Prepared and Filed by St Ives Financial


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, 2006

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

732 Montgomery Avenue, Narberth, PA 19072

(Address of principal Executive Offices)

(610) 668-4700

(Registrant’s telephone number, including area code)

N/A

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes No

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

Large accelerated filer      Accelerated filer      Non-accelerated filer

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
$2.00 par value
 
Class B Common Stock
$.10 par value
 Outstanding at July 31, 2006
10,710,306
 
Outstanding at July 31, 2006
2,009,196
 


PART I – FINANCIAL INFORMATION

ITEM I – FINANCIAL STATEMENTS

Royal Bancshares of Pennsylvania, Inc. and Subsidiaries

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except share data)

 

 

 

June 30, 2006

 

Dec. 31, 2005

 

 

 


 


 

 

 

(unaudited)

 

 

 

ASSETS

 

 

 

 

 

 

 

Cash and due from banks

 

$

20,919

 

$

17,095

 

Federal funds sold

 

 

2,350

 

 

13,800

 

 

 



 



 

Total cash and cash equivalents

 

 

23,269

 

 

30,895

 

Investment securities held to maturity (“HTM”) (fair value of $250,038 at June 30, 2006 and $253,198 at December 31, 2005)

 

 

255,446

 

 

255,467

 

Investment securities available for sale (“AFS”) –at fair value

 

 

309,801

 

 

326,189

 

FHLB Stock, at cost

 

 

16,415

 

 

17,073

 

Loans held for sale

 

 

1,619

 

 

803

 

Loans

 

 

635,772

 

 

549,636

 

Less allowance for loan losses

 

 

11,466

 

 

10,276

 

 

 



 



 

Net Loans

 

 

624,306

 

 

539,360

 

Premises and equipment, net

 

 

8,073

 

 

8,373

 

Real estate owned via equity investments

 

 

54,623

 

 

58,209

 

Accrued interest receivable

 

 

15,511

 

 

14,843

 

Bank owned life insurance

 

 

22,484

 

 

22,059

 

Other assets

 

 

27,662

 

 

27,748

 

 

 



 



 

Total Assets

 

$

1,359,209

 

$

1,301,019

 

 

 



 



 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

Deposits

 

 

 

 

 

 

 

Non-interest bearing deposits

 

$

63,996

 

$

75,754

 

Interest bearing (includes certificates of deposit in excess of $100 which was $252,186 at June 30, 2006 and $203,611 at December 31, 2005)

 

 

694,449

 

 

621,655

 

 

 



 



 

Total deposits

 

 

758,445

 

 

697,409

 

Accrued interest payable

 

 

7,579

 

 

6,606

 

Other liabilities

 

 

11,206

 

 

11,879

 

Borrowings

 

 

352,500

 

 

354,000

 

Obligations related to equity investments in real estate

 

 

45,653

 

 

47,356

 

Subordinated debentures

 

 

25,744

 

 

25,774

 

 

 



 



 

Total liabilities

 

 

1,201,127

 

 

1,143,024

 

Minority interests

 

 

2,164

 

 

2,487

 

Stockholders’ equity

 

 

 

 

 

 

 

Common stock

 

 

 

 

 

 

 

Class A, par value $2 per share, authorized 18,000,000 shares; issued, 10,707,679 at June 30, 2006 and 10,699,592 at December 31, 2005

 

 

21,415

 

 

21,400

 

Class B, par value $0.10 per share; authorized, 3,000,000 2,009,403 at June 30, 2006 and 1,992,957 at December 31, 2005

 

 

201

 

 

199

 

Undistributed Class B shares

 

 

 

 

2

 

Additional paid in capital

 

 

104,336

 

 

104,285

 

Retained earnings

 

 

35,703

 

 

32,827

 

Accumulated other comprehensive loss

 

 

(3,472

)

 

(940)

 

 

 



 



 

 

 

 

158,183

 

 

157,773

 

Treasury stock – at cost, shares of Class A, 215,388 at June 30, 2006 and December 31, 2005.

 

 

(2,265

)

 

(2,265

)

 

 



 



 

Total stockholders’ equity

 

 

155,918

 

 

155,508

 

 

 



 



 

Total liabilities and stockholders’ equity

 

$

1,359,209

 

$

1,301,019

 

 

 



 



 

The accompanying notes are an integral part of these statements.


Royal Bancshares of Pennsylvania, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

 

 

 

Three-months ended
June 30,

 

 

 


 

(in thousands, except per share data)

 

2006

 

2005

 


 


 


 

Interest income

 

 

 

 

 

 

 

Loans, including fees

 

$

15,494

 

$

12,166

 

Investment securities held to maturity

 

 

2,944

 

 

2,227

 

Investment securities available for sale

 

 

4,234

 

 

4,908

 

Deposits in banks

 

 

11

 

 

18

 

Federal funds sold

 

 

5

 

 

11

 

 

 



 



 

TOTAL INTEREST INCOME

 

 

22,688

 

 

19,330

 

 

 



 



 

Interest expense

 

 

 

 

 

 

 

Deposits

 

 

6,385

 

 

4,069

 

Borrowings

 

 

5,244

 

 

3,626

 

 

 



 



 

TOTAL INTEREST EXPENSE

 

 

11,629

 

 

7,695

 

 

 



 



 

NET INTEREST INCOME

 

 

11,059

 

 

11,635

 

Provision for loan losses

 

 

963

 

 

 

 

 



 



 

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES

 

 

10,096

 

 

11,635

 

 

 



 



 

Other income

 

 

 

 

 

 

 

Service charges and fees

 

 

354

 

 

288

 

Net gains (losses) on sales of investment securities

 

 

161

 

 

(88

)

Income related to equity investments

 

 

1,331

 

 

2,952

 

Gains on sales of other real estate

 

 

81

 

 

404

 

Gains on sales of loans

 

 

174

 

 

103

 

Other income

 

 

799

 

 

221

 

 

 



 



 

TOTAL OTHER INCOME

 

 

2,900

 

 

3,880

 

 

 



 



 

Other expenses

 

 

 

 

 

 

 

Salaries and wages

 

 

2,609

 

 

2,391

 

Employee benefits

 

 

840

 

 

1,550

 

Occupancy and equipment

 

 

892

 

 

408

 

Expenses related to equity investments

 

 

434

 

 

968

 

Other operating expenses

 

 

1,633

 

 

2,252

 

 

 



 



 

TOTAL OTHER EXPENSE

 

 

6,408

 

 

7,569

 

 

 



 



 

INCOME BEFORE INCOME TAXES

 

 

6,588

 

 

7,946

 

Income taxes

 

 

2,002

 

 

704

 

 

 



 



 

NET INCOME

 

$

4,586

 

$

7,242

 

 

 



 



 

Per share data

 

 

 

 

 

 

 

Net income – basic

 

$

0.36

 

$

0.57

 

 

 



 



 

Net income – diluted

 

$

0.36

 

$

0.56

 

 

 



 



 

Cash dividends– Class A shares

 

$

0.275

 

$

0.25

 

 

 



 



 

Cash dividends– Class B shares

 

$

0.31625

 

$

0.2875

 

 

 



 



 

The accompanying notes are an integral part of these statements.


Royal Bancshares of Pennsylvania, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

 

 

 

Six-months ended
June 30,

 

 

 


 

(in thousands, except per share data)

 

2006

 

2005

 


 


 


 

Interest income

 

 

 

 

 

 

 

Loans, including fees

 

$

29,590

 

$

22,292

 

Investment securities held to maturity

 

 

5,800

 

 

4,475

 

Investment securities available for sale

 

 

8,663

 

 

9,697

 

Deposits in banks

 

 

23

 

 

41

 

Federal funds sold

 

 

25

 

 

29

 

 

 



 



 

TOTAL INTEREST INCOME

 

 

44,101

 

 

36,534

 

 

 



 



 

Interest expense

 

 

 

 

 

 

 

Deposits

 

 

11,848

 

 

8,079

 

Borrowings

 

 

9,859

 

 

6,982

 

 

 



 



 

TOTAL INTEREST EXPENSE

 

 

21,707

 

 

15,061

 

 

 



 



 

NET INTEREST INCOME

 

 

22,394

 

 

21,473

 

Provision for loan losses

 

 

1,299

 

 

1

 

 

 



 



 

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES

 

 

21,095

 

 

21,472

 

 

 



 



 

Other income

 

 

 

 

 

 

 

Service charges and fees

 

 

708

 

 

581

 

Net gains on sales of investment securities

 

 

244

 

 

162

 

Income related to equity investments

 

 

2,109

 

 

4,395

 

Gains on sales of other real estate

 

 

1,574

 

 

693

 

Gains on sales of loans

 

 

217

 

 

228

 

Other income

 

 

1,046

 

 

434

 

 

 



 



 

TOTAL OTHER INCOME

 

 

5,898

 

 

6,493

 

 

 



 



 

Other expenses

 

 

 

 

 

 

 

Salaries and wages

 

 

5,054

 

 

4,705

 

Employee benefits

 

 

1,653

 

 

2,126

 

Occupancy and equipment

 

 

1,296

 

 

817

 

Expenses related to equity investments

 

 

710

 

 

1,788

 

Other operating expenses

 

 

3,883

 

 

4,492

 

 

 



 



 

TOTAL OTHER EXPENSE

 

 

12,596

 

 

13,928

 

 

 



 



 

INCOME BEFORE INCOME TAXES

 

 

14,397

 

 

14,037

 

Income taxes

 

 

4,465

 

 

2,474

 

 

 



 



 

NET INCOME

 

$

9,932

 

$

11,563

 

 

 



 



 

Per share data

 

 

 

 

 

 

 

Net income – basic

 

$

0.78

 

$

0.90

 

 

 



 



 

Net income – diluted

 

$

0.77

 

$

0.89

 

 

 



 



 

Cash dividends– Class A shares

 

$

0.55

 

$

0.50

 

 

 



 



 

Cash dividends– Class B shares

 

$

0.6325

 

$

0.5750

 

 

 



 



 

The accompanying notes are an integral part of these statements.


Royal Bancshares of Pennsylvania, Inc. and Subsidiaries

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

AND COMPREHENSIVE INCOME

Six Months ended June 30, 2006

(UNAUDITED)

 

(in thousands, except per share data)

 

 

 

Class A common stock

 

 

 

Class B common stock

 

 

 

Un-
Distributed
B-shares

 

Additional
Paid in
Capital

 

Retained
earnings

 

Accumulated
other
comprehensive
(loss)

 

Treasury
stock

 

Comprehensive
income

 

 

 

 


 


 

 

 

Shares

 

Amount

 

Shares

 

Amount

 

 


 


 


 


 


 


 


 


 


 


 


 

Balance, January 1, 2006

 

10,700

 

$

21,400

 

1,993

 

$

199

 

$

2

 

$

104,285

 

$

32,827

 

$

(940

)

$

(2,265

)

 

 

 

Net income

 

 

 

 

 

 

 

 

 

 

 

 

 

9,932

 

 

 

 

 

$

9,932

 

Conversion of Class B common stock to Class A common stock

 

4

 

 

7

 

(3

)

 

 

 

 

 

 

 

 

(8

)

 

 

 

 

 

 

Issuance of un-distributed shares

 

 

 

 

 

 

20

 

 

2

 

 

(2

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash in lieu of fractional shares

 

 

 

 

 

 

 

 

 

 

 

 

(11

)

 

 

 

 

 

 

Cash dividends on common stock (Class A $0.55, Class B $0.6325)

 

 

 

 

 

 

 

 

 

 

 

 

 

(7,037

)

 

 

 

 

 

 

Stock options exercised

 

4

 

 

8

 

 

 

 

 

 

 

51

 

 

 

 

 

 

 

 

 

Other comprehensive loss, net of reclassifications and tax benefit of $823

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(2,532

)

 

 

 

(2,532

)

 

 


 



 


 



 



 



 



 



 



 



 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

7,400

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Balance, June 30, 2006

 

10,708

 

$

21,415

 

2,010

 

$

201

 

$

 

$

104,336

 

$

35,703

 

$

(3,472

)

$

(2,265

)

 

 

 

 

 


 



 


 



 



 



 



 



 



 

 

 

 

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


Royal Bancshares of Pennsylvania, Inc. and Subsidiaries

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

AND COMPREHENSIVE INCOME

Six Months ended June 30, 2005

(UNAUDITED)

 

(in thousands, except per share data)

 

 

 

Class A Common Stock

 

 

 

Class B Common Stock

 

 

 

Additional
Paid in
Capital

 

Retained
Earnings

 

Treasury
Stock

 

Accumulated
Other
Comprehensive
Income (loss)

 

Comprehensive
Income

 

 

 

 

 


 


 

 

Shares

 

Amount

 

Shares

 

Amount

 

 


 


 


 


 


 


 


 


 


 


 

Balance, January 1, 2005

 

10,277

 

$

20,553

 

1,939

 

$

194

 

$

92,037

 

$

26,558

 

$

(2,265)

 

$

3,799

 

 

 

 

Net income

 

 

 

 

 

 

 

 

 

 

11,563

 

 

 

 

 

$

11,563

 

Conversion of Class B common stock to Class A

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock

 

6

 

 

12

 

(4

)

 

(1

)

 

 

 

(11

)

 

 

 

 

 

 

Purchase of treasury stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2% stock dividend declared

 

201

 

 

402

 

39

 

 

4

 

 

6,640

 

 

(7,046

)

 

 

 

 

 

 

 

Cash dividends on common stock

 

 

 

 

 

 

 

 

         

 

 

 

 

 

(per share: Class A $0.50 and Class B $0.575)

 

                       

 

 


(6,271

)

 

             

 

Cash in lieu of fractional shares

 

 

 

 

 

 

 

 

 

 

(12

)

 

 

 

 

 

 

Stock options exercised

 

10

 

 

20

 

 

 

 

 

151

 

 

 

 

 

 

 

 

 

Other comprehensive loss, net of reclassification adjustment and tax benefit of $190.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(542

)

 

(542

)

 

 


 



 


 



 



 



 



 



 



 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

11,021

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Balance, June 30, 2005

 

10,494

 

$

20,987

 

1,974

 

$

197

 

$

98,828

 

$

24,781

 

$

(2,265)

 

$

3,257

 

 

 

 

 

 


 



 


 



 



 



 



 



 

 

 

 

The accompanying notes are an integral part of the financial statement


CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

Six months ended June 30,

(in thousands)

 

 

 

2006

 

2005

 

 

 


 


 

Cash flows from operating activities

 

 

 

 

 

 

 

Net income

 

$

9,932

 

$

11,563

 

Adjustments to reconcile net income to net cash provided by operating activities

 

 

 

 

 

 

 

Depreciation

 

 

749

 

 

1,440

 

Stock compensation expense

 

 

357

 

 

 

Provision for loan losses

 

 

1,299

 

 

1

 

Net accretion of discounts and premiums on loans, mortgage-backed securities and investments

 

 

6,359

 

 

(1,901

)

Provision for deferred income taxes

 

 

(3,451

)

 

(135

)

Gains on sales of other real estate

 

 

(1,574

)

 

(693

)

Gains on sales of loans

 

 

(217

)

 

(228

)

Net gains on sales of investment securities

 

 

(244

)

 

(162

)

Changes in assets and liabilities:

 

 

 

 

 

 

 

(Increase) decrease in accrued interest receivable

 

 

(668

)

 

1,060

 

(Decrease) increase in other assets

 

 

1,788

 

 

(1,963

)

Increase in accrued interest payable

 

 

973

 

 

205

 

(Decrease) in other liabilities

 

 

(1,203

)

 

(612

)

 

 



 



 

Net cash provided by operating activities

 

 

14,100

 

 

8,575

 

Cash flows from investing activities

 

 

 

 

 

 

 

Proceeds from calls/maturities of HTM investment securities

 

 

 

 

36,650

 

Proceeds from calls/maturities of AFS investment securities

 

 

25,552

 

 

12,727

 

Proceeds from sales of AFS investment securities

 

 

4,230

 

 

6,345

 

Purchase of AFS investment securities

 

 

(18,375

)

 

(15,137

)

Purchase of HTM investment securities

 

 

 

 

(65,025

)

Redemption (Purchase) of FHLB Stock

 

 

658

 

 

(6,050

)

Net increase in loans

 

 

(87,885

)

 

(41,457

)

(Purchase) of premises and equipment

 

 

(299

)

 

(548

)

Deconsolidation of premises and equipment relating to VIE

 

 

 

 

12,976

 

Sales of premises and equipment relating to VIE

 

 

3,586

 

 

4,498

 

 

 



 



 

Net cash used in investing activities

 

 

(72,533

)

 

(55,021

)

Cash flows from financing activities:

 

 

 

 

 

 

 

Net decrease in non-interest bearing and interest bearing demand deposits and savings accounts

 

 

(15,172

)

 

(108,220

)

Net increase in certificates of deposit

 

 

76,208

 

 

66,957

 

Mortgage payments

 

 

(37

)

 

(34

)

Net (decrease) increase in FHLB borrowings

 

 

(1,500

)

 

108,500

 

Obligations through equity investments

 

 

(1,703

)

 

(13,484

)

Cash dividends

 

 

(7,037

)

 

(6,271

)

Cash in lieu of fractional shares

 

 

(11

)

 

(12

)

Issuance of common stock under stock option plans

 

 

59

 

 

171

 

 

 



 



 

Net cash provided by financing activities

 

 

50,807

 

 

47,607

 

NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS

 

 

(7,626

)

 

1,161

 

Cash and cash equivalents at beginning of period

 

 

30,895

 

 

27,109

 

 

 



 



 

Cash and cash equivalents at end of period

 

$

23,269

 

$

28,270

 

 

 



 



 

The accompanying notes are an integral part of these statements.


ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

The accompanying unaudited consolidated financial statements include the accounts of Royal Bancshares of Pennsylvania, Inc (“Company”) and its wholly-owned subsidiaries, Royal Investments of Delaware, Inc., Royal Asian Bank (effective July 17, 2006, prior thereto, a division of Royal Bank America) and Royal Bank America (“Royal Bank”), including Royal Bank’s subsidiaries, Royal Real Estate of Pennsylvania, Inc., Royal Investments America, LLC, and its two 60% ownership interests in Crusader Servicing Corporation and Royal Bank America Leasing, LP. The two Delaware trusts, Royal Bancshares Capital Trust I and Royal Bancshares Capital Trust II are not consolidated per requirements under FIN 46(R). These financial statements reflect the historical information of the Company. All significant inter-company transactions and balances have been eliminated.

1.

The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (US GAAP) for interim financial information. The interim financial information included herein is unaudited; however, such information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, necessary to present a fair statement of the results for the interim periods. These interim financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2005. The results of operations for the three-month and six-month periods ended June 30, 2006, are not necessarily indicative of the results to be expected for the full year.

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

2.

Segment Information

The Company’s Community Banking segment consists of commercial and retail banking. The Community Banking business segment is managed as a single strategic unit which generates revenue from a variety of products and services provided by Royal Bank. For example, lending is dependent upon the ability of Royal Bank to fund itself with retail deposits and other borrowings and to manage interest rate and credit risk.

Tax lien operation

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

Equity investments

As of June 30, 2006, the Company is reporting on a consolidated basis its interest in one Equity Investment as a Variable Interest Entity (“VIE”) which has different characteristics than the Community Banking segment. The Company has an equity investment in an apartment complex that is being converted into condominiums and a single tenant commercial building.


As of June 30, 2005, the Company reported on a consolidated basis its interest in two equity investments as VIE’s which has different characteristics than the Community Banking segment. The Company had investments in two apartment complexes.

Royal Bancshares’ investments in VIE’s is further discussed in Note 9.

The following table presents selected financial information for reportable business segments for the three month and six month periods ended June 30, 2006 and 2005.

 

 

 

Three months ended June 30, 2006

 

 

 


 

(in thousands)

 

Community
Banking

 

Tax Lien
Operation

 

Equity
Investments

 

Consolidated

 


 


 


 


 


 

Total assets

 

$

1,266,871

 

$

44,886

 

$

47,452

 

$

1,359,209

 

   

 

 

 

 

Total deposits

 

 

758,445

 

 

 

 

 

 

758,445

 

   

 

 

 

 

Interest income

 

$

21,601

 

$

1,087

 

 

 

$

22,688

 

Interest expense

 

 

9,907

 

 

832

 

 

890

 

 

11,629

 

   

 

 

 

 

Net interest income

 

 

11,694

 

 

255

 

 

(890

)

 

11,059

 

Provision for loan losses

 

 

962

 

 

1

 

 

 

 

963

 

Other income

 

 

1,356

 

 

213

 

 

1,331

 

 

2,900

 

Other expense

 

 

5,728

 

 

247

 

 

433

 

 

6,408

 

Income tax expense

 

 

1,973

 

 

29

 

 

 

 

2,002

 

 

 



 



 



 



 

Net income

 

$

4,387

 

$

191

 

$

8

 

$

4,586

 

 

 



 



 



 



 

 

 

 

Three months ended June 30, 2005

 

 

 


 

(in thousands)

 

Community
Banking

 

Tax Lien
Operation

 

Equity
Investments

 

Consolidated

 


 


 


 


 


 

Total assets

 

$

1,164,373

 

$

51,358

 

$

47,968

 

$

1,263,699

 

   

 

 

 

 

Total deposits

 

 

701,119

 

 

 

 

 

 

701,119

 

   

 

 

 

 

Interest income

 

$

18,204

 

$

1,126

 

 

 

$

19,330

 

Interest expense

 

 

6,775

 

 

659

 

 

261

 

 

7,695

 

   

 

 

 

 

Net interest income

 

 

11,429

 

 

467

 

 

(261

)

 

11,635

 

Provision for loan losses

 

 

 

 

 

 

 

 

 

Other income

 

 

566

 

 

362

 

 

2,952

 

 

3,880

 

Other expense

 

 

6,038

 

 

563

 

 

968

 

 

7,569

 

Income tax expense

 

 

636

 

 

68

 

 

 

 

704

 

 

 



 



 



 



 

Net income

 

$

5,321

 

$

198

 

$

1,723

 

$

7,242

 

 

 



 



 



 



 

Interest paid to the Community Banking segment by the Tax Lien Operation was approximately $832 thousand and $659 thousand for the three-month periods ended June 30, 2006, and 2005, respectively. Interest paid to the Community Banking segment by the Equity Investment segment was approximately $233 thousand and none for the three-month June 30, 2006 and 2005, respectively.


 

 

Six months ended June 30, 2006

 

 

 


 

(in thousands)

 

Community
Banking

 

Tax Lien
Operation

 

Equity
Investments

 

Consolidated

 


 


 


 


 


 

Total assets

 

$

1,266,871

 

$

44,886

 

$

47,452

 

$

1,359,209

 

   

 

 

 

 

Total deposits

 

 

758,445

 

 

 

 

 

 

758,445

 

   

 

 

 

 

Interest income

 

$

41,796

 

$

2,305

 

 

 

$

44,101

 

Interest expense

 

 

18,536

 

 

1,670

 

 

1,501

 

 

21,707

 

   

 

 

 

 

Net interest income

 

 

23,260

 

 

635

 

 

(1,501

)

 

22,394

 

Provision for loan losses

 

 

1,296

 

 

3

 

 

 

 

1,299

 

Other income

 

 

2,994

 

 

795

 

 

2,109

 

 

5,898

 

Other expense

 

 

11,165

 

 

722

 

 

709

 

 

12,596

 

Income tax expense

 

 

4,341

 

 

124

 

 

 

 

4,465

 

 

 



 



 



 



 

Net income

 

$

9,452

 

$

581

 

 

($101

)

$

9,932

 

 

 



 



 



 



 

 

 

 

Six months ended June 30, 2005

 

 

 


 

(in thousands)

 

Community
Banking

 

Tax Lien
Operation

 

Equity
Investments

 

Consolidated

 


 


 


 


 


 

Total assets

 

$

1,164,373

 

$

51,358

 

$

47,968

 

$

1,263,699

 

   

 

 

 

 

Total deposits

 

 

701,119

 

 

 

 

 

 

701,119

 

   

 

 

 

 

Interest income

 

$

34,116

 

$

2,418

 

 

 

$

36,534

 

Interest expense

 

 

12,969

 

 

1,277

 

 

815

 

 

15,061

 

Provision for loan losses

 

 

 

 

1

 

 

 

 

1

 

Other income

 

 

1,645

 

 

453

 

 

4,395

 

 

6,493

 

Other expense

 

 

11,080

 

 

1,075

 

 

1,773

 

 

13,928

 

Income tax expense

 

 

2,357

 

 

117

 

 

 

 

2,474

 

 

 



 



 



 



 

Net income

 

$

9,355

 

$

401

 

$

1,807

 

$

11,563

 

 

 



 



 



 



 

Interest paid to the Community Banking segment by the Tax Lien Operation was approximately $1.7 million and $1.3 million for the six-month periods ended June 30, 2006, and 2005, respectively. Interest paid to the Community Banking segment by the Equity Investment segment was approximately $463 thousand and none for the six-month June 30, 2006 and 2005, respectively


3.

Per Share Information

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

 

 

 

Three months ended June 30, 2006

 

 

 


 

 

 

Income
(numerator)

 

Average shares
(denominator)

 

Per share
Amount

 

 

 


 


 


 

Basic EPS

 

 

 

 

 

 

 

 

 

Income available to common shareholders

 

$

4,586

 

12,801

 

$

0.36

 

Effect of dilutive securities

 

 

 

 

 

 

 

 

 

Stock options

 

 

 

 

101

 

 

 

 

 



 


 



 

Diluted EPS

 

 

 

 

 

 

 

 

 

Income available to common shareholders plus assumed exercise of options

 

$

4,586

 

12,902

 

$

0.36

 

 

 



 


 



 

 

 

 

Three months ended June 30, 2005

 

 

 


 

 

 

Income
(numerator)

 

Average shares (denominator)

 

Per share
Amount

 

 

 


 


 


 

Basic EPS

 

 

 

 

 

 

 

 

 

Income available to common shareholders

 

$

7,242

 

12,796

 

$

0.57

 

Effect of dilutive securities

 

 

 

 

 

 

 

 

 

Stock options

 

 

 

 

79

 

 

(0.01

)

 

 



 


 



 

Diluted EPS

 

 

 

 

 

 

 

 

 

Income available to common shareholders plus assumed exercise of options

 

$

7,242

 

12,875

 

$

0.56

 

 

 



 


 



 

No options were anti-dilutive for the three-month periods ended June 30, 2006 and June 30, 2005.

Note:

The stock dividend resulted in the issuance of 205,120 additional shares of Class A common stock and 19,426 additional shares of Class B common stock. In addition, there were 20,117 Class B shares issued to the Tabas Family Trust that were deferred at December 31, 2005 and paid out in June 2006.

 

 

 

Six months ended June 30, 2006

 

 

 


 

 

 

Income (numerator)

 

Average shares (denominator)

 

Per share Amount

 

 

 


 


 


 

Basic EPS

 

 

 

 

 

 

 

 

 

Income available to common shareholders

 

$

9,932

 

12,800

 

$

0.78

 

Effect of dilutive securities

 

 

 

 

 

 

 

 

 

Stock options

 

 

 

 

102

 

 

(0.01

)

 

 



 


 



 

Diluted EPS

 

 

 

 

 

 

 

 

 

Income available to common shareholders plus assumed exercise of options

 

$

9,932

 

12,902

 

$

0.77

 

 

 



 


 



 

 

 

 

Six months ended June 30, 2005

 

 

 


 

 

 

Income (numerator)

 

Average shares (denominator)

 

Per share Amount

 

 

 


 


 


 

Basic EPS

 

 

 

 

 

 

 

 

 

Income available to common shareholders

 

$

11,563

 

12,794

 

$

0.90

 

Effect of dilutive securities

 

 

 

 

 

 

 

 

 

Stock options

 

 

 

 

86

 

 

(0.01

)

 

 



 


 



 

Diluted EPS

 

 

 

 

 

 

 

 

 

Income available to common shareholders plus assumed exercise of options

 

$

11,563

 

12,880

 

$

0.89

 

 

 



 


 



 


No options were anti-dilutive for the six-month periods ended June 30, 2006 and June 30, 2005.

Note:

The stock dividend resulted in the issuance of 205,120 additional shares of Class A common stock and 19,426 additional shares of Class B common stock. In addition, there were 20,117 Class B shares issued to the Tabas Family Trust that were deferred at December 31, 2005 and paid out in June 2006.

4.

Investment Securities:

The carrying value and approximate market value of investment securities at June 30, 2006 are as follows:

 

(in thousands)

 

Amortized
Purchased
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Approximate
Fair
Value

 

Carrying
Value

 


 


 


 


 


 


 

Held to maturity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage Backed

 

$

146

 

$

 

$

 

$

146

 

$

146

 

US Agencies

 

 

195,000

 

 

 

 

(5,409

)

 

189,591

 

 

195,000

 

Other Securities

 

 

60,300

 

 

1

 

 

 

 

60,301

 

 

60,300

 

 

 



 



 



 



 



 

 

 

$

255,446

 

$

1

 

 

($5,409

)

$

250,038

 

$

255,446

 

 

 



 



 



 



 



 

Available for sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage Backed

 

$

30,110

 

$

1

 

 

($1,375

)

$

28,736

 

$

28,736

 

CMO’s

 

 

21,604

 

 

10

 

 

(330

)

 

21,284

 

 

21,284

 

US Agencies

 

 

104,979

 

 

 

 

(5,580

)

 

99,399

 

 

99,399

 

Other securities

 

 

158,450

 

 

3,259

 

 

(1,327

)

 

160,382

 

 

160,382

 

 

 



 



 



 



 



 

 

 

$

315,143

 

$

3,270

 

 

($8,612

)

$

309,801

 

$

309,801

 

 

 



 



 



 



 



 

 

5.

Allowances for Loan Losses:

Changes in the allowance for loan losses were as follows:

 

 

 

Three months ended June 30,

 

 

 


 

(in thousands)

 

2006

 

2005

 


 


 


 

Balance at beginning period

 

$

10,550

 

$

12,495

 

Charge-offs

 

 

 

 

 

 

 

Single family residential

 

 

(50

)

 

(97

)

Non-residential

 

 

 

 

(2,162

)

Tax certificates

 

 

(1

)

 

 

Commercial and Industrial

 

 

 

 

 

Other loans

 

 

 

 

 

 

 



 



 

Total charge-offs

 

 

(51

)

 

(2,259

)

Recoveries

 

 

 

 

 

 

 

Single family residential

 

 

2

 

 

55

 

Non-residential

 

 

1

 

 

 

Tax certificates

 

 

 

 

 

Commercial and Industrial

 

 

1

 

 

3

 

Other loans

 

 

 

 

1

 

 

 



 



 

Total recoveries

 

 

4

 

 

59

 

Provision for loan losses

 

 

963

 

 

 

 

 



 



 

Balance at the end of period

 

$

11,466

 

$

10,295

 

 

 



 



 


 

 

Six months ended June 30,

 

 

 


 

 (in thousands)

 

2006

 

2005

 


 


 


 

Balance at beginning period

 

$

10,276

 

$

12,519

 

 

 

 

 

 

 

 

 

Charge-offs

 

 

 

 

 

 

 

Single family residential

 

 

(173

)

 

(127

)

Non-residential

 

 

(2

)

 

(2,162

)

Tax certificates

 

 

(1

)

 

(1

)

Commercial and Industrial

 

 

 

 

 

Other loans

 

 

 

 

(2

)

 

 



 



 

Total charge-offs

 

 

(176

)

 

(2,292

)

 

 

 

 

 

 

 

 

Recoveries

 

 

 

 

 

 

 

Single family residential

 

 

57

 

 

58

 

Non-residential

 

 

4

 

 

 

Tax certificates

 

 

 

 

 

Commercial and Industrial

 

 

1

 

 

7

 

Other loans

 

 

5

 

 

2

 

 

 



 



 

Total recoveries

 

 

67

 

 

67

 

 

 

 

 

 

 

 

 

Provision for loan losses

 

 

1,299

 

 

1

 

 

 



 



 

 

 

 

 

 

 

 

 

Balance at the end of period

 

$

11,466

 

$

10,295

 

 

 



 



 

6.

Pension Plan

The Company has a noncontributory nonqualified defined benefit pension plan (“Pension Plan”) covering certain eligible employees. The Company’s Pension Plan provides retirement benefits under pension trust agreements and under contracts with insurance companies. The benefits are based on years of service and the employee’s compensation during the highest three consecutive years during the last 10 years of employment. The Company’s policy is to fund pension costs allowable for income tax purposes.

Net periodic defined benefit pension expense for the three-months and six-months ended June 30, 2006 and 2005 included the following components:

 

 

 

Three months ended
June 30,

 

Six months ended
June 30,

 

 

 


 


 

(in thousands)

 

2006

 

2005

 

2006

 

2005

 


 


 


 


 


 

Service cost

 

$

93

 

$

206

 

$

187

 

$

412

 

Interest cost

 

 

85

 

 

65

 

 

170

 

 

130

 

 

 



 



 



 



 

Net periodic benefit cost

 

$

178

 

$

271

 

$

357

 

$

542

 

 

 



 



 



 



 

The total accumulated benefit obligation under the plan including adjustments is estimated to be $6.6 million at December 31, 2006.


7.

Stock-based Compensation

Prior to January 1, 2006, the Company accounted for stock-based compensation expense using the intrinsic value method as required by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and as permitted by SFAS No. 123, “Accounting for Stock-Based Compensation.” No compensation expense for stock options was reflected in net income for the three and six months ended June 30, 2005, as all options granted had an exercise price equal to the market price of the underlying common stock at the date of grant.

On January 1, 2006, the Company adopted SFAS No. 123(R) (revised version of SFAS No.123) which requires measurement of the compensation cost for stock-based awards based on the grant date fair value and the recognition of compensation cost over the service period of stock based awards. The fair value of stock options is determined using a Black-Scholes valuation model, which is consistent with the Company’s valuation methodology previously utilized for options in the footnote disclosures required under SFAS No.123. The Company has adopted SFAS No. 123(R) using the modified prospective method, which provides for no restatement of prior periods and no cumulative adjustment to equity accounts. It also provides for expense recognition, for both new and existing stock based awards.

The adoption of SFAS No. 123(R) had the following impact on reported amounts compared with what would have been reported using the intrinsic value under previous accounting.

 

 

 

Three Months Ended June 30, 2006

 

 

 


 

(In thousands, except for per share data)

 

Using Previous
Accounting

 

SFAS 123(R)
Adjustment

 

As
Reported

 


 


 


 


 

Income before income taxes

 

$

6,766

 

($178

)

$

6,588

 

Income taxes

 

$

2,064

 

($62

)

$

2,002

 

 

 



 


 



 

Net Income

 

$

4,702

 

($116

)

$

4,586

 

 

 



 


 



 

Basic earnings per share

 

$

0.37

 

($0.01

)

$

0.36

 

 

 



 


 



 

Diluted earnings per share

 

$

0.36

 

($0.00

)

$

0.36

 

 

 



 


 



 

 

 

 

Three Months Ended June 30, 2005

 

 

 


 

(In thousands, except for per share data)

 

As
Reported

 

SFAS 123(R)
Adjustment

 


Proforma

 


 


 


 


 

Income before income taxes

 

$

7,947

 

($271

)

$

7,676

 

Income taxes

 

$

705

 

($95

)

$

610

 

 

 



 


 



 

Net Income

 

$

7,242

 

($176

)

$

7,066

 

 

 



 


 



 

Basic earnings per share

 

$

0.57

 

($0.01

)

$

0.56

 

 

 



 


 



 

Diluted earnings per share

 

$

0.56

 

($0.01

)

$

0.55

 

 

 



 


 



 

 

 

 

Six Months Ended June 30, 2006

 

 

 


 

(In thousands, except for per share data)

 

Using Previous
Accounting

 

SFAS 123(R)
Adjustment

 

As
Reported

 


 


 


 


 

Income before income taxes

 

$

14,754

 

($357

)

$

14,397

 

Income taxes

 

$

4,590

 

($125

)

$

4,465

 

 

 



 


 



 

Net Income

 

$

10,164

 

($232

)

$

9,932

 

 

 



 


 



 

Basic earnings per share

 

$

0.79

 

($0.01

)

$

0.78

 

 

 



 


 



 

Diluted earnings per share

 

$

0.79

 

($0.02

)

$

0.77

 

 

 



 


 




 

 

 

 

Six Months Ended June 30, 2005

 

 

 


 

(In thousands, except for per share data)

 

As
Reported

 

SFAS 123(R)
Adjustment

 

Proforma

 


 


 


 


 

Income before income taxes

 

$

14,037

 

($542

)

$

13,495

 

Income taxes

 

$

2,474

 

($190

)

$

2,284

 

 

 



 


 



 

Net Income

 

$

11,563

 

($352

)

$

11,211

 

 

 



 


 



 

Basic earnings per share

 

$

0.90

 

($0.02

)

$

0.88

 

 

 



 


 



 

Diluted earnings per share

 

$

0.89

 

($0.02

)

$

0.87

 

 

 



 


 



 

Outside Directors’ Stock option Plan.

The Company has adopted a non-qualified Outside Directors’ Stock Option Plan (the “Director’s Plan”). Under the terms of the Director’s Plan, 250,000 shares of Class A stock are authorized for grants. Each director is entitled to a grant of an option to purchase 1,500 shares of stock annually, which are exercisable one year after the grant date. The options were granted at the fair market value at the date of the grant.

The following table presents the activity related to the Director’s Plan for the three months ended June 30, 2006.

 

 

 

Options

 

Weighted
Average
Exercise
Price

 

Weighted
Average
Remaining
Term (yrs)

 

 

 


 


 


 

Options outstanding at December 31, 2005

 

91,068

 

$

18.53

 

 

 

Granted

 

16,500

 

$

22.87

 

 

 

Exercised

 

 

 

 

 

 

 

Forfeited

 

 

 

 

 

 

 

 

 


 



 

 

 

Options outstanding at June 30, 2006

 

107,568

 

$

19.20

 

7.1

 

Options exercisable at June 30, 2006

 

91,068

 

$

18.53

 

6.2

 

Employee Stock Option Plan and Appreciation Right Plan

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


The following table presents the activity related to Employee Stock Option Plan for the three months ended June 30, 2006.

 

 

 

Options

 

Weighted
Average
Exercise
Price

 

Weighted
Average
Remaining
Term (yrs)

 

 


 


 


Options outstanding at December 31, 2005

 

737,170

 

$

19.61

 

 

Granted

 

150,000

 

$

22.87

 

 

Exercised

 

(3,866

)

$

14.84

 

 

Forfeited

 

(9,825

)

$

21.89

 

 

 

 


 



 

 

Options outstanding at June 30, 2006

 

873,479

 

$

20.17

 

7.7

Options exercisable at June 30, 2006

 

415,399

 

$

17.46

 

5.8

8.

Interest Rate Swaps

For asset/liability management purposes, the Company uses interest rate swap agreements to hedge various exposures or to modify interest rate characteristics of various balance sheet accounts. Such derivatives are used as part of the asset/liability management process and are linked to specific liabilities which have a high correlation between the contract and the underlying item being hedged, both at inception and throughout the hedge period.

The Company currently utilizes interest rate swap agreements to convert a portion of its fixed rate time deposits to a variable rate (fair value hedge) to fund variable rate loans. Interest rate swaps are contracts in which a series of interest flows are exchanged over a prescribed period. The notional amount ($55 million) on which interest payments are based is not exchanged. During the quarter ended September 30, 2005, the Company recorded expense in the amount of $676 thousand in other operating expenses which reflects the fair value of the interest rate swaps resulting from the Company not meeting the upfront documentation and the effectiveness assessment requirements of SFAS No. 133. As of October 1, 2005, December 31, 2005, and June 30, 2006, the Company has completed documentation determining the effectiveness of each hedge using the Volatility Reduction Measure (“VRM”). It was determined that these swaps are effective and are treated as fair value hedges.

At June 30, 2006 and December 31, 2005, the information pertaining to outstanding interest rate swap agreement used to hedge fixed rate loans and investments is as follows:

 

(in thousands)

 

June 30,
2006

 

Dec. 31,
2005

 


 


 


 

Notional Amount

 

$

55,000

 

$

60,000

 

Weighted average pay rate

 

 

5.08

%

 

4.40

%

Weighted average receive rate

 

 

3.92

%

 

3.87

%

Weighted average maturity (years)

 

 

4.4

 

 

4.5

 

Fair value relating to interest rate swaps

 

 

($1,962

)

 

($1,281

)

9.

Variable Interest Entities (“VIE”)

In July 2003, Royal Bank (through its wholly owned subsidiary Royal Investments America, LLC) received regulatory approval to acquire ownership interest in real estate projects. With the adoption of FIN 46(R) the Company is required to perform an analysis to determine whether such investments meet the criteria for consolidation into the Company’s financial statements.


In September 2005, the Company, together with a real estate development company, formed Royal Scully Associates, L.P. (“Royal Scully”). Royal Scully was formed to convert an apartment complex into condominiums in Blue Bell, Pennsylvania. [The development company is the general partner of Royal Scully.] The Company invested 66% of the initial capital contribution, or $2.5 million, with the development company holding the remaining equity interest. In addition, the Company holds two notes totaling $9.2 million with a competitive term and interest rate. Upon the repayment of the initial capital contributions and preferred return, distributions will convert to 50% for the Company and 50% for the development company. Royal Scully had total assets of $58.8 million and total borrowings of $54.9 million of which $9.2 million was lent by the Company and not included in the financial statements through eliminating entry. The net borrowings in the amount of $45.7 million are not guaranteed by the Company. The Company’s potential exposure to loss due to its investment is $11.2 million at June 30, 2006.

The Company, together with a real estate investment company, formed 212 C Associates, L.P. (“212 C”) in May 2002. 212 C was formed to acquire, hold, improve, and operate office space located in Lansdale, Pennsylvania. The investment company is the general partner of the project. The Company invested 90% of initial capital contributions with the investment company holding the remaining equity interest. Upon the repayment of the initial capital contributions and a preferred return, distributions converted to 50% for the Company and 50% for the investment company. On June 7, 2005, 212 C made a distribution to the Company of approximately $4.0 million which paid back the Company’s original investment and accrued preferred return. In addition, the Company recorded a profit of $1.8 million as result of this distribution during the second quarter of 2005. As a result of the transaction the Company no longer qualifies as the primary beneficiary and discontinued consolidating this VIE into the Company’s financial statement beginning with the second quarter of 2005.

The Company, together with a real estate development company, formed Brook View Investors, L.L.C. (“Brook View”) in May 2001. Brook View was formed to construct 13 apartment buildings with a total of 116 units in a gated apartment community. On October 19, 2005, the Company sold its ownership interest in Brook View which resulted in an after tax gain of approximately $3.3 million. As a result of the sale, the Company discontinued consolidating the financial statements of Brook View during the fourth quarter of 2005.

The Company, together with a real estate development company, formed Burrough’s Mill Apartment, L.L.C. (“Burrough’s Mill”) in December 2001. Burrough’s Mill was formed to construct 32 apartment buildings with a total of 308 units in a gated apartment community. On October 19, 2005, the Company sold its ownership interest in Burrough’s Mill which resulted in an after tax gain of approximately $7.6 million. As a result of the sale the Company discontinued consolidating the financial statements of Burrough’s Mill during the fourth quarter of 2005.

The Company, together with a real estate development company, formed Main Street West Associates, L.P. (“Main Street”) in February 2002. Main Street was formed to acquire, maintain, improve, and operate office space located in Norristown, Pennsylvania. On June 30, 2005, Main Street sold the property and paid back the Company’s original investment plus the accrued preferred return in full. As a result of the sale the Company discontinued consolidating the financial statements of Main Street during the second quarter of 2005.

As of June 30, 2006, Royal Scully met the requirements for consolidation under FIN 46(R) based on Royal Investments America being the primary financial beneficiary. This was determined based on the amount invested by Royal Investments America compared to our partners.

Trust Preferred Securities

Management has determined that The company Capital Trust I/II (“the Trusts”) qualify as VIE’s under FASB Interpretation 46 (FIN 46), “Consolidation of Variable Interest Entities,” as revised. The Trusts have previously issued mandatory redeemable trust preferred securities to investors and loaned the proceeds to the Company.


The Company adopted the provision under the revised interpretation, FIN 46(R), in the first quarter of 2004. Accordingly, The Company does not consolidate the Trust. FIN 46(R) precludes consideration of the call option embedded in the preferred securities when determining if the Company has the right to a majority of the Trusts’ expected residual returns. The deconsolidation resulted in the investment in the common stock of the Trusts to be included in other assets as of June 30, 2006 and the corresponding increase in outstanding debt of $774 thousand. In addition, income received on the Company’s stock investment is included in other income.

10.

Income Taxes.

Total income tax expense for the three months ended June 30, 2006 was $2.0 million, as compared to $705 thousand for the same period in 2005. The effective tax rate for the three months ended June 30, 2006, was 30.4% compared to the 8.9% for the same period in 2005. For the six months ended June 30, 2006, the income tax expense was $4.5 million with an effective tax rate of 31.0% as compared to $2.5 million with an effective tax rate of 17.6% for the same period in 2005. During the second quarter of 2005, the Company recorded an approximate $1.7 million decrease in tax expense resulting from the completion of an Internal Revenue Service audit with respect to a valuation allowance against the deferred tax asset derived from net operating loss carryovers.

11.

Commitments, Contingencies and Concentrations

The Company is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of risk in excess of the amount recognized in consolidated balance sheet.

A summary of the Company’s commitments is as follows:

 

(in thousands)

 

June 30,
2006

 

December 31,
2005


 


 


Open-end lines of credit

 

$

3,038

 

$

2,954

Loan commitments

 

 

145,288

 

 

173,461

Letters of credit

 

 

4,838

 

 

3,228

 

 



 



Total

 

$

153,164

 

$

179,643

 

 



 



12.

Recent accounting pronouncements

In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes-an interpretation of FASB No. 109” (FIN 48), which clarifies the accounting for uncertainty tax positions. This Interpretation requires that companies recognize in their financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. We are currently evaluating the impact of adopting FIN 48 on our financial statements.

In February 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 155, Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and 140 (FAS 155). FAS 155 permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest-only strips and principal-only strips are not subject to the requirements of Statement 133, establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and amends Statement 140 to eliminate the prohibition on a qualifying special purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. FAS 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The company does not expect the adoption of FAS 155 to have a material effect on the results of operations or the statement of condition.


In March 2006, the FASB issued Statement of Financial Accounting Standards No. 156 Accounting for Servicing of Financial Assets an amendment of FASB Statement No. 140 (FAS 140 and FAS 156). FAS 140 established, among other things, the accounting for all separately recognized servicing assets and servicing liabilities. This Statement amends FAS 140 to require that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. This Statement permits, but does not require, the subsequent measurement of separately recognized servicing assets and servicing liabilities at fair value. Under this Statement, an entity can elect subsequent fair value measurement to account for its separately recognized servicing assets and servicing liabilities. Adoption of this Statement is required as of the beginning of the first fiscal year that begins after September 15, 2006. Upon adoption, the company will apply the requirements for recognition and initial measurement of servicing assets and servicing liabilities prospectively to all transactions. The Company will adopt FAS 156 for the fiscal year beginning January 1, 2007 and currently has not determined if it will adopt FAS 156 using the fair value election.

In February 2006, the FASB issued FASB Staff Position No. FAS 123(R)-4, “Classification of Options and Similar Instruments Issued as Employee Compensation That Allow for Cash Settlement upon the Occurrence of a Contingent Event.” This position amends SFAS 123R to incorporate that a cash settlement feature that can be exercised only upon the occurrence of a contingent event that is outside the employee’s control does not meet certain conditions in SFAS 123R until it becomes probable that the event will occur. The guidance in this FASB Staff Position are incorporated. .

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

The following discussion and analysis is intended to assist in understanding and evaluating the changes in the financial condition and earnings performance of the Company and its subsidiaries for the three-month and six-month periods ended June 30, 2006 and June 30, 2005. 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, 2005 included in the Company’s 2005 Form 10-K.

FORWARD-LOOKING STATEMENTS

From time to time, the Company may include forward-looking statements relating to such matters as anticipated financial performance, business prospects, credit quality, credit risk, reserve adequacy, liquidity, new products, and similar matter in this and other filings with the Securities and Exchange Commission. These forward-looking statements may involve known and unknown risks, uncertainties and other factors which may cause actual results, performance or achievements of the Company to material different from the future results, performance or achievement expressed or implied by such forward-looking statements. When the Company uses words such as “expect,” “believe,” “anticipate,” “should,” “estimate,” or similar expressions, the Company is making a forward-looking statement. The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for such forward-looking statements. In order to comply with the terms of the “safe harbor,” the Company provides the following cautionary statement which identifies certain factors that could cause the Company’s actual results and experience to differ materially from the anticipated results or other expectations expressed in the forward-looking statements.


Certain risks and uncertainties could affect the future financial results of the Company including the following:

 

The effect of general economic conditions, including their impact on capital expenditures, credit risk, consumer confidence and savings rates.

 

Changes in interest rates and their impact on the level of deposits, loan demand and the value of loan collateral.

 

Business conditions in the banking industry.

 

The bank regulatory environment.

 

The accuracy of management’s assumptions.

 

The ability of the Company to adapt to rapidly changing technology and evolving banking industry standards.

 

Competitive factors, including increased competition with community, regional and national financial institutions.

 

The risk that anticipated demand for the Company’s new service and product offerings will not occur.

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

CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES

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

Note A to the Company’s consolidated financial statements (included in Item 8 of the Form 10-K for the year ended December 31, 2005) lists significant accounting policies used in the development and presentation of the Company’s financial statements. The following discussion and analysis, the significant accounting policies, and other financial statement disclosures identify and address key variables and other quantitative and qualitative factors that are necessary for an understanding and evaluation of the Company and its results of operations. The Company has identified accounting for allowance for loan losses, deferred tax assets and derivative securities as among the most critical accounting policies and estimates in that they are important to the presentation of the Company’s financial condition and results of operations, and they require difficult, subjective or complex judgments as a result of the need to make estimates.

RESULTS OF OPERATIONS

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


Consolidated Net Income

Consolidated net income (less non-recurring items) for the three months ended June 30, 2006 was $4.6 million or $0.36 basic earnings per share, compared to $4.1 million or $0.32 basic earnings per share for the same period in 2005. Net income (less non-recurring items) for the six months ended June 30, 2006 was $9.4 million or $0.74 basic earnings per share, compared to $8.5 million or $0.66 basic earnings per share. For the second quarter of 2005, non-recurring items include: a $1.3 million exit fee collected on a mezzanine loan, a $1.8 million equity distribution from a variable interest entity, and a $1.7 reduction in tax expense resulting from a deferred tax valuation offset by a $930 thousand expense related to the Company’s pension plan. During the first quarter of 2006, the Company recorded a $900 thousand gain from the sale of real estate held as other real estate owned.

Consolidated net income (including non-recurring items) for the three months ended June 30, 2006 was $4.6 million or $0.36 basis earnings per share, compared to $7.2 million or $0.57 basic earnings per share for the same period in 2005. Consolidated net income (including non-recurring items) for the six months ended June 30, 2006 was $9.9 million or $0.78 basic earnings per share, compared to $11.6 million or $0.90 basic earnings per share.

Management uses the non-GAAP measure of net income from core operations or operating earnings from its analysis of the Company’s performance. This measure, as used by the Company, adjust net income determined in accordance with GAAP to exclude the effects of certain non-recurring, special items including significant gains or losses that are unusual in nature. Because certain these items and their impact on the Company are difficult to predict, management believes that presentation of financial measures excluding the impact of such items provides useful supplemental information in evaluating operating results of the Company’s core businesses. These disclosures should not be viewed as a substitute for net income determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies.

(The remainder of this page was intentionally left blank)


The following table reconciles our GAAP earnings to operating earnings for the periods presented:

 

 

 

For the Three Months Ended
June 30th

 

For the Six Months Ended
June 30th

 

 

 


 


 

(amounts in thousands, except for per share data)

 

2006

 

2005

 

2006

 

2005

 


 


 


 


 


 

GAAP Net Income

 

$

4,586

 

$

7,242

 

$

9,932

 

$

11,563

 

Changes

 

 

 

 

 

 

 

 

 

 

 

 

 

Loan exit fee

 

 

 

 

(1,293

)

 

 

 

(1,293

)

Gains from variable interest entities

 

 

 

 

(1,792

)

 

 

 

(1,792

)

Pension plan expense

 

 

 

 

930

 

 

 

 

930

 

Gains on other real estate owned

 

 

 

 

 

 

(881

)

 

 

 

 



 



 



 



 

Total Changes

 

 

 

 

(2,155

)

 

(881

)

 

(2,155

)

Tax effect

 

 

 

 

754

 

 

308

 

 

754

 

Reduction in tax expense

 

 

 

 

(1,700

)

 

 

 

(1,700

)

 

 



 



 



 



 

Net impact of changes

 

 

 

 

(3,101

)

 

(573

)

 

(3,101

)

 

 



 



 



 



 

Net income adjusted

 

$

4,586

 

$

4,141

 

$

9,359

 

$

8,462

 

 

 



 



 



 



 

Basic earnings per share