share data) | | (numerator) | | | (denominator) | | | Amount | |
| Basic and Diluted EPS | | | | | | | | | |
| Loss available to common shareholders | | $ | (26,063 | ) | | | 13,256 | | | $ | (1.97 | ) |
At December 31, 2010, 594,939 options to purchase shares of common stock and restricted stock awards were anti-dilutive in the computation of diluted EPS, as exercise price exceeded average market price and as a result of the net loss for the year. Additionally 30,407 warrants were also anti-dilutive.
| | | For the year ended December 31, 2009 | |
| | | Loss | | | Average shares | | | Per share | |
| (In thousands, except for per share data) | | (numerator) | | | (denominator) | | | Amount | |
| Basic and Diluted EPS | | | | | | | | | |
| Loss available to common shareholders | | $ | (34,931 | ) | | | 13,294 | | | $ | (2.64 | ) |
At December 31, 2009, 713,098 options to purchase shares of common stock and restricted stock awards were anti-dilutive in the computation of diluted EPS, as exercise price exceeded average market price and as a result of the net loss for the year. Additionally 30,407 warrants were also anti-dilutive.
NOTE 19 – COMPREHENSIVE INCOME (LOSS)
FASB ASC Topic 220, “Comprehensive Income” (“ASC Topic 220”), requires the reporting of all changes in equity during the reporting period except investments from and distributions to shareholders. Net income (loss) is a component of comprehensive income (loss) with all other components referred to in the aggregate as other comprehensive income.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 19 – COMPREHENSIVE INCOME (LOSS) - Continued
The components of other comprehensive income (loss) and the related tax effects are as follows:
| | | For the year ended December 31, 2011 | |
| (In thousands) | | Before tax amount | | | Tax expense (benefit) | | | Net of tax amount | |
| Unrealized gains on investment securities: | | | | | | | | | |
| Unrealized holding gains arising during period | | $ | 531 | | | $ | 227 | | | $ | 304 | |
| Adjustment in deferred tax valuation allowance related to preferred and common stock | | | - | | | | 288 | | | | (288 | ) |
| Less adjustment for impaired investments | | | (1,796 | ) | | | (629 | ) | | | (1,167 | ) |
| Less reclassification adjustment for gains realized in net loss | | | 1,782 | | | | 624 | | | | 1,158 | |
| Unrealized gains on investment securities | | | 545 | | | | 520 | | | | 25 | |
| Unrecognized benefit obligation expense: | | | | | | | | | | | | |
| Actuarial loss | | | (2,026 | ) | | | (709 | ) | | | (1,317 | ) |
| Less reclassification adjustment for amortization | | | (231 | ) | | | (81 | ) | | | (150 | ) |
| | | | (1,795 | ) | | | (628 | ) | | | (1,167 | ) |
| Other comprehensive loss, net | | $ | (1,250 | ) | | $ | (108 | ) | | $ | (1,142 | ) |
| | | For the year ended December 31, 2010 | |
| (In thousands) | | Before tax amount | | | Tax expense (benefit) | | | Net of tax amount | |
| Unrealized gains on investment securities: | | | | | | | | | |
| Unrealized holding gains arising during period | | $ | 6,102 | | | $ | 1,764 | | | $ | 4,338 | |
| Reduction in deferred tax valuation allowance related to preferred and common stock | | | - | | | | (97 | ) | | | 97 | |
| Non-credit loss portion of other-than-temporary impairments | | | (87 | ) | | | (30 | ) | | | (57 | ) |
| Less adjustment for impaired investments | | | (479 | ) | | | (168 | ) | | | (311 | ) |
| Less reclassification adjustment for gains realized in net loss | | | 1,290 | | | | 452 | | | | 838 | |
| Unrealized gains on investment securities | | | 5,204 | | | | 1,547 | | | | 3,851 | |
| Unrecognized benefit obligation expense: | | | | | | | | | | | | |
| Actuarial loss | | | (538 | ) | | | (188 | ) | | | (350 | ) |
| Less reclassification adjustment for amortization | | | (143 | ) | | | (50 | ) | | | (93 | ) |
| | | | (395 | ) | | | (138 | ) | | | (257 | ) |
| Other comprehensive income, net | | $ | 4,809 | | | $ | 1,409 | | | $ | 3,594 | |
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 19 – COMPREHENSIVE INCOME (LOSS) - Continued
| | | For the year ended December 31, 2009 | |
| (In thousands) | | Before tax amount | | | Tax expense (benefit) | | | Net of tax amount | |
| Unrealized gains on investment securities: | | | | | | | | | |
| Unrealized holding gains arising during period | | $ | 26,597 | | | $ | 9,269 | | | $ | 17,328 | |
| Reduction in deferred tax valuation allowance related to preferred and common stock | | | - | | | | (3,022 | ) | | | 3,022 | |
| Non-credit loss portion of other-than-temporary impairments | | | (2,390 | ) | | | (836 | ) | | | (1,554 | ) |
| Less adjustment for impaired investments | | | (11,041 | ) | | | (3,864 | ) | | | (7,177 | ) |
| Less reclassification adjustment for gains realized in net loss | | | 1,892 | | | | 662 | | | | 1,230 | |
| Unrealized gains on investment securities | | | 33,356 | | | | 14,657 | | | | 24,743 | |
| Unrecognized benefit obligation expense: | | | | | | | | | | | | |
| Actuarial loss | | | (562 | ) | | | (197 | ) | | | (365 | ) |
| Less reclassification adjustment for amortization | | | (117 | ) | | | (41 | ) | | | (76 | ) |
| | | | (445 | ) | | | (156 | ) | | | (289 | ) |
| Other comprehensive income, net | | $ | 32,911 | | | $ | 14,501 | | | $ | 24,454 | |
The other components of accumulated other comprehensive loss included in shareholders’ equity at December 31, 2011, 2010, and 2009 are as follows:
| | | As of December 31, | |
| (In thousands) | | 2011 | | | 2010 | | | 2009 | |
| | | | | | | | | | |
| Unrecognized benefit obligation | | $ | (2,734 | ) | | $ | (1,567 | ) | | $ | (1,478 | ) |
| Unrealized gains (losses) on AFS investments | | | 3,534 | | | | 3,509 | | | | (174 | ) |
| Accumulated other comprehensive income (loss) | | $ | 800 | | | $ | 1,942 | | | $ | (1,652 | ) |
Refer to “Note 16 – Pension Plans” to the Consolidated Financial Statements for more information.
NOTE 20 - FAIR VALUE OF FINANCIAL INSTRUMENTS
Under FASB ASC Topic 820 “Fair Value Measurements and Disclosures” (“ASC Topic 820”), fair values are based on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When available, management uses quoted market prices to determine fair value. If quoted prices are not available, fair value is based upon valuation techniques such as matrix pricing or other models that use, where possible, current market-based or independently sourced market parameters, such as interest rates. If observable market-based inputs are not available, the Company uses unobservable inputs to determine appropriate valuation adjustments using discounted cash flow methodologies.
In April 2009, the FASB issued guidance under ASC Topic 820 for estimating fair value when the volume and level of activity for an asset or liability has significantly declined and for identifying circumstances when a transaction is not orderly. ASC Topic 820 establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under ASC Topic 820 are as follows:
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 20 - FAIR VALUE OF FINANCIAL INSTRUMENTS – Continued
| | Level 1: | Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. |
| | Level 2: | Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability. Level 2 includes debt securities with quoted prices that are traded less frequently then exchange-traded instruments. Valuation techniques include matrix pricing which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices. |
| | Level 3: | Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported with little or no market activity). |
A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.
Items Measured on a Recurring Basis
The Company’s available for sale investment securities are recorded at fair value on a recurring basis.
Fair value for Level 1 securities are determined by obtaining quoted market prices on nationally recognized securities exchanges. Level 1 securities include preferred and common stocks, and one trust preferred security which is actively traded.
Level 2 securities include obligations of U.S. government-sponsored agencies, debt securities with quoted prices, which are traded less frequently than exchange-traded instruments, whose value is determined using matrix pricing with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. The prices were obtained from third party vendors. This category generally includes mortgage-backed securities and CMOs issued by U.S. government and government-sponsored agencies, non-agency CMOs, and corporate and municipal bonds.
Level 3 securities include five trust preferred securities. The fair values for the trust preferred securities were derived by using contractual cash flows and a market rate of return for each of these securities. Factors that affected the market rate of return included (1) any uncertainty about the amount and timing of the cash flows, (2) the credit risk, (3) liquidity of the instrument, and (4) observable yields from trading data and bid/ask indications. Credit risk spreads and liquidity premiums were analyzed to derive the appropriate discount rate.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 20 - FAIR VALUE OF FINANCIAL INSTRUMENTS – Continued
For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at December 31, 2011 and 2010 are as follows:
| As of December 31, 2011 | | Fair Value Measurements Using | | | | |
| (In thousands) | | Level 1 | | | Level 2 | | | Level 3 | | | Fair Value | |
| Assets | | | | | | | | | | | | |
| Investment securities available-for-sale | | | | | | | | | | | | |
| Mortgage-backed securities-residential | | $ | - | | | $ | 17,005 | | | $ | - | | | $ | 17,005 | |
| U.S. government agencies | | | - | | | | 36,084 | | | | - | | | | 36,084 | |
| Common stocks | | | 248 | | | | - | | | | - | | | | 248 | |
| Collateralized mortgage obligations: | | | | | | | | | | | | | | | | |
| Issued or guaranteed by U.S. government agencies | | | - | | | | 234,034 | | | | - | | | | 234,034 | |
| Non-agency | | | - | | | | 4,832 | | | | - | | | | 4,832 | |
| Corporate bonds | | | - | | | | 12,975 | | | | - | | | | 12,975 | |
| Municipal bonds | | | - | | | | 965 | | | | - | | | | 965 | |
| Trust preferred securities | | | 3,342 | | | | - | | | | 12,603 | | | | 15,945 | |
| Other securities | | | - | | | | - | | | | 6,918 | | | | 6,918 | |
| Total available for sale | | $ | 3,590 | | | $ | 305,895 | | | $ | 19,521 | | | $ | 329,006 | |
| As of December 31, 2010 | | Fair Value Measurements Using | | | | |
| (In thousands) | | Level 1 | | | Level 2 | | | Level 3 | | | Fair Value | |
| Assets | | | | | | | | | | | | |
| Investment securities available-for-sale | | | | | | | | | | | | |
| Mortgage-backed securities-residential | | $ | - | | | $ | 8,840 | | | $ | - | | | $ | 8,840 | |
| U.S. government agencies | | | - | | | | 29,737 | | | | - | | | | 29,737 | |
| Common stocks | | | 483 | | | | - | | | | - | | | | 483 | |
| Collateralized mortgage obligations: | | | | | | | | | | | | | | | | |
| Issued or guaranteed by U.S. government agencies | | | - | | | | 234,653 | | | | - | | | | 234,653 | |
| Non-agency | | | - | | | | 7,137 | | | | - | | | | 7,137 | |
| Corporate bonds | | | - | | | | 9,286 | | | | - | | | | 9,286 | |
| Trust preferred securities | | | 3,594 | | | | - | | | | 15,020 | | | | 18,614 | |
| Other securities | | | - | | | | - | | | | 6,867 | | | | 6,867 | |
| Total available for sale | | $ | 4,077 | | | $ | 289,653 | | | $ | 21,887 | | | $ | 315,617 | |
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 20 - FAIR VALUE OF FINANCIAL INSTRUMENTS – Continued
The following table presents additional information about assets measured at fair value on a recurring basis and for which the Company has utilized Level 3 inputs to determine fair value for the year ended December 31, 2011:
| | | Investment Securities Available for Sale | |
| (In thousands) | | Trust preferred securities | | | Other securities | | | Total | |
| Beginning balance January 1, 2011 | | $ | 15,020 | | | $ | 6,867 | | | $ | 21,887 | |
| Total gains/(losses) - (realized/unrealized): | | | | | | | | | | | | |
| Included in earnings | | | (1,740 | ) | | | 561 | | | | (1,179 | ) |
| Included in other comprehensive income | | | 484 | | | | (99 | ) | | | 385 | |
| Purchases | | | - | | | | 917 | | | | 917 | |
| Sales and calls | | | (1,122 | ) | | | (1,328 | ) | | | (2,450 | ) |
| Amortization of premium | | | (39 | ) | | | - | | | | (39 | ) |
| Transfers in and/or out of Level 3 | | | - | | | | - | | | | - | |
| Ending balance December 31, 2011 | | $ | 12,603 | | | $ | 6,918 | | | $ | 19,521 | |
The following table presents additional information about assets measured at fair value on a recurring basis and for which the Company has utilized Level 3 inputs to determine fair value for the year ended December 31, 2010:
| | | Investment Securities | |
| | | Available for Sale | |
| | | December 31, | |
| (In thousands) | | 2010 | |
| Assets | | | |
| Balance at the beginning of the period | | $ | 53,294 | |
| Total gains/(losses) - (realized/unrealized): | | | | |
| Included in earnings | | | (169 | ) |
| Included in other comprehensive income | | | 648 | |
| Purchases, issuances, and settlements, net | | | (31,886 | ) |
| Transfers in and/or out of Level 3 | | | - | |
| Balance at the end of the period | | $ | 21,887 | |
Items Measured on a Nonrecurring Basis
Non-accrual loans are evaluated for impairment on an individual basis under FASB ASC Topic 310 “Receivables”. The impairment analysis includes current collateral values, known relevant factors that may affect loan collectability, and risks inherent in different kinds of lending. When the collateral value or discounted cash flows less costs to sell is less than the carrying value of the loan a specific reserve (valuation allowance) is established. Loans held for sale are carried at the lower of cost or fair value. Other real estate owned (“OREO”) is carried at the lower of cost or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 20 - FAIR VALUE OF FINANCIAL INSTRUMENTS – Continued
For financial assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at December 31, 2011 and 2010 are as follows:
| As of December 31, 2011 | | Fair Value Measurements Using | | | | |
| (In thousands) | | Level 1 | | | Level 2 | | | Level 3 | | | Fair Value | |
| Assets | | | | | | | | | | | | |
| Impaired loans | | $ | - | | | $ | - | | | $ | 8,583 | | | $ | 8,583 | |
| Other real estate owned | | | - | | | | - | | | | 21,016 | | | | 21,016 | |
| Loans and leases held for sale | | | - | | | | - | | | | 3,830 | | | | 3,830 | |
| As of December 31, 2010 | | Fair Value Measurements Using | | | | |
| (In thousands) | | Level 1 | | | Level 2 | | | Level 3 | | | Fair Value | |
| Assets | | | | | | | | | | | | |
| Impaired loans | | $ | - | | | $ | - | | | $ | 7,713 | | | $ | 7,713 | |
| Other real estate owned | | | - | | | | - | | | | 15,226 | | | | 15,226 | |
| Loans and leases held for sale | | | - | | | | - | | | | 29,621 | | | | 29,621 | |
The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful. The following methods and assumptions were used to estimate the fair values of the Company’s financial instruments at December 31, 2011 and 2010.
Cash and cash equivalents (carried at cost):
The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets’ fair values.
Securities:
Management uses quoted market prices to determine fair value of securities (level 1). If quoted prices are not available, fair value is based upon valuation techniques such as matrix pricing or other models that use, where possible, current market-based or independently sourced market parameters, such as interest rates (level 2). If observable market-based inputs are not available, the Company uses unobservable inputs to determine appropriate valuation adjustments using discounted cash flow methodologies (level 3).
Other Investment (carried at cost):
This investment includes the Solomon Hess SBA Loan Fund, which the Company invested in to partially satisfy its community reinvestment requirement. Shares in this fund are not publicly traded and therefore have no readily determinable fair market value. An investor can have their investment in the Fund redeemed for the balance of their capital account at any quarter end with 60 days notice to the Fund. The investment in this Fund is recorded at cost. The fair value is computed by applying the Company’s ownership percentage of the fund to the fund’s net asset value at year end.
Restricted investment in bank stock (carried at cost):
The carrying amount of restricted investment in bank stock approximates fair value, and considers the limited marketability of such securities.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 20 - FAIR VALUE OF FINANCIAL INSTRUMENTS – Continued
Loans receivable (carried at cost):
The fair values of loans are estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect the credit and interest rate-risk inherent in the loans. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Generally, for variable rate loans that re-price frequently and with no significant change in credit risk, fair values are based on carrying values.
Impaired loans (generally carried at fair value):
Impaired loans are accounted for under ASC Topic 310. Impaired loans are those in which the Company has measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based on the expected proceeds. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.
Accrued interest receivable and payable (carried at cost):
The carrying amount of accrued interest receivable and accrued interest payable approximates its fair value.
Deposit liabilities (carried at cost):
The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Short-term borrowings (carried at cost):
The carrying amounts of short-term borrowings approximate their fair values.
Long-term debt (carried at cost):
Fair values of FHLB advances and other long-term borrowings are estimated using discounted cash flow analysis, based on quoted prices for new FHLB advances with similar credit risk characteristics, terms and remaining maturity. These prices obtained from this active market represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party.
Subordinated debt (carried at cost):
Fair values of junior subordinated debt are estimated using discounted cash flow analysis, based on market rates currently offered on such debt with similar credit risk characteristics, terms and remaining maturity.
Off-balance sheet financial instruments (disclosed at cost):
Fair values for the Company’s off-balance sheet financial instruments (lending commitments and letters of credit) are based on fees currently charged in the market to enter into similar agreements, taking into account, the remaining terms of the agreements and the counterparties’ credit standing. They are not shown in the table because the amounts are immaterial.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 20 - FAIR VALUE OF FINANCIAL INSTRUMENTS – Continued
| | | As of December 31, | |
| | | 2011 | | | 2010 | |
| | | Carrying | | | Estimated | | | Carrying | | | Estimated | |
| (In thousands) | | amount | | | fair value | | | amount | | | fair value | |
| Financial Assets | | | | | | | | | | | | |
| Cash and cash equivalents | | $ | 24,506 | | | $ | 24,506 | | | $ | 51,733 | | | $ | 51,733 | |
| Investment securities available-for-sale | | | 329,006 | | | | 329,006 | | | | 315,617 | | | | 315,617 | |
| Other investment | | | 1,538 | | | | 1,538 | | | | 1,538 | | | | 1,538 | |
| Federal Home Loan Bank stock | | | 8,474 | | | | 8,474 | | | | 10,405 | | | | 10,405 | |
| Loans held for sale | | | 12,569 | | | | 12,569 | | | | 29,621 | | | | 29,621 | |
| Loans, net | | | 397,863 | | | | 395,616 | | | | 475,725 | | | | 473,349 | |
| Accrued interest receivable | | | 15,463 | | | | 15,463 | | | | 16,864 | | | | 16,864 | |
| | | | | | | | | | | | | | | | | |
| Financial Liabilities: | | | | | | | | | | | | | | | | |
| Demand deposits | | | 54,534 | | | | 54,534 | | | | 52,872 | | | | 52,872 | |
| NOW and money markets | | | 226,002 | | | | 226,002 | | | | 221,746 | | | | 221,746 | |
| Savings | | | 16,263 | | | | 16,263 | | | | 15,922 | | | | 15,922 | |
| Time deposits | | | 279,117 | | | | 274,546 | | | | 403,373 | | | | 398,696 | |
| Short-term borrowings | | | 54,218 | | | | 53,936 | | | | 22,000 | | | | 22,000 | |
| Long-term borrowings | | | 93,782 | | | | 88,394 | | | | 132,949 | | | | 128,787 | |
| Subordinated debt | | | 25,774 | | | | 18,673 | | | | 25,774 | | | | 15,136 | |
| Accrued interest payable | | | 3,450 | | | | 3,450 | | | | 3,983 | | | | 3,983 | |
NOTE 21 – SEGMENT INFORMATION
FASB ASC Topic 280, “Segment Reporting” (“ASC Topic 280”) established standards for public business enterprises to report information about operating segments in their annual financial statements and requires that those enterprises report selected information about operating segments in subsequent interim financial reports issued to shareholders. It also established standards for related disclosure about products and services, geographic areas, and major customers. Operating segments are components of an enterprise, which are evaluated regularly by the chief operating decision makers in deciding how to allocate and assess resources and performance. The Company’s chief operating decision makers are the Chief Executive Officer and the President. The Company has identified its reportable operating segments as “Community Banking” and “Tax Liens”. In previous years, the Company reflected “Equity Investments” and “Leasing” as operating segments. Management has determined that the operating results and assets related to Equity Investments and Leasing should be reflected under the Community Banking segment. The determination related to Equity Investments was based on the deconsolidation of the VIE as a result of the substantial completion of the project and minimal assets remaining. The determination related to Leasing was based on not meeting the quantitative thresholds for requiring disclosure. For additional discussion on the VIE, please refer to “Note 1- Summary of Significant Accounting Policies” to the Consolidated Financial Statements.
Community banking
The Company’s Community Banking segment, which includes Royal Bank and in the prior period Royal Asian Bank, consists of commercial and retail banking and leasing. The Community Banking business segment is managed as a single strategic unit which generates revenue from a variety of products and services provided by Royal Bank. For example, commercial lending is dependent upon the ability of Royal Bank to fund cash needed to make loans with retail deposits and other borrowings and to manage interest rate and credit risk. While Royal Bank makes very few consumer loans, cash needed to make such loans would be funded similarly to commercial loans.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 21 – SEGMENT INFORMATION - Continued
Royal Asian assets of $102.4 million and deposits of $89.3 million were included in “Community Banking” in the segment table for the year ended December 31, 2009. Royal Asian recorded a net loss of $953,000 and $838,000 for 2010 and 2009, respectively.
Tax lien operation
The Company’s Tax Lien Operation consists of purchasing delinquent tax certificates from local municipalities at auction and then processing those liens to either encourage the property holder to pay off 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 the on sale of foreclosed properties.
Selected segment information and reconciliations to consolidated financial information are as follows:
| (In thousands) | | Community | | | Tax Lien | | | | |
| December 31, 2011 | | Banking | | | Operation | | | Consolidated | |
| | | | | | | | | | |
| Total assets | | $ | 777,561 | | | $ | 70,887 | | | $ | 848,448 | |
| Total deposits | | | 575,916 | | | | - | | | $ | 575,916 | |
| | | | | | | | | | | | | |
| Interest income | | $ | 31,882 | | | $ | 7,495 | | | $ | 39,377 | |
| Interest expense | | | 11,624 | | | | 2,462 | | | | 14,086 | |
| Net interest income | | | 20,259 | | | | 5,032 | | | | 25,291 | |
| Provision for loan and lease losses | | | 6,644 | | | | 1,084 | | | | 7,728 | |
| Total other income | | | 6,270 | | | | 548 | | | | 6,818 | |
| Total other expenses | | | 30,365 | | | | 1,704 | | | | 32,069 | |
| Income tax (benefit) expense | | | (1,086 | ) | | | 1,086 | | | | - | |
| Net (loss) income | | $ | (9,395 | ) | | $ | 1,707 | | | $ | (7,688 | ) |
| Noncontrolling interest | | | 192 | | | | 683 | | | | 875 | |
| Net (loss) income attributable to Royal Bancshares | | $ | (9,587 | ) | | $ | 1,024 | | | $ | (8,563 | ) |
| (In thousands) | | Community | | | Tax Lien | | | | |
| December 31, 2010 | | Banking | | | Operation | | | Consolidated | |
| | | | | | | | | | |
| Total assets | | $ | 880,025 | | | $ | 100,601 | | | $ | 980,626 | |
| Total deposits | | | 693,913 | | | | - | | | | 693,913 | |
| | | | | | | | | | | | | |
| Interest income | | $ | 47,000 | | | $ | 10,262 | | | $ | 57,262 | |
| Interest expense | | | 22,557 | | | | 3,437 | | | | 25,994 | |
| Net interest income | | | 24,443 | | | | 6,825 | | | | 31,268 | |
| Provision for loan and lease losses | | | 22,011 | | | | 129 | | | | 22,140 | |
| Total other income | | | 7,376 | | | | 389 | | | | 7,765 | |
| Total other expenses | | | 34,598 | | | | 1,993 | | | | 36,591 | |
| Impairment -real estate joint venture | | | 1,552 | | | | - | | | | 1,552 | |
| Impairment -real estate owned via equity investment | | | 2,600 | | | | - | | | | 2,600 | |
| Income tax (benefit) expense | | | (2,068 | ) | | | 2,068 | | | | - | |
| Net (loss) income | | $ | (26,874 | ) | | $ | 3,024 | | | $ | (23,850 | ) |
| Noncontrolling interest | | | (967 | ) | | | 1,210 | | | | 243 | |
| Net (loss) income attributable to Royal Bancshares | | $ | (25,907 | ) | | $ | 1,814 | | | $ | (24,093 | ) |
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 21 – SEGMENT INFORMATION - Continued
| (In thousands) | | Community | | | Tax Lien | | | | |
| December 31, 2009 | | Banking | | | Operation | | | Consolidated | |
| | | | | | | | | | |
| Total assets | | $ | 1,187,706 | | | $ | 105,020 | | | $ | 1,292,726 | |
| Total deposits | | | 881,755 | | | | - | | | $ | 881,755 | |
| | | | | | | | | | | | | |
| Interest income | | $ | 55,619 | | | $ | 10,424 | | | $ | 66,043 | |
| Interest expense | | | 33,433 | | | | 4,006 | | | | 37,439 | |
| Net interest income | | | 22,186 | | | | 6,418 | | | | 28,604 | |
| Provision for loan and lease losses | | | 19,981 | | | | 624 | | | | 20,605 | |
| Total other income | | | (2,039 | ) | | | 313 | | | | (1,726 | ) |
| Total other expenses | | | 34,330 | | | | 3,326 | | | | 37,656 | |
| Income tax (benefit) expense | | | (607 | ) | | | 1,081 | | | | 474 | |
| Net (loss) income | | $ | (33,557 | ) | | $ | 1,700 | | | $ | (31,857 | ) |
| Noncontrolling interest | | | 722 | | | | 680 | | | | 1,402 | |
| Net (loss) income attributable to Royal Bancshares | | $ | (34,279 | ) | | $ | 1,020 | | | $ | (33,259 | ) |
Interest income earned by the Community Banking segment related to the Tax Lien Operation was approximately $2.5 million, $3.4 million, and $4.0 million for the years ended December 31, 2011, 2010, and 2009, respectively.
NOTE 22 - CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY
Condensed financial information for the parent company only follows.
CONDENSED BALANCE SHEETS
| | | As of December 31, | |
| (In thousands) | | 2011 | | | 2010 | |
| Assets | | | | | | |
| Cash | | $ | 5,101 | | | $ | 2,756 | |
| Investment in non-bank subsidiaries | | | 27,740 | | | | 26,712 | |
| Investment in Royal Bank | | | 63,474 | | | | 72,017 | |
| Loans, net | | | 130 | | | | 4,207 | |
| Other assets | | | 410 | | | | 774 | |
| Total assets | | $ | 96,855 | | | $ | 106,466 | |
| Subordinated debentures | | $ | 25,774 | | | $ | 25,774 | |
| Stockholders' equity | | | 71,081 | | | | 80,692 | |
| Total liabilities and stockholders' equity | | $ | 96,855 | | | $ | 106,466 | |
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 22 - CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY - Continued
CONDENSED STATEMENTS OF OPERATIONS
| | | For the years ended December 31, | |
| (In thousands) | | 2011 | | | 2010 | | | 2009 | |
| Income | | | | | | | | | |
| Other income | | $ | 19 | | | $ | 19 | | | $ | 51 | |
| Total Income | | | 19 | | | | 19 | | | | 51 | |
| Expenses | | | | | | | | | | | | |
| Other expenses | | | 389 | | | | 776 | | | | 931 | |
| Provision for loan losses | | | 945 | | | | 750 | | | | 809 | |
| Interest on subordinated debentures | | | 643 | | | | 647 | | | | 1,085 | |
| Total Expenses | | | 1,977 | | | | 2,173 | | | | 2,825 | |
| Loss before income taxes and equity in undistributed net loss | | | (1,958 | ) | | | (2,154 | ) | | | (2,774 | ) |
| Income tax expense | | | - | | | | - | | | | 109 | |
| Equity in undistributed net losses | | | (6,605 | ) | | | (21,939 | ) | | | (30,376 | ) |
| Net loss | | $ | (8,563 | ) | | $ | (24,093 | ) | | $ | (33,259 | ) |
CONDENSED STATEMENTS OF CASH FLOWS
| | | For the years ended December 31, | |
| (In thousands) | | 2011 | | | 2010 | | | 2009 | |
| Cash flows from operating activities | | | | | | | | | |
| Net loss | | $ | (8,563 | ) | | $ | (24,093 | ) | | $ | (33,259 | ) |
| Adjustments to reconcile net loss to net cash used in operating activities: | | | | | | | | | | | | |
| Undistributed losses from subsidiaries | | | 6,605 | | | | 21,939 | | | | 30,376 | |
| Provision for loan losses | | | 945 | | | | 750 | | | | 809 | |
| Interest on subordinated debentures | | | 643 | | | | 647 | | | | 1,085 | |
| Non-cash income tax expense | | | - | | | | - | | | | 109 | |
| Net cash used in operating activities | | | (370 | ) | | | (757 | ) | | | (880 | ) |
| Cash flows from investing activities | | | | | | | | | | | | |
| Investment in Royal Bank | | | - | | | | (15,260 | ) | | | (39,907 | ) |
| Loan payoffs (fundings) | | | 2,754 | | | | (1,207 | ) | | | - | |
| Sale of Royal Asian Bank | | | - | | | | 12,365 | | | | - | |
| Dividend proceeds from non-banking subsidiaries | | | - | | | | 5,000 | | | | 10,000 | |
| Net cash provided by (used in) investing activities | | | 2,754 | | | | 898 | | | | (29,907 | ) |
| Cash flows from financing activities: | | | | | | | | | | | | |
| Cash dividends paid | | | - | | | | - | | | | (359 | ) |
| Issuance of preferred stock | | | - | | | | - | | | | 30,407 | |
| Other, net | | | (39 | ) | | | (168 | ) | | | 494 | |
| Net cash (used in) provided by financing activities | | | (39 | ) | | | (168 | ) | | | 30,542 | |
| Net increase (decrease) in cash and cash equivalents | | | 2,345 | | | | (27 | ) | | | (245 | ) |
| Cash and cash equivalents at beginning of period | | | 2,756 | | | | 2,783 | | | | 3,028 | |
| Cash and cash equivalents at end of period | | $ | 5,101 | | | $ | 2,756 | | | $ | 2,783 | |
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 23 - SUMMARY OF QUARTERLY RESULTS (UNAUDITED)
The following summarizes the consolidated results of operations during 2011 and 2010, on a quarterly basis, for the Company:
| | | For the year ended December 31, 2011 | |
| (In thousands, except per share data) | | Fourth Quarter | | | Third Quarter | | | Second Quarter | | | First Quarter | |
| Interest income | | $ | 8,754 | | | $ | 10,049 | | | $ | 10,000 | | | $ | 10,574 | |
| Net interest income | | | 5,744 | | | | 6,832 | | | | 6,160 | | | | 6,555 | |
| Provision for loan and lease losses | | | 2,160 | | | | 428 | | | | 3,056 | | | | 2,084 | |
| Net interest income after provision | | | 3,584 | | | | 6,404 | | | | 3,104 | | | | 4,471 | |
| Other income | | | 2,594 | | | | 73 | | | | 2,787 | | | | 1,364 | |
| Other expenses | | | 7,206 | | | | 8,109 | | | | 9,785 | | | | 6,969 | |
| Loss before income tax | | $ | (1,028 | ) | | $ | (1,632 | ) | | $ | (3,894 | ) | | $ | (1,134 | ) |
| Net loss | | $ | (1,028 | ) | | $ | (1,632 | ) | | $ | (3,894 | ) | | $ | (1,134 | ) |
| Less net (loss) income attributable to noncontrolling interest | | | (94 | ) | | | 261 | | | | 331 | | | | 377 | |
| Net loss attributable to Royal Bancshares of Pennsylavania, Inc. | | $ | (934 | ) | | $ | (1,893 | ) | | $ | (4,225 | ) | | $ | (1,511 | ) |
| Net loss available to common shareholders | | $ | (1,438 | ) | | $ | (2,395 | ) | | $ | (4,724 | ) | | $ | (2,009 | ) |
| Net loss per common share | | | | | | | | | | | | | | | | |
| Basic and diluted | | $ | (0.11 | ) | | $ | (0.18 | ) | | $ | (0.36 | ) | | $ | (0.15 | ) |
Operating results for the fourth quarter of 2011 amounted to a loss of $934,000, which resulted in a decrease of $14.8 million from the loss recorded in the fourth quarter of 2010. The year over year improvement in the quarterly results was primarily related to a decline in the provision for loan and lease losses of $11.6 million coupled with a decline in other expenses of $5.1 million. The decline in the provision was almost entirely related to an increase in the provision of $11.4 million in the fourth quarter of 2010 associated with a mark to market at fair value of classified loans within a bulk asset sale. The Company had signed a letter of intent in the first quarter of 2011 to sell a pool of $54.1 million of classified assets ($30.3 million of non-performing loans, $10.8 million of classified accruing loans and $13.0 million of OREO properties) in a bulk sale, which were marked to market at the fair market value (projected sale price) at year end 2010. The decline in other expenses was principally related to a reduction in the OREO valuation allowance of $2.7 million and a reduction in expenses for the VIE related to real estate owned via equity investments associated with reduced impairment and lower investment partnership losses amounting to $926,000. The VIE was deconsolidated in 2011. Reduced FDIC and state assessments of $236,000 related to a decline in deposit balances due to the sale of Royal Asian and redemption of brokered CDs, lower professional and legal fees of $479,000 and reduced loan collection expenses of $347,000 also contributed to the favorable change year over year in the fourth quarter. The bulk asset sale previously noted required a valuation allowance of the OREO properties of $2.8 million in the fourth quarter of 2010 to reflect their fair market value based upon the projected sale price and accounted for the year over year change.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 23 - SUMMARY OF QUARTERLY RESULTS (UNAUDITED) - Continued
Partially offsetting the favorable change in the 2011 fourth quarter operating results were a decline in net interest income of $1.6 million and a decline in other income of $603,000. The decline in quarterly net interest income year over year was attributed to the decline in average loan balances related to the sale of Royal Asian and loan payoffs, pay-downs, loan sales and charge-offs coupled with lower yields on both loans and investments in the current lower rate environment. The overall decline was partially mitigated by the continued reduction in interest expense associated primarily with the redemption of brokered CDs, FHLB advances and declining rates on maturing retail CDs. The decline in other income of $603,000 from the previous year’s comparable quarter was mostly attributed to the deconsolidation of the VIE. Included in other income in 2010 was a non-recurring gain on the sale of the Company’s LBSF claim in a pending lawsuit for $1.7 million related to the collateral for an interest rate swap with LBSF, which had previously been written off in 2008 in the amount of $5.0 million shortly after Lehman Brothers Holdings, Inc. declared bankruptcy. Included in other income in 2011 was a non-recurring recovery of $1.5 million from a guarantor of a real estate joint venture that was fully impaired in 2007. If the operating results in 2010 were adjusted for the loss of $14.2 million associated with the asset sale, the fourth quarter loss for 2010 would have been $1.5 million and the fourth quarter loss in 2011 would have amounted to an improvement of $560,000 above the 2010 results.
| | | For the year ended December 31, 2010 | |
| (In thousands, except per share data) | | Fourth Quarter | | | Third Quarter | | | Second Quarter | | | First Quarter | |
| Interest income | | $ | 12,747 | | | $ | 13,719 | | | $ | 15,173 | | | $ | 15,623 | |
| Net interest income | | | 7,352 | | | | 7,562 | | | | 8,334 | | | | 8,020 | |
| Provision for loan and lease losses | | | 13,753 | | | | 2,194 | | | | 4,290 | | | | 1,903 | |
| Net interest income (loss) after provision | | | (6,401 | ) | | | 5,368 | | | | 4,044 | | | | 6,117 | |
| Other income | | | 2,919 | | | | 1,823 | | | | 1,718 | | | | 1,305 | |
| Other expenses | | | 12,316 | | | | 10,333 | | | | 10,041 | | | | 8,053 | |
| Loss before income tax | | $ | (15,798 | ) | | $ | (3,142 | ) | | $ | (4,279 | ) | | $ | (631 | ) |
| Net loss | | $ | (15,798 | ) | | $ | (3,142 | ) | | $ | (4,279 | ) | | $ | (631 | ) |
| Less net (loss) income attributable to noncontrolling interest | | | (111 | ) | | | (347 | ) | | | 259 | | | | 442 | |
| Net loss attributable to Royal Bancshares of Pennsylavania, Inc. | | $ | (15,687 | ) | | $ | (2,795 | ) | | $ | (4,538 | ) | | $ | (1,073 | ) |
| Net loss available to common shareholders | | $ | (16,182 | ) | | $ | (3,289 | ) | | $ | (5,029 | ) | | $ | (1,563 | ) |
| Net loss per common share | | | | | | | | | | | | | | | | |
| Basic and diluted | | $ | (1.22 | ) | | $ | (0.25 | ) | | $ | (0.38 | ) | | $ | (0.12 | ) |
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. 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, as defined in Rule 13a-15(e) of the Exchange Act. Based on that evaluation our CEO and CFO concluded that the Company’s disclosure controls and procedures were effective as December 31, 2011.
Changes in Internal Control over Financial Reporting
There have been no changes in the Company’s internal control over financial reporting during the fourth quarter of 2011 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. The Company’s management, with the participation of the Company’s principal executive officer and principal financial officer, has assessed the effectiveness of our internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).
Based on its assessment under the COSO framework, the Company’s management concluded that the Company’s control over financial reporting was effective as of December 31, 2011.
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.
This annual report does not include an attestation report of the Company’s registered accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to the Dodd-Frank Act, which permits smaller reporting companies, such as the Company, to provide only management’s report in this annual report.
| By: /s/ Robert R. Tabas | By: /s/ Robert A. Kuehl |
| Robert R. Tabas | Robert A. Kuehl |
| Principal Executive Officer | Principal Financial Officer and Principal Accounting Officer |
| March 30, 2012 | March 30, 2012 |
ITEM 9B. OTHER INFORMATION
None.
PART III.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS OF REGISTRANT AND CORPORATE GOVERNANCE
The information required in this Item, relating to directors, executive officers, and control persons is set forth in the Company’s Proxy Statement to be used in connection with the 2012 Annual Meeting of Shareholders under the captions “Information About Nominees, Continuing Directors and Executive Officers,” “ Section 16(a) Beneficial Ownership Reporting Compliance,” “Meetings and Committees of the Board of Directors,” and “Interests of Management and Others in Certain Transactions,” which pages are incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item, relating to executive compensation, is set forth in the Company’s Proxy Statement to be used in connection with the 2012 Annual Meeting of Shareholders, under the captions “Summary Compensation Table,” “Grants of Plan-Based Awards – 2011,” “Outstanding Equity Awards Table,” “Option Exercises and Stock Vested Table,” “Retirement Plans,” “Non-Qualified Deferred Compensation Plans,” “Other Potential Post-Employment Payments,” “Director Compensation Table,” “Outstanding Options Held by Directors,” and “Compensation Committee Report,” which pages are incorporated herein by reference.
In the TARP CPP Agreement, the Company agreed that, until such time as Treasury ceases to own any debt or preferred equity securities of the Company acquired pursuant to the Purchase Agreement, the Company will take all necessary action to ensure that its benefit plans with respect to its senior executive officers comply with Section 111(b) of the Emergency Economic Stabilization Act of 2008, as it may be amended from time to time (the “EESA”), and any rules or regulations promulgated thereunder, and has agreed to not adopt any benefit plans with respect to, or which covers, its senior executive officers that do not comply with the EESA any rules or regulations promulgated thereunder, and the applicable executives have consented to the foregoing.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERS MATTERS
The information required by this Item, relating to beneficial ownership of the Registrant’s Common Stock, is set forth in the Company’s Proxy Statement to be used in connection with the 2012 Annual Meeting of Shareholders, under the captions “Principal Shareholders” and “Information About Nominees, Continuing Directors and Executive Officers,” which pages are incorporated herein by reference.
Securities Authorized for Issuance Under Equity Compensation Plans
The following tables provide certain information regarding securities issued or issuable under the Company’s equity compensation plans as of December 31, 2011:
| Outside Director Stock Option Plan | | Number of Securities to be issued upon exercise of outstanding options, warrants and rights | | | Weighted average exercise price of outstanding options, warrants and rights | | | Number of securities remaining available for issuance under equity plans (excluding securities reflected in first column) | |
| | | | | | | | | | |
| Equity compensation plan approved by security holders | | | 68,620 | | | $ | 20.66 | | | | - | |
| Equity compensation plan not approved by security holders | | | - | | | | - | | | | - | |
| Total | | | 68,620 | | | $ | 20.66 | | | | - | |
| Employee Stock Option Plan | | Number of Securities to be issued upon exercise of outstanding options, warrants and rights | | | Weighted average exercise price of outstanding options, warrants and rights | | | Number of securities remaining available for issuance under equity plans (excluding securities reflected in first column) | |
| | | | | | | | | | |
| Equity compensation plan approved by security holders | | | 335,919 | | | $ | 21.01 | | | | - | |
| Equity compensation plan not approved by security holders | | | - | | | | - | | | | - | |
| Total | | | 335,919 | | | $ | 21.01 | | | | - | |
| Long Term Incentive Plan | | Number of Securities to be issued upon exercise of outstanding options, warrants and rights | | | Weighted average exercise price of outstanding options, warrants and rights | | | Number of securities remaining available for issuance under equity plans (excluding securities reflected in first column) | |
| | | | | | | | | | |
| Equity compensation plan approved by security holders | | | 116,440 | | | $ | 9.73 | | | | 808,928 | |
| Equity compensation plan not approved by security holders | | | - | | | | - | | | | - | |
| Total | | | 116,440 | | | $ | 9.73 | | | | 808,928 | |
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information required by this Item, relating to transactions with management and others, certain business relationships and indebtedness of management, is set forth in the Company’s Proxy Statement to be used in connection with the 2012 Annual Meeting of Shareholders, under the caption “Interests of Management and Others in Certain Transactions,” which pages are incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this item appears under the caption “Audit Committee Report” of the Proxy Statement to be used in connection with the 2012 Annual Meeting of Shareholders, which pages are incorporated herein by reference.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
| | The following financial statements are included by reference in Part II, Item 8 hereof. |
| | Report of Independent Registered Public Accounting Firm |
| | Consolidated Balance Sheets. |
| | Consolidated Statements of Operations. |
| | Consolidated Statements of Changes in Shareholders’ Equity. |
| | Consolidated Statement of Cash Flows. |
| | Notes to Consolidated Financial Statements. |
| 2. | Financial Statement Schedules |
| | Financial Statement Schedules are omitted because the required information is either not applicable, not required or is shown in the respective financial statements or in the notes thereto. |
| (b.) | The following Exhibits are filed herewith or incorporated by reference as a part of this Annual Report. |
| | 3.1 | Articles of Incorporation of the Company. (Incorporated by reference to Exhibit 3.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.) |
| | 3.2 | Bylaws of the Company. (Incorporated by reference to Exhibit 3.2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.) |
| | 4.1 | Junior Subordinated Debt Security Due 2034 issued by Royal Bancshares of Pennsylvania, Inc. to JPMorgan Chase Bank, as Institutional Trustee, dated October 27, 2004. (Incorporated by reference to Exhibit 4.1 to Registrant’s Current Report on Form 8-K (included as Exhibit A to Exhibit 10.1) filed with the Commission on November 1, 2004.) |
| | 4.2 | Junior Subordinated Debt Security Due 2034 issued by Royal Bancshares of Pennsylvania, Inc. to JPMorgan Chase Bank, as Institutional Trustee, dated October 27, 2004. (Incorporated by reference to Exhibit 4.2 to Registrant’s Current Report on Form 8-K (included as Exhibit A to Exhibit 10.2) filed with the Commission on November 1, 2004.) |
| | 4.3 | Indenture by and between Royal Bancshares of Pennsylvania, Inc. and JPMorgan Chase Bank, as Trustee, dated October 27, 2004. (Incorporated by reference to Exhibit 10.1 to Registrant’s Current Report on Form 8-K filed with the Commission on November 1, 2004.) |
| | 4.4 | Indenture by and between Royal Bancshares of Pennsylvania, Inc. and JPMorgan Chase Bank, as Trustee, dated October 27, 2004. (Incorporated by reference to Exhibit 10.2 to Registrant’s Current Report on Form 8-K filed with the Commission on November 1, 2004.) | |
| | 4.5 | Guarantee Agreement by and between Royal Bancshares of Pennsylvania, Inc. and JPMorgan Chase Bank, as Guarantee Trustee, dated October 27, 2004. (Incorporated by reference to Exhibit 10.3 to Registrant’s Current Report on Form 8-K filed with the Commission on November 1, 2004.) |
| | 4.6 | Guarantee Agreement by and between Royal Bancshares of Pennsylvania, Inc. and JPMorgan Chase Bank, as Guarantee Trustee, October 27, 2004. (Incorporated by reference to Exhibit 10.4 to Registrant’s Current Report on Form 8-K filed with the Commission on November 1, 2004.) |
| | 10.1 | Stock Option and Appreciation Right Plan. As amended on March 15, 2005 (Incorporated by reference to the Registrant’s Registration Statement N0. 333-135226, on form S-8 filed with the Commission on June 22, 2006).* |
| | 10.2 | Stock Option and Appreciation Right Plan. As amended on May 16, 2005 (Incorporated by reference to the Registrant’s Registration Statement N0. 333-129894, on form S-8 filed with the Commission on November 22, 2005).* |
| | 10.3 | Outside Directors’ Stock Option Plan. (Incorporated by reference to the Registrant’s Registration Statement N0. 333-25855, on form S-8 filed with the Commission on April 5, 1997).* |
| | 10.4 | Royal Bancshares of Pennsylvania, Inc. 2007 Long-Term Incentive Plan. (Incorporated by reference to Exhibit A to the Company’s definitive Proxy Statement dated April 6, 2007).* |
| | 10.5 | Letter Agreement, including Securities Purchase Agreement - Standard Terms, dated December 19, 2008, between Royal Bancshares of Pennsylvania, Inc. and the United States Department of the Treasury. (Incorporated by reference to exhibit 10.1 to Registrant’s Current Report on Form 8-K filed with the Commission on February 26, 2009.) |
| | 10.6 | Side Letter Agreement, dated February 20, 2009, between Royal Bancshares of Pennsylvania, Inc. and the United States Department of the Treasury. (Incorporated by reference to exhibit 10.2 to Registrant’s Current Report on Form 8-K filed with the Commission on February 26, 2009.) |
| | 10.7 | Form of Letter Agreement, dated December 19, 2008, between Royal Bancshares of Pennsylvania, Inc. and certain of its executive officers relating to executive compensation limitations under the United States Treasury Department’s Capital Purchase Program.* (Incorporated by reference to Exhibit 10.14 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 filed on March 30, 2009.) |
| | 10.8 | Employment Agreement, dated June 1, 2008, between the Company, Royal Bank America and Robert A. Kuehl. (Incorporated by reference to Exhibit 10.15 to the Company’s Amendment No. 2 on Form 10-K/A filed on November 13, 2009.) |
| | 10.9 | Royal Bank America Supplemental Executive Retirement Plan. (Incorporated by reference to Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q filed on November 13, 2009.) |
| | 10.10 | SERP Participation Agreement, as amended — Robert Tabas. (Incorporated by reference to Exhibit 10.6 to the Company’s Quarterly Report on Form 10-Q filed on November 13, 2009.) |
| | 10.11 | SERP Participation Agreement, as amended — James J. McSwiggan. (Incorporated by reference to Exhibit 10.7 to the Company’s Quarterly Report on Form 10-Q filed on November 13, 2009.) |
| | 10.12 | SERP Participation Agreement, as amended — Murray Stempel. (Incorporated by reference to Exhibit 10.8 to the Company’s Quarterly Report on Form 10-Q filed on November 13, 2009.) |
| | 10.13 | Form of Written Agreement between the Company and the Federal Reserve Bank of Philadelphia dated as of March 17, 2010. (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Commission on March 18, 2010). |
| | 11. | Statement re: Computation of Earnings Per Share. (Included at Item 8, hereof, Note 18, “Earnings Per Common Share”.) |
| | 12. | Statement re: Computation of Ratios. (Included at Item 8 here of, Note 15, “Regulatory Capital Requirements.”) |
| | | Subsidiaries of Registrant. |
| | | Consent of Independent Registered Public Accounting Firm. |
| | | Rule 13a-14(a)/15-d-14(a) Certification of Principal Executive Officer |
| | | Rule 13a-14(a)/15-d-14(a) Certification of Principal Financial Officer |
| | | Section 1350 Certification of Principal Executive Officer. |
| | | Section 1350 Certification of Principal Financial Officer. |
| | | Certification of Principal Executive Officer pursuant to the Emergency Economic Stabilization Act of 2008. |
| | | Certification of Principal Financial Officer pursuant to the Emergency Economic Stabilization Act of 2008. |
* Denotes compensation plan or arrangement.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
| By: /s/ Robert R. Tabas | By: /s/ Robert A. Kuehl |
| Robert R. Tabas | Robert A. Kuehl |
| Chief Executive Officer | Chief Financial Officer |
| (Principal Executive Officer) | Principal Financial Officer and Principal Accounting Officer |
| March 30, 2012 | March 30, 2012 |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURES
| By: /s/ Robert R. Tabas | By: /s/ James J. McSwiggan |
| Robert R. Tabas | James J. McSwiggan |
| Chief Executive Officer/Chairman of the Board | President/Chief Operating Officer/Director |
| March 30, 2012 | March 30, 2012 |
| | |
| By: /s/ Edward F. Bradley | By: /s/ William Hartman |
| Edward F. Bradley | William Hartman |
| Director | Director |
| March 30, 2012 | March 30, 2012 |
| | |
| By: /s/ Wayne R. Huey, Jr. | By: /s/ Anthony Micale |
| Wayne R. Huey, Jr | Anthony Micale |
| Director | Director |
| March 30, 2012 | March 30, 2012 |
| | |
| By: /s/ Michael Piracci | By: /s/ Linda Tabas Stempel |
| Michael Piracci | Linda Tabas Stempel |
| Director | Director |
| March 30, 2012 | March 30, 2012 |
| | |
| By: /s/ Murray Stempel, III | By: /s/ Edward B. Tepper |
| Murray Stempel, III | Edward B. Tepper |
Vice Chairman of the Board | Director |
| March 30, 2012 | March 30, 2012 |
| | |
| By: /s/ Gerard M. Thomchick | By: /s/ Howard Wurzak |
| Gerard M. Thomchick | Howard Wurzak |
| Director | Director |
| March 30, 2012 | March 30, 2012 |
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