Royal Bancshares of Pennsylvania (RBPAA) 10-Q 2017 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC  20549

FORM 10-Q

(Mark One)

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

for the quarterly period ended:           June 30, 2017         

☐ 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 the registrant as specified in its charter)

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

One Bala Plaza, Suite 522, 231 St. Asaph’s Road, Bala Cynwyd, PA 19004

(Address of principal Executive Offices)

(610)  668-4700

(Registrant’s telephone number, including area code)

 N/A

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒  No ☐

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 ☒  No ☐

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

Large accelerated filer ☐	Accelerated filer ☐	Non-accelerated filer ☐ (do not check if a smaller reporting company)
Smaller reporting company ☒		Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ☐  No ☒

Applicable only to corporate issuers:

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

Class A Common Stock	Outstanding at July 31, 2017
$2.00 par value	28,006,047

Class B Common Stock	Outstanding at July 31, 2017
$0.10 par value	1,857,072

TABLE OF CONTENTS

		PAGE
PART I	FINANCIAL STATEMENTS
Item 1	Financial Statements
	Consolidated Balance Sheets-unaudited	2
	Consolidated Statements of Income-unaudited	3
	Statements of Consolidated Comprehensive Income-unaudited	4
	Consolidated Statements of Changes in Shareholders’ Equity-unaudited	5
	Consolidated Statements of Cash Flows-unaudited	7
	Notes to Consolidated Financial Statements (unaudited)	9
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	43
Item 3	Quantitative and Qualitative Disclosures about Market Risk	70
Item 4	Controls and Procedures	70
PART II	OTHER INFORMATION	70
Item 1	Legal Proceedings	70
Item 1A	Risk Factors	71
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	71
Item 3	Defaults Upon Senior Securities	71
Item 4	Mine Safety Disclosures	71
Item 5	Other Information	71
Item 6	Exhibits	71
	SIGNATURES	72

1

PART I — FINANCIAL STATEMENTS

Item 1.Financial Statements

 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

Consolidated Balance Sheets-unaudited

	June 30,		December 31,
	2017		2016
ASSETS	(Dollars in thousands, except share data)
Cash and due from banks	$	14,552	$	13,146
Interest-earning deposits		17,159		8,084
Total cash and cash equivalents		31,711		21,230
Investment securities available for sale (“AFS”), at fair value		135,936		169,854
Other investment, at cost		2,250		2,250
Federal Home Loan Bank (“FHLB”) stock		2,276		3,216
Loans and leases held for sale (“LHFS”), at lower of cost or fair value		—		—
Loans and leases (“LHFI”)		605,693		602,009
Less allowance for loan and lease losses		10,262		10,420
Net loans and leases		595,431		591,589
Company owned life insurance		20,909		20,781
Accrued interest receivable		3,277		3,968
Other real estate owned (“OREO”), net		1,932		3,536
Premises and equipment, net		4,873		5,398
Other assets		10,160		10,663
Total assets	$	808,755	$	832,485
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits
Non-interest bearing	$	101,379	$	97,859
Interest-bearing		521,442		531,687
Total deposits		622,821		629,546
Short-term borrowings		21,000		19,000
Long-term borrowings		60,000		85,000
Subordinated debentures		25,774		25,774
Accrued interest payable		1,930		711
Other liabilities		18,904		20,181
Total liabilities		750,429		780,212
Shareholders’ equity
Royal Bancshares of Pennsylvania, Inc. equity:
Class A common stock, par value $2 per share, authorized 40,000,000 shares; issued 28,337,078 and 28,242,055 at June 30, 2017 and  December 31, 2016, respectively, and outstanding 28,006,047 and 27,887,024 at June 30, 2017 and  December 31, 2016, respectively		56,674		56,484
Class B common stock, par value $ 0.10 per share, authorized 3,000,000 shares; issued and outstanding, 1,857,072 and 1,924,629 at June 30, 2017 and  December 31, 2016, respectively		186		193
Additional paid in capital		99,467		99,667
Accumulated deficit		(89,841)		(94,512)
Accumulated other comprehensive loss		(4,188)		(5,219)
Treasury stock - at cost, shares of Class A, 331,031 and 355,031 at June 30, 2017 and  December 31, 2016, respectively		(4,629)		(4,965)
Total Royal Bancshares of Pennsylvania, Inc. shareholders’ equity		57,669		51,648
Noncontrolling interest		657		625
Total equity		58,326		52,273
Total liabilities and shareholders’ equity	$	808,755	$	832,485

The accompanying notes are an integral part of these consolidated financial statements.

2

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

Consolidated Statements of Income-unaudited

	For the three months ended				For the six months ended
	June 30,				June 30,
(In thousands, except per share data)	2017		2016		2017		2016
Interest Income
Loans and leases, including fees	$	8,489	$	6,958	$	16,405	$	13,822
Investment securities		956		1,206		1,982		2,540
Deposits in banks		17		17		33		33
Total Interest Income		9,462		8,181		18,420		16,395
Interest Expense
Deposits		1,169		1,067		2,286		2,107
Short-term borrowings		69		20		135		32
Long-term borrowings		724		677		1,482		1,348
Total Interest Expense		1,962		1,764		3,903		3,487
Net Interest Income		7,500		6,417		14,517		12,908
Provision for loan and lease losses		57		197		354		409
Net Interest Income after Provision for Loan and Lease Losses		7,443		6,220		14,163		12,499
Non-interest Income
Service charges and fees		339		277		702		593
Net gains (losses) on sales of loans and leases		29		—		(21)		—
Income from company owned life insurance		297		188		409		655
Gains on sales of premises and equipment		—		—		73		—
Net gains on the sale of AFS investment securities		276		735		276		1,102
Total other-than-temporary impairment on AFS investment securities		—		(146)		—		(146)
Other income		2		19		15		76
Total Non-interest Income		943		1,073		1,454		2,280
Non-interest Expense
Employee salaries and benefits		2,573		2,608		5,353		5,326
Occupancy and equipment		719		664		1,486		1,388
Professional and legal fees		451		514		836		906
Net OREO expenses (income)		107		(6)		(82)		213
Pennsylvania shares tax expense		169		126		338		239
FDIC and state assessments		198		171		420		344
Communications and data processing		255		244		502		491
Credit for credit losses on off-balance sheet credit exposures		(81)		(21)		(73)		(171)
Directors’ fees		123		99		339		240
Insurance		107		93		207		183
Merger expenses		162		—		405		—
Other operating expenses		387		554		815		1,108
Total Non-interest Expense		5,170		5,046		10,546		10,267
Income Before Tax Expense		3,216		2,247		5,071		4,512
Income Tax Expense		52		60		52		60
Net Income	$	3,164	$	2,187	$	5,019	$	4,452
Less Net Income Attributable to Noncontrolling Interest	$	157	$	153	$	200	$	229
Net Income Attributable to Royal Bancshares of Pennsylvania, Inc.	$	3,007	$	2,034	$	4,819	$	4,223
Less Preferred Stock Series A Accumulated Dividend and Accretion	$	—	$	338	$	—	$	672
Net Income Available to Common Shareholders	$	3,007	$	1,696	$	4,819	$	3,551
Per Common Share Data:
Net Income — Basic and Diluted	$	0.10	$	0.06	$	0.16	$	0.12

The accompanying notes are an integral part of these consolidated financial statements.

3

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

Statements of Consolidated Comprehensive Income-unaudited

	For the three months ended				For the six months ended
	June 30,				June 30,
(In thousands)	2017		2016		2017		2016
Net income	$	3,164	$	2,187	$	5,019	$	4,452
Other comprehensive income, net of tax
Unrealized gains on investment securities:
Unrealized holding gains arising during period, net of tax (1)		534		886		1,166		3,219
Less adjustment for impaired investments, net of tax (2)		—		(96)		—		(96)
Less reclassification adjustment for gains realized in net income, net of tax (3)		182		485		182		727
Unrealized gains on investment securities		352		497		984		2,588
Unrecognized benefit obligation:
Reclassification adjustment for amortization (4)		14		(51)		27		(154)
Unrecognized benefit obligation		14		(51)		27		(154)
Unrealized (loss) gain on derivative instrument, net of tax (5)		(25)		(123)		20		(445)
Other comprehensive income		341		323		1,031		1,989
Comprehensive income		3,505		2,510		6,050		6,441
Less net income attributable to noncontrolling interest		157		153		200		229
Comprehensive income attributable to Royal Bancshares of Pennsylvania, Inc.	$	3,348	$	2,357	$	5,850	$	6,212

(1) Net of $274 thousand and $600 thousand in tax expense for the three and six months ended June 30, 2017, respectively, and $659 thousand and $1.9 million for the three and six months ended June 30, 2016, respectively.

(2) Gross amounts are included in total other-than-temporary impairment on AFS investment securities on the Consolidated Statements of Income in total non-interest income, net of $50 thousand in taxes for the three and six months ended June 30, 2016. See Note 14. Comprehensive Income.

(3) Gross amounts are included in net gains on the sale of AFS investment securities on the Consolidated Statements of Income in total non-interest income; amounts in the above table are net of $94 thousand in income taxes for the three and six months ended June 30, 2017 and $250 thousand and $375 thousand in taxes for the three and six months ended June 30, 2016, respectively. See Note 14. Comprehensive Income.

(4) Gross amounts are included in salaries and benefits on the Consolidated Statements of Income in non-interest expense.

(5) Net of a tax benefit of $13 thousand for the three months ended June 30, 2017 and a tax expense of $10 thousand for the six months ended June 30, 2017 and $63 thousand and $229 thousand in tax benefit for the three and six months ended June 30, 2016, respectively.

The accompanying notes are an integral part of these consolidated financial statements.

4

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders’ Equity

Six months ended June 30, 2017-unaudited

											Accumulated
							Additional				other						Total
	Class A common stock			Class B common stock			paid in		Accumulated		comprehensive		Treasury		Noncontrolling		Shareholders’
(In thousands, except share data)	Shares	Amount		Shares	Amount		capital		deficit		loss		stock		Interest		Equity
Balance January 1, 2017	28,242	$	56,484	1,925	$	193	$	99,667	$	(94,512)	$	(5,219)	$	(4,965)	$	625	$	52,273
Net income										4,819						200		5,019
Other comprehensive income, net of reclassifications and taxes												1,031						1,031
Distributions to noncontrolling interests																(168)		(168)
Common stock conversion from Class B to Class A	78		155	(68)		(7)				(148)								—
Treasury shares issued for compensation (24,000 shares)								(239)						336				97
Stock options exercised (17,333 shares)	17		35					7										42
Stock option expense								32										32
Balance June 30,  2017	28,337	$	56,674	1,857	$	186	$	99,467	$	(89,841)	$	(4,188)	$	(4,629)	$	657	$	58,326

The accompanying notes are an integral part of these consolidated financial statements.

5

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders’ Equity

Six months ended June 30, 2016-unaudited

													Accumulated
	Preferred								Additional				other						Total
	stock		Class A common stock			Class B common stock			paid in		Accumulated		comprehensive		Treasury		Noncontrolling		Shareholders’
(In thousands, except share data)	Series A		Shares	Amount		Shares	Amount		capital		deficit		loss		stock		Interest		Equity
Balance January 1, 2016	$	18,856	28,204	$	56,408	1,928	$	193	$	110,494	$	(104,879)	$	(3,919)	$	(5,249)	$	394	$	72,298
Net income												4,223						229		4,452
Other comprehensive income, net of reclassifications and taxes														1,989						1,989
Distributions to noncontrolling interests																		(103)		(103)
Common stock conversion from Class B to Class A			2		4	(2)						(4)								—
Repurchase of 4,000 shares of preferred stock		(4,000)								(1,800)										(5,800)
Treasury shares issued for compensation (18,322 shares)										(219)						257				38
Stock options exercised (20,000 shares)			20		40					(11)										29
Stock option expense										44										44
Balance June 30,  2016	$	14,856	28,226	$	56,452	1,926	$	193	$	108,508	$	(100,660)	$	(1,930)	$	(4,992)	$	520	$	72,947

The accompanying notes are an integral part of these consolidated financial statements.

6

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows-unaudited

	Six Months Ended,
(In thousands)	2017		2016
Cash flows from operating activities:
Net income	$	5,019	$	4,452
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		305		264
Stock compensation expense		32		44
Provision for loan and lease losses		354		409
Credit for credit losses on off-balance sheet credit exposures		(73)		(171)
Impairment charge for OREO		192		89
Net amortization of premiums on AFS investment securities		697		728
Net accretion of net deferred fees on loans		(363)		(288)
Net gains on sales of premises and equipment		(73)		—
Losses on sales of loans and leases		21		—
Net gains on sales of OREO		(400)		(50)
Net gains on sales of investment securities		(276)		(1,102)
Income from company owned life insurance		(409)		(655)
Other-than-temporary impairment on AFS investment securities		—		146
Changes in assets and liabilities:
Decrease in accrued interest receivable		691		84
Decrease (increase) in other assets		42		(528)
Increase in accrued interest payable		1,219		1,054
(Decrease) increase in other liabilities		(1,204)		511
Net cash provided by operating activities		5,774		4,987
Cash flows from investing activities:
Proceeds from maturities, calls and paydowns of AFS investment securities		16,677		28,462
Proceeds from sales of AFS investment securities		19,492		10,705
Purchase of AFS investment securities		(1,179)		(14,779)
Net redemption (purchase) of Federal Home Loan Bank stock		940		(233)
Proceeds from sales of loans and leases		5,153		—
Net increase in loans		(9,052)		(48,240)
Additions to OREO		(35)		(157)
Proceeds from the sales of premises and equipment		297		—
Purchase of premises and equipment		(4)		(651)
Proceeds from sales of OREO		1,891		799
Net proceeds from life insurance policies		281		—
Net cash provided by (used in) investing activities		34,461		(24,094)

Statement is continued on the next page.

7

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows-unaudited (continued)

Six months ended June 30,

	2017		2016
Cash flows from financing activities:
Net increase in demand and NOW accounts	$	3,520	$	4,194
Net (decrease) increase in money market and savings accounts		(11,221)		15,501
Net increase in certificates of deposit		976		1,657
Net increase in short-term borrowings		2,000		15,000
Repayments of long-term borrowings		(25,000)		(10,226)
Distributions to noncontrolling interest		(168)		(103)
Issuance of treasury stock		97		38
Repurchase of preferred stock		—		(5,800)
Proceeds from stock options exercised		42		29
Net cash (used in) provided by financing activities		(29,754)		20,290
Net increase in cash and cash equivalents		10,481		1,183
Cash and cash equivalents at the beginning of the period		21,230		25,420
Cash and cash equivalents at the end of the period	$	31,711	$	26,603
Supplemental Disclosure:
Income taxes paid	$	52	$	60
Interest paid	$	2,684	$	2,433
Transfers from loans to OREO	$	44	$	454

The accompanying notes are an integral part of these consolidated financial statements.

8

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Note 1.Summary of Significant Accounting Policies

Nature of Operations

Royal Bancshares of Pennsylvania, Inc. (“Royal Bancshares”, the “Company”, “We” or “Our”), 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.

On January 30, 2017, the Company and Bryn Mawr Bank Corporation (“Bryn Mawr”) entered into an Agreement and Plan of Merger (the “Merger Agreement”).  The Merger Agreement provides that, upon the terms and subject to the conditions set forth therein, the Company will merge with and into Bryn Mawr, with Bryn Mawr as the surviving corporation (the “Merger”).  Immediately following the Merger, Royal Bank will merge with the Bryn Mawr Trust Company, the wholly owned subsidiary of Bryn Mawr.  Upon completion of the Merger, holders of Class A common stock of the Company will receive 0.1025 shares of Bryn Mawr common stock, par value of $1.00 per share (the “Bryn Mawr common stock”) for each share of Class A common stock they hold, and holders of Class B common stock of the Company will receive 0.1179 shares of Bryn Mawr common stock for each share of Class B common stock they hold. On May 24, 2017, the Company’s shareholders approved the merger transaction with Bryn Mawr Bank Corporation at a special meeting of the Company’s shareholders. The Merger, which is subject to a number of other closing conditions including receipt of required regulatory approvals, is expected to be completed in the third quarter of 2017.

Basis of Financial Presentation

The accompanying unaudited consolidated financial statements include the accounts of Royal Bancshares of Pennsylvania, Inc. and its wholly-owned subsidiaries, Royal Investments of Delaware, Inc., including Royal Investments of Delaware, Inc.’s wholly owned subsidiary, Royal Preferred, LLC, and Royal Bank, including Royal Bank’s subsidiaries, Royal Real Estate of Pennsylvania, Inc., Royal Investments America, LLC, RBA Property LLC, Narberth Property Acquisition LLC, Rio Marina LLC, and Royal Tax Lien Services, LLC (“RTL”).  Royal Bank also has an 80% and 60% ownership interest in Crusader Servicing Corporation (“CSC”) and Royal Bank America Leasing, LP, respectively. The 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”). These consolidated financial statements reflect the historical information of the Company. All significant intercompany transactions and balances have been eliminated in consolidation.

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information. Applications of the principles in our preparation of the consolidated financial statements in conformity with U.S. GAAP require management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and the accompanying notes.  These estimates and assumptions are based on information available as of the date of the consolidated financial statements; therefore, actual results could differ from those estimates. The interim financial information included herein is unaudited; however, such information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, necessary to present a fair statement of the results for the interim periods.  These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2016.  The results of operations for the three and six month periods ended June 30, 2017 are not necessarily indicative of the results to be expected for the full year.

9

Reclassifications

Certain items in the 2016 consolidated financial statements and accompanying notes have been reclassified to conform to the current year’s presentation format.  There was no effect on net income for the periods presented herein as a result of the reclassification.

Accounting Policies Recently Adopted and Pending Accounting Pronouncements

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which establishes a comprehensive revenue recognition standard for virtually all industries under U.S. GAAP, including those that previously followed industry-specific guidance such as the real estate, construction and software industries. The revenue standard’s core principle is built on the contract between a vendor and a customer for the provision of goods and services. It attempts to depict the exchange of rights and obligations between the parties in the pattern of revenue recognition based on the consideration to which the vendor is entitled. To accomplish this objective, the standard requires five basic steps: i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) the entity satisfies a performance obligation. The ASU is effective for public entities for annual periods beginning after December 15, 2016, including interim periods therein. Three basic transition methods are available – full retrospective, retrospective with certain practical expedients, and a cumulative effect approach. Under the third alternative, an entity would apply the new revenue standard only to contracts that are incomplete under legacy U.S. GAAP at the date of initial application (e.g. January 1, 2017) and recognize the cumulative effect of the new standard as an adjustment to the opening balance of retained earnings. That is, prior years would not be restated and additional disclosures would be required to enable users of the financial statements to understand the impact of adopting the new standard in the current year compared to prior years that are presented under legacy U.S. GAAP. Early adoption is prohibited under U.S. GAAP. In August 2015, the FASB Issued ASU 2015-14 which deferred the effective date to December 15, 2017 and the initial application date (e.g. January 1, 2018.) The majority of our revenue is comprised of net interest income on financial assets and liabilities, which is explicitly excluded from the scope of ASU 2014-09. We continue to analyze this update and do not believe that ASU 2014-09 will have a material effect on our financial statements.

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments – Overall (Topic 825-10): “Recognition and Measurement of Financial Assets and Financial Liabilities.” ASU 2016-01 amends the guidance on the classification and measurement of financial instruments.  Some of the amendments in ASU 2016-01 include the following: 1) requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; 2) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; 3) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; and 4) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value; among others.  ASU 2016-01 also clarifies that an entity should assess the need for a valuation allowance on a deferred tax asset related to unrealized losses of investments in debt instruments recognized in other comprehensive income in combination with the entity’s other deferred tax assets. Prior to this guidance, the alternative approach used in practice evaluated the need for a valuation allowance for a deferred tax asset related to unrealized losses on debt instruments recognized in other comprehensive income separately from other deferred tax assets. This alternative approach will no longer be acceptable. For public business entities, the amendments of ASU 2016-01 are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.  As of December 31, 2016 we did not hold a material amount of equity investments for which fair value is accounted through other comprehensive income.  Consequently, we continue to analyze ASU 2016-01 and do not believe that it will have a material effect on our financial statements. 

In February 2016, the FASB issued Accounting Standards Update No. 2016-02, “Leases” (“ASU 2016-02”). From the lessee's perspective, the new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement for a lessees. From the lessor's perspective, the new standard requires a lessor to classify leases as either sales-type, finance or operating.

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A lease will be treated as a sale if it transfers all of the risks and rewards, as well as control of the underlying asset, to the lessee. If risks and rewards are conveyed without the transfer of control, the lease is treated as a financing lease. If the lessor doesn’t convey risks and rewards or control, an operating lease results.  The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. A modified retrospective transition approach is required for lessors for sales-type, direct financing, and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. Our leases are operating leases and ASU 2016-02 will require us to gross up our balance sheet recording a lease right asset and an offsetting lease right obligation.  Our operating leases are predominantly related to real estate. We are currently evaluating other impacts of the pending adoption of the new standard on our consolidated financial statements.

In March 2016, FASB issued Accounting Standards Update No. 2016-09, “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”).  FASB issued ASU 2016-09 as part of its initiative to reduce complexity in accounting standards. The areas for simplification in this ASU 2016-09 involve several aspects of the accounting for employee share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Some of the areas for simplification apply only to nonpublic entities. For public business entities, the amendments in ASU 2016-09 were effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. We adopted ASU 2016-09 in the first quarter of 2017. ASU 2016-09 did not have a material effect on our financial statements.

In June 2016, FASB issued Accounting Standards Update No. 2016-13, “Financial Instruments-Credit Losses (Topic 326) Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13”).  The main objective of ASU 2016-13 is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in ASU 2016-13 replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates.  The amendments affect entities holding financial assets and net investment in leases that are not accounted for at fair value through net income. The amendments affect loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash.

The amendments in ASU 2016-13 affect an entity to varying degrees depending on the credit quality of the assets held by the entity, their duration, and how the entity applies current GAAP. There is diversity in practice in applying the incurred loss methodology, which means that before transition some entities may be more aligned, under current GAAP, than others to the new measure of expected credit losses.

The amendments in ASU 2016-13 require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset.  The income statement reflects the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period.  The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectibility of the reported amount. An entity must use judgment in determining the relevant information and estimation methods that are appropriate in its circumstances. The allowance for credit losses for purchased financial assets with a more-than insignificant amount of credit deterioration since origination (PCD assets) that are measured at amortized cost basis is determined in a similar manner to other financial assets measured at amortized cost basis; however, the initial allowance for credit losses is added to the purchase price rather than being reported as a credit loss expense. Only subsequent changes in the allowance for credit losses are recorded as a credit loss expense for these assets. Interest income for PCD assets should be recognized based on the effective interest rate, excluding the discount embedded in the purchase price that is attributable to the acquirer’s assessment of credit losses at acquisition.

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Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses. Available-for-sale accounting recognizes that value may be realized either through collection of contractual cash flows or through sale of the security. Therefore, the amendments limit the amount of the allowance for credit losses to the amount by which fair value is below amortized cost because the classification as available for sale is premised on an investment strategy that recognizes that the investment could be sold at fair value, if cash collection would result in the realization of an amount less than fair value. The amendments in ASU 2016-13 require that credit losses be presented as an allowance rather than as a writedown. This approach is an improvement to current GAAP because an entity will be able to record reversals of credit losses (in situations in which the estimate of credit losses declines) in current period net income, which in turn should align the income statement recognition of credit losses with the reporting period in which changes occur. Current GAAP prohibits reflecting those improvements in current period earnings.

For public business entities that are SEC filers, the amendments in ASU 2016-13 are effective for financial statements issued for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. All entities may adopt the amendments in ASU 2016-13 earlier as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.  An entity will apply the amendments in ASU 2016-13 through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (that is,  modified-retrospective approach).  A prospective transition approach is required for debt securities for which an other-than-temporary impairment had been recognized before the effective date. The effect of a prospective transition approach is to maintain the same amortized cost basis before and after the effective date of ASU 2016-13. Amounts previously recognized in accumulated other comprehensive income as of the date of adoption that relate to  improvements in cash flows expected to be collected should continue to be accreted into income over the remaining life of the asset. Recoveries of amounts previously written off relating to improvements in cash flows after the date of adoption should be recorded in earnings when received. We are currently evaluating the impact of the amendments in ASU 2016-13 on our consolidated financial statements.

In August 2016, FASB issued Accounting Standards Update No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments” (“ASU 2016-15”).  Stakeholders indicated that there is diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows under Topic 230, Statement of Cash Flows, and other Topics. The following eight specific cash flow issues are addressed in ASU 2016-15: Debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (“COLI”s) (including bank-owned life insurance policies (“BOLI”s)); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. For public business entities, the amendments in this ASU 2016-15 are effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The amendments in ASU 2016-15 should be applied using a retrospective transition method to each period presented. If it is impracticable to apply the amendments retrospectively for some of the issues, the amendments for those issues would be applied prospectively as of the earliest date practicable. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity that elects early adoption must adopt all of the amendments in the same period. We intend to adopt ASU 2016-15 during the first quarter of 2018, and it will have no effect on our results of operations because it only impacts the presentation of certain information on the statement of cash flows.

In December 2016, FASB issued Accounting Standards Update No. 2016-19, “Technical Corrections and Improvements” (“ASU 2016-19”).  The amendments in ASU 2016-19 cover a wide range of Topics in the Accounting Standards Codification.  The amendments generally fall into one of four categories: (1) amendments related to differences between original guidance and the codification, (2) guidance clarification and reference corrections, (3) simplification, and (4) minor improvements. Most of the amendments in ASU 2016-19 do not require transition guidance and were effective upon issuance. The amendments that require transition guidance are not applicable to the Company. The amendments that require transition guidance are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. FASB does not expect the changes to affect current accounting practice or result in any significant

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costs.  The adoption of ASU 2016-19 effective January 1, 2017, did not have a material impact on our consolidated financial statements.

In February 2017, FASB issued Accounting Standards Update No. 2017-07, “Compensation—Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost” (“ASU 2017-07”). To improve the consistency, transparency, and usefulness of financial information for users, the amendments in ASU 2017-07 require that an employer disaggregate the service cost component from the other components of net benefit cost and report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. It also requires the other components of net periodic pension cost and net periodic postretirement benefit cost to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if one is presented. The amendments in ASU 2017-07 are effective for public business entities for annual periods beginning after December 15, 2017, including interim periods within those annual periods. Early adoption is permitted as of the beginning of an annual period for which financial statements (interim or annual) have not been issued or made available for issuance.The amendments in ASU 2017-07 should be applied retrospectively for the presentation of the service cost component and the other components of net periodic pension cost and net periodic postretirement benefit cost in the income statement and prospectively, on and after the effective date, for the capitalization of the service cost component of net periodic pension cost and net periodic postretirement benefit in assets. We intend to adopt ASU 2017-07 during the first quarter of 2018, and it will have no effect on our results of operations because it only impacts the presentation of certain information on the statements of income.

In March 2017, FASB issued Accounting Standards Update No. 2017-08, “Receivables —Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities” (“ASU 2017-08”).ASU 2017-08 amends guidance on the amortization period of premiums on certain purchased callable debt securities. Specifically, the amendments shorten the amortization period of premiums on certain purchased callable debt securities to the earliest call date. The amendments affect all entities that hold investments in callable debt securities that have an amortized cost basis in excess of the amount that is repayable by the issuer at the earliest call date. For public business entities, the amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018.  Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity should apply the amendments in this Update on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. Additionally, in the period of adoption, an entity should provide disclosures about a change in accounting principle.  The effect of ASU 2017-08 would be lower interest income and a corresponding lower yield as the amortization period would be shortened.  As of March 31, 2017 we do not hold any callable debt securities that were purchased at a premium.  We intend to adopt ASU 2017-08 during the first quarter of 2019.

In May 2017, the FASB issued ASU 2017-09, Compensation-Stock Compensation (Topic 718): Scope of Modification Accounting. FASB issued this Update to address the diversity in practice as well as the cost and complexity when applying the guidance in Topic 718, Compensation – Stock Compensation, to a change to the terms or conditions of a share-based payment award. For public entities, this ASU is effective for annual reporting periods beginning after December 15, 2017.  We are currently assessing the applicability of ASU 2017-09 and have not determined the impact of the adoption, if any, as of June 30, 2017.

In July 2017, the Financial Accounting Standards Board FASB issued ASU 2017-11, Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), Derivatives and Hedging (Topic 815): I. Accounting for Certain Financial Instruments with Down Round Features II. Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interest with a Scope Exception. For public entities, this ASU is effective for annual reporting periods beginning after December 15, 2018. We are currently assessing the applicability of ASU 2017-11 and have not determined the impact of the adoption, if any, as of June 30, 2017.

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Note 2.Investment Securities

The carrying value and fair value of investment securities available-for-sale (“AFS”) at June 30, 2017 and December 31, 2016 are as follows:

As of June 30, 2017
			Gross		Gross
	Amortized		unrealized		unrealized
(In thousands)	cost		gains		losses		Fair value
U.S. government agencies	$	2,127	$	—	$	(5)	$	2,122
Mortgage-backed securities-residential		7,029		178		—		7,207
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		115,532		911		(854)		115,589
Non-agency		—		—		—		—
Corporate bonds		1,700		28		—		1,728
Municipal bonds		7,468		132		(42)		7,558
Other securities		1,706		—		—		1,706
Common stocks		26		—		—		26
Total available for sale	$	135,588	$	1,249	$	(901)	$	135,936

As of December 31, 2016
			Gross		Gross
	Amortized		unrealized		unrealized
(In thousands)	cost		gains		losses		Fair value
U.S. government agencies	$	988	$	—	$	(22)	$	966
Mortgage-backed securities-residential		6,985		70		(17)		7,038
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		146,666		1,022		(2,129)		145,559
Non-agency		4,121		—		(86)		4,035
Corporate bonds		1,700		1		—		1,701
Municipal bonds		8,691		92		(75)		8,708
Other securities		1,821		—		—		1,821
Common stocks		26		—		—		26
Total available for sale	$	170,998	$	1,185	$	(2,329)	$	169,854

The amortized cost and fair value of investment securities at June 30, 2017, 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 June 30, 2017
	Amortized
(In thousands)	cost		Fair value
Within 1 year	$	1,798	$	1,797
After 1 but within 5 years		7,490		7,544
After 5 but within 10 years		1,007		1,039
After 10 years		1,000		1,028
Mortgage-backed securities-residential		7,029		7,207
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		115,532		115,589
Total available for sale debt securities		133,856		134,204
No contractual maturity		1,732		1,732
Total available for sale securities	$	135,588	$	135,936

Proceeds from the sales of AFS investments during the three and six months ended June 30, 2017 were $19.5 million.  Proceeds from the sales of AFS investments during the three and six months ended June 30, 2016 were $683 thousand and

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$10.7 million, respectively. The following table summarizes gross realized gains and losses on the sale of securities recognized in earnings in the periods indicated:

	For the three months ended				For the six months ended
	June 30,				June 30,
(In thousands)	2017		2016		2017		2016
Gross realized gains	$	293	$	779	$	293	$	1,146
Gross realized losses		(17)		(44)		(17)		(44)
Net realized gains	$	276	$	735	$	276	$	1,102

The tables below indicate the length of time individual AFS securities have been in a continuous unrealized loss position at June 30, 2017 and December 31, 2016:

June 30, 2017	Less than 12 months					12 months or longer					Total
			Gross		Number			Gross		Number			Gross		Number
			unrealized		of			unrealized		of			unrealized		of
(In thousands)	Fair value		losses		positions	Fair value		losses		positions	Fair value		losses		positions
U.S. government agencies	$	2,122	$	(5)	2	$	—	$	—	—	$	2,122	$	(5)	2
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		47,191		(422)	18		15,647		(432)	6		62,838		(854)	24
Municipal bonds		664		(1)	2		2,151		(41)	3		2,815		(42)	5
Total available for sale	$	49,977	$	(428)	22	$	17,798	$	(473)	9	$	67,775	$	(901)	31

December 31, 2016	Less than 12 months					12 months or longer					Total
			Gross		Number			Gross		Number			Gross		Number
			unrealized		of			unrealized		of			unrealized		of
(In thousands)	Fair value		losses		positions	Fair value		losses		positions	Fair value		losses		positions
U.S. government agencies	$	966	$	(22)	1	$	—	$	—	—	$	966	$	(22)	1
Mortgage-backed securities-residential		4,237		(17)	2		—		—	—		4,237		(17)	2
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		73,864		(1,630)	31		12,045		(499)	4		85,909		(2,129)	35
Non-agency		4,035		(86)	3		—		—	—		4,035		(86)	3
Municipal bonds		1,678		(45)	3		2,314		(30)	3		3,992		(75)	6
Total available for sale	$	84,780	$	(1,800)	40	$	14,359	$	(529)	7	$	99,139	$	(2,329)	47

We evaluate declines in the fair value of securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis.  We assess whether OTTI is present when the fair value of a security is less than its amortized cost.  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. There were no credit-related impairment losses on debt securities held at June 30, 2017 and June 30, 2016 for which a portion of OTTI was recognized in other comprehensive income. 

For all debt security types discussed below the fair value is based on prices provided by brokers and safekeeping custodians.

U.S. government-sponsored agencies (“U.S. Agency”):  As of June 30, 2017, we had two U.S. Agency securities with a fair value of $2.1 million and a gross unrealized loss of $5 thousand.  The bonds have been in an unrealized loss position for less than twelve months at June 30, 2017. Management believes that the unrealized loss on these debt securities are a function of changes in investment spreads.  Management expects to recover the entire amortized cost basis of these securities. We do not intend to sell these securities before recovery of their cost basis and have not determined that it is not more likely than not that we will 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 June 30, 2017.

U.S. government issued or sponsored collateralized mortgage obligations (“Agency CMOs”):  As of June 30, 2017, we had 24 Agency CMOs with a fair value of $62.8 million and gross unrealized losses of $854 thousand.  Six of the Agency

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CMOs have been in an unrealized loss position for twelve months or longer and the remaining 18 Agency CMOs have been in an unrealized loss position for less than twelve 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 as a result of changes in credit quality.  Management expects to recover the entire amortized cost basis of these securities. We do not intend to sell these securities before recovery of their cost basis and have not determined that it is not more likely than not that we will 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 June 30, 2017.

Municipal bonds:  As of June 30, 2017 we had five municipal bonds with a fair value $2.8 million and gross unrealized losses of $42 thousand.  Two of the municipal bonds have been in an unrealized loss position for less than twelve months and three bonds have been in an unrealized loss position for twelve months or longer at June 30, 2017. Because we do not intend to sell the bonds and it is not more likely than not that we will be required to sell the bonds before recovery of their amortized cost basis, which may be maturity, we do not consider the bonds to be other-than-temporarily impaired at June 30, 2017.

We will continue to monitor these 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.

Note 3.Loans and Leases

At June 30, 2017 and December 31, 2016, the Company had no loans held for sale (“LHFS”).

Major classifications of LHFI are as follows:

	June 30,		December 31,
(In thousands)	2017		2016
Commercial real estate	$	258,662	$	261,561
Construction and land development		84,910		83,369
Commercial and industrial		116,200		108,146
Multi-family		29,030		23,389
Residential real estate		56,363		56,899
Leases		56,258		61,838
Tax certificates		1,378		3,705
Consumer		2,892		3,102
Total loans, net of unearned income	$	605,693	$	602,009

We use 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 Pass-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 in the calculation of the allowance for loan and lease losses.

· Pass: includes credits that demonstrate a low probability of default;

· Pass-watch: a classification which includes currently performing credits that are beginning to demonstrate above average risk through declining earnings, strained cash flows, increased leverage and/or weakening market fundamentals. This class may also include new loan originations which warrant approval but may contain certain risks that require closer than usual monitoring and supervision, such as construction loans;

· Special mention: includes credits that have potential weaknesses that if left uncorrected could weaken the credit or result in inadequate protection of our position at some future date. While potentially weak, credits in this classification are marginally acceptable and loss of principal or interest is not anticipated;

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· 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 we 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 are assigned an initial loan risk rating by the Underwriting and Credit Administration Officer (“UCAO”).  The initial loan risk rating is approved by another member of executive management or by the appropriate loan committee approving the loan request. 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 LHFI portfolio classification at June 30, 2017 and December 31, 2016

As of June 30, 2017
(In thousands)	Pass		Pass-Watch		Special Mention		Substandard		Non-accrual		Total
Commercial real estate	$	223,724		34,131		—		16		791	$	258,662
Construction and land development		8,032		76,750		—		—		128		84,910
Commercial and industrial		90,332		23,417		—		1,693		758		116,200
Multi-family		18,736		10,294		—		—		—		29,030
Residential real estate		55,736		20		—		82		525		56,363
Leases		53,955		329		264		—		1,710		56,258
Tax certificates		876		—		—		—		502		1,378
Consumer		2,818		74		—		—		—		2,892
Total loans, net of unearned income	$	454,209	$	145,015	$	264	$	1,791	$	4,414	$	605,693

As of December 31, 2016
(In thousands)	Pass		Pass-Watch		Special Mention		Substandard		Non-accrual		Total
Commercial real estate	$	221,862	$	38,814	$	—	$	—	$	885	$	261,561
Construction and land development		9,643		73,582		—		—		144		83,369
Commercial and industrial		92,174		13,308		320		1,692		652		108,146
Multi-family		16,974		6,415		—		—		—		23,389
Residential real estate		56,225		104		—		—		570		56,899
Leases		59,641		348		—		—		1,849		61,838
Tax certificates		1,798		—		—		—		1,907		3,705
Consumer		2,891		211		—		—		—		3,102
Total loans, net of unearned income	$	461,208	$	132,782	$	320	$	1,692	$	6,007	$	602,009

17

The following tables present an aging analysis of past due payments for each LHFI portfolio classification at June 30, 2017 and December 31, 2016.

As of June 30, 2017	30-59 Days		60-89 Days		90+ Days*
(In thousands)	Past Due		Past Due		Past Due		Current		Total
Commercial real estate	$	149	$	1,165	$	791		256,557	$	258,662
Construction and land development		—		—		128		84,782		84,910
Commercial and industrial		149		44		758		115,249		116,200
Multi-family		—		—		—		29,030		29,030
Residential real estate		186		1,037		525		54,615		56,363
Leases		329		264		1,710		53,955		56,258
Tax certificates		—		—		502		876		1,378
Consumer		—		—		—		2,892		2,892
Total loans, net of unearned income	$	813	$	2,510	$	4,414	$	597,956	$	605,693

As of December 31, 2016	30-59 Days		60-89 Days		90+ Days*
(In thousands)	Past Due		Past Due		Past Due		Current		Total
Commercial real estate	$	—	$	507	$	886	$	260,168	$	261,561
Construction and land development		—		—		144		83,225		83,369
Commercial and industrial		416		367		173		107,190		108,146
Multi-family		—		—		—		23,389		23,389
Residential real estate		978		—		355		55,566		56,899
Leases		348		104		1,577		59,809		61,838
Tax certificates		—		—		1,907		1,798		3,705
Consumer		—		—		—		3,102		3,102
Total loans, net of unearned income	$	1,742	$	978	$	5,042	$	594,247	$	602,009

*    All loans categorized as “90+ Days Past Due” are non-accrual.

If interest had accrued on non-accrual loans held for investment, such income would have been approximately $108 thousand and $226 thousand for the three and six months ended June 30, 2017 and $157 thousand and $315 thousand for the three and six months ended June 30, 2016, respectively.

Impaired Loans

Total cash collected on all impaired loans during the six months ended June 30, 2017 and 2016 was $934 thousand and $1.1 million, respectively, of which $900 thousand and $994 thousand was credited to the principal balance outstanding on such loans, respectively. Interest income recognized on a cash basis on impaired loans and leases was $0 for the three and six months ended June 30, 2017 and June 30, 2016.

Troubled Debt Restructurings (“TDRs”)

The following table details our TDRs that are on an accrual status and non-accrual status at June 30, 2017 and December 31, 2016.

	As of June 30, 2017
				Non-
	Number of	Accrual		Accrual
(In thousands)	loans	Status		Status		Total TDRs
Commercial real estate	1	$	16	$	—	$	16
Construction and land development	1		—		128		128
Commercial and industrial	2		1,693		166		1,859
Residential real estate	1		82		—		82
Total	5	$	1,791	$	294	$	2,085

18

	As of December 31, 2016
				Non-
	Number of	Accrual		Accrual
(In thousands)	loans	Status		Status		Total TDRs
Commercial real estate	1	$	19	$	—	$	19
Construction and land development	1		—		144		144
Commercial and industrial	2		1,692		173		1,865
Residential real estate	1		83		—		83
Total	5	$	1,794	$	317	$	2,111

At June 30, 2017, there were no TDRs modified within the past 12 months for which there was a payment default. We did not classify any loan modifications as TDRs during the first or second quarter of 2017.

We may obtain physical possession of real estate collateralizing residential mortgage loans or home equity loans through or in lieu of, foreclosure.  As of June 30, 2017, we have no foreclosed residential real estate properties as a result of physical possession.  In addition, as of June 30, 2017, we had residential mortgage loans with a carrying value of $215 thousand collateralized by residential real estate property for which formal foreclosure proceedings were in process.

Note 4.Allowance for Loan and Lease Losses

The following tables present the detail of the allowance and the LHFI portfolio disaggregated by loan portfolio classification as of June 30, 2017, December 31, 2016 and June 30, 2016.

Allowance for Loan and Lease Losses

As of and for the three months ended June 30, 2017

			Construction
	Commercial		and land		Commercial		Multi-		Residential				Tax
(In thousands)	real estate		development		and industrial		family		real estate		Leases		certificates		Consumer		Unallocated		Total
Beginning balance	$	3,366	$	2,405	$	1,378	$	313	$	651	$	2,239	$	179	$	27	$	—	$	10,558
Charge-offs		(59)		—		—		—		(7)		(300)		—		—		—		(366)
Recoveries		—		—		—		—		7		6		—		—		—		13
Provision (credit)		(146)		(132)		(7)		31		(28)		347		(9)		1		—		57
Ending balance	$	3,161	$	2,273	$	1,371	$	344	$	623	$	2,292	$	170	$	28	$	—	$	10,262
Ending balance: related to loans individually evaluated for impairment	$	—	$	—	$	—	$	—	$	16	$	195	$	14	$	—	$	—	$	225
Ending balance: related to loans collectively evaluated for impairment	$	3,161	$	2,273	$	1,371	$	344	$	607	$	2,097	$	156	$	28	$	—	$	10,037

19

Allowance for Loan and Lease Losses

As of and for the six months ended June 30, 2017

			Construction
	Commercial		and land		Commercial		Multi-		Residential				Tax
(In thousands)	real estate		development		and industrial		family		real estate		Leases		certificates		Consumer		Unallocated		Total
Beginning balance	$	3,295	$	2,294	$	1,346	$	263	$	656	$	2,295	$	242	$	29	$	—	$	10,420
Charge-offs		(79)		—		—		—		(8)		(797)		(8)		—		—		(892)
Recoveries		—		351		—		—		15		14		—		—		—		380
(Credit) provision		(55)		(372)		25		81		(40)		780		(64)		(1)		—		354
Ending balance	$	3,161	$	2,273	$	1,371	$	344	$	623	$	2,292	$	170	$	28	$	—	$	10,262
Ending balance: related to loans individually evaluated for impairment	$	—	$	—	$	—	$	—	$	16	$	195	$	14	$	—	$	—	$	225
Ending balance: related to loans collectively evaluated for impairment	$	3,161	$	2,273	$	1,371	$	344	$	607	$	2,097	$	156	$	28	$	—	$	10,037

Loans Evaluated for Impairment

As of June 30, 2017

			Construction
	Commercial		and land		Commercial		Multi-		Residential				Tax
	real estate		development		and industrial		family		real estate		Leases		certificates		Consumer		Unallocated		Total
(In thousands)
Ending balance	$	258,662	$	84,910	$	116,200	$	29,030	$	56,363	$	56,258	$	1,378	$	2,892	$	—	$	605,693
Ending balance: individually evaluated for impairment	$	806	$	128	$	1,859	$	—	$	614	$	1,059	$	502	$	—	$	—	$	4,968
Ending balance: collectively evaluated for impairment	$	257,856	$	84,782	$	114,341	$	29,030	$	55,749	$	55,199	$	876	$	2,892	$	—	$	600,725

Allowance for Loan and Lease Losses and Loans Evaluated for Impairment

As of and for the year ended December 31, 2016

			Construction
	Commercial		and land		Commercial		Multi-		Residential				Tax
(In thousands)	real estate		development		and industrial		family		real estate		Leases		certificates		Consumer		Unallocated		Total
Beginning balance	$	3,622	$	1,674	$	1,513	$	171	$	586	$	1,749	$	347	$	27	$	—	$	9,689
Charge-offs		(84)		—		(107)		—		(40)		(930)		(139)		—		—		(1,300)
Recoveries		201		306		174		—		35		57		14		2		—		789
(Credit) provision		(444)		314		(234)		92		75		1,419		20		—		—		1,242
Ending balance	$	3,295	$	2,294	$	1,346	$	263	$	656	$	2,295	$	242	$	29	$	—	$	10,420
Ending balance: related to loans individually evaluated for impairment	$	3	$	—	$	—	$	—	$	17	$	340	$	8	$	—	$	—	$	368
Ending balance: related to loans collectively evaluated for impairment	$	3,292	$	2,294	$	1,346	$	263	$	639	$	1,955	$	234	$	29	$	—	$	10,052
Loan Balances
Ending balance	$	261,561	$	83,369	$	108,146	$	23,389	$	56,899	$	61,838	$	3,705	$	3,102	$	—	$	602,009
Ending balance: individually evaluated for impairment	$	904	$	144	$	2,105	$	—	$	653	$	1,242	$	1,907	$	—	$	—	$	6,955
Ending balance: collectively evaluated for impairment	$	260,657	$	83,225	$	106,041	$	23,389	$	56,246	$	60,596	$	1,798	$	3,102	$	—	$	595,054

20

Allowance for Loan and Lease Losses

As of and for the three months ended June 30, 2016

			Construction
	Commercial		and land		Commercial		Multi-		Residential				Tax
(In thousands)	real estate		development		and industrial		family		real estate		Leases		certificates		Consumer		Unallocated		Total
Beginning balance	$	3,570	$	1,920	$	1,419	$	174	$	586	$	1,993	$	252	$	27	$	—	$	9,941
Charge-offs		—		—		—		—		(40)		(164)		(25)		—		—		(229)
Recoveries		8		64		4		—		8		9		6		—		—		99
(Credit) provision		(236)		7		(58)		57		93		214		125		(5)		—		197
Ending balance	$	3,342	$	1,991	$	1,365	$	231	$	647	$	2,052	$	358	$	22	$	—	$	10,008
Ending balance: related to loans individually evaluated for impairment	$	—	$	—	$	—	$	—	$	18	$	204	$	115	$	—	$	—	$	337
Ending balance: related to loans collectively evaluated for impairment	$	3,342	$	1,991	$	1,365	$	231	$	629	$	1,848	$	243	$	22	$	—	$	9,671

Allowance for Loan and Lease Losses

As of and for the six months ended June 30, 2016

			Construction
	Commercial		and land		Commercial		Multi-		Residential				Tax
(In thousands)	real estate		development		and industrial		family		real estate		Leases		certificates		Consumer		Unallocated		Total
Beginning balance	$	3,622	$	1,674	$	1,513	$	171	$	586	$	1,749	$	347	$	27	$	—	$	9,689
Charge-offs		(77)		—		(108)		—		(40)		(447)		(31)		—		—		(703)
Recoveries		184		258		127		—		19		17		8		—		—		613
Provision (credit)		(387)		59		(167)		60		82		733		34		(5)		—		409
Ending balance	$	3,342	$	1,991	$	1,365	$	231	$	647	$	2,052	$	358	$	22	$	—	$	10,008
Ending balance: related to loans individually evaluated for impairment	$	—	$	—	$	—	$	—	$	18	$	204	$	115	$	—	$	—	$	337
Ending balance: related to loans collectively evaluated for impairment	$	3,342	$	1,991	$	1,365	$	231	$	629	$	1,848	$	243	$	22	$	—	$	9,671

Loans Evaluated for Impairment

As of June 30, 2016

			Construction
	Commercial		and land		Commercial		Multi-		Residential				Tax
	real estate		development		and industrial		family		real estate		Leases		certificates		Consumer		Unallocated		Total
(In thousands)
Ending balance	$	239,776	$	65,385	$	97,270	$	21,010	$	50,104	$	66,898	$	4,390	$	2,254	$	—	$	547,087
Ending balance: individually evaluated for impairment	$	879	$	145	$	2,306	$	—	$	677	$	1,088	$	1,110	$	—	$	—	$	6,205
Ending balance: collectively evaluated for impairment	$	238,897	$	65,240	$	94,964	$	21,010	$	49,427	$	65,810	$	3,280	$	2,254	$	—	$	540,882

21

The following tables detail the loans that were evaluated for impairment by loan classification at June 30, 2017 and December 31, 2016.

	At June 30, 2017
	Unpaid
	principal		Recorded		Related
(In thousands)	balance		investment		allowance
With no related allowance recorded:
Commercial real estate	$	893	$	806	$	—
Construction and land development		531		128		—
Commercial and industrial		1,860		1,859		—
Residential real estate		178		89		—
Tax certificates		651		364		—
Total:	$	4,113	$	3,246	$	—

With an allowance recorded:
Residential real estate	$	642	$	525	$	16
Tax certificates		4,194		138		14
Leasing		1,059		1,059		195
Total:	$	5,895	$	1,722	$	225

	At and for the year ended December 31, 2016
	Unpaid						Average		Interest		Interest income
	principal		Recorded		Related		recorded		income		recognized
(In thousands)	balance		investment		allowance		investment		recognized		cash basis
With no related allowance recorded:
Commercial real estate	$	362	$	362	$	—	$	923	$	—	$	—
Construction and land development		546		144		—		145		—		—
Commercial and industrial		2,209		2,105		—		2,296		107		—
Residential real estate		133		83		—		45		4		—
Tax certificates		2,165		1,752		—		1,019		—		—
Total:	$	5,415	$	4,446	$	—	$	4,428	$	111	$	—
With an allowance recorded:
Commercial real estate	$	936	$	542	$	3	$	168	$	—	$	—
Commercial and industrial		—		—		—		17		—		—
Residential real estate		668		570		17		695		—		—
Leases		1,242		1,242		340		910		—		—
Tax certificates		4,202		155		8		26		—		—
Total:	$	7,048	$	2,509	$	368	$	1,816	$	—	$	—

22

The following tables present the average recorded investment in impaired loans and the related interest income recognized for the three and six months ended June 30, 2017 and 2016.

	For the three months ended June 30, 2017						For the six months ended June 30, 2017
	Average		Interest		Interest income		Average		Interest		Interest income
	recorded		income		recognized		recorded		income		recognized
(In thousands)	investment		recognized		cash basis		investment		recognized		cash basis
Commercial real estate	$	1,230	$	—	$	—	$	1,230	$	—	$	—
Construction and land development		128		—		—		135		—		—
Commercial and industrial		1,871		25		—		1,972		50		—
Residential real estate		582		2		—		610		4		—
Leasing		1,115		—		—		1,067		—		—
Tax certificates		938		—		—		1,345		—		—
Total:	$	5,864	$	27	$	—	$	6,359	$	54	$	—

	For the three months ended June 30, 2016						For the six months ended June 30, 2016
	Average		Interest		Interest income		Average		Interest		Interest income
	recorded		income		recognized		recorded		income		recognized
(In thousands)	investment		recognized		cash basis		investment		recognized		cash basis
Commercial real estate	$	1,239	$	—	$	—	$	1,323	$	—	$	—
Construction and land development		145		—		—		145		—		—
Commercial and industrial		2,313		27		—		2,429		57		—
Residential real estate		764		—		—		807		—		—
Leasing		756		—		—		835		—		—
Tax certificates		1,061		—		—		1,059		—		—
Total:	$	6,278	$	27	$	—	$	6,598	$	57	$	—

Note 5.Other Real Estate Owned

At June 30, 2017, OREO was comprised of one real estate property acquired in lieu of foreclosure in settlement of a loan and 24 real estate properties acquired through foreclosure related to tax liens.  Set forth below are tables which detail the changes in OREO from January 1, 2017 to June 30, 2017 and January 1, 2016 to December 31, 2016.

	For the six months ended June 30, 2017
(In thousands)	Loans		Tax Liens		Total
Beginning balance	$	236	$	3,300	$	3,536
Net proceeds from sales		(33)		(1,858)		(1,891)
Net gains on sales		5		395		400
Transfers in		—		44		44
Cash additions		—		35		35
Impairment charge		(27)		(165)		(192)
Ending balance	$	181	$	1,751	$	1,932

23

	For the year ended December 31, 2016
(In thousands)	Loans		Tax Liens		Total
Beginning balance	$	220	$	7,215	$	7,435
Net proceeds from sales		(7)		(5,458)		(5,465)
Net gain on sales		1		677		678
Transfers in		28		831		859
Cash additions		—		290		290
Impairment charge		(6)		(255)		(261)
Ending balance	$	236	$	3,300	$	3,536

At June 30, 2017, OREO was comprised of $181 thousand in land and $1.8 million in tax liens.  The properties acquired through the tax lien portfolio were primarily located in New Jersey. 

Note 6.Deposits

Our deposit composition as of June 30, 2017 and December 31, 2016 is presented below:

	June 30,		December 31,
(In thousands)	2017		2016
Non-interest bearing checking	$	101,379	$	97,859
Interest checking		44,845		47,835
Money Market		154,812		165,305
Savings		87,432		85,170
Certificates of deposit ($250 and over)		22,323		19,520
Certificates of deposit (less than $250)		186,304		192,368
Brokered deposits		25,726		21,489
Total deposits	$	622,821	$	629,546

Note 7.Borrowings and Subordinated Debentures

1. Advances from the Federal Home Loan Bank

As of June 30, 2017, Royal Bank had $276.8 million of available borrowing capacity at the FHLB, which is based on qualifying collateral.  Total advances from the FHLB were $46.0 million at June 30, 2017 and $69.0 million at December 31, 2016.  The advances and the line of credit are collateralized by FHLB stock, government agency securities, mortgage-backed securities, and a blanket lien on certain real estate loans.  As of June 30, 2017, investment securities with a market value of $9.5 million were pledged as collateral to the FHLB for the borrowings.

Presented below are the Company’s FHLB borrowings allocated by the year in which they mature with their corresponding weighted average rates:

	As of				As of
	June 30, 2017				December 31, 2016
(Dollars in thousands)	Amount		Rate		Amount		Rate
Advances maturing in
2017	$	21,000	1.30	%	$	44,000	1.19	%
2018		10,000	2.01	%		10,000	2.01	%
2021		15,000	1.40	%		15,000	1.40	%
Total FHLB borrowings	$	46,000			$	69,000

24

2. Other borrowings

At June 30, 2017 and December 31, 2016, we had additional borrowings of $35.0 million from PNC which will mature on January 7, 2018.  These borrowings have a weighted average interest rate of 3.65%. The borrowings are secured by government agency securities and mortgage-backed securities.

Royal Bank has an additional $20.0 million in lines of credit with two local financial institutions, of which $0 was outstanding at June 30, 2017 and December 31, 2016, respectively.

3. Subordinated debentures

We have outstanding $25.8 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”).  We issued an aggregate principal amount of $12.9 million of floating rate junior subordinated debt securities to Trust I and an aggregate principal amount of $12.9 million of fixed/floating rate junior subordinated debt securities to Trust II.  Both debt securities bear an interest rate of 3.40% at June 30, 2017, and reset quarterly at 3-month LIBOR plus 2.15%.

Each of Trust I and Trust II issued an aggregate principal amount of $12.5 million of capital securities initially bearing fixed and/or fixed/floating interest rates corresponding to the debt securities held by each trust to an unaffiliated investment vehicle and issued to the Company an aggregate principal amount of $387 thousand of common securities bearing fixed and/or fixed/floating interest rates corresponding to the debt securities held by each trust.  We have fully and unconditionally guaranteed all of the obligations of the Trusts, including any distributions and payments on liquidation or redemption of the capital securities.

Note 8.Derivative Instruments and Hedging Activity

In 2014, we entered into a forward-starting interest rate swap agreement to hedge the risk of variability in cash flows attributable to changes in the 3 month LIBOR rate. This particular hedging objective was to reduce the interest rate risk associated with our forecasted issuances of 3 month fixed rate debt arising from a rollover strategy of an FHLB advance, which matured in June 2016.  We have and will continue to rollover the FHLB advance through the swap expiration of June 2021. This derivative was used as part of the asset/liability management process, is linked to a specific liability and has a high correlation between the contract and the underlying item being hedged, both at inception and throughout the hedge period. The derivative was designated as a cash flow hedge with the change in fair value recorded as an adjustment through other comprehensive income (loss) until the underlying forecasted transactions occur, at which time the deferred gains and losses are recognized in earnings. As of June 30, 2017 an investment security with a fair value of $622 thousand was pledged as collateral to the counterparty of this transaction.

The effects of the derivative instrument on the Consolidated Financial Statements at June 30, 2017 and December 31, 2016 and for the three and six months ended June 30, 2017 were as follows:

	As of June 30, 2017
	Notional
	Contract				Balance Sheet	Expiration
(In thousands)	Amount		Fair Value		Location	Date
Derivatives designated as hedging instruments
Interest rate swaps:
Effective June 24, 2016	$	15,000	$	(464)	Other liabilities	June 24, 2021
Total:	$	15,000	$	(464)

25

	As of December 31, 2016
	Notional
	Contract				Balance Sheet	Expiration
(In thousands)	Amount		Fair Value		Location	Date
Derivatives designated as hedging instruments
Interest rate swaps:
Effective June 24, 2016	$	15,000	$	(494)	Other liabilities	June 24, 2021
Total:	$	15,000	$	(494)

	For the three months ended June 30, 2017
	Amount of Loss		Location of Loss	Amount of Loss
	Recognized		Recognized	Recognized
	in OCI		in Income	in Income
	on Derivatives		on Derivatives	on Derivatives
(In thousands)	(Effective Portion)		(Ineffective Portion)	(Ineffective Portion)
Derivatives designated as hedging instruments
Interest rate swaps:
Effective June 24, 2016	$	(25)	Not Applicable	$	—
Total:	$	(25)		$	—

	For the six months ended June 30, 2017
	Amount of Gain		Location of Loss	Amount of Loss
	Recognized		Recognized	Recognized
	in OCI		in Income	in Income
	on Derivatives		on Derivatives	on Derivatives
(In thousands)	(Effective Portion)		(Ineffective Portion)	(Ineffective Portion)
Derivatives designated as hedging instruments
Interest rate swaps:
Effective June 24, 2016	$	20	Not Applicable	$	—
Total:	$	20		$	—

	For the year ended December 31, 2016
	Amount of Gain		Location of Loss	Amount of Loss
	Recognized		Recognized	Recognized
	in OCI		in Income	in Income
	on Derivatives		on Derivatives	on Derivatives
(In thousands)	(Effective Portion)		(Ineffective Portion)	(Ineffective Portion)
Derivatives designated as hedging instruments
Interest rate swaps:
Effective June 24, 2016	$	40	Not Applicable	$	—
Total:	$	40		$	—

	For the three months ended June 30, 2016
	Amount of Loss		Location of Loss	Amount of Loss
	Recognized		Recognized	Recognized
	in OCI		in Income	in Income
	on Derivatives		on Derivatives	on Derivatives
(In thousands)	(Effective Portion)		(Ineffective Portion)	(Ineffective Portion)
Derivatives designated as hedging instruments
Interest rate swaps:
Effective June 24, 2016	$	(123)	Not Applicable	$	—
Total:	$	(123)		$	—

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	For the six months ended June 30, 2016
	Amount of Loss		Location of Loss	Amount of Loss
	Recognized		Recognized	Recognized
	in OCI		in Income	in Income
	on Derivatives		on Derivatives	on Derivatives
(In thousands)	(Effective Portion)		(Ineffective Portion)	(Ineffective Portion)
Derivatives designated as hedging instruments
Interest rate swaps:
Effective June 24, 2016	$	(445)	Not Applicable	$	—
Total:	$	(445)		$	—

Note 9.Commitments, Contingencies, and Concentrations

We are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers.  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 we have in particular classes of financial instruments.

Our 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.  We use the same credit policies in making commitments and conditional obligations as we do for on-balance-sheet instruments.

The contract amounts are as follows:

	June 30,		December 31,
(In thousands)	2017		2016
Financial instruments whose contract amounts represent credit risk:
Open-end lines of credit	$	76,366	$	74,858
Commitments to extend credit		13,341		43,344
Standby letters of credit and financial guarantees written		82		37

Legal Proceedings

From time to time, we are a party to routine legal proceedings within the normal course of business.  Such routine legal proceedings in the aggregate are believed by management to be immaterial to our financial condition or results of operations.

On January 30, 2017, the Company and Bryn Mawr Bank Corporation, (“BMBC”), entered into an Agreement and Plan of Merger (the “Merger Agreement”) pursuant to which, upon satisfaction of the conditions set forth in the Merger Agreement, the Company will merge with and into BMBC, with BMBC being the surviving corporation (the “Merger”).  On April 11, 2017, a shareholder filed a lawsuit in the United States District Court, Eastern District of Pennsylvania, against members of the Company’s board of directors, BMBC and the Company. The lawsuit, which is captioned Parshall v. Royal Bancshares of Pennsylvania, Inc., et al., Case No. 2:17-cv-01641-PBT alleges class claims on behalf of all Company shareholders based on allegations of material misstatements and omissions in the proxy statement/prospectus and violations of the Securities Exchange Act of 1934. The lawsuit seeks, among other remedies, to enjoin the Merger or, in the event the Merger is completed, rescission of the Merger or rescissory damages; to direct defendants to account for unspecified damages; and costs of the lawsuit, including attorneys’ and experts’ fees. As of the date of this filing, the Company cannot reasonably predict the outcome of the lawsuit or, in the event of an adverse outcome, the potential loss or range of possible loss relating to the lawsuit.

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Note 10.Shareholders’ Equity

1. Common Stock

Our Class A common stock trades on the NASDAQ Global Market under the symbol RBPAA.  There is no market for our 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.  Shareholders are 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.

2. Payment of Dividends

Under the Pennsylvania Business Corporation Law, the Company may pay dividends only if it 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”) affecting the payment of dividends to the Company by Royal Bank.  Under the Code, no dividends may be paid by a bank except from “accumulated net earnings” (generally retained earnings).  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. 

Note 11.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 our financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our 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. 

In July 2013, the federal bank regulatory agencies adopted the final reforms on capital and liquidity generally referred to as “Basel III”, which were published by the Basel Committee on Banking Supervision and the Financial Stability Board. The agencies view the new capital requirements as a better reflection of banking organizations’ risk profiles, thereby improving the overall resiliency of the banking system. The rules generally implement higher minimum capital requirements, add a new common equity tier 1 capital requirement or “CET1”, and establish criteria that instruments must meet to be considered common equity tier 1 capital, additional tier 1 capital, or tier 2 capital.  Basel III also introduced a non-risk adjusted tier 1 leverage ratio of 3%, based on a measure of total exposure rather than total assets, and new liquidity requirements.  

Under the rules, in order to avoid limitations on capital distributions (including dividend payments and certain discretionary bonus payments to executive officers), a banking organization must hold a capital conservation buffer comprised of CET1 above its minimum risk-based capital requirements in an amount greater than 2.5% of total risk-weighted assets.   The new minimum capital requirements became effective on January 1, 2015.  The capital conservation buffer requirements phase in over a three-year period beginning January 1, 2016. Effective January 1, 2019 the capital conservation buffer will effectively raise the minimum required common equity tier 1 capital ratio to 7.0%, the tier 1 capital ratio to 8.5%, and the total capital to 10.0%.  Management believes that as of June 30, 2017, the Company and Royal Bank would meet all capital adequacy requirements under the Basel III rules on a fully phased in basis as if all such requirements were currently in effect.  As of June 30, 2017, the Company and Royal Bank satisfied the criteria for a well-capitalized institution.

In connection with a prior bank regulatory examination, the FDIC concluded, based upon its interpretation of 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 June 30, 2017 and the previous 27 quarters in accordance with U.S. GAAP.  The change in the method of revenue recognition for the tax lien business for 

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regulatory accounting purposes affects Royal Bank’s and the Company’s capital ratios as shown below.  The resolution of this matter will be decided by additional joint regulatory agency guidance which includes the Federal Reserve Bank, the FDIC, and the OCC.

The table below sets forth Royal Bank’s capital ratios under RAP based on the FDIC’s interpretation of the Call Report instructions:

	At June 30, 2017
									To be well capitalized
					For capital				under prompt corrective
	Actual				adequacy purposes				action provision
(Dollars in thousands)	Amount		Ratio		Amount		Ratio*		Amount		Ratio
Total capital (to risk-weighted assets)	$	82,588	13.296	%	$	57,454	9.250	%	$	62,113	10.000	%
Tier 1 capital (to risk-weighted assets)	$	74,721	12.030	%	$	45,032	7.250	%	$	49,690	8.000	%
Tier 1 capital (to average assets, leverage)	$	74,721	9.148	%	$	32,671	4.000	%	$	40,838	5.000	%
Common equity Tier 1 (to risk-weighted assets)	$	74,081	11.927	%	$	35,715	5.750	%	$	40,373	6.500	%

*    Ratios related to risk-weighted assets include the capital conservation buffer of 1.25%.

The tables below reflect the adjustments to the net income as well as the capital ratios for Royal Bank under U.S. GAAP:

	For the six months ended
(In thousands)	June 30, 2017
RAP net income	$	4,338
Tax lien adjustment, net of noncontrolling interest		903
U.S. GAAP net income	$	5,241

	At June 30, 2017
	As reported		As adjusted
	under RAP		for U.S. GAAP
Total capital (to risk-weighted assets)	13.296	%	13.426	%
Tier 1 capital (to risk-weighted assets)	12.030	%	12.160	%
Tier 1 capital (to average assets, leverage)	9.148	%	9.251	%
Common equity Tier 1 (to risk-weighted assets)	11.927	%	12.054	%

The tables below reflect the Company’s capital ratios:

	At June 30, 2017
										To be well capitalized
					For capital					under the Federal
	Actual				adequacy purposes				Reserve's regulations
(Dollars in thousands)	Amount		Ratio		Amount		Ratio*		Amount		Ratio
Total capital (to risk-weighted assets)	$	88,975	14.267	%	$	57,689	9.250	%	$	62,366	10.00	%
Tier 1 capital (to risk-weighted assets)	$	75,024	12.030	%	$	45,216	7.250	%	$	37,420	6.00	%
Tier 1 capital (to average assets, leverage)	$	75,024	9.130	%	$	32,871	4.000	%		N/A	N/A
Common equity Tier 1 (to risk-weighted assets)	$	55,492	8.898	%	$	35,861	5.750	%		N/A	N/A

*Ratios related to risk-weighted assets include capital conservation buffer of 1.25%.

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The Company has filed the Consolidated Financial Statements for Bank Holding Companies-FR Y-9C (“FR Y-9C”) as of June 30, 2017 consistent with U.S. 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 six months ended
(In thousands)	June 30, 2017
U.S. GAAP net income	$	4,819
Tax lien adjustment, net of noncontrolling interest		(903)
RAP net income	$	3,916

	At June 30, 2017
	As reported		As adjusted
	under U.S. GAAP		for RAP
Total capital (to risk-weighted assets)	14.267	%	14.138	%
Tier 1 capital (to risk-weighted assets)	12.030	%	11.851	%
Tier 1 capital (to average assets, leverage)	9.130	%	8.991	%
Common equity Tier 1 (to risk-weighted assets)	8.898	%	8.766	%

Note 12.Pension Plan

We have a noncontributory nonqualified defined benefit pension plan (“Pension Plan”) covering certain eligible employees.  Our 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.

Net periodic defined benefit pension expense for the three and six months ended June 30, 2017 and 2016 included the following components:

	For the three months ended				For the six months ended
	June 30,				June 30,
(In thousands)	2017		2016		2017		2016
Service cost	$	13	$	12	$	26	$	24
Interest cost		138		143		276		285
Amortization of actuarial loss		50		43		100		86
Net periodic benefit cost	$	201	$	198	$	402	$	395

We plan to fund a substantial portion of the pension plan obligations through existing Company owned life insurance policies.  The cash surrender value for these policies was approximately $4.6 million and $4.7 million as of June 30, 2017 and December 31, 2016, respectively. The accumulated benefit obligation was $15.1 million and $15.2 million at June 30, 2017 and December 31, 2016, respectively. 

Note 13.Earnings Per Common Share

We follow the provisions of FASB ASC Topic 260, “Earnings per Share” (“ASC Topic 260”).  Basic earnings per share (“EPS”) excludes dilution and is computed by dividing income available to common shareholders by the weighted average common shares outstanding during the period.  We have two classes of common stock currently outstanding. The classes are A and B, of which one share of Class B is convertible into 1.15 shares of Class A.  Diluted EPS takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock using the if-converted method. For the three and six months ended June 30, 2017 and 2016, 58,139 and 68,139 options to purchase shares of common stock, respectively, were anti-dilutive in the computation of diluted EPS, as the exercise price exceeded average market price in each of those periods.  Additionally, warrants to purchase 1,368,040 shares of Class A common stock were also anti-dilutive.

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Basic and diluted EPS are calculated as follows:

	For the three months ended June 30, 2017
	Income		Average shares	Per share
(In thousands, except for per share data)	(numerator)		(denominator)	Amount
Basic EPS
Income available to common shareholders	$	3,007	30,133	$	0.10
Diluted EPS
Income available to common shareholders	$	3,007	30,237	$	0.10

	For the three months ended June 30, 2016
	Income		Average shares	Per share
(In thousands, except for per share data)	(numerator)		(denominator)	Amount
Basic EPS
Income available to common shareholders	$	1,696	30,084	$	0.06
Diluted EPS
Income available to common shareholders	$	1,696	30,170	$	0.06

	For the six months ended June 30, 2017
	Income		Average shares	Per share
(In thousands, except for per share data)	(numerator)		(denominator)	Amount
Basic EPS
Income available to common shareholders	$	4,819	30,128	$	0.16
Diluted EPS
Income available to common shareholders	$	4,819	30,230	$	0.16

	For the six months ended June 30, 2016
	Income		Average shares	Per share
(In thousands, except for per share data)	(numerator)		(denominator)	Amount
Basic EPS
Income available to common shareholders	$	3,551	30,073	$	0.12
Diluted EPS
Income available to common shareholders	$	3,551	30,141	$	0.12

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Note 14.Comprehensive Income

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 is a component of comprehensive income (loss) with all other components referred to in the aggregate as other comprehensive income.  Unrealized gains and losses on AFS securities is an example of another comprehensive income (loss) component.

	For the six months ended June 30, 2017
	Before tax		Tax		Net of tax
(In thousands)	amount		expense		amount
Unrealized losses on investment securities:
Unrealized holding gains arising during period	$	1,768	$	602	$	1,166
Less reclassification adjustment for gains
realized in net income		276		94		182
Unrealized gains on investment securities		1,492		508		984
Unrecognized benefit obligation expense:
Reclassification adjustment for amortization		27		—		27
Unrecognized benefit obligation		27		—		27
Unrealized gain on derivative instrument		30		10		20
Other comprehensive income, net	$	1,549	$	518	$	1,031

	For the six months ended June 30, 2016
			Tax
	Before tax		expense		Net of tax
(In thousands)	amount		(benefit)		amount
Unrealized gains on investment securities:
Unrealized holding gains arising during period	$	5,107	$	1,888	$	3,219
Less adjustment for impaired investments		(146)		(50)		(96)
Less reclassification adjustment for gains
realized in net income		1,102		375		727
Unrealized gains on investment securities		4,151		1,563		2,588
Unrecognized benefit obligation expense:
Reclassification adjustment for amortization		(154)		—		(154)
Unrecognized benefit obligation		(154)		—		(154)
Unrealized loss on derivative instrument		(674)		(229)		(445)
Other comprehensive income, net	$	3,323	$	1,334	$	1,989

The other components of accumulated other comprehensive loss included in shareholders’ equity at June 30, 2017 and December 31, 2016 are as follows:

	June 30,		December 31,
(In thousands)	2017		2016
Unrecognized benefit obligation	$	(4,111)	$	(4,138)
Unrealized gain (loss) on AFS investments		229		(755)
Unrealized loss on derivative instrument		(306)		(326)
Accumulated other comprehensive loss	$	(4,188)	$	(5,219)

Note 15.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

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market-based inputs are not available, we use unobservable inputs to determine appropriate valuation adjustments using discounted cash flow methodologies.

Management uses its best judgment in estimating the fair value of our financial instruments; however, there are inherent weaknesses in any estimation technique.  Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts we could have realized in a sales transaction on the dates indicated.  The estimated fair value amounts have been measured as of their respective period end and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates.  As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different from the amounts reported at each period-end.

ASC Topic 820 provides guidance 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:

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.  We did not have transfers of financial instruments within the fair value hierarchy during the three and six months ended June 30, 2017 and 2016.

Items Measured on a Recurring Basis

Our 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 common stocks.

Level 2 securities include obligations of U.S. government-sponsored agencies and 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 our mortgage-backed securities and CMOs issued by U.S. government and government-sponsored agencies, non-agency CMOs, and corporate and municipal bonds.  Additionally, Level 2 includes derivative instruments whose valuations are based on observable market data.

Level 3 securities include investments in five private equity funds which are predominantly invested in real estate.  The value of the private equity funds are derived from the funds’ financials and K-1 filings.  We also review the funds’ asset values and its near-term projections.

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For financial assets and liabilities measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at June 30, 2017 and December 31, 2016 are as follows:

	Fair Value Measurements Using:
	Quoted Prices
	in Active		Significant
	Markets for		Other		Significant
	Identical		Observable		Unobservable
As of June 30, 2017	Assets		Inputs		Inputs
(In thousands)	Level 1		Level 2		Level 3		Fair Value
Assets:
Investment securities available for sale
U.S. government agencies	$	—	$	2,122	$	—	$	2,122
Mortgage-backed securities-residential		—		7,207		—		7,207
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		—		115,589		—		115,589
Corporate bonds		—		1,728		—		1,728
Municipal bonds		—		7,558		—		7,558
Other securities		—		—		1,706		1,706
Common stocks		26		—		—		26
Total investment securities available for sale	$	26	$	134,204	$	1,706	$	135,936
Liabilities:
Derivative instruments
Interest rate swaps	$	—	$	464	$	—	$	464

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	Fair Value Measurements Using:
	Quoted Prices
	in Active		Significant
	Markets for		Other		Significant
	Identical		Observable		Unobservable
As of December 31, 2016	Assets		Inputs		Inputs
(In thousands)	Level 1		Level 2		Level 3		Fair Value
Assets:
Investment securities available for sale
U.S. government agencies	$	—	$	966	$	—	$	966
Mortgage-backed securities-residential		—		7,038		—		7,038
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		—		145,559		—		145,559
Non-agency		—		4,035		—		4,035
Corporate bonds		—		1,701		—		1,701
Municipal bonds		—		8,708		—		8,708
Other securities		—		—		1,821		1,821
Common stocks		26		—		—		26
Total investment securities available for sale	$	26	$	168,007	$	1,821	$	169,854
Liabilities:
Derivative instruments
Interest rate swaps	$	—	$	494	$	—	$	494

The following tables present 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 three and six months ended June 30, 2017 and 2016:

(In thousands)	Other securities
Investment Securities Available for Sale	2017		2016
Beginning balance April 1,	$	1,821	$	2,431
Total gains/(losses) - (realized/unrealized):
Included in earnings-net gains on sale and OTTI		192		634
Included in other comprehensive income		—		(315)
Purchases		—		31
Sales and calls		(307)		(904)
Transfers in and/or out of Level 3		—		—
Ending balance June 30,	$	1,706	$	1,877

(In thousands)	Other securities
Investment Securities Available for Sale	2017		2016
Beginning balance January 1,	$	1,821	$	2,495
Total gains/(losses) - (realized/unrealized):
Included in earnings-net gains on sale and OTTI		192		935
Included in other comprehensive income		—		(445)
Purchases		—		104
Sales and calls		(307)		(1,212)
Transfers in and/or out of Level 3		—		—
Ending balance June 30,	$	1,706	$	1,877

Items Measured on a Nonrecurring Basis

Non-accrual loans and TDRs 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. 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 real

35

estate.  Additionally, for collateral acquired from tax liens, fair value may be established using brokers opinions due to their lower carrying value.  These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.

For financial assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at June 30, 2017 and December 31, 2016 are as follows:

	Fair Value Measurements Using:
	Quoted Prices
	in Active		Significant
	Markets for		Other		Significant
	Identical		Observable		Unobservable
As of June 30, 2017	Assets		Inputs		Inputs
(In thousands)	Level 1		Level 2		Level 3		Fair Value
Assets
Impaired loans and leases	$	—	$	—	$	2,300	$	2,300
Other real estate owned		—		—		925		925

	Fair Value Measurements Using:
	Quoted Prices
	in Active		Significant
	Markets for		Other		Significant
	Identical		Observable		Unobservable
As of December 31, 2016	Assets		Inputs		Inputs
(In thousands)	Level 1		Level 2		Level 3		Fair Value
Assets
Impaired loans and leases	$	—	$	—	$	6,102	$	6,102
Other real estate owned		—		—		1,471		1,471

The following tables present additional quantitative information about assets measured at fair value on a nonrecurring basis and for which we have utilized Level 3 inputs to determine fair value at June 30, 2017 and December 31, 2016:

	Qualitative Information about Level 3 Fair Value Measurements
As of June 30, 2017			Valuation		Range
(In thousands)	Fair Value		Techniques	Unobservable Input	(WeightedAverage)
Impaired loans and leases	$	2,300	Appraisal of	Appraisal adjustments	0.0%	-	-20.0%	(-15.4%)
			collateral (1)	Liquidation expenses	0.0%	-	-8.2%	(-3.4%)
Other real estate owned		925	Appraisal of	Appraisal adjustments	0.0%	-	-43.8%	(-24.0%)
			collateral (1)	Liquidation expenses			-5.0%	(-5.0%)

	Qualitative Information about Level 3 Fair Value Measurements
As of December 31, 2016			Valuation		Range
(In thousands)	Fair Value		Techniques	Unobservable Input	(WeightedAverage)
Impaired loans and leases	$	6,102	Appraisal of	Appraisal adjustments	0.0%	-	-27.4%	(-12.3%)
			collateral (1)	Liquidation expenses	0.0%	-	-12.8%	(-5.2%)
Other real estate owned		1,471	Appraisal of	Appraisal adjustments	0.0%	-	-61.5%	(-32.5%)
			collateral (1)	Liquidation expenses	0.0%	-	-5.6%	(-5.6%)

(1) Appraisals may be adjusted for qualitative factors such as interior condition of the property and liquidation expenses.

The following methods and assumptions were used to estimate the fair values of our financial instruments at June 30, 2017 and December 31, 2016. 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 our assets and liabilities.  Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between our

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disclosures and those of other companies may not be meaningful.  The methodologies for estimating the fair value of financial instruments that are measured on a recurring or nonrecurring basis are discussed above.

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, we use unobservable inputs to determine appropriate valuation adjustments by reviewing the private equities funds’ financials and K-1 filings (level 3).

Other Investment (carried at cost):

This investment includes the Solomon Hess SBA Loan Fund, which we invested in to partially satisfy Royal Bank’s community reinvestment requirement.  Shares in this fund are not publicly traded and therefore have no readily determinable fair market value.  An investor can have its investment in the Fund redeemed for the balance of its capital account at any quarter end with 60-days notice to the Fund.  The investment in this Fund is recorded at cost.  We do not record this investment at fair value on a recurring basis, as this investment’s carrying amount approximates fair value.

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.

Loans held for sale (carried at lower of cost or fair value):

The fair values of loans held for sale are based upon appraised values of the collateral less costs to sell, management’s estimation of the value of the collateral or expected net sales 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.

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 we have 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.

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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.

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.

Derivative instruments:

We have contracted with a third party vendor to provide periodic valuations for our interest rate derivatives to determine the fair value of our interest rate swaps. The vendor utilizes standard valuation methodologies applicable to interest rate derivatives such as discounted cash flow analysis and extensions of the Black-Scholes model. Such valuations are based upon readily observable market data and are therefore considered Level 2 valuations by the Company.

Off-balance sheet financial instruments (disclosed at cost):

Fair values of our 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.

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The tables below indicate the fair value of our financial instruments at June 30, 2017 and December 31, 2016.

					Fair Value Measurements
					At June 30, 2017
					Quoted Prices
					in��Active		Significant
					Markets for		Other		Significant
					Identical		Observable		Unobservable
	Carrying		Estimated		Assets		Inputs		Inputs
(In thousands)	amount		fair value		Level 1		Level 2		Level 3
Financial Assets:
Cash and cash equivalents	$	31,711	$	31,711	$	31,711	$	—	$	—
Investment securities available for sale		135,936		135,936		26		134,204		1,706
Other investment		2,250		2,250		—		—		2,250
Federal Home Loan Bank stock		2,276		2,276		—		—		2,276
Loans, net		595,431		584,618		—		—		584,618
Accrued interest receivable		3,277		3,277		—		3,277		—
Financial Liabilities:
Demand deposits		101,379		101,379		—		101,379		—
NOW and money markets		199,657		199,657		—		199,657		—
Savings		87,432		87,432		—		87,432		—
Certificates of deposit and brokered funds		234,353		234,280		—		234,280		—
Short-term borrowings		21,000		21,000		21,000		—		—
Long-term borrowings		60,000		59,967		—		59,967		—
Subordinated debt		25,774		26,091		—		26,091		—
Accrued interest payable		1,930		1,930		—		1,930		—
Derivative Instruments (Liability):
Interest rate swaps		464		464		—		464		—

					Fair Value Measurements
					At December 31, 2016
					Quoted Prices
					in Active		Significant
					Markets for		Other		Significant
					Identical		Observable		Unobservable
	Carrying		Estimated		Assets		Inputs		Inputs
(In thousands)	amount		fair value		Level 1		Level 2		Level 3
Financial Assets:
Cash and cash equivalents	$	21,230	$	21,230	$	21,230	$	—	$	—
Investment securities available for sale		169,854		169,854		26		168,007		1,821
Other investment		2,250		2,250		—		—		2,250
Federal Home Loan Bank stock		3,216		3,216		—		—		3,216
Loans, net		591,589		578,732		—		—		578,732
Accrued interest receivable		3,968		3,968		—		3,968		—
Financial Liabilities:
Demand deposits		97,859		97,859		—		97,859		—
NOW and money markets		213,140		213,140		—		213,140		—
Savings		85,170		85,170		—		85,170		—
Certificates of deposit and brokered funds		233,377		233,288		—		233,288		—
Short-term borrowings		19,000		19,000		19,000		—		—
Long-term borrowings		85,000		84,617		—		84,617		—
Subordinated debt		25,774		26,538		—		26,538		—
Accrued interest payable		711		711		—		711		—
Derivative Instruments (Liability):
Interest rate swaps		494		494		—		494		—

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Limitations

The fair value estimates are made at a discrete point in time based on relevant market information and information about the financial instruments.  Fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors.

These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision.  Changes in assumptions could significantly affect the estimates.  Further, the foregoing estimates may not reflect the actual amount that could be realized if all or substantially all of the financial instruments were offered for sale.  This is due to the fact that no market exists for a sizable portion of the loan, deposit and off balance sheet instruments.

In addition, the fair value estimates are based on existing on-and-off balance sheet financial instruments without attempting to value anticipated future business and the value of assets and liabilities that are not considered financial instruments.  Other significant assets that are not considered financial assets include premises and equipment.  In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.

Finally, reasonable comparability between financial institutions may not be likely due to the wide range of permitted valuation techniques and numerous estimates which must be made given the absence of active secondary markets for many of the financial instruments.  This lack of uniform valuation methodologies introduces a greater degree of subjectivity to these estimated fair values.

Note 16.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.  Our chief operating decision makers are the CEO and the CFO. We have identified our reportable operating segments as “Community Banking” and “Tax Liens”.

Community banking

Our community banking segment consists of commercial and retail banking and equipment leasing. The community banking business segment includes Royal Bank and Royal Bank Leasing and generates revenue from a variety of products and services provided by those entities.  Royal Bank and Royal Bank Leasing have similar economic characteristics in that earnings are predominantly derived from net interest income.  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.

Tax liens

At June 30, 2017, Royal Bank’s tax liens segment includes its 80% and 100% ownership interest in CSC and RTL, respectively. Our tax liens segment consisted 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 liens segment earns income based on interest rates (determined at auction) and penalties assigned by the municipality along with gains on sale of foreclosed properties. CSC is liquidating its assets under an orderly, long term plan.  RTL ceased acquiring tax certificates at public auctions in 2010.

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The following tables present selected financial information for reportable business segments for the three and six months ended June 30, 2017 and 2016.

	For the three months ended June 30, 2017
	Community
(In thousands)	Banking		Tax Liens		Consolidated
Total assets	$	804,652	$	4,103	$	808,755
Total deposits	$	622,821	$	—	$	622,821
Interest income	$	9,062	$	400	$	9,462
Interest expense		1,940		22		1,962
Net interest income	$	7,122	$	378	$	7,500
Provision (credit) for loan and lease losses		66		(9)		57
Total non-interest income (loss)		1,101		(158)		943
Total non-interest expense		4,982		188		5,170
Income tax expense		52		—		52
Net income	$	3,123	$	41	$	3,164
Noncontrolling interest	$	77	$	80	$	157
Net income (loss) attributable to Royal Bancshares	$	3,046	$	(39)	$	3,007

	For the three months ended June 30, 2016
	Community
(In thousands)	Banking		Tax Liens		Consolidated
Total assets	$	803,262	$	13,190	$	816,452
Total deposits	$	599,244	$	—	$	599,244
Interest income	$	8,112	$	69	$	8,181
Interest expense		1,613		151		1,764
Net interest income (expense)	$	6,499	$	(82)	$	6,417
Provision for loan and lease losses		72		125		197
Total non-interest income		1,055		18		1,073
Total non-interest expense		4,775		271		5,046
Income tax expense		60		—		60
Net income (loss)	$	2,647	$	(460)	$	2,187
Noncontrolling interest	$	174	$	(21)	$	153
Net income (loss) attributable to Royal Bancshares	$	2,473	$	(439)	$	2,034

	For the six months ended June 30, 2017
	Community
(In thousands)	Banking		Tax Liens		Consolidated
Total assets	$	804,652	$	4,103	$	808,755
Total deposits	$	622,821	$	—	$	622,821
Interest income	$	17,880	$	540	$	18,420
Interest expense		3,806		97		3,903
Net interest income	$	14,074	$	443	$	14,517
Provision (credit) for loan and lease losses		418		(64)		354
Total non-interest income (loss)		1,649		(195)		1,454
Total non-interest expense		10,474		72		10,546
Income tax expense		52		—		52
Net income	$	4,779	$	240	$	5,019
Noncontrolling interest	$	124	$	76	$	200
Net income attributable to Royal Bancshares	$	4,655	$	164	$	4,819

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	For the six months ended June 30, 2016
	Community
(In thousands)	Banking		Tax Liens		Consolidated
Total assets	$	803,262	$	13,190	$	816,452
Total deposits	$	599,244	$	—	$	599,244
Interest income	$	16,245	$	150	$	16,395
Interest expense		3,181		306		3,487
Net interest income (expense)	$	13,064	$	(156)	$	12,908
Provision for loan and lease losses		375		34		409
Total non-interest income		2,245		35		2,280
Total non-interest expense		9,614		653		10,267
Income tax expense		60		—		60
Net income (loss)	$	5,260	$	(808)	$	4,452
Noncontrolling interest	$	270	$	(41)	$	229
Net income (loss) attributable to Royal Bancshares	$	4,990	$	(767)	$	4,223

Interest income earned by the community banking segment related to the tax liens segment was approximately $22 thousand and $151 thousand for the three month periods ended June 30, 2017 and 2016, respectively and approximately $97 thousand and $306 thousand for the six month periods ended June 30, 2017 and 2016, respectively.

Note 17.Federal Home Loan Bank Stock

As a member of the FHLB, we are 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. At June 30, 2017 and December 31, 2016, FHLB stock totaled $2.3 million and $3.2 million, respectively.

FHLB stock is held as a long-term investment and its value is determined based on the ultimate recoverability of the par value. We evaluate 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.  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 our FHLB stock as of June 30, 2017.

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ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis is intended to assist in understanding and evaluating the changes in the financial condition and earnings performance of the Company and its subsidiaries for the three and six months ended June 30, 2017 and 2016. This discussion and analysis should be read in conjunction with the Company’s consolidated financial statements and notes thereto for the year ended December 31, 2016, included in the Company’s Form 10-K for the year ended December 31, 2016.

FORWARD-LOOKING STATEMENTS

From time to time, Royal Bancshares of Pennsylvania, Inc. (the “Company”, “We”, “Our’) may include forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new products, 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”, “could”, “intend”, “may”, “plan” or similar expressions, we are making forward-looking statements. In order to comply with the terms of the safe harbor, we note that a variety of factors could cause our actual results and experience to differ materially from the anticipated results or other expectations expressed in our forward-looking statements. The risks and uncertainties that may affect the operations, performance, development and results of our 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; rapidly changing technology and evolving banking industry standards; competitive factors, including increased competition with community, regional and national financial institutions; changes in generally accepted accounting principles; new service and product offerings by competitors and price pressures and similar items.

All forward-looking statements contained in this report are based on information available as of the date of this report.  These statements speak only as of the date of this report, even if subsequently made available by us on our website, or otherwise.  We expressly disclaim any obligation to update any forward-looking statement to reflect future events or developments.

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.  Applications of the principles in preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and the accompanying notes.  These estimates and assumptions are based on information available as of the date of the consolidated financial statements; therefore, actual results could differ from those estimates.

Note 1 to the Company’s Consolidated Financial Statements (included in Item 8 of the Form 10-K for the year ended December 31, 2016) lists significant accounting policies used in the development and presentation of our consolidated financial statements.  The following discussion and analysis, the significant accounting policies, and other financial statement disclosures identify and address key variables and other quantitative and qualitative factors that are necessary for an understanding and evaluation of the Company and its results of operations.  We completed an internal review of this financial information.  This review requires substantive judgment and estimation. As disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016, we have identified other-than-temporary impairment (“OTTI”) on investment securities, accounting for allowance for loan and lease losses (“allowance”), the valuation of other real estate owned (“OREO”), the valuation allowance of deferred tax assets, fair value measurements, and the pension benefit obligation as among the most critical accounting policies and estimates.  These critical accounting policies and estimates are important to the presentation of our financial condition and results of operations, and they require difficult, subjective or complex judgments as a result of the need to make estimates. 

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Financial Highlights and Business Results

We are a Pennsylvania business corporation and a bank holding company registered under the Federal Bank Holding Company Act of 1956, as amended (the “BHCA”). We are supervised by the Board of Governors of the Federal Reserve System (“Federal Reserve Board”).  Our legal headquarters are located at One Bala Plaza, Suite 522, 231 St. Asaph’s Road, Bala Cynwyd, Pennsylvania, 19004.  The principal activities of the Company are supervising Royal Bank America (“Royal Bank”), which engages in a general banking business principally in Montgomery, Chester, Bucks, Philadelphia and Berks counties in Pennsylvania and in central and 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.

Our results of operations depend primarily on net interest 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 our 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. 

Interest-earning assets consist principally of loans and investment securities, while interest-bearing liabilities consist primarily of deposits and borrowings. Refer to the “Net Interest Income and Net Interest Margin” sections below for additional information on interest yield and cost. Royal Bank principally generates commercial real estate loans primarily secured by first mortgage liens, commercial and industrial loans, construction loans for commercial real estate projects and residential home development, land development loans, and leases. We are liquidating our tax lien portfolio. At June 30, 2017, commercial real estate and multi-family loans, commercial and industrial loans, construction and land development loans, and leases comprised 47%, 19%, 14%, and 9%, respectively, of the total loan portfolio. Construction loans and land development loans can have more risk associated with them, especially during the construction phase of the project, and require specific monitoring.   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 benefits, occupancy expenses and other operating expenses.

On January 30, 2017, the Company and Bryn Mawr Bank Corporation (“Bryn Mawr”) entered into an Agreement and Plan of Merger (the “Merger Agreement”).  The Merger Agreement provides that, upon the terms and subject to the conditions set forth therein, the Company will merge with and into Bryn Mawr, with Bryn Mawr as the surviving corporation (the “Merger”).  Immediately following the Merger, Royal Bank will merge with the Bryn Mawr Trust Company, the wholly owned subsidiary of Bryn Mawr.  Upon completion of the Merger, holders of Class A common stock of the Company will receive 0.1025 shares of Bryn Mawr common stock, par value of $1.00 per share (the “Bryn Mawr common stock”) for each share of Class A common stock they hold, and holders of Class B common stock of the Company will receive 0.1179 shares of Bryn Mawr common stock for each share of Class B common stock they hold. On May 24, 2017 the Company’s shareholders approved the merger transaction with Bryn Mawr Bank Corporation at a special meeting of the Company’s shareholders. The Merger, which is subject to a number of other closing conditions including receipt of required regulatory approvals, is expected to be completed in the third quarter of 2017.

Consolidated Net Income

Net income attributable to the Company was $3.0 million, or $0.10 per diluted share, for the three months ended June 30, 2017 compared to net income of $2.0 million, or $0.06 per diluted share, for the three months June 30, 2016. For the six months ended June 30, 2017, net income attributable to the Company was $4.8 million, or $0.16 per diluted share compared to net income of $4.2 million, or $0.12 per diluted share for the same period in 2016.  Factors that positively contributed to the net income results for the three months ended June 30, 2017 as compared to the three months ended June 30, 2016 were: 

· Net interest income increased $1.1 million, or 16.9%, due to a net increase of $28.2 million in average interest-earning assets coupled with a shift from investment securities into higher-yielding loans.

· The required provision for loan and leases losses declined $140 thousand.

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· There was no other-than-temporary impairment on AFS investment securities in 2017 compared to $146 thousand in 2016.

Partially offsetting these positive items was a decrease of $459 thousand in net gains on the sales of AFS investment securities, merger related expenses in the current period of $162 thousand and an increase of $113 thousand in net OREO expenses. 

Factors that positively contributed to the net income results for the six months ended June 30, 2017 as compared to the six months ended June 30, 2016 were: 

· Net interest income increased $1.6 million, or 12.5%.

· Net OREO expenses decreased $295 thousand.

· There was no other-than-temporary impairment on AFS investment securities in 2017 compared to $146 thousand in 2016.

Partially offsetting these positive items was a decrease of $826 thousand in net gains on the sales of AFS investment securities, merger related expenses in the current period of $405 thousand, and a decrease of $246 thousand in income from company owned life insurance. 

Interest Income

Total interest income of $9.5 million for the second quarter of 2017 increased $1.3 million, or 15.7%, from the comparable quarter of 2016. The growth in interest income was related to a $28.2 million increase in average interest-earning assets.  Average interest-earning assets amounted to $784.1 million for the second quarter of 2017 compared to $755.9 million for the second quarter of 2016. Average loan and lease balances grew $78.6 million, or 14.6%, from $537.9 million for the second quarter of 2016 to $616.4 million for the second quarter of 2017.  Average investment securities declined $39.7 million, or 19.6%, to $163.2 million for the second quarter of 2017 from $202.9 million for the comparable quarter of 2016. Average interest-earning deposits decreased from $15.2 million for the second quarter of 2016 to $4.5 million for the second quarter of 2017.  Quarter over quarter, interest income on loans and leases increased $1.5 million, or 22.0%. Second quarter 2017 interest income includes $392 thousand from the pay-off of a non-accruing tax certificate. Interest income on investment securities decreased $250 thousand, or 20.7%. Despite the $10.7 million decline in average interest-earning deposits, the income earned on such deposits was $17 thousand for both quarters.

Total interest income of $18.4 million for the six months ended June 30, 2017 increased $2.0 million, or 12.4%, from the comparable period in 2016. The growth in interest income was related to a $37.8 million increase in average interest-earning assets.  Average interest-earning assets amounted to $787.3 million for the six months ended June 30, 2017 compared to $749.5 million for the same period in 2016. Average loan and lease balances grew $88.2 million, or 16.8%, from $525.4 million for the first six months of 2016 to $613.6 million for the first six months of 2017.  Average investment securities declined $41.5 million, or 19.7%, to $168.7 million for the first six months of 2017 from $210.2 million for the comparable period of 2016. Year over year, interest income on loans and leases increased $2.6 million, or 18.7%. The 2017 year-to-date interest income includes $392 thousand from the pay-off of a non-accruing tax certificate. Interest income on investment securities decreased $558 thousand, or 22.0%.  Interest income on interest earning deposits was $33 thousand for the six months ended June 30, 2017 and 2016.

For the second quarter of 2017, the yield on average interest-earning assets of 4.84% amounted to an increase of 49 basis points from the yield of 4.35% for the prior year’s second quarter. The average yield on loans increased by 32 basis points to 5.52% in 2017 versus 5.20% in 2016. The average yield on investments declined four basis points quarter over quarter (2.35% in 2017 versus 2.39% in 2016).  The average yield on interest-earning deposits increased 108 basis points from 0.45% for the second quarter of 2016 to 1.53% for the second quarter of 2017 and was directly impacted by the increase in the Fed Funds rate.

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For the six months ended June 30, 2017, the yield on average interest-earning assets of 4.72% amounted to an increase of 32 basis points from the yield of 4.40% for the six months ended June 30, 2016. The average yield on loans increased by 10 basis points to 5.39% in 2017 versus 5.29% in 2016. The average yield on investments declined six basis points year over year (2.37% in 2017 versus 2.43% in 2016).  The average yield on interest-earning deposits increased 86 basis points from 0.48% for the six months ended June 30, 2016 to 1.34% for the six months ended June 30, 2017 and was directly impacted by the increase in the Fed Funds rate.

Interest Expense

Total interest expense of $2.0 million in the second quarter of 2017 increased $198 thousand, or 11.2%, from the comparable quarter of 2016. The increase in interest expense was associated with an increase in interest expense on average interest-bearing deposit accounts and average borrowings.  For the second quarter of 2017, average interest-bearing liabilities of $650.8 million increased $27.0 million, or 4.3%, from $623.8 million for the comparable period in 2016. For the quarter ended June 30, 2017, average interest bearing deposits increased $27.3 million, or 5.4%, to $534.2 million, while average borrowings were reduced by $320 thousand, or 0.3%, to $116.7 million. Average savings accounts and average certificates of deposit (“CDs”) grew $14.8 million and $37.5 million to $87.6 million and $245.3 million, respectively, quarter over quarter. Average interest checking and money market accounts declined $25.0 million, or 11.0%, to $201.3 million for the second quarter of 2017.  Included in the average interest checking and money market balance for the second quarter of 2016 was $25.0 million from a brokered checking deposit arrangement with another financial institution.  This arrangement was terminated in the third quarter of 2016 and was replaced during the past 10 months with brokered CDs through Promontory Interfinancial Network’s CDARS program.  For the second quarter of 2017, the interest paid on the average interest-bearing deposits increased $102 thousand, or 9.6%.

The interest paid on average borrowings increased $96 thousand, or 13.8% from the comparable quarter of 2016. We have one interest rate swap that was tied to a rollover strategy of an FHLB advance that matured on June 24, 2016. We have and will continue to rollover the FHLB advance every three months through the swap expiration of June 2021. The interest expense associated with the swap was $55 thousand for the second quarter of 2017. 

Total interest expense of $3.9 million for the first six months of 2017 increased $416 thousand, or 11.9%, from the comparable period in 2016. The increase in interest expense was associated with an increase in interest expense on average interest-bearing deposit accounts and average borrowings.  For the first six months of 2017, average interest-bearing liabilities of $664.2 million increased $45.5 million, or 7.4%, from $618.7 million for the comparable period in 2016. For the six months ended June 30, 2017, average interest bearing deposits increased $35.8 million, or 7.1%, to $538.3 million, while average borrowings increased by $9.7 million, or 8.4%, to $126.0 million. Average savings accounts and average certificates of deposit (“CDs”) grew $17.9 million and $32.2 million to $85.3 million and $240.2 million, respectively, year over year. Average interest checking and money market accounts declined $14.4 million, or 6.3%, to $212.9 million for the first six months of 2017.  Included in the average interest checking and money market balance for the second quarter of 2016 was $25.0 million from a brokered checking deposit arrangement with another financial institution.  This arrangement was terminated in the third quarter of 2016 and was replaced during the past 10 months with brokered CDs through Promontory Interfinancial Network’s CDARS program.  For the first six months of 2017, the interest paid on the average interest-bearing deposits increased $179 thousand, or 8.5%.

The interest paid on average borrowings increased $237 thousand, or 17.2% from the comparable six month period in 2016. We have one interest rate swap that was tied to a rollover strategy of an FHLB advance that matured on June 24, 2016. We have and will continue to rollover the FHLB advance every three months through the swap expiration of June 2021. The interest expense associated with the swap was $115 thousand for the first six months of 2017. 

The average interest rate paid on average total interest-bearing liabilities during the second quarters of 2017 and 2016 amounted to 1.21% and 1.14%, respectively. During the second quarters of 2017 and 2016 the average interest rate paid on average interest-bearing deposits was 0.88% and 0.85% respectively.  Despite the increase in average balances for CDs quarter versus quarter, the average rate paid on this deposit classification decreased 15 basis points (1.27% in 2017 versus 1.42% in 2016).  Additionally, the average rates paid on savings accounts decreased 10 basis points (0.61% in 2017 versus 0.71% in 2016).  While the recent rate increases by the Federal Reserve present pricing challenges, we have been able to mitigate this through our varied product offerings and our customer service.  The average interest rate paid for borrowings

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during the second quarter of 2017 was 2.73%, which amounted to an increase of 33 basis points from the average rate paid of 2.40% during the second quarter of 2016.  Short-term borrowing rates and the subordinated debt rate were directly impacted by the Federal Reserve Bank’s rate increase in December 2016, March 2017 and to a lesser extent the rate increase in June 2017. Additionally, the average borrowing rate paid was negatively impacted by the interest rate swap.

The average interest rate paid on average total interest-bearing liabilities during the first six months of 2017 and 2016 amounted to 1.18% and 1.13%, respectively. During the first six months of 2017 and 2016 the average interest rate paid on average interest-bearing deposits was 0.86% and 0.84% respectively.  Despite the increase in average balances for CDs year over year, the average rate paid on this deposit classification decreased 12 basis points (1.29% in 2017 versus 1.41% in 2016).  Additionally, the average rates paid on savings accounts decreased 10 basis points (0.60% in 2017 versus 0.70% in 2016).  The average interest rate paid for borrowings during the first six months of 2017 was 2.59%, which amounted to an increase of 20 basis points from the average rate paid of 2.39% during the first six months of 2016.  Short-term borrowing rates and the subordinated debt rate were directly impacted by the Federal Reserve Bank’s rate increase in December 2016, March 2017 and to a lesser extent the rate increase in June 2017.

Net Interest Income and Margin

Net interest income for the quarter ended June 30, 2017 amounted to $7.5 million, resulting in an increase of $1.1 million, or 16.9%, from the comparable quarter of 2016. The growth in net interest income was impacted by the growth in average interest-earning assets and was partially offset by the increase in the average rate paid on average interest-bearing deposits and average borrowings. Quarter over quarter, average loans and leases outstanding increased $78.6 million, or 14.6%, while average investments declined $39.7 million, or 19.6%.  The average rate paid on average borrowings grew 33 basis points while the corresponding average balances were reduced by $320 thousand.

Net interest income for the six months ended June 30, 2017 amounted to $14.5 million, resulting in an increase of $1.6 million, or 12.5%, from the comparable period of 2016. The growth in net interest income was impacted by the growth in average interest-earning assets and was partially offset by the increase in the average rate paid on average borrowings. Year over year, average loans and leases outstanding increased $88.2 million, or 16.8%, while average investments declined $41.5 million, or 19.7%.  The average rate paid on average borrowings grew 20 basis points while the corresponding balances were increased by $9.7 million.

The net interest margin for the second quarter of 2017 was 3.84%, which increased 43 basis points from 3.41% for the comparable quarter of 2016. The average yield on interest-earning assets for the second quarter of 2017 was 4.84% compared to 4.35% for the same period in 2016.  The average rate paid on interest checking and money market accounts increased 16 basis points while the average rates paid on average savings accounts and CDs went down by 10 and 15 basis points, respectively.  The average borrowing rate paid, which increased 33 basis points, was negatively impacted by the increase in short-term interest rates.

The net interest margin for the six months ended June 30, 2017 was 3.72%, which increased 26 basis points from 3.46% for the comparable period of 2016. The average yield on interest-earning assets for the six months ended June 30, 2017 was 4.72% compared to 4.40% for the same period in 2016.  The average rate paid on interest checking and money market accounts increased 11 basis points while the average rates paid on average savings accounts and CDs went down by 10 and 12 basis points, respectively.  The average borrowing rate paid, which increased 20 basis points, was negatively impacted by the increase in short-term interest rates.

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The following tables represent the average daily balances of assets, liabilities and shareholders’ equity and the respective interest-earning assets and interest-bearing liabilities, as well as average rates for the periods indicated.  The loans outstanding include non-accruing loans.  The yields are presented on an annualized basis.

	For the three months ended						For the three months ended
	June 30, 2017						June 30, 2016
(In thousands, except percentages)	Average Balance		Interest		Yield/Rate			Average Balance		Interest	Yield/Rate
Interest-earning deposits	$	4,458	$	17	1.53	%	$	15,183	$	17	0.45	%
Investment securities		163,192		956	2.35	%		202,857		1,206	2.39	%
Loans and leases		616,446		8,489	5.52	%		537,862		6,958	5.20	%
Total interest earning assets		784,096		9,462	4.84	%		755,902		8,181	4.35	%
Non-earning assets		44,042						47,463
Total average assets	$	828,138					$	803,365
Interest-bearing deposits
Interest checking and money markets	$	201,292	$	262	0.52	%	$	226,286	$	204	0.36	%
Savings		87,587		133	0.61	%		72,752		128	0.71	%
Certificates of deposit		245,296		774	1.27	%		207,825		735	1.42	%
Total interest bearing deposits		534,175		1,169	0.88	%		506,863		1,067	0.85	%
Borrowings		116,653		793	2.73	%		116,973		697	2.40	%
Total interest bearing liabilities		650,828		1,962	1.21	%		623,836		1,764	1.14	%
Non-interest bearing deposits		97,702						87,212
Other liabilities		23,524						21,468
Shareholders' equity		56,084						70,849
Total average liabilities and equity	$	828,138					$	803,365
Net interest income			$	7,500					$	6,417
Net interest margin					3.84	%					3.41	%

	For the six months ended						For the six months ended
	June 30, 2017						June 30, 2016
(In thousands, except percentages)	Average Balance		Interest		Yield/Rate			Average Balance		Interest	Yield/Rate
Interest-earning deposits	$	4,962	$	33	1.34	%	$	13,823	$	33	0.48	%
Investment securities		168,745		1,982	2.37	%		210,267		2,540	2.43	%
Loans and leases		613,563		16,405	5.39	%		525,399		13,822	5.29	%
Total interest earning assets		787,270		18,420	4.72	%		749,489		16,395	4.40	%
Non-earning assets		45,101						48,222
Total average assets	$	832,371					$	797,711
Interest-bearing deposits
Interest checking and money markets	$	212,858	$	497	0.47	%	$	227,228	$	409	0.36	%
Savings		85,283		255	0.60	%		67,334		235	0.70	%
Certificates of deposit		240,152		1,534	1.29	%		207,929		1,463	1.41	%
Total interest bearing deposits		538,293		2,286	0.86	%		502,491		2,107	0.84	%
Borrowings		125,979		1,617	2.59	%		116,243		1,380	2.39	%
Total interest bearing liabilities		664,272		3,903	1.18	%		618,734		3,487	1.13	%
Non-interest bearing deposits		89,775						84,390
Other liabilities		21,689						22,413
Shareholders' equity		56,635						72,174
Total average liabilities and equity	$	832,371					$	797,711
Net interest income			$	14,517					$	12,908
Net interest margin					3.72	%					3.46	%

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Rate Volume Analysis

The following table sets forth a rate/volume analysis, which segregates in detail the major factors contributing to the change in net interest income for the three and six months ended June 30, 2017, as compared to the respective period in 2016, into amounts attributable to both rates and volume variances.

	For the three months ended							For the six months ended
	June 30,							June 30,
	2017 vs. 2016							2017 vs. 2016
	Increase (decrease)							Increase (decrease)
(In thousands)	Volume		Rate		Total			Volume		Rate		Total
Interest income
Interest-earning deposits	$	(40)	$	40	$	—	$	(59)	$	59	$	-
Total short term earning assets		(40)		40		—		(59)		59		-
Investment securities		(229)		(21)		(250)		(494)		(64)		(558)
Loans and leases
Commercial demand loans		627		187		814		1,348		278		1,626
Commercial mortgages		418		53		471		924		(226)		698
Residential and home equity loans		71		(10)		61		131		(50)		81
Leases receivables		(195)		53		(142)		(324)		114		(210)
Tax certificates		(40)		372		332		(62)		452		390
Consumer loans		6		(2)		4		10		(3)		7
Loan fees		(9)		—		(9)		(9)		—		(9)
Total loans and leases		878		653		1,531		2,018		565		2,583
Total increase in interest income	$	609	$	672	$	1,281	$	1,465	$	560	$	2,025
Interest expense
Deposits
NOW and money market	$	(24)	$	83	$	59	$	(27)	$	113	$	86
Savings		24		(19)		5		57		(36)		21
Certificates of deposit		123		(85)		38		214		(142)		72
Total deposits		123		(21)		102		244		(65)		179
Borrowings
Borrowings		(2)		34		32		115		61		176
Subordinated debentures		—		64		64		—		61		61
Total borrowings		(2)		98		96		115		122		237
Total increase in interest expense	$	121	$	77	$	198	$	359	$	57	$	416
Total increase in net interest income	$	488	$	595	$	1,083	$	1,106	$	503	$	1,609

Provision for Loan and Lease Losses

We recorded a provision for loan and lease losses of $57 thousand and $197 thousand for the three months ended June 30, 2017 and 2016, respectively.  For the six months ended June 30, 2017 and June 30, 2016 we recorded a provision of $354 thousand and $409 thousand, respectively.  The provision for the three and six months ended June 30, 2017 was primarily driven by activity in the lease portfolio. Net Charge-offs for the leasing portfolio were $294 thousand and $783 for the three months and six months ended June 30, 2017, respectively, compared to $155 thousand and $430 thousand for the corresponding periods in 2016. 

Non-interest Income

Non-interest income for the second quarter of 2017 was $943 thousand compared to $1.1 million for the comparable quarter of 2016.  Net gains on the sale of investment securities decreased $459 thousand from $735 thousand for the three months ended June 30, 2016 to $276 thousand for the three months ended June 30, 2017. Partially offsetting this decrease was an improvement of $146 thousand in impairments on AFS investment securities ($0 in 2017 versus $146 thousand in 2016) and an increase of $109 in income from Company owned life insurance policies ($297 thousand for the second quarter of 2017 compared to $188 thousand for the comparable 2016 period). 

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Non-interest income for the six months ended June 30, 2017 was $1.5 million compared to $2.3 million for the comparable period in 2016.  Net gains on the sale of investment securities decreased $826 thousand from $1.1 million for the six months ended June 30, 2016 to $276 thousand for the six months ended June 30, 2017. Income from Company owned life insurance declined $246 thousand year over year. Partially offsetting these decreases was an improvement of $146 thousand in impairments on AFS investment securities ($0 in 2017 versus $146 thousand in 2016) and an increase of $109 thousand in service charges and fees.

Non-interest Expense

Non-interest expense was $5.2 million for the second quarter of 2017 compared to $5.0 million for the second quarter of 2016. The $124 thousand increase in expenses were driven by increases in merger related expenses of $162 thousand ($0 in 2016 compared to $162 thousand in 2017), and net OREO expenses of $113 thousand.  Occupancy and equipment expenses increased $55 thousand quarter versus quarter. Partially offsetting these increases was a reduction in professional and legal fees of $63 thousand and a reduction of $35 thousand in salaries and benefits.

Non-interest expense was $10.5 million for the six months ended June 30, 2017 compared to $10.3 million for the comparable period in 2016.  The $279 thousand increase in expenses was primarily driven by an increase in merger related expenses of $405 thousand ($0 in 2016 compared to $405 thousand in 2016). Pennsylvania shares tax expense and FDIC and state assessments increased $ 99 thousand and $76 thousand, respectively, year over year.  Occupancy and equipment expenses increased $98 thousand year over year. Salaries and benefit expenses increased $27 thousand year over year.  Partially offsetting these increases was a decrease of $295 thousand in net OREO expenses and a reduction in professional and legal fees of $70 thousand.  Included in net OREO expenses was an increase $350 thousand in net gains on the sales of OREO year over year.   

Income Tax Expense

The Company is subject to both a federal income and alternative minimum taxes (“AMT”).  For the three and six months ended June 30, 2017 and 2016, we recorded tax provisions of $52 thousand and $60 thousand respectively. The AMT limits the utilization of net operating loss carryforwards to 90% while federal income tax allows for 100% utilization of the net operating loss carryforwards. Our effective tax rate is the provision for federal income taxes expressed as a percentage of income or loss before federal income taxes. The effective tax rate for the three and six months ended June 30, 2017 was 1.6% and 1.0% respectively. The effective income tax rates differ from the statutory rate of 34% primarily due to the utilization of net operating loss carryforwards, non-taxable income related to cash surrender life insurance, state and local income taxes and non-taxable income.

As of June 30, 2017, we had net deferred tax assets totaling $7.4 million. We recognize 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. These deferred tax assets can only be realized if we generate sufficient taxable income in the future.  If we cannot, a valuation allowance is established. We regularly evaluate the realizability of deferred tax asset positions. In determining whether a valuation allowance is necessary, we consider the level of taxable income in prior years to the extent that carry backs are permitted under current tax laws, as well as estimates of future pre-tax book income, taxable income and tax planning strategies that would, if necessary, be implemented. Based on the analysis of the DTA at December 31, 2016, management concluded that it is more likely than not that a portion of the net DTA will be realized by the Company.  As a result of this conclusion, in 2016 we released $1.9 million of our valuation allowance previously recorded on the net DTAs and credited income tax expense. As of June 30, 2017, no additional increase or decrease in the valuation allowance for future tax benefits was required based on management’s assessment. We currently maintain a valuation allowance for certain state net operating losses and other deferred tax assets that may not be realized. We expect to realize the remaining deferred tax assets over the allowable carry back and/or carry forward periods. However, if an unanticipated event occurs that materially changes pre-tax book income and taxable income in future periods, an increase or decrease in the valuation allowance may become necessary and such change in the valuation allowance could be material to the Company’s financial statements.

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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”.  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.  Our chief operating decision makers are the Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”).  

	For the three months ended June 30, 2017
	Community
(In thousands)	Banking		Tax Liens		Consolidated
Total assets	$	804,652	$	4,103	$	808,755
Total deposits	$	622,821	$	—	$	622,821
Interest income	$	9,062	$	400	$	9,462
Interest expense		1,940		22		1,962
Net interest income	$	7,122	$	378	$	7,500
Provision (credit) for loan and lease losses		66		(9)		57
Total non-interest income (loss)		1,101		(158)		943
Total non-interest expense		4,982		188		5,170
Income tax expense		52		—		52
Net income	$	3,123	$	41	$	3,164
Noncontrolling interest	$	77	$	80	$	157
Net income (loss) attributable to Royal Bancshares	$	3,046	$	(39)	$	3,007

	For the three months ended June 30, 2016
	Community
(In thousands)	Banking		Tax Liens		Consolidated
Total assets	$	803,262	$	13,190	$	816,452
Total deposits	$	599,244	$	—	$	599,244
Interest income	$	8,112	$	69	$	8,181
Interest expense		1,613		151		1,764
Net interest income (expense)	$	6,499	$	(82)	$	6,417
Provision for loan and lease losses		72		125		197
Total non-interest income		1,055		18		1,073
Total non-interest expense		4,775		271		5,046
Income tax expense		60		—		60
Net income (loss)	$	2,647	$	(460)	$	2,187
Noncontrolling interest	$	174	$	(21)	$	153
Net income (loss) attributable to Royal Bancshares	$	2,473	$	(439)	$	2,034

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	For the six months ended June 30, 2017
	Community
(In thousands)	Banking		Tax Liens		Consolidated
Total assets	$	804,652	$	4,103	$	808,755
Total deposits	$	622,821	$	—	$	622,821
Interest income	$	17,880	$	540	$	18,420
Interest expense		3,806		97		3,903
Net interest income	$	14,074	$	443	$	14,517
Provision (credit) for loan and lease losses		418		(64)		354
Total non-interest income (loss)		1,649		(195)		1,454
Total non-interest expense		10,474		72		10,546
Income tax benefit		52		—		52
Net income	$	4,779	$	240	$	5,019
Noncontrolling interest	$	124	$	76	$	200
Net income attributable to Royal Bancshares	$	4,655	$	164	$	4,829

	For the six months ended June 30, 2016
	Community
(In thousands)	Banking		Tax Liens		Consolidated
Total assets	$	803,262	$	13,190	$	816,452
Total deposits	$	599,244	$	—	$	599,244
Interest income	$	16,245	$	150	$	16,395
Interest expense		3,181		306		3,487
Net interest income (expense)	$	13,064	$	(156)	$	12,908
Provision for loan and lease losses		375		34		409
Total non-interest income		2,245		35		2,280
Total non-interest expense		9,614		653		10,267
Income tax expense		60		—		60
Net income (loss)	$	5,260	$	(808)	$	4,452
Noncontrolling interest	$	270	$	(41)	$	229
Net income (loss) attributable to Royal Bancshares	$	4,990	$	(767)	$	4,223

Community Bank Segment

Royal Bank America

Royal Bank commenced operation as a Pennsylvania state-chartered bank in 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 to the highest amount permitted by law.  Royal Real Estate of Pennsylvania, Inc., RBA Property LLC, Narberth Property Acquisition LLC, and Rio Marina LLC are wholly owned subsidiaries of Royal Bank.  Royal Bank also has an 80% and 60% ownership interest in Crusader Servicing Corporation (“CSC”) and Royal Bank America Leasing, LP, respectively.  CSC and Royal Bank’s wholly owned subsidiary Royal Tax Lien Services, LLC, were formed to purchase and service delinquent tax liens. 

Royal Bank derives its income principally from interest charged on loans and leases, 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, principal payments on and maturities and sales of investment securities, loan and OREO sales and the repayment of outstanding loans provide the majority of funds for activities.

Royal Bank conducts business operations as a commercial bank offering traditional consumer and business deposit products and services (excluding trust) and commercial and consumer loans, including home equity and small business loans. Fee income services such as a suite of cash management products, remote deposit capture, mobile deposits, and

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payroll and merchant services have been greatly improved or expanded. Services may be added or deleted from time to time. Royal Bank’s business and services are not subject to significant seasonal fluctuations.

Service Area: Royal Bank’s primary service area includes Pennsylvania, primarily Montgomery, Chester, Bucks, Delaware, Berks and Philadelphia counties, and central and southern 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 two loan production offices and twelve retail branches located throughout Montgomery, Philadelphia, Delaware and Berks counties and Camden County, New Jersey. Royal Bank also considers New York, Maryland, and Delaware as a part of its service area for certain products and services. Royal Bank has loans in 19 states and Washington, DC via loan originations with service area borrowers 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.

Employees: Royal Bank employed approximately 102 people on a full-time equivalent basis as of June 30, 2017.

Deposits: At June 30, 2017, total deposits of Royal Bank were distributed among demand deposits (17%), money market, savings and NOW accounts (46%) and time deposits (37%). At June 30, 2017, deposits of $624.6 million decreased $7.3 million from $631.9 million at year end 2016. Included in Royal Bank’s deposits are approximately $1.8 million of intercompany deposits that are eliminated through consolidation.

Lending: At June 30, 2017, Royal Bank, including its subsidiaries, had a total net loan and lease portfolio of $595.4 million, representing 74% of total assets. The loan portfolio is categorized into commercial and industrial, commercial real estate mortgages, residential mortgages (including home equity lines of credit), construction and development, tax certificates, leases and consumer loans.  At June 30, 2017, net loans and leases increased by $3.8 million, or 0.6%, from year end 2016.

Business results: Total assets of Royal Bank were $804.1 million at June 30, 2017 compared to $828.1 million at year end 2016.  Royal Bank recorded net income of $3.2 million for the three months ended June 30, 2017 compared to $1.7 million for the three months ended June 30, 2016. Royal Bank’s total interest income for the quarter ended June 30, 2017 was $9.5 million compared to $8.2 million for the quarter ended June 30, 2016. Second quarter 2017 interest income includes $392 thousand from the pay-off of a non-accruing tax certificate. The remaining increase in interest income was driven by an increase in average interest-earning assets coupled with higher yields earned on loans.  For the three months ended June 30, 2017, the average balance for investments declined $39.7 million while average loans outstanding, which typically earn a higher yield than investment securities, increased $78.6 million from the 2016 average balances for the comparable quarter. Interest expense was $1.7 million and $1.8 million for the quarters ended June 30, 2017 and June 30, 2016 respectively.

The $1.5 million increase in net income quarter versus quarter was driven by a $1.3 million increase in net interest income and an increase in non-interest income of $648 thousand. Partially offsetting these positive items was an increase in non-interest expenses of $184 thousand.  Merger related expenses of $73 thousand for the quarter ended June 30, 2017 are included in non-interest expenses.

For the six months ended June 30, 2017 net income was $5.2 million compared to $3.9 million for the six months ended June 30, 2016.  The $1.3 million increase was primarily attributable to a $2.0 million increase in net interest income. Partially offsetting this increase was an increase in non-interest expenses of $626 thousand and a decline in non-interest income of $152 thousand.  Merger related expenses of $316 thousand for the six months ended June 30, 2017 are included in non-interest expenses.  

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The above amounts reflect the consolidated totals for Royal Bank and its subsidiaries.  The subsidiaries included in these amounts are Royal Investments America, Royal Real Estate, Royal Bank America Leasing, Royal Tax Lien Services, Crusader Servicing Corporation, RBA Property LLC, Narberth Property Acquisitions, and Rio Marina LLC.

Royal Investments of Delaware

On June 30, 1995, the Company established a special purpose Delaware investment company, Royal Investments of Delaware (“RID”), as a wholly owned subsidiary. Legal headquarters are at 1105 N. Market Street, Suite 1300, Wilmington, Delaware. RID buys, holds and sells investment securities.

Business results: For the three months ended June 30, 2017, RID reported net income of $185 thousand compared to net income of $604 thousand for the three months ended 2016. The $419 thousand decrease quarter over quarter was mainly related to a reduction in net investment security gains of $300 thousand and a $178 thousand decrease in net interest income.  For the six months ended June 30, 2017, RID reported net income of $176 thousand compared to net income of $795 thousand for the six months ended 2016.  The $619 thousand decrease was primarily attributable to a decline in net interest income of $356,000 and a reduction in net investment security gains of $326 thousand.  At June 30, 2017 and December 31, 2016, total assets of RID were $5.7 million and $5.5 million, of which $5.1 million and $4.8 million was held in cash and cash equivalents. Royal Bank previously extended loans to RID, secured by securities and as per the provisions of Regulation W.  At June 30, 2017, no loans were outstanding.

Royal Preferred LLC

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.  During 2016 the subordinated debenture was redeemed by Royal Bank.  At June 30, 2017, and December 31, 2016 Royal Preferred LLC had total assets of $0. 

Royal Bancshares Capital Trust I and II

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 $25.8 million of a private placement of trust preferred securities. The interest rates for the debt securities associated with the Trusts at June 30, 2017 were 3.40%.

Royal Bank America Leasing, LP

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. Legal headquarters are at 550 Township Line Road, Blue Bell, Pennsylvania. Royal Leasing was formed to originate small business financing leases. Royal Leasing originates the leases through its internal sales staff and through independent brokers located throughout its business area. In general, Royal Leasing will portfolio individual leases in amounts up to $250 thousand. Leases originated in amounts in excess of $250 thousand are held in the portfolio, sold or brokered to other leasing companies.

Business results: At June 30, 2017, total assets of Royal Leasing were $55.5 million and include $55.4 million in net leases.  Total assets were $61.6 million at December 31, 2016.  For the three months ended June 30, 2017, Royal Leasing had net income of $192 thousand compared to $436 thousand for the three months ended June 30, 2016. The quarter over quarter decline of $244 thousand was impacted by an increased provision for lease losses of $133 thousand and a decrease in net interest income of $127 thousand. For the six months ended June 30, 2017, Royal Leasing had net income of $310 thousand compared to $675 thousand for the six months ended June 30, 2016. The $365 thousand decrease in net income was primarily attributable to an increase in other operating expenses of $279 thousand and a decrease in net interest income of $170 thousand.  Royal Bank has extended loans to RBA Leasing at market interest rates, secured by the lease portfolio of RBA Leasing and as per the provisions of Regulation W. At June 30, 2017, the amount due Royal Bank from RBA Leasing was $50.6 million.

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Royal Investments America

On June 23, 2003, the Company, through its wholly owned subsidiary Royal Bank, established Royal Investments America, LLC (“RIA”) as a wholly owned subsidiary. Legal headquarters are at 732 Montgomery Avenue, Narberth, Pennsylvania. RIA was formed to invest in equity real estate ventures subject to limitations imposed by the FDIC and Pennsylvania Department of Banking by regulation.

Business results: At June 30, 2017 and December 31, 2016, total assets of RIA were $6.5 million.  For the quarter ended June 30, 2017, RIA had net income of $2 thousand compared to $114 thousand for the quarter ended June 30, 2016.  The decrease in net income for 2017 was predominantly related to gains on the sale of investment securities of $94 thousand recognized during the second quarter of 2016. For the six months ended June 30, 2017, RIA had net income of $7 thousand compared to $432 thousand for the first six months of 2016.  The $425 thousand decrease was primarily attributable to a $370 decrease in net gains on the sale of investment securities.  Royal Bank had previously extended loans to RIA at market interest rates, secured by the loan portfolio of RIA and as per the provisions of Regulation W. At June 30, 2017, there were no outstanding loans from Royal Bank to RIA.

Tax Lien Segment

Crusader Servicing Corporation

The Company, through its wholly owned subsidiary Royal Bank, holds an 80% ownership interest in Crusader Servicing Corporation (“CSC”). Its legal headquarters are at 732 Montgomery Avenue, Narberth, Pennsylvania.  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. CSC is currently being liquidated under an orderly, long term plan adopted by CSC management. 

Business results:  CSC recorded net income of $401 thousand for the three months ended June 30, 2017 compared to a net loss of $105 thousand for the comparable period in 2016.  Net interest income increased $438 thousand quarter over quarter as a result of the redemption of a non-accruing tax certificate that took place in the second quarter of 2017.  For the six months ended June 30, 2017 net income was $379 thousand compared to a net loss of $204 thousand for the first six months of 2016.  At June 30, 2017, total assets of CSC were $488 thousand, of which $188 thousand was held in tax liens and $221 thousand was in OREO compared to total assets of $1.4 million, of which $1.2 million was held in tax liens and $225 million was held in OREO at December 31, 2016. Royal Bank has extended loans to CSC at market interest rates, secured by the tax lien portfolio of CSC and as per the provisions of Regulation W.  At June 30, 2017, the amount due Royal Bank from CSC was $209 thousand.

Royal Tax Lien Services, LLC

The Company, through its wholly owned subsidiary Royal Bank, wholly owns Royal Tax Lien Services, LLC (“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 acquired 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.  RTL ceased acquiring tax certificates at public auctions in 2010.

Business results:  RTL recorded a net loss of $360 thousand for the three months ended June 30, 2017 compared to a net loss of $356 thousand for the comparable period in 2016. For the first six months of 2017, RTL recorded a net loss of $139 thousand compared to a net loss of $605 thousand for the first six months of 2016. The year over year improvement of $466 thousand was directly impacted by a $304 thousand reduction in net OREO expenses.  Included in net OREO expenses were net gains on the sales of OREO properties of $395 thousand for the first six months of 2017 compared to $81 thousand in net gains on the sales of OREO properties for the first six months of 2016. Additionally, RTLS recorded a credit to the provision for lien losses of $61 thousand during the first six months of 2017 compared to a provision of $34 thousand for the first six months of 2016. At June 30, 2017, total assets of RTL were $3.6 million, of which $1.2 million was held in tax liens and $1.5 million was held in OREO as compared to total assets at December 31, 2016 of $7.3 million, of which $2.6 million was held in tax liens and $3.1 million was held in OREO.  Royal Bank has extended loans to RTL

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at market interest rates, secured by the tax lien portfolio of RTL and as per the provisions of Regulation W.  At June 30, 2017, the amount due Royal Bank from RTL was $266 thousand.

FINANCIAL CONDITION

Consolidated Assets

Total consolidated assets at June 30, 2017 were $808.8 million, a decrease of $23.7 million, or 2.9%, from December 31, 2016.  This decline is mainly attributed to a reduction in investment securities partially offset by an increase in cash and cash equivalents and net loans.

Cash and Cash Equivalents

Total cash and cash equivalents of $31.7 million at June 30, 2017 increased $10.5 million from $21.2 million at December 31, 2016.  The increase in cash and cash equivalents was mainly associated with cash flows from  investment securities.

Investment Securities

AFS investment securities of $135.9 million at June 30, 2017, declined $33.9 million, or 20.0%, from the level at December 31, 2016.  The decline was primarily due to sales of investment securities and principal payments received.  Incoming cash flows from the investment portfolio were used to fund loan growth and payoff FHLB borrowings.  FHLB stock was $2.3 million and $3.2 million at June 30, 2017 and December 31, 2016. 

The AFS investment portfolio had a net unrealized gain of $348 thousand at June 30, 2017 compared to a net unrealized loss of $1.1 million at December 31, 2016.  The $1.5 million improvement was primarily attributable to a $1.2 million increase on U.S. Agency CMOs. 

The carrying value and fair value of investment securities available-for-sale (“AFS”) at June 30, 2017 and December 31, 2016 are as follows:

As of June 30, 2017
			Gross		Gross
	Amortized		unrealized		unrealized
(In thousands)	cost		gains		losses		Fair value
U.S. government agencies	$	2,127	$	—	$	(5)	$	2,122
Mortgage-backed securities-residential		7,029		178		—		7,207
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		115,532		911		(854)		115,589
Non-agency		—		—		—		—
Corporate bonds		1,700		28		—		1,728
Municipal bonds		7,468		132		(42)		7,558
Other securities		1,706		—		—		1,706
Common stocks		26		—		—		26
Total available for sale	$	135,588	$	1,249	$	(901)	$	135,936

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As of December 31, 2016
			Gross		Gross
	Amortized		unrealized		unrealized
(In thousands)	cost		gains		losses		Fair value
U.S. government agencies	$	988	$	—	$	(22)	$	966
Mortgage-backed securities-residential		6,985		70		(17)		7,038
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		146,666		1,022		(2,129)		145,559
Non-agency		4,121		—		(86)		4,035
Corporate bonds		1,700		1		—		1,701
Municipal bonds		8,691		92		(75)		8,708
Other securities		1,821		—		—		1,821
Common stocks		26		—		—		26
Total available for sale	$	170,998	$	1,185	$	(2,329)	$	169,854

Investment securities within the AFS portfolio are marked to market monthly and any resulting gains or losses are recorded in other comprehensive income, net of taxes, within the equity section of the balance sheet as shown in “Note 14 - Comprehensive Income (Loss)” to the Consolidated Financial Statements. When a loss is deemed to be other-than-temporary but we do not intend to sell the security and it is not more likely than not that we will have to sell the security before recovery of its cost basis, we will recognize the credit component of an OTTI charge in earnings and the remaining portion in other comprehensive income.

Loans and Leases

We originate loans primarily in the greater Philadelphia metropolitan area as well as selected locations throughout the Mid-Atlantic region. We have a concentration of credit risk in commercial real estate and construction and land development loans at June 30, 2017. The loans receivable portfolio is segmented into commercial loans, construction and development loans, residential loans, leases, tax certificates, and consumer loans. The commercial loan segment consists of the following classes: commercial real estate loans, multi-family real estate loans, and other commercial loans, which are also generally known as commercial and industrial loans or commercial business loans. The construction and development loan segment consists of the following classes: residential construction and commercial construction loans. Residential construction loans are made for the acquisition of and/or construction on a lot or lots on which a residential dwelling is to be built. Commercial construction loans are made for the purpose of acquiring, developing and/or constructing a commercial structure. The residential loan segment consists of the following classes: one- to four-family first lien residential mortgage loans, home equity lines of credit, and home equity loans. We classify our leases as finance leases, in accordance with FASB ASC Topic 840, “Leases”. The difference between our 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 tax certificate segment includes delinquent property tax certificates that have been acquired through public auctions in various jurisdictions. The tax certificates assume a lien position that is generally superior to any mortgage liens that are on the property and have certain foreclosure rights as defined by state law. The tax certificates are predominantly in New Jersey. We ceased acquiring new tax certificates in 2010. Consumer loans includes cash secured and unsecured loans and lines of credit.

Commercial Loans: The commercial real estate loan portfolio consists primarily of loans secured by office buildings, retail and industrial use buildings, strip shopping centers, mixed-use and other properties used for commercial purposes primarily located in our market area. Although terms for commercial real estate and multi-family loans vary, the underwriting standards generally allow for terms up to 10 years with the interest rate being reset in the sixth year and with monthly amortization not greater than 25 years and loan-to-value (“LTV”) ratios of not more than 80%. Interest rates are either fixed or adjustable and are based upon the prime rate or a borrowing rate from the Federal Home Loan Bank of Pittsburgh plus a margin. Prepayment fees are charged on most loans in the event of early repayment. Generally, the personal guarantees of the principals are obtained as additional collateral for commercial real estate and multi-family real estate loans.

Commercial and multi-family real estate loans generally present a higher level of risk than loans secured by one- to four-family residences. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effect of general economic conditions on income producing properties and the increased

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difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by commercial and multi-family real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed, a bankruptcy court modifies a lease term, or a major tenant is unable to fulfill its lease obligations), the borrower’s ability to repay the loan may be impaired.

Our commercial business loans generally have been made to small and mid-sized businesses predominantly located in our market area. The commercial business loans are either a revolving line of credit or for a fixed term of generally 10 years or less. Interest rates are adjustable, indexed to a published prime rate of interest, or fixed. Generally, equipment, machinery, real property or other corporate assets secure such loans. Personal guarantees from the business principals are generally obtained as additional collateral. Generally, commercial business loans are characterized as having higher risks associated with them than single-family residential loans.

Our underwriting procedures include evaluations of the stability of the property’s cash flow history, future operating projections, current and projected occupancy levels, location and physical condition. Generally, we require a debt service ratio (the ratio of net cash flows from operations before the payment of debt service to debt service) of not less than 120%. We also evaluate the credit and financial condition of the borrower, and if applicable, the guarantor. Appraisal reports prepared by independent appraisers are obtained on each loan to substantiate the property’s market value, and are reviewed prior to the closing of the loan.

Construction and Development Loans: We originate construction loans to builders and developers predominantly in our market area. Construction and development loans are riskier than other loan types because they are more speculative in nature. Deteriorating economic or environmental conditions can negatively affect a project. Construction loans are also more difficult to evaluate and monitor. In order to mitigate some of the risks inherent in construction lending, limits are placed on the number of units that can be built on a speculative basis based upon the reputation and financial position of the builder, his/her present obligations, the location of the property and prior sales in the development and the surrounding area. Additionally, the construction budget is reviewed prior to loan origination and the properties under construction are inspected. During the construction phase of a real estate project, the loan requires interest payments only. Construction loans generally are for 12 to 18 months with LTV ratios of not more than 75%.

Residential Loans: Our residential mortgages were acquired in recent years in pool purchases and are secured mainly by properties located in our primary market and surrounding areas. We originate home equity loans and home equity lines of credit in our market area with a maximum amount of $1.25 million. The collateral must be the borrower’s primary residence and the LTV ratio may not be more than 80%. Home equity lines of credit are variable rate and are indexed to the prime rate. Our home equity loans have a fixed rate and are either first or second liens. We have originated some home equity lines of credit or home equity loans for second homes.  In financing second homes, we must have a first lien position, the LTV does not exceed 65%, and the maximum amount is $750 thousand.

Consumer Loans: We originate cash-secured and unsecured loans and lines of credit to individuals. Unsecured loans and lines of credit have a maximum amount of $15 thousand. Unsecured consumer loans generally have a higher interest rate than residential loans because they have additional credit risk associated with them.

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Total loans and leases of $605.7 million increased $3.7 million, or 0.6%, from the level at December 31, 2016.  The following table represents balances by type for loans and leases held for investment (“LHFI”):

	June 30,		December 31,
(In thousands)	2017		2016
Commercial real estate	$	258,662	$	261,561
Construction and land development		84,910		83,369
Commercial and industrial		116,200		108,146
Multi-family		29,030		23,389
Residential real estate		56,363		56,899
Leases		56,258		61,838
Tax certificates		1,378		3,705
Consumer		2,892		3,102
Total loans, net of unearned income	$	605,693	$	602,009

Credit Classification Process and Credit Risk Management

We use 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 Pass-Watch, Special Mention, Substandard, Doubtful and Loss. During the underwriting process, the Underwriting and Credit Administration Officer (“UCAO”) assigns each loan with an initial risk rating, which is approved by the appropriate loan committee. 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 loan review function is outsourced to a third party vendor which examines credit quality and portfolio management. The loan review vendor applies our loan rating system to specific credits and reviews approximately 50% of the total commercial loan portfolio. Emphasis is on the larger new and seasoned loan relationships and includes criticized and classified loans. Additionally, the loan review vendor ensures that all critical industry segments are adequately represented in their review. The loan review vendor will also review loans specifically requested by management. Upon completion of a loan review, a copy of any review receiving an adverse classification by the reviewer is presented to the Classified, Charge-off and Impairment Committee (“CCIC”) for discussion. The UCAO is the primary bank officer dealing with the third party vendor during the reviews.

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 individual and the attention of the Special Assets Committee.  A watch list is maintained and reviewed at each meeting of CCIC. CCIC was formed to formalize the process and documentation required to classify, remove from classification, impair or charge-off a loan. The CCIC, which is comprised of the CEO, CFO, UCAO and Chief Lending Officer (“CLO”) meet as required and provide regular updated reports to the Board of Directors. 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 quarterly basis. Loans may be removed from the watch list if the CCIC 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.  Minutes outlining the CCIC’s findings and recommendations are issued after each meeting for follow-up by individual loan officers.

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Non-accrual Loans

The composition of non-accrual loans is as follows:

	As of June 30, 2017				As of December 31, 2016
	Loan		Specific		Loan		Specific
(In thousands)	balance		reserves		balance		reserves
Non-accrual loans
Commercial real estate	$	791	$	—	$	885	$	3
Construction and land development		128		—		144		—
Commercial and industrial		758		—		652		—
Residential real estate		525		16		570		17
Leases		1,710		195		1,849		340
Tax certificates		502		14		1,907		8
Total non-accrual loans	$	4,414	$	225	$	6,007	$	368

Non-accrual loan activity for the second quarter of 2017 is set forth below:

	For the six months ended June 30, 2017
					Payments
	Beginning				and other				Transfers to		Ending
(In thousands)	balance		Additions		decreases		Charge-offs		OREO		balance
Non-accrual loans held for investment
Commercial real estate	$	885	$	486	$	(501)	$	(79)	$	—	$	791
Construction and land development		144		—		(16)		—		—		128
Commercial and industrial		652		401		(295)		—		—		758
Residential real estate		570		—		(37)		(8)		—		525
Leases		1,849		1,188		(530)		(797)		—		1,710
Tax certificates		1,907		13		(1,366)		(8)		(44)		502
Total non-accrual LHFI	$	6,007	$	2,088	$	(2,745)	$	(892)	$	(44)	$	4,414
Non-accrual loans held for sale
Commercial and industrial	$	—	$	205	$	(205)	$	—	$	—	$	—
Total non-accrual LHFS	$	—	$	205	$	(205)	$	—	$	—	$	—
Total non-accrual loans	$	6,007	$	2,293	$	(2,950)	$	(892)	$	(44)	$	4,414

Total non-accrual loans at June 30, 2017 were $4.4 million compared to $6.0 million at December 31, 2016.  The decrease of $1.6 million was the result of additions of $2.3 million, which were offset by $892 thousand in charge-offs, mostly related to the leasing subsidiary, a $3.0 million reduction in existing non-accrual loan balances through payments and payoffs, and $44 thousand in transfers to OREO. Included in the amounts for non-accrual additions and payments was a $205 thousand loan that was transferred from LHFI to LHFS during the first quarter of 2017 and sold in the second quarter of 2017. During the first quarter of 2017, one commercial real estate loan with a carrying amount of $486 thousand became non-accrual because it was past its maturity date.  As a result of an impairment analysis this loan required a specific reserve of $25 thousand which was subsequently charged off during the second quarter. Four loans comprise the additions of $401 thousand in commercial and industrial non-accrual loans. The remainder of the additions to non-accrual loans were mainly in the lease portfolio.

Typically, 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 collectability of the total contractual principal and interest is no longer in doubt.

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Impaired Loans

We identify 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. Impaired loans include TDRs. For all classes of loans receivable, with the exception of tax certificates, the accrual of interest income 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. Excess proceeds received over the principal amounts due on impaired non-accrual loans are recognized as income on a cash basis.  We recognize 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, we do not recognize interest income. If interest had accrued on non-accrual loans, such income would have been approximately $108 thousand and $226 thousand for the three and six months ended June 30, 2017 and $157 thousand and $315 thousand for the three and six months ended June 30, 2016, respectively.  At June 30, 2017, we did not have any loans past due 90 days or more on which interest continues to accrue.

The following is a summary of information pertaining to impaired loans and leases:

	June 30,		December 31,
(In thousands)	2017		2016
Impaired loans and leases with a valuation allowance	$	1,722	$	2,509
Impaired loans without a valuation allowance		3,246		4,446
Impaired LHFS without a valuation allowance		—		—
Total impaired loans and leases	$	4,968	$	6,955
Valuation allowance related to impaired loans	$	225	$	368

	For the six months ended
	June 30,
(In thousands)	2017		2016
Average investment in impaired loans and leases	$	6,359	$	6,598
Interest income recognized on impaired loans and leases	$	54	$	57
Interest income recognized on a cash basis on impaired loans and leases	$	—	$	—

Troubled Debt Restructurings

A loan modification is deemed a TDR when two conditions are met: 1) the borrower is experiencing financial difficulty and 2) concessions are made by the Company that would not otherwise be considered for a borrower or collateral with similar credit risk characteristics.  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 collectability of the total contractual restructured principal and interest is no longer in doubt.  At June 30, 2017, we had five TDRs, with a total carrying value of $2.1 million. Our policy for TDRs is to recognize income on currently performing restructured loans under the accrual method. 

	As of June 30, 2017
				Non-
	Number of	Accrual		Accrual
(In thousands)	loans	Status		Status		Total TDRs
Commercial real estate	1	$	16	$	—	$	16
Construction and land development	1		—		128		128
Commercial and industrial	2		1,693		166		1,859
Residential real estate	1		82		—		82
Total	5	$	1,791	$	294	$	2,085

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Allowance for Loan and Lease Losses

Our loan and lease portfolio (the “credit portfolio”) is subject to varying degrees of credit risk. We maintain 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. Our 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 classifications that have similar risk characteristics. The general allowance is based upon historical loss rates using a weighted three-year rolling average of the historical loss experienced within each loan classification. The qualitative factors used to adjust the historical loss experience address various risk characteristics of our 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 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.  The estimated fair values of substantially all of our impaired loans are measured based on the estimated fair value of the loan’s collateral. We obtain 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

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portfolio and the net remaining balance will be used in the general and qualitative analysis.  A specific reserve is established for an impaired loan if its carrying value exceeds its estimated fair value.

The amount of the allowance is reviewed and approved by the CFO, CLO, and UCAO on a quarterly basis. Management believes that the allowance at June 30, 2017 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.

Changes in the allowance were as follows:

	For the three months ended				For the six months ended
	June 30,				June 30,
(In thousands)	2017		2016		2017		2016
Balance at period beginning	$	10,558	$	9,941	$	10,420	$	9,689
Charge-offs
Commercial real estate		(59)		—		(79)		(77)
Construction and land development		—		—		—		—
Commercial and industrial		—		—		—		(108)
Multi-family		—		—		—		—
Residential real estate		(7)		(40)		(8)		(40)
Leases		(300)		(164)		(797)		(447)
Tax certificates		—		(25)		(8)		(31)
Total charge-offs		(366)		(229)		(892)		(703)
Recoveries
Commercial real estate		—		8		—		184
Construction and land development		—		64		351		258
Commercial and industrial		—		4		—		127
Multi-family		—		—		—		—
Residential real estate		7		8		15		19
Leases		6		9		14		17
Tax certificates		—		6		—		8
Consumer		—		—		—		—
Total recoveries		13		99		380		613
Net (charge-offs) recoveries		(353)		(130)		(512)		(90)
Provision for loan and lease losses		57		197		354		409
Balance at period end	$	10,262	$	10,008	$	10,262	$	10,008

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An analysis of the allowance by loan type is set forth below:

	At June 30, 2017				At December 31, 2016
			Percent of				Percent of
			outstanding				outstanding
			loans in each				loans in each
	Allowance		category to		Allowance		category to
(In thousands, except percentages)	amount		total loans		amount		total loans
Commercial real estate	$	3,161	42.7	%	$	3,295	43.4	%
Construction and land development		2,273	14.0	%		2,294	13.8	%
Commercial and industrial		1,371	19.2	%		1,346	18.0	%
Multi-family		344	4.8	%		263	3.9	%
Residential real estate		623	9.3	%		656	9.5	%
Leases		2,292	9.3	%		2,295	10.3	%
Tax certificates		169	0.2	%		242	0.6	%
Consumer		29	0.5	%		29	0.5	%
Total allowance	$	10,262	100.0	%	$	10,420	100.0	%

The allowance decreased $158 thousand from $10.4 million at December 31, 2016 to $10.3 million at June 30, 2017. The decrease in the allowance was primarily attributable to an improvement in the historical loss factors which was partially offset by net charge-offs of $512 thousand during the first six months of 2017.   The required provision for loan and lease losses was $57 thousand for the second quarter of 2017 compared to $197 thousand for the second quarter of 2016. For the six months ended June 30, 2017 the required provision was $354 thousand compared to $409 thousand for the first six months of 2016. Net charge-offs for the leasing portfolio were $783 thousand during the first six months of 2017 compared to $430 thousand for the first six months of 2016. The allowance was 1.69% of total loans and leases at June 30, 2017 compared to 1.73% at December 31, 2016. 

Other Real Estate Owned

At June 30, 2017, OREO was comprised of one real estate property acquired in lieu of foreclosure in settlement of a loan and 24 real estate properties acquired through foreclosure related to tax liens.  Set forth below are tables which detail the changes in OREO from January 1, 2017 to June 30, 2017.

	For the six months ended June 30, 2017
(In thousands)	Loans		Tax Liens		Total
Beginning balance	$	236	$	3,300	$	3,536
Net proceeds from sales		(33)		(1,858)		(1,891)
Net gains on sales		5		395		400
Transfers in		—		44		44
Cash additions		—		35		35
Impairment charge		(27)		(165)		(192)
Ending balance	$	181	$	1,751	$	1,932

At June 30, 2017, OREO was comprised of $181 thousand in land and $1.8 million related to 24 properties acquired through foreclosure related to tax liens.  During 2017, we sold a single family home with a value of $28 thousand. We received net proceeds in the amount of $33 thousand and recorded a net gain of $5 thousand.

During the first six months of 2017, we transferred tax liens of $44 thousand to OREO which represented one property and added $35 thousand in lien redemptions on existing properties. During the same period we sold 17 tax lien properties, received proceeds of $1.9 million, and recorded net gains of $395 thousand as a result of these sales. Additionally, we recorded impairment charges of $59 thousand and $165 thousand during the three and six months ended June 30, 2017 related to the tax lien properties, respectively.  At December 31, 2016, OREO assets acquired through the tax lien portfolio were $3.3 million and were comprised of 41 properties.

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Non-performing Assets

The following table presents the principal amounts of non-accrual loans and other real estate owned:

	At June 30,			At December 31,
(Amounts in thousands)	2017			2016
Non-accrual loans	$	3,912		$	4,100
Non-accrual tax certificates		502			1,907
Total non-accrual loans (1)		4,414			6,007
Other real estate owned-loans		181			236
Other real estate owned-tax certificates		1,751			3,300
Total other real estate owned		1,932			3,536
Total non-performing assets	$	6,346		$	9,543
Non-performing assets to total assets		0.78	%		1.15	%
Total non-accrual loans to total loans		0.73	%		1.00	%
ALLL to total non-accrual loans		232.49	%		173.46	%
ALLL to total loans		1.69	%		1.73	%

(1) Generally, a loan is placed on non-accruing status when it has been delinquent for a period of 90 days or more.

Deposits

Total deposits, our primary source of funds, were $622.8 million at June 30, 2017 and decreased $6.7 million, or 1.1%, from $629.5 million at December 31, 2016.  Demand deposits, savings accounts, and brokered deposits increased $3.5 million, $2.3 million, and $4.2 million respectively.  Interest checking, money market accounts and certificates of deposit declined $3.0 million, $10.5 million, and $3.3 million, respectively. During the first six months of 2017, we increased our short-term brokered CDs through Promontory Interfinancial Network’s CDARS program.  The short-term CDARS deposits were less costly then FHLB borrowings. 

The following table represents ending deposit balances by type:

	June 30,		December 31,
(In thousands)	2017		2016
Non-interest bearing checking	$	101,379	$	97,859
Interest checking		44,845		47,835
Money Market		154,812		165,305
Savings		87,432		85,170
Certificates of deposit ($250 and over)		22,323		19,520
Certificates of deposit (less than $250)		186,304		192,368
Brokered deposits		25,726		21,489
Total deposits	$	622,821	$	629,546

Borrowings

Total borrowings, which include trust preferred securities, decreased $23.0 million from $129.8 million at December 31, 2016 to $106.8 million at June 30, 2017.  Our $15.0 million interest rate swap that was tied to a maturing FHLB advance became effective in June 2016. We will continue to roll over the $15.0 million FHLB advance every 90–days through the swap expiration of June 2021. Short-term borrowing rates and the subordinated debt rate for the second quarter of 2017 were directly impacted by the Federal Reserve Bank’s rate increases in December 2016, March 2017, and to a lesser extent by the rate increase in June 2017.

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Shareholders’ Equity

Shareholders’ equity attributable to the Company increased $6.1 million, or 11.7%, from $51.6 million at December 31, 2016 to $57.7 million at June 30, 2017.  During the first six months of 2017, we recorded net income of $4.8 million and an improvement in accumulated other comprehensive loss of $1.0 million. The improvement in accumulated other comprehensive loss was mostly related to an increase in the valuation of the investment portfolio.

CAPITAL ADEQUACY

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 our financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our 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.

In July 2013, the federal bank regulatory agencies adopted the final reforms on capital and liquidity generally referred to as “Basel III”, which were published by the Basel Committee on Banking Supervision and the Financial Stability Board. The agencies view the new capital requirements as a better reflection of banking organizations’ risk profiles, thereby improving the overall resiliency of the banking system. The rules generally implement higher minimum capital requirements, add a new common equity tier 1 capital requirement or “CET1”, and establish criteria that instruments must meet to be considered common equity tier 1 capital, additional tier 1 capital, or tier 2 capital.  Basel III also introduced a non-risk adjusted tier 1 leverage ratio of 3%, based on a measure of total exposure rather than total assets, and new liquidity requirements.  Under the rules, in order to avoid limitations on capital distributions (including dividend payments and certain discretionary bonus payments to executive officers), a banking organization must hold a capital conservation buffer comprised of CET1 above its minimum risk-based capital requirements in an amount greater than 2.5% of total risk-weighted assets.   The new minimum capital requirements became effective on January 1, 2015.  The capital conservation buffer requirements phase in over a three-year period beginning January 1, 2016. Effective January 1, 2019 the capital conservation buffer will effectively raise the minimum required common equity tier 1 capital ratio to 7.0%, the tier 1 capital ratio to 8.5%, and the total capital ratio to 10.0%.  Management believes that as of June 30, 2017, the Company and Royal Bank would meet all capital adequacy requirements under the Basel III rules on a fully phased in basis as if all such requirements were currently in effect. 

At June 30, 2017 and December 31, 2016, the Company and Royal Bank exceeded the minimum capital adequacy requirements of Tier 1 and total capital to risk-weighted assets and the minimum Tier 1 leverage ratio, as defined by banking regulation.  Royal Bank also met the criteria for a well-capitalized institution. Management believes that, under current regulations, we will continue to meet the minimum capital requirements in the foreseeable future.

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 June 30, 2017 and the previous 27 quarters in accordance with U.S. GAAP.  A 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.  The resolution of this matter will be decided by additional joint regulatory agency guidance which includes the Federal Reserve Bank, the FDIC, and the OCC.

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The table below sets forth Royal Bank’s capital ratios under RAP, based on the FDIC’s interpretation of the Call Report instructions:

	Actual				For capital adequacy purposes				To be well capitalized under prompt corrective action provision
(Dollars in thousands)	Amount		Ratio		Amount		Ratio*		Amount		Ratio
Total capital (to risk-weighted assets)
At June 30, 2017	$	82,588	13.296	%	$	57,454	9.250	%	$	62,113	10.000	%
At December 31, 2016	$	76,716	12.185	%	$	54,301	8.625	%	$	62,957	10.000	%
Tier 1 capital (to risk-weighted assets)
At June 30, 2017	$	74,721	12.030	%	$	45,032	7.250	%	$	49,690	8.000	%
At December 31, 2016	$	68,743	10.919	%	$	41,709	6.625	%	$	50,366	8.000	%
Tier 1 capital (to average assets, leverage)
At June 30, 2017	$	74,721	9.148	%	$	32,671	4.000	%	$	40,838	5.000	%
At December 31, 2016	$	68,743	8.573	%	$	32,076	4.000	%	$	40,095	5.000	%
Common equity Tier 1 (to risk-weighted assets)
At June 30, 2017	$	74,081	11.927	%	$	35,715	5.750	%	$	40,373	6.500	%
At December 31, 2016	$	69,681	11.068	%	$	32,266	5.125	%	$	40,922	6.500	%

*    Ratios related to risk-weighted assets include the capital conservation buffer of 1.25%.

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 six months ended		For the year ended
(In thousands)	June 30, 2017		December 31, 2016
RAP net income	$	4,338	$	8,775
Tax lien adjustment, net of noncontrolling interest		903		1,544
U.S. GAAP net income	$	5,241	$	10,319

	At June 30, 2017				At December 31, 2016
	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)	13.296	%	13.426	%	12.185	%	12.405	%
Tier 1 capital (to risk-weighted assets)	12.030	%	12.160	%	10.919	%	11.139	%
Tier 1 capital (to average assets, leverage)	9.148	%	9.251	%	8.573	%	8.750	%
Common equity Tier 1 (to risk-weighted assets)	11.927	%	12.054	%	11.068	%	11.040	%

The tables below reflect the Company’s capital ratios:

*Ratios related to risk-weighted assets include the capital conservation buffer of 1.25%.

The Company has filed the Consolidated Financial Statements for Bank Holding Companies-FR Y-9C (“FR Y-9C”) as of June 30, 2017 consistent with U.S. GAAP and the FR Y-9C instructions.  In the event that a similar adjustment for RAP

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purposes would be required by the Federal Reserve at the holding company level, the adjusted ratios are shown in the table below. 

	Actual				For capital adequacy purposes				To be well capitalized under the Federal Reserve's regulations
(Dollars in thousands)	Amount		Ratio		Amount		Ratio*		Amount		Ratio
Total capital (to risk-weighted assets)
At June 30, 2017	$	88,975	14.267	%	$	57,689	9.250	%	$	62,366	10.000	%
At December 31, 2016	$	84,056	13.302	%	$	54,503	8.625	%	$	63,192	10.000	%
Tier 1 capital (to risk-weighted assets)
At June 30, 2017	$	75,024	12.030	%	$	45,216	7.250	%	$	37,420	6.000	%
At December 31, 2016	$	68,326	10.812	%	$	41,865	6.625	%	$	37,915	6.000	%
Tier 1 capital (to average assets, leverage)
At June 30, 2017	$	75,024	9.130	%	$	32,871	4.000	%		N/A	N/A
At December 31, 2016	$	68,326	8.488	%	$	32,199	4.000	%		N/A	N/A
Common equity Tier 1 (to risk-weighted assets)
At June 30, 2017	$	55,492	8.898	%	$	35,861	5.750	%		N/A	N/A
At December 31, 2016	$	50,502	7.992	%	$	32,386	5.125	%		N/A	N/A

	For the six months ended		For the year ended
(In thousands)	June 30, 2017		December 31, 2016
U.S. GAAP net income attributable to Royal Bancshares	$	4,819	$	10,375
Tax lien adjustment, net of noncontrolling interest		(903)		(1,544)
RAP net income	$	3,916	$	8,831

	At June 30, 2017				At December 31, 2016
	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)	14.267	%	14.138	%	13.302	%	13.084	%
Tier 1 capital (to risk-weighted assets)	12.030	%	11.851	%	10.812	%	10.512	%
Tier 1 capital (to average assets, leverage)	9.130	%	8.991	%	8.488	%	8.248	%
Common equity Tier 1 (to risk-weighted assets)	8.898	%	8.766	%	7.992	%	8.012	%

LIQUIDITY & INTEREST RATE SENSITIVITY

Liquidity is the ability to ensure that adequate funds will be available to meet our financial commitments as they become due.  In managing our liquidity position, all sources of funds are evaluated, the largest of which is deposits.  Also taken into consideration are securities maturing in one year or less, other short-term investments and the repayment of loans. These sources provide alternatives to meet our short-term liquidity needs.  Longer liquidity needs may be met by issuing longer-term deposits and by raising additional capital.  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.  Our policy is to maintain a liquidity ratio equal to or greater than 12% and 10% of total deposits and total liabilities, respectively.  At June 30, 2017, our liquidity ratios were more than four times the policy minimums. 

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. We have a liquidity contingency plan in the event liquidity falls below an acceptable level, however, events could arise that may render sources of liquid funds unavailable in the future when required.  Our Asset and Liability Committee (“ALCO”) meets monthly to monitor liquidity management. 

Interest rate sensitivity is a function of the re-pricing characteristics of our 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 our interest rate sensitivity positions, we seek to develop and implement strategies to control exposure of net interest income to risks associated with interest rate movements.  The

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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 June 30, 2017, 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 June 30, 2017, we were in a liability sensitive position of $16.4 million, which indicates that within one year the re-pricing of liabilities is sooner than the re-pricing of assets.  The Company has exposure to rising rates as $170.7 million in assets re-price after five years.

(In millions)	Days						1 to 5		Over 5		Non-rate
Assets (1)	0 – 90			91 – 365			Years		Years		Sensitive		Total
Interest-earning deposits in banks	$	17.2		$	—		$	—	$	—	$	14.5	$	31.7
Investment securities AFS		7.6			20.9			68.6		38.3		0.5		135.9
Loans: (2)
Fixed rate		22.4			59.7			223.4		132.4		(10.3)		427.6
Variable rate		167.8			—			—		—		—		167.8
Total loans (including loans held for sale)		190.2			59.7			223.4		132.4		(10.3)		595.4
Other assets (3)		—			20.9			—		—		24.9		45.8
Total Assets	$	215.0		$	101.5		$	292.0	$	170.7	$	29.6	$	808.8
Liabilities & Capital
Deposits:
Non-interest bearing deposits	$	—		$	—		$	—	$	—	$	101.4	$	101.4
Interest-bearing deposits		31.4			94.2			161.4		—		—		287.0
Certificates of deposit		47.0			68.5			117.9		1.0		—		234.4
Total deposits		78.4			162.7			279.3		1.0		101.4		622.8
Borrowings		46.8			45.0			15.0		—		—		106.8
Other liabilities		—			—			—		—		20.9		20.9
Capital		—			—			—		—		58.3		58.3
Total liabilities & capital	$	125.2		$	207.7		$	294.3	$	1.0	$	180.6	$	808.8
Net  interest rate  GAP	$	89.8		$	(106.2)		$	(2.3)	$	169.7	$	(151.0)
Cumulative interest rate  GAP	$	89.8		$	(16.4)		$	(18.7)	$	151.0
GAP to total  assets		11	%		(13)	%
GAP to total equity		154	%		(182)	%
Cumulative GAP to total assets		11	%		(2)	%
Cumulative GAP to total equity		154	%		(28)	%

(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 rate loans and re-pricing for variable rate loans; includes non-performing loans.

(3) Includes FHLB stock.

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.  Prepayments and

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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.

The Company’s exposure to interest rate risk is mitigated somewhat by a portion of the Company’s loan portfolio consisting of floating rate loans, which are tied to the prime lending rate but which have interest rate floors and no interest rate ceilings.  Although the Company is originating fixed rate loans, a portion of the loan portfolio continues to be comprised of floating rate loans with interest rate floors. At June 30, 2017, floating rate loans with floors and without floors were $140.6 million and $28.4 million, respectively.

ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

ITEM 4 – CONTROLS AND PROCEDURES

(a)     Evaluation of Disclosure Controls and Procedures

The Company maintains a set of disclosure controls and procedures that are designed to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission’s rules and forms. As of the end of the period covered by this report, the Company evaluated, under the supervision and with the participation of our management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rule 13a-15(e) of the Exchange Act. Based on that evaluation, our CEO and CFO concluded, subject to the limitations on effectiveness described in Item 9A in our Annual Report on Form 10-K for the year ended December 31, 2016, that the Company’s disclosure controls and procedures were effective at June 30, 2017.

(b)     Changes in Internal Control Over Financial Reporting

There have been no changes in the Company’s internal control over financial reporting during the second quarter of 2017 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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

PART II - OTHER INFORMATION

Item 1.Legal Proceedings.

From time to time, the Company is a party to routine legal proceedings within the normal course of business.  Such routine legal proceedings in the aggregate are believed by management to be immaterial to the Company's financial condition or results of operations.  All non-routine legal proceedings are described in Item 3 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

On January 30, 2017, the Company and Bryn Mawr Bank Corporation, (“BMBC”), entered into an Agreement and Plan of Merger (the “Merger Agreement”) pursuant to which, upon satisfaction of the conditions set forth in the Merger Agreement, the Company will merge with and into BMBC, with BMBC being the surviving corporation (the “Merger”).  On April 11, 2017, a purported shareholder filed a lawsuit in the United States District Court, Eastern District of Pennsylvania, against members of the Company’s board of directors, BMBC and the Company. The lawsuit, which is

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captioned Parshall v. Royal Bancshares of Pennsylvania, Inc., et al., Case No. 2:17-cv-01641-PBT alleges class claims on behalf of all Company shareholders and based on allegations of material misstatements and omissions in the proxy statement/prospectus and violations of the Securities Exchange Act of 1934. The lawsuit seeks, among other remedies, to enjoin the Merger or, in the event the Merger is completed, rescission of the Merger or rescissory damages; to direct defendants to account for unspecified damages; and costs of the lawsuit, including attorneys’ and experts’ fees. As of the date of this filing, the Company cannot reasonably predict the outcome of the lawsuit or, in the event of an adverse outcome, the potential loss or range of possible loss relating to the lawsuit.

Item 1A.Risk Factors.

There have been no material changes from risk factors as previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2016.

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

None

Item 3.Defaults Upon Senior Securities.

None

Item 4.Mine Safety Disclosures.

None

Item 5.Other Information.

None

Item 6.Exhibits.  

(a)

3.1	Articles of Incorporation of the Company. (Incorporated by reference to Exhibit 3.1 of the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2013.)
3.21	Bylaws of the Company (Incorporated by reference to Exhibit 3(ii) to the Company’s Annual Report on Form 10-K filed with the Commission on March 30, 2009.)
31.1	Section 302 Certification Pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934 signed by F. Kevin Tylus, Principal Executive Officer of Royal Bancshares of Pennsylvania on August 10, 2017.
31.2	Section 302 Certification Pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934 signed by Michael S. Thompson, Principal Financial Officer of Royal Bancshares of Pennsylvania on August 10, 2017.
32.1	Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by F. Kevin Tylus, Principal Executive Officer of Royal Bancshares of Pennsylvania on August 10, 2017.
32.2	Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by Michael S. Thompson, Principal Financial Officer of Royal Bancshares of Pennsylvania on August 10, 2017.
101	Interactive Data File

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SIGNATURES

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

ROYAL BANCSHARES OF PENNSYLVANIA, INC

(Registrant)

Dated: August 10, 2017

/s/ Michael S. Thompson

Michael S. Thompson

Principal Financial and Accounting Officer

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