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| RBPAA > SEC Filings for RBPAA > Form 10-Q on 14-Aug-2012 | All Recent SEC Filings |
14-Aug-2012
Quarterly Report
The following discussion and analysis is intended to assist in understanding and evaluating the changes in the financial condition and earnings performance of the Company and its subsidiaries for the three and six month periods ended June 30, 2012 and 2011. 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, 2011, included in the Company's Form 10-K for the year ended December 31, 2011.
FORWARD-LOOKING STATEMENTS
From time to time, Royal Bancshares of Pennsylvania, Inc. (the "Company") may include forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new products, research and development activities and similar matters in this and other filings with the Securities and Exchange Commission. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. When we use words such as "believes," "expects," "anticipates" or similar expressions, we are making forward-looking statements. In order to comply with the terms of the safe harbor, the Company notes that a variety of factors could cause the Company's actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company's forward-looking statements. The risks and uncertainties that may affect the operations, performance development and results of the Company's business include the following: general economic conditions, including their impact on capital expenditures; interest rate fluctuations; business conditions in the banking industry; the regulatory environment: the nature, extent, and timing of governmental actions and reforms, including the rules of participation for the Troubled Asset Relief Program voluntary Capital Purchase Plan under the Emergency Economic Stabilization Act of 2008, which may be changed unilaterally and retroactively by legislative or regulatory actions; rapidly changing technology and evolving banking industry standards; competitive factors, including increased competition with community, regional and national financial institutions; new service and product offerings by competitors and price pressures and similar items.
All forward-looking statements contained in this report are based on information available as of the date of this report. These statements speak only as of the date of this report, even if subsequently made available by the Company on its website, or otherwise. 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 to 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 consolidated 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 consolidated financial statements and the accompanying notes. These estimates and assumptions are based on information available as of the date of the consolidated financial statements; therefore, actual results could differ from those estimates.
Note 1 to the Company's Consolidated Financial Statements (included in Item 8 of
the Form 10-K for the year ended December 31, 2011) lists significant accounting
policies used in the development and presentation of the Company's consolidated
financial statements. The following discussion and analysis, the significant
accounting policies, and other financial statement disclosures identify and
address key variables and other quantitative and qualitative factors that are
necessary for an understanding and evaluation of the Company and its results of
operations. We complete an internal review of this financial information. This
review requires substantive judgment and estimation. As disclosed in our Annual
Report on Form 10-K for the fiscal year ended December 31, 2011, we have
identified other-than-temporary impairment on investments securities, accounting
for allowance for loan and lease losses, and deferred tax assets as among the
most critical accounting policies and estimates. These critical accounting
policies and estimates 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.
Financial Highlights and Business Results
On June 29, 1995, pursuant to the plan of reorganization approved by the shareholders of Royal Bank America, formerly Royal Bank of Pennsylvania ("Royal Bank"), all of the outstanding shares of common stock of Royal Bank were acquired by Royal Bancshares and were exchanged on a one-for-one basis for common stock of Royal Bancshares. The principal activities of the Company are supervising Royal Bank, which engages in a general banking business principally in Montgomery, Chester, Bucks, Philadelphia and Berks counties in Pennsylvania and in northern and southern New Jersey and Delaware. The Company also has a wholly owned non-bank subsidiary, Royal Investments of Delaware, Inc., which is engaged in investment activities.
At June 30, 2012, the Company had consolidated total assets of $830.6 million, total loans and leases of approximately $372.3 million, total deposits of approximately $582.3 million, and shareholders' equity of approximately $72.6 million.
Like many other financial institutions the Company's financial results were negatively impacted by the recession, but the effects on the Company were more pronounced than the effects on its competitors. The concentration of commercial real estate loans coupled with the introduction of additional lines of business resulted in a much higher level of non-performing loans and losses. The past losses were partially attributed to charge-offs and impairment of commercial, construction and land loans associated with real estate projects, many of which were participation loans outside the Company's primary market. Some of the participation loans were located in Florida, Nevada, North Carolina and other markets that were overbuilt during the construction boom within the United States from 2000-2007. The Company also launched new business initiatives such as mezzanine lending, real estate joint ventures, hard money lending and equity investments in real estate shortly before the housing bubble burst which contributed to the losses. Additionally, the Company experienced a high level of investment impairment associated with corporate bonds, common stocks, private label mortgage backed securities and real estate investment funds that experienced declines in value during the past few years. Also contributing to the losses were increased costs associated with reduced credit quality, legal expenses related to credit quality issues and the U.S. Department of Justice ("DOJ") tax lien investigation, and higher Federal Deposit Insurance Corporation ("FDIC") assessments resulting from the higher rates for deposit insurance due to the Orders to Cease and Desist (the "Orders") which were issued in 2009. Finally, the establishment of a valuation allowance in 2008 and subsequent years that currently amounts to $36.4 million, has prevented the Company from utilizing tax credits on losses during the past four years.
As a result of the decline in the outstanding level of non-performing loans ($19.0 million in the past six months), the elimination of higher risk lines of business in 2008 and 2009, the overall reduced book balance of the remaining outstanding non-performing loans and OREO and the minimal migration of large new non-performing loans over the past few quarters, the Company has experienced a reduction in the magnitude of operating losses. Reduced operating expenses associated primarily with lower FDIC assessments have contributed to the improved results recently due to the replacement of the Orders with an informal agreement, known as a memorandum of understanding ("MOU"). Over the past four quarters all quarterly losses were less than $2.0 million and collectively amounted to only $5.6 million for the most recent fiscal year. This positive trend over the past year of reduced losses is expected to continue as credit quality costs associated with valuation allowances, legal fees and loan collection expenses are expected to decline consistent with the level of non-performing loans. However the Company's deleveraging strategy, which improved the risk profile of the Company by shedding higher risk assets and paying off higher cost brokered CDs has also had a negative impact on income. The deleveraging has resulted in lower average loan balances and a higher proportion of lower yielding investment securities, which have negatively impacted net interest income, a principal source of income. During the past four years net interest income has declined 32.2%. Due to the continued re-pricing of retail deposits and the redemption of FHLB advances and brokered CDs, net interest income has declined by only 4.1% over the past four quarters. While the Company still expects external headwinds and credit quality to negatively impact financial results over the next few quarters, their effects should be decreased resulting in less volatility than prior years.
The chief sources of revenue for the Company are interest income from extending loans and from investing in security instruments, mostly through its subsidiary Royal Bank. Royal Bank principally generates commercial real estate loans primarily secured by first mortgage liens, construction loans for commercial real estate projects and residential home development, land development loans, tax liens and leases. At June 30, 2012, commercial real estate loans, construction and land development loans, leases and tax liens comprised 45%, 12%, 10%, and 9%, respectively, of Royal Bank's loan portfolio. Construction loans and land development loans can have more risk associated with them, especially when a weakened economy, such as we have experienced the past few years, adversely impacts the commercial rental or home sales market. Net earnings of the Company are largely dependent on taking in deposits at competitive market rates, and then redeploying those deposited funds into loans and investments in securities at rates higher than those, paid to the depositors to earn an interest rate spread. Please see the "Net Interest Margin" section in Management's Discussion and Analysis of Financial Condition and Results of Operation below for additional information on interest yield and cost.
Consolidated Net Loss
The Company recorded a net loss of $2.0 million for the second quarter of 2012 compared to a net loss of $4.2 million for the comparable quarter of 2011. The $2.2 million improvement was primarily a result of a $2.0 million increase in gains on the sales of loans and leases which was largely due to the sale of one non-performing loan, a $1.8 million reduction in other real estate owned ("OREO") impairment, and a $1.5 million reduction in provision for loan and lease losses which was mainly related to a reduction in loan balances and an improvement in non-performing loans. Partially offsetting these favorable variances was a $1.1 million decrease in gains on the sales of AFS investment securities, a $645,000 decrease in net gains on the sales of OREO, a $478,000 increase in other-than-temporary impairment losses on investment securities which was related to one private equity real estate fund, a $476,000 decrease in income related to real estate owned via equity investments and a $400,000 addition to the legal contingency accrual. As a consequence of the slowdown in the housing market and the economic recession, the Company continues to have a high level of non-performing assets despite the recent progress which negatively impacts net interest income as well as operating expenses, such as legal, loan collection and OREO costs, and therefore the overall level of profitability. The Company has been able to mitigate part of the impact of the non-performing assets by reducing funding costs through the re-pricing of retail CDs and by the run off of higher costing brokered deposits and the paying down of FHLB advances. Impaired and non-accrual loans are reviewed in the "Credit Risk Management" section of this report. Losses per share for basic and diluted were both $0.19 for the second quarter of 2012, as compared to basic and diluted losses per share of $0.36 for the same quarter of 2011.
For the six months ended June 30, 2012, the net loss amounted to $2.8 million compared to a net loss of $5.7 million for the comparable period of 2011, which represents a $2.9 million, or 50.9% improvement. The year over year improvement was primarily due to a $3.5 million decrease in provision for loan and lease losses as a result of the decline in the loan portfolio and improvement in non-performing loans, a $2.1 million reduction in OREO impairment and a $2.0 increase in gains on the sales of loans and leases. Partially offsetting these improvements was a $2.0 million legal contingency accrual for a potential settlement with the DOJ related to the tax lien subsidiaries that was recorded during the first six months of 2012, a $1.2 million decrease in net gains on the sales of OREO, a $942,000 decrease in net gains on the sales of AFS investment securities, lower net interest income of $816,000 associated with a reduction in interest earning assets, primarily loans which declined on average $91.5 million year over year, and a $478,000 increase in other-than-temporary impairment losses on investment securities which was related to one private equity real estate fund. After adjusting for the noncontrolling interest, the Company's 60% share of the loss contingency amounts to $1.2 million. (For additional information on the DOJ matter, see Item 1 "Legal Proceedings" of this Form 10-Q.) As previously noted, as a consequence of the continued weak housing market and slow growth economy, the Company continued to experience a high level of non-performing assets despite the recent progress. Impaired and non-accrual loans are reviewed in the "Credit Risk Management" section of this report. Basic and diluted losses per share were both $0.29 for the first six months of 2012, while basic and diluted losses per share were both $0.51 for the first six months of 2011.
Interest Income
Total interest income for the second quarter of 2012 amounted to $8.4 million, which represented a decline of $1.6 million, or 15.8%, from the comparable quarter of 2011. The decrease was primarily driven by a decline in average loan balances year over year and a decline in the yield on investments. Average interest earning assets of $762.2 million in the current quarter declined $92.2 million, or 10.8%, from $854.4 million in the comparable quarter of 2011, which was primarily attributed to a decline in loans. Average loan balances of $400.6 million in the second quarter of 2012 decreased $83.2 million, or 17.2%, year over year. The decline in loan balances was attributed to loan prepayments, loan pay downs including $ 25.2 million in higher yielding tax lien certificates, and transfers to OREO through foreclosure proceedings and was accompanied by minimal loan growth. As a result of the hiring of a new Chief Lending Officer and recent additions to the lending staff, the Company is committed to increasing its emphasis on commercial and industrial and small business lending. Average investment securities of $339.5 million during the second quarter of 2012 experienced an increase of $21.3 million, or 6.7%, from the second quarter of 2011 primarily due to the decline in the loan portfolio and the ability to maintain a lower level of cash equivalents due to strong liquidity levels. Average cash equivalents for the three months ended June 30, 2012, amounted to $22.1 million, which resulted in a decline of $30.3 million, or 57.8%. The decline resulted from the strong liquidity levels and improved funding options relative to the comparable period of 2011.
For the second quarter of 2012, the yield on average interest earning assets of 4.44% decreased 25 basis points from the level recorded during the comparable quarter of 2011. The yield reduction was comprised of a 122 basis point reduction for investments (2.09% versus 3.31%) year over year, which was partially offset by an increase of 59 basis points for loans (6.68% versus 6.09%). The decrease in investment yield was due to the replacement of sold and called higher yielding investment securities and the replacement of increased payments received on cash flowing investment securities during 2011 and 2012 with lower yielding government agency securities during this continued lower interest rate environment. The increase in loan yield reflected a reduced concentration of non-performing loans within the loan portfolio, a higher concentration of higher yielding leases coupled with minimal interest reversals on new non-performing loans, which were partially offset by a reduced concentration of higher yielding tax liens.
For the six months ended June 30, 2012, total interest income amounted to $17.2 million resulting in a decline of $3.3 million, or 16.3% year over year. The decrease was primarily driven by a decline in average loan balances year over year and a decline in the yield on investments, which were partially offset by the increased yield on loans. Average interest earning assets were $771.3 million for the first six months of 2012 compared to $860.5 million for the comparable period of 2011 resulting in a decline of $89.3 million, or 10.4%. Average loan balances of $411.1 million in the first half of 2012 decreased $91.5 million, or 18.2%, year over year and accounted for a majority of the decline. The decline in loan balances for the first half of 2012 was consistent with the second quarter change and was attributed to minimal loan growth, loan prepayments, loan pay downs including $23.1 million in tax lien certificates, and transfers to OREO through foreclosure proceedings. Average investments of $339.2 million increased $21.6 million, or 6.8%, from the first six months of 2011 due to declining loan balances and a reduction in cash equivalents.
The yield on average interest earning assets for the six months ended June 30, 2012 of 4.49% declined by 33 basis points from 4.82% for the comparable period of 2011. The yield reduction was comprised of a year over year increase of 39 basis points for loans (6.59% versus 6.20%), which was more than offset by a 101 basis point decline in the investment yield (2.22% versus 3.23%). The improved loan yield was consistent with the second quarter results and reflected a higher concentration of higher yielding leases and a reduction in non-performing loans coupled with minimal interest reversals on new non-performing loans. The decrease in investment yield was due to the replacement of sold and called higher yielding investment securities during 2011 and 2012 with lower yielding government agency securities and the accelerated amortization of premiums on investment securities during the first quarter of 2012.
Interest Expense
Total interest expense amounted to $2.5 million in the second quarter of 2012, which resulted in a decline of $1.3 million, or 34.5%, from the comparable quarter of 2011. The reduction in interest expense was mainly associated with a lower level of interest bearing liabilities and a decline in the interest rates paid on those liabilities. Average balances for interest bearing liabilities of $680.4 million for the second quarter of 2012 represented a decline of $87.0 million, or 11.3%, from the comparable quarter of 2011 primarily due to the runoff of maturing brokered CDs and FHLB advances. Average time deposits, which include retail and brokered CDs, amounted to $277.3 million during the second quarter of 2012, which resulted in a decline of $81.8 million, or 22.8%, from the level of the comparable quarter of 2011 due principally to the reduction in brokered CDs and the intentional runoff of higher priced retail CDs primarily during the third quarter of 2011. The decline in retail CDs was partially offset by an increase in NOW and money market deposits. Average NOW and money market deposits increased $15.8 million, or 7.4%, year over year, as a portion of maturing retail CDs were transferred to more liquid money market accounts. As of June 30, 2012, Royal Bank no longer has any brokered CDs on the balance sheet. Management has redeemed $226.9 million in brokered CDs over the past few years as part of the deleveraging strategy and as part of the requirements of the previous Orders. Average balances for borrowings, primarily FHLB advances, amounted to $156.0 million for the second quarter of 2012, reflecting a decline of $22.4 million, or 12.6%, from the comparable period of 2011. During March of 2012 a maturing FHLB advance of $30.0 million at a rate of 4.32% was partially replaced with a five year FHLB advance of $15.0 million with a fixed rate of 1.39% to improve funding costs.
The yield on average interest bearing liabilities was 1.49% for the second quarter of 2012 down 52 basis points from 2.01% for the comparable quarter of 2011 as all interest bearing liabilities experienced interest rate declines year over year. The average interest rate paid on average interest bearing deposits for the second quarter of 2012 was 1.21% resulting in a decline of 53 basis points from the level of 1.74% during the comparable quarter of 2011. The average interest rate paid on CDs during the second quarter of 2012 was 1.66%, which declined 59 basis points, year over year, due to lower interest rates on new accounts, the re-pricing at lower interest rates on a significant portion of the maturing retail CDs and the continued runoff of maturing brokered CDs. The yield on average NOW and money market deposits of 0.72% declined year over year by 25 basis points due to lower market interest rates. The average interest rate paid on borrowings during the second quarter of 2012 was 2.43% resulting in a decline of 47 basis points year over year due to the redemption and partial replacement at more attractive interest rates of FHLB advances during 2011 and 2012.
For the six months ended June 30, 2012, total interest expense of $5.3 million decreased $2.5 million, or 32.2%, from the comparable period in 2011. The decline in interest expense for the first half of 2012 was due to an $88.8 million, or 11.4%, decline in average interest bearing liabilities relative to the comparable six month period of 2011 and a 48 basis point decline in the interest rates paid on interest bearing liabilities year over year. For the first half of 2012, average interest bearing deposits of $524.8 million decreased $73.5 million, or 12.3%, year over year. The reduction was almost entirely associated with CDs, which was primarily due to the runoff of brokered CDs as well as the intentional runoff of higher priced retail CDs. Average time deposits amounted to $279.8 million during the first six months of 2012, which resulted in a decline of $88.1 million, or 23.9%, from the level during the comparable period in 2011 for the reasons previously noted. Average borrowings of $164.0 million for the first six months of 2012 declined $15.3 million, or 8.5%, from the first six months of 2011 due to the redemption of higher rate FHLB advances. During March of 2012 a maturing FHLB advance of $30.0 million at a rate of 4.32% was partially replaced with a five year FHLB advance of $15.0 million with a fixed rate of 1.39%, which will enhance the margin in future quarters.
Consistent with the current quarter's results, the re-pricing of retail time deposits, the runoff of brokered deposits, and the redemption and replacement of FHLB advances have resulted in sizable reductions on interest rates paid on interest bearing liabilities in the first half of 2012 relative to the comparable period of 2011. The average interest rate paid on interest bearing liabilities amounted to 1.56% for the first half of 2012 which represented a decline of 48 basis points year over year. The average interest rate paid on interest bearing deposits in the first half of 2012 amounted to 1.23%, which resulted in a year over year decline of 55 basis points. Year over year lower average interest rates were paid on NOW and money market accounts (0.74% in 2012 versus 0.97% in 2011) and on CDs (1.67% in 2012 versus 2.30% in 2011). The average rate paid on borrowings amounted to 2.61% for the first half of 2012 as compared to 2.91%, which resulted in a 30 basis point decline for the comparable six month period of 2011.
Net Interest Margin
The net interest margin in the second quarter of 2012 of 3.12% improved 23 basis points from the comparable quarter of 2011. The improvement in the funding costs, which amounted to a reduction of 52 basis points, was partially offset by the overall decline of 25 basis points in the yield on interest earning assets. The decline in yield on interest earning assets was driven by lower yields on average investment securities which more than offset the improved yield for average loans year over year. The Company continued to pay down maturing brokered CDs throughout 2011 and was also able to lower retail deposit costs through the re-pricing of maturing CDs at lower interest rates while also retaining a significant portion of those maturing CDs. However the replacement of sold and called investment securities during the past year with lower yielding government agency securities in a lower interest rate environment accounted for the decline in the yield on interest-earning assets. The change in the mix of interest earning assets also negatively impacted the quarterly margin results year over year. The increased concentration of higher yielding leases and the reduced concentration of non-performing loans were more than offset by a lower concentration of higher-yielding tax liens, within interest earning assets year over year. During the second quarter of 2012, loans, which are the highest yielding interest earning asset, amounted to 53% of total interest earning assets, while they amounted to 57% of interest earning assets in the comparable quarter of 2011. In addition, the concentration of the lower yielding investment securities increased from 37% in the second quarter of 2011 to almost 45% in the current quarter of 2012.
The Company's second quarter net interest margin of 3.12% has resulted in an improvement of 80 basis points since the low margin of 2.32% recorded in the second quarter of 2009. The improvement in the margin has been attributable to the Company's re-pricing of maturing certificates of deposits, modest re-pricing of other retail customer accounts, and the runoff of maturing brokered CDs and FHLB advances during the past three years, which have more than offset the continued decline in yields of interest earning assets.
The net interest margin of 3.10% for the six month period ended June 30, 2012, improved 12 basis points from 2.98% in the comparable period of 2011. Interest rates paid on total interest bearing liabilities for the six month period ended June 30, 2012 declined 48 basis points to 1.56% from the prior year's comparable period for the same reasons noted above for the improved second quarter results. The yield on interest earning assets of 4.49% for the six month period of 2012 amounted to a decline of 33 basis points for the comparable period in 2011 and partially offset the benefit of the reduced funding costs. The change in the . . .
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