rbpaa_Current_Folio

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows-unaudited

Nine months ended September 30,


(In thousands)	2014		2013
Cash flows from operating activities:
Net income (loss)	$	4,298	$	(343)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		348		311
Stock compensation expense		12		20
Credit for loan and lease losses		(765)		(196)
Impairment charge for OREO		399		953
Net amortization of investment securities		1,495		3,492
Net accretion on loans		(303)		(263)
Net gains on sales of premises and equipment		(107)		(1,204)
Net gains on sales of OREO		(633)		(1,209)
Proceeds from sales of loans and leases		3,838		4,042
Gains on sales of loans and leases		(223)		(257)
Net gains on sales of investment securities		(330)		(69)
Income from bank owned life insurance		(384)		(401)
Share-based compensation		105		75
Impairment on loans held for sale		—		153
Changes in assets and liabilities:
Decrease in accrued interest receivable		1,500		2,387
Increase in other assets		(121)		(540)
Increase (decrease) in accrued interest payable		1,340		(1,289)
Decrease in other liabilities		(1,334)		(498)
Net cash provided by operating activities	$	9,135	$	5,164
Cash flows from investing activities:
Proceeds from maturities, calls and paydowns of AFS investment securities	$	33,272	$	77,237
Proceeds from sales of AFS investment securities		55,290		20,428
Purchase of AFS investment securities		(40,150)		(52,131)
Redemption of Federal Home Loan Bank stock		526		1,647
Net increase in loans		(37,001)		(41,043)
Additions to OREO		(1,292)		—
Proceeds from the sales of premises and equipment		303		1,651
Purchase of premises and equipment		(872)		(296)
Proceeds from sales of OREO		3,548		6,213
Net cash provided by investing activities	$	13,624	$	13,706

Table of Contents

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows-unaudited (continued)

Nine months ended September 30,


	2014		2013
Cash flows from financing activities:
Increase in demand and NOW accounts	$	3,854	$	1,384
Decrease in money market and savings accounts		(952)		(17,726)
Decrease in certificates of deposit		(16,080)		(15,955)
Repayments of short-term borrowings		(10,000)		—
Repayments of long-term borrowings		(341)		(50,339)
Proceeds from short-term borrowings		—		14,000
Proceeds from long-term borrowings		—		40,000
Payments to noncontrolling interest		(208)		(182)
Issuance of common stock, net		20,000		—
Redemption of preferred stock		(13,943)		—
Net cash used in financing activities	$	(17,670)	$	(28,818)
Net increase (decrease) in cash and cash equivalents		5,089		(9,948)
Cash and cash equivalents at the beginning of the period		16,844		28,802
Cash and cash equivalents at the end of the period	$	21,933	$	18,854
Supplemental Disclosure
Interest paid	$	3,530	$	6,802
Transfers to OREO	$	1,998	$	6,428
Transfers to LHFS	$	3,187	$	2,283

The accompanying notes are an integral part of these consolidated financial statements.

Table of Contents

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Note 1.Summary of Significant Accounting Policies

Basis of Financial Presentation

The accompanying unaudited consolidated financial statements include the accounts of Royal Bancshares of Pennsylvania, Inc. (“Royal Bancshares” or the “Company”) and its wholly-owned subsidiaries, Royal Investments of Delaware, Inc., including Royal Investments of Delaware, Inc.’s wholly owned subsidiary, Royal Preferred, LLC, and Royal Bank America (“Royal Bank”), including Royal Bank’s subsidiaries, Royal Real Estate of Pennsylvania, Inc., Royal Investments America, LLC, RBA Property LLC, Narberth Property Acquisition LLC, Rio Marina LLC, and Royal Tax Lien Services, LLC (“RTL”). Royal Bank also has an 80% and 60% ownership interest in Crusader Servicing Corporation (“CSC”) and Royal Bank America Leasing, LP, respectively. At September 30, 2013, Royal Bank’s ownership interest in CSC and RTL was 60%. Effective December 31, 2013, Royal Bank acquired the ownership interest of the former President of CSC and RTL. The two Delaware trusts, Royal Bancshares Capital Trust I and Royal Bancshares Capital Trust II are not consolidated per requirements under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 810, “Consolidation” (“ASC Topic 810”). These consolidated financial statements reflect the historical information of the Company. All significant intercompany transactions and balances have been eliminated.

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information. Applications of the principles in the Company’s preparation of the consolidated financial statements in conformity with U.S. GAAP require management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and the accompanying notes. These estimates and assumptions are based on information available as of the date of the consolidated financial statements; therefore, actual results could differ from those estimates. The interim 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 consolidated 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, 2013. The results of operations for the three and nine month periods ended September 30, 2014 are not necessarily indicative of the results to be expected for the full year.

Reclassifications

Certain items in the 2013 consolidated financial statements and accompanying notes have been reclassified to conform to the current year’s presentation format. There was no effect on net income or net loss for the periods presented herein as a result of the reclassification.

Accounting Policies Recently Adopted and Pending Accounting Pronouncements

In January 2014, FASB issued ASU No. 2014-04, Receivables (Topic 310): Troubled Debt Restructurings by Creditors (Subtopic 310-40) Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (“ASU 2014-04”). ASC Topic 310 includes guidance that states that a creditor should reclassify a collateralized mortgage loan such that the loan should be derecognized and the collateral asset recognized when it determines that there has been in substance a repossession or foreclosure by the creditor, that is, the creditor receives physical possession of the debtor’s assets regardless of whether formal foreclosure proceedings take place. However, the terms in substance a repossession or foreclosure and physical possession are not defined in the accounting literature and there is diversity about when a creditor should derecognize the loan receivable and recognize the real estate property. That diversity has been highlighted by recent extended foreclosure timelines and processes related to residential real estate properties.

The objectives in ASU 2014-04 are intended to reduce diversity in practice by clarifying when an in substance repossession or foreclosure occurs, that is, when a creditor should be considered to have received physical possession of residential real

Table of Contents

estate property collateralizing a consumer mortgage loan such that the loan should be derecognized and the real estate property recognized. Holding foreclosed real estate property presents different operational and economic risk to creditors compared with holding an impaired loan. Therefore, consistency in the timing of loan derecognition and presentation of foreclosed real estate properties is of qualitative significance to users of the creditor’s financial statements. Additionally, the disclosure of the amount of foreclosed residential real estate properties and of the recorded investment in consumer mortgage loans secured by residential real estate properties that are in the process of foreclosure is expected to provide decision-useful information to many users of the creditor’s financial statements. The amendments in ASU 2014-04 are effective for public companies for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. An entity can elect to adopt the amendments in ASU 2014-04 using either a modified retrospective transition method or a prospective transition method. Early adoption is permitted. The adoption of ASU 2014-04 is not expected to have a significant impact on the Company’s consolidated financial statements.

In April 2014, FASB issued ASU No. 2014-08 Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity (“ASU 2014-08”). The amendments in ASU 2014-08 change the criteria for reporting discontinued operations for all public and nonpublic entities. Currently, a component of an entity that is a reportable segment, an operating segment, a reporting unit, a subsidiary, or an asset group is eligible for discontinued operations presentation. Once the amendments of ASU 2014-08 take effect, only those disposals of components of an entity that represent a strategic shift that has (or will have) a major effect on an entity’s operations and financial results will be reported as discontinued operations in the financial statements. The amendments also require new disclosures about discontinued operations and disposals of components of an entity that do not qualify for discontinued operations reporting. The amendments in ASU 2014-08 are effective for public companies for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. Early adoption is permitted but only for disposals (or classifications as held for sale) that have not been reported in financial statements previously issued or available for issuance. The adoption of ASU 2014-08 is not expected to have a significant impact on the Company’s consolidated financial statements.

In June 2014, the FASB issued ASU No. 2014-12, Compensation – Stock Compensation (Topic 718) - Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (“ASU 2014-12”). The amendments in ASU 2014-12 require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in Topic 718, Compensation – Stock Compensation, as it relates to awards with performance conditions that affect vesting to account for such awards. The performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. If the performance target becomes probable of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period. The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest. The requisite service period ends when the employee can cease rendering service and still be eligible to vest in the award if the performance target is achieved. The amendments in ASU 2014-12 are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015. Early adoption is permitted. Entities may apply the amendments in this ASU either: (a) prospectively to all awards granted or modified after the effective date; or (b) retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. The adoption of ASU 2014-12 is not expected to have a significant impact on the Company’s consolidated financial statements.

In June 2014, the FASB issued ASU 2014-11, Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures (“ASU 2014-11”), which changes the accounting for repurchase-to-maturity transactions and repurchase financing arrangements. The new guidance aligns the accounting for repurchase-to-maturity transactions and repurchase agreements executed as a repurchase financing with the accounting for other typical repurchase agreements. Going forward, these transactions would all be accounted for as secured borrowings. It also requires additional disclosures about repurchase agreements and other similar transactions. The amendments in ASU 2014-11 and disclosure for certain transactions accounted for as a sale are effective for the first interim or annual period beginning after December

Table of Contents

15, 2014. The disclosure for transactions accounted for as secured borrowings is required to be presented for annual periods beginning after December 15, 2014, and interim periods beginning after March 15, 2015. Earlier application is prohibited. The adoption of ASU 2014-11 is not expected to have a material impact on the Company’s financial condition and results of operations.

Note 2.Regulatory Matters and Significant Risks or Uncertainties

FDIC and Department of Banking Memorandum of Understanding

During the fourth quarter of 2011, Royal Bank entered into an informal agreement, known as a memorandum of understanding (“MOU”) with each of the Federal Deposit Insurance Corporation (“FDIC”) and the Pennsylvania Department of Banking and Securities (the “Department”). Included in the MOU is the requirement of maintaining a ratio of Tier 1 capital to total assets (“leverage ratio”) equal to or greater than 8% and a total risk-based capital ratio equal to or greater than 12%. At September 30, 2014, based on capital levels calculated under regulatory principles (“RAP”), Royal Bank’s leverage and total risk-based capital ratios were 9.96% and 15.99%, respectively. Please refer to “Note 11 — Regulatory Capital Requirements” to the Consolidated Financial Statements. Under the MOU, Royal Bank must receive prior approval from the FDIC and the Department before declaring and paying a dividend to the Company.

Federal Reserve Agreement

As previously disclosed, in March 2010, the Company agreed to enter into a written agreement (the “Federal Reserve Agreement”) with the Federal Reserve Bank of Philadelphia (the “Federal Reserve Bank”). In July 2013, the Board of Governors of the Federal Reserve System terminated the enforcement action under the Federal Reserve Agreement, and it was replaced with an informal non-public agreement, an MOU, with the Federal Reserve Bank, effective July 17, 2013. Included in this MOU are certain continued reporting requirements and a requirement that the Company receive the prior approval of the Federal Reserve Bank and the Director of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System prior to declaring or paying any dividends on the Company’s capital stock, making interest payments related to the Company’s outstanding trust preferred securities or subordinate securities, incurring or guaranteeing certain debt with an original maturity date greater than one year, and purchasing or redeeming any shares of stock. Please refer to “Dividend and Interest Restrictions” below for a discussion on the partial redemption of the Series A Preferred Stock. The MOU will remain in effect until stayed, modified, terminated or suspended in writing by the Federal Reserve Bank.

Our success as a Company is dependent upon pursuing various alternatives in not only achieving the growth and expansion of our banking franchise but also in managing our day to day operations. The existence of the two MOUs may limit or impact our ability to pursue all previously available alternatives in the management of the Company. Our ability to retain existing retail and commercial customers as well as the ability to attract potentially new customers may be impacted by the existence of the MOUs. Additionally, the Company’s ability to raise capital in the current economic environment could be potentially limited or impacted as a result of the MOUs. Attracting new management talent is critical to the success of our business and could be potentially affected due to the existence of the MOUs.

Net Income (Loss)

The Company had recorded significant losses over the five years prior to 2013 which were primarily related to charge-offs on the loan and lease portfolio, other-than-temporary impairment (“OTTI”) charges on investment securities, impairment charges on OREO, credit related expenses and the establishment of a deferred tax valuation allowance. In addition to reducing the total shareholders’ equity, the accumulated deficit impacts the Company’s ability to pay cash dividends to its shareholders now and in future years. For the third quarter of 2014, the Company recorded net income of $1.4 million compared to $342,000 for the comparable period in 2013. The quarter over quarter improvement was mainly related to growth in net interest income of $498,000 and declines in credit related expenses of $750,000. Credit related expenses include loan collection expenses, OREO expenses, OREO impairment, and impairment on loans held for sale. For the first nine months of 2014, the Company recorded net income of $4.3 million compared to a net loss of $343,000 for the comparable period in 2013. The noteworthy improvement was mainly related to a $1.9 million increase in net interest income, a $493,000 decrease in salaries and benefits, a $475,000 reduction in professional and legal fees, a $1.2 million

Table of Contents

decrease in credit related expenses, and a $569,000 improvement in the credit for loans and lease losses. Additionally, the first nine months of 2013 included a $1.65 million loss contingency accrual for a settlement of the class action lawsuit related to Royal Bank’s tax lien subsidiaries. After adjusting for the noncontrolling interest, the Company’s 60% share of the loss contingency amounted to $990,000 on a pre-tax basis. Partially offsetting these positive items was a $1.1 million decline in gains on the sale of premises and equipment and a $576,000 decrease in net gains on the sale of OREO.

Credit Quality

The financial services and real estate industries were hit particularly hard during the “Great Recession” and as a result the Company’s loan and investment portfolios were directly affected. The Company’s commercial real estate loans, including construction and land development loans, saw a decline in the collateral values and a reduction in the borrowers’ ability to meet the payment terms of their loans due to reduced cash flow. Further declines in collateral values and borrowers’ liquidity may lead to additional increases in foreclosures and delinquencies. The Company is less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of more diverse economies.

Royal Bank was successful in reducing net classified assets, which includes special mention, substandard and impaired loans and OREO, from $61.4 million at December 31, 2013 to $37.7 million at September 30, 2014. Royal Bank’s delinquent loans held for investment (30 to 90 days) amounted to $445,000 at September 30, 2014 versus $2.6 million at December 31, 2013. Material advances on any classified or delinquent loan must be approved by the Board of Directors and determined to be in Royal Bank’s best interest. The Company recorded $271,000 and $1.7 million, in charge-offs for the three and nine months ended September 30, 2014, respectively, compared to $837,000 and $3.2 million in charge-offs and write-downs for the comparable periods of 2013, respectively.

Liquidity and Funds Management

As of September 30, 2014, Royal Bank had $180.0 million of available borrowing capacity at the FHLB. Royal Bank also has availability to borrow from the Federal Reserve Discount Window, which was approximately $5.7 million at September 30, 2014, based on collateral pledged. Borrowings were $97.5 million and $107.9 million at September 30, 2014 and December 31, 2013, respectively. During the first quarter of 2014, Royal Bank secured an additional $10.0 million line of credit, of which $0 is outstanding at September 30, 2014, with a local financial institution.

At September 30, 2014, the liquidity to deposits ratio was 67.9% compared to Royal Bank’s 12% policy target and the liquidity to total liabilities ratio was 53.5% compared to Royal Bank’s 10% policy target. The Company also has unfunded pension plan obligations, which potentially could impact liquidity, of $14.3 million as of September 30, 2014 compared to $14.5 million at December 31, 2013. The Company plans to fund the pension plan obligations through existing Company owned life insurance policies.

Dividend and Interest Restrictions

Due to the MOU, our ability to obtain lines of credit, to receive attractive collateral treatment from funding sources, and to pursue all attractive funding alternatives in this current low interest rate environment could be impacted and thereby limit liquidity alternatives. On August 13, 2009, the Company’s Board suspended the regular quarterly cash dividends on the 30,407 shares of Series A Preferred Stock. The Company made the decision to suspend the preferred cash dividends in order to support the liquidity position of Royal Bank.

The Company received approval from the Federal Reserve Bank to bid up to $14.0 million, which was raised in a private placement, to purchase shares of the Series A Preferred Stock in an auction of such shares to be conducted by the United States Department of Treasury (“Treasury”). On June 20, 2014, Treasury announced that it had priced auctions of preferred stock of six institutions, including all of the 30,407 shares of the Series A Preferred Stock, issued by the Company to the Treasury in 2009. The Series A Preferred Stock was priced in the auction at $1,207.11 per share for all 30,407 shares of Series A Preferred Stock outstanding. As previously disclosed, the Company was a bidder in the auction and was allocated 11,551 shares of Series A Preferred Stock for repurchase at the clearing price of $1,207.11. Closing for the sale of the Series A Preferred Stock by Treasury, including the repurchase of 11,551 shares of Series A Preferred Stock by the Company, occurred on July 2, 2014. The dividend in arrears on the remaining 18,856 shares of Series A preferred stock

Table of Contents

is approximately $6.1 million. In the event the Company declared the preferred dividend in arrears the Company’s equity and capital ratios would be negatively affected; however, they would remain above the required minimum ratios.

Royal Bank must receive prior approval from the FDIC and the Department before declaring and paying a dividend to the Company. Under the Federal Reserve Agreement the Company may not declare or pay any dividends on the Company’s capital stock or make interest payments related to the Company’s outstanding trust preferred securities or subordinate securities without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System. During the third quarter of 2014, the Company received approval from the Federal Reserve Bank and paid the third quarter interest payment on the trust preferred securities in September 2014.

Capital Adequacy

In connection with a prior bank regulatory examination, the FDIC concluded, based upon its interpretation of the Call Report instructions and under RAP, that income from Royal Bank’s tax lien business should be recognized on a cash basis, not an accrual basis. Royal Bank’s current accrual method is in accordance with U.S. GAAP. Royal Bank disagrees with the FDIC’s conclusion and filed the Call Report for September 30, 2014 and the previous 16 quarters in accordance with U.S. GAAP. However, the change in the manner of revenue recognition for the tax lien business for regulatory accounting purposes affects Royal Bank’s and potentially the Company’s capital ratios as disclosed in “Note 11 - Regulatory Capital Requirements” to the Consolidated Financial Statements. The resolution of this matter will be decided by additional joint regulatory agency guidance which includes the Federal Reserve Bank, the FDIC, and the OCC.

Under the MOU, Royal Bank must maintain a minimum Tier 1 leverage ratio and a minimum total risk-based capital ratio of 8% and 12%, respectively. At September 30, 2014, based on capital levels calculated under RAP, Royal Bank’s leverage and total risk-based capital ratios were 9.96% and 15.99%, respectively.

Company Plans and Strategy

During the past few years, the Company recorded significant impairment charges and carrying costs on non-accrual loans and OREO which have weighed heavily on earnings and were the largest contributing factors to the Company’s losses. The Company’s strategic plan included improving the overall level of credit quality, maintaining reduced credit risk within the investment portfolio, reducing the overall level of expenses, returning to profitability, and meeting the capital level requirements for Royal Bank as set forth in the FDIC and Department MOU.

While sustaining capital ratios above the required minimum, the Company has made progress in improving credit quality, reducing the CRE concentration, strengthening the Board and maintaining liquidity. As a result of the decline in level of classified assets, there have been credits rather than provisions to loan and lease losses and a reduction in the overall carrying costs associated with classified assets. The deleveraging of the balance sheet reduced earning assets, which resulted in a decline in net interest income and had a significant impact on overall earnings. To improve net interest margin and net interest income, management is diligently working on changing the mix of earning assets and interest-bearing liabilities.

During 2013, the strategic plan evolved into transitioning Royal Bank into a community bank built on a solid commercial revenue and retail delivery foundation. During the first quarter of 2013, to support the strategic goals, management announced a set of sweeping initiatives through the Company’s “Profitability Improvement Plan” (“PIP”) designed to enhance company-wide efficiency, productivity and modernization. During 2013, the Company realized a 22% reduction in the workforce, which included reorganizing and relocating certain personnel to improve departmental synergies and better align managers and staff so they can work together in cohesive teams to accomplish their objectives. Additionally, pursuant to the real estate rationalization plan under PIP, two branches were consolidated and four Company-owned buildings were sold.

During 2014, the Company reorganized the retail division to better serve existing customers, develop the retail sales teams, and promote attainment of new customer relationships. The Company continued a successful 50th anniversary campaign by offering a Kindle to new customers who met certain deposit account opening criteria. During the first nine months of

Table of Contents

2014, the Villanova, Phoenixville and Fairmount branches were relocated to more convenient, high-traffic locations within the same markets. In October 2014, the Sicklerville, New Jersey branch was relocated to Blackwood, New Jersey. Additionally, the Company opened a limited service office in Princeton, New Jersey to better serve our commercial customers in central New Jersey. In July, we introduced Royal Bank’s exciting fresh logo and an enhanced website. The redesigned products and contemporary technology are the future platform for enhanced banking convenience for commercial, consumer and retail customers.

Note 3.Investment Securities

The carrying value and fair value of investment securities available-for-sale (“AFS”) at September 30, 2014 and December 31, 2013 are as follows:


As of September 30, 2014			Included in AOCL*
			Gross		Gross
	Amortized		unrealized		unrealized
(In thousands)	cost		gains		losses		Fair value
U.S. government agencies	$	34,092	$	—	$	(1,551)	$	32,541
Mortgage-backed securities-residential		27,000		377		(250)		27,127
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		171,696		2,521		(1,533)		172,684
Non-agency		3,965		7		(34)		3,938
Corporate bonds		15,630		68		(65)		15,633
Municipal bonds		9,030		51		(54)		9,027
Other securities		2,829		1,597		(36)		4,390
Common stocks		33		17		—		50
Total available for sale	$	264,275	$	4,638	$	(3,523)	$	265,390


As of December 31, 2013			Included in AOCL*
			Gross		Gross
	Amortized		unrealized		unrealized
(In thousands)	cost		gains		losses		Fair value
U.S. government agencies	$	68,207	$	—	$	(6,171)	$	62,036
Mortgage-backed securities-residential		32,769		210		(882)		32,097
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		188,194		2,887		(1,978)		189,103
Non-agency		4,454		25		—		4,479
Corporate bonds		9,669		25		(256)		9,438
Municipal bonds		7,163		—		(263)		6,900
Other securities		3,363		1,405		(143)		4,625
Common stocks		33		16		—		49
Total available for sale	$	313,852	$	4,568	$	(9,693)	$	308,727

*Accumulated other comprehensive loss

Table of Contents

The amortized cost and fair value of investment securities at September 30, 2014, by contractual maturity, are shown below. 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.


	As of September 30, 2014
	Amortized
(In thousands)	cost		Fair value
Within 1 year	$	2,003	$	1,987
After 1 but within 5 years		10,345		10,324
After 5 but within 10 years		29,322		28,653
After 10 years		17,082		16,237
Mortgage-backed securities-residential		27,000		27,127
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		171,696		172,684
Non-agency		3,965		3,938
Total available for sale debt securities		261,413		260,950
No contractual maturity		2,862		4,440
Total available for sale securities	$	264,275	$	265,390

Proceeds from the sales of AFS investments during the three months ended September 30, 2014 and 2013 were $19.3 and $0 million, respectively. Proceeds from the sales of AFS investments during the nine months ended September 30, 2014 and 2013 were $55.3 and $20.4 million, respectively. The following table summarizes gross realized gains and losses on the sale of securities recognized in earnings in the periods indicated:


	For the three months				For the nine months ended
	ended September 30,				ended September 30,
(In thousands)	2014		2013		2014		2013
Gross realized gains	$	446	$	—	$	1,143	$	181
Gross realized losses		(208)		(1)		(813)		(112)
Net realized gains (losses)	$	238	$	(1)	$	330	$	69

The Company evaluates securities for OTTI at least on a quarterly basis. The Company assesses whether OTTI is present when the fair value of a security is less than its amortized cost. All investment securities are evaluated for OTTI under FASB ASC Topic 320, “Investments-Debt & Equity Securities” (“ASC Topic 320”). Non-agency collateralized mortgage obligations may be evaluated under FASB ASC Topic 325 Subtopic 40, “Beneficial Interests in Securitized Financial Assets”. In determining whether OTTI exists, management considers numerous factors, including but not limited to: (1) the length of time and the extent to which the fair value is less than the amortized cost, (2) the Company’s intent to hold or sell the security, (3) the financial condition and results of the issuer including changes in capital, (4) the credit rating of the issuer, (5) analysts’ earnings estimate, (6) industry trends specific to the security, and (7) timing of debt maturity and status of debt payments.

Under ASC Topic 320, OTTI is considered to have occurred with respect to debt securities (1) if an entity intends to sell the security; (2) if it is more likely than not an entity will be required to sell the security before recovery of its amortized cost basis; or (3) the present value of the expected cash flows is not sufficient to recover the entire amortized cost basis. If an entity intends to sell the security or will be required to sell the security, the OTTI is recognized in earnings equal to the entire difference between the fair value and the amortized cost basis at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before the recovery of its amortized cost basis, the OTTI is separated into two amounts, the credit-related loss and the noncredit-related loss. The credit-related loss is based on the present value of the expected cash flows and is recognized in earnings.

Table of Contents

The noncredit-related loss is based on other factors such as illiquidity and is recognized in other comprehensive income (loss). The Company did not record OTTI charges to earnings during the first three quarters of 2014 and 2013.

There was no credit-related impairment losses on debt securities held at September 30, 2014 for which a portion of OTTI was recognized in other comprehensive income. The following table presents a roll-forward of the balance of credit-related impairment losses on debt securities held at September 30, 2013 for which a portion of OTTI was recognized in other comprehensive income (loss).


(In thousands)	2013
Balance at January 1,	$	173
Reductions for securities sold during the period (realized)		(173)
Reductions for securities for which the amount previously recognized in other comprehensive income was recognized in earnings because the Company intends to sell the security		—
Balance at September 30,	$	—

The tables below indicate the length of time individual AFS securities have been in a continuous unrealized loss position at September 30, 2014 and December 31, 2013:


September 30, 2014	Less than 12 months				12 months or longer				Total
			Gross				Gross				Gross
			unrealized				unrealized				unrealized
(In thousands)	Fair value		losses		Fair value		losses		Fair value		losses
U.S. government agencies	$	—	$	—	$	32,541	$	(1,551)	$	32,541	$	(1,551)
Mortgage-backed securities-residential		7,619		(38)		9,017		(212)		16,636		(250)
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		49,360		(376)		37,312		(1,157)		86,672		(1,533)
Non-agency		1,464		(34)		—		—		1,464		(34)
Corporate bonds		9,027		(56)		991		(9)		10,018		(65)
Municipal bonds		623		(15)		3,539		(39)		4,162		(54)
Other securities		—		—		268		(36)		268		(36)
Total available-for-sale	$	68,093	$	(519)	$	83,668	$	(3,004)	$	151,761	$	(3,523)

Table of Contents


December 31, 2013	Less than 12 months				12 months or longer				Total
			Gross				Gross				Gross
			unrealized				unrealized				unrealized
(In thousands)	Fair value		losses		Fair value		losses		Fair value		losses
U.S. government agencies	$	48,919	$	(5,035)	$	12,267	$	(1,136)	$	61,186	$	(6,171)
Mortgage-backed securities-residential		18,045		(518)		6,276		(364)		24,321		(882)
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		67,240		(1,446)		9,974		(532)		77,214		(1,978)
Corporate bonds		4,848		(221)		965		(35)		5,813		(256)
Municipal bonds		3,019		(102)		3,881		(161)		6,900		(263)
Other securities		—		—		301		(143)		301		(143)
Total available-for-sale	$	142,071	$	(7,322)	$	33,664	$	(2,371)	$	175,735	$	(9,693)

In determining the Company’s intent not to sell and whether it is more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, management considers the following factors: current liquidity and availability of other non-pledged assets that permits the investment to be held for an extended period of time but not necessarily until maturity, capital planning, and any specific asset liability committee goals or guidelines related to the disposition of specific investments. The Company did not record OTTI charges in the first three quarters of 2014 or 2013.

Common stocks: As of September 30, 2014, the Company had two common stocks of financial institutions with a total fair value of $50,000 and an unrealized gain of $17,000.

For all debt security types discussed below the fair value is based on prices provided by brokers and safekeeping custodians.

U.S. government-sponsored agencies (“U.S. Agency”): As of September 30, 2014, the Company had 10 U.S. Agency securities with a fair value of $32.5 million and gross unrealized losses of $1.6 million. All 10 bonds had been in an unrealized loss position for twelve months or longer at September 30, 2014. Management believes that the unrealized losses on these debt securities are a function of changes in investment spreads. Management expects to recover the entire amortized cost basis of these securities. The Company does not intend to sell these securities before recovery of their cost basis and has not determined that it is not more likely than not that it will be required to sell these securities before recovery of their cost basis. Therefore, management has determined that these securities are not other-than-temporarily impaired at September 30, 2014.

Mortgage-backed securities issued by U.S. government agencies and U.S. government sponsored enterprises: As of September 30, 2014, the Company had six mortgage-backed securities with a fair value of $16.6 million and gross unrealized losses of $250,000. Three of the mortgage-backed securities had been in an unrealized loss position of twelve months or longer and three of the mortgage-backed securities had been in an unrealized loss position for less than twelve months. The unrealized loss is attributable to a combination of factors, including relative changes in interest rates since the time of purchase. The contractual cash flows for these securities are guaranteed by U.S. government agencies and U.S. government-sponsored enterprises. Based on its assessment of these factors, management believes that the unrealized losses on these debt securities are a function of changes in investment spreads and interest rate movements and not as a result of changes in credit quality. Management expects to recover the entire amortized cost basis of these securities. The Company does not intend to sell these securities before recovery of their cost basis and has not determined that it is not more likely than not that it will be required to sell these securities before recovery of their cost basis. Therefore, management has determined that these securities are not other-than-temporarily impaired at September 30, 2014.

Table of Contents

U.S. government issued or sponsored collateralized mortgage obligations (“Agency CMOs”): As of September 30, 2014, the Company had 28 Agency CMOs with a fair value of $86.7 million and gross unrealized losses of $1.5 million. Eleven of the Agency CMOs had been in an unrealized loss position for twelve months or longer and the remaining 17 Agency CMOs have been in an unrealized loss position for less than twelve months. The unrealized loss is attributable to a combination of factors, including relative changes in interest rates since the time of purchase. The contractual cash flows for these securities are guaranteed by U.S. government agencies and U.S. government-sponsored enterprises. Based on its assessment of these factors, management believes that the unrealized losses on these debt securities are a function of changes in investment spreads and interest rate movements and not as a result of changes in credit quality. Management expects to recover the entire amortized cost basis of these securities. The Company does not intend to sell these securities before recovery of their cost basis and has not determined that it is not more likely than not that it will be required to sell these securities before recovery of their cost basis. Therefore, management has determined that these securities are not other-than-temporarily impaired at September 30, 2014.

Non-agency collateralized mortgage obligations (“Non-agency CMOs”): As of September 30, 2014, the Company had one non-agency CMO with a fair value of $1.5 million and a gross unrealized loss of $34,000. The bond had been in an unrealized loss position for less than twelve months. The Company does not intend to sell this security before recovery of its cost basis, and it is not more likely than not that the Company be required to sell this security before recovery of its cost basis. Therefore, management has determined that this security is not other-than-temporarily impaired at September 30, 2014.

Corporate bonds: As of September 30, 2014, the Company had seven corporate bonds with a fair value of $10.0 million and gross unrealized losses of $65,000. One of the corporate bonds had been in an unrealized loss position for twelve months or longer and six bonds had been in an unrealized loss position for less than twelve months. These bonds are investment grade. The Company’s unrealized losses in investments in these corporate bonds represent interest rate risk and not credit risk of the underlying issuers. As previously mentioned management also considered (1) the length of time and the extent to which the fair value is less than the amortized cost, (2) the Company’s intent to hold or sell the security, (3) the financial condition and results of the issuer including changes in capital, (4) the credit rating of the issuer, (5) analysts’ earnings estimates, (6) industry trends specific to the security, and (7) timing of debt maturity and status of debt payments. Based on the analysis, there was no credit-related loss on the bonds. Because the Company does not intend to sell the corporate bonds and it is not more likely than not that the Company will be required to sell the bonds before recovery of their amortized cost basis, which may be maturity, the Company does not consider any of the seven bonds to be other-than-temporarily impaired at September 30, 2014.

Municipal bonds: As of September 30, 2014, the Company had five municipal bonds with a fair value $4.2 million and gross unrealized losses of $54,000. One of the municipal bonds had been in an unrealized loss position for less than twelve months and four municipal bonds had been in an unrealized loss position for twelve months or longer. Because the Company does not intend to sell the bonds and it is not more likely than not that the Company will be required to sell the bond before recovery of its amortized cost basis, which may be maturity, the Company does not consider the bonds to be other-than-temporarily impaired at September 30, 2014.

Other securities: As of September 30, 2014, the Company had six investments in private equity funds which were predominantly invested in real estate. In determining whether or not OTTI exists, the Company reviews the funds’ financials, asset values, and near-term projections. At September 30, 2014, one of the private equity fund investments had a fair value of $268,000 and an unrealized loss of $36,000. OTTI charges were recorded in a prior period on this fund. Management concluded that there was no additional impairment on this investment as of September 30, 2014.

The Company will continue to monitor these investments to determine if the discounted cash flow analysis, continued negative trends, market valuations or credit defaults result in impairment that is other than temporary.

Table of Contents

Note 4.Loans and Leases

Major classifications of LHFI are as follows:


	September 30,		December 31,
(In thousands)	2014		2013
Commercial real estate	$	164,522	$	148,293
Construction and land development		41,676		45,261
Commercial and industrial		70,743		79,589
Multi-family		16,893		11,737
Residential real estate		44,261		25,535
Leases		48,588		42,524
Tax certificates		8,230		12,716
Consumer		2,263		826
Total LHFI, net of unearned income	$	397,176	$	366,481

The Company originates commercial and real estate loans, including construction and land development loans primarily in the greater Philadelphia metropolitan area as well as selected locations throughout the mid-Atlantic region. The Company also has participated with other financial institutions in selected construction and land development loans outside our geographic area. The Company has a concentration of credit risk in commercial real estate, construction and land development loans at September 30, 2014. The Company originates mainly small business, owner-occupied commercial real estate, middle market business and consumer loans. Additionally, after thorough due diligence, the Company has purchased small residential loan pools. A substantial portion of its debtors’ ability to honor their contracts is dependent upon the housing sector specifically and the economy in general.

Loans and leases are classified as LHFI when management has the intent and ability to hold the loan or lease for the foreseeable future or until maturity or payoff. LHFI are stated at their outstanding unpaid principal balances, net of an allowance for loan and leases losses and any deferred fees or costs. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the yield (interest income) of the related loans. The Company is generally amortizing these amounts over the contractual life of the loan.

At September 30, 2014 and December 31, 2013, the Company’s LHFS were $1.0 million and $1.4 million, respectively. LHFS at September 30, 2014 were comprised of one non-accrual loan. The three loans that constituted the balance at December 31, 2013 were sold during the first quarter of 2014. During 2014, the Company transferred $3.2 million to LHFS from LHFI at fair value using expected net sales proceeds. For the nine months ended September 30, 2014, the Company received net proceeds of $3.8 million and recorded net gains of $223,000 as a result of loan sales.

The Company classifies its leases as finance leases, in accordance with FASB ASC Topic 840, “Leases”. The difference between the Company’s gross investment in the lease and the cost or carrying amount of the leased property, if different, is recorded as unearned income, which is amortized to income over the lease term by the interest method.

The Company uses a nine point grading risk classification system commonly used in the financial services industry as the credit quality indicator. The first four classifications are rated Pass. The riskier classifications include Pass-Watch, Special Mention, Substandard, Doubtful and Loss. The risk rating is related to the underlying credit quality and probability of default. These risk ratings are used in the calculation of the allowance for loan and lease losses.

Pass: includes credits that demonstrate a low probability of default;

Table of Contents

Pass-watch: a warning classification which includes credits that are beginning to demonstrate above average risk through declining earnings, strained cash flows, increased leverage and/or weakening market fundamentals;

Special mention: includes credits that have potential weaknesses that if left uncorrected could weaken the credit or result in inadequate protection of the Company’s position at some future date. While potentially weak, credits in this classification are marginally acceptable and loss of principal or interest is not anticipated;

Substandard accrual: includes credits that exhibit a well-defined weakness which currently jeopardizes the repayment of debt and liquidation of collateral even though they are currently performing. These credits are characterized by the distinct possibility that the Company may incur a loss in the future if these weaknesses are not corrected;

Non-accrual (substandard non-accrual, doubtful, loss): includes credits that demonstrate serious problems to the point that it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement.

All loans, at the time of presentation to the appropriate loan committee, are given an initial loan risk rating by the Chief Credit Officer (“CCO”). From time to time, and at the general direction of any of the various loan committees, the ratings may be changed based on the findings of that committee. Items considered in assigning ratings include the financial strength of the borrower and/or guarantors, the type of collateral, the collateral lien position, the type of loan and loan structure, any potential risk inherent in the specific loan type, higher than normal monitoring of the loan or any other factor deemed appropriate by any of the various committees for changing the rating of the loan. Any such change in rating is reflected in the minutes of that committee.

The following tables present risk ratings for each loan portfolio classification at September 30, 2014 and December 31, 2013, excluding LHFS.


As of September 30, 2014
(In thousands)	Pass		Pass-Watch		Special Mention		Substandard		Non-accrual		Total
Commercial real estate	$	128,983	$	25,167	$	5,062	$	1,578	$	3,732	$	164,522
Construction and land development		12,685		25,051		3,125		—		815		41,676
Commercial & industrial		56,385		7,688		750		3,337		2,583		70,743
Multi-family		16,050		321		522		—		—		16,893
Residential real estate		43,278		—		—		—		983		44,261
Leases		47,863		197		3		—		525		48,588
Tax certificates		7,102		—		—		—		1,128		8,230
Consumer		2,207		56		—		—		—		2,263
Total LHFI, net of unearned income	$	314,553	$	58,480	$	9,462	$	4,915	$	9,766	$	397,176

Table of Contents


As of December 31, 2013
(In thousands)	Pass		Pass-Watch		Special Mention		Substandard		Non-accrual		Total
Commercial real estate	$	99,525	$	32,267	$	11,572	$	2,604	$	2,325	$	148,293
Construction and land development		14,677		16,270		11,095		569		2,650		45,261
Commercial & industrial		50,478		10,508		5,735		9,239		3,629		79,589
Multi-family		10,792		410		535		—		—		11,737
Residential real estate		24,903		—		—		—		632		25,535
Leases		41,325		485		247		—		467		42,524
Tax certificates		12,262		—		—		—		454		12,716
Consumer		750		76		—		—		—		826
Total LHFI, net of unearned income	$	254,712	$	60,016	$	29,184	$	12,412	$	10,157	$	366,481

The following tables present an aging analysis of past due payments for each loan portfolio classification at September 30, 2014 and December 31, 2013, excluding LHFS.


As of September 30, 2014	30-59 Days		60-89 Days		Accruing
(In thousands)	Past Due		Past Due		90+ Days		Non-accrual		Current		Total
Commercial real estate	$	—	$	—	$	—	$	3,732	$	160,790	$	164,522
Construction and land development		—		—		—		815		40,861		41,676
Commercial & industrial		41		40		—		2,583		68,079		70,743
Multi-family		—		—		—		—		16,893		16,893
Residential real estate		47		116		—		983		43,115		44,261
Leases		198		3		—		525		47,862		48,588
Tax certificates		—		—		—		1,128		7,102		8,230
Consumer		—		—		—		—		2,263		2,263
Total LHFI, net of unearned income	$	286	$	159	$	—	$	9,766	$	386,965	$	397,176


As of December 31, 2013	30-59 Days		60-89 Days		Accruing
(In thousands)	Past Due		Past Due		90+ Days		Non-accrual		Current		Total
Commercial real estate	$	996	$	—	$	—	$	2,325	$	144,972	$	148,293
Construction and land development		—		—		—		2,650		42,611		45,261
Commercial & industrial		115		49		—		3,629		75,796		79,589
Multi-family		—		—		—		—		11,737		11,737
Residential real estate		458		262		—		632		24,183		25,535
Leases		485		247		—		467		41,325		42,524
Tax certificates		—		—		—		454		12,262		12,716
Consumer		—		—		—		—		826		826
Total LHFI, net of unearned income	$	2,054	$	558	$	—	$	10,157	$	353,712	$	366,481

Table of Contents

The following tables detail the composition of the non-accrual loans at September 30, 2014 and December 31, 2013.


	As of September 30, 2014				As of December 31, 2013
	Loan		Specific		Loan		Specific
(In thousands)	balance		reserves		balance		reserves
Non-accrual loans held for investment
Commercial real estate	$	3,732	$	205	$	2,325	$	331
Construction and land development		815		172		2,650		—
Commercial & industrial		2,583		5		3,629		452
Residential real estate		983		30		632		19
Leases		525		62		467		60
Tax certificates		1,128		19		454		24
Total non-accrual LHFI	$	9,766	$	493	$	10,157	$	886
Non-accrual loans held for sale
Construction and land development	$	1,018	$	—	$	—	$	—
Total non-accrual LHFS	$	1,018	$	—	$	—	$	—
Total non-accrual loans	$	10,784	$	493	$	10,157	$	886

Impaired Loans

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 agreement. For all classes of loans receivable, with the exception of tax certificates, the accrual of interest is discontinued on a loan when management believes that the borrower’s financial condition is such that collection of principal and interest is doubtful or when a loan becomes 90 days past due. Impaired loans include troubled debt restructurings (“TDRs”). Excess proceeds received over the principal amounts due on impaired non-accrual loans are recognized as income on a cash basis. The Company recognizes income under the accrual 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.

Total cash collected on non-accrual and impaired loans during the nine months ended September 30, 2014 and 2013 was $5.0 million and $10.6 million respectively, of which $4.5 million and $9.9 million was credited to the principal balance outstanding on such loans, respectively.

The following is a summary of information pertaining to impaired loans:



	September 30,		December 31,
(In thousands)	2014		2013
Impaired LHFI with a valuation allowance	$	4,232	$	3,835
Impaired LHFI without a valuation allowance		11,909		14,671
Impaired LHFS		1,018		—
Total impaired loans and leases	$	17,159	$	18,506
Valuation allowance related to impaired LHFI	$	493	$	886

Troubled Debt Restructurings

Table of Contents

similar credit risk characteristics. All loans classified as TDRs are considered to be impaired. TDRs are returned to an accrual status when the loan is brought current, has performed in accordance with the contractual restructured terms for a reasonable period of time (generally six months) and the ultimate collectibility of the total contractual restructured principal and interest is no longer in doubt. At September 30, 2014, the Company had twelve TDRs, with a total carrying value of $9.4 million. At the time of the modifications, three of the loans were already classified as impaired non-accrual loans. At December 31, 2013, the Company had twelve TDRs with a total carrying value of $12.1 million. The Company’s policy for TDRs is to recognize income on currently performing restructured loans under the accrual method.

The following table details the Company’s TDRs that are on an accrual status and non-accrual status at September 30, 2014 and December 31, 2013.


	As of September 30, 2014
				Non-
	Number of	Accrual		Accrual
(In thousands)	loans	Status		Status		Total TDRs
Commercial real estate	2	$	2,883	$	—	$	2,883
Construction and land development	3		378		815		1,193
Commercial & industrial	6		3,672		1,497		5,169
Residential real estate	1		—		105		105
Total	12	$	6,933	$	2,417	$	9,350


	As of December 31, 2013
				Non-
	Number of	Accrual		Accrual
(In thousands)	loans	Status		Status		Total TDRs
Commercial real estate	3	$	3,847	$	—	$	3,847
Construction and land development	4		1,257		479		1,736
Commercial & industrial	3		4,420		1,960		6,380
Residential real estate	2		—		121		121
Total	12	$	9,524	$	2,560	$	12,084

At September 30, 2014, all of the TDRs were in compliance with their restructured terms.

The following tables present newly restructured loans that occurred during the nine months ended September 30, 2014. The Company did not classify any loan modifications as TDRs during the third quarter of 2013.


	Modifications by type for the three months ended September 30, 2014
												Pre-		Post-
												Modification		Modification
												Outstanding		Outstanding
	Number of							Combination				Recorded		Recorded
(Dollars in thousands)	loans	Rate		Term		Payment		of types		Total		Investment		Investment
Commercial & industrial	1	$	—	$	188	$	—	$	—	$	188	$	189	$	189
Total	1	$	—	$	188	$	—	$	—	$	188	$	189	$	189

Table of Contents


	Modifications by type for the nine months ended September 30, 2014
												Pre-		Post-
												Modification		Modification
												Outstanding		Outstanding
	Number of							Combination				Recorded		Recorded
(Dollars in thousands)	loans	Rate		Term		Payment		of types		Total		Investment		Investment
Commercial & industrial	3	$	—	$	233	$	—	$	28	$	261	$	262	$	262
Total	3	$	—	$	233	$	—	$	28	$	261	$	262	$	262


	Modifications by type for the nine months ended September 30, 2013
												Pre-		Post-
												Modification		Modification
												Outstanding		Outstanding
	Number of							Combination				Recorded		Recorded
(Dollars in thousands)	loans	Rate		Term		Payment		of types		Total		Investment		Investment
Commercial real estate	2	$	—	$	—	$	—	$	3,705	$	3,705	$	3,761	$	3,761
Commercial & industrial	1		—		—		—		82		82		87		87
Total	3	$	—	$	—	$	—	$	3,787	$	3,787	$	3,848	$	3,848

Note 5.Allowance for Loan and Lease Losses

The following tables present the detail of the allowance and the loan portfolio disaggregated by loan portfolio classification as of September 30, 2014, December 31, 2013 and September 30, 2013.

Allowance for Loan and Lease Losses

For the three months ended September 30, 2014


			Construction
	Commercial		and land		Commercial		Multi-		Residential				Tax
(In thousands)	real estate		development		& industrial		family		real estate		Leases		certificates		Consumer		Unallocated		Total
Beginning balance	$	4,971	$	2,033	$	1,525	$	416	$	690	$	1,352	$	408	$	24	$	150	$	11,569
Charge-offs		—		—		—		—		—		(206)		(65)		—		—		(271)
Recoveries		—		205		12		—		5		13		—		—		—		235
(Credit) provision		(266)		3		(106)		(63)		25		325		29		9		(7)		(51)
Ending balance	$	4,705	$	2,241	$	1,431	$	353	$	720	$	1,484	$	372	$	33	$	143	$	11,482
Ending balance: related to loans individually evaluated for impairment	$	205	$	172	$	5	$	—	$	30	$	62	$	19	$	—	$	—	$	493
Ending balance: related to loans collectively evaluated for impairment	$	4,500	$	2,069	$	1,426	$	353	$	690	$	1,422	$	353	$	33	$	143	$	10,989

Allowance for Loan and Lease Losses

For the nine months ended September 30, 2014


			Construction
	Commercial		and land		Commercial		Multi-		Residential				Tax
(In thousands)	real estate		development		& industrial		family		real estate		Leases		certificates		Consumer		Unallocated		Total
Beginning balance	$	5,498	$	2,316	$	3,006	$	402	$	473	$	1,223	$	555	$	15	$	183	$	13,671
Charge-offs		(349)		—		(452)		—		—		(568)		(330)		—		—		(1,699)
Recoveries		—		205		23		—		11		35		1		—		—		275
(Credit) provision		(444)		(280)		(1,146)		(49)		236		794		146		18		(40)		(765)
Ending balance	$	4,705	$	2,241	$	1,431	$	353	$	720	$	1,484	$	372	$	33	$	143	$	11,482
Ending balance: related to loans individually evaluated for impairment	$	205	$	172	$	5	$	—	$	30	$	62	$	19	$	—	$	—	$	493
Ending balance: related to loans collectively evaluated for impairment	$	4,500	$	2,069	$	1,426	$	353	$	690	$	1,422	$	353	$	33	$	143	$	10,989

Table of Contents

Loans Held for Investment and Evaluated for Impairment

For the three and nine months ended September 30, 2014


			Construction
	Commercial		and land		Commercial		Multi-		Residential				Tax
(In thousands)	real estate		development		& industrial		family		real estate		Leases		certificates		Consumer		Unallocated		Total
LHFI
Ending balance	$	164,522	$	41,676	$	70,743	$	16,893	$	44,261	$	48,588	$	8,230	$	2,263	$	—	$	397,176
Ending balance: individually evaluated for impairment	$	6,877	$	1,192	$	5,897	$	—	$	983	$	64	$	1,128	$	—	$	—	$	16,141
Ending balance: collectively evaluated for impairment	$	157,645	$	40,484	$	64,846	$	16,893	$	43,278	$	48,524	$	7,102	$	2,263	$	—	$	381,035

Allowance for Loan and Lease Losses and Loans Held for Investment

For the year ended December 31, 2013


			Construction
	Commercial		and land		Commercial		Multi-		Residential				Tax
(In thousands)	real estate		development		& industrial		family		real estate		Leases		certificates		Consumer		Unallocated		Total
Beginning balance	$	8,750	$	2,987	$	1,924	$	654	$	1,098	$	1,108	$	472	$	29	$	239	$	17,261
Charge-offs		(1,684)		(820)		(383)		—		(46)		(382)		(578)		—		—		(3,893)
Recoveries		600		297		17		—		158		29		74		—		—		1,175
(Credit) provision		(2,168)		(148)		1,448		(252)		(737)		468		587		(14)		(56)		(872)
Ending balance	$	5,498	$	2,316	$	3,006	$	402	$	473	$	1,223	$	555	$	15	$	183	$	13,671
Ending balance: related to loans individually evaluated for impairment	$	331	$	—	$	452	$	—	$	19	$	60	$	24	$	—	$	—	$	886
Ending balance: related to loans collectively evaluated for impairment	$	5,167	$	2,316	$	2,554	$	402	$	454	$	1,163	$	531	$	15	$	183	$	12,785
LHFI
Ending balance	$	148,293	$	45,261	$	79,589	$	11,737	$	25,535	$	42,524	$	12,716	$	826	$	—	$	366,481
Ending balance: individually evaluated for impairment	$	5,325	$	3,907	$	8,049	$	—	$	632	$	139	$	454	$	—	$	—	$	18,506
Ending balance: collectively evaluated for impairment	$	142,968	$	41,354	$	71,540	$	11,737	$	24,903	$	42,385	$	12,262	$	826	$	—	$	347,975

Allowance for Loan and Lease Losses

For the three months ended September 30, 2013


			Construction
	Commercial		and land		Commercial		Multi-		Residential				Tax
(In thousands)	real estate		development		& industrial		family		real estate		Leases		certificates		Consumer		Unallocated		Total
Beginning balance	$	7,952	$	2,017	$	2,465	$	588	$	353	$	999	$	586	$	18	$	201	$	15,179
Charge-offs		(605)		—		(34)		—		(32)		(40)		(126)		—		—		(837)
Recoveries		1		106		4		—		2		4		2		—		—		119
Provision (credit)		(1,159)		72		1,080		(114)		175		133		41		(3)		(7)		218
Ending balance	$	6,189	$	2,195	$	3,515	$	474	$	498	$	1,096	$	503	$	15	$	194	$	14,679
Ending balance: related to loans individually evaluated for impairment	$	230	$	—	$	209	$	—	$	16	$	138	$	67	$	—	$	—	$	660
Ending balance: related to loans collectively evaluated for impairment	$	5,959	$	2,195	$	3,306	$	474	$	482	$	958	$	436	$	15	$	194	$	14,019

Table of Contents

Allowance for Loan and Lease Losses

For the nine months ended September 30, 2013


			Construction
	Commercial		and land		Commercial		Multi-		Residential				Tax
(In thousands)	real estate		development		& industrial		family		real estate		Leases		certificates		Consumer		Unallocated		Total
Beginning balance	$	8,750	$	2,987	$	1,924	$	654	$	1,098	$	1,108	$	472	$	29	$	239	$	17,261
Charge-offs		(1,440)		(820)		(228)		—		(32)		(149)		(410)		—		—		(3,079)
Recoveries		127		297		14		—		157		24		74		—		—		693
Provision (credit)		(1,248)		(269)		1,805		(180)		(725)		113		367		(14)		(45)		(196)
Ending balance	$	6,189	$	2,195	$	3,515	$	474	$	498	$	1,096	$	503	$	15	$	194	$	14,679
Ending balance: related to loans individually evaluated for impairment	$	230	$	—	$	209	$	—	$	16	$	138	$	67	$	—	$	—	$	660
Ending balance: related to loans collectively evaluated for impairment	$	5,959	$	2,195	$	3,306	$	474	$	482	$	958	$	436	$	15	$	194	$	14,019

Loans Held for Investment and Evaluated for Impairment

For the three and nine months ended September 30, 2013


			Construction
	Commercial		and land		Commercial		Multi-		Residential				Tax
(In thousands)	real estate		development		& industrial		family		real estate		Leases		certificates		Consumer		Unallocated		Total
LHFI
Ending balance	$	158,223	$	39,594	$	86,401	$	11,678	$	24,830	$	40,408	$	15,364	$	831	$	—	$	377,329
Ending balance: individually evaluated for impairment	$	10,045	$	4,019	$	8,112	$	—	$	520	$	190	$	532	$	—	$	—	$	23,418
Ending balance: collectively evaluated for impairment	$	148,178	$	35,575	$	78,289	$	11,678	$	24,310	$	40,218	$	14,832	$	831	$	—	$	353,911

Table of Contents

The following tables detail the LHFI that were evaluated for impairment by loan classification at September 30, 2014 and December 31, 2013.


	At September 30, 2014
	Unpaid
	principal		Recorded		Related
(In thousands)	balance		investment		allowance
With no related allowance recorded:
Commercial real estate	$	7,410	$	5,986	$	—
Construction and land development		2,690		633		—
Commercial & industrial		8,133		4,400		—
Residential real estate		—		—		—
Tax certificates		5,376		890		—
Total:	$	23,609	$	11,909	$	—


With an allowance recorded:
Commercial real estate	$	1,137	$	891	$	205
Construction and land development		559		559		172
Commercial & industrial		1,721		1,497		5
Residential real estate		1,080		983		30
Leasing		64		64		62
Tax certificates		4,244		238		19
Total:	$	8,805	$	4,232	$	493


	At and for the year ended December 31, 2013
	Unpaid						Average		Interest
	principal		Recorded		Related		recorded		income
(In thousands)	balance		investment		allowance		investment		recognized
With no related allowance recorded:
Commercial real estate	$	4,429	$	4,158	$	—	$	7,956	$	73
Construction and land development		9,850		3,907		—		3,933		209
Commercial & industrial		6,693		6,491		—		5,960		250
Residential real estate		—		—		—		84		27
Tax certificates		179		115		—		167		—
Total:	$	21,151	$	14,671	$	—	$	18,100	$	559


With an allowance recorded:
Commercial real estate	$	1,435	$	1,435	$	331	$	1,879	$	—
Construction and land development		—		—		—		381		—
Commercial & industrial		2,592		1,290		452		2,456		—
Residential real estate		827		631		19		492		—
Leases		139		139		60		106		—
Tax certificates		4,322		340		24		341		—
Total:	$	9,315	$	3,835	$	886	$	5,655	$	—

Table of Contents

The following tables present the average recorded investment in impaired LHFI and the related interest income recognized for the three and nine months ended September 30, 2014 and 2013.


	For the three months ended September 30, 2014				For the nine months ended September 30, 2014
	Average		Interest		Average		Interest
	recorded		income		recorded		income
(In thousands)	investment		recognized		investment		recognized
Commercial real estate	$	5,571	$	33	$	5,258	$	65
Construction and land development		1,673		11		2,823		68
Commercial & industrial		6,085		52		6,658		159
Residential real estate		993		—		833		—
Leasing		75		—		112		—
Tax certificates		1,134				918
Total:	$	15,531	$	96	$	16,602	$	292


	For the three months ended September 30, 2013				For the nine months ended September 30, 2013
	Average		Interest		Average		Interest
	recorded		income		recorded		income
(In thousands)	investment		recognized		investment		recognized
Commercial real estate	$	11,676	$	59	$	4,556	$	45
Construction and land development		4,047		18		10,779		129
Commercial & industrial		8,050		92		8,988		241
Residential real estate		523		—		580		27
Leasing		168		—		105		—
Tax certificates		433		—		509		—
Total:	$	24,897	$	169	$	25,517	$	442

Note 6.Other Real Estate Owned

OREO slightly decreased $24,000 and was $9.6 million at December 31, 2013d September 30, 2014. OREO is comprised of three real estate properties acquired through, or in lieu of foreclosure in settlement of loans and 73 real estate properties

Table of Contents

acquired through foreclosure related to tax liens. Set forth below are tables which detail the changes in OREO from December 31, 2013 to September 30, 2014 and December 31, 2012 to December 31, 2013.


	For the nine months ended September 30, 2014
(In thousands)	Loans		Tax Liens		Total
Beginning balance	$	1,725	$	7,892	$	9,617
Net proceeds from sales		(1,214)		(2,334)		(3,548)
Net gains on sales		22		611		633
Transfers in		—		1,998		1,998
Cash additions		—		1,292		1,292
Impairment charge		(100)		(299)		(399)
Ending balance	$	433	$	9,160	$	9,593


	For the year ended December 31, 2013
(In thousands)	Loans		Tax Liens		Total
Beginning balance	$	11,365	$	2,070	$	13,435
Net proceeds from sales		(8,869)		(3,910)		(12,779)
Net gain on sales		228		1,199		1,427
Transfers in		100		8,951		9,051
Cash additions		—		—		—
Impairment charge		(1,099)		(418)		(1,517)
Ending balance	$	1,725	$	7,892	$	9,617

At September 30, 2014, OREO was comprised of $229,000 in land, $9.2 million in tax liens, and residential real estate, related to a condominium construction project in Minneapolis, Minnesota in which the Company is a participant with a fair value of $204,000. During the first nine months of 2014, the Company sold ten condominiums related to the construction project. The Company received its pro rata share of net proceeds in the amount of $193,000 and recorded a net gain of $37,000. Additionally, during the third quarter of 2014, the Company sold a parcel of land and a commercial real estate building. As a result of these sales the Company received $1.0 million in net proceeds and recorded a net loss of $15,000. During the first quarter of 2014, the Company recorded impairment charges of $75,000 on the remaining, larger condominium units and $25,000 on the commercial real estate which was sold in the third quarter.

As shown in the tables above, the composition of the OREO assets has evolved to properties primarily acquired through the tax lien portfolio. During the first nine months of 2014, the Company transferred $2.0 million to OREO which represents 40 properties and added $1.3 million in lien redemptions on existing properties. During the same period the Company sold 30 tax lien properties, received proceeds of $2.3 million, and recorded net gains of $611,000 as a result of these sales. Additionally, the Company recorded impairment charges of $299,000 during the first nine months of 2014 related to the tax lien properties. At December 31, 2013, OREO assets acquired through the tax lien portfolio were $7.9 million and were comprised of 59 properties.

Table of Contents

Note 7.Deposits

The Company’s deposit composition as of September 30, 2014 and December 31, 2013 is presented below:


	September 30,		December 31,
(In thousands)	2014		2013
Demand	$	67,901	$	60,473
NOW		41,801		45,375
Money Market		162,177		164,678
Savings		19,142		17,593
Time deposits (over $100)		85,603		92,763
Time deposits (under $100)		139,162		148,082
Total deposits	$	515,786	$	528,964

Note 8.Borrowings and Subordinated Debentures

Advances from the Federal Home Loan Bank

As of September 30, 2014, Royal Bank had $180.0 million of available borrowing capacity at the FHLB, which is based on qualifying collateral. Total advances from the FHLB were $55.0 million at September 30, 2014 and $65.0 million at December 31, 2013. The advances and the line of credit are collateralized by FHLB stock, government agencies and mortgage-backed securities. As of September 30, 2014, investment securities with a market value of $51.5 million were pledged as collateral to the FHLB.

Presented below are the Company’s FHLB borrowings allocated by the year in which they mature with their corresponding weighted average rates:


	As of				As of
	September 30, 2014				December 31, 2013
(Dollars in thousands)	Amount		Rate		Amount		Rate
Advances maturing in
2014	$	—	—	%	$	10,000	0.24	%
2015		10,000	0.71	%		10,000	0.71	%
2016		10,000	1.11	%		10,000	1.11	%
2017		25,000	1.46	%		25,000	1.46	%
2018		10,000	2.01	%		10,000	2.01	%
Total FHLB borrowings	$	55,000			$	65,000

Other borrowings

The Company has a note payable with PNC Bank (“PNC”) at September 30, 2014 in the amount of $2.5 million compared to $2.9 million at December 31, 2013. The note’s maturity date is August 25, 2016. The interest rate is a variable rate equal to one month LIBOR + 15 basis points and adjusts monthly. The interest rate at September 30, 2014 was 0.31%.

At September 30, 2014 and December 31, 2013, the Company had additional borrowings of $40.0 million from PNC which will mature on January 7, 2018. These borrowings have a weighted average interest rate of 3.65%. The note payable and the borrowings are secured by government agencies and mortgage-backed securities.

Table of Contents

Subordinated debentures

The Company has outstanding $25.0 million of Trust Preferred Securities issued through two Delaware trust affiliates, Royal Bancshares Capital Trust I (“Trust I”) and Royal Bancshares Capital Trust II (“Trust II”) (collectively, the “Trusts”). The Company issued an aggregate principal amount of $12.9 million of floating rate junior subordinated debt securities to Trust I and an aggregate principal amount of $12.9 million of fixed/floating rate junior subordinated debt securities to Trust II. Both debt securities bear an interest rate of 2.38% at September 30, 2014, and reset quarterly at 3-month LIBOR plus 2.15%.

Each of Trust I and Trust II issued an aggregate principal amount of $12.5 million of capital securities initially bearing fixed and/or fixed/floating interest rates corresponding to the debt securities held by each trust to an unaffiliated investment vehicle and an aggregate principal amount of $387,000 of common securities bearing fixed and/or fixed/floating interest rates corresponding to the debt securities held by each trust to the Company. The Company has fully and unconditionally guaranteed all of the obligations of the Trusts, including any distributions and payments on liquidation or redemption of the capital securities.

Under the Federal Reserve Agreement as described in “Note 2 — Regulatory Matters and Significant Risks or Uncertainties” to the Consolidated Financial Statements, the Company and its non-bank subsidiaries may not make any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System. The Company received approval and paid all accumulated deferred interest in 2013 and the required interest payments through the first nine months of 2014.

Note 9.Commitments, Contingencies, and Concentrations

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. 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.

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:


	September 30,		December 31,
(In thousands)	2014		2013
Financial instruments whose contract amounts represent credit risk:
Open-end lines of credit	$	47,455	$	21,182
Commitments to extend credit		6,430		200
Standby letters of credit and financial guarantees written		847		2,679

Legal Proceedings

On or about March 15, 2012, CSC, RTL and the Company were named defendants, among others, in a complaint filed by Marina Bay Towers Urban Renewal II, LP (“MBT”) in the Superior Court of New Jersey, Law Division, Cape May County. The complaint alleges a conspiracy to rig bids in municipal tax lien auctions. MBT does not seek to represent

Table of Contents

a class and only seeks remedies related to itself. As of the date of this filing, the Company cannot reasonably estimate the possible loss or range of loss that may result from this proceeding.

Note 10.Shareholders’ Equity

Preferred Stock

On February 20, 2009, as part of the Capital Purchase Program (“CPP”) established by the Treasury, the Company issued to Treasury 30,407 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, without par value per share (the “Series A Preferred Stock”), and a liquidation preference of $1,000 per share. In conjunction with the purchase of the Series A Preferred Stock, Treasury received a warrant to purchase 1,104,370 shares of the Company’s Class A common stock. The aggregate purchase price for the Series A Preferred Stock and warrant was $30.4 million in cash. The Series A Preferred Stock qualifies as Tier 1 capital and originally paid cumulative dividends at a rate of 5% per annum. In February 2014, the cumulative dividend rate on the Series A Preferred Stock increased to 9% per annum. The Series A Preferred Stock may generally be redeemed by the Company at any time following consultation with its primary banking regulators. The warrant issued to Treasury has a 10-year term and is immediately exercisable upon its issuance, with an exercise price, subject to anti-dilution adjustments, equal to $4.13 per share of the common stock. As a result of the shareholders’ right offering described below, the number of warrants to purchase the Company’s Class A common stock adjusted to 1,368,040 and the warrant exercise price decreased to $3.33 per share of the common stock.

The Company received approval from the Federal Reserve Bank to bid up to $14.0 million, which was raised in a private placement, to purchase shares of the Series A Preferred Stock in an auction of such shares to be conducted by the Treasury. The auction closed on June 19, 2014. The Series A Preferred Stock was priced in the auction at $1,207.11 per share for all 30,407 shares of Series A Preferred Stock outstanding. The Company was allocated 11,551 shares of Series A Preferred Stock for repurchase at the clearing price of $1,207.11. Closing for the sale of the Series A Preferred Stock by the Treasury, including the repurchase of 11,551 shares of Series A Preferred Stock by the Company occurred, on July 2, 2014. As part of this redemption, the Company eliminated nearly $3.5 million in preferred dividend in arrears.

Common Stock

The Company’s Class A common stock trades on the NASDAQ Global Market under the symbol RBPAA. There is no market for the Company’s Class B common stock. The Class B shares may not be transferred in any manner except to the holder’s immediate family. Class B shares may be converted to Class A shares at the rate of 1.15 to 1. Shareholders are 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 conversion equivalent per share dividends when declared.

To fund the purchase of the Series A Preferred Stock, described above, the Company sold 11,666,667 shares of its Class A common stock in a private placement transaction at a price of $1.20 per share. Additionally, during the third quarter of 2014, the Company conducted a shareholder rights offering to existing shareholders to limit their ownership dilution from the sale of Class A common stock to the other investors in the private placement. The Company issued approximately 5.0 million shares and received gross proceeds of approximately $6.0 million. The private placement and the shareholders rights offering combined to increase tangible common equity by nearly $17.6 million.

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 “Code”) and in the Federal Deposit Insurance Act (“FDIA”) affecting the payment of dividends to the Company by Royal Bank. Under the Code, no dividends may be paid by a bank except from “accumulated net earnings” (generally retained earnings). In addition, dividends paid by Royal Bank to the Company would be prohibited if the effect thereof would cause Royal Bank’s capital to be reduced below applicable minimum capital requirements. Royal Bank must receive prior approval from the FDIC and the Department before declaring and paying a dividend to the Company.

Table of Contents

On August 13, 2009, the Company’s Board suspended the regular quarterly cash dividends on the $30.4 million in Series A Preferred Stock. The Company’s Board took this action in consultation with the Federal Reserve Bank of Philadelphia as required by regulatory policy guidance. In February 2014, the preferred cumulative dividend rate prospectively increased to 9% per annum. As a result of the Company’s repurchase of 11,551 shares of Series A Preferred Stock, approximately $3.5 million of the Series A Preferred stock dividend in arrears was eliminated. As of September 30, 2014, the Series A Preferred stock dividend in arrears was approximately $6.1 million and has not been recognized in the consolidated financial statements. In the event the Company declared the preferred dividend the Company’s capital ratios would be negatively affected; however, they would remain above the required minimum ratios. Under the Federal Reserve MOU as described in “Note 2 — Regulatory Matters and Significant Risks or Uncertainties” to the Consolidated Financial Statements, the Company may not declare or pay any dividends without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System.

Note 11.Regulatory Capital Requirements

In connection with a prior bank regulatory examination, the FDIC concluded, based upon its interpretation of the Call Report instructions and under RAP, that income from Royal Bank’s tax lien business should be recognized on a cash basis, not an accrual basis. Royal Bank’s current accrual method is in accordance with U.S. GAAP. Royal Bank disagrees with the FDIC’s conclusion and filed the Call Report for September 30, 2014 and the previous 16 quarters in accordance with U.S. GAAP. The change in the method of revenue recognition for the tax lien business for regulatory accounting purposes affects Royal Bank’s and the Company’s capital ratios as shown below. The resolution of this matter will be decided by additional joint regulatory agency guidance which includes the Federal Reserve Bank, the FDIC, and the OCC.

The table below sets forth Royal Bank’s capital ratios under RAP based on the FDIC’s interpretation of the Call Report instructions:


	At September 30, 2014
									To be well capitalized
					For capital				under prompt corrective
	Actual				adequacy purposes				action provision
(Dollars in thousands)	Amount		Ratio		Amount		Ratio		Amount		Ratio
Total capital (to risk-weighted assets)	$	76,403	15.99	%	$	38,237	8.00	%	$	47,796	10.00	%
Tier I capital (to risk-weighted assets)	$	70,970	14.85	%	$	19,118	4.00	%	$	28,677	6.00	%
Tier I capital (to average assets, leverage)	$	70,970	9.96	%	$	28,492	4.00	%	$	35,615	5.00	%

Table of Contents

The tables below reflect the adjustments to the net income as well as the capital ratios for Royal Bank under U.S. GAAP:


	For the nine
	months ended
(In thousands)	September 30, 2014
RAP net income	$	682
Tax lien adjustment, net of noncontrolling interest		3,556
U.S. GAAP net income	$	4,238


	At September 30, 2014
	As reported		As adjusted
	under RAP		for U.S. GAAP
Total capital (to risk-weighted assets)	15.99	%	16.61	%
Tier I capital (to risk-weighted assets)	14.85	%	15.49	%
Tier I capital (to average assets, leverage)	9.96	%	10.42	%

The tables below reflect the Company’s capital ratios:


	At September 30, 2014
									To be well capitalized
					For capital				under prompt corrective
	Actual				adequacy purposes				action provision
(Dollars in thousands)	Amount		Ratio		Amount		Ratio		Amount	Ratio
Total capital (to risk-weighted assets)	$	94,205	19.37	%	$	38,899	8.00	%	N/A	N/A
Tier I capital (to risk-weighted assets)	$	85,328	17.55	%	$	19,449	4.00	%	N/A	N/A
Tier I capital (to average assets, leverage)	$	85,328	11.78	%	$	28,975	4.00	%	N/A	N/A

The Company has filed the Consolidated Financial Statements for Bank Holding Companies-FR Y-9C (“FR Y-9C”) as of September 30, 2014 consistent with U.S. GAAP and the FR Y-9C instructions. In the event that a similar adjustment for RAP purposes would be required by the Federal Reserve on the holding company level, the adjusted ratios are shown in the table below.


	For the nine
	months ended
(In thousands)	September 30, 2014
U.S. GAAP net income	$	4,298
Tax lien adjustment, net of noncontrolling interest		(3,556)
RAP net income	$	742


	At September 30, 2014
	As reported		As adjusted
	under U.S. GAAP		for RAP
Total capital (to risk-weighted assets)	19.37	%	18.78	%
Tier I capital (to risk-weighted assets)	17.55	%	16.68	%
Tier I capital (to average assets, leverage)	11.78	%	11.17	%

Table of Contents

Note 12.Pension Plan

The Company has a noncontributory nonqualified defined benefit pension plan (“Pension Plan”) covering certain eligible employees. The Company’s Pension Plan provides retirement benefits under pension trust agreements. 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.

Net periodic defined benefit pension expense for the three and nine months ended September 30, 2014 and 2013 included the following components:


	Three months ended				Nine months ended
	September 30,				September 30,
(In thousands)	2014		2013		2014		2013
Service cost	$	15	$	19	$	45	$	56
Interest cost		155		133		466		399
Amortization of prior service cost		22		22		66		67
Amortization of actuarial loss		32		122		96		367
Net periodic benefit cost	$	224	$	296	$	673	$	889

The Company has unfunded pension plan obligations of $14.3 million as of September 30, 2014 compared to $14.5 million at December 31, 2013. The Company plans to fund the pension plan obligations through existing Company owned life insurance policies.

Note 13.Earnings (Loss) Per Common Share

The Company follows the provisions of FASB ASC Topic 260, “Earnings per Share” (“ASC Topic 260”). Basic earnings per share (“EPS”) excludes dilution and is computed by dividing income available to common shareholders by the weighted average common shares outstanding during the period. The Company has two classes of common stock currently outstanding. The classes are A and B, of which one share of Class B is convertible into 1.15 shares of Class A. 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 using the treasury stock method. For the three and nine months ended September 30, 2014 and 2013, 168,907 options to purchase shares of common stock, respectively, were anti-dilutive in the computation of diluted EPS, as the exercise price exceeded average market price in each of those periods. For the three and nine months ended September 30, 2013, 202,408 options to purchase shares of common stock, respectively, were anti-dilutive in the computation of diluted EPS, as the exercise price exceeded average market price and as a result of the net loss for the the three and nine months ended September 30, 2013. Additionally warrants to purchase 1,368,040 shares of Class A common stock were also anti-dilutive.

Basic and diluted EPS are calculated as follows:


	Three months ended September 30, 2014
	Income		Average shares	Per share
(In thousands, except for per share data)	(numerator)		(denominator)	Amount
Basic and Diluted EPS
Income available to common shareholders	$	1,271	27,329	$	0.05

Table of Contents


	Three months ended September 30, 2013
	Loss		Average shares	Per share
(In thousands, except for per share data)	(numerator)		(denominator)	Amount
Basic and Diluted EPS
Loss available to common shareholders	$	(178)	13,286	$	(0.01)


	Nine months ended September 30, 2014
	Income		Average shares	Per share
(In thousands, except for per share data)	(numerator)		(denominator)	Amount
Basic and Diluted EPS
Income available to common shareholders	$	2,654	18,042	$	0.15


	Nine months ended September 30, 2013
	Loss		Average shares	Per share
(In thousands, except for per share data)	(numerator)		(denominator)	Amount
Basic and Diluted EPS
Loss available to common shareholders	$	(1,896)	13,272	$	(0.14)

Note 14.Comprehensive Income (Loss)

FASB ASC Topic 220, “Comprehensive Income” (“ASC Topic 220”), requires the reporting of all changes in equity during the reporting period except investments from and distributions to shareholders. Net income (loss) is a component of comprehensive income (loss) with all other components referred to in the aggregate as other comprehensive income. Unrealized gains and losses on AFS securities is an example of another comprehensive income (loss) component.


	Nine months ended September 30, 2014
			Tax
	Before tax		expense		Net of tax
(In thousands)	amount		(benefit)		amount
Unrealized gains on investment securities:
Unrealized holding gains arising during period	$	6,570	$	2,101	$	4,469
Less reclassification adjustment for gains
realized in net income		330		112		218
Unrealized gains on investment securities		6,240		1,989		4,251
Unrecognized benefit obligation expense:
Less reclassification adjustment for amortization		(85)		(29)		(56)
Other comprehensive income, net	$	6,325	$	2,018	$	4,307

Table of Contents


	Nine months ended September 30, 2013
			Tax
	Before tax		expense		Net of tax
(In thousands)	amount		(benefit)		amount
Unrealized losses on investment securities:
Unrealized holding losses arising during period	$	(8,833)	$	(3,128)	$	(5,705)
Less reclassification adjustment for gains
realized in net loss		69		23		46
Unrealized losses on investment securities		(8,902)		(3,151)		(5,751)
Unrecognized benefit obligation expense:
Less reclassification adjustment for amortization		(429)		(146)		(283)
Other comprehensive loss, net	$	(8,473)	$	(3,005)	$	(5,468)

Note 15.Fair Value of Financial Instruments

Under FASB ASC Topic 820 “Fair Value Measurements and Disclosures” (“ASC Topic 820”), fair values are based on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When available, management uses quoted market prices to determine fair value. If quoted prices are not available, fair value is based upon valuation techniques such as matrix pricing or other models that use, where possible, current market-based or independently sourced market parameters, such as interest rates. If observable market-based inputs are not available, the Company uses unobservable inputs to determine appropriate valuation adjustments using discounted cash flow methodologies.

Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in a sales transaction on the dates indicated. The estimated fair value amounts have been measured as of their respective period end and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each period-end.

ASC Topic 820 provides guidance for estimating fair value when the volume and level of activity for an asset or liability has significantly declined and for identifying circumstances when a transaction is not orderly. ASC Topic 820 establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under ASC Topic 820 are as follows:


Level 1:	Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2:	Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability. Level 2 includes debt securities with quoted prices that are traded less frequently then exchange-traded instruments. Valuation techniques include matrix pricing which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices.

Level 3:	Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported with little or no market activity).

Table of Contents

A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company did not have transfers of financial instruments within the fair value hierarchy during the three and nine months ended September 30, 2014 and 2013.

Items Measured on a Recurring Basis

The Company’s available for sale investment securities are recorded at fair value on a recurring basis.

Fair value for Level 1 securities are determined by obtaining quoted market prices on nationally recognized securities exchanges. Level 1 securities include common stocks.

Level 2 securities include obligations of U.S. government-sponsored agencies and debt securities with quoted prices, which are traded less frequently than exchange-traded instruments, whose value is determined using matrix pricing with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. The prices were obtained from third party vendors. This category generally includes the Company’s mortgage-backed securities and CMOs issued by U.S. government and government-sponsored agencies, non-agency CMOs, and corporate and municipal bonds.

Level 3 securities include investments in seven private equity funds which are predominantly invested in real estate. The value of the private equity funds are derived from the funds’ financials and K-1 filings. The Company also reviews the funds’ asset values and its near-term projections.

For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2014 and December 31, 2013 are as follows:


	Fair Value Measurements Using:
	Quoted Prices
	in Active		Significant
	Markets for		Other		Significant
	Identical		Observable		Unobservable
As of September 30, 2014	Assets		Inputs		Inputs
(In thousands)	Level 1		Level 2		Level 3		Fair Value
Investment securities available-for-sale
U.S. government agencies	$	—	$	32,541	$	—	$	32,541
Mortgage-backed securities-residential		—		27,127		—		27,127
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		—		172,684		—		172,684
Non-agency		—		3,938		—		3,938
Corporate bonds		—		15,633		—		15,633
Municipal bonds		—		9,027		—		9,027
Other securities		—		—		4,390		4,390
Common stocks		50		—		—		50
Total investment securities available-for-sale	$	50	$	260,950	$	4,390	$	265,390

Table of Contents


	Fair Value Measurements Using:
	Quoted Prices
	in Active		Significant
	Markets for		Other		Significant
	Identical		Observable		Unobservable
As of December 31, 2013	Assets		Inputs		Inputs
(In thousands)	Level 1		Level 2		Level 3		Fair Value
Investment securities available-for-sale
U.S. government agencies	$	—	$	62,036	$	—	$	62,036
Mortgage-backed securities-residential		—		32,097		—		32,097
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		—		189,103		—		189,103
Non-agency		—		4,479		—		4,479
Corporate bonds		—		9,438		—		9,438
Municipal bonds		—		6,900		—		6,900
Other securities		—		—		4,625		4,625
Common stocks		49		—		—		49
Total investment securities available-for-sale	$	49	$	304,053	$	4,625	$	308,727

The following tables present additional information about assets measured at fair value on a recurring basis and for which the Company has utilized Level 3 inputs to determine fair value for the nine months ended September 30, 2014 and 2013:


(In thousands)	Other securities
Investment Securities Available for Sale	2014		2013
Beginning balance January 1,	$	4,625	$	4,164
Total gains/(losses) - (realized/unrealized):
Included in earnings		251		5
Included in other comprehensive income		299		361
Purchases		14		32
Sales and calls		(799)		(300)
Transfers in and/or out of Level 3		—		—
Ending balance September 30,	$	4,390	$	4,262

Items Measured on a Nonrecurring Basis

Non-accrual loans and TDRs are evaluated for impairment on an individual basis under FASB ASC Topic 310 “Receivables”. The impairment analysis includes current collateral values, known relevant factors that may affect loan collectability, and risks inherent in different kinds of lending. When the collateral value or discounted cash flows less costs to sell is less than the carrying value of the loan a specific reserve (valuation allowance) is established. Loans held for sale are carried at the lower of cost or fair value. OREO is carried at the lower of cost or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the real estate. Additionally, for collateral acquired from tax liens, fair value may be established using brokers opinions due to their lower carrying value. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Table of Contents

For financial assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2014 and December 31, 2013 are as follows:


	Fair Value Measurements Using:
	Quoted Prices
	in Active		Significant
	Markets for		Other		Significant
	Identical		Observable		Unobservable
As of September 30, 2014	Assets		Inputs		Inputs
(In thousands)	Level 1		Level 2		Level 3		Fair Value
Assets
Impaired loans and leases	$	—	$	—	$	3,739	$	3,739
Other real estate owned		—		—		2,624		2,624
Loans and leases held for sale		—		—		1,018		1,018


	Fair Value Measurements Using:
	Quoted Prices
	in Active		Significant
	Markets for		Other		Significant
	Identical		Observable		Unobservable
As of December 31, 2013	Assets		Inputs		Inputs
(In thousands)	Level 1		Level 2		Level 3		Fair Value
Assets
Impaired loans and leases	$	—	$	—	$	4,073	$	4,073
Other real estate owned		—		—		9,182		9,182
Loans and leases held for sale		—		—		1,446		1,446

The following tables present additional quantitative information about assets measured at fair value on a nonrecurring basis and for which the Company has utilized Level 3 inputs to determine fair value at September 30, 2014 and December 31, 2013:


	Qualitative Information about Level 3 Fair Value Measurements
As of September 30, 2014			Valuation		Range
(In thousands)	Fair Value		Techniques	Unobservable Input	(Weighted Average)
Impaired loans and leases	$	3,739	Appraisal of	Appraisal adjustments	0.0%	-	-28.9%	(-20.9%)
			collateral (1)	Liquidation expenses	0.0%	-	-21.1%	(-7.5%)

Other real estate owned		2,624	Appraisal of	Appraisal adjustments	0.0%	-	-69.7%	(-11.3%)
			collateral (1)	Liquidation expenses			-14.7%	(-14.7%)

Loans and leases held for sale		1,018	Appraisal of	Agreement of sale			0.0%
			collateral (1)

Table of Contents


	Qualitative Information about Level 3 Fair Value Measurements
As of December 31, 2013			Valuation		Range
(In thousands)	Fair Value		Techniques	Unobservable Input	(Weighted Average)
Impaired loans and leases	$	4,073	Appraisal of	Appraisal adjustments	0.0%	-	-25.0%	(-2.0%)
			collateral (1)	Liquidation expenses	0.0%	-	-23.2%	(-6.7%)

Other real estate owned		9,182	Appraisal of	Appraisal adjustments	0.0%	-	-62.5%	(-11.2%)
			collateral (1)	Liquidation expenses	-2.8%	-	-6.8%	(-5.0%)

Loans and leases held for sale		1,446	Appraisal of	Agreement of sale			0.0%
			collateral (1)

(1)

Appraisals may be adjusted for qualitative factors such as interior condition of the property and liquidation expenses.

The following methods and assumptions were used to estimate the fair values of the Company’s financial instruments at September 30, 2014 and December 31, 2013. The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful. The methodologies for estimating the fair value of financial instruments that are measured on a recurring or nonrecurring basis are discussed above.

Cash and cash equivalents (carried at cost):

The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets’ fair values.

Securities:

Management uses quoted market prices to determine fair value of securities (level 1). If quoted prices are not available, fair value is based upon valuation techniques such as matrix pricing or other models that use, where possible, current market-based or independently sourced market parameters, such as interest rates (level 2). If observable market-based inputs are not available, the Company uses unobservable inputs to determine appropriate valuation adjustments by reviewing the private equities funds’ financials and K-1 filings (level 3).

Other Investment (carried at cost):

This investment includes the Solomon Hess SBA Loan Fund, which the Company invested in to partially satisfy its community reinvestment requirement. Shares in this fund are not publicly traded and therefore have no readily determinable fair market value. An investor can have their investment in the Fund redeemed for the balance of their capital account at any quarter end with 60 days notice to the Fund. The investment in this Fund is recorded at cost. The Company does not record this investment at fair value on a recurring basis, as this investment’s carrying amount approximates fair value.

Restricted investment in bank stock (carried at cost):

The carrying amount of restricted investment in bank stock approximates fair value, and considers the limited marketability of such securities.

Table of Contents

Loans held for sale (carried at lower of cost or fair value):

The fair values of loans held for sale are based upon appraised values of the collateral less costs to sell, management’s estimation of the value of the collateral or expected net sales proceeds. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Loans receivable (carried at cost):

The fair values of loans are estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect the credit and interest rate-risk inherent in the loans. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Generally, for variable rate loans that re-price frequently and with no significant change in credit risk, fair values are based on carrying values.

Impaired loans (generally carried at fair value):

Impaired loans are accounted for under ASC Topic 310. Impaired loans are those in which the Company has measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based on the expected proceeds. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Accrued interest receivable and payable (carried at cost):

The carrying amount of accrued interest receivable and accrued interest payable approximates its fair value.

Deposit liabilities (carried at cost):

The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Short-term borrowings (carried at cost):

The carrying amounts of short-term borrowings approximate their fair values.

Long-term debt (carried at cost):

Fair values of FHLB advances and other long-term borrowings are estimated using discounted cash flow analysis, based on quoted prices for new FHLB advances with similar credit risk characteristics, terms and remaining maturity. These prices obtained from this active market represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party.

Subordinated debt (carried at cost):

Fair values of junior subordinated debt are estimated using discounted cash flow analysis, based on market rates currently offered on such debt with similar credit risk characteristics, terms and remaining maturity.

Off-balance sheet financial instruments (disclosed at cost):

Fair values for the Company’s off-balance sheet financial instruments (lending commitments and letters of credit) are based on fees currently charged in the market to enter into similar agreements, taking into account, the remaining terms of

Table of Contents

the agreements and the counterparties’ credit standing. They are not shown in the table because the amounts are immaterial.

The tables below indicate the fair value of the Company’s financial instruments at September 30, 2014 and December 31, 2013.


					Fair Value Measurements
					At September 30, 2014
					Quoted Prices
					in Active		Significant
					Markets for		Other		Significant
					Identical		Observable		Unobservable
	Carrying		Estimated		Assets		Inputs		Inputs
(In thousands)	amount		fair value		Level 1		Level 2		Level 3
Financial Assets:
Cash and cash equivalents	$	21,933	$	21,933	$	21,933	$	—	$	—
Investment securities available-for-sale		265,390		265,390		50		260,950		4,390
Other investment		2,250		2,250		—		—		2,250
Federal Home Loan Bank stock		3,678		3,678		—		—		3,678
Loans held for sale		1,018		1,018		—		—		1,018
Loans, net		385,694		383,088		—		—		383,088
Accrued interest receivable		5,554		5,554		—		5,554		—
Financial Liabilities:
Demand deposits		67,901		67,901		—		67,901		—
NOW and money markets		203,978		203,978		—		203,978		—
Savings		19,142		19,142		—		19,142		—
Time deposits		224,765		223,270		—		223,270		—
Long-term borrowings		97,540		94,885		—		94,885		—
Subordinated debt		25,774		24,209		—		24,209		—
Accrued interest payable		2,305		2,305		—		2,305		—


					Fair Value Measurements
					At December 31, 2013
					Quoted Prices
					in Active		Significant
					Markets for		Other		Significant
					Identical		Observable		Unobservable
	Carrying		Estimated		Assets		Inputs		Inputs
(In thousands)	amount		fair value		Level 1		Level 2		Level 3
Financial Assets:
Cash and cash equivalents	$	16,844	$	16,844	$	16,844	$	—	$	—
Investment securities available-for-sale		308,727		308,727		49		304,053		4,625
Other investment		2,250		2,250		—		—		2,250
Federal Home Loan Bank stock		4,204		4,204		—		—		4,204
Loans held for sale		1,446		1,446		—		—		1,446
Loans, net		352,810		349,336		—		—		349,336
Accrued interest receivable		7,054		7,054		—		7,054		—
Financial Liabilities:
Demand deposits		60,473		60,473		—		60,473		—
NOW and money markets		210,053		210,053		—		210,053		—
Savings		17,593		17,593		—		17,593		—
Time deposits		240,845		239,102		—		239,102		—
Short-term borrowings		10,000		10,000		10,000		—		—
Long-term borrowings		97,881		94,896		—		94,896		—
Subordinated debt		25,774		26,000		—		26,000		—
Accrued interest payable		965		965		—		965		—

Table of Contents

Limitations

The fair value estimates are made at a discrete point in time based on relevant market information and information about the financial instruments. Fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors.

These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Further, the foregoing estimates may not reflect the actual amount that could be realized if all or substantially all of the financial instruments were offered for sale. This is due to the fact that no market exists for a sizable portion of the loan, deposit and off balance sheet instruments.

In addition, the fair value estimates are based on existing on-and-off balance sheet financial instruments without attempting to value anticipated future business and the value of assets and liabilities that are not considered financial instruments. Other significant assets that are not considered financial assets include premises and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.

Finally, reasonable comparability between financial institutions may not be likely due to the wide range of permitted valuation techniques and numerous estimates which must be made given the absence of active secondary markets for many of the financial instruments. This lack of uniform valuation methodologies introduces a greater degree of subjectivity to these estimated fair values.

Note 16.Segment Information

FASB ASC Topic 280, “Segment Reporting” (“ASC Topic 280”) established 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 the chief operating decision makers in deciding how to allocate and assess resources and performance. The Company’s chief operating decision makers are the CEO and the Chief Administrative and Risk Officer (“CARO”). The Company has identified its reportable operating segments as “Community Banking” and “Tax Liens”.

Community banking

The Company’s community banking segment which includes Royal Bank consists of commercial and retail banking and equipment leasing. 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 and Royal Bank Leasing. For example, commercial lending is dependent upon the ability of Royal Bank to fund cash needed to make loans with retail deposits and other borrowings and to manage interest rate and credit risk.

Tax liens

At September 30, 2014, Royal Bank’s tax liens segment includes its 80% and 100% ownership interest in CSC and RTL, respectively. At September 30, 2013, Royal Bank’s ownership interest in CSC and RTL was 60%. The Company’s tax liens segment consisted of purchasing delinquent tax certificates from local municipalities at auction and then processing those liens to either encourage the property holder to pay off the lien, or to foreclose and sell the property. The tax liens segment earns income based on interest rates (determined at auction) and penalties assigned by the municipality along with gains on sale of foreclosed properties. CSC is liquidating its assets under an orderly, long term plan. RTL ceased acquiring tax certificates at public auctions in 2010.

Table of Contents

The following table presents selected financial information for reportable business segments for the three and nine months ended September 30, 2014 and 2013.


	Three months ended September 30, 2014
	Community
(In thousands)	Banking		Tax Liens		Consolidated
Total assets	$	701,803	$	21,666	$	723,469
Total deposits	$	515,786	$	—	$	515,786

Interest income	$	6,889	$	302	$	7,191
Interest expense		1,367		256		1,623
Net interest income	$	5,522	$	46	$	5,568
(Credit) provision for loan and lease losses		(79)		28		(51)
Total non-interest income		987		217		1,204
Total non-interest expense		4,916		459		5,375
Income tax expense (benefit)		—		—		—
Net income (loss)	$	1,672	$	(224)	$	1,448
Noncontrolling interest	$	69	$	(44)	$	25
Net income (loss) attributable to Royal Bancshares	$	1,603	$	(180)	$	1,423


	Three months ended September 30, 2013
	Community
(In thousands)	Banking		Tax Liens		Consolidated
Total assets	$	708,864	$	28,136	$	737,000
Total deposits	$	522,620	$	—	$	522,620

Interest income	$	6,485	$	475	$	6,960
Interest expense		1,560		330		1,890
Net interest income	$	4,925	$	145	$	5,070
Provision for loan and lease losses		178		40		218
Total non-interest income		1,344		593		1,937
Total non-interest expense		5,683		607		6,290
Income tax expense (benefit)		—		—		—
Net income	$	408	$	91	$	499
Noncontrolling interest	$	121	$	36	$	157
Net income attributable to Royal Bancshares	$	287	$	55	$	342

Table of Contents


	Nine months ended September 30, 2014
	Community
(In thousands)	Banking		Tax Liens		Consolidated
Total assets	$	701,803	$	21,666	$	723,469
Total deposits	$	515,786	$	—	$	515,786

Interest income	$	20,549	$	1,002	$	21,551
Interest expense		4,030		840		4,870
Net interest income	$	16,519	$	162	$	16,681
(Credit) provision for loan and lease losses		(911)		146		(765)
Total non-interest income		2,019		773		2,792
Total non-interest expense		14,221		1,507		15,728
Income tax expense (benefit)		—		—		—
Net income (loss)	$	5,228	$	(718)	$	4,510
Noncontrolling interest	$	337	$	(125)	$	212
Net income (loss) attributable to Royal Bancshares	$	4,891	$	(593)	$	4,298


	Nine months ended September 30, 2013
	Community
(In thousands)	Banking		Tax Liens		Consolidated
Total assets	$	708,864	$	28,136	$	737,000
Total deposits	$	522,620	$	—	$	522,620

Interest income	$	18,556	$	1,899	$	20,455
Interest expense		4,525		1,142		5,667
Net interest income	$	14,031	$	757	$	14,788
(Credit) provision for loan and lease losses		(563)		367		(196)
Total non-interest income		3,056		1,250		4,306
Total non-interest expense		16,348		3,649		19,997
Income tax expense (benefit)		—		—		—
Net income (loss)	$	1,302	$	(2,009)	$	(707)
Noncontrolling interest	$	422	$	(786)	$	(364)
Net income (loss) attributable to Royal Bancshares	$	880	$	(1,223)	$	(343)

Interest income earned by the community banking segment related to the tax liens segment was approximately $256,000 and $330,000 for the three month periods ended September 30, 2014 and 2013, respectively and $840,000 and $1.1 million for the nine months ended September 30, 2014 and 2013, respectively.

Note 17.Federal Home Loan Bank Stock

As a member of the FHLB, the Company is required to purchase and hold stock in the FHLB to satisfy membership and borrowing requirements. The stock can only be sold to the FHLB or to another member institution, and all sales of FHLB stock must be at par. As a result of these restrictions, there is no active market for the FHLB stock. As of September 30, 2014 and December 31, 2013, FHLB stock totaled $3.7 million and $4.2 million, respectively.

FHLB stock is held as a long-term investment and its value is determined based on the ultimate recoverability of the par value. The Company evaluates impairment quarterly. The decision of whether impairment exists is a matter of judgment that reflects management’s view of the FHLB’s long-term performance, which includes factors such as the following: (1) its operating performance, (2) the severity and duration of declines in the fair value of its net assets related to its capital stock amount, (3) its liquidity position, and (4) the impact of legislative and regulatory changes on the FHLB. Based on the capital adequacy and the liquidity position of the FHLB, management believes that the par value of its investment in FHLB stock will be recovered. Accordingly, there is no other-than-temporary impairment related to the carrying amount of the Company’s FHLB stock as of September 30, 2014.

Table of Contents

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

The following discussion and analysis is intended to assist in understanding and evaluating the changes in the financial condition and earnings performance of the Company and its subsidiaries for the the three and nine months ended September 30, 2014 and 2013. 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, 2013, included in the Company’s Form 10-K for the year ended December 31, 2013.

FORWARD-LOOKING STATEMENTS

From time to time, Royal Bancshares of Pennsylvania, Inc. (the “Company”) may include forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new products, research and development activities and similar matters in this and other filings with the Securities and Exchange Commission. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. When we use words such as “believes,” “expects,” “anticipates” or similar expressions, we are making forward-looking statements. In order to comply with the terms of the safe harbor, the Company notes that a variety of factors could cause the Company’s actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company’s forward-looking statements. The risks and uncertainties that may affect the operations, performance, development and results of the Company’s business include the following: general economic conditions, including their impact on capital expenditures; interest rate fluctuations; business conditions in the banking industry; the regulatory environment: the nature, extent, and timing of governmental actions and reforms; rapidly changing technology and evolving banking industry standards; competitive factors, including increased competition with community, regional and national financial institutions; changes in generally accepted accounting principles; new service and product offerings by competitors and price pressures and similar items.

All forward-looking statements contained in this report are based on information available as of the date of this report. These statements speak only as of the date of this report, even if subsequently made available by the Company on its website, or otherwise. The Company expressly disclaims any obligation to update any forward-looking statement to reflect future events or developments.

CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES

The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and general practices within the financial services industry. Applications of the principles in the Company’s preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and the accompanying notes. These estimates and assumptions are based on information available as of the date of the consolidated financial statements; therefore, actual results could differ from those estimates.

Note 1 to the Company’s Consolidated Financial Statements (included in Item 8 of the Form 10-K for the year ended December 31, 2013) lists significant accounting policies used in the development and presentation of the Company’s consolidated financial statements. The following discussion and analysis, the significant accounting policies, and other financial statement disclosures identify and address key variables and other quantitative and qualitative factors that are necessary for an understanding and evaluation of the Company and its results of operations. We completed an internal review of this financial information. This review requires substantive judgment and estimation. As disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013, we have identified other-than-temporary impairment on investment securities, accounting for allowance for loan and lease losses, valuation allowance of deferred tax assets, loans held for sale, the valuation of other real estate owned, net periodic pension costs and the pension benefit obligation as among the most critical accounting policies and estimates. These critical accounting policies and estimates are important to the presentation of the Company’s financial condition and results of operations, and they require difficult, subjective or complex judgments as a result of the need to make estimates.

Table of Contents

Financial Highlights and Business Results

On June 29, 1995, pursuant to the plan of reorganization approved by the shareholders of Royal Bank America, formerly Royal Bank of Pennsylvania (“Royal Bank”), all of the outstanding shares of common stock of Royal Bank were acquired by Royal Bancshares and were exchanged on a one-for-one basis for common stock of Royal Bancshares. The principal activities of the Company are supervising Royal Bank, which engages in a general banking business principally in Montgomery, Chester, Bucks, Philadelphia and Berks counties in Pennsylvania and in central and southern New Jersey and Delaware. The Company also has a wholly owned non-bank subsidiary, Royal Investments of Delaware, Inc., which is engaged in investment activities.

The Company’s results of operations depend primarily on net interest income, which is the difference between interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities. Interest-earning assets consist principally of loans and investment securities, while interest-bearing liabilities consist primarily of deposits and borrowings. Refer to the “Net Interest Income and Net Interest Margin” section in Management’s Discussion and Analysis of Financial Condition and Results of Operation below for additional information on interest yield and cost. Royal Bank principally generates commercial real estate loans primarily secured by first mortgage liens, construction loans for commercial real estate projects and residential home development, land development loans, tax liens and leases. At September 30, 2014, commercial real estate and multi-family loans, commercial and industrial loans, leases, and construction and land development loans comprised 46%, 18%, 12%, and 10%, respectively, of the total loan portfolio. Construction loans and land development loans can have more risk associated with them, especially when a weakened economy, such as we have experienced the past few years, adversely impacts the commercial rental or home sales market. Net income is also affected by the provision for loan and lease losses and the level of non-interest income as well as by non-interest expenses, including salary and benefits, occupancy expenses and other operating expenses.

From 2008 through 2012, the Company recorded significant impairment charges on non-accrual loans, OREO and investment securities, which weighed heavily on earnings and was the largest contributing factor to the Company’s losses in those years. Also contributing to the losses were increased costs associated with the historically high level of non-performing assets and legal expenses related to credit quality issues and the tax lien subsidiaries. Finally, the establishment of a deferred tax asset valuation allowance in 2008 and subsequent years that currently amounts to $37.2 million, has prevented the Company from utilizing tax credits from losses during the past five years.

Management successfully executed the Company’s strategic plan which included improving the overall level of credit quality, maintaining reduced credit risk within the investment portfolio, cutting the overall level of expenses, and returning to profitability. While the Company’s past deleveraging strategy improved the risk profile of the Company by shedding higher risk assets and paying off higher cost brokered CDs, it has had a negative impact on income. The deleveraging has resulted in lower average loan balances and a higher proportion of lower yielding investment securities, which have negatively impacted net interest income, a principal source of income. While credit quality costs associated with non-performing assets negatively affect financial results, their impact has diminished as the overall level of non-performing assets has declined.

The financial results for the first nine months of 2014 illustrate the further progress of the Company’s current multi-faceted strategic plan with the goal of consistent profitability. A key strategy in 2014 has been to refresh Royal Bank’s retail products and branch network. During 2014, the Company reorganized the retail division to better serve existing customers, develop the retail sales teams, and attain new customer relationships. Royal Bank held a successful 50th anniversary campaign, offering a Kindle to new customers who met certain deposit account opening criteria. Early in 2014, the Villanova and Phoenixville branches were relocated to more visible, high-traffic locations within their markets. During the third quarter of 2014, the Company relocated the Fairmount branch to a state of the art customer convenience center in the Northern Liberties section of Philadelphia and opened a limited service office in Princeton, New Jersey to more effectively work with our commercial customers in central New Jersey. Most recently the Sicklerville, New Jersey branch was moved to busy Blackwood, New Jersey. Additionally, customers now have access to 55,000 ATMs nationwide from a new arrangement. During 2014, six highly experienced industry veterans joined the Company. These included two commercial relationship managers, two retail sales managers, the head of sales and product training and a new Chief Credit Officer. Their collective experience spans community and regional banks. The hiring of these individuals was funded through the rightsizing of the organization and is fully integrated into the Company’s budget. In July, we introduced Royal

Table of Contents

Bank’s enhanced website and exciting fresh logo, which highlights our four key constituents: customers, shareholders, co-workers, and community. The redesigned products and contemporary technology are the future platform for enhanced banking convenience for commercial, consumer and retail customers. Overall positive financial results have benefited from our rebranding and the ability to attract and retain commercial and consumer customers.

Consolidated Net Income (Loss)

Net income for the third quarter of 2014 amounted to $1.4 million, or earnings attributable to the Company of $0.05 per diluted common share, compared to a net income of $342,000, or a loss attributable to the Company of $0.01 per diluted common share, for the comparable quarter in 2013. Factors that positively contributed to the $1.1 million improvement for the three months ended September 30, 2014 as compared to the three months ended September 30, 2013 were:

Net interest income grew $498,000, or 9.8%.

Due to the improvement in overall credit quality, the Company was able to record a credit for loan and lease losses of $51,000 compared to a provision for loan and lease losses of $218,000 for the comparable period in 2013.

Other real estate owned (“OREO”) expenses and impairment decreased $690,000, or 81.8%.

Problem loan expenses declined $60,000, or 46.2%.

Gains on sales of AFS investment securities were $238,000.

Partially offsetting these positive items was a $419,000 reduction in gains on the sale of premises and equipment and a $456,000 decrease in net gains on the sale of OREO.

For the nine months ended 2014, net income amounted to $4.3 million, or earnings attributable to the Company of $0.15 per diluted common share compared to a net loss of $343,000, or a loss attributable to the Company of $0.14 per diluted common share for the comparable period in 2013. The $4.6 million improvement for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013 was mainly related to the following items:

Net interest income grew $1.9 million, or 12.8%.

The credit for loan and lease losses improved $569,000 (from a credit of $196,000 to a credit of $765,000) due to the continued positive progress in loan credit quality.

Professional and legal fees decreased $475,000, or 23.3%.

Salaries and benefits declined $493,000, or 6.2%.

OREO expenses and impairment fell $849,000, or 48.8%.

Problem loan expenses declined $334,000, or 59.5%.

The 2013 period included legal settlement expense related to a tax lien subsidiary, of which the Company’s share was $990,000 after adjusting for noncontrolling interest.

Partially offsetting these positive items was a $1.1 million decline in gains on the sale of premises and equipment and a $576,000 decrease in net gains on the sale of OREO.

Interest Income

Total interest income of $7.2 million for the third quarter of 2014 grew $231,000, or 3.3%, from the comparable quarter of 2013. The improvement was primarily driven by an increase of $206,000 quarter versus quarter in interest income on investment securities and a smaller increase of $25,000 in interest income on loans and leases. Average interest-earning assets amounted to $679.0 million in the third quarter of 2014, which resulted in a decrease of $5.9 million, or 0.9%, from the level of $684.9 million in the third quarter of 2013. Average loans and leases grew $12.6 million to $386.3 million, while average investment securities dropped $24.6 million to $280.6 million for the quarter ended September 30, 2014. Average cash equivalents increased $6.1 million quarter over quarter. Despite the decline in average investments, the interest income earned on the portfolio grew 13.5% and partially resulted from a $447,000 decrease in premium amortization due to a reduction in principal prepayments.

Table of Contents

Total interest income of $21.6 million for the first nine months of 2014 grew $1.1 million or 5.4%, from the comparable period in 2013. The improvement was primarily driven by an increase of $1.5 million in interest income on investment securities. Average interest-earning assets amounted to $686.7 million for the first nine months of 2014, which resulted in a decline of $5.7 million, or 0.8%, from the level of $692.5 million in the first nine months of 2013. The decrease in average interest-earning assets was due to a $13.0 million decline in average investment securities and a $3.1 million decrease in average cash equivalents which were partially offset by an increase of $10.4 million in average loan balances for the nine months ended September 30, 2014. While average loan balances increased to $374.3 million for the first nine months of 2014, the associated interest income declined $406,000 and was directly related to the tax lien portfolio. Interest income related to tax liens fell $897,000 year over year due to a $9.6 million, or 45.1% decline in average balances. Interest income on the remaining loan portfolio increased $491,000.

For the third quarter of 2014, the yield on average interest-earning assets of 4.20% amounted to an enhancement of 17 basis points from the yield of 4.03% for the prior year’s third quarter. Driving the improvement in yield quarter over quarter was an increase of 46 basis points in the average yield on investments (2.45% versus 1.99%) which contributed an increase of $206,000 to interest income. The investment yield in the third quarter of 2013 was negatively impacted by the accelerated amortization of premiums due to prepayments of government agency mortgage-backed (“MBS”) and collateralized mortgage obligation (“CMO”) securities. The average yield on loans declined 16 basis points (5.60% versus 5.76%). The decrease in loan yields reflects the decline in average balances of higher yielding tax liens quarter versus quarter which adversely affected interest income by $159,000.

For the nine months ended September 30, 2014, the yield on average interest-earning assets of 4.20% amounted to an enhancement of 25 basis points from the yield of 3.95% for the comparable 2013 period. Spurring the improvement in yield period over period was an increase of 74 basis points in the average yield on investments (2.47% versus 1.73%) which contributed a $1.5 million increase to interest income. The average yield on loans declined 31 basis points (5.69% versus 6.00%). The investment yield in the first nine months of 2013 was negatively impacted by the accelerated amortization of premiums due to prepayments of government agency MBS and CMO securities. The decrease in loan yields reflects the decline in average balances of higher yielding tax liens year over year which adversely affected interest income by $897,000.

Interest Expense

Total interest expense of $1.6 million in the third quarter of 2014 declined $267,000, or 14.1%, from the comparable quarter of 2013. The reduction in interest expense was primarily associated with a decline in the average interest rates paid on average interest-bearing liabilities as well as slightly lower average balances of such liabilities. For the third quarter of 2014, average interest-bearing liabilities of $576.6 million decreased $16.4 million, or 2.8%, from $593.0 million for the comparable period in 2013. For the three months ended September 30, 2014, average certificates of deposit amounted to $225.7 million which reflected a decline of $12.0 million, or 5.1% from the comparable quarter of 2013. The decline in this average balance combined with a reduction in the average interest rate resulted in a decrease in interest expense of $94,000. Average borrowings amounted to $123.7 million which represented an decrease of $10.4 million, or 7.8% from the comparable quarter of 2013. For the third quarter of 2014, the interest paid on the average borrowings declined $184,000 from the comparable quarter of 2013. The majority of this decline is attributable to a $174,000 penalty that was assessed when the interest payment in arrears on the trust preferred securities was paid in the third quarter of 2013.

Total interest expense of $4.9 million for the first three quarters of 2014 declined $797,000, or 14.1%, from the comparable period in 2013. The reduction in interest expense was primarily associated with a decline in the average interest rates paid on average interest-bearing liabilities as well as lower average balances of such liabilities. For the first nine months of 2014, average interest-bearing liabilities of $589.5 million decreased $13.5 million, or 2.2%, from $603.0 million for the comparable period in 2013. For the nine months ended September 30, 2014, average certificates of deposit, average NOW and money market accounts and average borrowings amounted to $230.7 million, $209.8 million and $130.5 million, respectively, and reflected declines of $8.8 million, or 3.7%, $1.8 million, or 0.8% and $3.6 million, or 2.7%, respectively, from the comparable period of 2013. These declines in average balances combined with interest rate reductions resulted in interest expense decreases of $375,000 and $448,000 for average CDs and borrowings, respectively. Additionally, the 2013 period included a $174,000 penalty on the trust preferred securities which was cited in the previous paragraph.

Table of Contents

The average interest rate paid on average total interest-bearing liabilities during the third quarter of 2014 amounted to 1.12%, which represented an improvement of 14 basis points from the average interest rate paid during the comparable quarter of 2013. During the third quarter of 2014 the average interest rate paid on average interest-bearing deposits was 0.79% which resulted in a decline of 6 basis points from the level of 0.85% during the comparable quarter of 2013. Quarter versus quarter lower average interest rates were paid on CDs (1.29% in 2014 versus 1.38% in 2013), while NOW and money market rates slightly increased 2 basis points (0.31% in 2014 versus 0.29% in 2013). The decline in average interest rates paid on CDs was attributed to lower rates on new accounts and the continued run off of maturing retail CDs. The average interest rate paid for borrowings during the third quarter of 2014 was 2.32%, which amounted to a reduction of 36 basis points from the average rate paid of 2.68% during the third quarter of 2013.

The average interest rate paid on average total interest-bearing liabilities during the first three quarters of 2014 amounted to 1.10%, which represented an improvement of 16 basis points from the average interest rate paid during the comparable quarters of 2013. During the first nine months of 2014 the average interest rate paid on average interest-bearing deposits was 0.79% which resulted in a decline of 8 basis points from the level of 0.87% during the comparable period of 2013. Year over year lower average interest rates were paid on CDs (1.27% in 2014 versus 1.43% in 2013), while NOW and money market rates slightly increased 2 basis points (0.31% in 2014 versus 0.29% in 2013). The decline in average interest rates paid on CDs was attributed to lower rates on new accounts and the continued run off of maturing retail CDs. The average interest rate paid for borrowings during the first nine months of 2014 was 2.21%, which amounted to a reduction of 39 basis points from the average rate paid of 2.60% during the first nine months of 2013.

Net Interest Income and Margin

Net interest income for the quarter ended September 30, 2014 amounted to $5.6 million resulting in an increase of $498,000, or 9.8%, from the comparable quarter of 2013. The improvement in net interest income was primarily attributed to an increase in the average yield on investment securities and a net reduction in the average rates paid on average interest-bearing liabilities quarter versus quarter. The increase in the average yield on investment securities was due to higher yields on new purchases of approximately $13.9 million in the third quarter of 2014. Additionally, the prepayments on government agency MBS and CMO investment securities declined, which had a positive effect of $447,000 on the amortization of premiums. The decrease in average CD and borrowing balances combined with their respective interest rate reductions contributed $278,000 to the decline in interest expense.

Net interest income for the nine months ended September 30, 2014 amounted to $16.7 million resulting in an increase of $1.9 million, or 12.8%, from the comparable period of 2013. The improvement in net interest income was primarily attributed to the same factors mentioned above, an increase in the average yield on investment securities and a net reduction in the average rates paid on average interest-bearing liabilities. The increase in the average yield on investment securities was due to higher yields on new purchases. Additionally, the prepayments on government agency MBS and CMO investment securities declined, which had a positive effect of $2.0 million in premium amortization. The decrease in average CD and borrowing balances combined with their respective interest rate reductions contributed $823,000 to the decline in interest expense.

The net interest margin for the third quarter of 2014 was 3.25%, which grew 31 basis points from 2.94% for the comparable quarter of 2013. Quarter over quarter, the contribution from the 46 basis point improvement in the average yield on investment securities (2.45% versus 1.99%) was partially offset by the 16 basis point reduction in the average yield on loans and leases (5.60% versus 5.76%). The average yield on interest-earning assets for the third quarter of 2014 was 4.20% compared to 4.03% for the same period in 2013. Funding costs improved from an average interest rate paid of 1.26% for the third quarter of 2013 to 1.12% for the third quarter of 2014. The Company continued to redeem and re-price maturing retail CDs which led to a 9 basis point reduction in average interest rates paid quarter over quarter (1.29% in 2014 versus 1.38% in 2013). Additionally the average rates paid on borrowings declined 36 basis points (2.32% in 2014 versus 2.68% in 2013).

The net interest margin for the first nine months of 2014 was 3.25%, which grew 39 basis points from 2.86% for the comparable period of 2013. For the year over year period, the contribution from the 74 basis point improvement in the average yield on investment securities (2.47% versus 1.73%) was partially offset by the 31 basis point reduction in the average yield on loans and leases (5.69% versus 6.00%). The average yield on interest-earning assets for the first nine

Table of Contents

months of 2014 was 4.20% compared to 3.95% for the same period in 2013. Funding costs improved from an average interest rate paid of 1.26% for the first nine months of 2013 to 1.10% for the first nine months of 2014. The Company continued to redeem and re-price maturing retail CDs which led to a 16 basis point reduction in average interest rates paid quarter over quarter (1.27% in 2014 versus 1.43% in 2013). Additionally the average rates paid on borrowings declined 39 basis points (2.21% in 2014 versus 2.60% in 2013).

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


	For the three months ended						For the three months ended
	September 30, 2014						September 30, 2013
(In thousands, except percentages)	Average Balance		Interest		Yield			Average Balance		Interest	Yield
Cash equivalents	$	12,152	$	6	0.20	%	$	6,072	$	6	0.39	%
Investment securities		280,579		1,734	2.45	%		305,152		1,528	1.99	%
Loans		386,308		5,451	5.60	%		373,722		5,426	5.76	%
Total interest earning assets		679,039		7,191	4.20	%		684,946		6,960	4.03	%
Non-earning assets		45,335						52,532
Total average assets	$	724,374					$	737,478
Interest-bearing deposits
NOW and money markets	$	207,731	$	161	0.31	%	$	203,189	$	149	0.29	%
Savings		19,449		8	0.16	%		17,958		9	0.20	%
Time deposits		225,679		731	1.29	%		237,689		825	1.38	%
Total interest bearing deposits		452,859		900	0.79	%		458,836		983	0.85	%
Borrowings		123,743		723	2.32	%		134,186		907	2.68	%
Total interest bearing liabilities		576,602		1,623	1.12	%		593,022		1,890	1.26	%
Non-interest bearing deposits		66,251						61,513
Other liabilities		23,150						30,669
Shareholders' equity		58,371						52,274
Total average liabilities and equity	$	724,374					$	737,478
Net interest margin			$	5,568	3.25	%			$	5,070	2.94	%


	For the nine months ended						For the nine months ended
	September 30, 2014						September 30, 2013
(In thousands, except percentages)	Average Balance		Interest		Yield			Average Balance		Interest	Yield
Cash equivalents	$	8,964	$	16	0.24	%	$	12,083	$	21	0.23	%
Investment securities		303,485		5,610	2.47	%		316,474		4,103	1.73	%
Loans		374,270		15,925	5.69	%		363,909		16,331	6.00	%
Total interest earning assets		686,719		21,551	4.20	%		692,466		20,455	3.95	%
Non-earning assets		46,165						55,782
Total average assets	$	732,884					$	748,248
Interest-bearing deposits
NOW and money markets	$	209,772	$	494	0.31	%	$	211,529	$	464	0.29	%
Savings		18,620		24	0.17	%		17,911		28	0.21	%
Time deposits		230,688		2,194	1.27	%		239,460		2,569	1.43	%
Total interest bearing deposits		459,080		2,712	0.79	%		468,900		3,061	0.87	%
Borrowings		130,452		2,158	2.21	%		134,068		2,606	2.60	%
Total interest bearing liabilities		589,532		4,870	1.10	%		602,968		5,667	1.26	%
Non-interest bearing deposits		64,832						59,595
Other liabilities		24,316						29,579
Shareholders' equity		54,204						56,106
Total average liabilities and equity	$	732,884					$	748,248
Net interest margin			$	16,681	3.25	%			$	14,788	2.86	%

Table of Contents

Rate Volume Analysis

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 three and nine months ended September 30, 2014, as compared to the respective period in 2013, into amounts attributable to both rates and volume variances.


	For the three months ended						For the nine months ended
	September 30,						September 30,
	2014 vs. 2013						2014 vs. 2013
		Increase (decrease)						Increase (decrease)
(In thousands)	Volume		Rate		Total		Volume		Rate		Total
Interest income
Interest-bearing deposits	$	5	$	(5)	$	—	$	(5)	$	—	$	(5)
Total short term earning assets		5		(5)		—		(5)		—		(5)
Investments securities		(152)		358		206		(245)		1,752		1,507
Loans
Commercial demand loans		(125)		—		(125)		(343)		223		(120)
Commercial mortgages		(12)		(24)		(36)		3		(300)		(297)
Residential and home equity		187		2		189		624		(112)		512
Leases receivables		180		(15)		165		445		(13)		432
Tax certificates		(215)		56		(159)		(824)		(73)		(897)
Other loans		11		(1)		10		6		(5)		1
Loan fees		(19)		—		(19)		(37)		—		(37)
Total loans		7		18		25		(126)		(280)		(406)
Total (decrease) increase in interest income	$	(140)	$	371	$	231	$	(376)	$	1,472	$	1,096
Interest expense
Deposits
NOW and money market	$	4	$	8	$	12	$	(4)	$	34	$	30
Savings		1		(2)		(1)		1		(5)		(4)
Time deposits		(41)		(53)		(94)		(91)		(284)		(375)
Total deposits		(36)		(47)		(83)		(94)		(255)		(349)
Borrowings and subordinated debentures		(63)		(121)		(184)		(64)		(384)		(448)
Total decrease in interest expense	$	(99)	$	(168)	$	(267)	$	(158)	$	(639)	$	(797)
Total (decrease) increase in net interest income	$	(41)	$	539	$	498	$	(218)	$	2,111	$	1,893

Credit Risk Management

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

Table of Contents

reserves reflecting historical loss rates by loan type, (2) specific reserves for risk-rated credits based on probable losses on an individual or portfolio basis and (3) qualitative reserves based upon current economic conditions and other risk factors.

The loan portfolio is stratified into loan classifications that have similar risk characteristics. The general allowance is based upon historical loss rates using a weighted three-year rolling average of the historical loss experienced within each loan segment. The qualitative factors used to adjust the historical loss experience address various risk characteristics of the Company’s loan and lease portfolio include evaluating: (1) trends in delinquencies and other non-performing loans, (2) changes in the risk profile related to large loans in the portfolio, (3) changes in the growth trends of categories of loans comprising the loan and lease portfolio, (4) concentrations of loans and leases to specific industry segments, and (5) changes in economic conditions on both a local and national level, (6) quality of loan review and board oversight, (7) changes in lending policies and procedures, and (8) changes in lending staff. Each factor is assigned a value to reflect improving, stable or declining conditions based on management’s best judgment using relevant information available at the time of the evaluation. Adjustments to the factors are supported through documentation of changes in conditions in a report accompanying the allowance calculation.

The specific reserves are determined utilizing standards required under ASC Topic 310. A loan is considered impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. Non-accrual loans and loans restructured under a troubled debt restructuring are evaluated for impairment on an individual basis considering all known relevant factors that may affect loan collectability such as the borrower’s overall financial condition, resources and payment record, support available from financial guarantors and the sufficiency of current collateral values (current appraisals or rent rolls for income producing properties), and risks inherent in different kinds of lending (such as source of repayment, quality of borrower and concentration of credit quality). Non-accrual loans that experience insignificant payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed.

Impairment is measured on a loan by loan basis for commercial and industrial loans, commercial real estate loans and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent. The estimated fair values of substantially all of the Company’s impaired loans are measured based on the estimated fair value of the loan’s collateral. The Company obtains third-party appraisals on the fair value of real estate collateral. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property. For commercial and industrial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Once a loan is determined to be impaired it will be deducted from the portfolio and the net remaining balance will be used in the general and qualitative analysis. A specific reserve is established for an impaired loan if its carrying value exceeds its estimated fair value.

The amount of the allowance is reviewed and approved by the Chief Financial Officer (“CFO”), Chief Administrative and Risk Officer (“CARO”), Chief Lending Officer (“CLO”), and Chief Credit Officer (“CCO”) on at least a quarterly basis. Management believes that the allowance at September 30, 2014 is adequate. However, its determination requires significant judgment, and estimates of probable losses inherent in the credit portfolio can vary significantly from the amounts actually observed. While management uses available information to recognize probable losses, future changes to the allowance may be necessary based on changes in the credits comprising the portfolio and changes in the financial condition of borrowers, such as may result from changes in economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the credit portfolio and the allowance. Such review may result in additional provisions based on their judgment of information available at the time of each examination.

Due to the continuing improvement in the credit quality of the loan portfolio and the decline in impaired loan balances, the Company recorded credits to the allowance of $51,000 and $765,000 for the three and nine months ended September 30, 2014, respectively, compared to a provision of $218,000 and a credit of $196,000 for the the three and nine months ended

Table of Contents

September 30, 2013, respectively. The allowance decreased $2.2 million from $13.7 million at December 31, 2013 to $11.5 million at September 30, 2014. The decline in the allowance was directly related to the charge-off of specific reserves and a reduction of approximately $29.1 million in classified and impaired loans. The allowance was 2.89% of total loans and leases held for investment at September 30, 2014 compared to 3.73% at December 31, 2013.

Changes in the allowance were as follows:


	For the three months ended				For the nine months ended
	September 30,				September 30,
(In thousands)	2014		2013		2014		2013
Balance at period beginning	$	11,569	$	15,179	$	13,671	$	17,261
Charge-offs
Commercial real estate		—		(605)		(349)		(1,440)
Construction and land development		—		—		—		(820)
Commercial & industrial		—		(34)		(452)		(228)
Residential real estate		—		(32)		—		(32)
Leases		(206)		(40)		(568)		(149)
Tax certificates		(65)		(126)		(330)		(410)
Total charge-offs		(271)		(837)		(1,699)		(3,079)
Recoveries
Commercial real estate		—		1		—		127
Construction and land development		205		106		205		297
Commercial & industrial		12		4		23		14
Residential real estate		5		2		11		157
Leases		13		4		35		24
Tax certificates		—		2		1		74
Total recoveries		235		119		275		693
Net charge offs		(36)		(718)		(1,424)		(2,386)
Credit for loan and lease losses		(51)		218		(765)		(196)
Balance at period end	$	11,482	$	14,679	$	11,482	$	14,679

Table of Contents

An analysis of the allowance by loan type is set forth below:


	September 30, 2014				December 31, 2013
			Percent of				Percent of
			outstanding				outstanding
			loans in each				loans in each
	Allowance		category to		Allowance		category to
(In thousands, except percentages)	amount		total loans		amount		total loans
Commercial real estate	$	4,705	41.4	%	$	5,498	40.5	%
Construction and land development		2,241	10.5	%		2,316	12.3	%
Commercial and industrial		1,431	17.8	%		3,006	21.7	%
Multi-family		353	4.3	%		402	3.2	%
Residential real estate		720	11.1	%		473	7.0	%
Leases		1,484	12.2	%		1,223	11.6	%
Tax certificates		372	2.1	%		555	3.5	%
Consumer		33	0.6	%		15	0.2	%
Unallocated		143	—	%		183	—	%
Total allowance	$	11,482	100.00	%	$	13,671	100.0	%

The following table presents the principal amounts of non-accrual loans and other real estate owned:


	September 30,			December 31,
(Amounts in thousands)	2014			2013
Non-accrual LHFI (1)	$	9,766		$	10,157
Non-accrual LHFS		1,018			—
Other real estate owned		9,593			9,617
Total nonperforming assets	$	20,377		$	19,774

Nonperforming assets to total assets		2.82	%		2.70	%
Total non-accrual loans to total loans		2.71	%		2.76	%
ALLL to non-accrual LHFI		117.57	%		134.60	%
ALLL to total LHFI		2.89	%		3.73	%

(1) Generally, a loan is placed on non-accruing status when it has been delinquent for a period of 90 days or more. This excludes non-accrual loans held for sale of $1.0 million at September 30, 2014.

Table of Contents

The composition of non-accrual loans is as follows:


	As of September 30, 2014				As of December 31, 2013
	Loan		Specific		Loan		Specific
(In thousands)	balance		reserves		balance		reserves
Non-accrual loans held for investment
Commercial real estate	$	3,732	$	205	$	2,325	$	331
Construction and land development		815		172		2,650		—
Commercial & industrial		2,583		5		3,629		452
Residential real estate		983		30		632		19
Leases		525		62		467		60
Tax certificates		1,128		19		454		24
Total non-accrual LHFI	$	9,766	$	493	$	10,157	$	886
Non-accrual loans held for sale
Construction and land development	$	1,018	$	—	$	—	$	—
Total non-accrual LHFS	$	1,018	$	—	$	—	$	—
Total non-accrual loans	$	10,784	$	493	$	10,157	$	886

Non-accrual loan activity for the first three quarters of 2014 is set forth below:


			1st Quarter Activity
(In thousands)	Balance at January 1, 2014		Additions		Payments and other decreases		Charge-offs/Impairment*		Transfer to OREO		Balance at March 31, 2014
Non-accrual loans held for investment
Commercial real estate	$	2,325	$	—	$	(395)	$	(350)	$	—	$	1,580
Construction and land development		2,650		—		(332)		—		—		2,318
Commercial & industrial		3,629		99		(339)		(452)		—		2,937
Residential real estate		632		114		—		—		—		746
Leases		467		278		—		(118)		—		627
Tax certificates		454		1,521		—		(265)		(573)		1,137
Total non-accrual LHFI	$	10,157	$	2,012	$	(1,066)	$	(1,185)	$	(573)	$	9,345
Non-accrual loans held for sale
Construction and land development	$	—	$	215	$	(215)	$	—	$	—	$	—
Total non-accrual LHFS	$	—	$	215	$	(215)	$	—	$	—	$	—
Total non-accrual loans	$	10,157	$	2,227	$	(1,281)	$	(1,185)	$	(573)	$	9,345

Table of Contents


			2nd Quarter Activity
(In thousands)	Balance at March 31, 2014		Additions		Payments and other decreases		Charge-offs/Impairment*		Transfer to OREO		Balance at June 30, 2014
Non-accrual loans held for investment
Commercial real estate	$	1,580	$	—	$	(245)	$	—	$	—	$	1,335
Construction and land development		2,318		—		(1,416)		—		—		902
Commercial & industrial		2,937		—		(52)		—		—		2,885
Residential real estate		746		258		—		—		—		1,004
Leases		627		15		—		(244)		—		398
Tax certificates		1,137		312		—		—		(309)		1,140
Total non-accrual LHFI	$	9,345	$	585	$	(1,713)	$	(244)	$	(309)	$	7,664
Non-accrual loans held for sale
Construction and land development(1)	$	—	$	1,396	$	—	$	—	$	—	$	1,396
Total non-accrual LHFS	$	—	$	1,396	$	—	$	—	$	—	$	1,396
Total non-accrual loans	$	9,345	$	1,981	$	(1,713)	$	(244)	$	(309)	$	9,060

Table of Contents


			3rd Quarter Activity
(In thousands)	Balance at June 30, 2014		Additions		Payments and other decreases		Charge-offs/Impairment*		Transfer to OREO		Balance at September 30, 2014
Non-accrual loans held for investment
Commercial real estate	$	1,335	$	2,409	$	(12)	$	—	$	—	$	3,732
Construction and land development		902		559		(646)		—		—		815
Commercial & industrial		2,885		—		(302)		—		—		2,583
Residential real estate		1,004		—		(21)		—		—		983
Leases		398		348		(15)		(206)		—		525
Tax certificates		1,140		1,181		(12)		(65)		(1,116)		1,128
Total non-accrual LHFI	$	7,664	$	4,497	$	(1,008)	$	(271)	$	(1,116)	$	9,766
Non-accrual loans held for sale
Construction and land development(1)	$	1,396	$	631	$	(1,009)	$	—	$	—	$	1,018
Total non-accrual LHFS	$	1,396	$	631	$	(1,009)	$	—	$	—	$	1,018
Total non-accrual loans	$	9,060	$	5,128	$	(2,017)	$	(271)	$	(1,116)	$	10,784

*Charge-offs on LHFI were recorded in the allowance.

(1) Additions column shows the transfer from non-accrual LHFI to non-accrual LHFS.

Total non-accrual loans at September 30, 2014 were $10.8 million and includes $1.0 million in LHFS. Total non-accrual loans were $10.2 million at December 31, 2013. The increase of $627,000 was the result of $1.7 million in charge-offs mostly related to specific reserves, $2.8 million reduction in existing non-accrual loan balances through payments and payoffs, and $2.0 million in transfers to OREO, which were partially offset by additions to non-accrual loans of $7.1 million. During the third quarter of 2014, two commercial real estate loans totaling $2.4 million and one construction and land development loan for $559,000 were placed on non-accrual. The leasing and tax certificate portfolios accounted for the remainder of the new non-accrual activity and transfers to OREO. If interest had been accrued, such income would have been approximately $290,000 and $830,000 for the three and nine months ended September 30, 2014, respectively. The Company had no loans past due 90 days or more on which it has continued to accrue interest during the quarter. Typically, loans are restored to accrual status when the loan is brought current, has performed in accordance with the contractual terms for a reasonable period of time (generally six months) and the ultimate collectability of the total contractual principal and interest is no longer in doubt.

Impaired Loans

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 agreement. Impaired loans include troubled debt restructurings (“TDRs”). The Company does not accrue interest income on impaired non-accrual loans. Excess proceeds received over the principal amounts due on impaired non-accrual loans are recognized as income on a cash basis. The Company recognizes interest income under the accrual basis when the principal payments on the loans become current and the collateral on the loan is

Table of Contents

sufficient to cover the outstanding obligation to the Company. If these factors do not exist, the Company does not recognize income.

The following is a summary of information pertaining to impaired loans and leases:



	September 30,		December 31,
(In thousands)	2014		2013
Impaired LHFI with a valuation allowance	$	4,232	$	3,835
Impaired LHFI without a valuation allowance		11,909		14,671
Impaired LHFS		1,018		—
Total impaired loans and leases	$	17,159	$	18,506
Valuation allowance related to impaired LHFI	$	493	$	886


	For the nine months ended
	September 30,
(In thousands)	2014		2013
Average investment in impaired loans	$	17,412	$	26,572
Interest income recognized on impaired loans and leases	$	292	$	442
Interest income recognized on a cash basis on impaired loans and leases	$	292	$	27

Troubled Debt Restructurings

A loan modification is deemed a TDR when two conditions are met: 1) the borrower is experiencing financial difficulty and 2) concessions are made by the Company that would not otherwise be considered for a borrower or collateral with similar credit risk characteristics. All loans classified as TDRs are considered to be impaired. TDRs are returned to an accrual status when the loan is brought current, has performed in accordance with the contractual restructured terms for a reasonable period of time (generally six months) and the ultimate collectability of the total contractual restructured principal and interest is no longer in doubt. At September 30, 2014, the Company had twelve TDRs, with a total carrying value of $9.4 million. At the time of the modifications, three of the loans were already classified as impaired non-accrual loans. At December 31, 2013, the Company had twelve TDRs with a total carrying value of $12.1 million. The Company’s policy for TDRs is to recognize income on currently performing restructured loans under the accrual method.

Other Real Estate Owned

OREO slightly decreased $24,000 and was $9.6 million at December 31, 2013 and September 30, 2014. OREO is comprised of three real estate properties acquired through, or in lieu of foreclosure in settlement of loans and 73 real estate properties acquired through foreclosure related to tax liens. Set forth below is a table which details the changes in OREO from December 31, 2013 to September 30, 2014.


	For the nine months ended September 30, 2014
(In thousands)	Loans		Tax Liens		Total
Beginning balance	$	1,725	$	7,892	$	9,617
Net proceeds from sales		(1,214)		(2,334)		(3,548)
Net gains on sales		22		611		633
Transfers in		—		1,998		1,998
Cash additions		—		1,292		1,292
Impairment charge		(100)		(299)		(399)
Ending balance	$	433	$	9,160	$	9,593

Table of Contents

The composition of the OREO assets has evolved to properties primarily acquired through the tax lien portfolio. During the first nine months of 2014, the Company transferred $2.0 million to OREO which represents 40 properties and added $1.3 million in lien redemptions on existing properties. During the same period the Company sold 30 tax lien properties, received proceeds of $2.3 million, and recorded net gains of $611,000 as a result of these sales. Additionally, the Company recorded impairment charges of $299,000 during the first nine months of 2014 related to the tax lien properties. At December 31, 2013, OREO assets acquired through the tax lien portfolio were $7.9 million and were comprised of 59 properties.

Credit Classification Process

The Company uses a nine point risk rating classification system commonly used in the financial services industry. The first four risk rating classifications are rated Pass. The riskier classifications include Pass-Watch, Special Mention, Substandard, Doubtful and Loss. During the underwriting process, the CCO assigns each loan with an initial risk rating, which is approved by the appropriate loan committee. From time to time, and at the general direction of any of the various loan committees, the ratings may be changed based on the findings of that committee. Items considered in assigning ratings include the financial strength of the borrower and/or guarantors, the type of collateral, the collateral lien position, the type of loan and loan structure, any potential risk inherent in the specific loan type, higher than normal monitoring of the loan or any other factor deemed appropriate by any of the various committees for changing the rating of the loan. Any such change in rating is reflected in the minutes of that committee.

The loan review function is outsourced to a third party vendor which examines credit quality and portfolio management. The loan review vendor applies the Company’s loan rating system to specific credits and reviews approximately 50% of the total commercial loan portfolio. Emphasis is on the larger new and seasoned loan relationships and includes criticized and classified loans. Additionally, the loan review vendor ensures that all critical industry segments are adequately represented in their review. The loan review vendor will also review loans specifically requested by management. Upon completion of a loan review, a copy of any review receiving an adverse classification by the reviewer is presented to the Classified, Charge-off and Impairment Committee (“CCIC”) for discussion. The CCO is the primary bank officer dealing with the third party vendor during the reviews.

Loans on the Company’s Special Assets Committee list are also subject to loan review even though they are receiving the daily attention of an assigned officer and monthly attention of the Special Assets Committee. A watch list is maintained and reviewed at each meeting of CCIC. CCIC was formed to formalize the process and documentation required to classify, remove from classification, impair or charge-off a loan. The CCIC, which is comprised of the CEO, CARO, CFO, CCO, and CLO meet as required and provide regular updated reports to the Board of Directors. Loans are added to the watch list, even though the loans may be current or less than 30 days delinquent if they exhibit elements of substandard creditworthiness. The watch list contains a statement for each loan as to why it merits special attention, and this list is distributed to the Board of Directors on a monthly basis. Loans may be removed from the watch list if the CCIC determines that exception items have been resolved or creditworthiness has improved. Additionally, if loans become serious collection matters and are listed on the Company’s monthly delinquent loan or Special Assets Committee lists, they may be removed from the watch list. Minutes outlining the CCIC’s findings and recommendations are issued after each meeting for follow-up by individual loan officers.

Potential Problem Loans

Table of Contents

Potential problem loans are loans not currently classified as non-performing loans, but for which management has doubts as to the borrowers’ ability to comply with present repayment terms. The loans are usually delinquent more than 30 days but less than 90 days and include non-impaired substandard loans. Potential problem loans amounted to approximately $2.0 million and $9.1 million at September 30, 2014 and December 31, 2013. The $7.1 million decline in potential problem loans included one $4.9 million relationship which paid off in full during the second quarter of 2014. Additionally, two loans totaling $1.1 million were placed on non-accrual during 2014.

Non-interest Income

Non-interest income for the third quarter of 2014 was $1.2 million compared to $1.9 million for the comparable quarter of 2013 resulting in a decrease of $733,000. Net gains on the sale of OREO declined $456,000 ($173,000 in 2014 versus $629,000 in 2013). Gains on the sales of premises and equipment fell $419,000 ($107,000 in 2014 versus $526,000 in 2013). Additionally, net gains on the sales of loans and leases decreased $161,000 ($80,000 in 2014 versus $241,000 in 2013). Partially mitigating these reductions was an increase of $239,000 in net gains on the sale of AFS investment securities ($238,000 in 2014 versus a loss of $1,000 in 2013). Because the 10-year US Treasury rate retreated during the quarter, the Company was able to sell certain investment securities which had extension risk in a rising interest rate environment for a net gain.

For the nine months ended September 30, 2014, non-interest income was $2.8 million compared to $4.3 million for the comparable period in 2013 resulting in a decrease of $1.5 million. During the first nine months of 2013, the Company recorded $1.2 million in gains on the sale of premises and equipment predominantly related to the sale of three Company owned properties. Gains on the sale of premises and equipment were $107,000 for 2014. Additionally, net gains on the sale of OREO declined $576,000 ($633,000 in 2014 versus $1.2 million in 2013) and service charges and fees declined $222,000 ($779,000 in 2014 versus $1.1 million in 2013) of which the majority was related to the leasing subsidiary. Partially offsetting these items was a $261,000 increase in net gains on the sale of AFS investment securities ($330,000 in 2014 versus $69,000 in 2013).

Non-interest Expense

Non-interest expense improved $915,000, or 14.5%, from $6.3 million for the third quarter of 2013 to $5.4 million for the third quarter of 2014. As credit quality has improved, OREO expenses and impairment fell $690,000 ($154,000 in 2014 versus $844,000 in 2013), and loan collection expenses decreased $60,000 ($70,000 in 2014 versus $130,000 in 2013). In the third quarter of 2013, the Company recorded restructuring charges of $119,000 related to an effective lease termination. There were no restructuring charges recorded in 2014. Partially offsetting these declines was a $157,000 increase in salaries and benefits ($2.7 million in 2014 versus $2.5 million in 2013), which was impacted by a contractual payment due to an executive retirement.

Non-interest expense significantly improved by $4.3 million, or 21.3%, from $20.0 million for the nine months ended September 30, 2013 to $15.7 million for the first nine months of 2014. The 2013 period included a $1.65 million legal settlement expense related to a tax lien subsidiary, of which the Company’s share was $990,000. Additional improvements include a $493,000 decrease in salaries and benefits ($7.5 million in 2014 versus $8.0 million in 2013) due to a reduction in the workforce, a $1.2 million decrease in credit quality expenses, and a $475,000 reduction in professional and legal fees ($1.6 million in 2014 versus $2.0 million in 2013). Credit related expenses include loan collection expenses, OREO expenses, OREO impairment, and impairment on loans held for sale. As asset credit quality continued to improve, OREO expenses and impairment declined $849,000 ($892,000 in 2014 versus $1.7 million in 2013), loan collection expenses decreased $181,000 ($227,000 in 2014 versus $408,000 in 2013) and impairment on LHFS fell $153,000 ($0 in 2014 versus $153,000 in 2013). In addition, the Company did not record restructuring charges in 2014 ($0 in 2014 versus $230,000 in 2013). The 2013 restructuring charges were related to the reduction in work force of twelve employees which occurred during the first quarter of 2013 and a lease termination. Partially offsetting these declines was a $183,000 increase in occupancy and equipment expenses ($1.9 million in 2014 versus $1.7 million in 2013) and was due to branch relocations and minor renovations, along with higher utility costs. Additionally, marketing and advertising expenses increased $150,000 ($325,000 in 2014 versus $175,000 in 2013) for promotion of the Company’s new and enhanced products and services.

Table of Contents

Income Tax Expense

Total income tax expense for the first three quarters of 2014 and the comparable quarters of 2013 was $0. Despite net income of $4.3 million for the first nine months of 2014, the Company did not record a tax expense due to the net operating loss carryforward from prior years.

The Company concluded at September 30, 2014 and December 31, 2013 that it was more likely than not that the Company would not generate sufficient future taxable income to realize all of the deferred tax assets. Management’s conclusion was based on consideration of the relative weight of the available evidence and the uncertainty of future market conditions on results of operations. As a result the Company has recorded a cumulative non-cash charge of $37.2 million in the consolidated statement of operations that began in the period ended December 31, 2008 related to the establishment of a valuation allowance for the deferred tax asset for the portion of the future tax benefit that more likely than not will not be utilized in the future. The effective tax rate for the first nine months of both 2014 and 2013 was 0%.

Results of Operations by Business Segments

Operating segments are components of an enterprise, which are evaluated regularly by the chief operating decision makers in deciding how to allocate and assess resources and performance. The Company’s chief operating decision makers are the CEO and the CARO. The Company has identified two reportable operating segments, “Community Banking” and “Tax Liens”.


	Three months ended September 30, 2014
	Community
(In thousands)	Banking		Tax Liens		Consolidated
Total assets	$	701,803	$	21,666	$	723,469
Total deposits	$	515,786	$	—	$	515,786

Interest income	$	6,889	$	302	$	7,191
Interest expense		1,367		256		1,623
Net interest income	$	5,522	$	46	$	5,568
(Credit) provision for loan and lease losses		(79)		28		(51)
Total non-interest income		987		217		1,204
Total non-interest expense		4,916		459		5,375
Income tax expense (benefit)		—		—		—
Net income (loss)	$	1,672	$	(224)	$	1,448
Noncontrolling interest	$	69	$	(44)	$	25
Net income (loss) attributable to Royal Bancshares	$	1,603	$	(180)	$	1,423

Table of Contents


	Three months ended September 30, 2013
	Community
(In thousands)	Banking		Tax Liens		Consolidated
Total assets	$	708,864	$	28,136	$	737,000
Total deposits	$	522,620	$	—	$	522,620

Interest income	$	6,485	$	475	$	6,960
Interest expense		1,560		330		1,890
Net interest income	$	4,925	$	145	$	5,070
Provision for loan and lease losses		178		40		218
Total non-interest income		1,344		593		1,937
Total non-interest expense		5,683		607		6,290
Income tax expense (benefit)		—		—		—
Net income	$	408	$	91	$	499
Noncontrolling interest	$	121	$	36	$	157
Net income attributable to Royal Bancshares	$	287	$	55	$	342


	Nine months ended September 30, 2014
	Community
(In thousands)	Banking		Tax Liens		Consolidated
Total assets	$	701,803	$	21,666	$	723,469
Total deposits	$	515,786	$	—	$	515,786

Interest income	$	20,549	$	1,002	$	21,551
Interest expense		4,030		840		4,870
Net interest income	$	16,519	$	162	$	16,681
(Credit) provision for loan and lease losses		(911)		146		(765)
Total non-interest income		2,019		773		2,792
Total non-interest expense		14,221		1,507		15,728
Income tax expense (benefit)		—		—		—
Net income (loss)	$	5,228	$	(718)	$	4,510
Noncontrolling interest	$	337	$	(125)	$	212
Net income (loss) attributable to Royal Bancshares	$	4,891	$	(593)	$	4,298

Table of Contents


	Nine months ended September 30, 2013
	Community
(In thousands)	Banking		Tax Liens		Consolidated
Total assets	$	708,864	$	28,136	$	737,000
Total deposits	$	522,620	$	—	$	522,620

Interest income	$	18,556	$	1,899	$	20,455
Interest expense		4,525		1,142		5,667
Net interest income	$	14,031	$	757	$	14,788
(Credit) provision for loan and lease losses		(563)		367		(196)
Total non-interest income		3,056		1,250		4,306
Total non-interest expense		16,348		3,649		19,997
Income tax expense (benefit)		—		—		—
Net income (loss)	$	1,302	$	(2,009)	$	(707)
Noncontrolling interest	$	422	$	(786)	$	(364)
Net income (loss) attributable to Royal Bancshares	$	880	$	(1,223)	$	(343)

Community Bank Segment

Royal Bank America

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. The deposits of Royal Bank are insured by the FDIC to the highest amount permitted by law. Royal Real Estate LLC, RBA Property LLC, Narberth Property Acquisition LLC, and Rio Marina LLC are wholly owned subsidiaries of Royal Bank. These four entities were established to hold other real estate owned acquired through foreclosure of collateral associated with non-performing loans. Royal Bank also owns 60% of Royal Bank America Leasing, LP. At September 30, 2014, Royal Bank owns 80% of its subsidiary, Crusader Servicing Corporation and wholly owns Royal Tax Lien Services, LLC, each of which was formed to purchase and service delinquent tax liens. At September 30, 2013, Royal Bank’s ownership interest in CSC and RTL was 60%.

Royal Bank derives its income principally from interest charged on loans and leases, interest earned 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 borrowings and operating expenses. Operating revenues, deposit growth, investment maturities, loan sales and the repayment of outstanding loans provide the majority of funds for activities.

Royal Bank conducts business operations as a commercial bank offering checking, money market and savings accounts and time deposits, and commercial and consumer 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. Royal Bank’s business and services are not subject to significant seasonal fluctuations. Royal Bank is a member of the Federal Reserve FedLine Wire Transfer System.

Service Area: Royal Bank’s primary service area includes Pennsylvania, primarily Montgomery, Chester, Bucks, Delaware, Berks and Philadelphia counties, and central and southern New Jersey. 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 thirteen retail branches located throughout Montgomery, Philadelphia, Delaware and Berks counties and Camden County, New Jersey. Additionally, during the third quarter of 2014, Royal Bank opened a limited service office in Princeton, New Jersey to offer more convenience to its central New Jersey customers. Royal Bank also considers New York, Maryland, and Delaware as a part of its service area for certain products and services. In the past, Royal Bank had frequently conducted business with clients located outside of its service area. Royal Bank has loans in thirteen states via loan originations and/or participations with other lenders who have broad experience in those respective markets. Royal Bank’s headquarters are located at 732 Montgomery Avenue, Narberth, Pennsylvania 19072.

Table of Contents

Competition: The financial services industry in our service area is extremely competitive. Competitors within our 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, brokerage firms, mortgage companies, leasing companies, finance companies and other financial services companies offer products and services similar to those offered by Royal Bank, on competitive terms.

Employees: Royal Bank employed approximately 118 people on a full-time equivalent basis as of September 30, 2014.

Deposits: At September 30, 2014, total deposits of Royal Bank were distributed among demand deposits (14%), money market deposit, savings and NOW accounts (43%) and time deposits (43%). At September 30, 2014, deposits of $523.6 million decreased $8.0 million from $531.6 million at year end 2013. Included in Royal Bank’s deposits are approximately $7.8 million of intercompany deposits that are eliminated through consolidation.

Lending: At September 30, 2014, Royal Bank, including its subsidiaries, had a total net loan portfolio of $385.7 million, representing 54% of total assets. The loan portfolio is categorized into commercial and industrial, commercial mortgages, residential mortgages (including home equity lines of credit), construction, tax liens, small business leases and consumer loans. At September 30, 2014, net loans increased $32.9 million from year end 2013 due to new loan originations coupled with residential loan pool purchases, which were partially offset by pay downs, payoffs, charge-offs, transfers to OREO and a decline in the allowance.

Business results: Total assets of Royal Bank were $714.7 million at September 30, 2014 compared to $724.7 million at year end 2013. Royal Bank recorded net income of $1.3 million for the third quarter of 2014 compared to $587,000 for the comparable quarter of 2013. For the first nine months of 2014, Royal Bank recorded net income of $4.2 million compared to $92,000 for the first nine months of 2013. The 2013 period was negatively impacted by a $1.65 million legal settlement expense related to the tax lien subsidiaries. After adjusting for noncontrolling interest, Royal Bank’s share of the loss contingency amounted to $990,000. Total interest income of Royal Bank for the quarter ended and nine months ended September 30, 2014 was $7.1 million and $21.5 million, respectively compared to $6.9 million and $20.4 million for the quarter and nine months ended September 30, 2013, respectively. The growth in interest income was primarily attributed to an increase in the yield on investment securities, which was partially offset by a decline in interest income on loans and leases. The increase in investment interest income was due to a decline in the prepayments of government agency MBS and CMO securities which had a positive effect on the amortization of premiums coupled with higher yields on new purchases. Interest expense was $1.6 million and $4.9 million for the third quarter and nine months ended September 30, 2014, respectively, compared to $1.7 million and $5.5 million for the quarter and nine months ended September 30, 2013. The $707,000 improvement in net income quarter versus quarter was mainly attributable to a $328,000 million increase in net-interest income and a $51,000 credit to the allowance in the 2014 period compared to a $218,000 provision in the 2013 period. The $4.1 million improvement in net income year over year was related to the legal settlement expense mentioned above, a $1.7 million increase in net interest income, and a $1.2 million decline in credit related expenses, which were partially offset by a $1.1 million decline in gains on the sale premises and equipment. The above amounts reflect the consolidation totals for Royal Bank and its subsidiaries. The subsidiaries included in these amounts are Royal Investments America, Royal Real Estate, Royal Bank America Leasing, Royal Tax Lien Services, Crusader Servicing Corporation, RBA Property LLC, Narberth Property Acquisitions, and Rio Marina LLC.

Royal Investments of Delaware

On June 30, 1995, the Company established a special purpose Delaware investment company, Royal Investments of Delaware (“RID”), as a wholly owned subsidiary. Legal headquarters are at 1105 N. Market Street, Suite 1300, Wilmington, Delaware. RID buys, holds and sells investment securities.

Business results: For the three months ended September 30, 2014, RID reported net income of $362,000, compared to net income of $159,000 for the three months ended September 30,. The quarter versus quarter increase was primarily related to an increase in gains on the sale of investment securities of $219,000. For the first nine months of 2014, RID reported net income of $718,000 compared to net income of $476,000 for the first nine months of 2013. At September 30, 2014 total assets of RID were $31.1 million, of which $3.4 million was held both in cash and cash equivalents and in investment securities. The amounts shown above include the activity related to RID’s wholly owned subsidiary Royal Preferred LLC.

Table of Contents

Royal Bank previously extended loans to RID, secured by securities and as per the provisions of Regulation W. At September 30, 2014 no loans were outstanding.

Royal Preferred LLC

On June 16, 2006, the Company, through its wholly owned subsidiary RID, established Royal Preferred LLC as a wholly owned subsidiary. Royal Preferred LLC was formed to purchase a subordinated debenture from Royal Bank America. At September 30, 2014, Royal Preferred LLC had total assets of $24.6 million.

Royal Bancshares Capital Trust I and II

On October 27, 2004, the Company formed two Delaware trust affiliates, Royal Bancshares Capital Trust I and Royal Bancshares Capital Trust II, in connection with the sale of an aggregate of $25.0 million of a private placement of trust preferred securities. The interest rates for the debt securities associated with the Trusts at September 30, 2014 were 2.38%.

Under the Federal Reserve Agreement as described in “Note 2 – Regulatory Matters and Significant Risks or Uncertainties” to the Consolidated Financial Statements, the Company and its non-bank subsidiaries may not make any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System. The Company received approval and paid the required interest payments in 2014.

Royal Bank America Leasing, LP

On July 25, 2005, the Company, through its wholly owned subsidiary Royal Bank, formed Royal Bank America Leasing, LP (“Royal Leasing”). Royal Bank holds a 60% ownership interest in Royal Leasing. Legal headquarters are 550 Township Line Road, Blue Bell, Pennsylvania. Royal Leasing was formed to originate small business financing leases. Royal Leasing originates the leases through its internal sales staff and through independent brokers located throughout its business area. In general, Royal Leasing will portfolio individual leases in amounts up to $250,000. Leases originated in amounts in excess of $250,000 are sold to other leasing companies.

Business results: At September 30, 2014, total assets of Royal Leasing were $48.5 million, and includes $48.4 million in net leases. Total assets were $42.3 million at December 31, 2013. For the quarter ended September 30, 2014, Royal Leasing had net interest income of $676,000 compared to $577,000 for the comparable period of 2013; provision for lease losses of $325,000 versus $134,000 in the comparable quarter of 2013; non-interest income of $87,000 as compared to $168,000 in the third quarter of 2013; and non-interest expense of $68,000 compared to $309,000 quarter over quarter. Prior to partner distributions, net income for the quarter ended September 30, 2014 was $370,000, a decrease of $147,000 from $517,000 for the three months ended September 30, 2013. For the first nine months of 2014, Royal Leasing recorded net income prior to management distributions of $1.3 million compared to $1.7 million for the first nine months of 2013. The decline in net income prior to partner distributions was mainly due to the increase in provision for lease losses.

Royal Bank has extended loans to RBA Leasing at market interest rates, secured by the lease portfolio of RBA Leasing and as per the provisions of Regulation W. At September 30, 2014, the amount due Royal Bank from RBA Leasing was $44.8 million.

Royal Investments America

On June 23, 2003, the Company, through its wholly owned subsidiary Royal Bank, established Royal Investments America, LLC (“RIA”) as a wholly owned subsidiary. Legal headquarters are at 732 Montgomery Avenue, Narberth, Pennsylvania. RIA was formed to invest in equity real estate ventures subject to limitations imposed by the FDIC and Pennsylvania Department of Banking by regulation.

Business results: At September 30, 2014 and December 31, 2013, total assets of RIA were $5.9 million. For the quarter ended September 30, 2014, RIA recorded a net loss of $6,000 compared to $9,000 for the comparable period of 2013. For the first nine months of 2014, RIA recorded a net loss of $9,000 compared to $13,000 for the same period in 2013. Royal

Table of Contents

Bank had previously extended loans to RIA at market interest rates, secured by the loan portfolio of RIA and as per the provisions of Regulation W. At September 30, 2014, there were no outstanding loans from Royal Bank to RIA.

Tax Lien Segment

Crusader Servicing Corporation

The Company, through its wholly owned subsidiary Royal Bank, holds an 80% ownership interest in Crusader Servicing Corporation (“CSC”). Effective December 31, 2013, Royal Bank acquired the ownership interest of the former President of CSC. At September 30, 2013 Royal Bank’s ownership interest was 60%. Its legal headquarters are at 732 Montgomery Avenue, Narberth, Pennsylvania. CSC acquired, 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. CSC is currently being liquidated under an orderly, long term plan adopted by CSC management.

Business results: CSC had net interest expense of $59,000 for the quarter ended September 30, 2014 compared to $85,000 for the comparable quarter in 2013. The $26,000 improvement was primarily related to the decline in average lien balances. CSC recorded net losses of $219,000 and $625,000 for the three and nine months ended September 30, 2014, respectively, compared to $227,000 and $552,000, respectively, for the comparable periods of 2013. The $73,000 year over year increase in net loss was primarily related to a $200,000 drop in net gains on the sales of OREO, which was partially offset by a $76,000 decline in the provision for lien losses. At September 30, 2014, total assets of CSC were $5.1 million, of which $650,000 was held in tax liens and $4.4 million was in OREO while at December 31, 2013 total assets were $4.8 million, of which $896,000 was held in tax liens and $3.8 million was held in OREO. Royal Bank has extended loans to CSC at market interest rates, secured by the tax lien portfolio of CSC and as per the provisions of Regulation W. At September 30, 2014, the amount due Royal Bank from CSC was $5.7 million.

Royal Tax Lien Services, LLC

On November 17, 2006, the Company, through its wholly owned subsidiary Royal Bank, formed Royal Tax Lien Services, LLC (“RTL”). Effective December 31, 2013, Royal Bank acquired the ownership interest of the former President of RTL and now holds 100% of the ownership interests. At September 30, 2013 Royal Bank held a 60% ownership interest in RTL. Its legal headquarters is located at 732 Montgomery Avenue, Narberth, Pennsylvania 19072. RTL was formed to purchase and service delinquent tax certificates. RTL typically acquired delinquent property tax liens through public auctions in various jurisdictions, assuming a lien position that is generally superior to any mortgage liens that are on the property, and obtaining certain foreclosure rights as defined by local statute. RTL ceased acquiring tax certificates at public auctions in 2010.

Business results: RTL’s net interest income of $105,000, for the quarter ended September 30, 2014, significantly decreased from $230,000 for the comparable quarter of 2013. The decrease in net interest income was largely due to a quarter-versus-quarter substantial decline in tax liens outstanding. For the quarter and nine months ended September 30, 2014, RTL recorded a net loss of $5,000 and $92,000, respectively, compared to net income of $317,000 and a net loss of $1.4 million, respectively for the comparable periods in 2013. The majority of the 2013 loss was related to the $1.65 million legal settlement accrual previously mentioned. At September 30, 2014, total assets of RTL were $16.6 million, of which $7.6 million was held in tax liens and $4.8 million was held in OREO as compared to total assets at December 31, 2013 of $21.7 million, of which $11.8 million was held in tax liens and $4.1 million was held in OREO.

Royal Bank has extended loans to RTL at market interest rates, secured by the tax lien portfolio of RTL and as per the provisions of Regulation W. At September 30, 2014, the amount due Royal Bank from RTL was $9.4 million.

Table of Contents

FINANCIAL CONDITION

Consolidated Assets

Total consolidated assets at September 30, 2014 were $723.5 million, a decrease of $8.8 million, or 1.2%, from December 31, 2013. This slight decrease was mainly attributed to a $43.3 million reduction in investment securities and was partially offset by increases of $32.9 million and $5.1 million in net loans and leases and cash and cash equivalents, respectively. Cash flows from investment securities sales and payments were partially invested in loans and held in cash due to expected redeployment into new loan originations.

Cash and Cash Equivalents

Total cash and cash equivalents of $21.9 million at September 30, 2014 grew $5.1 million from $16.8 million at December 31, 2013 due to cash flows from the investment portfolio. It is anticipated that some of the cash will fund new loan originations.

Investment Securities

AFS investment securities of $265.4 million at September 30, 2014, dropped $43.3 million from the level at December 31, 2013. The decline was primarily due to the sales of investment securities to fund loan growth. FHLB stock was $3.7 million at September 30, 2014 and $4.2 million at December 31, 2013.

The AFS portfolio had gross unrealized losses of $3.5 million at September 30, 2014 compared to $9.7 million at December 31, 2013. The $6.2 million improvement in the gross unrealized loss was directly related to decreases of $4.6 million, $445,000 and $632,000 in gross unrealized losses on U.S. government agency debt securities, Agency CMOs, and MBS, respectively. These securities carry lower coupons and their market value was positively impacted by the 51 basis point decrease in the 10-year Treasury yield from 3.03% at December 31, 2013 to 2.52% at September 30, 2014. Additionally, during the second and third quarters, the Company was able to sell some bonds with either lower yields or extension risk which also positively contributed to the improvement in the unrealized loss. The AFS portfolio contained a net unrealized gain of $1.1 million at September 30, 2014, which recovered $6.2 million from a net unrealized loss of $5.1 million at December 31, 2013 for the reasons mentioned above. There was no OTTI impairment for any of the investments during the first three quarters of 2014 or the first three quarters of 2013.

Investment securities within the AFS portfolio are marked to market quarterly and any resulting gains or losses are recorded in other comprehensive income, net of taxes, within the equity section of the balance sheet as shown in “Note 14 - Comprehensive Income (Loss)” to the Consolidated Financial Statements. When a loss is deemed to be other-than-temporary but the Company does not intend to sell the security and it is not more likely than not that the Company will have to sell the security before recovery of its cost basis, the Company will recognize the credit component of an OTTI charge in earnings and the remaining portion in other comprehensive income.

The Company will continue to monitor these investments to determine if the continued negative trends, market valuations or credit defaults result in impairment that is other than temporary.

Loans and Leases

Total loans and leases held for investment of $397.2 million increased $30.7 million, or 8.4%, from the level at December 31, 2013. The Company has shifted its lending focus to diversifying the loan portfolio through the origination of small business loans, owner occupied commercial real estate, middle market business lending and consumer loans. Additionally, after thorough due diligence, the Company has purchased small residential loan pools. The net growth in loans and leases was directly impacted by an approximate $28.7 million reduction in classified loans due to payoffs and pay downs coupled with payoffs of out of market loans and a $4.5 million decline in tax certificates from the balance at December 31, 2013.

Table of Contents

The following table represents loan balances by type:


	September 30,		December 31,
(In thousands)	2014		2013
Commercial real estate	$	164,522	$	148,293
Construction and land development		41,676		45,261
Commercial and industrial		70,743		79,589
Multi-family		16,893		11,737
Residential real estate		44,261		25,535
Leases		48,588		42,524
Tax certificates		8,230		12,716
Consumer		2,263		826
Total LHFI, net of unearned income	$	397,176	$	366,481

Deposits

Total deposits, the Company’s primary source of funds, declined $13.2 million, or 2.5%, from $529.0 million at December 31, 2013 to $515.8 million at September 30, 2014. The decrease in deposits reflects a focused change in the deposit product composition. Checking and savings accounts increased $9.0 million while NOW and money market accounts and certificates of deposit declined $22.2 million.

The following table represents ending deposit balances by type:


	September 30,		December 31,
(In thousands)	2014		2013
Demand	$	67,901	$	60,473
NOW		41,801		45,375
Money Market		162,177		164,678
Savings		19,142		17,593
Time deposits (over $100)		85,603		92,763
Time deposits (under $100)		139,162		148,082
Total deposits	$	515,786	$	528,964

Borrowings

Total borrowings, which include long-term borrowings and trust preferred securities, amounted to $123.3 million at September 30, 2014 compared to $133.7 million at December 31, 2013. The $10.3 million decline is attributable to a $10.0 million decrease in short-term borrowings and payments made on an amortizing loan with another financial institution.

Shareholders’ Equity

Consolidated shareholders’ equity of $62.5 million at September 30, 2014 increased $14.7 million, or 30.8%, from $47.8 million at December 31, 2013. The increase was related to $6.0 million raised in a shareholder rights offering through the issuance of class A common stock; an increase of $4.3 million in other comprehensive income mostly related to improvement in the valuation of the investment portfolio and net income of $4.3 million for the first nine months of 2014.

Table of Contents

The Company received approval from the Federal Reserve Bank to bid up to $14.0 million to purchase shares of the Company’s Series A Preferred Stock in an auction of such shares to be conducted by the Treasury. The auction closed on June 19, 2014. The Series A Preferred Stock was priced in the auction at $1,207.11 per share for all 30,407 shares of Series A Preferred Stock outstanding. The Company was allocated 11,551 shares of Series A Preferred Stock for repurchase at the clearing price of $1,207.11. Closing for the sale of the Series A Preferred Stock by Treasury, including the repurchase of 11,551 shares of Series A Preferred Stock by the Company, occurred on July 2, 2014. As part of this redemption, the Company eliminated nearly $3.5 million in preferred dividend in arrears.

To fund the purchase of the Series A Preferred Stock, described above, the Company sold 11,666,667 shares of its Class A common stock in a private placement transaction at a price of $1.20 per share. Additionally, during the third quarter of 2014, the Company conducted a shareholder rights offering to all existing shareholders to increase liquidity at the holding company and to limit their ownership dilution from the sale of Class A common stock to the other investors in the private placement. The Company issued approximately 5.0 million shares and received gross proceeds of approximately $6.0 million. The private placement and the shareholders rights offering combined to increase tangible common equity by nearly $17.6 million.

CAPITAL ADEQUACY

The Company and Royal Bank are 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 Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s and Royal Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. The capital adequacy guidelines require the Company and Royal 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). Under the informal agreement referenced in “Note 2 – Regulatory Matters and Significant Risks And Uncertainties” to the Consolidated Financial Statements, Royal Bank is required to maintain a minimum Tier 1 leverage ratio of 8% and a Total risk-based capital ratio of 12%. At September 30, 2014 and December 31, 2013, the Company and Royal Bank met and compared favorably to the minimum capital adequacy requirements of Tier 1 and total capital to risk-weighted assets and the minimum Tier 1 leverage ratio, as defined by banking regulation. Royal Bank also met the criteria for a well-capitalized institution. Management believes that, under current regulations, the Company will continue to meet its minimum capital requirements in the foreseeable future.

In July 2013, the federal bank regulatory agencies adopted final rules to revise the agencies’ capital adequacy guidelines and prompt corrective action rules, which were designed to enhance such requirements and implement the revised standards of the Basel Committee on Banking Supervision, commonly referred to as Basel III. The July 2013 final rules generally implement higher minimum capital requirements, add a new common equity tier 1 capital requirement, and establish criteria that instruments must meet to be considered common equity tier 1 capital, additional tier 1 capital or tier 2 capital. The new minimum capital to risk-adjusted assets requirements are a common equity tier 1 capital ratio of 4.5% (6.5% to be considered “well capitalized”) and a tier 1 capital ratio of 6.0%, increased from 4.0% (and increased from 6.0% to 8.0% to be considered “well capitalized”); the total capital ratio remains at 8.0% under the new rules (10.0% to be considered “well capitalized”). Under the new rules, in order to avoid limitations on capital distributions (including dividend payments and certain discretionary bonus payments to executive officers), a banking organization must hold a capital conservation buffer comprised of common equity tier 1 capital above its minimum risk-based capital requirements in an amount greater than 2.5% of total risk-weighted assets. The new minimum capital requirements are effective on January 1, 2015. The capital contribution buffer requirements phase in over a three-year period beginning January 1, 2016.

In December 2013, Federal banking regulators issued rules for complying with the Volcker Rule provision of the Dodd-Frank Act. The Bank does not engage in, and does not expect to engage in, any transactions that are considered “covered activities” as defined by the Volcker Rule. Therefore, the Bank does not have any additional compliance obligations under the Volcker Rule.

Table of Contents

The Company and the Bank will continue to analyze these new rules and their effects on the business, operations and capital levels of the Company and the Bank.

In connection with a prior bank regulatory examination, the FDIC concluded, based upon its interpretation of the Consolidated Reports of Condition and Income (the “Call Report”) instructions and under regulatory accounting principles (“RAP”), that income from Royal Bank’s tax lien business should be recognized on a cash basis, not an accrual basis. Royal Bank’s current accrual method is in accordance with U.S. GAAP. Royal Bank disagrees with the FDIC’s conclusion and filed the Call Report for September 30, 2014 and the previous 16 quarters in accordance with U.S. GAAP. A change in the method of revenue recognition for the tax lien business for regulatory accounting purposes affects Royal Bank’s capital ratios as shown below. The resolution of this matter will be decided by additional joint regulatory agency guidance which includes the Federal Reserve Bank, the FDIC, and the OCC.

The table below sets forth Royal Bank’s capital ratios under RAP, based on the FDIC’s interpretation of the Call Report instructions:


	Actual				For capital adequacy purposes				To be well capitalized under prompt corrective action provision
(Dollars in thousands)	Amount		Ratio		Amount		Ratio		Amount		Ratio
Total capital (to risk-weighted assets)
At September 30, 2014	$	76,403	15.99	%	$	38,237	8.00	%	$	47,796	10.00	%
At December 31, 2013	$	71,417	15.61	%	$	36,590	8.00	%	$	45,737	10.00	%
Tier I capital (to risk-weighted assets)
At September 30, 2014	$	70,970	14.85	%	$	19,118	4.00	%	$	28,677	6.00	%
At December 31, 2013	$	65,602	14.34	%	$	18,295	4.00	%	$	27,442	6.00	%
Tier I capital (to average assets, leverage)
At September 30, 2014	$	70,970	9.96	%	$	28,492	4.00	%	$	35,615	5.00	%
At December 31, 2013	$	65,602	9.13	%	$	28,739	4.00	%	$	35,924	5.00	%

The tables below reflect the adjustments to the net loss as well as the capital ratios for Royal Bank under U.S. GAAP:


	For the nine months ended		For the year ended
(In thousands)	September 30, 2014		December 31, 2013
RAP net income (loss)	$	682	$	(139)
Tax lien adjustment, net of noncontrolling interest		3,556		2,844
U.S. GAAP net income	$	4,238	$	2,705


	At September 30, 2014				At December 31, 2013
	As reported		As adjusted		As reported		As adjusted
	under RAP		for U.S. GAAP		under RAP		for U.S. GAAP
Total capital (to risk-weighted assets)	15.99	%	16.61	%	15.61	%	16.49	%
Tier I capital (to risk-weighted assets)	14.85	%	15.49	%	14.34	%	15.22	%
Tier I capital (to average assets, leverage)	9.96	%	10.42	%	9.13	%	9.73	%

Table of Contents

The tables below reflect the Company’s capital ratios:


	Actual				For capital adequacy purposes				To be well capitalized under prompt corrective action provision
(Dollars in thousands)	Amount		Ratio		Amount		Ratio		Amount		Ratio
Total capital (to risk-weighted assets)
At September 30, 2014	$	94,205	19.37	%	$	38,899	8.00	%		N/A	N/A
At December 31, 2013	$	84,384	18.09	%	$	37,315	8.00	%		N/A	N/A
Tier I capital (to risk-weighted assets)
At September 30, 2014	$	85,328	17.55	%	$	19,449	4.00	%		N/A	N/A
At December 31, 2013	$	71,432	15.31	%	$	18,658	4.00	%		N/A	N/A
Tier I capital (to average assets, leverage)
At September 30, 2014	$	85,328	11.78	%	$	28,975	4.00	%		N/A	N/A
At December 31, 2013	$	71,432	9.79	%	$	29,178	4.00	%		N/A	N/A


	For the nine months ended		For the year ended
(In thousands)	September 30, 2014		December 31, 2013
U.S. GAAP net income	$	4,298	$	2,109
Tax lien adjustment, net of noncontrolling interest		(3,556)		(2,844)
RAP net income (loss)	$	742	$	(735)


	At September 30, 2014				At December 31, 2013
	As reported under U.S. GAAP		As adjusted for RAP		As reported under U.S. GAAP		As adjusted for RAP
Total capital (to risk-weighted assets)	19.37	%	18.78	%	18.09	%	17.24	%
Tier I capital (to risk-weighted assets)	17.55	%	16.68	%	15.31	%	14.10	%
Tier I capital (to average assets, leverage)	11.78	%	11.17	%	9.79	%	8.98	%

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 investments and the repayment of loans. These sources provide alternatives to meet the Company’s short-term liquidity needs. Longer liquidity needs may be met by issuing longer-term deposits and by raising additional capital. The liquidity ratios are specifically defined as the ratio of net cash, available FHLB and other lines of credit, and unpledged marketable securities relative to both total deposits and total liabilities. The Company’s policy is to maintain a liquidity ratio as a percentage of total deposits of at least 12% and a liquidity ratio as a percentage of total liabilities of at least 10%. At September 30, 2014, the Company’s liquidity ratios were more than five times the policy minimums.

Table of Contents

Our funding decisions can be influenced by unplanned events, which include, but are not limited to, the inability to fund asset growth, difficulty renewing or replacing funds that mature, the ability to maintain or draw down lines of credit with other financial institutions, significant customer withdrawals of deposits, and market disruptions. The Company has a liquidity contingency plan in the event liquidity falls below an acceptable level, however in today’s economic environment, events could arise that may render sources of liquid funds unavailable in the future when required. The Company’s ALCO meets monthly to monitor liquidity management.

On August 13, 2009, the Company’s Board of Directors suspended the regular quarterly cash dividends on the $30.4 million in Series A Preferred Stock issued to the United States Department of the Treasury (“Treasury”) as part of the Capital Purchase Program (“CPP”) established by the Treasury. The Company’s Board of Directors took this action in consultation with the Federal Reserve Bank of Philadelphia as required by recent regulatory policy guidance. As described under “Shareholders’ Equity”, on July 2, 2014, the Company redeemed 11,551 of the Series A Preferred stock and eliminated nearly $3.5 million in preferred dividends in arrears. As of September 30, 2014 the Series A Preferred stock dividend in arrears was approximately $6.1 million and has not been recognized in the consolidated financial statements.

Interest rate sensitivity is a function of the re-pricing characteristics of the Company’s assets and liabilities. These include the volume of assets and liabilities re-pricing, the timing of re-pricing, and the interest rate sensitivity gaps, which are a continual challenge in a changing rate environment. 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. The interest rate 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 re-pricing, they may react in different degrees to changes in market interest rates. Additionally, re-pricing characteristics of certain assets and liabilities may vary substantially within a given period.

The following table summarizes re-pricing intervals for interest earning assets and interest bearing liabilities as of September 30, 2014, 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 September 30, 2014, the Company is in a liability sensitive position of $45.0 million, which indicates that within one year the re-pricing of liabilities is sooner than the re-pricing of assets. Additionally, the Company has exposure to rising rates as $196.0 million in assets re-price after five years.

Table of Contents


(In millions)	Days						1 to 5		Over 5		Non-rate
Assets (1)	0 – 90			91 – 365			Years		Years		Sensitive		Total
Interest-earning deposits in banks	$	13.1		$	—		$	—	$	—	$	8.8	$	21.9
Investment securities AFS		12.2			25.9			151.8		74.4		1.1		265.4
Loans: (2)
Fixed rate		23.4			34.0			134.3		121.6		(11.5)		301.8
Variable rate		52.6			32.3			—		—		—		84.9
Total loans		76.0			66.3			134.3		121.6		(11.5)		386.7
Other assets (3)		—			21.5			—		—		28.0		49.5
Total Assets	$	101.3		$	113.7		$	286.1	$	196.0	$	26.4	$	723.5
Liabilities & Capital
Deposits:
Non-interest bearing deposits	$	—		$	—		$	—	$	—	$	67.9	$	67.9
Interest bearing deposits		24.4			73.2			125.5		—		—		223.1
Certificate of deposits		29.0			95.1			86.9		13.8		—		224.8
Total deposits		53.4			168.3			212.4		13.8		67.9		515.8
Borrowings		28.3			10.0			85.0		—		—		123.3
Other liabilities		—			—			—		—		21.9		21.9
Capital		—			—			—		—		62.5		62.5
Total liabilities & capital	$	81.7		$	178.3		$	297.4	$	13.8	$	152.3	$	723.5
Net interest rate GAP	$	19.6		$	(64.6)		$	(11.3)	$	182.2	$	(125.9)
Cumulative interest rate GAP	$	19.6		$	(45.0)		$	(56.3)	$	125.9
GAP to total assets		3	%		(9)	%
GAP to total equity		31	%		(103)	%
Cumulative GAP to total assets		3	%		(6)	%
Cumulative GAP to total equity		31	%		(72)	%

(1)

Interest earning assets are included in the period in which the balances are expected to be repaid and/or re-priced as a result of anticipated prepayments, scheduled rate adjustments, and contractual maturities.

(2)

Reflects principal maturing within the specified periods for fixed rate loans and re-pricing for variable rate loans; includes non-performing loans.

(3)

Includes FHLB stock.

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 re-price 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 changes 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. 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.

The Company’s 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. At September 30, 2014, floating rate loans with floors and without floors were $67.9 million and $17.0 million, respectively.

Table of Contents

REGULATORY ACTIONS

FDIC and Department of Banking Memorandum of Understanding

During the fourth quarter of 2011, Royal Bank entered into an informal agreement, known as a memorandum of understanding (“MOU”) with each of the FDIC and the Department. Included in the MOU is the requirement of maintaining a ratio of tier 1 capital to total assets (“leverage ratio”) equal to or greater than 8% and a total risk-based capital ratio equal to or greater than 12%. At September 30, 2014, based on capital levels calculated under regulatory accounting purposes (“RAP”), Royal Bank’s leverage and total risk-based capital ratios were 9.96% and 15.99%, respectively. Please refer to “Capital Adequacy” under “Financial Condition”.

Federal Reserve Memorandum of Understanding

As previously disclosed, in March 2010, the Company agreed to enter into a written agreement (the “Federal Reserve Agreement”) with the Federal Reserve Bank of Philadelphia (the “Federal Reserve Bank”). Effective July 17, 2013, the Board of Governors of the Federal Reserve System terminated the enforcement action under the Federal Reserve Agreement, and it was replaced with an informal non-public agreement, an MOU, with the Federal Reserve Bank. Included in the MOU are certain continued reporting requirements and a requirement that the Company receive the prior approval of the Federal Reserve Bank prior to declaring or paying any dividends on the Company’s capital stock, making interest payments related to the Company’s outstanding trust preferred securities or subordinate securities, incurring or guaranteeing certain debt with an original maturity date greater than one year, and purchasing or redeeming any shares of stock. The MOU will remain in effect until stayed, modified, terminated or suspended in writing by the Federal Reserve Bank.

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

The Company maintains a set of disclosure controls and procedures that are designed to ensure that information required to be disclosed in 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, the Company evaluated, under the supervision and with the participation of our management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rule 13a-15(e) of the Exchange Act. Based on that evaluation, except as described below, our CEO and CFO concluded, subject to the limitations on effectiveness described in Item 9A in our Annual Report on Form 10-K for the year ended December 31, 2013, that the Company’s disclosure controls and procedures were effective at September 30, 2014.

As described in Item 9A in our Annual Report on Form 10-K for the year-ended December 31, 2013, management had identified a material weakness associated with internal controls over financial reporting for income taxes. The Company is making improvements to the accounting procedures related to income taxes to remediate this weakness.

(b) Changes in Internal Control Over Financial Reporting

There have been no changes in the Company’s internal control over financial reporting during the third quarter of 2014 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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

Table of Contents

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.

PART II - OTHER INFORMATION

Item 1.Legal Proceedings.

From time to time, the Company is a party to routine legal proceedings within the normal course of business. Such routine legal proceedings in the aggregate are believed by management to be immaterial to the Company's financial condition or results of operations. All non-routine legal proceedings are described in Item 3 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

Item 1A.Risk Factors.

There have been no material changes from risk factors as previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013.

Item 2.Unregistered Sales of Equity Securities and Use of Proceeds.

On July 1, 2014, the Company completed the issuance and sale of 11,264,037 shares of its Class A common stock in a private placement. The shares were sold to accredited investors under Rule 506 promulgated by the United States Securities and Exchange Commission. Each share was sold at a price of $1.20 per share, and no underwriting discounts or commissions were paid in connection with the sale of such shares.

On September 4, 2014, the Company sold an additional 402,630 shares of its Class A common stock to two of the institutional investors that purchased shares in the private placement pursuant to top-up rights granted to such investors in connection with their purchases in the private placement. Such shares were sold at a price of $1.20 per share, and no underwriting discounts or commissions were paid in connection with the issuance and sale of such additional shares. The total gross proceeds, before related expenses, from the sale of shares in the private placement were approximately $14,000,000. The proceeds from the sale of shares in the private placement were used to fund the repurchase by the Company of 11,551 shares of its Series A Preferred Stock from the U.S. Treasury as described Item 2 of Part I of this Report under “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS—Shareholders’ Equity.”

Item 3.Defaults Upon Senior Securities.

None

Item 4.Mine Safety Disclosures.

None

Item 5.Other Information.

None

Table of Contents

Item 6.Exhibits.

(a)


3.1	Articles of Incorporation of the Company. (Incorporated by reference to Exhibit 3.1 of the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2013.)
3.21	Bylaws of the Company (Incorporated by reference to Exhibit 3(ii) to the Company’s report on Form 10-K filed with the Commission on March 30, 2009.)
31.1	Section 302 Certification Pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934 signed by F. Kevin Tylus, Principal Executive Officer of Royal Bancshares of Pennsylvania on November 12, 2014.
31.2	Section 302 Certification Pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934 signed by Michael S. Thompson, Principal Financial Officer of Royal Bancshares of Pennsylvania on November 12, 2014.
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 F. Kevin Tylus, Principal Executive Officer of Royal Bancshares of Pennsylvania on November 12, 2014.
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 Michael S. Thompson, Principal Financial Officer of Royal Bancshares of Pennsylvania on November 12, 2014.
101	Interactive Data File

Table of Contents

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: November 12, 2014

/s/ Michael S. Thompson

Michael S. Thompson

Principal Financial and Accounting Officer


PENNSYLVANIA		23-2812193
(State or other jurisdiction of incorporation or organization)		(IRS Employer identification No.)


Large accelerated filer ☐	Accelerated filer ☐
Non-accelerated filer ☐ (do not check if a smaller reporting company)	Smaller reporting company ☒


Class A Common Stock		Outstanding at October 31, 2014
$2.00 par value		27,801,904


Class B Common Stock		Outstanding at October 31, 2014
$0.10 par value		1,931,692


☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		PAGE
PART I	FINANCIAL STATEMENTS
Item 1	Financial Statements
	Consolidated Balance Sheets-unaudited	2
	Consolidated Statements of Operations-unaudited	3
	Statements of Consolidated Comprehensive Income (Loss)-unaudited	4
	Consolidated Statements of Changes in Shareholders’ Equity-unaudited	5
	Consolidated Statements of Cash Flows-unaudited	7
	Notes to Consolidated Financial Statement (Unaudited)	9
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	47
Item 3	Quantitative and Qualitative Disclosures about Market Risk	76
Item 4	Controls and Procedures	76
PART II	OTHER INFORMATION	77
Item 1	Legal Proceedings	77
Item 1A	Risk Factors	77
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	77
Item 3	Defaults Upon Senior Securities	77
Item 4	Mine Safety Disclosures	77
Item 5	Other Information	77
Item 6	Exhibits	78
	SIGNATURES	79


													Accumulated
	Preferred								Additional				other						Total
	stock		Class A common stock			Class B common stock			paid in		Accumulated		comprehensive		Treasury		Noncontrolling		Shareholders’
(In thousands, except share data)	Series A		Shares	Amount		Shares	Amount		capital		deficit		(loss)		stock		Interest		Equity
Balance January 1, 2014	$	29,950	11,470	$	22,940	1,987	$	199	$	127,299	$	(120,396)	$	(6,122)	$	(6,336)	$	271	$	47,805
Net income												4,298						212		4,510
Other comprehensive income, net of reclassifications and taxes														4,307						4,307
Distributions to noncontrolling interests																		(208)		(208)
Common stock conversion from Class B to Class A			64		127	(55)		(6)				(121)								—
Redemption of 11,551 shares of preferred stock		(11,551)								(2,392)										(13,943)
Accretion of discount on preferred stock		457										(457)								—
Common shares issued			16,666		33,333					(13,333)										20,000
Treasury shares issued for compensation										(463)						541				78
Other adjustment to additional paid in capital										(28)										(28)
Stock option expense										12										12
Balance September 30, 2014	$	18,856	28,200	$	56,400	1,932	$	193	$	111,095	$	(116,676)	$	(1,815)	$	(5,795)	$	275	$	62,533