form10q.htm


 UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, DC  20549

FORM 10-Q
 (Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

for the quarterly period ended:          June 30, 2011          

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from:  to
Commission file number: 0-26366

ROYAL BANCSHARES OF PENNSYLVANIA, INC.
(Exact name of the registrant as specified in its charter)
 
 PENNSYLVANIA    23-2812193
(State or other jurisdiction of incorporation or organization)    (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 x    No o

Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding twelve months (or for such shorter period that the registrant was required to submit and post such files).  Yes x    No o
 
Indicate by check mark 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 12-b-2 of the Exchange Act.
 
  Large accelerated filer o   Accelerated filer o
  Non-accelerated filer   o (do not check if a smaller reporting company)   Smaller reporting company x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o    No. x

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, 2011
$2.00 par value       11,361,580
     
Class B Common Stock      Outstanding at July 31, 2011
 $0.10 par value      2,081,371 
 


 
-1-

 
 
PART I – FINANCIAL STATEMENTS
Item 1.     Financial Statements

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(unaudited)
 
   
June 30,
   
December 31,
 
   
2011
   
2010
 
ASSETS
 
(In thousands, except share data)
 
Cash and due from banks
  $ 14,064     $ 26,811  
Interest bearing deposits
    40,742       24,922  
Total cash and cash equivalents
    54,806       51,733  
                 
Investment securities available-for-sale ("AFS”)
    318,689       317,155  
Federal Home Loan Bank ("FHLB") stock
    9,390       10,405  
                 
Loans and leases held for sale
    24,359       29,621  
                 
Loans and leases
    437,983       496,854  
Less allowance for loan and lease losses
    19,614       21,129  
Net loans and leases
    418,369       475,725  
Bank owned life insurance
    8,827       8,642  
Real estate owned via equity investment
    3,381       6,794  
Accrued interest receivable
    16,277       16,864  
Other real estate owned ("OREO"), net
    25,448       29,244  
Premises and equipment, net
    5,572       5,735  
Other assets
    24,566       28,708  
Total assets
  $ 909,684     $ 980,626  
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
Liabilities
               
Deposits
               
Non-interest bearing
  $ 53,800     $ 52,872  
Interest bearing
    575,161       641,041  
Total deposits
    628,961       693,913  
Short-term borrowings
    22,000       22,000  
Long-term borrowings
    129,503       132,949  
Subordinated debentures
    25,774       25,774  
Accrued interest payable
    5,488       3,983  
Other liabilities
    18,814       17,914  
Total liabilities
    830,540       896,533  
Shareholders’ equity
               
Royal Bancshares of Pennsylvania, Inc. equity:
               
Preferred stock, Series A perpetual, $1,000 liquidation value, 500,000 shares authorized,
               
30,407 shares issued and outstanding at June 30, 2011 and December 31, 2010
    28,633       28,395  
Class A common stock, par value $2.00 per share, authorized 18,000,000 shares; issued,
               
11,361,580 and 11,355,466 at June 30, 2011 and December 31, 2010, respectively
    22,723       22,711  
Class B common stock, par value $0.10 per share; authorized 3,000,000 shares; issued,
               
2,081,371 and 2,086,689 at June 30, 2011 and December 31, 2010, respectively
    208       209  
Additional paid in capital
    126,198       126,152  
Accumulated deficit
    (97,731 )     (91,746 )
Accumulated other comprehensive income
    1,975       1,942  
Treasury stock - at cost, shares of Class A, 498,488 at June 30, 2011 and December 31, 2010
    (6,971 )     (6,971 )
Total Royal Bancshares of Pennsylavania, Inc. shareholders’ equity
    75,035       80,692  
Noncontrolling interest
    4,109       3,401  
Total equity
    79,144       84,093  
Total liabilities and shareholders’ equity
  $ 909,684     $ 980,626  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
-2-

 

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Consolidated Statements of Operations - (unaudited)
 
 
 
For the three months
   
For the six months
 
   
ended June 30,
   
ended June 30,
 
(In thousands, except per share data)
 
2011
   
2010
   
2011
   
2010
 
Interest income
                       
Loans and leases, including fees
  $ 7,347     $ 11,331     $ 15,441     $ 22,450  
Investment securities available-for-sale
    2,623       3,804       5,082       8,273  
Deposits in banks
    28       38       49       73  
Federal funds sold
    2       -       2       -  
Total Interest Income
    10,000       15,173       20,574       30,796  
Interest expense
                               
Deposits
    2,549       4,472       5,274       9,479  
Short-term borrowings
    40       1,056       84       2,336  
Long-term borrowings
    1,251       1,306       2,501       2,608  
Obligations related to real estate owned via equity investments
    -       5       -       19  
Total Interest Expense
    3,840       6,839       7,859       14,442  
Net Interest Income
    6,160       8,334       12,715       16,354  
Provision for loan and lease losses
    3,056       4,290       5,140       6,193  
Net Interest Income after Provision for Loan and Lease Losses
    3,104       4,044       7,575       10,161  
                                 
Other income
                               
Service charges and fees
    252       285       509       576  
Income from bank owned life insurance
    91       93       186       188  
Income related to real estate owned via equity investments
    495       583       545       780  
Gains on sales of loans and leases
    6       124       18       628  
Income from real estate joint ventures
    -       -       250       -  
Net gains on sales of other real estate owned
    900       174       1,294       331  
Net gains on the sale of AFS investment securities
    1,093       422       1,101       588  
Other income
    331       202       629       273  
Total other-than-temporary impairment losses on investment securities
    (502 )     (165 )     (502 )     (341 )
Portion of loss recognized in other comprehensive loss
    121       -       121       -  
Net impairment losses recognized in earnings
    (381 )     (165 )     (381 )     (341 )
Total Other Income
    2,787       1,718       4,151       3,023  
Other expenses
                               
Employee salaries and benefits
    2,707       2,793       5,361       5,754  
OREO impairment
    2,747       960       3,140       1,762  
Professional and legal fees
    1,276       1,130       2,347       1,933  
Occupancy and equipment
    572       788       1,177       1,587  
OREO and loan collection expenses
    535       670       1,177       1,358  
FDIC and state assessments
    561       765       1,086       1,629  
Pennsylvania shares tax
    312       370       624       739  
Impairment on loans held for sale
    304       -       304       -  
Directors' fees
    92       98       168       179  
Expenses related to real estate owned via equity investments
    53       140       101       265  
Stock option expense (benefit)
    23       50       46       (22 )
Impairment of real estate joint ventures
    -       1,552       -       1,552  
Other operating expenses
    603       725       1,223       1,358  
Total Other Expenses
    9,785       10,041       16,754       18,094  
Loss Before Taxes
    (3,894 )     (4,279 )     (5,028 )     (4,910 )
Income taxes
    -       -       -       -  
Net Loss
  $ (3,894 )   $ (4,279 )   $ (5,028 )   $ (4,910 )
Less net income attributable to noncontrolling interest
  $ 331     $ 259     $ 708     $ 701  
Net loss attributable to Royal Bancshares of Pennsylvania, Inc.
  $ (4,225 )   $ (4,538 )   $ (5,736 )   $ (5,611 )
Less Preferred stock Series A accumulated dividend and accretion
  $ 499     $ 491     $ 997     $ 981  
Net loss available to common shareholders
  $ (4,724 )   $ (5,029 )   $ (6,733 )   $ (6,592 )
Per common share data
                               
Net loss – basic and diluted
  $ (0.36 )   $ (0.38 )   $ (0.51 )   $ (0.50 )
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
-3-

 
 
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Consolidated Statement of Changes in Shareholders' Equity and Comprehensive Loss
Six months ended June 30, 2011
(unaudited)
 
   
Preferred stock
   
Class A common stock
   
Class B common stock
   
Additional paid in
   
Accumulated
   
Accumulated other comprehensive
   
Treasury
   
Noncontrolling
   
Total Shareholders'
 
(In thousands, except share data)
 
Series A
   
Shares
   
Amount
   
Shares
   
Amount
   
capital
   
deficit
   
income
   
stock
   
Interest
   
Equity
 
Balance January 1, 2011
  $ 28,395       11,355     $ 22,711       2,087     $ 209     $ 126,152     $ (91,746 )   $ 1,942     $ (6,971 )   $ 3,401     $ 84,093  
Comprehensive loss
                                                                                       
Net loss
                                                    (5,736 )                     708       (5,028 )
Other comprehensive income, net of reclassifications and taxes
                                                            33                       33  
Total comprehensive loss
                                                                                  $ (4,995 )
Common stock conversion from Class B to Class A
            6       12       (5 )     (1 )             (11 )                             -  
Accretion of discount on preferred stock
    238                                               (238 )                             -  
Stock option expense
                                            46                                       46  
Balance June 30, 2011
  $ 28,633       11,361     $ 22,723       2,082     $ 208     $ 126,198     $ (97,731 )   $ 1,975     $ (6,971 )   $ 4,109     $ 79,144  
 
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Consolidated Statement of Changes in Shareholders' Equity and Comprehensive Loss
Six months ended June 30, 2010
(unaudited)
 
   
Preferred stock
   
Class A common stock
   
Class B common stock
   
Additional paid in
   
Accumulated
   
Accumulated other comprehensive
   
Treasury
   
Noncontrolling
   
Total Shareholders'
 
(In thousands, except share data)
 
Series A
   
Shares
   
Amount
   
Shares
   
Amount
   
capital
   
deficit
   
income
   
stock
   
Interest
   
Equity
 
Balance January 1, 2010
  $ 27,945       11,352     $ 22,705       2,089     $ 209     $ 126,117     $ (67,197 )   $ (1,652 )   $ (6,971 )   $ 3,158     $ 104,314  
Comprehensive loss
                                                                                       
Net loss
                                                    (5,611 )                     701       (4,910 )
Other comprehensive income, net of reclassification and taxes
                                                            4,623                       4,623  
Total comprehensive loss
                                                                                  $ (287 )
Accretion of discount on preferred stock
    222                                               (222 )                             -  
Common stock conversion from Class B to Class A
            3       6       (2 )     -               (6 )                             -  
Stock option benefit
                                            (22 )                                     (22 )
Balance June 30, 2010
  $ 28,167       11,355     $ 22,711       2,087     $ 209     $ 126,095     $ (73,036 )   $ 2,971     $ (6,971 )   $ 3,859     $ 104,005  

The accompanying notes are an integral part of these consolidated financial statements.
 
 
-4-

 
 
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (unaudited)
Six months ended June 30,
 
(In thousands)
 
2011
   
2010
 
Cash flows from operating activities:
           
Net loss
  $ (5,736 )   $ (5,611 )
Adjustments to reconcile net loss to net cash provided by operating activities:
               
Depreciation and amortization
    238       347  
Stock compensation expense (benefit)
    46       (22 )
Provision for loan and lease losses
    5,140       6,193  
Impairment charge for other real estate owned
    3,140       1,762  
Net amortization of investment securities
    1,354       1,257  
Net accretion on loans
    (151 )     (285 )
Net gains on sales of other real estate
    (1,294 )     (331 )
Proceeds from sales of loans and leases
    168       4,145  
Gains on sales of loans and leases
    (18 )     (628 )
Net gains on sales of investment securities
    (1,101 )     (596 )
Distribution from investments in real estate
    (100 )     (110 )
Gain from sale of premises of real estate owned via equity investment
    (445 )     (328 )
Income from real estate joint ventures
    (250 )     -  
Income from bank owned life insurance
    (186 )     (188 )
Impairment of loans held for sale
    304       -  
Impairment of real estate joint ventures
    -       1,552  
Impairment of available-for-sale investment securities
    381       341  
Changes in assets and liabilities:
               
Decrease (increase) in accrued interest receivable
    587       (1,043 )
Decrease in other assets
    8,337       17,266  
Increase in accrued interest payable
    1,505       2,189  
Increase in other liabilities
    1,599       1,048  
Net cash provided by operating activities
    13,518       26,958  
Cash flows from investing activities:
               
Proceeds from call/maturities of available-for-sale ("AFS") investment securities
    29,571       58,231  
Proceeds from sales of AFS investment securities
    70,477       113,318  
Purchase of AFS investment securities
    (102,369 )     (66,113 )
Redemption of Federal Home Loan Bank stock
    1,015       -  
Net decrease in loans
    52,875       27,262  
Purchase of premises and equipment
    (75 )     (81 )
Net proceeds from sale of premises of real estate owned via equity investments
    6,090       3,498  
Distribution from investments in real estate
    100       110  
Net decrease in real estate owned via equity investments
    (5,645 )     (3,170 )
Proceeds from sales of foreclosed real estate
    5,914       7,709  
Net cash provided by investing activities
    57,953       140,764  
Cash flows from financing activities:
               
Increase (decrease) in demand and NOW accounts
    3,245       (2,809 )
Decrease in money market and savings accounts
    (2,230 )     (6,674 )
Decrease in certificates of deposit
    (65,967 )     (80,445 )
Repayments in short-term borrowings
    -       (15,000 )
Repayments of long-term borrowings
    (3,446 )     (3,336 )
Repayment of mortgage debt of real estate owned via equity investments
    -       (2,925 )
Net cash used in financing activities
    (68,398 )     (111,189 )
Net increase in cash and cash equivalents
    3,073       56,533  
Cash and cash equivalents at the beginning of the period
    51,733       58,298  
Cash and cash equivalents at the end of the period
  $ 54,806     $ 114,831  
Supplemental Disclosure
               
Interest paid
  $ 6,354     $ 12,253  
Transfers to other real estate owned
  $ 4,499     $ 9,618  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
-5-

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

Note 1.              Summary of Significant Accounting Policies
 
Basis of Financial Presentation
 
The accompanying unaudited consolidated financial statements include the accounts of Royal Bancshares of Pennsylvania, Inc. (“Royal Bancshares” or the “Company”) 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 America (“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 its three 60% ownership interests in Crusader Servicing Corporation, Royal Tax Lien Services, LLC, and Royal Bank America Leasing, LP.  During the fourth quarter of 2010, the Company’s wholly-owned subsidiary, Royal Captive Insurance, was dissolved. On December 30, 2010, the Company completed the sale of all of the outstanding common stock of Royal Asian Bank (“Royal Asian”), a wholly-owned subsidiary, to an investor group.  Royal Asian recorded net income of $139,000 and a net loss of $856,000 for the three months and six months ended June 30, 2010, 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.
 
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 the Company’s 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, 2010.  The results of operations for the three and six month periods ended June 30, 2011 are not necessarily indicative of the results to be expected for the full year.
 
Accounting Policies Recently Adopted and Pending Accounting Pronouncements
 
In January 2010, the FASB issued Accounting Standard Update (“ASU”) No. 2010-06, “Improving Disclosures about Fair Value Measurements” (“ASU 2010-06”), which updates ASC Topic 820 “Fair Value Measurements and Disclosures”.  ASU 2010-06 is intended to provide a greater level of disaggregated information and more robust disclosures about valuation techniques and inputs to fair value measurements. A reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers. Additionally, a reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. Those disclosures are required for fair value measurements that fall in either Level 2 or Level 3. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009.  The disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements were effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of ASU 2010-06 did not have a significant impact on the Company’s consolidated financial statements.
 
 
-6-

 
 
In July 2010, the FASB issued ASU No. 2010-20, “Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses” (“ASU 2010-20”), which is intended to help investors assess the credit risk of a company’s receivables portfolio and the adequacy of its allowance for credit losses held against the portfolios by expanding credit risk disclosures.  (“ASU 2010-20”) requires more information about the credit quality of financing receivables in the disclosures to financial statements, such as aging information and credit quality indicators.  Both new and existing disclosures must be disaggregated by portfolio segment or class.  The disaggregation of information is based on how a company develops its allowance for credit losses and how it manages its credit exposure. The disclosure requirements as of December 31, 2010 are included in “Note 4 - Loans and Leases” and “Note 5 – Allowance for Loan and Lease Losses” to the Consolidated Financial Statements.  Disclosures about activity that occurs during a reporting period was effective in the interim reporting period ending March 31, 2011.
 
In April 2011, the FASB issued ASU 2011-02, “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring” (“ASU 2011-02”) which is intended to amend guidance related to troubled debt restructurings (“TDRs”).  ASU 2011-02 provides additional guidance to assist creditors in concluding whether the restructuring has granted a concession to the borrower and that the borrower is experiencing financial difficulties.  ASU 2011-02 is effective for public entities for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. The adoption of ASU 2011-02 is not expected to have a significant impact on the Company’s consolidated financial statements.
 
In May 2011, the FASB issued ASU 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” (“ASU 2011-04”) which generally clarifies guidance in ASC Topic 820 “Fair Value Measurements and Disclosures”.  The amendments in ASU 2011-004 explain how to measure fair value and change the wording used to describe the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements.  ASU 2011-04 does not require additional fair value measurements and is not intended to establish valuation standards or affect valuation practices outside of financial reporting.  For public entities, ASU 2011-04 is effective for the first interim or annual period beginning after December 15, 2011.  The adoption of ASU 2011-04 is not expected to have a significant impact on the Company’s consolidated financial statements.
 
In June 2011, the FASB issued ASU 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”) which amends ASC Topic 220 “Comprehensive Income”.  To increase the prominence of items reported in other comprehensive income and to facilitate convergence of U.S. GAAP and International Financial Reporting Standards (“IFRS”), the FASB decided to eliminate the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity, among other amendments in ASU 2011-05.  The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income.  For public entities, ASU 2011-05 is effective for the first interim or annual period beginning after December 15, 2011.  The adoption of ASU 2011-05 is not expected to have a significant impact on the Company’s consolidated financial statements.

Note 2.              Regulatory Matters and Significant Risks or Uncertainties
 
FDIC Orders
 
On July 15, 2009, Royal Bank agreed to enter into a Stipulation and Consent to the Issuance of an Order to Cease and Desist (the “Orders”) with each of the Federal Deposit Insurance Corporation (“FDIC”) and the Commonwealth of Pennsylvania Department of Banking (“Department”). The material terms of the Orders are identical and require Royal Bank to: (i) have and retain qualified management, and notify the FDIC and the Department of any changes in Royal Bank’s board of directors or senior management; (ii) increase participation of Royal Bank’s board of directors in Royal Bank’s affairs by having the board assume full responsibility for approving Royal Bank’s policies and objectives and for supervising Royal Bank’s management; (iii) eliminate all assets classified as “Loss” and formulate a written plan to reduce assets classified as “Doubtful” and “Substandard” at its regulatory examination; (iv) develop a written plan to reduce delinquent loans, and restrict additional advances to borrowers with existing credits classified as “Loss,” “Doubtful” or “Substandard”; (v) develop a written plan to reduce Royal Bank’s commercial real estate loan concentration; (vi) maintain, after establishing an adequate allowance for loan and lease losses, a ratio of Tier 1 capital to total assets (“leverage ratio”) equal to or greater than 8% and a ratio of qualifying total capital to risk-weighted assets (total risk-based capital ratio) equal to or greater than 12%; (vii) formulate and implement written profit plans and comprehensive budgets for each year during which the Orders are in effect; (viii) formulate and implement a strategic plan covering at least three years, to be reviewed quarterly and revised annually; (ix) revise the liquidity and funds management policy and update and review the policy annually; (x) refrain from increasing the amount of brokered deposits held by Royal Bank and develop a plan to reduce the reliance on non-core deposits and wholesale funding sources; (xi) refrain from paying cash dividends without prior approval of the FDIC and the Department; (xii) refrain from making payments to or entering contracts with Royal Bank’s Holding Company or other Royal Bank affiliates without prior approval of the FDIC and the Department; (xiii) submit to the FDIC for review and approval an executive compensation plan that incorporates qualitative as well as profitability performance standards for Royal Bank’s executive officers; (xiv) establish a compliance committee of the board of directors of Royal Bank with the responsibility to ensure Royal Bank’s compliance with the Orders; and (xv) prepare and submit quarterly reports to the FDIC and the Department detailing the actions taken to secure compliance with the Orders.  The Orders will remain in effect until modified or terminated by the FDIC and the Department.
 
 
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The Orders do not materially restrict Royal Bank from transacting its normal banking business. Royal Bank continues to serve its customers in all areas including making loans, establishing lines of credit, accepting deposits and processing banking transactions. Customer deposits remain fully insured to the highest limits set by the FDIC. The FDIC and the Department did not impose or recommend any monetary penalties in connection with the Orders.
 
Royal Bank created a Regulatory Compliance Committee comprised of outside directors and management in the third quarter of 2009.  The purpose of the Committee is to monitor compliance with the Orders.  Royal Bank has submitted an internal assessment of senior management’s qualifications report to the FDIC and the Department.  Additionally Royal Bank has submitted plans for reducing classified assets, reducing delinquencies, reducing commercial real estate concentrations, liquidity and funds management, and reducing non-core deposits and whole-sale funding sources, and a compensation plan.  All plans submitted prior to 2011 have been approved by the FDIC and the Department where required.   Royal Bank has submitted on a timely basis all required plans for 2011 to the FDIC and the Department for their review.
 
Royal Bank has submitted all required quarterly reports to the FDIC and the Department detailing the actions taken to maintain compliance with the Orders as of the date of this Report.
 
Federal Reserve Agreement
 
On March 17, 2010, the Company agreed to enter into a Written Agreement (the “Federal Reserve Agreement”) with the Federal Reserve Bank of Philadelphia (the “Reserve Bank”). The material terms of the Federal Reserve Agreement provide that: (i) the Company’s board of directors will take appropriate steps to fully utilize the Company’s financial and managerial resources to serve as a source of strength to its subsidiary banks, including taking steps to ensure that Royal Bank complies with the Orders previously entered into with the FDIC and the Department on July 15, 2009; (ii) the Company’s board of directors will, within 60 days of the Federal Reserve Agreement, submit to the Reserve Bank a written plan to strengthen board oversight of the management and operations of the consolidated operation; (iii) the Company will not declare or pay any dividends without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System; (iv) the Company and its non-bank subsidiaries will not make any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without the prior approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System; (v) the Company and its nonbank subsidiaries will not, directly or indirectly, incur, increase, or guarantee any debt without the prior written approval of the Reserve Bank; (vi) the Company will not, directly or indirectly, purchase or redeem any shares of its stock without the prior written approval of the Reserve Bank; (vii) the Company will, within 60 days of the Federal Reserve Agreement, submit to the Reserve Bank an acceptable written capital plan to maintain sufficient capital at the Company on a consolidated basis, which plan will at a minimum address: regulatory requirements for the Company and the Banks, the adequacy of the Banks’ capital taking into account the volume of classified credits, the allowance for loan and lease losses, current and projected asset growth, and projected retained earnings; the source and timing of additional funds necessary to fulfill the consolidated organization’s and the Banks’ future capital requirements; supervisory requests for additional capital at the Banks or the requirements of any supervisory action imposed on the Banks by federal or state regulators; and applicable legal requirements that the Company serve as a source of strength to the Banks; (viii) the Company will, within 60 days of the Federal Reserve Agreement, submit to the Reserve Bank cash flow projections for 2010 showing planned sources and uses of cash for debt service, operating expenses, and other purposes, and will submit similar cash flow projections for each subsequent calendar year at least one month prior to the beginning of such year; (ix) the Company will comply with applicable legal  notice provisions in advance of appointing any new director or senior executive officer or changing the responsibilities of any senior executive officer such that the officer would assume a different senior executive officer position, and comply with restrictions on indemnification and severance payments imposed by the Federal Deposit Insurance Act; and (x) the Company’s board of directors will, within 30 days after the end of each quarter, submit progress reports to the Reserve Bank detailing the form and manner of all actions taken to secure compliance with the Agreement and the results thereof, together with a parent company-level balance sheet, income statement, and, as applicable, report of changes in shareholders’ equity.
 
 
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The Federal Reserve Agreement will remain in effect and enforceable until stayed, modified, terminated or suspended by the Reserve Bank. Royal Bancshares has submitted all progress reports and responses required under the Federal Reserve Agreement as of the date of this Report. In April 2011, with respect to the capital plan submissions by the Company to the Reserve Bank, the Reserve Bank advised the Company that it will not approve a capital plan until such time as the Company is able to successfully raise additional capital and/or substantially reduce its risk profile, or is able to offer credible assurances that the Company will be able to raise capital or reduce its risk profile.
 
Our success as a Company is dependent upon pursuing various alternatives in not only achieving the growth and expansion of our banking franchise but also in managing our day to day operations. The existence of the Orders and the Federal Reserve Agreement may limit or impact our ability to pursue all previously available alternatives in the management of the Company. Our ability to retain existing retail and commercial customers as well as the ability to attract potentially new customers may be impacted by the existence of the Orders and the Federal Reserve Agreement. The Company has been successful in commercial real estate lending; however, our ability to expand into construction loans at this time is limited. The Company’s ability to raise capital in the current economic environment could be potentially limited or impacted as a result of the Orders and the Federal Reserve Agreement. Attracting new management talent is critical to the success of our business and could be potentially impacted due to the existence of the Orders and the Federal Reserve Agreement. At June 30, 2011, each of the Company and Royal Bank met all capital regulatory requirements to which it is subject.
 
Continued Losses
 
Over the past 14 quarters, the Company has recorded significant losses totaling $101.1 million ($5.7 million for the six months ended June 30, 2011, and $24.1 million, $33.2 million and $38.1 million for the years ended December 31, 2010, 2009 and 2008, respectively) which were primarily related to charge-offs on the loan and lease portfolio, impairment charges on investment securities, and the establishment of a deferred tax valuation allowance.  The year-over-year decrease in losses was mainly related to the reduction in other-than-temporary impairment (“OTTI”) on investment securities.   As a result of these losses, the Company has negative retained earnings of $97.7 million at June 30, 2011.  Also contributing to the negative retained earnings were the cash and stock dividends declared and paid in previous years.  In addition to reducing the total shareholders’ equity, the continued losses,  negative retained earnings, and required regulatory approval impact the Company’s ability to pay cash dividends to its shareholders now and in future years.
 
The deterioration of the real estate market over the past few years has significantly impacted the Company’s loan portfolio which has a high concentration of real estate secured loans.   Net loan charge-offs were $6.5 million and $6.7 million for the three and six months ended June 30, 2011, respectively, and $30.4 million, $19.2 million, and $12.2 million for the years ended 2010, 2009, and 2008, respectively.  The provision for loan and lease losses was $3.1 million and $5.1 million for the three and six months ended June 30, 2011, respectively, compared to $4.3 million and $6.2 million for the three and six months ended June 30, 2010, respectively.  The 2011 provision is directly related to $5.1 million in additional specific reserves that were charged-off during the second quarter of 2011. The level of charge-offs was the primary reason for the significant provision for loan and lease losses of $22.1 million, $20.6 million, and $21.8 million that were recorded in 2010, 2009, and 2008, respectively.  Non-performing loans held for investment (“LHFI”) totaled $45.3 million at June 30, 2011 compared to $43.2 million at December 31, 2010, $73.7 million at December 31, 2009 and $85.8 million at December 31, 2008.  Total non-performing loans at June 30, 2011 and December 31, 2010 were $62.7 million and $65.8 million, respectively, and include $17.4 million and $22.6 million in loans held for sale (“LHFS”), respectively.
 
 
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For the three months and six months ended June 30, 2011, the Company recorded OTTI of $381,000 on the investment portfolio compared to $165,000 and $341,000 for the comparable 2010 periods, respectively.  OTTI charges totaled $479,000, $11.0 million, and $23.4 million in 2010, 2009, and 2008, respectively.   As evidenced by the significant reduction in impairment charges, the Company has reduced the credit risk within its investment portfolio.  This was accomplished by taking advantage of opportunities to sell investments that had potential credit risk for minimal losses as well as instituting new policy guidelines regarding types of investments, as well as limits on the amount of each type of investment.
 
The establishment of a deferred tax valuation allowance resulted in a $15.5 million non-cash charge to the consolidated statement of operations in 2008.  This was a result of management’s conclusion that it was more likely than not that the Company would not generate sufficient future taxable income to realize all of the deferred tax assets. Subsequent additions to the allowance have resulted in a deferred tax valuation allowance of $33.5 million at June 30, 2011.
 
In addition to the losses mentioned above, the Company has experienced an increase in other operating expenses related to credit quality which includes OREO impairment charges, OREO and loan collection expenses, and legal expenses.  Impairment charges related to real estate owned via equity investments totaled $2.6 million, $0, and $1.5 million in 2010, 2009, and 2008 respectively.  There was no further impairment on real estate owned via equity investments in the first six months of 2011. Also included in other operating expenses are FDIC and state assessments which totaled $3.0 million, $3.8 million, and $658,000 in 2010, 2009, and 2008, respectively.  As a result of the reduction of deposits in 2010, largely related to the decline in brokered deposits, the FDIC assessment decreased in 2010. The FDIC assessment for the first six months of 2011 amounted to $1.0 million, which results in a decline year over year on an annualized basis.
 
Credit Quality
 
The Company’s success significantly depends on the growth in population, income levels, loans and deposits and on the continued stability in real estate values in our markets.  If the communities in which we operate do not grow or if prevailing economic conditions locally or nationally are unfavorable, our business may be adversely affected.  Adverse economic conditions in our specific market areas, specifically decreases in real estate property values due to the nature of our loan portfolio could reduce our growth rate, affect the ability of customers to repay their loans and generally affect our financial condition and results of operations.  Many industries have been impacted by the effects of the economic conditions over the past three years, with financial services, housing, and commercial real estate being hit particularly hard.  The Company’s loan and investment portfolios were directly affected.  The Company’s commercial real estate loans, including construction and land development loans, have seen a decline in the collateral values, and a reduction in the borrowers’ ability to meet the payment terms of their loans due to reduced cash flow.  Further declines in collateral values and borrowers’ liquidity with sustained unemployment at current levels may lead to increases in foreclosures, delinquencies and customer bankruptcies.  The Company is less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of more diverse economies.
 
Our allowance for loan and lease losses is based on our historical loss experience as well as an evaluation of the risks associated with our loan portfolio, including the size and composition of the loan portfolio, current economic conditions and trends in delinquencies and non-performing loans within the portfolio.  Our allowance for loan and lease losses may not be adequate to cover actual loan and lease losses and future provisions for loan and lease losses could materially and adversely affect our financial results.
 
 
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The Company had non-performing loans of $62.7 million ($45.3 million in LHFI and $17.4 million in LHFS) at June 30, 2011.  Non-performing loans were $65.8 million ($43.2 million in LHFI and $22.6 million in LHFS), $73.7 million, and $85.8 million at December 31, 2010, 2009 and 2008, respectively.  The Company recorded $6.9 million and $7.1 million in charge-offs for the three and six months ended June 30, 2011, respectively, compared to $10.8 million and $14.5 million in charge-offs for the three and six months ended June 30, 2010.  Charge-offs recorded for the years ended 2010, 2009, and 2008 were $31.7 million, $19.8 million, and $12.3 million, respectively.  OREO balances were $25.4 million at June 30, 2011 and $29.2 million, $30.3 million, and $10.3 million at December 31, 2010, 2009, and 2008, respectively.
 
The Company signed a letter of intent in the first quarter of 2011 to sell a pool of $54.1 million of classified assets in a bulk sale, which was expected to close in the second quarter of 2011. The associated sale value, or fair market value, of the classified assets resulted in an additional loss of $14.2 million during the fourth quarter of 2010. The Company was unable to arrive at a mutually satisfactory purchase and sale agreement with the prospective purchaser and terminated negotiations. The Company has marketed these assets within the pool to individual buyers to facilitate the reduction of classified assets and improve the credit quality of the loan portfolio. Efforts through the six months ended June 30, 2011 have resulted in the sale of $4.8 million of assets originally within the pool.  The Company recorded a net gain of $898,000 on these sold assets.
 
In accordance with the Orders, Royal Bank has eliminated from the balance sheet via charge-off all assets classified as “Loss”. Royal Bank was successful in reducing classified assets, which includes LHFS and OREO, from $149.6 million at June 30, 2009 to $109.3 million at June 30, 2011. Royal Bank’s delinquent loans (30 to 90 days) amounted to $36.3 million at June 30, 2009 versus $1.6 million at June 30, 2011. No material advances were made on any classified or delinquent loan unless approved by the board of directors and determined to be in Royal Bank’s best interest.  The Company has restructured the investment portfolio to reduce credit risk by selling corporate debt securities and equity securities and replacing their maturities with U.S. government issued or sponsored securities. For the six months ended June 30, 2011 the Company recorded OTTI losses amounting to $381,000 on the investment portfolio compared to $341,000 for the six months ended June 30, 2010. Year-over-year OTTI losses have decreased from $23.4 million at December 31, 2008 to $11.0 million at December 31, 2009 to $479,000 at December 31, 2010.
 
Commercial Real Estate Concentrations
 
As mentioned previously the adverse economic conditions have primarily impacted the real estate secured loan portfolio.  Non-residential real estate and construction and development loans are often riskier and tend to have significantly larger balances than home equity loans or residential mortgage loans to individuals.  While the Company believes that the commercial real estate concentration risk is mitigated by diversification among the types and characteristics of real estate collateral properties, sound underwriting practices, and ongoing portfolio monitoring and market analysis, the repayments of these loans usually depend on the successful operation of a business or the sale of the underlying property.  As a result, these loans are more likely to be unfavorably affected by adverse conditions in the real estate market or the economy in general.  The remaining loans in the portfolio are commercial or industrial loans, which are collateralized by various business assets the value of which may decline during adverse market and economic conditions.  Adverse conditions in the real estate market and the economy may result in increasing levels of loan charge-offs and non-performing assets and the reduction of earnings. When we take collateral in foreclosures and similar proceedings, we are required to mark the related asset to the fair market value of the collateral, which may ultimately result in a loss.  It is possible that Royal Bank may be required to maintain higher levels of capital than it would be otherwise be expected to maintain as a result of the Bank’s commercial real estate loans, which may require the Company to obtain additional capital.
 
Management has been working diligently to reduce the concentration in commercial real estate loans (“CRE loans”). Our non-residential real estate and construction and land development loan portfolio held for investment was $256.3 million at June 30, 2011 comprising 58% of total loans compared to $284.1 million or 57% of total loans at December 31, 2010.  Royal Bank was successful in reducing the CRE concentration, which includes loans held for sale from $289.1 million at June 30, 2009 to $197.4 million at June 30, 2011, which amounted to 202.7% of total capital and 220.1% of Tier 1 capital. At June 30, 2011, total construction/land loans (“CL loans”) including loans held for sale amounted to $81.0 million, or 83.2%, of total capital and 90.3% of Tier 1 capital. Based on capital levels calculated under U.S. GAAP, Royal Bank no longer has a concentration of commercial real estate loans as defined in the joint agency Guidance on Concentrations in Commercial Real Estate Lending Sound Risk Management Practices issued in December 2006 (Guidance). Based on capital levels calculated under regulatory accounting principles (“RAP”) (see discussion under “Note 11 – Regulatory Capital Requirements” to the Consolidated Financial Statements), CRE loans and CL loans as a percentage of total capital and Tier 1 capital, respectively, are 235.9%, 259.0%, 96.8% and 106.3%. Under RAP, Royal Bank does not have a concentration in CL loans as defined in the Guidance.  Included in the figures above are loans held for sale as of June 30, 2011.
 
 
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Balance Sheet Reduction (Deleveraging)
 
During the past 24 months, Royal Bank has continued to record losses in earnings, which have negatively impacted its capital ratios. The Company implemented a strategy to mitigate this impact to the capital ratios through the reduction of the assets (deleveraging). The balance sheet deleveraging was accomplished primarily through the run off of maturing brokered certificates of deposit (“CDs”) and FHLB borrowings as required under the Orders by reducing the balances of cash, investment securities and loans. This strategy of reducing the size of the balance sheet has provided greater use of the existing capital despite the continued loss of income by maintaining that level of capital as a percentage of the remaining reduced level of assets in order to achieve capital ratios at required regulatory levels. The Company recognizes that deleveraging will also potentially have a negative impact on future earnings, but will provide a short-term benefit to capital levels.

The deleveraging of the balance sheet over the past 24 months resulted from paying off and paying down FHLB advances and the run off of brokered CDs totaling $323.0 million within Royal Bank.  The Company does not plan to roll over maturing brokered CDs during the remainder of 2011.  As part of the restructuring of the investment portfolio, the Company also reduced the investment portfolio by approximately $122 million during 2010, which is almost entirely within Royal Bank with no substantive change during the first six months of 2011. At year end 2010, loans had declined by approximately $116 million, with an additional decline of $64.1 million in the first six months of 2011 due to pay downs of principal, payoffs, charge-offs, sales, and transfers to OREO.
 
Liquidity and Funds Management
 
Royal Bank may not accept new brokered deposits and has limited capacity to borrow additional funds in the event such funds are needed for liquidity purposes. However, Royal Bank has continued to maintain liquidity measures that are more than two times the target levels.  As discussed in “Note 8 – Borrowings and Subordinated Debentures” to the Consolidated Financial Statements, Royal Bank has an over collateralized delivery requirement of 105% with the Federal Home Loan Bank (“FHLB”) as a result of the level of non-performing assets and the losses that have been experienced over the past three years.   The ability to borrow additional funds is based on the amount of collateral that is available to be pledged.  As of June 30, 2011, Royal Bank had approximately $8 million of available borrowing capacity at the FHLB as a result of excess collateral that has been pledged.  In addition, Royal Bank has approximately $136 million of unpledged agency securities that are available to be pledged as collateral if needed.  Royal Bank also has limited availability to borrow from the Federal Reserve Discount Window.  The availability, which is approximately $7 million at June 30, 2011, is based on collateral pledged.
 
At June 30, 2011, Royal Bank had $54.8 million in cash on hand and $135.8 million in unpledged agency securities.At June 30, 2011, the liquidity to deposits ratio was 35.9% compared to Royal Bank’s 12% policy target and the liquidity to total liabilities ratio was 27.2% compared to Royal Bank’s 10% policy target.  Since entering the Orders Royal Bank has not renewed, accepted, or rolled over any maturing brokered CDs; nor has Royal Bank issued new brokered CDs. Brokered CDs declined $190.9 million from $226.9 million at June 30, 2009 to $36.0 million at June 30, 2011. Borrowings declined $132.4 million from $283.9 million at June 30, 2009 to $151.5 million at June 30, 2011.
 
 
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The Company also has unfunded pension plan obligations of $12.7 million as of June 30, 2011 which potentially could impact liquidity.  The Company plans to fund the pension plan obligations through existing Company owned life insurance policies.
 
Dividend and Interest Restrictions
 
Due to the Orders and the Federal Reserve Agreement, our ability to obtain lines of credit, to receive attractive collateral treatment from funding sources, and to pursue all attractive funding alternatives in this current low interest rate environment could be impacted and thereby limit liquidity alternatives. On August 13, 2009, the Company’s board of directors determined to suspend regular quarterly cash dividends on the $30.4 million in Series A Preferred Stock which had been issued to the United States Department of Treasury (“Treasury”) as part of the Capital Purchase Program (“CPP”), and to suspend interest payments on the $25.8 million in trust preferred securities.  As of June 30, 2011, the Series A Preferred stock dividend in arrears was $3.2 million and has not been recognized in the consolidated financial statements.  As of June 30, 2011, the trust preferred interest payment in arrears was $1.5 million and has been recorded in interest expense and accrued interest payable. The decision to suspend the preferred cash dividends and the trust preferred interest payments better supports the capital and liquidity position of Royal Bank.  As a consequence of missing the sixth dividend payment in the fourth quarter of 2010, the Treasury has the right to appoint two directors to our board of directors until all accrued but unpaid dividends have been paid. On July 13, 2011, the Treasury exercised its right to appoint a director to the Company's board of directors.  The Company expects the Treasury to appoint a second director in the near future, subject to the approval of the Federal Reserve.
 
At June 30, 2011, as a result of significant losses within Royal Bank and cash and stock dividends declared and paid in previous years, the Company had negative retained earnings and therefore would not have been able to declare and pay any cash dividends.  Under the Orders, Royal Bank must receive prior approval from the FDIC and the Department before declaring and paying a dividend to the Company.  Under the Federal Reserve Agreement the Company may not declare or pay any dividends without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System.
 
Capital Adequacy
 
In connection with a recent bank regulatory examination, the FDIC concluded, based upon its interpretation of the Consolidated Reports of Condition and Income (the “Call Report”) instructions and under 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, 2011, and the three previous quarterly filings in accordance with U.S. GAAP.  However, the change in the manner of revenue recognition for the tax lien business for regulatory accounting purposes affects Royal Bank’s and the Company’s capital ratios as disclosed in “Note 11 - Regulatory Capital Requirements” to the Consolidated Financial Statements.  Royal Bank is in discussions with the FDIC to resolve the difference of opinion.
 
Under the Orders, Royal Bank must maintain a minimum total risk-based capital ratio and a minimum Tier 1 leverage ratio of 12% and 8%, respectively. At June 30, 2011, based on capital levels calculated under RAP, Royal Bank’s total risk-based capital and Tier 1 leverage ratios were 14.23% and 8.34%, respectively. As of June 30, 2011, each of the Company and Royal Bank met all capital adequacy requirements to which it is subject.
 
Department of Justice Investigation (“DOJ”)
 
On March 4, 2009, each of CSC and RTL received a grand jury subpoena issued by the U.S. District Court for New Jersey upon application of the Antitrust Division of the DOJ.  The subpoena sought certain documents and information relating to an ongoing investigation being conducted by the DOJ. It is possible that the outcome of the investigation could result in fines and penalties being assessed against both CSC and RTL, which could also result in reputational risk due to negative publicity. However, Royal Bank has been advised that neither CSC nor RTL are targets of the DOJ investigation, but they are “subjects” of the investigation and therefore the Company has concluded that it is unlikely that a contingent liability exists.  Royal Bank, CSC and RTL are cooperating in the investigation.
 
 
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Management Plans
 
The Company was successful during the past year reducing the cost of funds, which improved the net interest margin; completing the sale of Royal Asian, which permitted the Company to contribute additional capital of $10.3 million to Royal Bank; minimizing investment impairment, recouping $1.7 million of the $5.0 million collateral loss associated with the collapse of Lehman in 2008; and addressing the matters set forth in the Orders, which included maintaining required capital ratios and liquidity measures. During the first two quarters of 2011, the Company has been successful in reducing the level of classified assets, reducing the level of loan delinquencies, experiencing minimal investment impairment, significantly reducing the unsold condo units within the partnership of the real estate owned via equity investment through a successful auction, and reducing the cost of funds.
 
In addition to increased board oversight and the creation of a Regulatory Compliance Committee in response to the Orders, the Company has enhanced the board through the addition of experienced directors with diverse backgrounds. The new members are comprised of the following: the CEO of a public company who has legal and consulting experience, a former regulator with consulting experience, a former CEO of a much larger financial institution who has bank turnaround experience and a former senior partner of a public accounting firm. Moreover, the director that was recently appointed by Treasury has significant experience in banking, most recently as the Chief Executive Officer for a larger financial institution.
 
The board and management have developed a contingency plan to maintain capital ratios at required levels under the Orders that expands the deleveraging beyond the run off of maturing brokered CDs and FHLB advances, which includes the potential securitization or sale of a significant portion of the tax lien portfolio. The Company will also consider the following measures as part of the contingency plan, if required, to insure that capital ratios continue to meet the requirements of the Orders. These additional measures, if required, include the following: sales of selected branches with high concentrations of retail CDs, sales of performing loans or specific segments of the loan portfolio, a shareholder rights offering, a reduction in the level of investment securities, and allow maturing CDs to selectively run off.  It is extremely unlikely that all of the above alternatives would be initiated. The Company recognizes that some of these measures will also potentially have a negative impact on future earnings due to the loss of earning assets, but they also can potentially provide a short-term benefit to capital levels. The board of directors and management of the Company remain committed to meeting the capital level requirements for Royal Bank as set forth in the Orders.
 
The Company’s strategic plan includes compliance with the Orders and the Federal Reserve Agreement discussed above, reducing the level of classified loans within the loan portfolio and improving the overall level of credit quality, maintaining reduced credit risk within the investment portfolio and returning to profitability. In concert with these efforts, the Company will transition more toward a community bank focus within its geographic footprint and adjacent markets. This will be achieved through the continued diversification of the loan portfolio, increased emphasis on the growth of core deposits, the utilization of enterprise risk management for reviewing strategic initiatives and maintenance of improved underwriting standards. The strategic plan provides a framework for maintaining required capital ratios while also reducing the risk profile of the Company and Royal Bank.
 
 
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Note 3.              Investment Securities
 
The carrying value and fair value of investment securities AFS at June 30, 2011 are as follows:
 
         
Included in Accumulated Other Comprehensive Income (AOCI)
       
               
Gross unrealized losses
       
(In thousands)
 
Amortized cost
   
Gross unrealized gains
   
Non-OTTI in AOCI
   
Non-credit related OTTI in AOCI
   
Fair value
 
Mortgage-backed  securities-residential
  $ 7,909     $ 240     $ -     $ -     $ 8,149  
U.S. government agencies
    35,481       41       (430 )     -       35,092  
Common stocks
    333       138       -       -       471  
Collateralized mortgage obligations:
                                       
Issued or guaranteed by U.S. government agencies
    229,966       2,685       (1,168 )     -       231,483  
Non-agency
    5,624       149       (3 )     -       5,770  
Corporate bonds
    10,462       10       (81 )     -       10,391  
Municipal bonds
    985       12       -       -       997  
Trust preferred securities
    15,548       2,788       -       (121 )     18,215  
Other securities
    7,510       626       (15 )     -       8,121  
Total available for sale
  $ 313,818     $ 6,689     $ (1,697 )   $ (121 )   $ 318,689  
 
The carrying value and fair value of investment securities AFS at December 31, 2010 are as follows:
 
         
Included in Accumulated Other Comprehensive Income (AOCI)
       
               
Gross unrealized losses
       
(In thousands)
 
Amortized cost
   
Gross unrealized gains
   
Non-OTTI in AOCI
   
Non-credit related OTTI in AOCI
   
Fair value
 
Mortgage-backed  securities-residential
  $ 8,492     $ 348     $ -     $ -     $ 8,840  
U.S. government agencies
    30,492       -       (755 )     -       29,737  
Common stocks
    381       152       (50 )     -       483  
Collateralized mortgage obligations:
                                       
Issued or guaranteed by U.S. government agencies
    231,717       3,640       (704 )     -       234,653  
Non-agency
    7,026       114       (3 )     -       7,137  
Corporate bonds
    9,483       -       (197 )     -       9,286  
Trust preferred securities
    16,566       2,135       -       (87 )     18,614  
Other securities
    7,974       431       -       -       8,405  
Total available for sale
  $ 312,131     $ 6,820     $ (1,709 )   $ (87 )   $ 317,155  
 
The amortized cost and fair value of investment securities at June 30, 2011, by contractual maturity, are shown below.  Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
 
-15-

 
 
   
As of June 30, 2011
 
(In thousands)
 
Amortized cost
   
Fair value
 
Within 1 year
  $ 100     $ 100  
After 1 but within 5 years
    12,805       12,754  
After 5 but within 10 years
    14,978       14,846  
After 10 years
    34,593       36,995  
Mortgage-backed  securities-residential
    7,909       8,149  
Collateralized mortgage obligations:
               
Issued or guaranteed by U.S. government agencies
    229,966       231,483  
Non-agency
    5,624       5,770  
Total available for sale debt securities
    305,975       310,097  
No contractual maturity
    7,843       8,592  
Total available for sale securities
  $ 313,818     $ 318,689  
 
Proceeds from the sales of investments AFS during the three months ended June 30, 2011 and 2010 were $26.9 million and $57.1 million, respectively.  Proceeds from the sales of investments AFS for the six months ended June 30, 2011 and 2010 were $70.5 million and $113.3 million, respectively.  The following table summarizes gross realized gains and losses realized on the sale of securities recognized in earnings in the periods indicated:
 
   
For the three months
ended June 30,
   
For the six months
ended June 30,
 
(In thousands)
 
2011
   
2010
   
2011
   
2010
 
Gross realized gains
  $ 1,140     $ 604     $ 1,727     $ 857  
Gross realized losses
    (47 )     (182 )     (626 )     (269 )
Net realized gains
  $ 1,093     $ 422     $ 1,101     $ 588  
 
The Company evaluates securities for OTTI at least on a quarterly basis.  The Company assesses whether OTTI is present when the fair value of a security is less than its amortized cost.  All investment securities are evaluated for OTTI under FASB ASC Topic 320, “Investments-Debt & Equity Securities” (“ASC Topic 320”).  The non-agency collateralized mortgage obligations that are rated below AA are evaluated under FASB ASC Topic 320 Subtopic 40, “Beneficial Interests in Securitized Financial Assets” under FASB ASC Topic 325, “Investments-Other”.  In determining whether OTTI exists, management considers numerous factors, including but not limited to: (1) the length of time and the extent to which the fair value is less than the amortized cost, (2) the Company’s intent to hold or sell the security, (3) the financial condition and results of the issuer including changes in capital, (4) the credit rating of the issuer, (5) analysts earnings estimate, (6) industry trends specific to the security, and (7) timing of debt maturity and status of debt payments.
 
Under ASC Topic 320, OTTI is considered to have occurred with respect to debt securities (1) if an entity intends to sell the security; (2) if it is more likely than not an entity will be required to sell the security before recovery of its amortized cost basis; or (3) the present value of the expected cash flows is not sufficient to recover the entire amortized cost basis.  In addition, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell or will more likely than not be required to sell the security.  If an entity intends to sell the security or will be required to sell the security, the OTTI shall be recognized in earnings equal to the entire difference between the fair value and the amortized cost basis at the balance sheet date.  If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before the recovery of its amortized cost basis, the OTTI shall be separated into two amounts, the credit-related loss and the noncredit-related loss. The credit-related loss is based on the present value of the expected cash flows and is recognized in earnings.  The noncredit-related loss is based on other factors such as illiquidity and is recognized in other comprehensive income. 
 
 
-16-

 
 
The following table summarizes OTTI losses on securities recognized in earnings in the periods indicated:
 
   
For the three months
ended June 30,
   
For the six months
ended June 30,
 
(In thousands)
 
2011
   
2010
   
2011
   
2010
 
Preferred stocks
  $ -     $ 165     $ -     $ 165  
Common stocks
    47       -       47       -  
Corporate bonds
    -       -       -       58  
Trust preferred securities
    334       -       334       55  
Other securities
    -       -       -       63  
Total OTTI
  $ 381     $ 165     $ 381     $ 341  
 
The following table presents a roll-forward of the balance of credit-related impairment losses on debt securities held at June 30, 2011 and 2010 for which a portion of OTTI was recognized in other comprehensive income:
 
(In thousands)
 
2011
   
2010
 
Balance at January 1,
  $ 924     $ 1,896  
Additional credit-related impairment loss on debt securities for which an other-than-temporary impairment was previously recognized
    334       -  
Reductions for securities sold during the period (realized)
    -       (573 )
Reductions for securities for which the amount previously recognized in other comprehensive income was recognized in earnings because the Company intends to sell the security
    -       (113 )
Balance at June 30,
  $ 1,258     $ 1,210  
 
The tables below indicate the length of time individual securities have been in a continuous unrealized loss position at June 30, 2011 and December 31, 2010:
 
June 30, 2011
 
Less than 12 months
   
12 months or longer
   
Total
 
(In thousands)
 
Fair value
   
Gross unrealized losses
   
Fair value
   
Gross unrealized losses
   
Fair value
   
Gross unrealized losses
 
U.S. government agencies
  $ 23,051     $ (430 )   $ -     $ -     $ 23,051     $ (430 )
Collateralized mortgage obligations:
                                               
Issued or guaranteed by U.S. government agencies
    80,196       (1,168 )     -       -       80,196       (1,168 )
Non-agency
    -       -       788       (3 )     788       (3 )
Corporate bonds
    9,081       (81 )     -       -       9,081       (81 )
Trust preferred securities
    -       -       1,294       (121 )     1,294       (121 )
Other securities
    414       (15 )     -       -       414       (15 )
Total available for sale
  $ 112,742     $ (1,694 )   $ 2,082     $ (124 )   $ 114,824     $ (1,818 )
 
 
-17-

 
 
December 31, 2010
 
Less than 12 months
   
12 months or longer
   
Total
 
(In thousands)
 
Fair value
   
Gross unrealized losses
   
Fair value
   
Gross unrealized losses
   
Fair value
   
Gross unrealized losses
 
U.S. government agencies
  $ 29,737     $ (755 )   $ -     $ -       29,737       (755 )
Common stocks
    96       (50 )     -       -       96       (50 )
Collateralized mortgage obligations:
                                               
Issued or guaranteed by U.S. government agencies
    73,169       (687 )     4,429       (17 )     77,598       (704 )
Non-agency
    918       (3 )     -       -       918       (3 )
Corporate bonds
    8,986       (197 )     -       -       8,986       (197 )
Trust preferred securities
    -       -       1,662       (87 )     1,662       (87 )
Total available for sale
  $ 112,906     $ (1,692 )   $ 6,091     $ (104 )   $ 118,997     $ (1,796 )
 
The AFS portfolio had gross unrealized losses of $1.8 million at June 30, 2011 and December 31, 2010.  For the three and six months ended June 30, 2011, the Company recorded $502,000 in OTTI, of which $121,000 was the non-credit related loss on a trust preferred security and was recognized in other comprehensive income. In determining the Company’s intent not to sell and that it is more likely than not that the Company will not be required to sell the investments before recovery of its amortized cost basis, management considers the following factors: current liquidity and availability of other non-pledged assets that permits the investment to be held for an extended period of time but not necessarily until maturity, capital planning, and any specific investment committee goals or guidelines related to the disposition of specific investments.
 
Common stocks:  During the second quarter of 2011, the Company recorded an OTTI charge to earnings of $47,000 related to one common stock which represented 33.0% of its cost basis. The stock had been in an unrealized loss position for a year.
 
For all debt security types discussed below the fair value is based on prices provided by brokers and safekeeping custodians with the exception of trust preferred securities which are described below. 
 
U.S. government-sponsored agencies (“U.S. Agencies”):  As of June 30, 2011, the Company had six U.S. Agencies with a fair value of $23.1 million and gross unrealized losses of $430,000, or 1.8%, of their aggregate cost.  All of these U.S. Agencies have been in an unrealized loss position for seven months or less.  Management believes that the unrealized losses on these debt securities are a function of changes in investment spreads.  Management expects to recover the entire amortized cost basis of these securities.  The Company does not intend to sell these securities before recovery of their cost basis and will not more likely than not be required to sell these securities before recovery of their cost basis.  Therefore, management has determined that these securities are not other-than-temporarily impaired at June 30, 2011.
 
U.S. government issued or sponsored collateralized mortgage obligations (“Agency CMOs”):  As of June 30, 2011, the Company had 19 Agency CMOs with a fair value of $80.2 million and gross unrealized losses of $1.2 million, or 1.4% of their aggregate cost. All of these 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 changes in credit quality.  Management expects to recover the entire amortized cost basis of these securities.  The Company does not intend to sell these securities before recovery of their cost basis and will not more likely than not be required to sell these securities before recovery of their cost basis.  Therefore, management has determined that these securities are not other-than-temporarily impaired at June 30, 2011.
 
Non-agency collateralized mortgage obligations (“Non-agency CMOs”):  As of June 30, 2011, the Company had one non-agency CMO with a fair value of $788,000 and a gross unrealized loss of $3,000, or 0.3% of the aggregate cost.  The non-agency CMO bond has been in an unrealized loss position for more than twelve months and was rated AAA. The Company does not intend to sell the non-agency CMO and it is not more likely than not that the Company will be required to sell the investment before recovery of the amortized cost basis.  Therefore, the Company does not consider the bond to be other-than–temporarily impaired as of June 30, 2011.  The total gross unrealized loss of $3,000 was recognized in comprehensive income.
 
 
-18-

 
 
Corporate bonds:  As of June 30, 2011, the Company had nine corporate bonds with a fair value of $9.1 million and gross unrealized losses of $81,000, or 0.9% of the aggregate cost.  All nine bonds have been in an unrealized loss position for seven months and are above investment grade.  The Company’s unrealized losses in investments in corporate bonds represent interest rate risk and not credit risk of the underlying issuers. As previously mentioned management also considered (1) the length of time and the extent to which the fair value is less than the amortized cost, (2) the Company’s intent to hold or sell the security, (3) the financial condition and results of the issuer including changes in capital, (4) the credit rating of the issuer, (5) analysts earnings estimate, (6) industry trends specific to the security, and (7) timing of debt maturity and status of debt payments.  Management utilized discounted cash flow analysis based upon the credit ratings of the securities, liquidity risk premiums, and the recent corporate spreads for similar securities as required under ASC Topic 320 to determine the credit risk component of the corporate bonds.  Based on these analyses, there was no credit-related loss on the nine bonds. Because the Company does not intend to sell the corporate bonds and it is not more likely than not that the Company will be required to sell the bonds before recovery of their amortized cost basis, which may be maturity, the Company does not consider the nine bonds to be other-than-temporarily impaired at June 30, 2011.
 
Trust preferred securities:  At June 30, 2011, the Company had seven trust preferred securities issued by five individual name companies (reflecting, where applicable the impact of mergers and acquisitions of issuers subsequent to original purchase) in the financial services/banking industry.  The valuations of trust preferred securities were based upon the fair market values of active trades for one of the securities and ASC Topic 320 using cash flow analysis for the remaining six securities. Contractual cash flows and a market rate of return were used to derive fair value for each of these securities.  Factors that affected the market rate of return included (1) any uncertainty about the amount and timing of the cash flows, (2) the credit risk, (3) liquidity of the instrument, and (4) observable yields from trading data and bid/ask indications.  Credit risk spreads and liquidity premiums were analyzed to derive the appropriate discount rate.  As of June 30, 2011, the Company had one trust preferred security with a fair value of $1.3 million. This trust preferred security has been in an unrealized loss position for longer than twelve months, is not rated, and was deemed other-than-temporarily impaired at June 30, 2009.  The unrealized loss on the trust preferred security reflects the credit concerns related to the financial institution that issued this long term financial obligation. The recent financial losses and reductions of capital coupled with bank failures and the overall market uncertainty within the financial services industry has resulted in a lower value. Management applied a discounted cash flow analysis based upon the liquidity risk premiums and the recent corporate spreads for similar securities to arrive at the credit risk component of the unrealized loss as required by ASC Topic 320.  The resulting credit-related loss recognized in earnings was $334,000 and the remaining noncredit-related loss of $121,000 was recognized in other comprehensive income at June 30, 2011.
 
Other securities:  As of June 30, 2011, the Company had eight investments in real estate and SBA funds.   As of June 30, 2011, one of the private equity real estate funds has a fair value of $414,000 and an unrealized loss of $15,000.  During the first quarter of 2010, management concluded that the fund was other-than-temporarily impaired and recorded an impairment charge of $63,000.  After reviewing the fund’s financials, asset values, and its near-term projections, management concluded that there was no additional impairment during the second quarter of 2011.
 
The Company 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.
 
 
-19-

 
 
Note 4.              Loans and Leases
 
Major classifications of loans held for investment (“LHFI”) are as follows:
 
   
June 30,
   
December 31,
 
(In thousands)
 
2011
   
2010
 
Commercial and industrial
  $ 56,282     $ 74,027  
Construction
    22,894       29,044  
Land Development
    43,419       50,594  
Real Estate - residential
    27,631       29,299  
Real Estate - non-residential
    180,103       194,203  
Real Estate - multi-family
    9,880       10,277  
Tax certificates
    60,009       70,443  
Leases
    37,598       38,725  
Other
    745       793  
Total gross loans and leases
  $ 438,561     $ 497,405  
Deferred fees, net
    (578 )     (551 )
Total loans and leases
  $ 437,983     $ 496,854  
 
The Company grants commercial and real estate loans, including construction and land development loans primarily in the greater Philadelphia metropolitan area as well as selected locations throughout the mid-Atlantic region.  The Company also has participated with other financial institutions in selected construction and land development loans outside our geographic area. The Company has a concentration of credit risk in commercial real estate, construction and land development loans at June 30, 2011.  A substantial portion of its debtors’ ability to honor their contracts is dependent upon the housing sector specifically and the economy in general.
 
The Company classifies its leases as finance leases, in accordance with FASB ASC Topic 840, “Leases”. The difference between the Company’s gross investment in the lease and the cost or carrying amount of the leased property, if different, is recorded as unearned income, which is amortized to income over the lease term by the interest method.
 
The Company’s policy for income recognition on troubled debt restructurings (“TDRs”) is to recognize income on currently performing restructured loans under the accrual method.  At June 30, 2011, the Company had six TDRs of which five are on non-accrual loans, with a total carrying value of $14.0 million.
 
At June 30, 2011 and December 31, 2010, the Company had $24.4 million and $29.6 million; respectively, in loans held for sale (“LHFS”).  LHFS at June 30, 2011 are comprised of $17.4 million in non-accrual loans and $7.0 million in classified loans. These loans were transferred from LHFI in the fourth quarter of 2010 at the lower of cost or fair market value.
 
The Company uses a nine point grading risk classification system commonly used in the financial services industry as the credit quality indicator.  The first four classifications are rated Pass.  The riskier classifications include Watch, Special Mention, Substandard, Doubtful and Loss.  The risk rating is related to the underlying credit quality and probability of default.  These risk ratings are used to calculate the historical loss component of the ALLL.
 
 
·
Pass: includes credits that demonstrate a low probability of default;
 
 
·
Watch: a warning classification which includes credits that are beginning to demonstrate above average risk through declining earnings, strained cash flows, increased leverage and/or weakening market fundamentals;
 
 
·
Special mention: includes credits that have potential weaknesses that if left uncorrected could weaken the credit or result in inadequate protection of the Company’s position at some future date. While potentially weak, credits in this classification are marginally acceptable and loss of principal or interest is not anticipated;
 
 
-20-

 
 
 
·
Substandard accrual: includes credits that exhibit a well-defined weakness which currently jeopardizes the repayment of debt and liquidation of collateral even though they are currently performing. These credits are characterized by the distinct possibility that the Company may incur a loss in the future if these weaknesses are not corrected;
 
 
·
Non-accrual: (substandard non-accrual, doubtful, loss)-includes credits that demonstrate serious problems to the point that it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement.
 
All loans, at the time of presentation to the appropriate loan committee, are given an initial loan “risk” rating by the Chief Credit Officer. From time to time, and at the general direction of any of the various loan committees, the ratings may be changed based on the findings of that committee. Items considered in assigning ratings include the financial strength of the borrower and/or guarantors, the type of collateral, the collateral lien position, the type of loan and loan structure, any potential risk inherent in the specific loan type, higher than normal monitoring of the loan or any other factor deemed appropriate by any of the various committees for changing the rating of the loan. Any such change in rating is reflected in the minutes of that committee.
 
The following tables present risk ratings for each loan portfolio segment at June 30, 2011 and December 31, 2010, excluding LHFS.
 
June 30, 2011
             
Special
                   
(In thousands)
 
Pass
   
Watch
   
Mention
   
Substandard
   
Non-accrual
   
Total
 
Construction and land development
  $ 1,678     $ 19,708     $ 28,551     $ -     $ 16,376     $ 66,313  
Real Estate-non-residential
    82,880       59,211       28,336       -       9,676       180,103  
Commercial & industrial
    21,355       7,411       13,959       -       13,557       56,282  
Residential real estate
    19,151       6,762       323       -       1,395       27,631  
Multi-family
    3,146       4,069       889       -       1,776       9,880  
Leasing
    36,555       175       61       -       807       37,598  
Consumer
    695       50       -       -       -       745  
Tax certificates
    58,300       -       -       -       1,709       60,009  
Subtotal LHFI
    223,760       97,386       72,119       -       45,296       438,561  
Less: Deferred loan fees
                                            (578 )
Total LHFI
                                          $ 437,983  
 
 
December 31, 2010
             
Special
                   
(In thousands)
 
Pass
   
Watch
   
Mention
   
Substandard
   
Non-accrual
   
Total
 
                                     
Construction and land development
  $ 7,913     $ 24,056     $ 27,911     $ -     $ 19,758     $ 79,638  
Real Estate-non-residential
    97,142       49,278       37,723       -       10,060       194,203  
Commercial & industrial
    27,864       6,488       25,400       8,317       5,958       74,027  
Residential real estate
    19,272       7,430       198       -       2,399       29,299  
Multi-family
    2,804       4,117       903       -       2,453       10,277  
Leasing
    37,731       252       10       -       732       38,725  
Consumer
    768       25       -       -       -       793  
Tax certificates
    68,641       -       -       -       1,802       70,443  
Subtotal LHFI
    262,135       91,646       92,145       8,317       43,162       497,405  
Less: Deferred loan fees
                                            (551 )
Total LHFI
                                          $ 496,854  
 
 
-21-

 
 
The past due status of all classes of loans and leases receivable is determined based on contractual due dates for loan payments. Generally, a loan is placed on non-accruing status when it has been delinquent for a period of 90 days or more.  The following tables present an aging analysis of past due payments for each loan portfolio segment at June 30, 2011 and December 31, 2010, excluding LHFS.
 
June 30, 2011
 
30-59 Days
   
60-89 Days
   
Accruing
   
Total
             
(In thousands)
 
Past Due
   
Past Due
   
90+ Days
   
Non-accrual
   
Current
   
Total
 
Construction and land development
  $ -     $ -     $ -     $ 16,376     $ 49,937     $ 66,313  
Real Estate-non-residential
    410       -       -       9,676       170,017       180,103  
Commercial & industrial
    98       41       -       13,557       42,586       56,282  
Residential real estate
    229       587       -       1,395       25,420       27,631  
Multi-family
    -       -       -       1,776       8,104       9,880  
Leasing
    175       62       -       807       36,554       37,598  
Consumer
    -       -       -       -       745       745  
Tax certificates
    -       -       -       1,709       58,300       60,009  
Subtotal LHFI
    912       690       -       45,296       391,663       438,561  
Less: Deferred loan fees
                                            (578 )
Total LHFI
                                          $ 437,983  
 
 
June 30, 2011
 
30-59 Days
   
60-89 Days
   
Accruing
   
Total
             
(In thousands)
 
Past Due
   
Past Due
   
90+ Days
   
Non-accrual
   
Current
   
Total
 
Construction and land development
  $ -     $ -     $ -     $ 19,756     $ 59,880     $ 79,638  
Real Estate-non-residential
    9,469       -