10-Q 1 ten-q.txt FORM 10-Q FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarterly period ended: MARCH 31, 2006 -------------- [ ] 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 the registrant as specified in its charter) PENNSYLVANIA 23-2812193 ------------------------------- ------------------ (State or other jurisdiction of (IRS Employer incorporated or organization) identification No.) 732 MONTGOMERY AVENUE, NARBERTH, PA 19072 ----------------------------------------- (Address of principal Executive Offices) (610) 668-4700 -------------- (Registrant's telephone number, including area code) N/A --- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 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 whether the registrant is a large accelerated filer, an accelerated filer, or a non- accelerated filer. See definitions of large accelerated filer and accelerated filer in Rule 12-b-2 of the Exchange Act. Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] Applicable only to corporate issuers: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class A Common Stock Outstanding at April 30, 2006 -------------------- ----------------------------- $2.00 PAR VALUE 10,700,720 Class B Common Stock Outstanding at April 30, 2006 -------------------- ----------------------------- $.10 PAR VALUE 1,992,129 PART I-FINANICAL INFORMATION ITEM 1- FINANCIAL STATEMENTS ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (dollars in thousands, except share data)
(UNAUDITED) ASSETS MAR 31, 2006 DEC 31, 2005 ------------ ------------ Cash and due from banks $ 19,279 $ 17,095 Federal funds sold 1,000 13,800 ---------- ---------- Total cash and cash equivalents 20,279 30,895 Investment securities held to maturity (HTM) (fair value of $250,650 at March 31, 2006 and $253,198 at December 31, 2005) 255,456 255,467 Investment securities available for sale (AFS) - at fair value 306,441 326,189 FHLB Stock, at cost 16,062 17,073 Loans held for sale 1,291 803 Loans 593,625 549,636 Less allowance for loan losses 10,550 10,276 ---------- ---------- Net loans 583,075 539,360 Premises and equipment, net 66,918 66,582 Accrued interest and other assets 67,251 64,650 ---------- ---------- Total assets $1,316,773 $1,301,019 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Deposits Non-interest bearing $ 67,151 $ 75,754 Interest bearing (includes certificates of deposit in excess of $100 of $222,295 at March 31, 2006 and $203,611 at December 31, 2005) 651,739 621,655 ---------- ---------- Total deposits 718,890 697,409 Accrued interest payable 7,367 6,606 Borrowings 422,189 427,130 Other liabilities 10,356 11,879 ---------- ---------- Total liabilities 1,158,802 1,143,024 MINORITY INTEREST 2,150 2,487 Stockholders' equity Common stock Class A, par value $2 per share; authorized, 18,000,000 shares; issued, 10,700,689 at March 31, 2006 and 10,699,592 at December 31, 2005 21,401 21,400 Class B, par value $.10 per share; authorized, 2,000,000 shares; issued, 1,992,156 at March 31, 2006 and 1,992,957 at December 31, 2005 199 199 Undistributed Class B shares 2 2 Additional paid in capital 104,285 104,285 Retained earnings 34,649 32,827 Accumulated other comprehensive loss (2,450) (940) ---------- ---------- 158,086 157,773 Treasury stock - at cost, shares of Class A, 215,388 at March 31, 2006, and December 31, 2005. (2,265) (2,265) ---------- ---------- Total stockholders' equity 155,821 155,508 ---------- ---------- Total liabilities and stockholders' equity $1,316,773 $1,301,019 ========== ==========
The accompanying notes are an integral part of these statements. ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
THREE MONTHS ENDED MARCH 31, ------------------------- (in thousands, except per share data) 2006 2005 -------- ------- Interest income Loans, including fees $ 14,096 $10,126 Investment securities held to maturity 2,856 2,248 Investment securities available for sale 4,429 4,789 Deposits in banks 12 23 Federal funds sold 20 18 -------- ------- TOTAL INTEREST INCOME 21,413 17,204 -------- ------- Interest expense Deposits 5,464 4,010 Borrowings 4,615 3,356 -------- ------- TOTAL INTEREST EXPENSE 10,079 7,366 -------- ------- NET INTEREST INCOME 11,334 9,838 Provision for loan losses 335 1 -------- ------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 10,999 9,837 -------- ------- Other income Service charges and fees 354 293 Net gains on sales of investment securities 83 250 Income related to equity investments 778 1,443 Gains on sales of other real estate 1,493 289 Gains on sales of loans 43 125 Other income 247 213 -------- ------- 2,998 2,613 -------- ------- Other expenses Salaries and wages 2,445 2,314 Employee benefits 813 576 Occupancy and equipment 404 409 Expenses related to equity investments 276 1,064 Other operating expenses 2,248 1,997 -------- ------- 6,186 6,360 -------- ------- INCOME BEFORE INCOME TAXES 7,811 6,090 Income taxes 2,465 1,769 -------- ------- NET INCOME 5,346 $ 4,321 ======== ======= Per share data Net income - basic $ 0.42 $ 0.34 ======== ======= Net income - diluted $ 0.41 $ 0.34 ======== ======= Cash dividends- Class A shares $ 0.275 $ 0.25 ======== ======= Cash dividends- Class B shares $0.31625 $0.2875 ======== =======
The accompanying notes are an integral part of these statements. ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME THREE MONTHS ENDED MARCH 31, 2006 (UNAUDITED)
(in thousands, except per share data) Class A common stock Class B common stock Un- Additional -------------------- -------------------- Distributed Paid in Retained Shares Amount Shares Amount B-shares Capital earnings -------- -------- -------- -------- ----------- ---------- -------- Balance, January 1, 2006 10,700 $ 21,400 1,993 $ 199 $ 2 $ 104,285 32,827 Net income - - - - - - 5,346 Conversion of Class B common stock to Class A common stock 1 1 (1) - - - (1) Cash in lieu of fractional shares - - - - - - (12) Cash dividends on common stock (Class A $0.275, Class B $0.31625) - - - - - - (3,511) Other comprehensive loss, net of reclassifications and tax benefit of $529 - - - - - - - ------ -------- ----- ------ ----- --------- -------- Comprehensive income Balance, March 31, 2006 10,701 $ 21,401 1,992 $ 199 $ 2 $ 104,285 $ 34,649 ====== ======== ===== ====== ===== ========= ======== Accumulated other comprehensive Treasury Comprehensive income (loss) stock income ------------- -------- ------------- Balance, January 1, 2006 $ (940) $ (2,265) Net income - - $ 5,346 Conversion of Class B common stock to Class A common stock - - - Cash in lieu of fractional shares - - - Cash dividends on common stock (Class A $0.275, Class B $0.31625) - - - Other comprehensive loss, net of reclassifications and tax benefit of $529 (1,510) - (1,510) -------- -------- ------- Comprehensive income $ 3,836 ======= Balance, March 31, 2006 $ (2,450) $ (2,265) ======== ========
The accompanying notes are an integral part of the financial statement. ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME THREE MONTHS ENDED MARCH 31, 2005 (UNAUDITED)
CLASS A COMMON STOCK CLASS B COMMON STOCK ADDITIONAL ----------------------- ---------------------- PAID IN RETAINED (in thousands, except per share data) SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS -------- -------- -------- -------- ---------- -------- Balance, January 1, 2005 10,277 $20,553 1,939 $194 $92,037 $26,558 Net income - - - - - 4,321 Conversion of Class B common stock to Class A Common stock - - - - - - Purchase of treasury stock - - - - - - 2% stock dividend declared 201 402 39 4 6,640 (7,046) Cash dividends on common stock - - - - - (per share: Class A $0.25 and Class B $0.2875) (3,135) Cash in lieu of fractional shares - - - - - (12) Stock options exercised 7 14 - - 64 - Other comprehensive loss, net of reclassification adjustment and tax benefit of $1,045 - - - - - - ------ ------- ------ ---- ------- ------- Comprehensive income Balance, March 31, 2005 10,485 $20,969 1,978 $198 $98,741 $20,686 ====== ======= ====== ==== ======= ======= ACCUMULATED OTHER TREASURY COMPREHENSIVE COMPREHENSIVE STOCK INCOME (LOSS) INCOME -------- ------------- ------------- Balance, January 1, 2005 $(2,265) $3,799 Net income - - $4,321 Conversion of Class B common stock to Class A Common stock - - - Purchase of treasury stock - - - 2% stock dividend declared - - - Cash dividends on common stock - - - (per share: Class A $0.25 and Class B $0.2875) Cash in lieu of fractional shares - - - Stock options exercised - - - Other comprehensive loss, net of reclassification adjustment and tax benefit of $1,045 - (2,987) (2,987) ------- ------ ------ Comprehensive income $1,334 ====== Balance, March 31, 2005 $(2,265) $ 812 ======= ======
The accompanying notes are an integral part of the financial statement CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) THREE MONTHS ENDED MARCH 31, (in thousands)
Cash flows from operating activities 2006 2005 --------- --------- Net income $5,346 $4,321 Adjustments to reconcile net income to net cash provided by operating activities Depreciation 291 587 Stock compensation expense 178 -- Provision for loan losses 335 1 Net accretion of discounts and premiums on loans, mortgage-backed securities and investments 1,494 1,788 Provision for deferred income taxes (1,998) (1,007) Gains on sales of other real estate (1,493) (289) Gains on sales of loans (43) (125) Net gains on sales of investment securities (83) (250) Changes in assets and liabilities: Increase in accrued interest receivable (1,007) (1,056) (Increase) decrease in other assets (408) 1,709 Increase (decrease) in accrued interest payable 761 (18) (Decrease) increase in other liabilities (2,160) 1,323 --------- --------- Net cash provided by operating activities 1,213 6,984 Cash flows from investing activities Proceeds from calls/maturities of HTM investment securities -- 32,750 Proceeds from calls/maturities of AFS investment securities 13,951 3,970 Proceeds from sales of AFS investment securities 1,595 6,345 Purchase of AFS investment securities (185) (5,137) Purchase of HTM investment securities -- (40,025) Redemption (Purchase) of FHLB Stock 1,011 (4,825) Net increase in loans (40,570) (23,018) (Purchase) of premises and equipment (77) 933 (Purchase) sales of premises and equipment relating to VIE (550) -- --------- --------- Net cash used in investing activities (24,825) (29,007) Cash flows from financing activities: Net decrease in non-interest bearing and interest bearing demand deposits and savings accounts (5,417) (77,263) Net increase in certificates of deposit 26,898 5,655 Mortgage payments (21) (15) Net (decrease)increase in FHLB borrowings (5,000) 96,500 Obligations through equity investments 59 1,292 Cash dividends (3,511) (3,135) Cash in lieu of fractional shares (12) (12) Issuance of common stock under stock option plans -- 64 --------- --------- Net cash provided by financing activities 12,996 23,086 NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (10,616) 1,063 Cash and cash equivalents at beginning of period 30,895 27,109 --------- --------- Cash and cash equivalents at end of period $ 20,279 $ 28,172 ========= =========
The accompanying notes are an integral part of these statements. ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) The accompanying unaudited consolidated financial statements include the accounts of Royal Bancshares of Pennsylvania, Inc ("Company") and its wholly-owned subsidiaries, Royal Investments of Delaware, Inc. and Royal Bank America ("Royal Bank"), including Royal Bank's subsidiaries, Royal Real Estate of Pennsylvania, Inc., Royal Investments America, LLC, and their two 60% ownership interests in Crusader Servicing Corporation and Royal Bank America Leasing, LP. The two Delaware trusts, Royal Bancshares Capital Trust I and Royal Bancshares Capital Trust II are not consolidated per requirements under FIN 46(R). These financial statements reflect the historical information of the Company. All significant inter-company transactions and balances have been eliminated. 1. The accompanying unaudited condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (US GAAP) for interim financial information. The financial information included herein is unaudited; however, such information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, necessary to present a fair statement of the results for the interim periods. These interim financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2005. The results of operations for the three-month period ended March 31, 2006, are not necessarily indicative of the results to be expected for the full year. 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. Applications of the principles in the Company's preparation of the 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. These estimates and assumptions are based on information available as of the date of the financial statements; therefore, actual results could differ from those estimates. 2. Segment Information 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 Royal Bank. For example, commercial lending is dependent upon the ability of Royal 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' Tax Lien Operation does not meet the quantitative thresholds for requiring disclosure, but has different characteristics than the community banking operation. The Company' 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 auctions along with periodic penalties imposed. As of March 31, 2006, the Company is reporting on a consolidated basis its interest in one Equity Investment as a Variable Interest Entity ("VIE") which has different characteristics than the community banking segment. Royal Bancshares has an equity investment in an apartment complex that is being converted into condominiums. As of March 31, 2005, the Company reported on a consolidated basis its interest in four equity investments as "VIE's" which have different characteristics than the community banking segment. Royal Bancshares has investments in two apartment complexes and two buildings leased as commercial office space. Royal Bancshares' investments in VIE's is further discussed in Note 9. The following table presents selected financial information for reportable business segments for the three month periods ended March 31, 2006 and 2005.
THREE MONTHS ENDED MARCH 31, 2006 --------------------------------- (in thousands) COMMUNITY TAX LIEN EQUITY BANKING OPERATION INVESTMENTS CONSOLIDATED --------- --------- ----------- ------------ Total assets $1,208,287 $48,062 $66,424 $1,316,773 ========== ======= ======= ========== Total deposits 718,890 -- -- 718,890 ========== ======= ======= ========== Net interest income $ 11,565 $ 380 ($ 611) $ 11,334 Provision for loan losses 333 2 -- 335 Other income 1,638 582 778 2,998 Other expense 5,435 475 276 6,186 Income tax expense 2,370 95 -- 2,465 ---------- ------- ------- ---------- Net income $ 5,065 $ 390 ($ 109) $ 5,346 ========== ======= ======= ========== THREE MONTHS ENDED MARCH 31, 2005 --------------------------------- (in thousands) COMMUNITY TAX LIEN EQUITY BANKING OPERATION INVESTMENTS CONSOLIDATED --------- --------- ----------- ------------ Total assets $1,117,768 $46,400 $66,858 $1,231,026 ========== ======= ======= ========== Total deposits 670,772 -- 670,772 ========== ======= ======= ========== Net interest income $ 9,718 $ 674 ($ 554) $ 9,838 Provision for loan losses -- 1 -- 1 Other income 1,079 91 1,443 2,613 Other expense 4,632 512 1,064 6,360 Income tax expense 1,720 49 -- 1,769 ---------- ------- ------- ---------- Net income $ 4,445 $ 203 ($ 175) $ 4,321 ========== ======= ======= ==========
Interest paid to the Community Banking segment by the Tax Lien Operation was approximately $837 thousand and $617 thousand for the three-month periods ended March 31, 2006, and 2005, respectively. Equity Investments, interest paid to Community Banking segment from mezzanine financing was approximately $230 thousand and $0 thousand for the three-month periods ended March 31, 2006 and 2005, respectively. 3. Per Share Information The Company follows the provisions of Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share". The Company has two classes of common stock currently outstanding. The classes are A and B, of which a share of Class B is convertible into 1.15 shares of Class A. 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. On December 22, 2005, the Company declared a 2% stock dividend payable on January 17, 2006. All share and per share information has been restated to reflect this dividend. Basic and diluted EPS are calculated as follows (in thousands, except per share data):
THREE MONTHS ENDED MARCH 31, 2006 Income Average shares Per share (numerator) (denominator) Amount ----------- -------------- --------- Basic EPS Income available to common shareholders $5,346 12,799 $0.42 Effect of dilutive securities Stock options 103 -- ------ ------ ----- Diluted EPS Income available to common shareholders plus assumed exercise of options $5,346 12,902 $0.41 ====== ====== ===== THREE MONTHS ENDED MARCH 31, 2005 Income Average shares Per share (numerator) (denominator) Amount ----------- -------------- --------- Basic EPS Income available to common shareholders $4,321 12,792 $0.34 Effect of dilutive securities Stock options 93 -- ------ ------ ----- Diluted EPS Income available to common shareholders plus assumed exercise of options $4,321 12,885 $0.34 ====== ====== =====
No options were anti dilutive for the periods ended March 31, 2006 and March 31, 2005. Note: The stock dividend resulted in the issuance of 205,120 additional shares of Class A common stock and 19,426 additional shares of Class B common stock. There was 20,117 Class B shares deferred (agreed to by the Tabas Family Trust) until the Annual Shareholders meeting to be held on May 17, 2006, where the Company will request the shareholders to approve amending Royal Bancshares' Articles of Incorporation to increased the number of Class B shares authorized. 4. Investment Securities: The carrying value and approximate market value of investment securities at March 31, 2006 are as follows:
AMORTIZED GROSS GROSS APPROXIMATE PURCHASED UNREALIZED UNREALIZED FAIR CARRYING (in thousands) COST GAINS LOSSES VALUE VALUE --------- ---------- ---------- ----------- -------- HELD TO MATURITY: Mortgage Backed $ 156 $ -- $ -- $ 156 $156 US Agencies 195,000 -- (4,931) 190,069 195,000 Other Securities 60,300 125 -- 60,425 60,300 -------- ------ ------ -------- -------- $255,456 $ 125 ($4,931) $250,650 $255,456 ======== ====== ====== ======== ======== AVAILABLE FOR SALE: Mortgage Backed $31,504 $ 1 ($1,095) $ 30,410 $ 30,410 CMO's 22,647 10 (354) 22,303 22,303 US Agencies 104,979 -- (4,660) 100,319 100,319 Other securities 151,080 3,888 (1,559) 153,409 153,409 -------- ------ ------ -------- -------- $310,210 $3,899 ($7,668) $306,441 $306,441 ======== ====== ====== ======== ========
5. Allowance for Loan Losses: Changes in the allowance for loan losses were as follows: THREE MONTHS ENDED MARCH 31, 2006 2005 ---- ---- (in thousands) Balance at beginning period $10,276 $12,519 Charge-offs Single family residential (122) (30) Non-residential -- -- Tax certificates (2) (1) Commercial and Industrial -- -- Other loans -- (2) ------- ------- Total charge-offs (124) (33) Recoveries Single family residential 55 3 Non-residential 3 -- Tax certificates -- -- Commercial and Industrial -- 4 Other loans 5 1 ------- ------- Total recoveries 63 8 Provision for loan losses 335 1 ------- ------- Balance at the end of period $10,550 $12,495 ======= ======= 6. Pension Plan The Company has a noncontributory nonqualified defined benefit pension plan covering certain eligible employees. The Company's 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 three consecutive years during the last 10 years of employment. The Company's policy is to fund pension costs allowable for income tax purposes. Net periodic defined benefit pension expense for the three months ended March 31, 2006 and 2005 included the following components: Three months ended March 31, ------------------ (in thousands) 2006 2005 ---- ---- Service cost $ 93 $206 Interest cost 85 65 ---- ---- Net periodic benefit cost $178 $271 ==== ==== The total accumulated benefit obligation under the plan including adjustments is estimated to be $6.6 million at December 31, 2006. 7. Stock-based Compensation Prior to January 1, 2006, the Company accounted for stock-based compensation expense using the intrinsic value method as required by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and as permitted by SFAS No. 123, "Accounting for Stock-Based Compensation." No compensation expense for stock options was reflected in net income for the quarter ended March 31, 2005, as all options granted had an exercise price equal to the market price of the underlying common stock at the date of grant. On January 1, 2006, the Company adopted SFAS No. 123(R) (revised version of SFAS No.123) which requires measurement of the compensation cost for stock-based awards based on the grant date fair value and recognition of compensation cost over the service period of stock based awards. The fair value of stock options is determined using a Black-Scholes valuation model, which is consistent with the Company's valuation methodology previously utilized for options in the footnote disclosures required under SFAS No.123. The Company has adopted SFAS No. 123(R) using the modified prospective method, which provides for no restatement of prior periods and no cumulative adjustment to equity accounts. It also provides for expense recognition, for both new and existing stock based awards. The adoption of SFAS No. 123(R) had the following impact on reported amounts compared with what would have been reported using the intrinsic value under previous accounting.
THREE MONTHS ENDED MARCH 31, 2006 (In thousands, except for per share data) USING PREVIOUS SFAS 123(R) AS ACCOUNTING ADJUSTMENT REPORTED ---------- ---------- -------- Income before income taxes $7,989 ($178) $7,811 Income taxes $2,527 ($62) $2,465 ------ ------ ------ Net Income $5,462 ($116) $5,346 ====== ====== ====== Basic earnings per share $0.43 ($0.01) $0.42 ====== ====== ====== Diluted earnings per share $0.42 ($0.01) $0.41 ====== ====== ======
The following table illustrates the effect on net income and earnings per share if expense had been measured using the fair value recognition provisions of SFAS No. 123(R).
THREE MONTHS ENDED MARCH 31, 2005 (In thousands, except for per share data) AS SFAS 123(R) REPORTED ADJUSTMENT PROFORMA -------- ---------- -------- Income before income taxes $6,090 ($189) $5,901 Income taxes $1,769 ($66) $1,703 ------ ------ ------ Net Income $4,321 ($123) $4,198 ====== ====== ====== Basic earnings per share $0.34 ($0.01) $0.33 ====== ====== ====== Diluted earnings per share $0.33 -- $0.33 ====== ====== ======
Outside Directors' Stock option Plan. Royal Bancshares 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 a grant of an option to purchase 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. The following table presents the activity related to Outside Directors Stock Option Plan for the three months ended March 31, 2006.
Weighted Weighted Average Average Exercise Remaining Options Price Term (yrs) Options outstanding at December 31, 2005 91,068 $18.53 Granted -- Exercised -- Forfeited -- Options outstanding at March 31, 2006 91,068 $18.53 6.6 Options exercisable at March 31, 2006 74,238 $17.53 6.0
Employee Stock Option Plan and Appreciation Right Plan Royal Bancshares 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 1,650,000 shares of Royal Bancshares' Class A common stock (but not in excess of 15% of outstanding shares). At the time a stock option is granted, 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. The following table presents the activity related to Employee Stock Option Plan for the three months ended March 31, 2006.
Weighted Weighted Average Average Exercise Remaining Options Price Term (yrs) Options outstanding at December 31, 2005 737,170 $19.61 Granted -- Exercised 176 $12.64 Forfeited -- Options outstanding at March 31, 2006 736,994 $19.61 7.1 Options exercisable at March 31, 2006 292,176 $16.11 8.1
8. Interest Rate Swaps For asset/liability management purposes, The Company uses interest rate swap agreements to hedge various exposures or to modify interest rate characteristics of various balance sheet accounts. Such derivatives are used as part of the asset/liability management process and are linked to specific liabilities which have a high correlation between the contract and the underlying item being hedged, both at inception and throughout the hedge period. The Company currently utilizes interest rate swap agreements to convert a portion of its fixed rate time deposits to a variable rate (fair value hedge) to fund variable rate loans. Interest rate swaps are contracts in which a series of interest flows are exchanged over a prescribed period. The notional amount ($60 million) on which interest payments are based is not exchanged. During the quarter ended September 30, 2005, the Company recorded expense in the amount of $676 thousand in other operating expenses which reflects the fair value of the interest rate swaps resulting from the Company not meeting the upfront documentation and the effectiveness assessment requirements of SFAS No. 133. As of October 1, 2005 and March 31, 2006 the Company has completed documentation determining the effectiveness of each hedge using the Volatility Reduction Measure ("VRM"). It was determined that these swaps are effective and are treated as fair value hedges. At March 31, 2006 and December 31, 2005, the information pertaining to outstanding interest rate swap agreement used to hedge fixed rate loans and investments is as follows: Mar. 31 Dec. 31 (in thousands) 2006 2005 ---- ---- Notional Amount $60,000 $60,000 Weighted average pay rate 4.79% 4.40% Weighted average receive rate 3.87% 3.87% Weighted average maturity (years) 4.3 4.5 Fair value relating to interest rate swaps ($1,447) ($1,281) 9. Variable Interest Entities ("VIE") Royal Bancshares, together with a real estate development company, formed Royal Scully Associates, G.P. ("Royal Scully") in September 2005. Royal Scully was formed to convert an apartment complex into condominiums in Blue Bell, Pennsylvania. The development company is the general partner of Royal Scully. Royal Bancshares invested 66% of the initial capital contribution, or $2.5 million, with the development company holding the remaining equity interest. In addition The Company holds two notes totaling $9.2 million with a competitive term and interest rate. Upon the repayment of the initial capital contributions and preferred return, distributions will convert to 50% for the Company and 50% for the development company. Royal Scully had total assets of $60.4 million and total borrowings of $47.4 million, of which $-0- is guaranteed by the Company. The Company has determined that Royal Scully is a VIE and it is the primary beneficiary. The Company's exposure to loss due to its investment is $11.3 million at March 31, 2006. Royal Bancshares, together with a real estate investment company, formed 212 C Associates, L.P. ("212 C") in May 2002. 212 C was formed to acquire, hold, improve, and operate office space located in Lansdale, Pennsylvania. The investment company is the general partner of the project. The Company invested 90% of initial capital contributions with the investment company holding the remaining equity interest. Upon the repayment of the initial capital contributions and a preferred return, distributions will convert to 50% for the Company and 50% for the investment company. On June 7, 2005, 212 C made a distribution to the Company of approximately $4.0 million which paid back the Company's original investment and accrued preferred return. In addition, the Company recorded a profit of $1.8 million as result of this distribution during the second quarter of 2005. As a result of the transaction the Company no longer qualifies as the primary beneficiary and discontinued consolidating this VIE into the Company's financial statement beginning with the second quarter of 2005. Royal Bancshares, together with a real estate development company, formed Brook View Investors, L.L.C. ("Brook View") in May 2001. Brook View was formed to construct 13 apartment buildings with a total of 116 units in a gated apartment community. On October 19, 2005, the Company sold its ownership interest in Brook View which resulted in an after tax gain of approximately $3.3 million. As a result of the sale the Company discontinued consolidating the financial statements of Brook View during the fourth quarter of 2005. Royal Bancshares, together with a real estate development company, formed Burrough's Mill Apartment, L.L.C. ("Burrough's Mill") in December 2001. Burrough's Mill was formed to construct 32 apartment buildings with a total of 308 units in a gated apartment community. On October 19, 2005, the Company sold its ownership interest in Burrough's Mill which resulted in an after tax gain of approximately $7.6 million. As a result of the sale the Company discontinued consolidating the financial statements of Burrough's Mill during the fourth quarter of 2005. Royal Bancshares, together with a real estate development company, formed Main Street West Associates, L.P. ("Main Street") in February 2002. Main Street was formed to acquire, maintain, improve, and operate office space located in Norristown, Pennsylvania. On June 30, 2005, Main Street sold the property and paid back the Company's original investment plus the accrued preferred return in full. As a result of the sale the Company discontinued consolidating the financial statements of Main Street during the second quarter of 2005. Trust Preferred Securities Management has determined that The Company Capital Trust I/II ("the Trusts") qualify as VIE's under FASB Interpretation 46 (FIN 46), "Consolidation of Variable Interest Entities," as revised. The Trusts have previously issued mandatory redeemable trust preferred securities to investors and loaned the proceeds to The Company. The Company adopted the provision under the revised interpretation, FIN 46(R), in the first quarter of 2004. Accordingly, The Company does not consolidate the Trust. FIN 46(R) precludes consideration of the call option embedded in the preferred securities when determining if the Company has the right to a majority of the Trusts' expected residual returns. The deconsolidation resulted in the investment in the common stock of the Trusts to be included in other assets as of March 31, 2006 and the corresponding increase in outstanding debt of $774 thousand. In addition, income received on the Company's stock investment is included in other income. 10. Income Taxes. Total income tax expense for the three months ended March 31, 2006 was $2.5 million, as compared to $1.8 million for the same period in 2005. The effective tax rate for the three months ended March 31, 2006, was 31.6% compared to the 29.0% for the same period in 2005. 11. Commitments, Contingencies and Concentrations The Company is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters. These instruments involve, to varying degrees, elements of risk in excess of the amount recognized in consolidated balance sheet. A summary of the Company's commitments is as follows: (in thousands) MARCH 31, 2006 DECEMBER 31,2005 -------------- ---------------- Open-end lines of credit 3,005 2,954 Loan commitments 154,085 173,461 Letters of credits 5,056 3,228 ------- ------- Total 162,146 179,643 ======= ======= 12. Recent Accounting Pronouncements In February 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments -- an amendment of SFAS No. 133 and 140 (SFAS No. 155). SFAS No. 155 permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133, establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and amends SFAS No. 140 to eliminate the prohibition on a qualifying special purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS No.155 is effective for all financial instruments acquired or issued after the beginning of an entity's first fiscal year that begins after September 15, 2006. The Company does not expect the adoption of SFAS No. 155 to have a material effect on the results of operations or the statement of condition. In March 2006, the FASB issued SFAS No. 156 Accounting for Servicing of Financial Assets an amendment of SFAS No. 140 (SFAS 140 and SFAS 156). SFAS No. 140 establishes, among other things, the accounting for all separately recognized servicing assets and servicing liabilities. SFAS No. 156 amends SFAS No. 140 to require that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. This Statement permits, but does not require, the subsequent measurement of separately recognized servicing assets and servicing liabilities at fair value. Under this Statement, an entity can elect subsequent fair value measurement to account for its separately recognized servicing assets and servicing liabilities. Adoption of this Statement is required as of the beginning of the first fiscal year that begins after September 15, 2006. Upon adoption, the Company will apply the requirements for recognition and initial measurement of servicing assets and servicing liabilities prospectively to all transactions. The Company will adopt SFAS No. 156 for the fiscal year beginning January 1, 2007 and currently has not determined if it will adopt SFAS No. 156 using the fair value election. In February 2006, the FASB issued FASB Staff Position No. FAS 123(R)-4, "Classification of Options and Similar Instruments Issued as Employee Compensation That Allow for Cash Settlement upon the Occurrence of a Contingent Event." This position amends SFAS 123R to incorporate that a cash settlement feature that can be exercised only upon the occurrence of a contingent event that is outside the employee's control does not meet certain conditions in SFAS 123R until it becomes probable that the event will occur. The guidance in this FASB Staff Position shall be applied upon initial adoption of Statement 123R. The Company is currently evaluating the impact that the adoption of SFAS 123R will have on its financial statements. ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULT OF OPERATIONS The following discussion and analysis is intended to assist in understanding and evaluating the changes in the financial condition and earnings performance of the Company and its subsidiaries for the three-month period ended March 31, 2006. This discussion and analysis should be read in conjunction with the Company's consolidated financial statements and notes thereto for the year ended December 31, 2005 included in the Company's 2005 Form 10-K. Operating results for the three months ended March 31, 2006 are not necessarily indicative of the results for the year ending December 31, 2006. Forward-Looking Statements. From time to time, the Company may include forward-looking statements relating to such matters as anticipated financial performance, business prospects, credit quality, credit risk, reserve adequacy, liquidity, new products, and similar matter in this and other filings with the Securities and Exchange Commission. These forward-looking statements may involve known and unknown risks, uncertainties and other factors which may cause actual results, performance or achievements of the Company to material different from the future results, performance or achievement expressed or implied by such forward-looking statements. When the Company uses words such as "expect," "believe," "anticipate," "should," "estimate," or similar expressions, the Company is making a forward-looking statement. The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for such forward-looking statements. In order to comply with the terms of the "safe harbor," the Company provides the following cautionary statement which identifies certain factors that could cause the Company's actual results and experience to differ materially from the anticipated results or other expectations expressed in the forward-looking statements. Certain risks and uncertainties could affect the future financial results of the Company including the following: o The effect of general economic conditions, including their impact on capital expenditures, credit risk, consumer confidence and savings rates. o Changes in interest rates and their impact on the level of deposits, loan demand and the value of loan collateral. o Business conditions in the banking industry. o The bank regulatory environment. o The accuracy of management's assumptions. o The ability of the Company to adapt to rapidly changing technology and evolving banking industry standards. o Competitive factors, including increased competition with community, regional and national financial institutions. o The risk that anticipated demand for the Company's new service and product offerings will not occur. All forward-looking statements contained in this report are based on information available as of the date of this report. The Company expressly disclaims any obligation to update any forward-looking statement to reflect future statements to reflect future events or developments. CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES The accounting and reporting policies of the Company conform with accounting principles generally accepted in the United States of America and general practices within the financial services industry. Applications of the principles in the Company's preparation of the 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. These estimates and assumptions are based on information available as of the date of the financial statements; therefore, actual results could differ from those estimates. Allowance for Loan Losses 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. Management determines the allowance for loan losses with the objective of maintaining a reserve level sufficient to absorb estimated probable credit losses. Management has determined the Company's balance in the allowance for loan losses based on management's detailed analysis and review loan portfolio. Management considers all known relevant internal and external factors that may affect loan collectibility. The periodic analysis and review includes an evaluation of the loan portfolio in relation to past loss experience, the size and composition of the portfolio, current economic events and conditions, and other pertinent factors, including Management's assumptions as to future delinquencies, recoveries and losses. Management's evaluation is inherently subjective and all of these factors may be susceptible to significant change. To the extent actual outcomes differ from management's the Company may be required to make additional provisions for loan losses that could adversely impact earnings in future periods. The Company uses the reserve method of accounting for loans losses. The balance in the allowance for loan and lease losses is determined based on management's review and evaluation of the loan portfolio in relation to past loss experience, the size and composition of the portfolio, current economics events and conditions, and other pertinent factors, including management's assumptions related to future delinquencies, recoveries and losses. Increases to the allowance for loans and leases losses are made by charges to the provision for loan losses. Credit exposures deemed to be uncollectible are charged against the allowance for loans losses. Recoveries of amounts previously charged-off are credited to the allowance for loan losses. Non-performing loans Loans on which the accrual of interest has been discontinued or reduced amounted to approximately $2.9 million at March 31, 2006, as compared to $4.4 million at December 31, 2005, a decrease of $1.5 million. This decrease is primarily attributed to multiple payments totaling approximately $860 thousand received from a participation loan secured by a pool of golf courses, charge-offs during the quarter of approximately $124 thousand, and $153 thousand of loans being transferred to other real estate owned. Although the Company has non-performing loans of approximately $2.9 million at March 31, 2006, management believes it has adequate collateral to limit its credit risk with these loans. The balance of impaired loans and loans on which the accrual of interest has been discontinued, was approximately $12.3 million and $10.0 million at March 31, 2006 and December 31, 2005, respectively. The Company identifies 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 or where there is a significant reduction in collateral associated with the loan. As of March 31, 2006 the company had five loans in the amount of $9.4 million that are considered to be potential problem loans with a specific reserve of $1.3 million. The $1.3 million associated with impaired loans consist of: $1.0 million related to a golf course in New Jersey, $249 thousand for a hotel under construction in New Orleans and approximately $50 thousand associated with residential loans. During the quarter a loan to a hospital in Louisiana was restructured to modify the payment terms. Based upon a review of the collateral value a specific reserve was not applied. The income that was recognized on impaired loans during the three-month period ended March 31, 2006 was $139 thousand. The cash collected on impaired loans during the same period ended March 31, 2006 was $1.0 million, of which $938 thousand was credited to the principal balance outstanding on such loans. 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. Income Taxes Under the liability method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities. Deferred tax assets are subject to management's judgment based upon available evidence that future realization of the gain or loss attributable to the asset or liability is more likely than not. If management determines that the Company may be unable to realize all or part of the net deferred tax assets in the future, a direct charge to income tax expense may be required to reduce the recorded value of net deferred tax assets to the expected realizable amount. Interest Rate Swaps The Company uses derivatives instruments, such as interest rate swap agreements to hedge various exposures or to modify interest rate characteristics of various balance sheet accounts. Such derivatives are used as part of the asset/liability management process and are linked to specific liabilities which have a high correlation between the contract and the underlying item being hedged, both at inception and throughout the hedge period. The Company currently utilizes interest rate swap agreements to convert a portion of its fixed rate time deposits to a variable rate (fair value hedge) to fund variable rate loans and investments. Interest rate swaps are contracts in which a series of interest flows are exchanged over a prescribed period. The notional amount ($60 million) on which interest payments are based is not exchanged. FINANCIAL CONDITION Total consolidated assets as of March 31, 2006 were $1.317 billion, an increase of $16 million from the $1.301 billion reported at year-end, December 31, 2005. This increase is primarily due to a $44 million increase in the loan balance which was funded by an increase in deposit balances and a reduction of $21 million of available for sale securities due to maturities and the $10.6 million reduction in cash and cash equivalents. Total loans increased $44.0 million from the $549.6 million level at December 31, 2005 to $593.6 million at March 31, 2006. This increase is attributed to an increase in lending staff, competitive interest rates and expansion of the Company's lending area into the Virginia, Washington D.C. and Northern New Jersey area. The year-to-date average balance of loans was $565.8 million at March 31, 2006 compared to $480.2 million for the same three month period in 2005. The allowance for loan loss increased $274 thousand to $10.6 million at March 31, 2006 from $10.3 million at December 31, 2005. The $274 thousand increase was attributed to recording a provision of $335 thousand offset by net charge offs of $61 thousand. The level of allowance for loan loss reserve represents approximately 1.8% of total loans at March 31, 2006 versus 1.9% at December 31, 2005. While management believes that, based on information currently available, the allowance for loan loss is sufficient to cover losses inherent in the Company's loan portfolio at this time, no assurances can be given that the level of allowance will be sufficient to cover future loan losses or that future adjustments to the allowance will be sufficient to cover future loan losses or that future adjustments to the allowance will not be necessary if economic and/or other conditions differ substantially from the economic and other conditions considered by management in evaluating the adequacy of the current level of the allowance. Analysis of the Allowance for Loan losses by loan type
MARCH 31, 2006 DECEMBER 31, 2005 Percent of loans Reserve Percent of loans Reserve in each Amount in each Amount category (in category to (in to total thousands) total loans thousands) loans Domestic Construction loans $ 4,765 33.04% $ 3,397 31.43% Single family residents $ 734 5.21% $ 925 7.74% Tax certificates -- 5.62% -- 6.44% Real estate - non-residential $ 4,008 44.81% $ 5,132 43.19% Real estate - multi-family $ 463 4.51% $ 277 4.51% Commercial and industrial $ 455 5.59% $ 494 5.45% Installment loans to individual $ 20 .39% $ 41 .70% Lease financing $ 108 .83% $ 75 .54% Foreign -- 00% -- 00% Unallocated ($ 3) N/A ($ 65) N/A ------- ------- ------- ------- $10,550 100.00% $10,276 100.00% ======= ======= ======= =======
Total investment securities decreased $20.8 million to $578.0 million at March 31, 2006, from $598.8 million at December 31, 2005. This decrease in total investment securities during the first quarter of 2006 is primarily attributable to $11.5 million of corporate bonds maturing along with principal payments received from mortgaged-back securities. Total cash and cash equivalents decreased $10.6 million from the $30.9 million level at December 31, 2005 to $20.3 million at March 31, 2006. This decrease was primarily attributed to the funding of loan originations during the period and payments to reduce overnight advance balance. Total deposits, the primary source of funds, increased $21.5 million to $718.9 million at March 31, 2006, from $697.4 million at December 31, 2005. The balance of brokered deposits was $151.1 million, representing approximately 21% of total deposits at March 31, 2006. Generally, these brokered deposits cannot be redeemed prior to the stated maturity, except in the event of the death or adjudication of incompetence of the deposit holder. Total borrowings decreased $4.9 million to $422.2 million at March 31, 2006, from $427.1 million at December 31, 2005. This decrease is primarily attributed to a reduction of overnight borrowings resulting from a decline in the investment portfolio and an increase in deposits. Consolidated stockholders' equity increased $313 thousand to $155.8 million at March 31, 2006 from $155.5 million at December 31, 2005. This increase is primarily due to increased earnings offset by a cash dividend paid and a decline in market value of the Company's available for sale portfolio. RESULTS OF OPERATIONS 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 and borrowings. Interest income is recognized according to the effective interest yield method. 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. Consolidated net income for the three months ended, March 31, 2006 was $5.3 million or $0.42 basic earnings per share, as compared to net income of $4.3 million or $0.34 basic earnings per share for the same three month period in 2005. For the first quarter of 2006, net interest income was $11.3 million as compared to $9.8 million for the same quarter in 2005, an increase of $1.5 million. This increase is primarily due to an increase in the average loan balances along with an increase of interest rates on variable rate loans. There was a $335 thousand provision for loan losses taken during the first quarter of 2006 as compared to $1 thousand taken during the first quarter of 2005, an increase of $334 thousand. This increase is primarily due to an increase in the loan balance where the amount was determined according to documentation required by SAB No. 102. Charge-offs and recoveries for the first quarter of 2006 were $124 thousand and $63 thousand, as compared to $33 thousand and $8 thousand for the first quarter of 2005, respectively. Overall, management considers the current level of allowance for loan losses to be adequate at March 31, 2006. Total non-interest income for the three-month period ended March 31, 2006 was $3.0 million as compared to $2.6 million for the same three-month period in 2005. This increase is primarily attributed to the sale of other real estate owned which included a $949 thousand gain from the sale of a bowling alley in Texas. This increase was partially offset by a reduction in income related to VIE's, due to 2006 including only Royal Scully whereas in 2005 income related to VIE's include four investments. Total non-interest expense for the three months ended March 31, 2006 was $6.2 million, as compared to $6.4 million for the same period in 2005, a decrease of $200 thousand. The decrease is primarily attributed to expenses related to VIE's which was partially offset by the recording of stock option expense in the amount of $178 thousand and an increase in minority interest expense. Total income tax expense for the three months ended March 31, 2006 was $2.5 million, as compared to $1.8 million for the same period in 2005. This increase is attributed to an increase in earnings during 2006 as compared to 2005. The effective tax rate for the three months ended March 31, 2006, was 31.6% compared to the 29.0% for the same period in 2005. CAPITAL ADEQUACY The Company and its banking subsidiary are subject to various regulatory capital requirements administered by state and federal banking agencies. Capital adequacy guidelines involve quantitative measure of assets and liabilities calculated under regulatory accounting practices. Quantitative measures established by banking regulations, designed to ensure capital adequacy, required the maintenance of minimum amounts of capital to total "risk weighted" assets and a minimum Tier 1 leverage ratio, as defined by the banking regulations. At March 31, 2006, the Company was required to have a minimum Tier 1 and total capital ratios of 4% and 8%, respectively, and a minimum Tier 1 leverage ratio of 3% plus an additional 100 to 200 basis points. The table below provides a comparison of Royal Bancshares of Pennsylvania's and Royal Bank's risk-based capital ratios and leverage ratios:
ROYAL BANCSHARES ROYAL BANK MARCH 31, DEC 31, MARCH 31, DEC 31, 2006 2005 2006 2005 ---- ---- ---- ---- CAPITAL LEVELS Tier 1 leverage ratio 14.2% 14.2% 10.4% 10.4% Tier 1 risk-based ratio 18.3% 18.8% 13.5% 13.8% Total risk-based ratio 19.4% 19.8% 14.6% 14.9% CAPITAL PERFORMANCE Return on average assets 1.7%(1) 2.5% 1.7%(1) 2.6% Return on average equity 13.9%(1) 22.0% 16.3%(1) 27.0%
(1) annualized The Company's ratios compare favorably to the minimum required amounts of Tier 1 and total capital to "risk weighted" assets and the minimum Tier 1 leverage ratio, as defined by banking regulations. The Company currently meets the criteria for a well-capitalized institution, and management believes that the Company will continue to meet its minimum capital requirements. At present, the Company has no commitments for significant capital expenditures. The Company is not under any agreement with regulatory authorities nor is the Company aware of any current recommendations by the regulatory authorities that, if such recommendations were implemented, would have a material effect on liquidity, capital resources or operations of the Company. LIQUIDITY & INTEREST RATE SENSITIVITY Liquidity is the ability to ensure that adequate funds will be available to meet the Company's financial commitments as they become due. In managing its liquidity position, all sources of funds are evaluated, the largest of which is deposits. Also taken into consideration are securities maturing in one year or less, other short-term investment and the repayment of loans. These sources provide alternatives to meet its short-term liquidity needs. In addition, the FHLB is available to provide short-term liquidity when other sources are unavailable. Longer liquidity needs may be met by issuing longer-term deposits and by raising additional capital. The liquidity ratio is calculated by adding total cash and investments less reserve requirements divided by deposits and short-term liabilities which is generally maintained at a level equal to or greater than 25%. The liquidity ratio of the Company remains adequate at approximately 28% and exceeds the Company's target ratio set forth in the Asset/Liability Policy. The Company's level of liquidity is provided by funds invested primarily in corporate bonds, capital trust securities, US Treasuries and agencies, and to a lesser extent, federal funds sold. The overall liquidity position is monitored on a monthly basis. In managing its interest rate sensitivity positions, the Company seeks to develop and implement strategies to control exposure of net interest income to risks associated with interest rate movements Interest rate sensitivity is a function of the repricing characteristics of the Company's assets and liabilities. These include the volume of assets and liabilities repricing, the timing of the repricing, and the interest rate sensitivity gaps is a continual challenge in a changing rate environment. The following table shows separately the interest sensitivity of each category of interest earning assets and interest bearing liabilities as of March 31, 2006:
INTEREST RATE SENSITIVITY (IN MILLIONS) DAYS -------------------------- 1 TO 5 OVER 5 NON-RATE ASSETS 0 - 90 91 - 365 YEARS YEARS SENSITIVE TOTAL ------ --------------------------------------------------------------------------------- Interest-bearing deposits in banks $4.2 $0.0 $0.0 $0.0 $15.1 $19.3 Federal funds sold 1.0 0.0 0.0 0.0 0.0 1.0 Investment securities: Available for sale 8.5 20.7 187.6 93.4 (3.8) 306.4 Held to maturity 25.0 26.1 204.1 0.0 0.0 255.5 --------------------------------------------------------------------------------- Total investment securities 33.5 46.8 392.0 93.4 (3.8) 561.9 Loans: Fixed rate 10.7 24.2 140.5 38.2 0.0 213.6 Variable rate 269.5 57.4 54.3 0.0 (10.5) 370.7 --------------------------------------------------------------------------------- Total loans 280.2 81.6 194.8 38.2 (10.5) 584.3 Other assets 38.4 0.0 0.0 0.0 111.9 150.3 --------------------------------------------------------------------------------- Total Assets $357.3 $128.4 $586.8 $131.6 $112.7 $1,316.8 ================================================================================= LIABILITIES & CAPITAL Deposits: Non interest bearing deposits $0.0 $0.0 $0.0 $0.0 $67.1 $67.1 Interest bearing deposits 26.5 79.5 196.9 0.0 0.0 302.9 Certificate of deposits 62.1 82.4 201.0 3.3 0.0 348.8 --------------------------------------------------------------------------------- Total deposits 88.6 161.9 397.9 3.3 67.1 718.9 Borrowings (1) 106.5 12.9 212.5 42.9 47.4 422.2 Other liabilities 0.0 0.0 0.1 0.0 19.8 19.9 Capital 0.0 0.0 0.0 0.0 155.8 155.8 --------------------------------------------------------------------------------- Total liabilities & capital $195.1 $174.8 $610.5 $46.2 $290.1 $1,316.8 ================================================================================= Net interest rate GAP $162.2 ($46.4) ($23.7) $85.4 ($177.4) =================================================================== Cumulative interest rate GAP $162.2 $115.8 $92.1 $177.4 =================================================================== GAP to total assets 12% (4%) ========================= GAP to total equity 104% (30%) ========================= Cumulative GAP to total assets 12% 9% ========================= Cumulative GAP to total equity 104% 74% =========================
(1) The $60.3 in borrowings classified as non-rate sensitive are related to variable interest entities and are not obligations of the Company. Royal Bancshares' exposure to interest rate risk is mitigated somewhat by a portion of the Company's loan portfolio consisting of floating rate loans, which are tied to the prime lending rate but which have interest rate floors and no interest rate ceilings. Although the Company is originating fixed rate loans, a portion of the loan portfolio continues to be comprised of floating rate loans with interest rate floors. ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The information presented in the Liquidity and Interest Rate Sensitivity section of the Management's Discussion and Analysis of Financial Condition and Results Operations of this Report is incorporated herein by reference. ITEM 4 - CONTROLS AND PROCEDURES (a) Evaluation of disclosure controls and procedures. We maintain a set of disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission's rules and forms. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based on that evaluation, our CEO and CFO concluded that the Company's disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's Exchange Act filings. There are inherent limitations to the effectiveness of any controls system. A controls system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that its objectives are met. Further, the design of a control system must reflect the fact that there are limits on resources, and the benefits of controls must be considered relative to their costs and their impact on the business model. We intend to continue to improve and refine our internal control over financial reporting. (b) Changes in internal controls. There has not been any change in our internal control over financial reporting during our quarter ended March 31, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. RECENT DEVELOPMENTS On February 20, 2006, the Company announced the appointment of Patrick J. McCormick to its Board of Directors. RECENT ACCOUNTING PRONOUNCEMENTS In February 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 155, Accounting for Certain Hybrid Financial Instruments -- an amendment of FASB Statements No. 133 and 140 (FAS 155). FAS 155 permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest-only strips and principal-only strips are not subject to the requirements of Statement 133, establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and amends Statement 140 to eliminate the prohibition on a qualifying special purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. FAS 155 is effective for all financial instruments acquired or issued after the beginning of an entity's first fiscal year that begins after September 15, 2006. The company does not expect the adoption of FAS 155 to have a material effect on the results of operations or the statement of condition. In March 2006, the FASB issued Statement of Financial Accounting Standards No. 156 Accounting for Servicing of Financial Assets an amendment of FASB Statement No. 140 (FAS 140 and FAS 156). FAS 140 established, among other things, the accounting for all separately recognized servicing assets and servicing liabilities. This Statement amends FAS 140 to require that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. This Statement permits, but does not require, the subsequent measurement of separately recognized servicing assets and servicing liabilities at fair value. Under this Statement, an entity can elect subsequent fair value measurement to account for its separately recognized servicing assets and servicing liabilities. Adoption of this Statement is required as of the beginning of the first fiscal year that begins after September 15, 2006. Upon adoption, the company will apply the requirements for recognition and initial measurement of servicing assets and servicing liabilities prospectively to all transactions. The Company will adopt FAS 156 for the fiscal year beginning January 1, 2007 and currently has not determined if it will adopt FAS 156 using the fair value election. In February 2006, the FASB issued FASB Staff Position No. FAS 123(R)-4, "Classification of Options and Similar Instruments Issued as Employee Compensation That Allow for Cash Settlement upon the Occurrence of a Contingent Event." This position amends SFAS 123R to incorporate that a cash settlement feature that can be exercised only upon the occurrence of a contingent event that is outside the employee's control does not meet certain conditions in SFAS 123R until it becomes probable that the event will occur. The guidance in this FASB Staff Position shall be applied upon initial adoption of Statement 123R. The Company is currently evaluating the impact that the adoption of SFAS 123R will have on its financial statements. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS None ITEM 1A. RISK FACTORS There have been no material changes from risk factors as previously disclosed in our Form 10-K for the year ended December 31, 2005. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS None ITEM 3. DEFAULT UPON SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATTERS TO VOTE SECURITY HOLDERS None ITEM 5. OTHER INFORMATION None ITEM 6. EXHIBITS (a) 31.1 Section 302 Certification Pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934 signed by Joseph P. Campbell, Chief Executive Officer of Royal Bancshares of Pennsylvania on May 9, 2006. 31.2 Section 302 Certification Pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934 signed by Jeffrey T. Hanuscin, Chief Financial Officer of Royal Bancshares of Pennsylvania on May 9, 2006. 32.1 Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by Joseph P. Campbell, Chief Executive Officer of Royal Bancshares of Pennsylvania on May 9, 2006. 32.2 Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by Jeffrey T. Hanuscin, Chief Financial Officer of Royal Bancshares of Pennsylvania on May 9, 2006. SIGNATURES Pursuant to the requirements 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. (Registrant) Dated: May 9, 2006 /s/ Jeffrey T. Hanuscin ----------------------- Jeffrey T. Hanuscin Chief Financial Officer