10-K 1 ten-k.txt 10-K ================================================================================ U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------- FORM 10-K (Mark One) [X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2003 ----------------- or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________________ to _______________________ Commission File Number 0-26366 ------- ROYAL BANCSHARES OF PENNSYLVANIA, INC. -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Pennsylvania 23-2812193 -------------------------------------------- ------------------------ (State of other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 732 Montgomery Avenue, Narberth, Pennsylvania 19072 ------------------------------------------------------ ------------------------ (Address of principal executive offices) (Zip Code) (610) 668-4700 -------------------------------------------------------------------------------- (Issuer's telephone number, including area code) -------------------------------------------------------------------------------- (Former name, former address and former year, if changed since last report) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Class A Common Stock ($2.00 par value) Class B Common Stock ($.10 par value) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 of 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contended, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [X] No [_] The aggregate market value of common shares of the Registrant held by non-affiliates, based on the closing sale price as of February 29, 2004, was $109,346,226. As of February 29, 2004, the Registrant had 10,227,226 and 1,945,422 shares outstanding of Class A and Class B common stock, respectively. ================================================================================ Item 1. BUSINESS ---------------- The Company ----------- Royal Bancshares of Pennsylvania, Inc. ("Royal Bancshares") is a Pennsylvania business corporation and a bank holding company registered under the Federal Bank Holding Company Act of 1956, as amended (the "Holding Company Act"). Royal Bancshares is supervised by the Board of Governors of the Federal Reserve System (Federal Reserve Board). Its legal headquarters is located at 732 Montgomery Avenue, Narberth, PA. On June 29, 1995, pursuant to the plan of reorganization approved by the shareholders of Royal Bank of Pennsylvania ("Royal Bank"), all of the outstanding shares of common stock of Royal Bank were acquired by the Royal Bancshares and were exchanged on a one-for-one basis for common stock of Royal Bancshares. The principal activities of Royal Bancshares are owning and supervising Royal Bank, which engages in a general banking business in principally Montgomery, Philadelphia and Berks counties in Pennsylvania and Southern New Jersey. Royal Bank operates one Branch in New Jersey under the registered fictitious name of Royal Bank America. Royal Bancshares also has a wholly owned non-bank subsidiary, Royal Equity Partners, Inc., which is engaged in investment activities. At December 31, 2003, Royal Bancshares had consolidated total assets of approximately $1.15 billion, total deposits of approximately $791 million and shareholders' equity of approximately $135 million. From time to time, Royal Bancshares 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 safe harbor for forward-looking statements. When we use words such as "believes", or "expects," "anticipates" or similar expressions, we are making forward-looking statements. In order to comply with the terms of the safe harbor, Royal Bancshares notes that a variety of factors could cause Royal Bancshares actual results and experience to differ materially from the anticipated results or other expectations expressed in Royal Bancshares forward-looking statements. The risks and uncertainties that may affect the operations, performance development and results of Royal Bancshares 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; 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. The company has one reportable operating segment, Community Banking, as described in Note C of the Notes to Consolidated Financial Statements included in this Report. The segment reporting information in Note C is incorporated by reference into this Item 1. Royal Bank ---------- Royal Bank was incorporated in the Commonwealth of Pennsylvania on July 30, 1963, was chartered by the Commonwealth of Pennsylvania Department of Banking and commenced operation as a Pennsylvania state-chartered bank on October 22, 1963. Royal Bank is the successor of the Bank of King of Prussia, the principal ownership of which was acquired by The Tabas Family in 1980. Royal Bank of Pennsylvania is an insured bank under the Federal Deposit Insurance Corporation (the "FDIC"). As of June 22, 2001, the bank completed its acquisition of substantially all the assets of Crusader Holding Corporation. Under the terms of the acquisition certain assets and liabilities were purchased for $41.5 million, which represented the approximate fair value of the assets acquired. The purchase price was paid in cash with $15.2 million of Royal Bank's cash on hand being utilized. This transaction was accounted for under the purchase method of accounting. Royal Bank derives its income principally from interest charged on loans and interest on investment securities and fees received in connection with the origination of loans and other services. Royal Bank's principal expenses are interest expense on deposits and operating expenses. Principally operating revenues, deposit growth and the repayment of outstanding loans provide funds for activities. Service Area. Royal Bank's primary service area includes Montgomery, Chester, Bucks, Delaware, Berks and Philadelphia counties, southern New Jersey and the State of Delaware. This area includes residential areas and industrial and commercial businesses of the type usually found within a major metropolitan area. Royal Bank serves this area from sixteen branches located throughout Montgomery, Philadelphia and Berks counties and New Jersey. The Bank also considers the states of Pennsylvania, New Jersey, New York and Delaware as a part of its service area for certain products and services. Frequently, Royal Bank will do business with clients located outside of its service area. Royal Bank has loans in twenty-nine states via participations with other lenders who have broad experience in those respective markets. Royal Bank's legal headquarters are located at 732 Montgomery Avenue, Narberth, PA. 2 Royal Bank conducts business operations as a commercial bank offering checking accounts, savings and time deposits, and loans, including residential mortgages, home equity and SBA loans. Royal Bank also offers safe deposit boxes, collections, internet banking and bill payment along with other customary bank services (excluding trust) to its customers. Drive-up, ATM, and night depository facilities are available. Services may be added or deleted from time to time. The services offered and the business of Royal Bank is not subject to significant seasonal fluctuations. Royal Bank is a member of the Federal Reserve Fedline Wire Transfer System. Royal Bank became a 16.5% partner in Bankers Settlement Services of Eastern Pennsylvania, L.L.C., a title company ("Bankers"). The Bank, together with five other banks in the area, formed this title company on August 16, 2000. Royal Bank's ownership decreased to 15% with the addition of a new bank partner in 2001. Competition. The financial services industry in the company's service area is extremely competitive. The company's competitors within its service area include banks and bank holding companies with greater resources. Many competitors have substantially higher legal lending limits. In addition, savings banks, savings and loan associations, credit unions, money market and other mutual funds, mortgage companies, leasing companies, finance companies and other financial services companies offer products and services similar to those offered by the bank, on competitive terms. Many bank holding companies have elected to become financial holding companies under the Gramm-Leach-Bliley Act, which give a broader range of products with which the bank must compete. Although the long-range effects of this development cannot be predicted, most probably it will further narrow the differences and intensify competition among commercial banks, investment banks, insurance firms and other financial services companies. Employees. Royal Bancshares employed approximately 156 persons on a full-time equivalent basis as of December 31, 2003. Deposits. At December 31, 2003, total deposits of Royal Bank were distributed among demand deposits (7%), money market deposit accounts, savings and Super Now (63%) and time deposits (30%). At year-end 2003, deposits decreased $30 million from year-end 2002, or 4%, primarily due to maturing brokered deposits being replaced by lower cost borrowed funds. Lending. At December 31, 2003, Royal Bank had a total loan portfolio of $516 million, representing 45% of total assets. The loan portfolio is categorized into commercial, commercial mortgages, residential mortgages (including home equity lines of credit), construction, real estate tax liens and installment loans. Current market and regulatory trends in banking are changing the basic nature of the banking industry. Royal Bank intends to keep pace with the banking industry by being competitive with respect to interest rates and new types or classes of deposits insofar as it is practical to do so consistent with Royal Bank's size, objective of profit maintenance and stable capital structure. Non-Bank Subsidiary ------------------- On June 30, 1995, Royal Bancshares established a special purpose Delaware investment company, Royal Equity Partners, ("REP") as a wholly owned subsidiary. Its legal headquarters is at 103 Springer Building, 3411 Silverside Road, Wilmington, DE. REP buys, holds and sells investment securities. At December 31, 2003, total assets of REP were $22 million, of which $4 million was held in cash and cash equivalents, $17 million was held in investment securities. On June 22, 2001, Royal Bancshares through its wholly owned subsidiary Royal Bank purchased a 60% ownership in Crusader Servicing Corporation ("CSC") from Crusader Holding Corporation. Its legal headquarters is at 732 Montgomery Avenue, Narberth, PA. CSC acquires, through auction, delinquent property tax liens in various jurisdictions, assuming a lien position that is generally superior to any mortgage liens on the property, and obtaining certain foreclosure rights as defined by local statute. At December 31, 2003, total assets of CSC were $51 million. 3 On June 23, 2003, Royal Bancshares through its wholly owned subsidiary Royal Bank of Pennsylvania established Royal Investments of Pennsylvania, LLC ("RIP") as a wholly owned subsidiary. Its legal headquarters is at 732 Montgomery Avenue, Narberth, Pennsylvania. RIP was formed to invest in equity real estate ventures subject to limitations imposed by regulation. At December 31, 2003, total assets of RIP were $9.8 million. Website Access to Company Reports. ---------------------------------- We post publicly available reports required to be filed with the SEC on our website, www.royalbankpa.com, as soon as reasonably practicable after filing such reports with the SEC. The required reports are available free of charge through our website. Products and Services with Reputation Risk ------------------------------------------ Royal Bancshares offers a diverse range of financial and banking products and services. In the event one or more customers and/or governmental agencies become dissatisfied or object to any product or service offered by Royal Bancshares or any of its subsidiaries, whether legally justified or not, negative publicity with respect to any such product or service could have a negative impact on the company's reputation. The discontinuance of any product or service, whether or not any customer or governmental agency has challenged any such product or service, could have a negative impact on Royal Bancshares reputation. Future Acquisitions ------------------- Royal Bancshares's acquisition strategy consists of identifying financial institutions, insurance agencies and other financial companies with business philosophies that are similar to the company's, which operate in strong markets that geographically compatible with our operations, and which can be acquired at an acceptable cost. In evaluating acquisitions opportunities, the company generally considers potential revenue enhancements and operating efficiencies, asset quality, interest rate risk, and management capabilities. Royal Bancshares currently has no formal commitments with respect to future acquisitions although discussions with acquisition candidates take place occasionally. Concentrations, Seasonality --------------------------- Royal Bancshares does not have any portion of its business dependent on a single or limited number of customers, the loss of which would have a material adverse effect on its business. No substantial portion of loans or investments is concentrated within a single industry or group of related industries, except a significant majority of loans are secured by real estate much of which is located in southeastern Pennsylvania. The business of Royal Bancshares and its subsidiaries is not seasonal in nature. Environment Compliance ---------------------- Royal Bancshares and its subsidiaries' compliance with federal, state and local environment protection laws had no material effect on capital expenditures, earnings or their competitive position in 2003, and is not expected to have a material effect on such expenditures, earnings or competitive position in 2004. Supervision and Regulation -------------------------- Bank holding companies and banks operate in a highly regulated environment and are regularly examined by federal and state regulatory authorities. The following discussion concerns various federal and state laws and regulations and the potential impact of such laws and regulation on Royal Bancshares and its subsidiaries. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory or regulatory provisions themselves. Proposals to change laws and regulations are frequently introduced in Congress, the state legislatures, and before the various bank regulatory agencies. The company cannot determine the likelihood or timing of any such proposals or legislations or the impact they may have on Royal Bancshares and its subsidiaries. A change in law, regulations or regulatory policy may have a material effect on the company's business. 4 Holding Company. Royal Bancshares, as a Pennsylvania business corporation, is subject to the jurisdiction of the Securities and Exchange Commission (the "SEC") and of state securities commissions for matters relating to the offering and sale of its securities. Accordingly, if Royal Bancshares wishes to issue additional shares of its Common Stock, in order, for example, to raise capital or to grant stock options, Royal Bancshares will have to comply with the registration requirements of the Securities Act of 1933 as amended, or find an applicable exemption from registration. Royal Bancshares is subject to the provisions of the Holding Company Act, and to supervision by the Federal Reserve Board. The Holding Company Act requires Royal Bancshares to secure the prior approval of the Federal Reserve Board before it owns or controls, directly or indirectly, more than 5% of the voting shares of any corporation, including another bank. In addition, the Holding Company Act prohibits Royal Bancshares from acquiring more than 5 % of the voting shares of, or interest in, or all or substantially all of the assets of, any bank located outside Pennsylvania, unless such an acquisition is specifically authorized by laws of the state in which such bank is located. A bank holding company also is prohibited from engaging in or acquiring direct or indirect control of more than 5% of the voting shares of any such company engaged in non-banking activities unless the Federal Reserve Board, by order or regulation, has found such activities to be closely related to banking or managing or controlling banks as to be a proper incident thereto. In making this determination, the Federal Reserve Board considers whether the performance of these activities by a bank holding company would offer benefits to the public that outweigh possible adverse effects. As a bank holding company, Royal Bancshares is required to file an annual report with the Federal Reserve Board and any additional information that the Federal Reserve Board may require pursuant to the Holding Company Act. The Federal Reserve Board may also make examinations of the holding company and any or all of subsidiaries. Further, under Section 106 of the 1970 amendments to the Holding Company Act and the Federal Reserve Board's regulation, a bank holding company and its subsidiaries are prohibited from engaging in certain tying arrangements in connection with any extension of credit or provision of credit of any property or services. The so called "anti-tying" provisions state generally that a bank may not extend credit, lease, sell property or furnish any service to a customer on the condition that the customer obtain additional credit or service from the bank, its bank holding company or any other subsidiary of its bank holding company, or on the condition that the customer not obtain other credit or services from a competitor of the bank, its bank holding company or any subsidiary of its bank holding company. Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve Act and by state banking laws on any extensions of credit to the bank holding company or any of its subsidiaries, on investments in the stock or other securities of the bank holding company and on taking of such stock or securities as collateral for loans to any borrower. Under Pennsylvania law, Royal Bancshares is permitted to control an unlimited number of banks. However, Royal Bancshares would be required under the Holding Company Act to obtain the prior approval of the Federal Reserve Board before acquiring all or substantially all of the assets of any bank, or acquiring ownership or control of any voting shares of any other than the Bank, if, after such acquisition, would control more than 5% of the voting shares of such bank. Royal Bank. The deposits of Royal Bank are insured by the FDIC. Royal Bank is subject to supervision, regulation and examination by the Pennsylvania Department of Banking and by the FDIC. In addition, Royal Bank is subject to a variety of local, state and federal laws that affect its operation. Under the Pennsylvania Banking Code of 1965, as amended, the ("Code"), Royal Bancshares is permitted to control an unlimited number of banks. This rule has been in effect since March 4, 1990. However, Royal Bancshares would be required under the Holding Company Act to obtain the prior approval of the Federal Reserve Board before it could acquire all or substantially all of the assets of any bank, or acquiring ownership or control of any voting shares of any bank other than Royal Bank, if, after such acquisition, the registrant would own or control more than 5% of the voting shares of such bank. The Holding Company Act has been amended by the Riegle-Neal Interstate Banking and Branching Act of 1994, which authorizes bank holding companies subject to certain limitations and restrictions to acquire banks located in any state. 5 In 1995, the Code was amended to harmonize Pennsylvania law with the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 to enable Pennsylvania institutions to participate fully in interstate banking and to remove obstacles to the choice by banks from other states engaged in interstate banking to select Pennsylvania as a head office location. Some of the more salient features of the amendment are described below. A bank holding company located in Pennsylvania, another state, the District of Columbia or a territory or possession of the United States may control one or more banks, bank and trust companies, national banks, interstate banks and, with the prior written approval of the Pennsylvania Department of Banking, may acquire control of a bank and trust company or a national bank located in Pennsylvania. A Pennsylvania-chartered institution may maintain branches in any other state, the District of Columbia, or a territory or possession of the United States upon the written approval of the Pennsylvania Department of Banking. Finally, a banking institution existing under the laws of another jurisdiction may establish a branch in Pennsylvania if the laws of the jurisdiction in which it is located permit a Pennsylvania-chartered institution or a national bank located in Pennsylvania to establish and maintain a branch in such jurisdiction on substantially the same terms and conditions. A subsidiary bank of a holding company is subject to certain restrictions imposed by the Federal Reserve Act, as amended, on any extensions of credit to the bank holding company or its subsidiaries, on investments in the stock or other securities of the bank holding company or its subsidiaries, and on taking such stock or securities as collateral for loans. The Federal Reserve Act, as amended, and Federal Reserve Board regulations also place certain limitations and reporting requirements on extensions of credit by a bank to principal shareholders of its parent holding company, among others, and to related interests of such principal shareholders. In addition, such legislation and regulations may affect the terms upon which any person who becomes a principal shareholder of a holding company may obtain credit from banks with which the subsidiary bank maintains a correspondent relationship. Federal law also prohibits the acquisition of control of a bank holding company without prior notice to certain federal bank regulators. Control is defined for this purpose as the power, directly or indirectly, to direct the management or policies of the bank or bank holding company or to vote 25% or more of any class of voting securities of the bank holding company. From time to time, various types of federal and state legislation have been proposed that could result in additional regulation of, and restrictions on, the business of Royal Bank. It cannot be predicted whether any such legislation will be adopted or how such legislation would affect the business of Royal Bank. As a consequence of the extensive regulation of commercial banking activities in the United States, Royal Bank's business is particularly susceptible to being affected by federal legislation and regulations that may increase the costs of doing business. Under the Federal Deposit Insurance Act ("FDIC Act"), the FDIC possesses the power to prohibit institutions regulated by it (such as Royal Bank) from engaging in any activity that would be an unsafe and unsound banking practice or in violation of applicable law. Moreover, the FDIC Act: (i) empowers the FDIC to issue cease-and-desist or civil money penalty orders against Royal Bank or its executive officers, directors and/or principal shareholders based on violations of law or unsafe and unsound banking practices; (ii) authorizes the FDIC to remove executive officers who have participated in such violations or unsound practices; (iii) restricts lending by Royal Bank to its executive officers, directors, principal shareholders or related interests thereof; (iv) restricts management personnel of a bank from serving as directors or in other management positions with certain depository institutions whose assets exceed a specified amount or which have an office within a specified geographic area. Additionally, the FDIC Act provides that no person may acquire control of Royal Bank unless the FDIC has been given 60-days prior written notice and within that time has not disapproved the acquisition or extended the period for disapproval. In April 1995, regulators revised the Community Reinvestment Act ("CRA") with an emphasis on performance over process and documentation. Under the revised rules, the five-point rating scale is still utilized by examiners to assign a numerical score for a bank's performance in each of three areas: lending, service and investment. Under the CRA, the FDIC is required to: (i) assess the records of all financial institutions regulated by it to determine if these institutions are meeting the credit needs of the community (including low-and moderate-income neighborhoods) which they serve, and (ii) take this record into account in its evaluation of any application made by any such institutions for, among other things, approval of a branch or other deposit facility, office relocation, a merger or an acquisition of bank shares. The CRA also requires the federal banking agencies to make public disclosures of their evaluation of each bank's record of meeting the credit needs of its entire community, including low-and moderate-income neighborhoods. This evaluation will include a descriptive rate ("outstanding," "satisfactory," "needs to improve" or "substantial noncompliance") and a statement describing the basis for the rating. After its most recent examination of Royal Bank under CRA, the FDIC gave Royal Bank a CRA rating of satisfactory. 6 Under the Bank Secrecy Act ("BSA"), banks and other financial institutions are required to report to the Internal Revenue Service currency transactions of more than $10,000 or multiple transactions in any one day of which Royal Bank is aware that exceed $10,000 in the aggregate. Civil and criminal penalties are provided under the BSA for failure to file a required report, for failure to supply information required by the BSA or for filing a false or fraudulent report. Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. Royal Bank believes that further merger activity within Pennsylvania is likely to occur in the future, resulting in increased concentration levels in banking markets within Pennsylvania and other significant changes in the competitive environment. The Riegle-Neal allows adequately capitalized and managed bank holding companies to acquire banks in any state starting one year after enactment (September 29, 1995). Another provision of the Riegle-Neal Act allows interstate merger transactions beginning June 1, 1997. States are permitted, however, to pass legislation providing for either earlier approval of mergers with out-of-state banks, or "opting-out" of interstate mergers entirely. Through interstate merger transactions, banks will be able to acquire branches of out-of-state banks by converting their offices into branches of the resulting bank. The Riegle-Neal Act provides that it will be the exclusive means for bank holding companies to obtain interstate branches. Under the Riegle-Neal Act, banks may establish and operate a "de novo branch" in any State that "opts-in" to de novo branching. Foreign banks are allowed to operate branches, either de novo or by merger. These branches can operate to the same extent that the establishment and operation of such branches would be permitted if the foreign bank were a national bank or state bank. All these changes are expected to intensify competition in local, regional and national banking markets. The Pennsylvania Banking Code has been amended to enable Pennsylvania institutions to participate fully in interstate banking (see discussion above). Management cannot anticipate what changes Congress may enact, or, if enacted, their impact on Royal Bancshares' financial position and reported results of operation. As a consequence of the extensive regulation of commercial banking activities in the United States, Royal Bancshares and Royal Bank's business is particularly susceptible to being affected by federal and state legislation and regulations that may increase the costs of doing business. Federal Deposit Insurance Corporation Improvement Act of 1991 ------------------------------------------------------------- General. The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDIC Improvement Act") includes several provisions that have a direct impact on Royal Bank. The most significant of these provisions are discussed below. The FDIC is required to conduct periodic full-scope, on-site examinations of Royal Bank. In order to minimize losses to the deposit insurance funds, the FDIC Improvement Act establishes a format to more monitor FDIC-insured institutions and to enable prompt corrective action by the appropriate federal supervisory agency if an institution begins to experience any difficulty. The FDIC Improvement Act establishes five "capital" categories. They are: (1) well capitalized, (2) adequately capitalized, (3) undercapitalized, (4) significantly undercapitalized, and (5) critically undercapitalized. The overall goal of these new capital measures is to impose more scrutiny and operational restrictions on banks as they descend the capital categories from well capitalized to critically undercapitalized. Under Current regulations, a "well-capitalized" institution would be one that has at least a 10% total risk-based capital ratio, a 6% Tier 1 risk-based capital ratio, a 5% Tier 1 Leverage Ratio, and is not subject to any written order or final directive by the FDIC to meet and maintain a specific capital level. Royal Bank is presently categorized as a "well-capitalized" institution. An "adequately capitalized" institution would be one that meets the required minimum capital levels, but does not meet the definition of a "well-capitalized" institution. The existing capital rules generally require banks to maintain a Tier 1 Leverage Ratio of at least 4% and an 8% total risk-based capital ratio. Since the risk-based capital requirement to be in the form of Tier 1 capital, this also will mean that a bank would need to maintain at least 4% Tier 1 risk-based capital ratio. An institution must meet each of the required minimum capital levels in order to be deemed "adequately capitalized." An "undercapitalized" institution is one that fails to meet one or more of the required minimum capital levels for an "adequately capitalized" institution. Under the FDIC Improvement Act, an "undercapitalized" institution must file a capital restoration plan and is automatically subject to restrictions on dividends, management fees and asset growth. In addition, the institution is prohibited from making acquisitions, opening new branches or engaging in new lines of business without the prior approval of its primary federal regulator. A number of other restrictions may be imposed. 7 A "critically undercapitalized" institution is one that has a tangible equity (Tier 1 capital) ratio of 2% or less. In addition to the same restrictions and prohibitions that apply to "undercapitalized" and "significantly undercapitalized" institutions, any institution that becomes "critically undercapitalized" is prohibited from taking the following actions without the prior written approval of its primary federal supervisory agency: engaging in any material transactions other than in the usual course of business; extending credit for highly leveraged transactions; amending its charter or bylaws; making any material changes in accounting methods; engaging in certain transactions with affiliates; paying excessive compensation or bonuses; and paying interest on liabilities exceeding the prevailing rates in the institution's market area. In addition, a "critically undercapitalized" institution is prohibited from paying interest or principal on its subordinated debt and is subject to being placed in conservatorship or receivership if its tangible equity capital level is not increased within certain mandated time frames. Real Estate Lending Guidelines. Pursuant to the FDIC Improvement Act, the FDIC has issued real estate lending guidelines that establish loan-to-value ("LTV") ratios for different types of real estate loans. A LTV ratio is generally defined as the total loan amount divided by the appraised value of the property at the time the loan is originated. If a bank does not hold a first lien position, the total loan amount would be combined with the amount of all senior liens when calculating the ratio. In addition to establishing the LTV ratios, the FDIC's real estate guidelines require all real estate loans to be based upon proper loan documentation and a recent independent appraisal of the property. The FDIC's guidelines establish the following limits for LTV ratios: Loan Category LTV Limit ------------- --------- Raw Land 65% Land Development Construction: Commercial, Multifamily (includes condos and co-ops), and other Nonresidential 80% Improved Property 85% Owner occupied 1-4 Family and Home Equity (without credit enhancements) 90% The guidelines provide exceptions to the LTV ratios for government-backed loans; loans facilitating the sale of real estate acquired by the lending institution in the normal course of business; loans where Royal Bank's decision to lend is not based on the offer of real estate as collateral and such collateral is taken only out of an abundance of caution; and loans renewed, refinanced, or restructured by the original lender to the same borrower, without the advancement of new money. The regulation also allows institutions to make a limited amount of real estate loans that do not conform to the proposed LTV ratios. Under this exception, Royal Bank would be allowed to make real estate loans that do not conform to the LTV ratio limits, up to an amount not to exceed 100% of Royal Bank's total capital. Truth in Savings Act. The FDIC Improvement Act also contains the Truth in Savings Act. The purpose of this Act is to require the clear and uniform disclosure of the rates of interest that are payable on deposit accounts by Royal Bank and the fees that are assessable against deposit accounts, so that consumers can make a meaningful comparison between the competing claims of banks with regard to deposit accounts and products. This Act requires Royal Bank to include, in a clear and conspicuous manner, the following information with each periodic statement of a deposit account: (1) the annual percentage yield earned, (2) the amount of interest earned, (3) the amount of any fee and charges imposed and (4) the number of days in the reporting period. This Act allows for civil lawsuits to be initiated by customers if Royal Bank violates any provision or regulation under this Act. Gramm-Leach-Bliley Act. On November 12, 1999, President Clinton signed the Gramm-Leach-Bliley Act of 1999, the Financial services Modernization Act. The Financial Services Modernization Act repeals the two affiliation provisions of the Glass-Steagall Act: o Section 20, which restricted the affiliation of Federal Reserve Member Banks with firms "engaged principally" in specified securities activities; and 8 o Section 32, which restricts officer, director, or employee interlocks between a member bank and any company or person "primarily engaged" in specified securities activities. In addition, the Financial Services Modernization Act contains provisions that expressly preempt any state insurance law. The law establishes a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers. It revises and expands the framework of the Holding Company Act framework to permit a holding company system to engage in a full range of financial activities through a new entity known as a Financial Holding Company. "Financial activities" is broadly defined to include not only banking, insurance and securities activities, but also merchant banking and additional activities that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to such financial activities, or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. In general, the Financial Services Modernization Act: o Repeals historical restrictions on, and eliminates many federal and state law barriers to, affiliations among banks, securities firms, insurance companies, and other financial service providers; o Provides a uniform framework for the functional regulation of the activities of banks, savings institutions and their holding companies; o Broadens the activities that may be conducted by national banks, banking subsidiaries of bank holding companies, and their financial subsidiaries; o Provides an enhanced framework for protecting the privacy of consumer information; o Adopts a number of provisions related to the capitalization, membership, corporate governance, and the other measures designed to modernize the Federal Home Loan Bank system; o Modifies the laws governing the implementation of the CRA; and o Addresses a variety of other legal and regulatory issues affecting both day-to-day operations and long-term activities of financial institutions. In order for the Royal Bancshares to take advantage of the ability to affiliate with other financial service providers, Royal Bancshares must become a "Financial Holding Company" as permitted under an amendment to the Holding Company Act. To become a Financial Holding Company, a company must file a declaration with the Federal Reserve, electing to engage in activities permissible for Financial Holding Companies and certifying that it is eligible to do so because all of its insured depository institution subsidiaries are well-capitalized and well-managed. In addition, the Federal Reserve Board must determine that each insured depository institution subsidiary of the company has at least a satisfactory CRA rating. Royal Bancshares currently meets the requirements to make an election to become a Financial Holding Company. The Royal Bancshares management has not determined at this time whether it will seek an election to become a Financial Holding Company. Royal Bancshares is examining its strategic business plan to determine whether, based on market conditions, the relative financial conditions of Royal Bancshares and its subsidiaries, regulatory capital requirements, general economic conditions, and other factors, Royal Bancshares desires to utilize any of its expanded powers provided in the Financial Service Modernization Act. The Financial Services Modernization Act also includes a new section of the FDIC Act governing subsidiaries of state banks that engage in "activities as principal that would only be permissible" for a national bank to conduct in a financial subsidiary. It expressly preserves the ability of a state bank to retain all existing subsidiaries. Because Pennsylvania permits commercial banks chartered by the state to engage in any activity permissible for national banks, Royal Bank will be permitted to form subsidiaries to engage in the activities authorized by the Financial Services Modernization Act, to the same extent as a national bank. In order to form a financial subsidiary, Royal Bank must be well-capitalized, and Royal Bank would be subject to the same capital deduction, risk management and affiliate transaction rules as applicable to national banks. 9 Royal Bancshares and Royal Bank do not believe that the Financial Services Modernization Act will have a material adverse effect on its operations in the near-term. However, to the extent that it permits banks, securities firms, and insurance companies to affiliate, the financial services industry may experience further consolidation. The Financial Services Modernization Act is intended to grant to community banks certain powers as a matter of right that larger institutions have accumulated on an ad hoc basis. Nevertheless, this act may have the result of increasing the amount of competition that Royal Bancshares and Royal Bank face from larger institutions and other types of companies offering financial products, many of which may have substantially more financial resources than Royal Bancshares and Royal Bank. Recent Legislation ------------------ USA Patriot Act of 2001. In October 2001, the USA Patriot Act of 2001 was enacted in response to the terrorist attacks in New York, Pennsylvania and Washington D.C., which occurred on September 11, 2001. The Patriot Act is intended to strengthen U.S. law enforcements' and the intelligence communities' abilities to work cohesively to combat terrorism on a variety of fronts. The potential impact of the Patriot Act on financial institutions of all kinds is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and imposes various regulations, including standards for verifying client identification at account opening, and rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering. Sarbanes-Oxley Act of 2002. On July 30, 2002, President Bush signed in law the Sarbanes-Oxley Act of 2002, or the SOA. The stated goals of the SOA are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The SOA is the most far-reaching U.S. securities legislation enacted in some time. The SOA generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the SEC under the Securities Exchange Act of 1934, or the Exchange Act. Given the extensive SEC role in implementing rules relating to many of the SOA's new requirements, the final scope of the requirements remains to be determined. The SOA addressed, among other matters: - Audit committees for all reporting companies; - Certification of financial statements by the chief executive officer and chief financial officer; - The forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer's securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement; - A prohibition on insider trading during pension plan black out periods; - Disclosure of off-balance sheet transactions; - A prohibition on personal loans to directors and officers; expedited filings requirements for Form S-4's; - Disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code; - "Real time" filing of periodic reports; - The formation of a public accounting oversight board; - Auditor independence; and - Various increased criminal penalties for violations of securities laws. 10 The SOA contains provisions which became effective upon enactment on July 30, 2002 and provisions which will become effective from within 30 days to one year from enactment. The SEC has been delegated the task of enacting rules to implement various provisions with the respect to, among other matters, disclosure in periodic filings pursuant to the Exchange Act. Regulation W. Transactions between a bank and its "affiliates" are quantitatively and qualitatively restricted under the Federal Reserve Act. The FDIC Act applies Section 23A and 23B to insured nonmember banks in the same manner and to the same extent as if they were members of the Federal Reserve System. The Federal Reserve Board has also recently issued Regulation W, which codifies prior regulations under Section 23A and 23B of the Federal Reserve Act and interpretative guidance with respect to affiliate transactions. Regulation W incorporates the exemption from the affiliate transaction rules but expands the exemption to cover the purchase of any type of loan or extension of credit from an affiliate. Affiliates of a bank include, among other entities, the bank's holding company and companies that are under common control with the bank. Royal Bancshares is considered to be an affiliate of Royal Bank. In general, subject to certain specified exemptions, a bank or its subsidiaries are limited in their ability to engage in "covered transactions" with affiliates: - To an amount equal to 10% of the bank's capital and surplus, in the case of covered transactions with any one affiliate; and - To an amount equal to 20% of the bank's capital and surplus, in the case of covered transactions with all affiliates. In addition, a bank and its subsidiaries may engage in covered transactions and other specified transactions only on terms and under circumstances that are substantially the same, or at least as favorable to the bank or its subsidiary, as those prevailing at the time for comparable transactions with nonaffiliated companies. A "covered transaction" includes: - A loan or extension of credit to an affiliate; - A purchase of, or an investment in, securities issued by an affiliate; - A purchase of assets from an affiliate, with some exceptions; - The acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any party; and - This issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate. In addition, under Regulation W: - A bank and its subsidiaries may not purchase a low-quality asset from an affiliate; - Covered transactions and other specified transactions between a bank or its subsidiaries and an affiliate must be on terms and conditions that are consistent with safe and sound bank practices; and - With some exceptions, each loan or extension of credit by a bank to an affiliate must be secured by collateral with a market value ranging from 100% to 130%, depending on the type of collateral, of the amount of the loan or extension of credit. Regulation W generally excludes all non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve Board decides to treat these subsidiaries as affiliates. Concurrently with the adoptions of Regulation W, the Federal Reserve Board has proposed a regulation which would further limit the amount of loans that could be purchased by a bank from an affiliate to not more than 100% of the bank's capital and surplus. 11 Monetary Policy --------------- The earnings of Royal Bank are affected by the policies of regulatory authorities including the Federal Reserve Board. An important function of the Federal Reserve System is to influence the money supply and interest rates. Among the instruments used to implement those objectives are open market operations in United States government securities, changes in reserve requirements against member bank deposits and limitations on interest rates that member banks may pay on time and savings deposits. These instruments are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may also affect rates charged on loans or paid for deposits. The policies and regulations of the Federal Reserve Board have had and will probably continue to have a significant effect on its reserve requirements, deposits, loans and investment growth, as well as the rate of interest earned and paid, and are expected to affect Royal Bank's operations in the future. The effect of such policies and regulations upon the future business and earnings of Royal Bank cannot be predicted. Effects of Inflation -------------------- Inflation has some impact on Royal Bancshares' operating costs. Unlike many industrial companies, however, substantially all of Royal Bancshares' assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on Royal Bancshares' performance than the general level of inflation. Over short periods of time, interest rates may not necessarily move in the same direction or in the same magnitude as prices of goods and services. Critical Accounting Policies, Judgments and Estimates ----------------------------------------------------- The accounting and reporting policies of the company conform with accounting principles generally accepted in the United States of America and general practices within the financial services industry. The preparation of 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 financial statements and the accompanying notes. Actual results could differ from those estimates. The company considers that the determination of the allowance for loan losses involves a higher degree of judgment and complexity than its other significant accounting policies. The allowance for loan losses is calculated with the objective of maintaining a reserve level believed by management to be sufficient to absorb estimated credit losses. Management's determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective as it requires material estimates, including, among others, expected default probabilities, loss given default, expected commitment usage, the amounts of timing of expected future cash flows on impaired loans, mortgages, and general amounts for historical loss experience. The process also considers economic conditions, uncertainties in estimating losses and inherent risks in the loan portfolio. All of these factors may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses may be required that would adversely impact earnings in future periods. Royal Bancshares recognizes deferred tax assets and liabilities for the future tax effects of temporary differences, net operating loss carry forwards and tax credits. Deferred tax assets are subject to management's judgment based upon available evidence that future realization is more likely than not. If management determines that the company may be unable to realize all or part of net deferred tax assets in the future, a direct charge to income tax expense may be required to reduce the recorded value of the net deferred tax asset to the expected realizable amount. The accounting and reporting policies of Royal Bancshares conform to accounting principles generally accepted in the United States of America and general practices within the financial services industry. Critical accounting policies, judgments and estimates relate to loans, the allowance for loan losses and deferred tax assets. These policies which significantly affect the determination of the company's financial position, results of operations and cash flows, are summarized in Note A "Summary of Significant Accounting Polices" of the Notes to Consolidated Financial Statements and are discussed in the section captioned "Recent Accounting Pronouncements" of Management's Discussion and Analysis of Financial Condition and Results of Operations, included in Items 7 and 8 of this Report, each of which is incorporated herein by reference. 12 Available Information --------------------- Upon a shareholder's written request, a copy of the company's Annual Report on 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, as required to be filed with the SEC pursuant to Securities Exchange Act Rule 13a-1, may be obtained, without charge, on our website: RoyalBankPA.com or from Jeffrey T. Hanuscin, Chief Financial Officer, Royal Bank 732 Montgomery Avenue, Narberth, Pennsylvania 19072. ITEM 2. PROPERTIES ------------------ Royal Bank has sixteen banking offices, which are located in Pennsylvania and Southern NJ. Narberth Office (1) Villanova Office King of Prussia Office (1) ------------------- ---------------- -------------------------- 732 Montgomery Ave 801 East Lancaster Avenue Rt. 202 at Wilson Road Narberth, PA 19072 Villanova, PA 19085 King of Prussia, PA 19406 Philadelphia Offices Shillington Office Bridgeport Office (1) -------------------- ------------------ --------------------- - One Penn Square West 516 East Lancaster Avenue 105 W. 4th Street 30 South 15th Street Shillington. PA 19607 Bridgeport, PA 19406 Philadelphia, PA 19102 Trooper Office(1) Upper Merion Office - 1340 Walnut Street ----------------- ------------------- Philadelphia, PA 19107 Trooper & Egypt Roads Beidler & Henderson Roads Trooper, PA 19401 King of Prussia, PA 19406 - 401 Fairmount Avenue (1) Philadelphia, PA 19123 Reading Office Phoenixville Office (1) -------------- ----------------------- - 6526 Castor Avenue 501 Washington Street 808 Valley Forge Road Philadelphia, PA 19149 Reading, PA 19601 Phoenixville, PA 19460 Philadelphia Loan Office (2) Royal Bank America - 1650 Grant Avenue (1) ----------------------------- ------------------ Philadelphia, PA 19115 2 Penn Center 3501 Black Horse Pike Philadelphia, PA 19102 Turnersville, NJ 08012 Jenkintown Office (1) --------------------- Narberth Training Ctr. (1) (3) 600 Old York Road ------------------------------ Jenkintown, PA 19046 814 Montgomery Ave Narberth, PA 19072
(1) Owned (2) Residential Loan Office-Not a branch (3) Used for employee training Royal Bank owns nine of the above properties. One property is subject to a mortgage. The remaining nine properties are leased with expiration dates between 2004 and 2012. Royal Bank also leases storage warehouse space in Bridgeport, PA. at an annual rate of $21,000. During 2003, Royal Bank made aggregate lease payments of approximately $542,000. Royal Bank believes that all of its properties are attractive, adequately insured, and well maintained and are adequate for Royal Bank's purposes. Royal Bank also owns a property located at 144 Narberth Avenue, Narberth, PA, which may serve as a site for future expansion. ITEM 3. LEGAL PROCEEDINGS ------------------------- Management, after consulting with Royal Bancshares's legal counsel, is not aware of any litigation that would have a material adverse effect on the consolidated financial position of Royal Bancshares. There are no proceedings pending other than routine litigation incident to the business of Royal Bancshares. In addition, no material proceedings are known to be contemplated by governmental authorities against Royal Bancshares. 13 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ------------------------------------------------------------ None. ITEM 5. MARKET FOR THE BANK'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS ------------------------------------------------------------------------------- On September 6, 1988 the Royal Bancshares' Class A Common Stock commenced trading on the NASDAQ National Market System (NASDAQ/NMS). Royal Bancshares' NASDAQ Symbol is RBPAA and is included in the NASDAQ National Market Stock Table, which is published in most major newspapers. There is no market for Royal Bancshares' Class B Common Stock, as such is prohibited by the terms of the Class B Common Stock. The following table shows the range of high, low-end and closing bid prices for Royal Bancshares' stock as reported by NASDAQ.
Bid Prices ---------- 2003 High Low Close ---- ---- --- ----- First Quarter ............................... $21.127 $17.402 $19.078 Second Quarter .............................. 21.569 18.990 21.000 Third Quarter ............................... 26.912 20.520 26.324 Fourth Quarter .............................. 26.627 23.824 25.000 2002 High Low Close ---- ---- --- ----- First Quarter ............................... $20.598 $18.132 $19.037 Second Quarter .............................. 20.227 18.561 20.379 Third Quarter ............................... 20.750 16.181 17.419 Fourth Quarter .............................. 20.893 16.828 20.369 (Source: This summary reflects information supplied by NASDAQ.)
The bid information shown above is derived from statistical reports of the NASDAQ Stock Market and reflects inter-dealer prices without retail mark-up, mark-down or commissions and may not necessarily represent actual transaction. The bid prices reflect the 2% stock dividend that was declared on January 21, 2004. The NASDAQ Stock Market, Inc., is a wholly-owned subsidiary of National Association of Securities Dealers, Inc. The approximate number of recorded holders of Royal Bancshares' Class A and Class B Common Stock, as of February 29, 2004, is shown below:
Title of Class Number of Record Holders -------------- ------------------------ Class A Common Stock 370 Class B Common Stock 133
Because substantially all of the holders of Class B Common Stock are also holders of Class A Common stock the number of record holders of the two classes on a combined basis was approximately 417 as of February 29, 2004. 14 Securities Authorized for Issuance Under Equity Compensation Plans ------------------------------------------------------------------ The following two tables discloses the number of outstanding options, warrants and rights granted by the Company to participants in equity compensation plans, as well as the number of securities remaining available for future issuance under the plans. The tables provide this information separately for equity compensation plans that have and have not been approved by security holders.
(c) Number of securities (a) remaining available for Number of securities to (b) future issuance under be issued upon Weighted-average equity compensation exercise of outstanding exercise price of plans (excluding options, warrants and outstanding options, securities reflected in rights warrants and rights column (a)) ---------------------- --------------------- --------------------- Outside Directors Stock Option Plan ----------------------------------- Equity compensation plan approved by stockholders 70,061 $15.21 84,937 Equity compensation plan not approved by stockholders -- -- -- ---------------------- --------------------- Total 70,061 $15.21 84,937
(c) Number of securities (a) remaining available for Number of securities to (b) future issuance under be issued upon Weighted-average equity compensation exercise of outstanding exercise price of plans (excluding options, warrants and outstanding options, securities reflected in rights warrants and rights column (a)) ---------------------- --------------------- --------------------- Employees Stock Option Plan --------------------------- Equity compensation plan approved by stockholders 420,032 $16.08 251,112 Equity compensation plan not approved by stockholders -- -- -- ---------------------- --------------------- Total 420,032 $16.08 251,112
Dividends --------- Subject to certain limitations imposed by law, the Board of Directors of Royal Bancshares may declare a dividend on shares of common stock. Stock dividends. On April 21, 1999, the Board of Directors of Royal Bancshares declared a 4% stock dividend on both its Class A Common Stock and Class B Common Stock shares payable May 14, 1999, to shareholders of record on May 3, 1999. The stock dividend resulted in the issuance of 288,728 additional shares of Class A Common Stock and 65,296 additional shares of Class B Common Stock. On October 20, 1999, the Board of Directors of Royal Bancshares declared a 5% stock dividend on both its Class A Common Stock and Class B Common Stock shares payable on January 17, 2000, to shareholders of record on January 3, 2000. The stock dividend resulted in the issuance of 382,857 additional shares of Class A Common Stock and 84,234 additional shares of Class B Common Stock. 15 On January 17, 2001, the Board of Directors of Royal Bancshares declared a 5% stock dividend on both its Class A Common Stock and Class B Common Stock shares payable on February 12, 2001, to shareholders of record on January 29, 2001. The stock dividend resulted in the issuance of 408,197 additional shares of Class A Common Stock and 86,614 additional shares of Class B Common Stock. On January 16, 2002, the Board of Directors of Royal Bancshares declared a 6% stock dividend on both its Class A Common Stock and Class B Common Stock shares payable on February 8, 2002, to shareholders of record on January 28, 2002. The stock dividend resulted in the issuance of 517,635 additional shares of Class A common stock and 108,282 additional shares of Class B common stock. On January 15, 2003, the Board of Directors of Royal Bancshares declared a 3% stock dividend on both its Class A Common Stock and Class B Common Stock shares payable on February 12, 2003, to shareholders of record on January 29, 2003. The stock dividend resulted in the issuance of 281,196 additional shares of Class A common stock and 55,820 additional shares of Class B common stock. On January 21, 2004, the Board of Directors of Royal Bancshares declared a 2% stock dividend on both its Class A Common Stock and Class B Common Stock shares payable on February 18, 2004, to shareholders of record on February 4, 2004. The stock dividend resulted in the issuance of 195,861 additional shares of Class A common stock and 38,216 additional shares of Class B common stock. Future stock dividends, if any, will be at the discretion of the Board of Directors and will be dependent on the level of earnings and compliance with regulatory requirements. Cash Dividends. Royal Bancshares paid cash dividends in each quarter of 2003 and 2002 for holders of Class A Common Stock and for holders of Class B Common Stock. This resulted in a charge to retained earnings of approximately $11.3 million and $10.6 million for 2003 and 2002, respectively. The following table sets forth on a quarterly basis the dividend paid to holders of each Class A and Class B Common Stock for 2003 and 2002, adjusted to give effect to the stock dividends paid.
Cash Dividends Per Share ------------------------ 2003 Class A Class B ---- ------- ------- First Quarter ....................................... $.2375 $.2731 Second Quarter ...................................... $.2375 $.2731 Third Quarter ....................................... $.2375 $.2731 Fourth Quarter ...................................... $.2500 $.2875
Cash Dividends Per Share ------------------------ 2002 Class A Class B ---- ------- ------- First Quarter........................................ $.2300 $.2645 Second Quarter....................................... $.2300 $.2645 Third Quarter........................................ $.2300 $.2645 Fourth Quarter....................................... $.2375 $.2731
Future dividends must necessarily depend upon net income, capital requirements, appropriate legal restrictions and other factors relevant at the time the Board of Directors of Royal Bancshares considers dividend policy. Cash necessary to fund dividends available for dividend distributions to the shareholders of Royal Bancshares must initially come from dividends paid by Royal Bank to Royal Bancshares. Therefore, the restrictions on the Royal Bank's dividend payments are directly applicable to Royal Bancshares. Under the Pennsylvania Banking Code of 1965, as amended, Royal Bank places a restriction on the availability of capital surplus for payment of dividends. Under the Pennsylvania Business Corporation Law of 1988, as amended, Royal Bancshares may pay dividends only if after payment the Registrant would be able to pay its debts as they become due in the usual course of business and the total assets are greater than the sum of its total liabilities plus the amount that would be needed if Royal Bancshares were to be dissolved at the time of the dividend to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the dividend. See Regulatory Matters Note to the Consolidated Financial Statements in Item 8 of this report. 16 ITEM 6. SELECTED FINANCIAL DATA ------------------------------- The following selected consolidated financial and operating information for Royal Bancshares should be read in conjunction with ITEM 7, Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements and accompanying notes in ITEM 8:
Years ended December 31, (in thousands, except per share data) --------------------------------------------- 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- Income Statement Data (in thousands) ------------------------------------ Interest income $72,320 $77,104 $69,224 $58,875 $44,682 Interest expense 29,941 36,491 31,808 22,549 15,922 ------- ------- ------- ------- ------- Net interest income 42,379 40,613 37,416 36,326 28,760 Provision for loan losses 674 250 -- 250 -- ------- ------- ------- ------- ------- Net interest income after loan losses 41,705 40,363 37,416 36,076 28,760 Gains on sale of loans 637 767 372 -- 45 Gains on sale of real estate 568 455 188 53 350 Gains (losses) on investment securities 719 790 60 (1,302) -- Other income 1,780 1,188 1,118 1,207 1,644 ------- ------- ------- ------- ------- Total other income 3,704 3,200 1,738 (42) 2,039 Income before other expenses & income taxes 45,410 43,563 39,154 36,034 30,799 Non-interest expense Salaries and benefits 9,959 9,440 10,479 7,979 7,265 Other 8,929 9,481 7,124 5,813 5,865 ------- ------- ------- ------- ------- Total operating expenses 18,888 18,921 17,603 13,792 13,130 ------- ------- ------- ------- ------- Income before taxes 26,522 24,642 21,551 22,242 17,669 Incomes taxes 7,996 7,237 5,797 7,982 5,564 ------- ------- ------- ------- ------- Net income $18,526 $17,405 $15,754 $14,260 $12,105 ======= ======= ======= ======= ======= Basic earnings per share (1) $ 1.52 $ 1.44 $ 1.32 $ 1.20 $ 1.03 ------- ------- ------- ------- ------- Diluted earnings per share (1) $ 1.52 $ 1.41 $ 1.30 $ 1.18 $ 1.02 ------- ------- ------- ------- -------
(1) Earnings per share has the weighted average number of shares used in the calculation adjusted to reflect a 2% stock dividend in 2004, a 3% stock dividend in January 2003, a 6% stock dividend in 2002, a 5% stock dividend in 2001, a 5% stock dividend in 2000, and a 4% stock dividend in 1999.
As of December 31, ---------------------------------------------------------------- Balance Sheet Data (in thousands) 2003 2002 2001 2000 1999 --------------------------------- ---- ---- ---- ---- ----- Total assets $1,154,410 $1,088,484 $930,980 $630,081 $522,536 Total average assets 1,160,354 1,048,875 788,419 573,780 469,193 Loans, net 503,288 564,264 634,347 411,973 343,081 Total deposits 791,059 820,840 701,860 472,582 381,286 Total long term debt 212,000 124,500 70,225 30,000 30,000 Total stockholders equity 134,833 121,331 108,449 103,502 95,835 Total average stockholders equity 127,728 114,655 105,072 99,746 94,824 Return on average assets 1.6% 1.7% 2.0% 2.5% 2.6% Return on average equity 14.5% 15.2% 15.0% 14.3% 12.8% Average equity to average assets 11.0% 10.9% 13.3% 17.4% 20.2% Cash dividend payout ratio 61.1% 60.8% 56.9% 55.0% 70.3%
17 Average Balances ---------------- The following table represents the average daily balances of assets, liabilities and shareholders' equity and the respective interest paid on interest bearing assets and interest bearing liabilities, as well as average rates for the periods indicated:
2003 2002 2001 ----------------------------- ----------------------------- ----------------------------- Average Yield/ Average Yield/ Average Yield/ Assets (In thousands) Balance Interest Rate Balance Interest Rate Balance Interest Rate --------------------- ---------- -------- ---- ---------- -------- ---- ------- -------- -------- Interest bearing deposits $ 40,856 $ 475 1.16% $ 32,760 $ 682 2.08% $ 18,230 $ 533 2.92% Federal funds 13,598 142 1.04% 16,780 272 1.62% 18,468 752 4.07% Investment securities Held to maturity 46,302 3,087 6.67% 53,226 4,019 7.55% 97,055 7,610 7.84% Available for sale 446,210 22,007 4.93% 297,457 18,817 6.33% 76,338 6,945 9.10% ---------- ------- ----- ---------- ------- ----- -------- ------- -------- Total investment securities 492,512 25,094 5.10% 350,683 22,836 6.51% 173,392 14,555 8.39% Loans Commercial and Industrial 225,224 15,812 7.02% 230,556 17,020 7.38% 202,327 20,012 9.89% Real estate secured 333,168 30,532 9.16% 383,816 36,070 9.40% 337,410 32,936 9.76% Other loans 4,373 265 6.06% 2,784 224 8.05% 4,116 436 10.59% ---------- ------- ----- ---------- ------- ----- -------- ------- -------- Total loans 562,765 46,609 8.28% 617,156 53,314 8.64% 543,854 53,384 9.82% ---------- ------- ----- ---------- ------- ----- -------- ------- -------- Total interest earnings 1,109,731 72,320 6.52% 1,017,379 77,104 7.58% 753,944 69,224 9.18% assets Non interest earnings assets Cash & due from banks 8,348 8,597 5,432 Other assets 56,781 38,039 46,113 Allowance for loan loss (12,472) (12,108) (12,264) Unearned discount (2,033) (3,032) (4,806) ---------- ---------- -------- Total non-interest earning assets 50,624 31,496 34,475 ---------- ---------- -------- Total assets $1,160,354 $1,048,875 $788,419 ========== ========== ======== Liabilities & Shareholders' Equity ---------------------------------- Deposits: Savings $ 23,714 $ 182 0.77% $ 25,658 $ 370 1.44% $ 26,312 $ 637 2.42% Now 32,510 339 1.04% 34,866 697 2.00% 38,353 869 2.27% Money market 442,873 9,661 2.18% 270,454 8,491 3.14% 108,792 4,031 3.71% Time deposits 269,293 12,011 4.46% 385,370 19,358 5.02% 369,680 22,237 6.02% ---------- ------- ----- ---------- ------- ----- -------- ------- -------- Total interest bearing deposits 768,390 22,193 2.89% 716,348 28,916 4.04% 543,137 27,774 5.11% Federal funds -- -- -- -- -- -- 334 15 4.49% Borrowings 183,339 7,748 4.23% 137,460 7,575 5.51% 68,129 4,019 5.90% ---------- ------- ----- ---------- ------- ----- -------- ------- -------- Total interest bearing liabilities 951,729 29,941 3.15% 853,808 36,491 4.27% 611,600 31,808 5.20% ---------- ------- ----- ---------- ------- ----- -------- ------- -------- Non interest bearing deposits 56,814 53,800 49,903 Other liabilities 24,083 26,612 21,844 ---------- ---------- -------- Total liabilities 1,032,626 934,220 683,347 Shareholders' equity 127,728 114,665 105,072 ---------- ---------- -------- Total liabilities and Shareholders' equity $1,160,354 $1,048,875 $788,419 ========== ========== ======== Net interest income $42,379 $40,613 $37,416 ======= ======= ======= 3.82% 3.99% 4.96% ===== ===== ========
(1) The indicated income and annual rate are presented in a taxable equivalent basis using the federal tax rate of 34% for all periods. (2) Nonaccruing loans have been included in the appropriate average loan balance category, but interest on these loans has not been included. 18 Rate Volume ----------- The following table sets forth a rate/volume analysis, which segregates in detail the major factors contributing to the change in net interest income for the years ended, December 31, 2003 and 2002, as compared to respective previous periods, into amounts attributable to both rate and volume variances.
2003 Vs 2002 2002 Vs 2001 Changes due to: Changes due to: ------------------------------ ------------------------------ Interest income Volume Rate Total Volume Rate Total --------------- ------- ------- ------- ------- -------- -------- (In thousands) ------------ Interest bearing deposits in banks $ 142 ($349) ($207) $ 335 ($186) $ 149 Federal funds sold (45) (85) (130) (63) (417) (480) Investments securities Held to maturity (491) (441) (932) (3,319) (272) (3,591) Available for sale 7,972 (4,782) 3,190 14,579 (2,707) 11,872 ------- ------- ------- ------- -------- ------- Total investment securities 7,481 (5,223) 2,258 11,260 (2,979) 8,281 Loans Commercial and industrial (387) (821) (1,208) 2,541 (5,533) (2,992) Mortgages secured by real estate (4,659) (880) (5,538) 4,397 (1,262) 3,135 Other loans 106 (65) 41 (122) (90) (212) ------- ------- ------- ------- -------- ------- Total loans (4,940) (1,766) (6,705) 6,816 (6,885) (69) ------- ------- ------- ------- -------- ------- Total increase (decrease) in interest income 2,638 (7,423) (4,784) 18,348 (10,467) 7,881 Interest expense ---------------- Deposits Savings ($26) ($162) ($188) ($15) ($252) ($267) Now and Money Market 4,109 (3,297) 812 4,789 (501) 4,288 Time deposits (5,353) (1,994) (7,347) 913 (3,792) (2,879) ------- ------- ------- ------- -------- ------- Total deposits (1,270) (5,453) (6,723) 5,687 (4,545) 1,142 Federal funds purchase -- -- -- (7) (8) (15) Borrowings 2,182 (2,009) 173 3,837 (281) 3,556 ------- ------- ------- ------- -------- ------- Total increase (decrease) in interest expense 912 (7,462) (6,550) 9,517 (4,834) 4,683 Total increase (decrease) in net interest income $ 1,726 $ 39 $ 1,766 $ 8,831 ($5,633) $ 3,198 ======= ======= ======= ======= ======== =======
19 Loans ----- The following table reflects the composition of the loan portfolio of Royal Bank and the percent of gross outstandings represented by each category at the dates indicated.
As of December 31, (in thousands) ------------------------------------------------------------------------------------------ 2003 2002 2001 2000 1999 ---------------- --------------- ---------------- --------------- ---------------- Loans ----- Comm'l and Industrial $225,268 44% $241,373 42% $218,498 34% $193,398 45% $168,329 47% Real Estate Secured 286,997 55% 333,972 57% 417,028 64% 230,999 54% 189,459 52% Other 4,942 1% 3,509 1% 13,909 2% 4,561 1% 4,506 1% -------- ------ -------- ----- -------- ----- -------- ----- -------- ----- Total gross loans 517,207 100% 578,854 100% 649,435 100% 428,958 100% 362,294 100% Unearned income (1,203) (1,082) (1,056) (1,992) (2,154) Discount on loans purchased (290) (1,038) (2,144) (3,020) (5,322) -------- -------- -------- -------- -------- 515,714 576,734 646,235 423,946 354,818 Allowance for loan loss (12,426) (12,470) (11,888) (11,973) (11,737) -------- -------- -------- -------- -------- Total net loans $503,288 $564,264 $634,347 $411,973 $343,081 ======== ======== ======== ======== ========
Analysis of Allowance for Loan Loss -----------------------------------
Year ending December 31, (in thousands) --------------------------------------------------------------- 2003 2002 2001 2000 1999 ---------- ----------- ---------- ---------- ---------- Total Loans $ 515,714 $ 576,734 $ 646,235 $ 423,946 $ 354,818 ========= ========== ========= ========= ========= Daily average loan balance $ 562,765 $ 617,156 $ 543,854 $ 404,794 $ 320,544 ========= ========== ========= ========= ========= Allowance for loan loss: Balance at the beginning of the year $ 12,470 $ 11,888 $ 11,973 $ 11,737 $ 11,919 Charge offs by loan type: Commercial 22 47 82 523 1,062 Real estate 789 878 435 105 13 --------- ---------- --------- --------- --------- Total charge offs 811 925 517 628 1,075 Recoveries by loan type: Commercial 26 19 212 596 850 Individual 2 32 32 4 36 Real estate 65 1,206 188 14 7 --------- ---------- --------- --------- --------- Total recoveries 93 1,257 432 614 893 --------- ---------- --------- --------- --------- Net loan charge offs (718) 332 (85) (14) (182) Provision for loan loss 674 250 -- 250 -- --------- ---------- --------- --------- --------- Balance at end of year $ 12,426 $ 12,470 $ 11,888 $ 11,973 $ 11,737 ========= ========== ========= ========= ========= Net charge offs to average loans (0.13%) 0.05% (0.02%) -- (0.06%) ========= ========== ========= ========= ========= Allowance to total loans at year end 2.41% 2.16% 1.84% 2.82% 3.31% ========= ========== ========= ========= =========
The allowance for loan losses is established through provisions for loan losses based on management's on-going evaluation of the risks inherent in Royal Bank's loan portfolio. Factors considered in the evaluation process include growth of the loan portfolio, risk characteristics of the types of loans in the portfolio, geographic and large borrower concentrations, current regional economic and real estate market conditions that could affect the ability of borrowers to pay, the value of underlying collateral, and trends in loan delinquencies and charge-offs. 20 Royal Bank utilizes an internal rating system to monitor and evaluate the credit risk inherent in its loan portfolio. All loans approved by the loan committee, executive board committee and the Board of Directors are initially assigned a rating of pass. The Vice President of Special Assets and the loan review committee are expected to recommend changes in loan ratings when facts come to their attention that warrant an upgrade or downgrade in a loan rating. Problem and potential problem assets are assigned the three lowest ratings. Such ratings coincide with the "Substandard", "Doubtful" and "Loss" classifications used by federal regulators in their examination of financial institutions. Generally, an asset is considered Substandard if it is inadequately protected by the current net worth and paying capacity of the obligors and/or the collateral pledged. Substandard assets have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Assets classified as Doubtful have all the weaknesses inherent in those classified Substandard with the added characteristics that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, highly questionable and improbable. Assets classified as Loss are those considered uncollectable and of such little value that their continuance as assets is not warranted. On a regular basis, the Loan Review Committee and senior management review the status of each loan. While Royal Bank believes that it has established an adequate allowance for loan losses, there can be no assurance that the regulators, in reviewing Royal Bank's loan portfolio, will not request the company to materially increase its allowances for loan losses. Although management believes that adequate specific and general loan loss allowances have been established, actual losses are dependant upon future events and, as such, further additions to the level of specific and general loss allowances could become necessary. Loans and Lease Financing Receivables ------------------------------------- The following table summarizes the loan portfolio by loan category and amount that corresponds to the appropriate regulatory definitions.
As of December 31, (in thousands) -------------------------------- 2003 2002 2001 -------- -------- -------- Loans secured by real estate Construction and land development $107,463 $ 82,736 $ 64,551 Secured by 1-4 family residential properties: Revolving, open-end loans secured by 1-4 family residential properties and extended under lines of credit 5,854 7,564 35,367 All other loans secured by 1-4 family residential properties: Secured by first liens 50,716 116,248 110,351 Secured by junior liens 3,796 3,418 5,302 Secured by multi family (5 or more) residential properties 21,728 33,017 35,718 Secured by nonfarm nonresidential properties 97,902 87,448 165,547 Commercial and industrial loans to US addresses 225,268 241,373 218,498 Loans to individuals for household, family, and other personal expenditures 1,182 3,146 13,909 Obligations of state and political subdivisions in the US 3,134 3,541 192 All other loans 163 363 -- Less: Any unearned income on loans listed above 1,492 2,120 3,200 -------- -------- -------- Total loans and leases, net of unearned income $515,714 $576,734 $646,235 ======== ======== ========
21 Credit Quality -------------- The following table presents the principal amounts of nonaccruing loans and other real estate.
As of December 31, (in thousands) --------------------------------------------------------------- 2003 2002 2001 2000 1999 ---------- ----------- ---------- ---------- ---------- Non-accruing loans (1)(2) $ 11,328 $ 11,908 $ 10,794 $ 3,548 $ 1,209 Other real estate 4,371 1,444 884 - 19 ---------- ----------- ----------- ---------- ---------- Total nonperforming assets $ 15,699 $ 13,352 $ 11,678 $ 3,548 $ 1,228 ========== =========== ========== ========== ========== Nonperforming assets to total assets 1.36% 1.23% 1.25% 0.56% 0.24% ========== =========== ========== ========== ========== Nonperforming loans to total loans 2.20% 2.06% 1.67% 0.84% 0.34% ========== =========== ========== ========== ========== Allowance for loan loss to nonperforming loans 109.69% 104.72% 110.14% 337.46% 970.80% ========== =========== ========== ========== ==========
(1) Generally a loan is placed on nonaccruing status when it has been delinquent for a period of 90 days or more unless the loan is both well secured and in the process of collection. (2) If interest had been accrued on these nonaccruing loans, such income would have approximated $401,000 for 2003, $473,000 for 2002, $526,000 for 2001, $319,000 for 2000, $109,000 for 1999. Investments Securities ---------------------- The contractual maturity distribution and weighted average rate of Royal Bancshares' investments held to maturity and available for sale portfolios at December 31, 2003 are presented in the following table. Weighted average rate on tax-exempt obligations have been computed on a fully taxable equivalent basis assuming a tax rate of 34%.
As of December 31, 2003 (in thousands) ----------------------------------------------------------------------------------------------- After 1 year but After 5 years, but Within 1 year within 5 years within 10 years After 10 years Total ----------------- ----------------- -------------------- ---------------- ----------------- Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate -------- ------ -------- ------ -------- ------ -------- ------ -------- ------- Securities held to maturity --------------------------- M.B.S. $ 9 7.7% $ 60 7.6% $ 33 11.0% $ 238 5.8% $ 340 6.7% Agencies -- --% -- --% 49,282 4.5% 42,348 5.0% 91,630 4.8% Other securities 4,131 6.8% 16,990 8.1% -- --% -- --% 21,121 7.8% -------- ------ -------- ------ -------- ------ -------- ------ -------- ------- Total $ 4,140 6.8% $ 17,050 8.1% $ 49,315 4.5% $ 42,586 5.0% $113,091 5.3% ======== ====== ======== ====== ======== ====== ======== ====== ======== ======= Available for sale ------------------ M.B.S. $ 23 9.3% $ 6,492 5.5% $ -- --% $ 61,198 5.0% $ 67,713 5.0% CMO'S -- --% -- --% -- --% 44,162 5.0% 44,162 5.0% Foreign 266 8.8% 11,900 7.3% -- --% -- --% 12,166 7.3% Trust Preferred -- --% -- --% -- --% 37,139 9.7% 37,139 9.7% Other securities 20,848 6.7% 138,626 6.3% 95,772 4.4% 35,819 4.9% 291,066 4.9% -------- ------ -------- ------ -------- ------ -------- ------ -------- ------- Total $ 21,137 6.8% $150,018 6.3% $ 95,772 4.4% $178,318 5.6% $452,246 5.4% ======== ====== ======== ====== ======== ====== ======== ====== ======== =======
The following tables presents the consolidated book values and approximate fair value at December 31, 2003 and 2002, respectively, for each major category of Royal Bancshares' investment securities portfolio for held to maturity securities and available for sale securities. 22
As of December 31, (in thousands) ---------------------------------------------------------------------------- 2003 2002 2001 ----------------------- ------------------------ ----------------------- Amortized Fair Amortized Fair Amortized Fair Cost Value Cost Value Cost Value ---------- ---------- ----------- ---------- ---------- ---------- Securities held to maturity --------------------------- Mortgage backed securities $ 340 $ 340 $ 538 $ 538 $ 1,077 $ 1,078 US agencies 91,630 91,333 -- -- 35,000 34,679 Other securities 21,121 22,602 30,076 32,207 56,826 58,868 ---------- ---------- ----------- ---------- ---------- ---------- Total $ 113,091 $ 114,275 $ 30,614 $ 32,745 $ 92,903 $ 94,625 ========== ========== =========== ========== ========== ========== Securities available for sale ----------------------------- Federal Home Loan Bank stock $ 11,407 $ 11,407 $ 8,949 $ 8,949 $ 4,875 $ 4,875 Preferred and common stock 40 55 56 56 39 54 Other securities 431,080 440,784 405,667 409,311 128,888 124,826 ---------- ---------- ----------- ---------- ---------- ---------- Total $ 442,527 $ 452,246 $ 414,672 $ 418,316 $ 133,802 $ 129,755 ========== ========== =========== ========== ========== ==========
Deposits -------- The average balance of Royal Bank's deposits by major classifications for each of the last three years is presented in the following table.
As of December 31, (in thousands) -------------------------------------------------------------------------- 2003 2002 2001 ---------------------- ---------------------- --------------------- Average Average Average Balance Rate Balance Rate Balance Rate ---------- ------ ----------- ----- ---------- ----- Demand deposits: Non interest bearing $ 56,814 --% $ 53,800 --% $ 49,903 --% Interest bearing (NOW) 32,510 1.04% 34,866 2.00% 38,353 2.27% Money market deposits 442,873 2.18% 270,454 3.14% 108,792 3.71% Savings deposits 23,714 0.77% 25,658 1.44% 26,312 2.42% Certificate of deposit 269,293 4.46% 385,370 5.02% 369,680 6.02% ---------- ----------- ---------- Total deposits $ 825,204 $ 770,148 $ 593,040 ========== =========== ==========
The remaining maturity of Certificates of Deposit of $100,000 or greater:
As of December 31, (in thousands) ----------------------- Maturity 2003 2002 -------- ---------- ---------- Three months or less $ 6,396 $ 57,804 Over three months through twelve months 47,549 28,694 Over twelve months through five years 46,128 77,244 Over five years 4,050 17,236 ---------- ---------- Total $ 104,123 $ 180,978 ========== ==========
23 Short and Long Term Borrowings ------------------------------
Year ending December 31, (in thousands) --------------------------------------------------------------- 2003 2002 2001 2000 1999 ---------- ----------- ---------- ---------- ---------- Short term borrowings $ -- $ 3,000 $ 30,000 $ 3,000 $ -- Long term borrowings: Other borrowings -- -- 2,725 -- -- FHLB advances 212,000 124,500 67,500 30,000 30,000 ---------- ----------- ---------- ---------- ---------- Total borrowings $ 212,000 $ 127,500 $ 100,225 $ 33,000 $ 30,000 ========== =========== ========== ========== ==========
ITEM 7. MANAGEMENT'S DISCUSSIONS AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS -------------------------------------------------------------------------------- OF OPERATIONS ------------- The following discussion and analysis of financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements of Royal Bancshares (see Item 8) and related notes included herein. Financial Condition ------------------- Total assets increased $66 million, or 6%, to $ 1.15 billion at December 31, 2003 from $1.09 billion at year-end 2002. Cash and Cash Equivalents. Cash and cash equivalents are comprised of cash on hand, and cash in interest bearing and non-interest bearing accounts in banks, in addition to federal funds sold. Cash and cash equivalents decreased $15.5 million, to $25.1 million at December 31, 2003. The average balance of cash and cash equivalents was approximately $62.8 million for 2003 versus $58.1 million for 2002. The majority of this average balance is held in interest-bearing accounts or invested daily in overnight fed funds. The average balance of these funds that earn interest was $54.5 million in 2003. The decrease in the balance of cash and cash equivalents at year end was primarily due to re-investing cash on hand into higher yielding investments. Investment Securities Held to Maturity. Held to maturity ("HTM") investment securities represents approximately 4% of average earning assets during 2003 and are comprised of primarily government agency bonds and corporate debt securities of investment grade quality, at the time of purchase. During 2003, HTM investment securities increased by $82.5 million to $113.1 million at December 31, 2003, from $30.6 million at December 31, 2002. Investment Securities Available for Sale. AFS investment securities represent 40% of average earning assets during 2003 and are primarily comprised of government secured agency bonds and government secured mortgaged-backed securities, capital trust security issues of regional banks, domestic corporate debt and U.S. denominated foreign corporate debt. At December 31, 2003, AFS investment securities were $452.2 million as compared to $418.3 million at December 31, 2002, an increase of $33.9 million. This increase was primarily due to the redeployment of excess cash on hand to achieve a higher rate of return. Loans. Royal Bancshares' primary earning assets are loans, representing approximately 51% of average earning assets during 2003. The loan portfolio has historically been comprised primarily of business demand loans and commercial mortgages in roughly equal amounts, and to a significantly lesser extent, consumer loans comprised of one to four family residential and home equity loans. During 2003, total loans decreased $61.0 million from $576.7 million at December 31, 2002 to $515.7 million at December 31, 2003 primarily due to an increased number of loans being paid in full as compared to new originations. In the current interest rate environment, Royal Bank has avoided lending in transactions where its management perceived the risk/reward ratio to be too high. 24 Deposits. Royal Bancshares' deposits are the primary source of funding. Total deposits decreased $29.7 million, or 4%, from $820.8 million at December 31, 2002 to $791.1 million at December 31, 2003. This decrease in deposits is primarily due to maturities of higher costing brokered deposits that matured were and replaced with lower costing FHLB advances. At December 31, 2003, brokered deposits were $80.9 million as compared to $127 million at December 31, 2002. Certificate of deposit accounts decreased $93.3 million, or 28% from $330.2 million at December 31, 2002 to $236.9 million at December 31, 2003. Other deposit categories comprised of demand, NOW, money markets and savings deposits increased $63.5 million during 2003 over their levels at December 31, 2002. The increase in all savings categories is primarily due to the competitive rates offered. Borrowings. Borrowings are comprised of long-term borrowings (advances) and short-term borrowings (overnight borrowings, advances). Long-term borrowings increased $87.5 million to $212.0 million at December 31, 2003 from $124.5 million at December 31, 2002. At December 31, 2003 there was no short term advances. The average balance of borrowings during 2003 was $183.3 million versus $137.5 million for 2002. Shareholders' Equity. Shareholders' equity increased $13.5 million or 11% in 2003 to $134.8 million primarily due to net income of $18.5 million partially offset by $11.3 million in cash dividends paid in 2003. Additionally, shareholders' equity was affected by the increase in market value of AFS investment securities during 2003, which resulted in an upward adjustment of $4 million. Results of Operations --------------------- General. Royal Bancshares' results of operations depend primarily on net interest income, which is the difference between interest income on interest earning assets and interest expense on interest bearing liabilities. Interest earning assets consist principally of loans and investment securities, while interest bearing liabilities consist primarily of deposits. Net income is also affected by the provision for loan losses and the level of non-interest income as well as by non-interest expenses, including salary and employee benefits, occupancy expenses and other operating expenses. Net Income. Net income in 2003 was $18.5 million as compared to $17.4 million in 2002 and $15.8 million in 2001. Basic earnings per share were $1.52, $1.44 and $1.32 for 2003, 2002, and 2001, respectively. The $1.1 million increase in net income for 2003 represents a 6% increase over 2002, and is primarily attributable to the reduction of interest paid on deposits and borrowings as compared to the interest income earned relating to loans and the investment security portfolio, and to a lesser extent, non-recurring fee and accretion income on loans. The increase in net income of $1.6 million for 2002 represents a 10% increase over 2001 and is primarily attributable to the increase in interest income relating to loans and the investment security portfolio. Net Interest Income. Net interest income is Royal Bancshares' primary source of income. Its level is a function of the average balance of interest-earning assets, the average balance of interest-bearing liabilities, and the spread between the yield on assets and liabilities. In turn, these factors are influenced by the pricing and mix of Royal Bancshares' interest-earning assets and funding sources. Additionally, net interest income is affected by market and economic conditions, which influence rates on loan and deposit growth. Net interest income was $42.4 million in 2003 as compared to $40.6 million in 2002. The increase in 2003 of net interest income of $1.8 million is primarily due to the reduction of interest paid on deposits and borrowings. Interest paid on interest bearing liabilities decreased $6.6 million from $36.5 million in 2002, to $29.9 million in 2003. The reduction is primarily due the reduction of rates offered during 2003. Net interest income was $40.6 million in 2002 compared to $37.4 million in 2001. The increase in 2002 of net interest income of $3.2 million is primarily due to an increase in the average earning assets in 2002 to $1.02 billion. This is an increase of $263 million, or 35% over the level for 2001. This increase in average interest earning assets contributed to a $7.9 million increase in interest income to $77.1 million in 2002, as compared to $69.2 million in 2001. Interest expense on interest bearing liabilities increased $4.7 million, to $36.5 million in 2002, from $31.8 million in 2001. The increase is primarily due to an increase in the average balance of interest-bearing liabilities, primarily deposits in 2002 to $853.8 million from $611.6 million in 2001. 25 Loans and Mortgages -------------------
2003 2002 2001 ---- ---- ---- Average loan outstandings $562,765,000 $617,156,000 $543,854,000 Interest and fees on loans $46,609,000 $53,314,000 $53,384,000 Average Yield 8.28% 8.64% 9.82%
Royal Bancshares continues to originate both fixed rate and variable rate loans. At December 31, 2003 variable rate loans represented 55% of total loans. Together with some matching funding of fixed rate deposits to fixed rate loans, variable rate loans have helped Royal Bank manage interest rate risk. However, the continued effects from the 12 interest rate cuts during 2002 and 2001 caused the variable rate loan portfolio to reprice faster than most deposits, resulting in continued compression of the bank interest rate margin versus prior years. In 2003, the average balance of loans decreased $54.3 million to $562.8 million primarily due a large amount of loans being paid off as interest rates remained at historically low levels. The average yield on loans decreased 36 basis points in 2003 primarily due to interest rates re-pricing at lower levels on variable rate loans. In 2002, the average balance of loans increased $73.3 million to $617.2 million primarily due to retaining a large amount of loans purchased from Crusader Holding Corporation on June 22, 2001. The average yield on loans decreased 118 basis points in 2002 primarily due to the continued decline of interest rates during the year. HTM Investment Securities -------------------------
2003 2002 2001 ---- ---- ---- Average HTM investment securities $46,302,000 $53,226,000 $97,055,000 Interest income $3,087,000 $4,019,000 $7,610,000 Average yield 6.67% 7.55% 7.84%
HTM investment securities are comprised primarily of taxable corporate debt issues and US Treasuries and agencies. The corporate debt issues are investment grade at the time of purchase, with maturities in the three to fifteen year range. It is Royal Bancshares' expressed intention to hold these securities to maturity. In 2003, the yield on HTM investment securities decreased 88 basis points to 6.67% from 7.55% in 2002. This decrease was primarily due to higher yielding investments that have maturing and being replaced with lower yielding investments as a result of current market conditions. In 2002, the yield on HTM investment securities decreased 29 basis points to 7.55% from 7.84% in 2001. This decrease was primarily due to higher yielding investments that have matured. AFS Investment Securities -------------------------
2003 2002 2001 ---- ---- ---- Average AFS investment securities $446,210,000 $297,457,000 $76,338,000 Interest and dividend income $22,007,000 $18,817,000 $6,945,000 Average yield 4.93% 6.33% 9.10%
26 AFS investment securities are comprised primarily of government secured mortgage-backed securities non-rated capital trust security issues of regional banks, rated domestic and US denominated foreign corporate debt securities and to a lesser extent preferred and common stock. In 2003, the average balance of AFS investment securities increased $148.8 million to $446.2 million primarily due to the redeployment of excess cash on hand to achieve a higher rate of return than overnight funds. The 140 basis point decrease in average yield is primarily due to the lower yields on the new investment purchases. In 2002, the average balance of AFS investment securities increased $221.1 million to $297.5 million primarily due to the redeployment of excess cash on hand to achieve a higher rate of return and a change in investment philosophy in classifying most new security investments as AFS. The 277 basis point decrease in average yield is primarily due to the declining interest rate environment. Interest Expense on NOW and Money Market Deposits -------------------------------------------------
2003 2002 2001 ---- ---- ---- Average NOW & Money Market deposits $475,383,000 $305,320,000 $147,145,000 Interest expense $10,000,000 $9,188,000 $4,900,000 Average cost of funds 2.10% 3.01% 3.33%
In 2003 the average cost of funds on NOW and money market deposits decreased 91 basis points to 2.10% from 3.01% in 2002 primarily due to a decline in the interest rate paid on these deposits. In 2002, the average cost of funds on NOW and money market deposits decreased 32 basis points to 3.01% from 3.33% for 2001, primarily due to a decline in interest rate paid on these deposits. Interest Expense on Time Deposits ---------------------------------
2003 2002 2001 ---- ---- ---- Average time deposits $269,293,000 $385,370,000 $369,680,000 Interest expense $12,011,000 $19,358,000 $22,237,000 Average cost of funds 4.46% 5.02% 6.02%
In 2003, the average balance of time deposits decreased $116.1 million to $269.3 million. This decrease in average time deposits is primarily due to the maturity of higher yielding brokered deposits. In 2002, the average balance of time deposits increased $15.7 million to $385.4 million. This increase in time deposits is primarily due to the asset and liability acquisition of Crusader Holding Corporation on June 22, 2001, being reflected on the records of Royal Bank for a full twelve months in 2002 as compared for six months during 2001. Although rates in general continued to move downward in 2003, the reaction of deposits to rate changes (both increases and decreases) is slower than the change in the prime rate because these time deposits must mature before a rate adjustment would become effective. At December 31, 2003, 44% of time deposits were comprised of certificates of deposits accounts with balances of $100,000 or more, while in 2002, 55% of time deposits were comprised of certificates of deposit accounts with balances of $100,000 or more. These types of deposit have traditionally been considered more rate volatile than other types of deposits, however Royal Bank's penalty for early redemption somewhat mitigates this volatility. Provision for Possible Loan Losses ---------------------------------- The provision for loan losses is an amount charged to expense to provide for future losses on existing loans. In order to determine the amount of the provision for loan loss, Royal Bank conducts a quarterly review of the loan portfolio to evaluate overall credit quality. This evaluation consists of an analysis of individual loans and overall risk characteristics and size of the loan, and takes into consideration current economic and market conditions, changes in non-performing loans, the capability of specific borrowers to repay loan obligations as well as current collateral values. 27 In 2003, a provision for loan losses was recorded at $674 thousand, as compared to $250 thousand in 2002 due to senior management assessment that the level of loan loss reserve was not adequate. Net charge-offs were $718 thousand in 2003 as compared to net recoveries of $332 thousand for 2002. In 2002, a provision for loan losses was recorded at $300 thousand, as compared to no provision being taken in 2001 due to senior management assessment that the level of loan loss reserve was not adequate. Net recoveries were $332 thousand in 2002 as compared to net charge-offs of $85 thousand for 2001. The allowance for possible loan loss at December 31, 2003 was $12.4 million, or 2.41% of net loans as compared to $12.5 million at December 31, 2002 or 2.16% of net loans, and $11.9 million at December 31, 2001, or 1.84% of net loans. Non-Interest Income ------------------- Non-interest income includes service charges on depositors' accounts, safe deposit rentals and various services such as cashing checks, issuing money orders and traveler's checks, and similar activities. In connection with the acquisition of certain assets and liabilities held by Crusader Holding Corporation, Royal Bank retained the residential mortgage department to originate residential mortgages for resale in the secondary market. Most components of non-interest income are a modest and stable source of income, with exceptions of one-time gains and losses from the sale of investments securities and other real estate owned, from period to period these sources of income may vary considerably. Service charges on depositors' accounts, safe deposit rentals and other fees are periodically reviewed by management to remain competitive with other local banks. In 2003, total non-interest income increased $0.5 million primarily due income earned on the purchase of Bank Owned Life Insurance ("BOLI") and the sale of insurance products through an affiliation with the MONY Group. In 2002, total non-interest income increased $1.5 million primarily due to gains on investment securities sold and the addition of residential mortgage division. The residential mortgage division's primary function is to originate residential mortgages for resale in the secondary market. Non-Interest Expense -------------------- Non-interest expense includes compensation and employee benefits, occupancy, advertising, FDIC insurance, state taxes, depreciation, and other expenses such as auditing, automatic teller machines (ATMs), data processing, legal, outside service charges, postage, printing and other expenses relating to other real estate owned. Non-interest expense decreased $34 thousand to $18.9 million in 2003, from $18.9 million in 2002. Salaries and employee benefits increased $519 thousand to $10.0 million in 2003, from $9.4 million in 2002. This was primarily due to annual salary increases and an increase in pension cost. Occupancy expense increased $151 thousand to $1.3 million in 2003 primarily due the addition of our Turnersville Branch. Other operating expenses decreased $704 thousand to $7.6 million in 2003. Non-interest expense increased $1.3 million to $18.9 million in 2002, from $17.6 million in 2001. This increase was offset by $1.0 million decrease in salaries and employee benefits in 2002 primarily due to a reduced required obligation to the companies stock appreciation rights program. Occupancy expense increased $61 thousand to $1.2 million in 2002. Other operating expenses increased $2.3 million to $8.3 million in 2002. Accounting for Income Taxes --------------------------- The provision for federal income taxes was $8.0 million in 2003 as compared to $7.2 million for 2002, and $5.8 million for 2001 representing an effective tax rate of 30%, 29% and 27%, respectively. The $800 thousand increase in the tax provision for 2003 was primarily due to the increased level of earnings offset by the use of tax goodwill related to the acquisition of Knoblauch State Bank in 1995. 28 Accounting for Debt and Equity Securities ----------------------------------------- Royal Bancshares accounts for investment securities in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." This standard requires investments in securities to be classified in one of three categories; held to maturity, trading or available for sale. Debt securities that Royal Bank has the positive intent and ability to hold to maturity are classified as held to maturity and are reported at amortized cost. As Royal Bank does not engage in security trading, the balance of its debt securities and any equity securities are classified as available for sale. Net unrealized gains and losses for such securities, net of tax effect, are required to be recognized as a separate component of shareholders' equity and excluded from the determination of net income. Asset Liability Management -------------------------- The primary functions of asset-liability management are to assure adequate liquidity and maintain an appropriate balance between interest earning assets and interest bearing liabilities. This process is overseen by the Asset-Liability Committee ("ALCO") which monitors and controls, among other variables, the liquidity, balance sheet structure and interest rate risk of the consolidated company within policy parameters established and outlined in the Funds, Cash Flow and Liquidity Policies and Procedures which are reviewed by the Board of Directors at least annually. Additionally, the ALCO committee meets periodically and reports on liquidity, interest rate sensitivity and projects financial performance in various interest rate scenarios. Liquidity. Liquidity is the ability of the financial institution to ensure that adequate funds will be available to meet its financial commitments as they become due. In managing its liquidity position, the financial institution evaluates all sources of funds, the largest of which is deposits. Also taken into consideration is the repayment of loans. These sources provide the financial institution with alternatives to meet its short-term liquidity needs. Longer-term liquidity needs may be met by issuing longer-term deposits and by raising additional capital. Royal Bancshares generally maintains a liquidity ratio equal to or greater than 25% of total deposits and short-term liabilities. Liquidity is specifically defined as the ratio of net cash, short term and marketable assets to net deposits and short-term liabilities. The liquidity ratio for the years ended December 31, 2003, 2002 and 2001 was 60%, 42% and 33%, respectively. Management believes that Royal Bancshares' liquidity position continues to be adequate, continues to be in excess of its peer group level and meets or exceeds the liquidity target set forth in the Asset/Liability Management Policy. Management believes that due to its financial position, it will be able to raise deposits as needed to meet liquidity demands. However, any financial institution could have unmet liquidity demands at any time. Contractual Obligations and Other Commitments. The following table sets forth contractual obligations and other commitments representing required and potential cash outflows as of December 31, 2003.
Less than More than 5 (in thousands) Total 1 year 1-3 years 4-5 years years ------------------------------------------------------------------- FHLB Advances $212,000 $ -- $ 37,500 $ -- $174,500 Operating leases 2,038 511 656 443 428 Standby letters of credit 5,099 5,066 33 Time deposits 236,902 132,710 79,125 19,451 5,616 -------- -------- -------- ------- -------- Total $456,039 $138,287 $117,314 $19,894 $180,544 ======== ======== ======== ======= ========
Interest-Rate Sensitivity. Interest rate sensitivity is a function of the repricing characteristics of the financial institution's assets and liabilities. These include the volume of assets and liabilities repricing, the timing of repricing, and the relative levels of repricing. Attempting to minimize the interest rate sensitivity gaps is a continual challenge in a changing rate environment. The interest sensitivity report examines the positioning of the interest rate risk exposure in a changing interest rate environment. Ideally the rate sensitive assets and liabilities will be maintained in a matched position to minimize interest rate risk. The interest rate sensitivity analysis is an important management tool, however, it does have some inherent shortcomings. It is a "static" analysis. Although certain assets and liabilities may have similar maturities or repricing, they may react in different degrees to changes in market interest rates. Additionally, repricing characteristics of certain assets and liabilities may vary substantially within a given period. 29 The following table summarizes repricing intervals for interest earning assets and interest bearing liabilities as of December 31, 2003, and the difference or "gap" between them on an actual and cumulative basis for the periods indicated. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. During a period of falling interest rates, a positive gap would tend to adversely affect net interest income, while a negative gap would tend to result in an increase in net interest income. During a period of rising interest rates, a positive gap would tend to result in an increase in net interest income while a negative gap would tend to affect net interest income adversely. At December 31, 2003, Royal Bancshares is in an asset sensitive positive of $69.4 million, which indicates assets will reprice somewhat faster than liabilities within one year. Interest Rate Sensitivity ------------------------- (in millions)
Days ---------------------- 1 to 5 Over 5 Non-rate Assets (1) 0 - 90 91 - 365 Years Years Sensitive Total ------------------------------------------------------------------------------ Interest-bearing deposits in banks $ 10.1 $ -- $ -- $ -- $ 7.4 $ 17.5 Federal funds sold 7.6 -- -- -- -- 7.6 Investment securities: Available for sale 38.3 20.8 301.3 91.8 -- 452.2 Held to maturity 49.4 4.3 53.6 5.8 -- 113.1 ---------------------------------------------------------------------------- Total investment securities 87.7 25.1 354.9 97.6 -- 565.3 Loans:(2) Fixed rate 25.7 45.0 149.5 5.2 -- 225.4 Variable rate 195.0 75.6 19.7 -- -- 290.3 ---------------------------------------------------------------------------- Total loans 220.7 120.6 169.2 5.2 515.7 Other assets(3) -- -- -- -- 48.3 48.3 ---------------------------------------------------------------------------- Total Assets $ 326.1 $ 145.7 $ 524.1 $ 102.8 $ 55.7 $ 1,154.4 ============================================================================ Liabilities & Capital Deposits: Non interest bearing deposits $ -- $ -- $ -- $ -- $ 58.9 $ 58.9 Interest bearing deposits 58.1 174.4 259.8 0.0 -- 492.3 Certificate of deposits 27.1 105.8 101.4 5.6 -- 239.9 ---------------------------------------------------------------------------- Total deposits 85.2 280.2 361.2 5.6 58.9 791.1 Borrowings 37.0 -- 117.5 57.5 -- 212.0 Other liabilities -- -- -- .3 16.2 16.5 Capital -- -- -- -- 134.8 134.8 ---------------------------------------------------------------------------- Total liabilities & capital $ 122.2 $ 280.2 $ 478.7 $ 63.4 $ 209.9 $ 1,154.4 ============================================================================ Net interest rate GAP $ 203.9 $ (134.5) $ 45.4 $ 39.4 $ (154.2) ============================================================= Cumulative interest rate GAP $ 203.9 $ 69.4 $ 114.8 $ 154.2 $ -- ============================================================= GAP to total assets 18% -12% ===================== GAP to total equity 151% -100% ===================== Cumulative GAP to total assets 18% 6% ===================== Cumulative GAP to total equity 151% 51% =====================
(1) Interest earning assets are included in the period in which the balances are expected to be repaid and/or repriced as a result of anticipated prepayments, scheduled rate adjustments, and contractual maturities. (2) Reflects principal maturing within the specified periods for fixed and repricing for variable rate loans; includes nonperforming loans. (3) For purposes of gap analysis, other assets include the allowance for possible loan loss; unamortized discount on purchased loans and deferred fees on loans. 30 The method of analysis of interest rate sensitivity in the table above has a number of limitations. Certain assets and liabilities may react differently to changes in interest rates even though they reprice or mature in the same time periods. The interest rates on certain assets and liabilities may change at different times than changes in market interest rates, with some changing in advance of changes in market rates and some lagging behind changes in market rates. Also, certain assets have provisions, which limit changes in interest rates each time the interest rate changes and for the entire term of the loan. Additionally, prepayments and withdrawals experienced in the event of a change in interest rates may deviate significantly from those assumed in the interest rate sensitivity table. Additionally, the ability of some borrowers to service their debt may decrease in the event of an interest rate increase. Capital Adequacy ---------------- The table shown below sets forth Royal Bancshares' consolidated capital level and performance ratios:
Regulatory 2003 2002 2001 Minimum --------- --------- -------- ------------ Capital Level ------------- Leverage ratio 11.1% 11.4% 14.1% 3.0% Risk based capital ratio: Tier 1 15.3% 14.6% 14.4% 4.0% Total 16.5% 15.9% 15.9% 8.0% Capital Performance ------------------- Return on average assets 1.6% 1.7% 2.0% - Return on average equity 14.5% 15.2% 15.0% -
Royal Bancshares' sources of capital have been derived from the issuance of stock as well as retained earnings. While Royal Bancshares has not had a stock offering since 1986, total shareholders' equity has increased primarily due to steady increases in retained earnings. At December 31, 2003, Royal Bancshares had an average equity to average asset ratio of 11%. Royal Bancshares has no current plans to raise capital through new stock offerings and indeed, seeks ways to leverage its existing capital. In early 1989, each of the federal bank regulatory agencies issued risk-based capital standards, which were phased in December 31, 1992. The new standards place assets in various categories of risk with varying weights assigned, and consider certain off-balance sheet activities, such as letters of credit and loan commitments in the base for purposes of determining capital adequacy. The principal objective of establishing the risk-based capital framework is to achieve greater convergence in the measurement and assessment of capital adequacy due to the divergence of asset mixes maintained from one depository institution to the next. At December 31, 2003, Royal Bancshares' ratio using these standards was 16.5%. Management Options to Purchase Securities ----------------------------------------- In May 2001, the directors of the Royal Bancshares approved the amended Royal Bancshares of Pennsylvania Non-qualified Stock Option and Appreciation Right Plan (the Plan). The shareholders in connection with the formation of the holding company reapproved the Plan. The Plan is an incentive program under which Bank officers and other key employees may be awarded additional compensation in the form of options to purchase up to 1,500,000 shares of the Royal Bancshares' Class A common stock (but not in excess of 15% of outstanding shares). The option price is equal to the fair market value at the date of the grant. At December 31, 2003, 420,032 options have been granted which are exercisable at 20% per year. At December 31, 2003, options covering 149,904 shares were exercisable by 98 employees. In May 2001, the directors of the Royal Bancshares approved an amended non-qualified Outside Directors Stock Option Plan. The shareholders in connection with the formation of the holding company reapproved the Plan. Under the terms of the plan, 250,000 shares of Class A stock are authorized for grants. Each director is entitled to 1,500 shares of stock annually, which is exercisable one year from the grant date. The options were granted at the fair market value at the date of the grant. At December 31, 2003, 70,061 options were outstanding and options covering 54,761 shares were exercisable. 31 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK ------------------------------------------------------------------ A simulation model is used to estimate the impact of various changes, both upward and downward, in market interest rates and volumes of assets and liabilities on the net income. This model produces an interest rate exposure report that forecast changes in the market value of portfolio equity under alternative interest rate environment. The market value of portfolio is defined as the present value of existing assets and liabilities. The calculated estimates of changes in the market value of portfolio value are as follows: As of December 31, 2003 (Dollars in Thousands) ---------------------------------------------- Market Value of Percent of Changes in Rates Portfolio Equity Change ---------------- ---------------- ---------- + 200 basis points 144,210 -10.0% + 100 basis points 155,298 -3.1% Flat rate 160,217 0% - 100 basis points 156,307 -2.4% - 200 basis points 141,030 -12.0% The assumptions used in evaluating the vulnerability of earnings and capital to changes in interest rates are based on management's considerations of past experience, current position and anticipated future economic conditions. The interest rate sensitivity of assets and liabilities as well as the estimated effect of changes in interest rates on the market value of portfolio equity could vary substantially if different assumptions are used or actual experience differs from what the calculations may be based. RECENT ACCOUNTING PRONOUNCEMENTS -------------------------------- In December 2003, the Financial Accounting Standards Board (FASB) issued SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," which requires additional disclosures about there assets, obligations, cash flows and net periodic benefit costs of defined benefit pension plans and defined benefit other post retirement plans. Royal Bancshares adopted FIN 45 "Guarantor's Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others" on January 1, 2003 ("FIN 45"). FIN 45 requires a guarantor entity, at the inception of a guarantee covered by the measurement provisions of the interpretation, to record a liability for the fair value of the obligation undertaken in issuing the guarantee. Royal Bancshares has financial and performance letters of credit. Financial letters of credit require a company to make a payment if the customer's condition deteriorates, as defined in agreements. Performance letters of credits require Royal Bancshares to make payments if the customer fails to perform certain non-financial contractual obligation. Royal Bancshares previously did not record a liability when guaranteeing obligations unless it became probable that Royal Bancshares would have to perform under the guarantee. FIN 45 applies prospectively to guarantees Royal Bancshares issues or modifies subsequent to December 31, 2002. Royal Bancshares defines the initial fair value of these letters of credit as the fee received from the customer. The potential undiscounted amounts of future payments of the letters of credit as of December 31, 2003 are $5.1 million and they expire through August 2005. Amounts due under these letters of credit would be reduced by any proceeds that Royal Bancshares would be able to obtain in liquidating the collateral for the loans, which varies depending on the customer. In January 2003, FASB issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities ("FIN 46"). FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns, or both. FIN 46 also requires disclosures about variable interest entities that a company is not required to consolidate, but in which it has a significant variable interest. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. Subsequent to the issuance for FIN 46, the FASB issued a revised interpretation, FIN 46(R), the provisions of which must be applied to certain variable interest entities by March 31, 2004. Royal Bancshares is in the process of determining what impact, if any, the adoption of the provisions of FIN 46 will have upon its financial condition or results of operation. 32 Royal Bancshares adopted Statement of Financial Accounting Standard 149 (SFAS No. 149), Amendment of Statement 133 on Derivative Instruments and Hedging Activities, on July 1, 2003. SFAS No. 149 clarifies and amends SFAS No. 133 for implementation issues raised by constituents or includes the conclusions reached by the FASB on certain FASB Staff Implementation Issues. Statement 149 also amends SFAS No. 133 to require a lender to account for loan commitments related to mortgage loans that will be held for sale as derivatives. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003. Royal Bancshares periodically enters into commitments with its customers, which it intends to sell in the future. The adoption of SFAS No. 149 did not have a material impact on Royal Bancshares' financial position or results of operations. The FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, on May 15, 2003. SFAS No. 150 changes the classification in the statement of financial position of certain common financial instruments from either equity or mezzanine presentation to liabilities and requires an issuer of those financial statements to recognize changes in fair value or redemption amount, as applicable, in earnings. SFAS No. 150 is effective for public companies for financial instruments entered into or modified after May 31, 2003 and is effective at the beginning of the first interim period beginning after June 15, 2003. Management has not entered into any financial instruments that would qualify under SFAS No. 150. The adoption of SFAS No. 150 did not have a material impact on Royal Bancshares' financial position or results of operations. Royal Bancshares adopted EITF 03-1, The Meaning of Other than Temporary Impairment and Its Applications to Certain Investments, as of December 31, 2003. EITF 03-1 includes certain disclosures regarding quantitative and qualitative disclosures for investment securities accounted for under FASB 115, "Accounting for Certain Investments in Debt and Equity Securities", that are impaired at the balance sheet date, but an other-than-temporary impairment has not been recognized. The disclosures under EITF 03-1 are required for financial statements for years ending after December 15, 2003 and are included in these financial statements. In October 2003, the AICPA issued SOP 03-3, Accounting for Loans or Certain Debt Securities Acquired in a Transfer. This statement addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor's initial investment in loans or debt securities ("loans") acquired in a transfer as result of credit quality deterioration. The statement requires recognition of the excess of all cash flows expected at acquisition over the investor's initial investment in the loan as interest income on a level-yield basis over the life of the loan as the accretable yield. The loan's contractual required payments receivable in excess of the amount of its cash flows expected at acquisition (nonaccretable difference) should not be recognized as an adjustment to yield, a loss accrual or a valuation allowance for credit risk. This statement is effective for loans acquired in fiscal years beginning after December 31, 2004. Early adoption is permitted. Management is currently evaluating the provisions of SOP 03-3. 33 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA --------------------------------------------------- FINANCIAL STATEMENTS AND REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES December 31, 2003 and 2002 34 [GRAPHIC OMITTED] Report of Independent Certified Public Accountants -------------------------------------------------- Board of Directors Royal Bancshares of Pennsylvania, Inc. and Subsidiaries We have audited the accompanying consolidated balance sheets of Royal Bancshares of Pennsylvania, Inc. and Subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Royal Bancshares of Pennsylvania, Inc. and Subsidiaries as of December 31, 2003 and 2002, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. /s/ Grant Thornton LLP Philadelphia, Pennsylvania January 22, 2004 35
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, ---------------------------- ASSETS 2003 2002 ----------- ----------- (In thousands, except share data) Cash and due from banks $ 17,470 $ 27,081 Federal funds sold 7,600 13,490 ----------- ----------- Total cash and cash equivalents 25,070 40,571 ----------- ----------- Investment securities held to maturity (fair value of $114,275 and $32,745 in 2003 and 2002, respectively) 113,091 30,614 Investment securities available for sale - at fair value 452,246 418,316 Total loans 515,714 576,734 Less allowance for loan losses 12,426 12,470 ----------- ----------- Net loans 503,288 564,264 Premises and equipment, net 7,480 8,002 Accrued interest receivable 16,353 13,778 Other assets 36,882 12,939 ----------- ----------- Total assets $ 1,154,410 $ 1,088,484 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Deposits Non-interest bearing $ 58,942 $ 55,575 Interest bearing 732,117 765,265 ----------- ----------- Total deposits 791,059 820,840 Accrued interest payable 7,733 11,406 Other liabilities 7,920 6,682 Borrowings 212,000 127,500 ----------- ----------- Total liabilities 1,018,712 966,428 ----------- ----------- Minority interest 865 726 Stockholders' equity Common stock Class A, par value $2.00 per share; authorized, 18,000,000 shares; issued, 10,027,284 and 9,595,191 shares in 2003 and 2002, respectively 20,055 19,190 Class B, par value $0.10 per share; authorized, 2,000,000 shares; issued, 1,909,742 and 1,860,668 shares in 2003 and 2002, respectively 191 186 Additional paid in capital 85,448 76,984 Retained earnings 24,989 24,819 Accumulated other comprehensive income 6,415 2,416 ----------- ----------- 137,098 123,595 Treasury stock - at cost, 215,388 Class A shares in 2003 and 2002 (2,265) (2,265) ----------- ----------- Total stockholders' equity 134,833 121,330 ----------- ----------- Total liabilities and stockholders' equity $ 1,154,410 $ 1,088,484 =========== ===========
The accompanying notes are an integral part of these statements. 36
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Consolidated Statements of Income Year ended December 31, ---------------------------------------- 2003 2002 2001 ----------- ----------- ----------- (In thousands, except per share data) Interest income Loans, including fees $ 46,609 $ 53,314 $ 53,384 Investment securities held to maturity 3,087 4,019 7,610 Investment securities available for sale 22,007 18,817 6,945 Deposits in banks 475 682 533 Federal funds sold 142 272 752 --------- --------- --------- TOTAL INTEREST INCOME 72,320 77,104 69,224 --------- --------- --------- Interest expense Deposits 22,193 28,916 27,774 Borrowings and mortgage payable 7,748 7,575 4,019 Federal funds purchased - - 15 --------- --------- --------- TOTAL INTEREST EXPENSE 29,941 36,491 31,808 --------- --------- --------- NET INTEREST INCOME 42,379 40,613 37,416 Provision for loan losses 674 250 - --------- --------- --------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 41,705 40,363 37,416 --------- --------- --------- Other income Service charges and fees 1,217 1,124 966 Gain on sale of investment securities available for sale 719 790 60 Gains on other real estate 568 457 188 Gains on sale of loans 637 767 372 Other income 563 62 152 --------- --------- --------- 3,704 3,200 1,738 --------- --------- --------- Other expenses Salaries and employee benefits 9,958 9,440 10,479 Occupancy and equipment 1,330 1,180 1,119 Advertising 314 520 442 Pennsylvania bank shares tax 828 764 759 Professional fees 441 448 875 Losses on investment partnership 514 461 267 Travel 287 449 297 Other operating expenses 5,215 5,659 3,365 --------- --------- --------- 18,887 18,921 17,603 --------- --------- --------- INCOME BEFORE INCOME TAXES 26,522 24,642 21,551 Income taxes 7,996 7,237 5,797 --------- --------- --------- NET INCOME $ 18,526 $ 17,405 $ 15,754 ========= ========= ========= Per share data Net income - basic $ 1.52 $ 1.44 $ 1.32 ========= ========= ========= Net income - diluted $ 1.52 $ 1.41 $ 1.30 ========= ========= =========
The accompanying notes are an integral part of these statements. 37
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Consolidated Statement of Changes in Stockholders' Equity Years ended December 31, 2003, 2002 and 2001 (In thousands, except per share data) Class A common stock Class B common stock Additional -------------------- -------------------- paid in Retained Shares Amount Shares Amount capital earnings -------- ------- ------- ------ ------- -------- Balance, January 1, 2001 8,388 $16,775 1,731 $ 173 $57,768 $ 31,640 Net income for the year ended December 31, 2001 - - - - - 15,754 Conversion of Class B common stock to Class A common stock 15 29 (13) (1) - (28) 5% stock dividends declared 408 817 87 8 7,094 (7,919) Cash in lieu of fractional shares - - - - - (6) Stock options exercised 38 77 - - 149 - Cash dividends on common stock - - - - - (8,984) Other comprehensive income, net of reclassifications and taxes - - - - - - ----- ------- ----- ------ ------- -------- Comprehensive income Balance, December 31, 2001 8,849 17,698 1,805 180 65,011 30,457 Net income for the year ended December 31, 2002 - - - - - 17,405 Conversion of Class B common stock to Class A common stock 60 120 (52) (5) - (115) 6% stock dividends declared 518 1,036 108 11 11,285 (12,331) Cash in lieu of fractional shares - - - - - (7) Stock options exercised 168 336 - - 688 - Cash dividends on common stock - - - - - (10,590) Other comprehensive loss, net of reclassifications and taxes - - - - - - ----- ------- ----- ------ ------- -------- Comprehensive income Balance, December 31, 2002 9,595 19,190 1,861 186 76,984 24,819
[RESTUBBED TABLE]
Accumulated other comprehensive Treasury Comprehensive income (loss) stock income ------------- ------- ------- Balance, January 1, 2001 $ (590) $(2,265) Net income for the year ended December 31, 2001 - - $15,754 Conversion of Class B common stock to Class A common stock - - - 5% stock dividends declared - - - Cash in lieu of fractional shares - - - Stock options exercised - - - Cash dividends on common stock - - - Other comprehensive income, net of reclassifications and taxes (2,042) - (2,042) -------- ------- ------- Comprehensive income $13,712 ======= Balance, December 31, 2001 (2,632) (2,265) Net income for the year ended December 31, 2002 - - $17,405 Conversion of Class B common stock to Class A common stock - - - 6% stock dividends declared - - - Cash in lieu of fractional shares - - - Stock options exercised - - - Cash dividends on common stock - - - Other comprehensive loss, net of reclassifications and taxes 5,047 - 5,047 --------- ------- ------- Comprehensive income $22,452 ======= Balance, December 31, 2002 2,415 (2,265)
(Continued) 38 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Consolidated Statement of Changes in Stockholders' Equity - Continued Years ended December 31, 2003, 2002 and 2001 (In thousands, except per share data)
Class A common stock Class B common stock Additional -------------------- -------------------- paid in Retained Shares Amount Shares Amount capital earnings -------- ------- ------- ------ ------- -------- Balance, January 1, 2003 9,595 $19,190 1,861 $ 186 $76,984 $ 24,819 Net income for the year ended December 31, 2003 - - - - - 18,526 Conversion of Class B common stock to Class A common stock 8 16 (7) (1) - (15) 3% stock dividends declared 281 562 55 6 6,443 (7,011) Cash in lieu of fractional shares - - - - - (8) Purchase of treasury stock - - - - - - Stock options exercised 143 286 - - 2,021 - Cash dividends on common stock - - - - - (11,321) Other comprehensive income, net of reclassifications and taxes - - - - - - ------ ------- ------ ------ ------- -------- Comprehensive income Balance, December 31, 2003 10,027 $20,054 1,909 $ 191 $85,448 $ 24,990 ====== ======= ====== ====== ======= ========
[RESTUBBED TABLE]
Accumulated other comprehensive Treasury Comprehensive income (loss) stock income ------------- ------- ------- Balance, January 1, 2003 $ 2,415 $(2,265) Net income for the year ended December 31, 2003 - - $18,526 Conversion of Class B common stock to Class A common stock - - - 3% stock dividends declared - - - Cash in lieu of fractional shares - - - Purchase of treasury stock - - - Stock options exercised - - - Cash dividends on common stock - - - Other comprehensive income, net of reclassifications and taxes 4,000 - 4,000 -------- ------- ------- Comprehensive income $22,526 ======= Balance, December 31, 2003 $ 6,415 $ (2,265) ======== ========
The accompanying notes are an integral part of this statement. 39
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Year ended December 31, 2003 2002 2001 ----------- ----------- ----------- (In thousands, except per share data) Cash flows from operating activities Net income $ 18,526 $ 17,405 $ 15,754 Adjustments to reconcile net income to net cash (used in) provided by operating activities Depreciation and amortization 1,035 1,297 865 Provision for loan losses 674 250 -- Amortizations of premiums and discounts on loans, mortgage-backed securities and investments 289 (1,495) (3,527) Provision (benefit) for deferred income taxes 2,078 (32) (2,779) Gains on other real estate (568) (457) (188) Gains on sale of loans (637) (767) (372) Gains (losses) on sales of investment securities available for sale (719) (790) (60) (Increase) in accrued interest receivable (2,575) (2,082) (4,667) Decrease (increase) in other assets (26,021) 842 (3,421) Increase (decrease) in accrued interest payable (3,673) (228) 364 Increase (decrease) in other liabilities 1,238 (1,452) (2,418) --------- --------- --------- Net cash (used in) provided by operating activities (10,353) 12,491 (449) --------- --------- --------- Cash flows from investing activities Proceeds from calls and maturities of investment securities held to maturity 9,982 60,563 78,194 Purchases of investment securities held to maturity (89,310) -- (85,000) Proceeds from calls, maturities and sales of investment securities available for sale 201,341 309,710 21,169 Proceeds from sales of investment securities available for sale 91,339 115,250 4,850 Redemption (purchase) of Federal Home Loan Bank stock (3,532) (4,074) 1,420 Cash paid for asset acquisition -- -- (15,239) Cash borrowed for asset acquisition -- -- 26,548 Purchases of investment securities available for sale (321,451) (699,480) (53,125) Net decrease in loans 61,647 70,581 46,703 Purchase of premises and equipment (513) (787) (1,706) --------- --------- --------- Net cash provided by (used in) investing activities (50,497) (148,237) 23,814 --------- --------- ---------
(Continued) 40
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows - Continued Year ended December 31, 2003 2002 2001 ----------- ----------- ------- (In thousands, except per share data) Cash flows from financing activities Net increase in non-interest bearing and interest bearing demand deposits and savings accounts $ 63,511 $ 253,560 $ 44,974 Net (decrease) increase in certificates of deposit (93,292) (134,579) (66,731) Principal payments on mortgage (62) (49) (49) Cash dividends in lieu of fractional shares (8) (7) (6) Proceeds from borrowings, net of repayments 84,500 27,275 4,000 Issuance of common stock under stock option plans 2,021 688 227 Cash dividends paid (11,321) (10,589) (8,984) --------- --------- --------- Net cash (used in) provided by financing activities 45,349 136,299 (26,569) --------- --------- ---------- Net increase (decrease) in cash and cash equivalents (15,501) 553 (3,204) Cash and cash equivalents at beginning of year 40,571 40,018 43,222 --------- --------- --------- Cash and cash equivalents at end of year $ 25,070 $ 40,571 $ 40,018 ========= ========= ========= Supplemental disclosure of cash flow information Cash paid during the year for Interest $ 33,615 $ 36,719 $ 31,412 ========= ========= ========= Income taxes $ 7,000 $ 5,650 $ 6,800 ========= ========= =========
The accompanying notes are an integral part of these statements. 41 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements December 31, 2003 and 2002 NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Royal Bancshares of Pennsylvania, Inc. (the Company), through its subsidiary Royal Bank of Pennsylvania (the Bank), offers a full range of banking services to individual and corporate customers located in eastern Pennsylvania. The Bank competes with other banking and financial institutions in certain markets, including financial institutions with resources substantially greater than its own. Commercial banks, savings banks, savings and loan associations, credit unions and money market funds actively compete for savings and time deposits and for various types of loans. Such institutions, as well as consumer finance and insurance companies, may be considered competitors of the Bank with respect to one or more of the services it renders. 1. Basis of Financial Statement Presentation ----------------------------------------- The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries: Royal Equity Partners, Inc. and the Bank, including the Bank's subsidiaries, Royal Real Estate, Inc., Royal Investment of Pennsylvania, LLC, and Crusader Servicing Corporation. On June 22, 2001, the Bank purchased a 60% ownership in Crusader Servicing Corporation from Crusader Holding Corporation. All significant intercompany transactions and balances have been eliminated. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenditures for the period. Therefore, actual results could differ significantly from those estimates. The principal estimate that is particularly susceptible to significant change in the near term relates to the allowance for loan losses. In connection with this estimate, when circumstances warrant, management obtains independent appraisals for significant properties. However, future changes in real estate market conditions and the economy could affect the Company's allowance for loan losses. In addition to being subject to competition from other financial institutions, the Company is subject to regulations of certain federal agencies and, accordingly, it is periodically examined by those regulatory authorities. Statement of Financial Accounting Standards (SFAS) No. 131, "Segment Reporting" establishes standards for the way public business enterprises report information about operating segments. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assess performance. The statement also requires that public enterprises report a measure of segment profit of loss, certain specific revenue and expense items and segment assets. The Company has one reportable segment, "Community Banking." All of the Company's activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Company supports the others. For example, commercial lending is dependent upon the ability of the Bank to fund itself with retail deposits and other borrowings and to manage interest rate and credit risk. This situation is also similar for consumer and residential mortgage lending. Accordingly, all significant operating decisions are based upon analysis of the Company as one operating segment or unit. In January 2003, FASB issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities ("FIN 46"). FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities (Continued) 42 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued or entitled to receive a majority of the entity's residual returns, or both. FIN 46 also requires disclosures about variable interest entities that a company is not required to consolidate, but in which it has a significant variable interest. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. Subsequent to the issuance of FIN 46, the FASB issued a revised interpretation, FIN 46(R), the provisions of which must be applied to certain variable interest entities by March 31, 2004. Royal Bancshares is in the process of determining what impact, if any, the adoption of the provisions of FIN 46 will have upon its financial condition or results of operation. 2. Investment Securities --------------------- Investment securities are classified in one of three categories: held to maturity, available for sale or trading. Debt securities that the Company has the positive intent and ability to hold to maturity are classified as held to maturity and are reported at amortized cost. As the Company does not engage in security trading, the balance of its debt securities and any equity securities are classified as available for sale. Net unrealized gains and losses for such investment securities available for sale, net of tax effect, are required to be recognized as a separate component of stockholders' equity and excluded from the determination of net income. Gains or losses on disposition are computed by the specific identification method. Royal Bancshares adopted EITF 03-1, The Meaning of Other than Temporary Impairment and Its Applications to Certain Investments, as of December 31, 2003. EITF 03-1 includes certain disclosures regarding quantitative and qualitative disclosures for investment securities accounted for under FASB 115, "Accounting for Certain Investments in Debt and Equity Securities", that are impaired at the balance sheet date, but an other than-temporary impairment has not been recognized. The disclosures under EITF 03-1 are required for financial statements for years ending after December 15, 2003 and are included in these financial statements. The Company adopted the provisions of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS No. 133), as amended, as of January 1, 2001. The statement requires the Company to recognize all derivative instruments at fair value as either assets or liabilities. Financial derivatives are reported at fair value in other assets or other liabilities. The accounting for changes in the fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship. For derivatives not designated as hedges, the gain or loss is recognized in current earnings. 3. Loans held for sale ------------------- Residential mortgage loans are only originated for sale to the secondary mortgage loans market. These loans have a prior sales commitment on a best efforts basis in place prior to the loan closing. These loans are classified as loans held for sale and are carried at the lower of cost or estimated fair value. Fair value is determined by the purchase price quoted in the sales agreement. The Company accounts for the transfer of financial assets in accordance with SFAS No. 140 "Accounting for Transfers and Servicing of Assets and Extinguishments of Liabilities." The standard is based on consistent application of a financial-components approach that recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered and derecognizes liabilities when extinguished. The standard provides consistent guidelines for distinguishing transfers of financial assets from transfers that are secured borrowings. (Continued) 43 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued 4. Loans and Allowance for Loan Losses ----------------------------------- Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at the amount of unpaid principal, reduced by unearned income and an allowance for loan and lease losses. The allowance for loan losses is maintained at a level believed adequate by management to absorb potential losses in the loan portfolio. Management's determination of the adequacy of the allowance is based on an evaluation of the portfolio, past loan loss experience, current economic conditions, volume, growth, and composition of the loan portfolio, and other relevant factors. The allowance is increased by provisions for loan losses charged against income. Decreases in the allowance result from management's determination that the allowance for loan losses exceeds their estimates of potential loan loss. Royal Bancshares accounts for its impaired loans in accordance with SFAS No. 114, "Accounting by Creditors for Impairment of a Loan", was amended by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosure", which requires that a creditor measure impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan's observable market price, or the fair value of the collateral if the loan is collateral-dependent. Regardless of the measurement method, a creditor must measure impairment based on the fair value of the collateral when the creditor determines that foreclosure is probable. Interest on loans is accrued and credited to operations based upon the principal amount outstanding. Accretion of unearned discounts on loans has been added to the related interest income. Accrual of interest is discontinued on a loan when management believes that the borrower's financial condition is such that collection of interest is doubtful and generally when a loan becomes 90 days past due as to principal or interest. When interest accruals are discontinued, interest credited to income in the current year is reversed and interest accrued in the prior year is charged to the allowance for loan losses. On July 6, 2001, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 102 "Selected Loan Loss Allowance Methodology and Documentation Issues". SAB No. 102 provides guidance on the development, documentation, and application of a systematic methodology for determining the allowance for loans and leases in accordance with US GAAP and is effective upon issuance. The adoption of SAB No. 102 did not have a material impact on the Company's financial position or results of operations. In October 2003, the AICPA issued SOP 03-3, Accounting for Loans or Certain Debt Securities Acquired in a Transfer. This statement addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor's initial investment in loans or debt securities ("loans") acquired in a transfer as result of credit quality deterioration. The statement requires recognition of the excess of all cash flows expected at acquisition over the investor's initial investment in the loan as interest income on a level-yield basis over the life of the loan as the accretable yield. The loan's contractual required payments receivable in excess of the amount of its cash flows expected at acquisition (nonaccretable difference) should not be recognized as an adjustment to yield, a loss accrual or a valuation allowance for credit risk. This statement is effective for loans acquired in fiscal years beginning after December 31, 2004. Early adoption is permitted. Management is currently evaluating the provisions of SOP 03-3. Royal Bancshares adopted FIN 45 "Guarantor's Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others" on January 1, 2003 ("FIN 45"). FIN 45 requires a guarantor entity, at the inception of a guarantee covered by the measurement (Continued) 44 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued provisions of the interpretation, to record a liability for the fair value of the obligation undertaken in issuing the guarantee. Royal Bancshares has financial and performance letters of credit. Financial letters of credit require a company to make a payment if the customer's condition deteriorates, as defined in agreements. Performance letters of credits require Royal Bancshares to make payments if the customer fails to perform certain non-financial contractual obligation. Royal Bancshares previously did not record a liability when guaranteeing obligations unless it became probable that Royal Bancshares would have to perform under the guarantee. 5. Other Real Estate ----------------- Other real estate is recorded at the lower of the customer's loan balance or the adjusted fair market value of the real estate securing the loan. The adjusted fair market value is determined by reducing the fair market value by estimated costs for the disposition of the property. Costs relating to holding the property are expensed when incurred. Other real estate owned of approximately $4,371,000 and $1,444,000 at December 31, 2003 and 2002, respectively, is included in other assets on the consolidated balance sheets. (Continued) 45 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued 6. Premises and Equipment ---------------------- Premises and equipment are stated at cost less accumulated depreciation, which is computed principally on the MACRS method over the estimated useful lives of the assets. Leasehold improvements are amortized on the MACRS method over the shorter of the estimated useful lives of the improvements or the terms of the related leases. The Company adopted FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" on January 1, 2001. SFAS No. 144 retains the existing requirements to recognize and measure the impairment of long-lived assets to be held and used or to be disposed of by sale. The adoption of this statement did not have a significant impact on the financial condition or results of operations of the Company. 7. Bank-Owned Life Insurance ------------------------- Royal bank has purchased life insurance policies on certain executives. These policies are recorded in other assets at their cash surrender value, or the amount that can be realized. Income from these policies and changes in the cash surrender value are recorded in other income. 8. Income Taxes ------------ Under the liability method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by the enacted tax rates which will be in effect when these differences reverse. Deferred tax expense is the result of changes in deferred tax assets and liabilities. The principal types of differences between assets and liabilities for financial statement and tax return purposes are the allowance for loan losses, asset valuation reserves and net operating loss carryovers. 9. Per Share Information --------------------- Basic EPS excludes dilution and is computed by dividing income available to common shareholders by the weighted average common shares outstanding during the period. Diluted EPS takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock. 10. Stock Option Plans ------------------ The Company accounts for stock options under SFAS No. 123, Accounting for Stock-Based Compensation, as Amended by SFAS No.148, which contains a fair value-based method for valuing stock-based compensation that entities may use, which measures compensation cost at the grant date based on fair value of the award. Compensation is recognized over service period, which is usually the vesting period. Alternatively, SFAS No. 123 permits entities to continue accounting for employee stock options and similar equity instruments under Accounting Principles Board (APB) Opinion 25, Accounting (Continued) 46 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued for Stock Issued to Employees. Entities that continue to account for stock options using APB Opinion 25 are required to make a proforma disclosures of net income and earnings per share, as if the fair value-based method of accounting defined in SFAS No. 123 had been applied. At December 31, 2003, the Company had both a director and employee stock-based compensation plan, which is more fully described in Note M. The Company accounts for that plan under the recognition and measurement principles of APB No. 25, "Accounting for Stock Issued to Employees", and related interpretations. Stock-based employee compensation cost are not reflected in net income, as all options granted under the plan had an exercise price equal to the market value under the underlying common stock of the date of the grant. The following table illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of FASB No. 123, "Accounting for Stock-Based Compensation", to stock-based employee compensation.
2003 2002 2001 ---- ------- ------- Net income (loss), as reported $18,526 $17,405 $15,754 Less: Stock-based compensation costs under Fair value based method for all awards (425) (435) (96) ------- ------- ------- Pro forma net income (loss) 18,101 16,970 15,658 Earnings per share -Basis As Reported $1.52 $1.44 $1.32 Pro forma 1.49 1.40 1.32 Earnings per share -Diluted As Reported 1.52 1.41 1.30 Pro forma 1.49 1.38 1.30
11. Benefit Plans ------------- The Company has a noncontributory nonqualified, defined benefit pension plan covering certain eligible employees. Net pension expense consists of service costs, interest costs, return on pension assets and amortization of unrecognized initial net assets. The Company accrues pension costs as incurred. 12. Cash and Cash Equivalents ------------------------- For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, short-term investments and federal funds sold. Generally, federal funds are purchased and sold for one-day periods. 13. Financial Instruments --------------------- SFAS No. 107, "Disclosures About Fair Value of Financial Instruments", requires all entities to disclose the estimated fair value of their assets and liabilities considered to be financial instruments. Financial instruments consist primarily of investment securities, loans and deposits. (Continued) 47 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued 14. Advertising Costs ----------------- The Company and the Bank expense advertising costs as incurred. 15. Comprehensive Income -------------------- The Company reports comprehensive income which includes net income as well as certain other items, which result in a change to equity during the period. The income tax effects allocated to comprehensive income is as follows (in thousands):
December 31, 2003 --------------------------------------------- Tax Net of Before tax (benefit) tax amount expense amount ----------- ----------- ----------- Unrealized gains on securities Unrealized holding gains arising during period $ 6,791 $ 2,316 $ 4,475 Less reclassification adjustment for gains realized in net income 719 244 475 ------------ ----------- ----------- Other comprehensive gain, net $ 6,072 $ 2,072 $ 4,000 ============ =========== ===========
December 31, 2002 ---------------------------------------------- Tax Net of Before tax (benefit) tax amount expense amount ----------- ----------- ----------- Unrealized gains on securities Unrealized holding losses arising during period $ 8,436 $ 2,868 $ 5,568 Less reclassification adjustment for gains realized in net income 790 269 521 ------------ ----------- ----------- Other comprehensive gain, net $ 7,646 $ 2,599 $ 5,047 ============ =========== ===========
December 31, 2001 --------------------------------------------- Tax Net of Before tax (benefit) tax amount expense amount ----------- ----------- ----------- Unrealized losses on securities Unrealized holding gains arising during period $ (3,213) $ (1,131) $ (2,082) Less reclassification adjustment for losses realized in net income 60 20 40 ------------ ----------- ----------- Other comprehensive loss, net $ (3,153) $ (1,111) $ (2,042) ============ =========== ===========
(Continued) 48 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued 16. Reclassifications ----------------- Certain reclassifications of prior year amounts have been made to conform to the current year presentation. 17. Summary of accounting policies ------------------------------ In January 2003, FASB issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities ("FIN 46"). FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from variable interest entity's activities or entitled to receive a majority of the entity's residual returns, or both. FIN 46 also requires disclosures about variable interest entities that a company is not required to consolidate, but in which it has a significant variable interest. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to existing entities in the first fiscal year or interim period beginning after June 15, 2003. The company is in the process of determining what impact, if any, the adoption of provisions of FIN 46 will have upon its financial condition or results of operation. NOTE B - ACQUISITIONS As of June 22, 2001, Royal Bancshares of Pennsylvania completed its acquisition of the assets of Crusader Holding Corporation (Crusader). Under the terms of the acquisition, certain assets and liabilities were purchased for approximately $41,500,000, which represented the approximate fair value of the net assets acquired. Included in this purchase was approximately $331,300,000 of assets, of which $236,500,000 was related to the loan portfolio. The purchase also included the assumption of deposits in the approximate amount of $251,000,000. The purchase price was paid in cash. This transaction was accounted for under the purchase method of accounting. There was no goodwill recorded in connection with this transaction. The Financial Accounting Standards Board (FASB) issued SFAS No. 147, Acquisitions of Certain Financial Institutions: An amendment of FASB Statement No. 72 and 144 and FASB Interpretation No 9, which removes acquisitions of financial institutions from the scope of SFAS 72, Accounting for Certain Acquisitions of Banking or Thrift Institutions, except for transactions between mutual enterprises. SFAS No. 147 also requires that the acquisition of a less-than-whole financial institution, such as a branch, be accounted for as a business combination if the transferred assets and activities constitute a business. The adoption of SFAS No. 147 did not have a material impact on the Company's financial position or results of operations. NOTE C - SEGMENT INFORMATION SFAS No. 131, Segment Reporting, establishes standards for public business enterprises to report information about operating segments in their annual financial statements and requires that those enterprises report selected information about operating segments in subsequent interim financial reports issued to shareholders. It also established standards for related disclosure about products and services, geographic areas, and major customers. Operating segments are components of an enterprise, which are evaluated regularly by chief operating decision maker in deciding how to allocate and assess resources and performance. The Company's chief operating decision maker is the President and Chief Executive Officer. The Company has identified its reportable operating segment as "Community Banking". (Continued) 49 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE C - SEGMENT INFORMATION - Continued The Company's community banking segment consists of commercial and retail banking. The community banking business segment is managed as a single strategic unit which generates revenue from a variety of products and services provided by the Banks. For example, commercial lending is dependent upon the ability of the Bank to fund itself with retail deposits and other borrowings and to manage interest rate and credit risk. This situation is also similar for consumer and residential mortgage lending. The Company's tax lien operation does not meet the quantitative thresholds for requiring disclosure, but has different characteristics to the community banking operation. The Company's tax lien operation consists of purchasing delinquent tax certificates from local municipalities at auction. The tax lien segment is managed as a single strategic unit which generates revenue from a nominal interest rate achieved at the individual auction along with periodic penalties imposed. The accounting policies used in this disclosure of business segments are the same as those described in the summary of significant accounting policies. The consolidating adjustments reflect certain eliminations of inter-segment revenues, cash and investments in subsidiaries. Selected segment information and reconciliations to consolidated financial information is as follows:
Community Tax Lien (in thousands) Bank Operation Consolidated --------- --------- ------------ December 31, 2003 Total assets $1,103,619 $50,791 $1,154,410 Total deposits 791,059 -- 791,059 Net interest income 38,273 3,432 41,705 Total non-interest income 3,196 508 3,704 Total non-interest expense 23,551 3,332 26,883 ---------- ------- ---------- Net Income 17,918 608 18,526 December 31, 2002 Total assets $1,040,389 $48,095 $1,088,484 Total deposits 820,840 -- 820,840 Net interest income 37,185 3,178 40,363 Total non-interest income 2,829 371 3,200 Total non-interest expense 23,173 2,985 26,158 ---------- ------- ---------- Net Income 16,841 564 17,405
Interest was paid to the Community Bank segment by the Tax Lien Operation was approximately $1,879,000 and $2,039,000 for the years ending December 31, 2003 and 2002, respectively. 50 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE D - INVESTMENT SECURITIES The amortized cost, gross unrealized gains and losses, and fair value of the Company's investment securities held to maturity and available for sale are summarized as follows (in thousands):
2003 ---------------------------------------------- Gross Gross Amortized unrealized unrealized Fair cost gains losses value -------- ------- ------- -------- Investment securities held to maturity Corporate securities $ 21,121 $ 1,481 $ -- $ 22,602 U.S. government agencies 91,630 168 (465) 91,333 Mortgage backed securities 340 -- -- 340 -------- ------- ------- -------- $113,091 $ 1,649 $ (465) $114,275 ======== ======= ======= ========
2003 ---------------------------------------------- Gross Gross Amortized unrealized unrealized Fair cost gains losses value -------- ------- ------- -------- Investment securities available for sale Federal Home Loan Bank stock $ 11,407 $ -- $ -- $ 11,407 Preferred and common stock 40 15 -- 55 Corporate bonds 148,487 8,474 (12) 156,949 U.S. government agencies 122,785 139 (1,812) 121,112 Trust preferred securities 36,251 3,049 (2,161) 37,139 Foreign bonds 11,363 803 -- 12,166 Mortgage backed securities 110,596 1,345 (66) 111,875 Other securities 1,598 -- (55) 1,543 -------- ------- ------- -------- $442,527 $13,825 $(4,106) $452,246 ======== ======= ======= ========
2002 ---------------------------------------------- Gross Gross Amortized unrealized unrealized Fair cost gains losses value -------- ------- ------- -------- Investment securities held to maturity Corporate securities $ 30,076 $ 2,131 $ -- $ 32,207 U.S. government agencies -- -- -- -- Mortgage backed securities 538 -- -- 538 -------- ------- ------- -------- $ 30,614 $ 2,131 $ -- $ 32,745 ======== ======= ======= ========
51 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE D - INVESTMENT SECURITIES - Continued
2002 -------------------------------------------------- Gross Gross Amortized unrealized unrealized Fair cost gains losses value -------- -------- -------- -------- Investment securities available for sale Federal Home Loan Bank stock $ 8,949 $ -- $ -- $ 8,949 Preferred and common stock 56 -- -- 56 Corporate bonds 111,227 4,732 (221) 115,738 Trust preferred securities 39,160 726 (2,557) 37,329 Foreign bonds 16,068 554 (259) 16,363 Mortgage backed securities 235,965 1,155 (487) 236,633 Other securities 3,247 1 - 3,248 -------- -------- -------- -------- $414,672 $ 7,168 $ (3,524) $418,316 ======== ======== ======== ========
The amortized cost and estimated fair value of investment securities at December 31, 2003, by contractual maturity, are shown below (in thousands). Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
2003 -------------------------------------------------- Held to maturity Available for sale ---------------------- ---------------------- Amortized Fair Amortized Fair cost value cost value -------- -------- -------- -------- Within 1 year $ 4,140 $ 4,326 $ 9,268 $ 9,675 After 1 but within 5 years 17,049 18,344 148,403 157,018 After 5 but within 10 years 49,315 48,850 96,796 95,773 After 10 years 42,587 42,755 176,613 178,318 Federal Home Loan Bank stock -- -- 11,407 11,407 Preferred and common stocks -- -- 40 55 -------- -------- -------- -------- $113,091 $114,275 $442,527 $452,246 ======== ======== ======== ========
Proceeds from the sale of investment securities available for sale during 2003, 2002 and 2001 were $91,339,000, $115,250,000 and $4,850,000, respectively, resulting in gross realized gain (loss) of $719,000, $790,000 and $60,000 during 2003, 2002 and 2001, respectively. As of December 31, 2003 and 2002, investment securities with a book value of $11,185,000 and $135,499,000, respectively, were pledged as collateral to secure public deposits and for other purposes required or permitted by law. 52 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE D - INVESTMENT SECURITIES - Continued The table below indicates the length of time individual securities have been in a continuous unrealized loss position at December 31, 2003:
Description of Securities Less than 12 months 12 months or longer Total Unrealized Fair Unrealized Unrealized Fair Value Losses Value Losses Fair Value Losses ---------------------------------------------------------------------------- US Agencies $126,998 $2,277 $ -- $ -- $126,998 $2,277 MBS 29,763 66 -- -- 29,763 66 Corporate Bonds 2,058 91 20,074 2,137 22,132 2,228 -------------------------------------------------------------------------- Subtotal debt securities 158,819 2,434 20,074 2,137 178,893 4,571 Common Stock -- -- -- -- -- -- -------------------------------------------------------------------------- Total temporarily impaired securities $158,819 $2,434 $20,074 $2,137 $178,893 $4,571
NOTE E - LOANS Major classifications of loans are as follows (in thousands):
2003 2002 ------------- ------------- Commercial and industrial $ 225,268 $ 241,373 Real Estate Construction and land development 107,463 82,736 Residential 60,367 127,230 Other 119,167 124,006 Consumer 4,942 3,509 ----------- ----------- Total gross loans 517,207 578,854 Less Unearned income (1,203) (1,082) Unamortized discount on purchased loans (290) (1,038) ----------- ----------- Total loans $ 515,714 $ 576,734 =========== ===========
Loans on which the accrual of interest has been discontinued or reduced amounted to approximately $11,328,000 and $11,908,000 at December 31, 2003 and 2002, respectively. If interest had been accrued, such income would have been approximately $401,000, $473,000 and $526,000 for the years ended December 31, 2003, 2002 and 2001, respectively. Management believes it has adequate collateral to limit its credit risk with these loans. The Company granted loans to the officers and directors of the Company and to their associates. Related party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than normal risk of collectibility. The aggregate dollar amount of these loans was $4,667,000 and $5,290,000 at December 31, 2003 and 2002, respectively. During 2003, two new loans in the amount $2,717,000 were made and repayments totaled $3,340,000. (Continued) 53 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE E - LOANS -Continued The balance of impaired loans, which include the loans on which the accrual of interest has been discontinued, was approximately $11,328,000 and $11,966,000 at December 31, 2003 and 2002, respectively. The Company has identified a loan as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreements. The income recognized on impaired loans during 2003 was $1,000. Total cash collected on impaired loans during 2003 was $108,000 of which $107,000 was credited to the principal balance outstanding on such loans. Interest that would have been accrued on impaired loans during 2003 was $401,000. The Company's policy for interest income recognition on impaired loans is to recognize income on currently performing restructured loans under the accrual method. The Company recognizes income on non-accrual loans under the cash basis when the principal payments on the loans become current and the collateral on the loan is sufficient to cover the outstanding obligation to the Company. If these factors do not exist, the Company does not recognize income. The Company primarily grants commercial and real estate loans in the greater Philadelphia metropolitan area. The Company has concentrations of credit risk in real estate development loans at December 31, 2003. A substantial portion of its debtors' ability to honor these contracts is dependent upon the economic sector. Changes in the allowance for loan losses were as follows (in thousands):
2003 2002 2001 ------- ------- ------- Balance at beginning of year $12,470 $11,888 $11,973 Charge-offs (811) (925) (517) Recoveries 93 1,257 432 ------- ------- ------- Net charge-offs (718) 332 (85) Provision for loan losses 674 250 -- ------- ------- ------- Balance at end of year $12,426 $12,470 $11,888 ======= ======= =======
(Continued) 54 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE F - PREMISES AND EQUIPMENT Premises and equipment are summarized as follows (in thousands):
Estimated useful lives 2003 2002 --------------- ------------- ------------- Land - $ 2,396 $ 2,396 Buildings and leasehold improvements 15 - 31.5 years 6,989 6,424 Furniture and fixtures 3 - 7 years 5,605 5,748 ------------ ------------ 14,990 14,568 Less accumulated depreciation and amortization 7,510 6,566 ------------ ------------ $ 7,480 $ 8,002 ============ ============
Depreciation and amortization in expense was approximately $944,000, $1,296,000 and $865,000 for the years ended 2003, 2002 and 2001, respectively. NOTE G - DEPOSITS Deposits are summarized as follows (in thousands):
2003 2002 ------------- ------------- Demand $ 58,942 $ 55,575 NOW and money market 471,140 412,860 Savings 24,075 22,212 Time, $100,000 and over 104,123 180,977 Other time 132,779 149,216 ------------ ------------ $ 791,059 $ 820,840 ============ ============
Maturities of certificates of deposit for the next five years and thereafter are as follows (in thousands): 2004 $ 132,710 2005 58,371 2006 20,754 2007 8,196 2008 11,255 Thereafter 5,616 ------------ $ 236,902 ============
(Continued) 55 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE H - BORROWINGS 1. Advances from the Federal Home Loan Bank At December 31, 2003, advances from the Federal Home Loan Bank (FHLB) totaling $212,000,000 will mature within one to ten years. The advances are collateralized by FHLB stock and certain first mortgage loans and mortgage-backed securities. These advances had a weighted average interest rate of 3.90%. Outstanding borrowings mature as follows (in thousands): 2004 $ -- 2005 7,500 2006 30,000 2007 -- 2008 -- Thereafter 174,500 ---------- $ 212,000 NOTE I - LEASE COMMITMENTS The Company leases various premises under non-cancelable agreements, which expire through 2012 and require minimum annual rentals. The approximate minimum rental commitments under the leases are as follows for the year ended December 31, (in thousands): 2004 $ 511 2005 405 2006 251 2007 229 2008 214 Thereafter 428 ---------- $ 2,038 Rental expense for all leases was approximately $612,000, $614,000 and $501,000 for the years ended December 31, 2003, 2002 and 2001, respectively. (Continued) 56 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE J - COMMON STOCK Each holder of Class A and Class B common stock is entitled to one vote for each Class A share and ten votes for each Class B share held. Holders of either class of common stock are entitled to equal per share dividends when declared. The Class B shares may not be transferred in any manner except to the holder's immediate family. Class B shares maybe converted to Class A shares at the rate of 1.15 to 1. Per share information and weighted average shares outstanding have been restated to reflect the 2% stock dividend of January 2004, the 3% stock dividend of January 2003, the 6% stock dividend of January 2002, and the 5% stock dividend of January 2001. NOTE K - INCOME TAXES The components of the income tax expense (benefit) included in the consolidated statements of income are as follows (in thousands):
2003 2002 2001 ------------- ------------- ------------- Income tax expense (benefit) Current $ 9,221 $ 7,269 $ 6,485 Deferred federal tax (1,225) (32) (1,560) Benefit applied to reduce goodwill -- -- 872 ------------ ------------ ------------ $ 7,996 $ 7,237 $ 5,797 ============ ============ ============
The difference between the applicable income tax expense and the amount computed by applying the statutory federal income tax rate of 35% in 2003, 2002 and 2001 is as follows (in thousands):
2003 2002 2001 ------------- ------------- ------------- Computed tax expense at statutory rate $ 9,286 $ 8,620 $ 7,543 Tax-exempt income (263) (101) (130) Low-income housing tax credit (545) (545) (650) Other, net (482) (737) (966) Effect of 34% rate bracket - - - ------------ ------------ ------------ Applicable income tax expense $ 7,996 $ 7,237 $ 5,797 ============ ============ ============
(Continued) 57 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE K - INCOME TAXES - Continued Deferred tax assets and liabilities consist of the following (in thousands):
2003 2002 ------------- ------------- Deferred tax assets Allowance for loan losses $ 4,153 $ 2,843 Unrealized losses on investment securities available for sale -- -- Accrued stock-based compensation 149 194 Asset valuation reserves 812 812 Other 1,671 1,458 Net operating loss carryovers from Knoblauch State Bank 7,107 7,277 ---------- ---------- 13,892 12,584 Less valuation allowance (7,107) (7,277) ---------- ---------- 6,785 5,307 ---------- ---------- Deferred tax liabilities Unrealized gains on investment securities available for sale 3,304 1,199 Other 975 722 ---------- ---------- 4,279 1,921 ---------- ---------- Net deferred tax asset, included in other assets $ 2,506 $ 3,386 ========== ==========
The Company has approximately $21,000,000 of net operating loss carryovers from the acquisition of Knoblauch State Bank (KSB). These losses will fully expire in 2015. The utilization of these losses is subject to limitation under Section 382 of the Internal Revenue Code. As a result, a valuation allowance has been established to eliminate the deferred tax asset attributable to these net operating losses. During 2003, 2002 and 2001, the Company realized a tax benefit related to the net operating loss carryovers from the acquisition of KSB. The deferred tax asset associated with those loss carryovers is fully offset by a valuation allowance. Accordingly, the realized tax benefit is reflected as a reduction of the goodwill associated with the acquisition and a corresponding reduction of deferred income tax benefit for the year. (Continued) 58 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE K - INCOME TAXES - Continued In addition, the Company has approximately $15,700,000 of tax goodwill from the acquisition of KSB. The ability to deduct this goodwill for tax purposes will expire in 2015. The utilization of this goodwill for tax purposes was subject to the limitations under Section 382 of the Internal Revenue Code. For 2003, approximately $1,353,000 has been deducted for tax purposes. For 2001, the Company has taken a recovery of $550,000 from income tax payable and reduced its federal income tax expense accordingly in order to recapture a provision established for issues that arose concerning the low income housing tax credits acquired from the Kearsley limited partnership in 1994. All issues regarding this tax credit were resolved favorably and as a result there is no need to maintain this tax reserve. NOTE L - EARNINGS PER SHARE Basic and diluted EPS are calculated as follows (in thousands, except per share data):
2003 ---------------------------------------------- Income Average shares Per share (numerator) (denominator) amount ----------- -------------- --------- Basic EPS Income available to common shareholders $ 18,526 12,149 $ 1.52 Effect of dilutive securities Stock options -- 52 -- ----------- -------------- --------- Diluted EPS Income available to common shareholders plus assumed exercise of options $ 18,526 12,188 $ 1.52 =========== ============== =========
All options to purchase shares of common stock were included in the computation of 2003 diluted EPS because the exercise price was less than the average market price of the common stock.
2002 ---------------------------------------------- Income Average shares Per share (numerator) (denominator) amount ----------- -------------- --------- Basic EPS Income available to common shareholders $ 17,405 12,082 $ 1.44 Effect of dilutive securities Stock options - 253 (0.03) ----------- -------------- --------- Diluted EPS Income available to common shareholders plus assumed exercise of options $ 17,405 12,335 $ 1.41 =========== ============== =========
All options to purchase shares of common stock were included in the computation of 2002 diluted EPS because the exercise price was less than the average market price of the common stock. (Continued) 59 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE L - EARNINGS PER SHARE - Continued
2001 ---------------------------------------------- Income Average shares Per share (numerator) (denominator) amount ----------- -------------- --------- Basic EPS Income available to common shareholders $ 15,754 11,904 $ 1.32 Effect of dilutive securities Stock options - 174 (0.02) ----------- -------------- --------- Diluted EPS Income available to common shareholders plus assumed exercise of options $ 15,754 12,079 $ 1.30 =========== ============== =========
All options to purchase shares of common stock were included in the computation of 2001 diluted EPS because the exercise price was less than the average market price of the common stock. NOTE M - STOCK OPTION PLANS The Company has two stock-based compensation plans, which are described below. The Company accounts for these plans under APB Opinion No. 25. 1. Outside Directors' Stock Option Plan The Company adopted a non-qualified outside Directors' Stock Option Plan (the Director's Plan). Under the terms of the Director's Plan, 250,000 shares of Class A stock are authorized for grants. Each director is entitled to 1,500 shares of stock annually, which are exercisable one year after the grant date. The options were granted at the fair market value at the date of the grant. Stock option transactions consist of the following:
2003 2002 2001 ----------------------- ----------------------- ---------------------- Weighted Weighted Weighted average average average exercise exercise exercise Shares price Shares price Shares price --------- ----------- --------- ----------- --------- ----------- Outstanding at beginning of year 78,717 $ 13.18 73,820 $ 11.70 62,593 $ 11.82 Granted 16,356 20.36 15,723 19.95 16,167 13.66 Exercised (25,012) 12.27 (10,826) 9.85 (4,940) 10.09 Cancelled - - - - - - ------- ------- ------ Outstanding at end of year 70,061 15.21 78,717 $ 13.18 73,820 $ 11.82 ======= ======= ====== Weighted average fair value of options granted during the year $ 3.62 $ 8.70 $ 3.36
(Continued) 60 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE M - STOCK OPTION PLANS - Continued The following table summarizes information about options outstanding and exercisable at December 31, 2003:
Options outstanding Options exercisable ----------------------------------------------- --------------------------- Weighted average Weighted Weighted remaining average average Range of Number contractual exercise Number exercise exercise prices outstanding life (years) price exercisable price --------------- ------------- ------------ ------------- ---------------- ------ $5.33 - 7.25 5,641 1.2 $ 6.09 5,641 $ 6.09 $9.97 - 13.01 26,985 5.8 12.17 26,985 12.17 $15.04 - 19.96 37,435 7.7 18.76 22,135 15.69 ------ ------ 70,061 54,761 ====== ======
2. Employee Stock Option and Appreciation Right Plan ------------------------------------------------- The Company adopted a Stock Option and Appreciation Right Plan (the Plan). The Plan is an incentive program under which Company officers and other key employees may be awarded additional compensation in the form of options to purchase up to 1,500,000 shares of the Company's Class A common stock (but not in excess of 15% of outstanding shares). At the time a stock option is issued, a stock appreciation right for an identical number of shares may also be granted. The option price is equal to the fair market value at the date of the grant. The options are exercisable at 20% per year beginning one year after the date of grant and must be exercised within ten years of the grant. Stock option transactions consist of the following:
2003 2002 2001 ----------------------- ----------------------- ---------------------- Weighted Weighted Weighted average average average exercise exercise exercise Shares price Shares price Shares price --------- ----------- --------- ----------- --------- ----------- Outstanding at beginning of year 489,022 $ 14.40 502,362 $ 10.44 375,778 $ 9.34 Granted 154,334 20.36 160,336 19.95 174,577 13.66 Exercised (118,148) 11.66 (157,623) 5.83 (33,488) 5.30 Cancelled (105,176) 17.50 (16,053) 17.62 (14,505) 13.22 --------- --------- --------- Outstanding at end of year 420,032 $ 16.08 489,022 $ 14.40 502,362 $10.44 ========= ========= ========= Weighted average fair value of options granted during the year $ 3.62 $ 8.70 $ 3.36
(Continued) 61 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE M - STOCK OPTION PLANS - Continued The following table summarizes information about options outstanding and exercisable at December 31, 2003:
Options outstanding Options exercisable ----------------------------------------------- --------------------------- Weighted average Weighted Weighted remaining average average Range of Number contractual exercise Number exercise exercise prices outstanding life (years) price exercisable price --------------- ------------- ------------ ------------- ---------------- ------ $7.24 - 9.67 32,108 1.7 $ 8.74 32,108 $ 8.74 $15.04 - 19.96 387,924 6.7 16.68 117,796 14.16 ------- ------- 420,032 149,904 ======= =======
NOTE N - PENSION PLAN The Company has a noncontributory nonqualified defined benefit pension plan covering certain eligible employees. The Company-sponsored pension plan provides retirement benefits under pension trust agreements and under contracts with insurance companies. The benefits are based on years of service and the employee's compensation during the highest five consecutive years during the last 10 years of employment. The Company's policy is to fund pension costs allowable for income tax purposes. The following table sets forth the plan's funded status and amounts recognized in the Company's consolidated balance sheets (in thousands):
2003 2002 ------------- ------------- Change in benefit obligation Benefit obligation at beginning of year $ 3,048 $ 2,377 Service cost 317 (800) Interest cost 214 191 Other changes 12 1,280 ---------- ---------- Benefits obligation at end of year $ 3,591 $ 3,048 ========== ==========
Weighted-average assumptions used to determine benefit obligations, end of year December 31 2003 2002 ---- ---- Discount rate 7.00% 7.00% Rate of compensation increase 4.00% 4.00% (Continued) 62 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE N - PENSION PLAN-Continued The asset allocation for the Company's pension plans ant the end of 2003 and 2002 consists of insurance policies under the Company Owned Life Insurance program. The cash surrender value for these policies was approximately $993,000 and $761,000 for the years ended December 31, 2003 and 2002, respectively. Net pension cost included the following components (in thousands):
2003 2002 2001 ------------- ------------- ------------- Service cost $ 410 $ 208 $ 553 Interest cost 214 191 124 ----------- ------------ ------------ Net periodic benefit cost $ 624 $ 399 $ 677 =========== ============ ============
The Company has a capital accumulation and salary reduction plan under Section 401(k) of the Internal Revenue Code of 1986, as amended. Under the plan, all employees are eligible to contribute from 1% to a maximum of 15% of their annual salary, with the Company matching 100% of any contribution between 1% and 5% subject to a $2,500 per employee annual limit. Matching contributions to the plan were approximately $199,000, $187,000 and $167,000 for the years ended December 31, 2003, 2002 and 2001, respectively. NOTE O - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF CREDIT RISK The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they become payable. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. (Continued) 63 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE O - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF CREDIT RISK - Continued The Company's exposure to credit loss in the event of non-performance by the other party to commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. The contract amounts are as follows (in thousands):
December 31, ------------------------------ 2003 2002 ------------- ------------- Financial instruments whose contract amounts represent credit risk Commitments to extend credit $ 59,829 $ 89,792 Standby letters of credit and financial guarantees written 5,099 5,188
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, and others are for staged construction, the total commitment amounts do not necessarily represent immediate cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation. Collateral held varies but may include personal or commercial real estate, accounts receivable, inventory and equipment. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. Most guarantees extend for one year and expire in decreasing amounts through 2004. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds personal or commercial real estate, accounts receivable, inventory and equipment as collateral supporting those commitments for which collateral is deemed necessary. The extent of collateral held for those commitments is 80%. NOTE P - FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS No. 107 requires disclosure of the estimated fair value of an entity's assets and liabilities considered to be financial instruments. For the Company, as for most financial institutions, the majority of its assets and liabilities are considered financial instruments as defined in SFAS No. 107. However, many of such instruments lack an available trading market, as characterized by a willing buyer and seller engaging in an exchange transaction. Also, it is the Company's general practice and intent to hold its financial instruments to maturity and not to engage in trading or sales activities. Therefore, the Company had to use significant estimations and present value calculations to prepare this disclosure. (Continued) 64 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE P - FAIR VALUE OF FINANCIAL INSTRUMENTS - Continued Changes in the assumptions or methodologies used to estimate fair value may materially affect the estimated amounts. Also, management is concerned that there may not be reasonable comparability between institutions due to the wide range of permitted assumptions and methodologies in the absence of active markets. This lack of uniformity gives rise to a high degree of subjectivity in estimating financial instrument fair value. Fair values have been estimated using data which management considered the best available and estimation methodologies deemed suitable for the pertinent category of financial instrument. The estimation methodologies, resulting fair values and recorded carrying amounts at December 31, 2003 and 2002 were as follows: Fair values of loans and deposits with floating interest rates are generally presumed to approximate the recorded carrying amounts. Fair value of financial instruments actively traded in a secondary market has been estimated using quoted market prices as follows (in thousands):
2003 2002 ------------------------------ ------------------------------ Estimated Estimated fair Carrying fair Carrying value amount value amount ------------- -------------- ------------- -------------- Cash and cash equivalents $ 25,070 $ 25,070 $ 40,571 $ 40,571 Investment securities held to maturity 114,275 113,091 32,745 30,614 Investment securities available for sale 452,246 452,246 418,316 418,316
Fair value of financial instruments with stated maturities has been estimated using present value cash flow, discounted at a rate approximating current market for similar assets and liabilities, as follows (in thousands):
2003 2002 ------------------------------ ------------------------------ Estimated Estimated fair Carrying fair Carrying value amount value amount ------------- -------------- ------------- -------------- Deposits with stated maturities $ 245,409 $ 236,902 $ 319,551 $ 330,193 Long-term borrowings 217,319 212,000 122,448 127,500
Fair value of financial instrument liabilities with no stated maturities has been estimated to equal the carrying amount (the amount payable on demand), totaling approximately $554,157,000 and $490,647,000 at December 31, 2003 and 2002, respectively. Fair value of the net loan portfolio has been estimated using present value cash flow, discounted at the treasury rate adjusted for non-interest operating costs and giving consideration to estimated prepayment risk and credit loss factors, as follows (in thousands): (Continued) 65 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE P - FAIR VALUE OF FINANCIAL INSTRUMENTS - Continued
2003 2002 ------------------------------ ------------------------------ Estimated Estimated fair Carrying fair Carrying value amount value amount ------------- -------------- ------------- -------------- Net loans $ 516,639 $ 515,715 $ 635,495 $ 576,734
The fair value of commitments to extend credit is estimated based on the amount of unamortized deferred loan commitment fees. The fair value of letters of credit is based on the amount of unearned fees plus the estimated cost to terminate the letters of credit. Fair values of unrecognized financial instruments including commitments to extend credit and the fair value of letters of credit are considered immaterial. The Company's remaining assets and liabilities are not considered financial instruments. No disclosure of the relationship value of the Company's deposits is required by SFAS No. 107. NOTE Q - REGULATORY MATTERS 1. Payment of Dividends -------------------- Under the Pennsylvania Business Corporation Law, the Company may pay dividends only if it is solvent and would not be rendered insolvent by the dividend payment. There are also restrictions set forth in the Pennsylvania Banking Code of 1965 (the Banking Code) and in the Federal Deposit Insurance Act (FDIA) concerning the payment of dividends by the Company. Under the Banking Code, no dividends may be paid except from "accumulated net earnings" (generally undivided profits). Under the FDIA, no dividend may be paid if a bank is in arrears in the payment of any insurance assessment due to the Federal Deposit Insurance Corporation (FDIC). 2. Capital Ratios -------------- The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory--and possible additional discretionary--actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulations to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). As of December 31, 2003, management believes that the Bank meets all capital adequacy requirements to which it is subject. (Continued) 66 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE Q - REGULATORY MATTERS - Continued As of December 31, 2003, the Bank met all regulatory requirements for classification as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank's category. The Bank's actual capital amounts and ratios are also presented in the table (in thousands).
2003 ----------------------------------------------------------------------- To be well capitalized under For capital prompt corrective Actual adequacy purposes action provisions ---------------------- ---------------------- ---------------------- Amount Ratio Amount Ratio Amount Ratio ----------- --------- ----------- -------- ----------- --------- Total capital (to risk-weighted assets) Company (consolidated) $ 139,876 16.50% $ 67,792 8.00% N/A N/A Bank 113,922 13.73% 66,371 8.00% $ 82,964 10.00% Tier I capital (to risk-weighted assets) Company (consolidated) 129,283 15.30% 33,896 4.00% N/A N/A Bank 103,523 12.47% 33,186 4.00% 49,778 6.00% Tier I capital (to average assets, leverage) Company (consolidated) 129,283 11.10% 34,811 3.00% N/A N/A Bank 103,523 8.99% 34,556 3.00% 57,593 5.00%
2002 ----------------------------------------------------------------------- To be well capitalized under For capital prompt corrective Actual adequacy purposes action provisions ---------------------- ---------------------- ---------------------- Amount Ratio Amount Ratio Amount Ratio ----------- --------- ----------- -------- ----------- --------- Total capital (to risk-weighted assets) Company (consolidated) $ 129,873 15.91% $ 65,304 8.00% N/A N/A Bank 93,276 11.69% 63,815 8.00% $ 79,769 10.00% Tier I capital (to risk-weighted assets) Company (consolidated) 119,641 14.61% 32,742 4.00% N/A N/A Bank 83,279 10.41% 32,006 4.00% 48,010 6.00% Tier I capital (to average assets, leverage) Company (consolidated) 119,641 11.41% 31,466 3.00% N/A N/A Bank 83,279 8.10% 30,836 3.00% 51,393 5.00%
67 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE R - CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY Condensed financial information for the parent company only follows (in thousands). CONDENSED BALANCE SHEETS
December 31, ------------------------------ 2003 2002 ------------- ------------- Assets Cash $ 4,775 $ 2,527 Investment in Royal Investments of Delaware, Inc. - at equity 20,995 33,531 Investment in Royal Bank of Pennsylvania - at equity 109,063 84,960 Other assets -- 312 ----------- ----------- $ 134,833 $ 121,330 =========== =========== Stockholders' equity 134,833 121,330 ----------- ----------- $ 134,833 $ 121,330 =========== ===========
CONDENSED STATEMENTS OF INCOME
Year ended December 31, ------------------------------------------------ 2003 2002 2001 ------------- ------------- ------------- Income Equity in undistributed net earnings of subsidiaries $ 7,241 $ 6,840 $ 6,796 Dividends from subsidiary bank 11,321 10,589 8,984 Other income 25 49 35 ---------- ---------- ---------- Total income 18,587 17,478 15,815 ---------- ---------- ---------- Expenses Other expenses 81 85 75 Income tax benefit (20) (12) (14) ---------- ---------- ---------- Total expenses 61 73 61 ---------- ---------- ---------- Net income $ 18,526 $ 17,405 $ 15,754 ========== ========== ==========
(Continued) 68 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE R - CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY - Continued CONDENSED STATEMENTS OF CASH FLOWS
Year ended December 31, ------------------------------------------------ 2003 2002 2001 ------------- ------------- ------------- Cash flows from operating activities Net income $ 18,526 $ 17,405 $ 15,754 Adjustments to reconcile net income to net cash provided by operating activities Undistributed earnings from subsidiaries (7,241) (6,840) (6,796) Operating expenses 81 85 75 Rental income (25) (49) (35) Non-cash income tax benefit (20) (12) (14) ---------- ---------- ---------- Net cash provided by operating activities 11,321 10,589 8,984 ---------- ---------- ---------- Cash flows from financing activities Cash dividends paid (11,321) (10,589) (8,984) Other, net 2,248 1,083 48 ---------- ---------- ---------- Net cash used in financing activities (9,073) (9,506) (8,936) ---------- ---------- ---------- Net increase in cash 2,248 1,083 48 Cash at beginning of year 2,527 1,444 1,396 ---------- ---------- ---------- Cash at end of year $ 4,775 $ 2,527 $ 1,444 ========== ========== ==========
NOTE S - SUMMARY OF QUARTERLY RESULTS (UNAUDITED) The following summarizes the consolidated results of operations during 2003 and 2002, on a quarterly basis, for the Company (in thousands except per share data):
2003 ------------------------------------------------------ Fourth Third Second First Quarter Quarter Quarter Quarter ---------- ---------- ----------- ---------- Interest income $ 17,939 $ 18,197 $ 17,753 $ 18,431 Net interest income 10,885 10,967 10,123 10,404 Provision for loan losses 160 197 167 150 Income before income taxes 7,325 6,984 5,879 6,334 Net income 5,383 4,763 3,980 4,400 Net income per share Basic $ 0.44 $ 0.39 $ 0.33 $ 0.36 Diluted $ 0.44 $ 0.39 $ 0.33 $ 0.36
(Continued) 69 ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES Notes To Consolidated Financial Statements - Continued December 31, 2003 and 2002 NOTE R - SUMMARY OF QUARTERLY RESULTS (UNAUDITED) - Continued
2002 ------------------------------------------------------ Fourth Third Second First Quarter Quarter Quarter Quarter ---------- ---------- ----------- ---------- Interest income $ 19,332 $ 19,797 $ 18,833 $ 19,143 Net interest income 10,540 10,543 9,605 9,926 Provision for loan losses - - 50 200 Income before income taxes 6,308 6,930 5,428 5,976 Net income 4,831 4,462 3,897 4,215 Net income per share Basic $ 0.40 $ 0.37 $ 0.32 $ 0.35 Diluted $ 0.40 $ 0.36 $ 0.31 $ 0.34
70 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND ----------------------------------------------------------------------- FINANCIAL DISCLOSURE -------------------- None. ITEM 9A. CONTROLS AND PROCEDURES -------------------------------- We maintain a system of controls and procedures designed to provide reasonable assurance to the reliability of the financial statements and other disclosures included in this report, as well as to safeguard assets from unauthorized use or disposition. We evaluated the effectiveness of the design and operation of our disclosure controls and procedures under supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, within 90 days prior to the filing date of this report. Based upon that evaluation, our disclosure controls and procedures are effective in timely alerting them of material information required to be included in our periodic Securities and Exchange Commission filings. No significant changes were made to our internal controls or other factors that could significantly affect these controls subsequent to the date of their evaluation. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT -------------------------------------------------------- The information required in this Item, relating to directors, executive officers, and control persons is set forth in Royal Bancshares' Proxy Statement to be used in connection with the 2004 Annual Meeting of Shareholders under the heading "Remuneration of Directors and Officers and Other Transactions", which pages are incorporated herein by reference. Beneficial Ownership - Compliance. Section 16(a) of the Securities Exchange Act of 1934, as amended, requires Royal Bancshares' officers and directors, and persons who own more than 10 percent of the registered class of Royal Bancshares' equity securities, to file reports of ownership and changes in ownership with the SEC. Officers, directors and greater than 10 percent shareholders are required by SEC regulation to furnish the Corporation copies of all Section 16(a) forms they file. Based solely on its review of forms that were received from certain reporting persons, Royal Bancshares believes that during the period January 1, 2003 through December 31, 2003, its officers and directors were in compliance with all filing requirements applicable to them. ITEM 11. EXECUTIVE COMPENSATION ------------------------------- The information required by this Item, relating to executive compensation, is set forth in the Royal Bancshares' Proxy Statement to be used in connection with the 2004 Annual Meeting of Shareholders, under the heading "Remuneration of Directors and Officers and Other Transactions", which pages are incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ----------------------------------------------------------------------- The information required by this Item, relating to beneficial ownership of the Registrant's Common Stock, is set forth in Royal Bancshares' Proxy Statement to be used in connection with the 2004 Annual Meeting of Shareholders, under the heading "Information About Nominees, Continuing Directors and Executive Officers", which pages are incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ------------------------------------------------------- The information required by this Item, relating to transactions with management and others, certain business relationships and indebtedness of management, is set forth in Royal Bancshares' Proxy Statement to be used in connection with the 2004 Annual Meeting of Shareholders, under the heading "Interest of Management and Others in Certain Transactions", which page are incorporated herein by reference. 71 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES ----------------------------------------------- Information required by this item appears under the heading "AUDIT FEES" of the Proxy Statement to be used in connection with the 2004 Annual Meeting of Shareholders. ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K ------------------------------------------------------------------------- a. 1. Financial Statements The following financial statements are included by reference in Part II, Item 8 hereof. Report of Independent Certified Public Accountants. Consolidated Balance Sheets. Consolidated Statements of Income. Consolidated Statements of Changes in Stockholders' Equity. Consolidated Statement of Cash Flows. Notes To Consolidated Financial Statements. 2. Financial Statement Schedules Financial Statement Schedules are omitted because the required information is either not applicable, not required or is shown in the respective financial statements or in the notes thereto. 3. The following Exhibits are files herewith or incorporated by reference as a part of this Annual Report. 2 Purchase and Assumption Agreement, dated as of March 12, 2001, among Royal Bank of Pennsylvania, Crusader Holding Corporation, Crusader Savings Bank, F.S.B. and Asset Investment Corporation. (Incorporated by reference to Exhibit 2 to Registrant's Report on Form 8-K, filed with the Commission on March 15, 2001.) 3(i) Articles of Incorporation. (Incorporated by reference to Exhibit 3(i) to Registrant's Registration Statement No. 0-26366 on Form S-4.) 3(ii) By-laws. (Incorporated by reference to Exhibit 99 to Registrant's Current Report on Form 8-K, filed with the Commission on March 13, 2001.) 10.1 Stock Option and Appreciation Right Plan. (Incorporated by reference to the Registrant's Registration Statement N0. 333-25855, on form S-8 filed with the Commission on April 5, 1997). 10.2 Outside Directors' Stock Option Plan. (Incorporated by reference to the Registrant's Registration Statement N0. 333-25855, on form S-8 filed with the Commission on April 5, 1997). 11. Statement Re: Computation of Earnings Per Share. Included at Item 8, hereof, Note A, "Per Share Information". 12. Statement re: Computation of Ratios. (Included at Item 8 here of, Note Q, "Regulatory Matters.") 14. Royal Bancshares of Pennsylvania, Inc. Code of Ethics. 21. Subsidiaries of Registrant. 72 23. Consent of Independent Accountants. 31.1 Rule 13a-14(a)/15-d-14(a) Certification of Chief Executive Officer 31.2 Rule 13a-14(a)/15-d-14(a) Certification of Chief Financial Officer 32.1 Section 1350 Certification of Chief Executive Officer. 32.2 Section 1350 Certification of Chief Financial Officer. (b) Reports on Form 8-K was filed by the Registrant during the fourth quarter and through of this Form 10K filing are as follows: Royal Bancshares filed a report on Form 8-K with the Securities and Exchange Commission as of October 16, 2003 announcing the appointment of Robert R. Tabas as Chairman of the Board of Directors and the appointment of Linda Stempel to the Board of Directors. Royal Bancshares filed a report on Form 8-K with the Securities and Exchange Commission as of January 27, 2004, reporting its fourth quarter earnings and the declaration of 2% stock dividend along with its 35th consecutive cash dividend. Royal Bancshares filed a report on Form 8-K with the Securities and Exchange Commission as of February 26, 2004, announcing the opening of Royal Asian Bank, a division of Royal Bank of Pennsylvania. (c) The exhibits required to be filed by this Item are listed under Item 14(a)3 above. (d) Not applicable. Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of l934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. 73 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ROYAL BANCSHARES OF PENNSYLVANIA, INC. -------------------------------------- /s/ Joseph P. Campbell ---------------------- Joseph P. Campbell Chief Executive Officer March 12, 2004. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. SIGNATURES ---------- By: /s/ Joseph P. Campbell March 12, 2004. ------------------------------------- Joseph P. Campbell CEO/President/Director By: /s/ Jeffrey T. Hanuscin March 12, 2004. ------------------------------------- Jeffrey T. Hanuscin Chief Financial Officer By: /s/ James J. McSwiggan March 12, 2004. ------------------------------------- James J. McSwiggan Director/Executive Vice President By: /s/Robert R. Tabas March 12, 2004. ------------------------------------- Robert R. Tabas Chairman of the Board By: /s/ Albert Ominsky March 12, 2004. ------------------------------------- Albert Ominsky Director By: /s/ Anthony J. Micale March 12, 2004. ------------------------------------- Anthony J. Micale Director By: /s/ Gregory T. Reardon March 12, 2004. ------------------------------------- Gregory T. Reardon Director By: /s/ Murray Stempel,III March 12, 2004. ------------------------------------- Murray Stempel, III Director/ Senior Vice President By: /s/ John M. Decker March 12, 2004. ------------------------------------- John M. Decker Director/ Senior Vice President 74 By: /s/ Carl M. Cousins March 12, 2004. ------------------------------------- Carl M. Cousins Director By: March 12, 2004. ------------------------------------- Lee E. Tabas Director By: /s/ Jack R. Loew March 12, 2004. ------------------------------------- Jack R. Loew Director By: /s/ Howard Wurzak March 12, 2004. ------------------------------------- Howard Wurzak Director By: /s/ Evelyn Rome Tabas March 12, 2004. ------------------------------------- Evelyn Rome Tabas Director By: /s/ Mitchell L. Morgan March 12, 2004. ------------------------------------- Mitchell L. Morgan Director By: /s/ Edward B. Tepper March 12, 2004. ------------------------------------- Edward B. Tepper Director By: /s/ Linda Tabas Stempel March 12, 2004. ------------------------------------- Linda Tabas Stempel Director 75 ROYAL BANCSHARES OF PENNSYLVANIA, INC. ANNUAL REPORT ON FORM 10-K EXHIBIT INDEX 2. Purchase and Assumption Agreement, dated as of March 12, 2001, among Royal Bank of Pennsylvania, Crusader Holding Corporation, Crusader Savings Bank, F.S.B. and Asset Investment Corporation. (Incorporated by reference to Exhibit 2 to Registrant's Report on Form 8-K, filed with the Commission on March 15, 2001.) 3(i) Articles of Incorporation. (Incorporated by reference to Exhibit 3(i) to Registrant's Registration Statement No. 0-26366 on Form S-4.) 3(ii) By-laws. (Incorporated by reference to Exhibit 99 to Registrant's Current Report on Form 8-K, filed with the Commission on March 13, 2001.) 10.1 Stock Option and Appreciation Right Plan. (Incorporated by reference to the Registrant's Registration Statement N0. 333-25855, on form S-8 filed with the Commission on April 5, 1997). 10.2 Outside Directors' Stock Option Plan. (Incorporated by reference to the Registrant's Registration Statement N0. 333-25855, on form S-8 filed with the Commission on April 5, 1997). 11. Statement Re: Computation of Earnings Per Share. (Included at Item 8, hereof, Note A, "Per Share Information".) 12. Statements re: Computation of Ratios. (Included at Item 8 here of, Note Q, "Regulatory Matters.") 14. Royal Bancshares of Pennsylvania, Inc. Code of Ethics. 21. Subsidiaries of Registrant. 23. Consent of Independent Accountants. 31.1 Rule 13a-14(a)/15-d-14(a) Certification of Chief Executive Officer 31.2 Rule 13a-14(a)/15-d-14(a) Certification of Chief Financial Officer 32.1 Section 1350 Certification of Chief Executive Officer. 32.2 Section 1350 Certification of Chief Financial Officer. 76