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RBPAA > SEC Filings for RBPAA > Form 10-Q on 12-Nov-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


12-Nov-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 nine month periods ended September 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.

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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 September 30, 2013, commercial real estate loans, commercial and industrial loans, leases, and construction and land development loans comprised 42%, 23%, 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. The Company has managed to improve the mix of loan types with commercial and industrial loans increasing more than double from year end 2012 and tax certificates and commercial real estate loans declining 37% and 5%, respectively, from year end 2012. 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.

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 focused on adjustments to personnel of the Company and discretionary expenses to bring the Company more in line with efficient peers. These efforts, which included a 21% reduction in workforce 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. The Company also finalized a unique opportunity to reduce employee expenses as eight individuals became employees of a local company that provides 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 enables the Company to focus on the expansion of its core banking products while de-emphasizing legacy non-core activity such as tax liens. Under the Plan the Company has developed a facilities rationalization plan as part of the overall strategic goal to return to profitability. During 2013, the Company sold its storage facility site and a parking lot in Philadelphia and a building in Narberth that housed the training center. The Company recorded gains of $1.2 million as a result of these sales.
During 2013, Royal Bank consolidated the leased Henderson Road office between the King of Prussia and Bridgeport offices and consolidated the 15th Street branch office into the Walnut Street branch office, which are both located in Center City Philadelphia. These branch consolidations had minimal effect on deposit levels. As a result of the reduction in workforce and the vacating of leased real estate, the Company recorded $230,000 in restructuring charges directly related to one-time employee termination benefits and an effective termination of a lease. The Company is negotiating the relocations of approximately three branches to more attractive facilities and nearby locations over the next six to eight months. 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 LHFI $33.1 million from $344.2 million at December 31, 2012 to $377.3 million at September 30, 2013. All of these plans are focused on repositioning the Company for 2013 and beyond.

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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.

Consolidated Net Loss

The Company recorded net income of $342,000 for the third quarter of 2013 compared to a net loss of $4.8 million for the comparable quarter of 2012. The quarter over quarter improvement was mainly related to a $2.6 million decrease in credit related expenses as the total level of non-performing assets continues to decline; a $1.5 million decline in provision for loan and lease losses due to the improving credit quality of the loan portfolio, a $526,000 gain on the sale of a Company owned parking lot, and a $401,000 increase on net gains on sales of other real estate owned ("OREO"). 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. Impaired and non-accrual loans are reviewed in the "Credit Risk Management" section of this report. 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 re-pricing of FHLB advances. Net interest margin improved six basis points quarter over quarter.
Losses per share for basic and diluted were both $0.01 for the third quarter of 2013, as compared to basic and diluted losses per share of $0.40 for the same quarter of 2012.

For the nine months ended September 30, 2013, the net loss amounted to $343,000 compared to a net loss of $7.6 million for the comparable period 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 amounted 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 $647,000 for the nine months ended September 30, 2013. The year over year improvement was mainly related to a $3.8 million decrease in credit related expenses as the total level of non-performing assets continues to fall, a $3.6 million decline in provision for loan and lease losses as a result of the improvement in the credit quality of the loan portfolio, a decline of a $2.0 million accrual recorded in 2012 for a DOJ fine related to the tax lien subsidiaries, a $1.3 million decrease in professional and legal fees, $1.2 million in gains on the sale of Company owned real estate, a $913,000 reduction in employee salaries and benefits, a $864,000 increase on net gains on sales of OREO, and a $859,000 decline in other-than-temporary investment impairment.
Partially offsetting these positive items was a $2.5 million drop in net interest income, a $1.8 million decrease in gains on sales of loans and leases, and the $1.65 million loss contingency accrual previously stated. 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 $0.14 for the first nine months of 2013, while basic and diluted loss per share were both $0.69 for the first nine months of 2012.

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Interest Income

Total interest income of $7.0 million for the third quarter of 2013 amounted to a decline of $801,000 or 10.3%, from the comparable quarter of 2012. The decrease was primarily driven by a decline in average balances on tax certificates within the loan portfolio quarter over quarter. The 2013 third quarter average balance of the tax certificate portfolio declined $14.0 million, or 45.2% from the same period in 2012. This decline in average balances resulted in a $743,000 decrease in interest income. Average interest-earning assets of $684.9 million in the third quarter of 2013 declined $59.4 million, or 8.0%, from $744.4 million in the third quarter of 2012, which was primarily attributed to a decline in investments. Average investment securities of $305.2 million during the third quarter of 2013 decreased $47.2 million, or 13.4%, from the third quarter of 2012 due to sales of investment securities to fund loan advances and incoming cash flows on the Company's government agency mortgage-backed ("MBS") and collateralized mortgage obligation ("CMO") investment securities. Despite the decline in the investment portfolio, interest income increased $75,000 quarter over quarter as amortization of premiums on the MBS/CMO portfolio declined as prepayments slowed due to rising mortgage rates. Average loan balances amounted to $373.7 million in the third quarter of 2013, which resulted in a small improvement of $6.1 million, or 1.6%, quarter over quarter. Absent the decline in tax certificates the loan portfolio would have grown $20.0 million quarter over quarter. Average cash equivalents for the three months ended September 30, 2013, amounted to $6.1 million which resulted in a decline of $18.3 million, or 75.1%, from the comparable quarter of 2012. The decline resulted from funding new loan originations and improved funding options relative to the comparable period of 2012.

For the third quarter of 2013, the yield on average interest-earning assets of 4.03% decreased 12 basis points from the level recorded during the comparable quarter of 2012. The yield reduction was primarily driven by a quarter over quarter decline of 105 basis points on loans (5.76% in 2013 versus 6.81% in 2012) and was partially offset by a quarter over quarter increase of 35 basis points on investments (1.99% in 2013 versus 1.64% in 2012) and an increase of 23 basis points on cash equivalents (0.39% in 2013 versus 0.16% in 2012). The increase in investment yield was due to lower amortization of premiums paid on investment securities within the MBS/CMO portfolio as the result of a decline in prepayments. The decline in loan yield reflected the reduced concentration of higher yielding tax certificates and lower rates on new loans.

For the nine months ended September 30, 2013, total interest income amounted to $20.5 million resulting in a decline of $4.5 million, or 18.1% 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 $692.5 million for the first nine months of 2013 compared to $762.2 million for the comparable period of 2012 resulting in a decline of $69.8 million, or 9.2%. Average loan balances of $363.9 million for the first nine months of 2013 decreased $32.6 million, or 8.2%, year over year and negatively impacted interest income by $3.4 million of which $2.2 million was directly related to the tax lien portfolio. The decline in loan balances for the first nine months of 2013 was attributed to loan prepayments, loan pay downs, and transfers to OREO through foreclosure proceedings. Average investments of $316.5 million decreased $27.1 million, or 7.9%, from the first nine months of 2012 due to sales of investment securities to fund loan advances and to incoming cash flows on the Company's MBS and CMO investment securities. The decrease in average investments contributed to a $1.1 million decline in interest income.

The yield on average interest-earning assets for the nine months ended September 30, 2013 of 3.95% declined by 43 basis points from 4.38% for the comparable period of 2012. The yield reduction was comprised of a year over year decrease of 66 basis points for loans (6.00% in 2013 versus 6.66% in 2012) and a 32 basis point decline in the investment yield (1.73% in 2013 versus 2.02% in 2012). The drop in loan yield was consistent with the third quarter results and reflected a decline in the higher yielding tax certificates coupled with lower rates on new loan originations. The decrease in investment yield was due to the replacement of sold and called higher yielding investment securities during 2012 with lower yielding government agency securities coupled with the accelerated amortization of premiums on investment securities during the first nine months of 2012.

Interest Expense

For the third quarter of 2013, total interest expense amounted to $1.9 million which resulted in a decline of $489,000, or 20.6%, from the comparable quarter of 2012. 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 $593.0 million for the third quarter of 2013 represented a decline of $62.5 million, or 9.5%, from the comparable quarter of 2012 primarily due to a $60.8 million decline in average interest-bearing deposits. Average time deposits declined $40.2 million, or 14.5%, from the third quarter of 2012 to $237.7 million for the third quarter of 2013 principally due to the intentional runoff of higher priced retail CDs. Average NOW and money market deposits decreased $21.7 million, or 9.7%, quarter over quarter. Average balances for borrowings, primarily FHLB advances, declined $1.7 million, or 1.2%, quarter over quarter.

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The yield on average interest-bearing liabilities was 1.26% for the third quarter of 2013 down 18 basis points from 1.44% for the comparable quarter of 2012 as all interest-bearing liabilities experienced interest rate declines quarter over quarter. The average interest rate paid on average interest-bearing deposits for the third quarter of 2013 was 0.85% resulting in a decline of 25 basis points from the level of 1.10% during the comparable quarter of 2012. The average interest rate paid on CDs during the third quarter of 2013 was 1.38%, which declined 24 basis points, quarter over quarter, due to lower interest rates on new accounts and the re-pricing at lower interest rates on a significant portion of the maturing retail CDs. The yield on average NOW and money market deposits of 0.29% declined quarter over quarter by 23 basis points due to lower market interest rates. The average interest rate paid on borrowings during the third quarter of 2013 was 2.68% resulting in a decline of 7 basis points quarter over quarter due to the re-pricing of FHLB advances.

For the nine months ended September 30, 2013, total interest expense of $5.7 million decreased $2.0 million, or 26.5%, from the comparable period in 2012. The decline in interest expense for the first nine months of 2013 was due to a $74.6 million, or 11.0%, decline in average interest-bearing liabilities relative to the comparable nine month period of 2012 and a 26 basis point decline in the interest rates paid on interest-bearing liabilities year over year. For the first nine months of 2013, average interest-bearing deposits of $468.9 million decreased $54.2 million, or 10.4%, year over year. The reduction was mainly associated with the intentional runoff of higher priced retail CDs.
Average time deposits amounted to $239.5 million during the first nine months of 2013, which resulted in a decline of $39.7 million, or 14.2%, from the level during the comparable period in 2012. Average NOW and money market deposits decreased $15.5 million, or 6.8%, year over year. Average borrowings of $134.1 million for the first nine months of 2013 declined $20.5 million, or 13.2%, from the first nine months of 2012 due to the pay down of FHLB advances.

The average interest rate paid on interest-bearing liabilities amounted to 1.26% for the first nine months of 2013 which represented a decline of 26 basis points year over year. The average interest rate paid on interest-bearing deposits in the first nine months of 2013 amounted to 0.87%, which resulted in a year over year decline of 31 basis points. Year over year lower average interest rates were paid on NOW and money market accounts (0.32% in 2013 versus 0.66% in 2012) and on CDs (1.43% in 2013 versus 1.65% in 2012). The average rate paid on borrowings amounted to 2.60% for the first nine months of 2013 as compared to 2.65%. 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 rate of 1.13%. This re-pricing opportunity will favorably impact interest expense in future quarters.
Partially offsetting the decrease in the average interest rate paid on interest-bearing liabilities was a $174,000 penalty that was assessed when the interest payment in arrears on the trust preferred securities was paid in the third quarter of 2013.

Net Interest Income and Net Interest Margin

Net interest income for the quarter ended September 30, 2013 was $5.1 million declining $312,000, or 5.8%, from the comparable quarter of 2012. The decrease was primarily attributed to a reduction in interest-earning assets coupled with a decline in the yield on loans quarter over quarter. The decrease in the investment portfolio was primarily due to incoming cash flows on the Company's MBS and CMO investment securities. However, the investment yield increased due to lower amortization of premiums paid on investment securities within the MBS/CMO portfolio as the result of a decline in prepayments. The decrease in loan yields reflects a $14.0 million decline in higher yielding tax liens which negatively impacted interest income by $743,000 quarter over quarter and lower rates on new loan originations. The decline in net interest income was partially offset by a reduction in the average balance of interest-bearing deposits and the average interest rates paid on those deposits which primarily were associated with the redemption of maturing retail CDs and lower rates paid on renewing and new retail CDs and NOW and money market accounts.

The net interest margin in the third quarter of 2013 of 2.94% rose 6 basis points from the comparable quarter of 2012. The 18 basis point improvement in funding costs was partially offset by a 12 basis point decline in the yield on . . .

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