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RBPAA > SEC Filings for RBPAA > Form 10-Q on 14-May-2013All Recent SEC Filings

Show all filings for ROYAL BANCSHARES OF PENNSYLVANIA INC | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for ROYAL BANCSHARES OF PENNSYLVANIA INC


14-May-2013

Quarterly Report


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

The following discussion and analysis is intended to assist in understanding and evaluating the changes in the financial condition and earnings performance of the Company and its subsidiaries for the three month periods ended March 31, 2013 and 2012. 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, 2012, included in the Company's Form 10-K for the year ended December 31, 2012.

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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, 2012) 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, 2012, we have identified other-than-temporary impairment on investment securities, accounting for allowance for loan and lease losses, deferred tax assets, loans held for sale, the valuation of other real estate owned, net periodic pension costs and the pension benefit obligation as among the most critical accounting policies and estimates. These critical accounting policies and estimates are important to the presentation of 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.

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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 March 31 2013, commercial real estate loans, commercial and industrial loans, leases, and construction and land development loans comprised 49%, 19%, 11%, and 10%, 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. Refer to the "Net Interest Income and Net Interest Margin" section in Managements Discussion and Analysis of Financial Condition and Results of Operation below for additional information on interest yield and cost.

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 the high level of non-performing assets, legal expenses related to credit quality issues and the U. S. Department of Justice ("DOJ") tax lien investigation (for additional information refer to Item 1 "Legal Proceedings" under Part II "Other Information" of this Form 10-Q), 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 and replaced in 2011 with an informal agreement, known as a memorandum of understanding ("MOU"). Finally, the establishment of a valuation allowance in 2008 and subsequent years that currently amounts to $39.6 million, has prevented the Company from utilizing tax credits on losses during the past five years.

While the Company's deleveraging strategy improved the risk profile of the Company by shedding higher risk assets and paying off higher cost brokered CDs, it has 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. While the Company still expects external headwinds and credit quality costs associated with non-performing assets to negatively affect financial results, over time their impact may decline as the overall level of non-performing assets declines.

After announcing the retirements of the Company's Chief Executive Officer ("CEO") and President during the second quarter of 2012, the Company's Board conducted an executive search for a candidate for the combined role of President and CEO. On December 18, 2012 the Company announced F. Kevin Tylus as President and CEO of Royal Bank. On February 20, 2013, the Company announced that Mr. Tylus was appointed President, CEO and a Class III member of the Board of Directors of the Company. Former CEO, Robert Tabas, remains as Chairman of the Board of Directors. The Company is focused on transitioning Royal Bank into a more traditional community bank with the branches becoming selling centers and not just service centers. Traditional consumer products such as home equity loans and a new mobile banking application are part of the enhanced product offerings. The Company has developed a Profitability Improvement Plan to generate steady revenue growth, expense management and gain operational efficiencies. The Company has reorganized and relocated certain personnel to improve departmental synergies and better align managers and staff so they can work together in cohesive teams to accomplish these objectives. Consequently, the Company eliminated twelve personnel positions and recorded $87,000 in restructuring charges directly related to one-time employee termination benefits. Additionally, the Company is currently developing a facilities rationalization plan as part of the overall strategic goal to return to profitability. During the first quarter of 2013, the Company sold its storage facility site in Philadelphia and a building in Narberth that housed the training center. The Company recorded gains of $676,000 as a result of these sales. Additionally, in January 2013, Royal Bank consolidated the leased Henderson Road office into the King of Prussia and Bridgeport offices and retained the majority of the deposits. During 2012, Royal Bank hired a new Chief Lending Officer ("CLO") who has significant experience in commercial and consumer lending with a larger bank within the Philadelphia market. Through the reorganizing of the Lending and Credit departments during the last half of 2012, Royal Bank was able to increase loans held for investment ("LHFI") $13.9 million from $344.2 million at December 31, 2012 to $358.1 million at March 31, 2013. All of these initiatives are focused on repositioning the Company for 2013 and beyond.

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Consolidated Net Income (Loss)

During the first quarter of 2013, the Company recorded net income of $118,000, compared to a net loss of $869,000 for the comparable quarter of 2012. The quarter versus quarter improvement was mainly related to $676,000 in gains on the sales of two premises, a $335,000 decline in provision for loan and lease losses and a decline of a $1.6 million accrual recorded in the first quarter of 2012 for a DOJ fine related to the tax lien subsidiaries. After adjusting for the noncontrolling interest, the Company's 60% share of the DOJ fine amounted to $960,000. Additionally, other real estate owned ("OREO") expenses and impairment associated with foreclosed properties declined $435,000 while gains on the sale of OREO increased $300,000. Partially offsetting these items was a $1.2 million reduction in net interest income, a $100,000 impairment on loans held for sale and $87,000 in restructuring charges. Although the level of non-performing assets has declined it continues to negatively impact net interest income as well as operating expenses, such as legal, loan collection and OREO costs, and therefore the overall level of profitability. The loss in the first quarter of 2012 was mainly attributable to the DOJ fine previously mentioned. The Company has been able to mitigate part of the impact of the nonperforming assets by reducing funding costs through the re-pricing of retail CDs, the runoff 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. Basic and diluted loss per common share were $0.03 for the first quarter of 2013, as compared to basic and diluted loss per common share of $0.10 for the first quarter of 2012.

Interest Income

Total interest income of $6.8 million for the first quarter of 2013 represented a decline of $2.0 million, or 23.3%, from the comparable quarter of 2012. The decrease was primarily driven by a decline in average loan balances quarter versus quarter coupled with a decline in the yield on investment securities. Average interest-earning assets amounted to $708.9 million in the first quarter of 2013, which resulted in a decline of $71.5 million, or 9.2%, from the level of $780.4 million in the first quarter of 2012. The decrease in interest-earning assets was mainly related to a $69.2 million decline in average loan balances, which negatively impacted interest income by $1.2 million. Average loan balances amounted to $352.5 million for the first quarter of 2013 compared to $421.7 million for the first quarter of 2012. The decline in average loan balances was attributed to loan payoffs, loan pay downs, loan charge-offs, and transfers to OREO that was accompanied by minimal new loan growth.

The yield on average interest-earning assets for the first quarter of 2013 of 3.83% amounted to a decline of 71 basis points from the yield of 4.54% in the prior year's first quarter. The yield reduction was comprised of quarter versus quarter declines of 82 and 22 basis points for investments (1.53% versus 2.35%) and loans (6.28% versus 6.50%), respectively. The decline in the investment yield was due to the replacement of sold and called higher yielding investment securities during 2012 with lower yielding government agency securities due to increased mortgage re-financings and the accelerated amortization of premiums due to prepayments of government agency mortgage-backed ("MBS") and collateralized mortgage obligation ("CMO") securities. The decrease in loan yields reflects the $21.6 million decline in higher yielding tax liens quarter versus quarter and the lower rates of new loans.

Interest Expense

Total interest expense of $2.0 million in the first quarter of 2013 declined by $833,000, or 29.6%, from the comparable quarter of 2012. The reduction in interest expense was primarily associated with both lower balances of interest-bearing liabilities as well as a decline in the interest rates paid on those liabilities. Average interest-bearing liabilities of $617.7 million for the first quarter of 2013, amounted to a decline of $79.4 million, or 11.4%, primarily resulting from the intentional run off of maturing retail CDs and the payoff of maturing FHLB advances. For the quarter ended March 31, 2013, average certificates of deposit and average borrowings amounted to $245.3 million and $134.1 million, respectively, and reflected a decline of $37.0 million, or 13.1%, and $37.9 million, or 22.0%, respectively, from the comparable quarter of 2012. These declines in average balances contributed $406,000 to the $558,000 decline in interest expense on certificates of deposit and borrowings. The remaining $152,000 was related to a reduction in rates paid on retail CDs and trust preferred securities.

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The average interest rate paid on average total interest-bearing liabilities during the first quarter of 2013 amounted to 1.30%, which represented an improvement of 32 basis points from the interest rate paid during the comparable quarter of 2012. During the first quarter of 2013 the average interest rate paid on average interest-bearing deposits was 0.90% which resulted in a decline of 35 basis points from the level of 1.25% during the comparable quarter of 2012. Quarter versus quarter lower average interest rates were paid on existing customer NOW and money market rates (0.30% in 2013 versus 0.75% in 2012) and on CDs (1.49% in 2013 versus 1.68% in 2012). The decline in interest rates paid on CDs was attributed to lower rates on new accounts and the continued run off of maturing retail CDs. The average interest rate paid for borrowings during the first quarter of 2013 amounted to 2.74% which amounted to a small reduction of 3 basis points from the average rate paid of 2.77% during the first quarter of 2012.

Net Interest Income and Net Interest Margin

Net interest income for the quarter ended March 31, 2013 amounted to $4.8 million resulting in a decline of $1.2 million, or 20.4%, from the comparable quarter of 2012. The decline was primarily attributed to a lower yield on investment securities and a reduction of average loan balances quarter versus quarter. The reduction of the yield on investment securities was due mainly to the replacement of sold investment securities and principal payments and prepayments on government agency investments with comparable investment securities at lower interest rates. The reduction of average loan balances quarter versus quarter was primarily caused by charge-offs, payoffs and pay downs, which were partially attributable to the de-leveraging of the balance sheet. The decline was partially offset by a reduction in the average balances and the average interest rate paid on interest-bearing liabilities associated with the redemption of maturing retail CDs and lower rates paid on renewing and new retail CDs.

The net interest margin in the first quarter of 2013 of 2.73% declined 36 basis points from the comparable quarter of 2012. The improvement in the funding costs, which amounted to a reduction of 32 basis points, was entirely offset by the overall decline in the yield on investment securities quarter versus quarter and a change in the mix of interest-earning assets in the first quarter of 2013. The Company continued to redeem maturing retail CDs and was also able to lower retail deposit costs through the re-pricing of maturing CDs at lower interest rates. However the replacement of sold and called investment securities during 2012 with lower yielding government agency MBS and CMO securities and the accelerated amortization of premiums on investment securities during the first quarter of 2013 accounted for the decline in the yield on interest-earning assets. The change in the mix of interest-earning assets also negatively impacted the margin results quarter versus quarter. The increased concentration of lower yielding investment securities and the reduced concentration of higher-yielding tax liens more than offset the level of the higher yielding lease portfolio and accounted for the decline in the margin. During the first quarter of 2013, loans, which are the highest yielding interest-earning asset, amounted to 50% of total interest-earning assets, while they amounted to 54% of interest-earning assets in the comparable quarter of 2012.

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

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                               For the three months ended                    For the three months ended
                                     March 31, 2013                                March 31, 2012
(In thousands, except     Average                                       Average
percentages)              Balance         Interest        Yield         Balance         Interest        Yield
Cash equivalents        $    15,508      $        7          0.18 %   $    19,727      $        9          0.18 %
Investment securities       340,806           1,284          1.53 %       338,946           1,980          2.35 %
Loans                       352,541           5,461          6.28 %       421,674           6,817          6.50 %
Total interest
earning assets              708,855           6,752          3.83 %       780,347           8,806          4.54 %
Non-earning assets           53,637                                        69,494
Total average assets    $   762,492                                   $   849,841
Interest-bearing
deposits
NOW and money markets   $   220,813             162          0.30 %   $   226,189             424          0.75 %
Savings                      17,581               9          0.21 %        16,700              22          0.53 %
Time deposits               245,267             902          1.49 %       282,304           1,182          1.68 %
Total interest
bearing deposits            483,661           1,073          0.90 %       525,193           1,628          1.25 %
Borrowings                  134,064             907          2.74 %       171,971           1,185          2.77 %
Total interest
bearing liabilities         617,725           1,980          1.30 %       697,164           2,813          1.62 %
Non-interest bearing
deposits                     58,373                                        54,670
Other liabilities            27,757                                        21,625
Shareholders' equity         58,637                                        76,382
Total average
liabilities and
equity                  $   762,492                                   $   849,841
Net interest margin                      $    4,772          2.73 %                    $    5,993          3.09 %

Rate Volume Analysis

The following tables sets forth a rate/volume analysis, which segregates in detail the major factors contributing to the change in net interest income exclusive of interest on obligation through real estate owned via equity investment, for the three month period ended March 31, 2013, as compared to the respective period in 2012, into amounts attributable to both rates and volume variances.

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                                            For the three months ended
                                                     March 31,
                                                   2013 vs. 2012
                                                Increase (decrease)
(In thousands)                            Volume         Rate       Total
Interest income
Interest-bearing deposits               $       (2 )    $    -     $     (2 )
Total short term earning assets                 (2 )         -           (2 )
Investments securities                         (11 )      (685 )       (696 )
Loans
Commercial demand loans                       (694 )    $   26         (668 )
Commercial real estate                         188        (141 )         47
Residential real estate                          9          39           48
Leases                                           8         (16 )         (8 )
Tax certificates                              (683 )       (66 )       (749 )
Other loans                                    (16 )        (5 )        (21 )
Loan fees                                       (5 )         -           (5 )
Total loans                                 (1,193 )      (163 )     (1,356 )
Total decrease in interest income           (1,206 )      (848 )     (2,054 )
Interest expense
Deposits
NOW and money market                           (10 )    $ (252 )       (262 )
Savings                                          1         (14 )        (13 )
Time deposits                                 (143 )      (137 )       (280 )
Total deposits                                (152 )      (403 )       (555 )
Borrowings                                    (263 )         2         (261 )
Trust preferred                                  -         (17 )        (17 )
Total decrease in interest expense            (415 )      (418 )       (833 )
Total decrease in net interest income   $     (791 )    $ (430 )   $ (1,221 )

Credit Risk Management

The Company's loan and lease portfolio (the "credit portfolio") is subject to varying degrees of credit risk. The Company maintains an allowance for loan and lease losses (the "allowance") to absorb losses in the loan and lease portfolio. The allowance is based on the review and evaluation of the loan and lease portfolio, along with ongoing, quarterly assessments of the probable losses inherent in that portfolio. The allowance represents an estimation made pursuant to FASB ASC Topic 450, "Contingencies" ("ASC Topic 450") or FASB ASC Topic 310, "Receivables" ("ASC Topic 310"). The adequacy of the allowance is determined through evaluation of the credit portfolio, and involves consideration of a number of factors, as outlined below, to establish a prudent level. Determination of the allowance is inherently subjective and requires significant estimates, including estimated losses on pools of homogeneous loans and leases based on historical loss experience and consideration of current economic trends, which may be susceptible to significant change. Loans and leases deemed uncollectible are charged against the allowance, while recoveries are credited to the allowance. Management adjusts the level of the allowance through the provision for loan and lease losses, which is recorded as a current period expense. The Company's systematic methodology for assessing the appropriateness of the allowance includes: (1) general reserves reflecting historical loss rates by loan type, (2) specific reserves for risk-rated credits based on probable losses on an individual or portfolio basis and (3) qualitative reserves based upon current economic conditions and other risk factors.

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The loan portfolio is stratified into loan segments that have similar risk characteristics. The general allowance is based upon historical loss rates using . . .

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