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

Show all filings for ROYAL BANCSHARES OF PENNSYLVANIA INC

Form 10-Q for ROYAL BANCSHARES OF PENNSYLVANIA INC


14-Aug-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 and six month periods ended June 30, 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.

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.

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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.

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, 2013, commercial real estate loans, commercial and industrial loans, leases, and construction and land development loans comprised 49%, 18%, 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. Refer to the "Net Interest Income and 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.

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.

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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. Recently the Company launched a new website, which takes advantage of the latest technologies and trends in web development, including responsive design which reformats content to fit any screen, improving both aesthetics and user experience. Visitors will also find a renewed emphasis on our most important products and services, including quick links to key revenue driving product lines, our newly launched secure home equity application and our powerful online and mobile banking tools. The Company is also evaluating the addition of fee-based business lines to complement and enhance existing services. With the recent retirement of Royal Bank's Senior Vice President of Branch Administration, the Company has launched an executive search for a retail executive with prior experience in expanding retail sales capabilities, refreshing the branch footprint and achieving further penetration of its recently-expanded retail and web-based products.

The Company has developed a management Profitability Improvement Plan (the "Plan") to generate steady revenue growth, expense management and gain operational efficiencies. Specific initiatives of the Plan effectuated in the first two quarters of 2013 focused on adjustments to personnel of the Company and discretionary expenses. These efforts, which included a 9% reduction in workforce during the first quarter of 2013 and an annualized reduction of approximately 10% of discretionary expenses, were implemented and enhanced day-to-day operations and the ability of the Company to drive new revenue. 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. 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. In January 2013, Royal Bank consolidated the leased Henderson Road office between the King of Prussia and Bridgeport offices and retained over 90% of the deposits. Additionally, in April 2013, to achieve operational efficiencies, the tax lien subsidiaries relocated from their leased office space in Jenkintown, Pennsylvania to the corporate location in Narberth. As a result of the reduction in workforce and the vacating of leased real estate, the Company recorded $111,000 in restructuring charges directly related to one-time employee termination benefits and an effective termination of a lease. During the third quarter of 2013, the Company will consolidate the 15th Street branch office into the Walnut Street branch office, which are both located in Center City Philadelphia. The Company continues to review its retail footprint and will explore additional branch office relocations, consolidations or both. The Company also is implementing a unique opportunity to reduce employee expenses as certain individuals will become employees of a local company who in turn will provide servicing of the remaining tax lien and non-performing assets portfolios. Those portfolios continue to diminish per the Company's strategic plan. This outsourcing arrangement allows the Company to focus on the expansion of its core banking products while de-emphasizing legacy non-core activities such as tax liens. The Company has targeted to have the Plan fully implemented by the end of 2013. 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") $23.7 million from $344.2 million at December 31, 2012 to $367.9 million at June 30, 2013. All of these plans are focused on repositioning the Company for 2013 and beyond.

During the second quarter of 2013, the Company was able to resolve the uncertainties around two separate legal matters. In June 2013, Lehman Brothers Special Financing voluntarily dismissed without prejudice and without costs all claims against the Company related to a $25.0 million CDO transaction.
Additionally, the Company accrued a loss contingency of $1.65 million as a reasonable estimate for a potential settlement with the plaintiffs of a class action lawsuit regarding the tax lien subsidiaries. (For additional information refer to Item 1 "Legal Proceedings" under Part II "Other Information" of this Form 10-Q). As mentioned previously the legal expenses associated with the DOJ investigation and these two matters have been significant and negatively impacted earnings. As a result of these legal proceedings being finalized or coming to a conclusion soon, the Company anticipates legal expenses to decline.

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Consolidated Net Loss

The Company recorded a net loss of $803,000 for the second quarter of 2013 compared to a net loss of $2.0 million for the comparable quarter of 2012.
Contributing to the net loss was a $1.65 million loss contingency accrual for a settlement of the class action lawsuit related to the Company's tax lien subsidiaries. After adjusting for the noncontrolling interest, the Company's 60% share of the loss contingency amounts to $990,000. (For additional information on the DOJ matter, see Item 1 "Legal Proceedings" of this Form 10-Q.) Absent the loss contingency accrual the Company would have recorded net income of $187,000 for the quarter ended June 30, 2013. The quarter over quarter improvement was mainly related to a $1.7 million decline in provision for loan and lease losses due to the improving credit quality of the loan portfolio, a $943,000 decrease in credit related expenses and an $859,000 decline in other-than-temporary impairment on investment securities. In addition employee salaries and benefits and professional and legal fees declined $505,000 and $498,000, respectively, quarter over quarter. Partially offsetting these positive items was a $2.0 million reduction in gains on the sales of loans and leases and a $960,000 decline in net interest income quarter over quarter.
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 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 and the paying down and re-pricing of FHLB advances. Impaired and non-accrual loans are reviewed in the "Credit Risk Management" section of this report. Loss per share for basic and diluted were both $0.10 for the second quarter of 2013, as compared to basic and diluted loss per share of $0.19 for the same quarter of 2012.

For the six months ended June 30, 2013, the net loss amounted to $685,000 compared to a net loss of $2.8 million for the comparable period of 2012. Contributing to the net loss was a $1.65 million loss contingency accrual as mentioned previously. After adjusting for the noncontrolling interest, the Company's 60% share of the loss contingency amounts to $990,000. Absent the loss contingency accrual the Company would have recorded net income of $305,000 for the six months ended June 30, 2013. The year over year improvement was due to a $2.0 million decrease in provision for loan and lease losses as a result of the improvement in the credit quality of the loan portfolio, a $1.1 million reduction in credit related expenses, an $859,000 decline in other-than-temporary impairment on investment securities and $678,000 in gains primarily on the sales of two premises. In addition gains on the sale of OREO increased $463,000 while professional and legal fees and employee salaries and benefits declined $842,000 and $600,000, respectively. Partially offsetting these improvements were a $2.2 million reduction in net interest income and a $2.0 million decrease in gains on the sales of loans and leases. In 2012, the Company recorded a $2.0 million accrual 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 $1.2 million. As previously noted, while 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. Impaired and non-accrual loans are reviewed in the "Credit Risk Management" section of this report. Basic and diluted loss per share were both $0.13 for the first six months of 2013, while basic and diluted loss per share were both $0.29 for the first six months of 2012.

Interest Income

For the second quarter of 2013, total interest income of $6.7 million declined $1.7 million, or 19.9%, from the comparable quarter of 2012. The decrease was driven by a decline in average loan and investment balances quarter over quarter coupled with a decline in the yield on loans and investments. Average interest-earning assets of $685.2 million in the current quarter declined $77.0 million, or 10.1%, from $762.2 million in the comparable quarter of 2012, which was primarily attributed to a decline in loans and investments. Average loan balances of $363.2 million in the second quarter of 2013 decreased $37.4 million, or 9.3%, year over year and negatively impacted interest income by $1.2 million of which $683,000 is directly related to the tax lien portfolio. The decline in loan balances was attributed to loan prepayments, loan pay downs including $16.1 million in higher yielding tax lien certificates and transfers to OREO. Average investment securities of $307.2 million during the second quarter of 2013 decreased $32.3 million, or 9.5%, from the second quarter of 2012 primarily due to incoming cash flows on the Company's government agency mortgage-backed ("MBS") and collateralized mortgage obligation ("CMO") investment securities. Average cash equivalents for the three months ended June 30, 2013 of $14.8 million declined $7.4 million, or 33.3%. The decline resulted from funding new loan originations and improved funding options relative to the comparable period of 2012.

For the second quarter of 2013, the yield on average interest-earning assets of 3.95% decreased 48 basis points from the level recorded during the comparable quarter of 2012. The yield reduction was comprised of a 67 basis point decline for loans (6.01% in 2013 versus 6.68% in 2012) and a 40 basis point reduction for investments (1.69% in 2013 versus 2.09% in 2012) quarter over quarter. The decrease in loan yields reflects the $16.1 million, or 43.0%, decline in higher yielding tax liens quarter versus quarter and lower rates on new loan originations. The decline in the investment yield was due to the replacement of sold and called higher yielding investment securities with lower yielding government agency securities and the accelerated amortization of premiums due to prepayments of MBS and CMO securities due to mortgage re-financings.

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For the six months ended June 30, 2013, total interest income amounted $13.5 million declined $3.7 million, or 21.7% 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. Average interest-earning assets were $695.4 million for the first six months of 2013 compared to $771.3 million for the comparable period of 2012 resulting in a decline of $75.8 million, or 9.8%.
Average loan balances of $358.1 million in the first half of 2013 decreased $53.1 million, or 12.9%, year over year and negatively impacted interest income by $2.6 million of which $1.4 million is directly related to the tax lien portfolio. The decline in loan balances for the first half of 2013 was attributed to loan prepayments, loan pay downs including $18.9 million in tax lien certificates, and transfers to OREO through foreclosure proceedings. Average investments of $322.2 million decreased $17.0 million, or 5.0%, from the first six months of 2012 primarily due to incoming cash flows on the Company's MBS and CMO investment securities.

The yield on average interest-earning assets for the six months ended June 30, 2013 of 3.91% declined by 58 basis points from 4.49% for the comparable period of 2012. The yield reduction was comprised of a year over year decrease of 61 basis points in the investment yield (1.61% in 2013 versus 2.22% in 2012) and a 45 basis point reduction in the yield on the loan portfolio (6.14% in 2013 versus 6.59% in 2012 ). The decrease in investment yield was due to the replacement of sold and called higher yielding investment securities with lower yielding government agency securities. Additionally the investment yield was negatively impacted by the accelerated amortization of premiums due to prepayments of MBS and CMO securities. The decrease in loan yields reflects the $18.9 million, or 45.0%, decline in higher yielding tax liens year over year and lower rates on new loan originations.

Interest Expense

For the second quarter of 2013, total interest expense of $1.8 million declined $720,000, or 28.6%, from the comparable quarter of 2012. The reduction in interest expense was mainly 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 for the second quarter of 2013 were $598.4 million decreasing $81.9 million, or 12.0%, from the comparable quarter of 2012. The reduction was primarily due to maturing CDs and the payoff of maturing FHLB advances. Average time deposits declined $41.8 million, or 15.1%, from the second quarter of 2012 to $235.5 million for the second quarter of 2013, principally due to the intentional runoff of higher priced retail CDs. Additionally, average NOW and money market deposits decreased $19.2 million, or 8.3%, quarter over quarter. Average borrowings declined $22.0 million, or 14.1%, from $156.0 million to $134.0 million quarter over quarter.

The yield on average interest-bearing liabilities was 1.20% for the second quarter of 2013 down 28 basis points from 1.48% for the comparable quarter of 2012 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 2013 was 0.87% resulting in a decline of 34 basis points from the level of 1.21% during the comparable quarter of 2012. The average interest rate paid on CDs during the second quarter of 2013 was 1.43%, which declined 23 basis points, year over year, due to lower interest rates on new accounts and the maturities re-pricing at lower interest rates. The yield on average NOW and money market deposits of 0.29% declined quarter over quarter by 43 basis points due to lower market interest rates. The average interest rate paid on borrowings during the second quarter of 2013 was 2.37% resulting in a decline of 6 basis points year over year due to the re-pricing of FHLB advances. During the second quarter of 2013 a maturing $50.0 million FHLB advance with a rate of 2.64% was replaced with four separate FHLB advances and short-term borrowings which carry an average yield of 1.13%. This re-pricing opportunity will enhance the margin in future quarters.

For the six months ended June 30, 2013, total interest expense of $3.8 million decreased $1.6 million, or 29.1%, from the comparable period in 2012. The decline in interest expense for the first half of 2013 was due to an $80.7 million, or 11.7%, decline in average interest-bearing liabilities relative to the comparable six month period of 2012 and a 31 basis point decline in the interest rates paid on interest-bearing liabilities year over year. For the first half of 2013, average interest-bearing deposits of $474.0 million decreased $50.8 million, or 9.7%, year over year. The reduction was mainly associated with the intentional runoff of higher priced retail CDs. Average time deposits amounted to $240.4 million during the first six months of 2013, which resulted in a decline of $39.4 million, or 14.1%, from the level during the comparable period in 2012. Average borrowings of $134.0 million for the first six months of 2013 declined $30.0 million, or 18.3%, from the first six months of 2012 due to the redemption or re-pricing of higher rate FHLB advances.

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The average interest rate paid on interest-bearing liabilities amounted to 1.25% for the first half of 2013 which represented a decline of 31 basis points year over year. The average interest rate paid on interest-bearing deposits in the first half of 2013 amounted to 0.88%, which resulted in a year over year decline of 35 basis points. Year over year lower average interest rates were paid on NOW and money market accounts (0.29% in 2013 versus 0.74% in 2012) and on CDs (1.46% in 2013 versus 1.67% in 2012). The average rate paid on borrowings amounted to 2.56% for the first half of 2013 as compared to 2.61%, which resulted in a 5 basis point decline for the comparable six month period of 2012. As stated previously, during the second quarter of 2013, a maturing $50.0 million FHLB advance with a rate of 2.64% was replaced with four separate FHLB advances and short-term borrowings which carry an average yield of 1.13%. This re-pricing opportunity will enhance the margin in future quarters.

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