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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC  20549

FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended:          December 31, 2016         

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

For the transition period from: to

Commission file number:  0-26366

ROYAL BANCSHARES OF PENNSYLVANIA, INC.

(Exact name of the registrant as specified in its charter)

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

One Bala Plaza, Suite 522, 231 St. Asaph’s Road, Bala Cynwyd, PA 19004

(Address of principal Executive Offices)

Registrant’s telephone number, including area code: (610)  668-4700

Securities registered pursuant to Section 12(b) of the Act:

Name of Each Exchange on Which Registered	Title of Each Class
The NASDAQ Stock Market, LLC	Class A Common Stock ($2.00 par value)

Securities registered pursuant to Section 12(g) of the Act:

Name of Each Exchange on Which Registered	Title of Each Class
None	Class B Common Stock ($0.10 par value)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. [ ] Yes [X] No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act.
[ ] Yes [X] No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 of 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes [ X ]   No [  ]

Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding twelve months (or for such shorter period that the registrant was required to submit and post such files).  Yes [ X ]    No [   ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   Yes [  ]  No [ X ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ___     Accelerated filer ___    Non-accelerated filer ____     Small reporting company __X__

Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act) Yes [  ]   No [ X ]

The aggregate market value of the Registrant’s Common Stock held by non-affiliates is $43,485,825 based on the June 30, 2016 closing price of the Registrant’s Common Stock of $2.26 per share.

As of February 28, 2017, the Registrant had 27,913,024 and 1,924,629 shares outstanding of Class A and Class B common stock, respectively.

Documents Incorporated by Reference:

None.

Table of Contents

	Page
FORWARD LOOKING STATEMENTS	3
PART I
ITEM 1.  BUSINESS	3
ITEM 1A.  RISK FACTORS	14
ITEM 1B.  UNRESOLVED STAFF COMMENTS	20
ITEM 2.  PROPERTIES	20
ITEM 3.  LEGAL PROCEEDINGS	21
ITEM 4.  MINE SAFETY DISCLOSURES	21
PART II
ITEM 5.   MARKET FOR REGISTRANT’S COMMON EQUITY, AND RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES	21
ITEM 6.  SELECTED FINANCIAL DATA	24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	25
ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK	49
ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA	52
ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE	112
ITEM 9A.  CONTROLS AND PROCEDURES	112
ITEM 9B.   OTHER INFORMATION	112
PART III.
ITEM 10.  DIRECTORS,  EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE	113
ITEM 11.  EXECUTIVE COMPENSATION	116
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERS MATTERS	124
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE	126
ITEM 14.  PRINCIPAL ACCOUNTING FEES AND SERVICES	127
PART IV
ITEM 15.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K	128
SIGNATURES	131

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FORWARD LOOKING STATEMENTS

From time to time, Royal Bancshares of Pennsylvania, Inc. (the “Company”, “We”, or “Our”) 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”, “could”, “may”, “plan”, or similar expressions, we are making forward-looking statements.

In order to comply with the terms of the safe harbor, we note that a variety of factors could cause our actual results and experience to differ materially from the anticipated results or other expectations expressed in our forward-looking statements. The risks and uncertainties that may affect the operations, performance, development and results of our 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; 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 us on our website, or otherwise.  We expressly disclaim any obligation to update any forward-looking statement to reflect future statements to reflect future events or developments.

PART I

ITEM 1.  BUSINESS

Royal Bancshares of Pennsylvania, Inc.

Royal Bancshares of Pennsylvania, Inc. (the “Company”, “We”, or “Our”), is a Pennsylvania business corporation and a bank holding company registered under the Federal Bank Holding Company Act of 1956, as amended (the “BHCA”). We are supervised by the Board of Governors of the Federal Reserve System (“Federal Reserve Board”).  Our legal headquarters are located at One Bala Plaza, Suite 522, 231 St. Asaph’s Road, Bala Cynwyd, Pennsylvania, 19004. 

The principal activities of the Company are supervising Royal Bank America (“Royal Bank”) which engages in general banking business principally in Montgomery, Delaware, Chester, Bucks, Philadelphia and Berks counties in Pennsylvania, central and southern New Jersey, and Delaware.  Royal Bank is subject to supervision, regulation and examination by the Federal Deposit Insurance Corporation (“FDIC”) and by the Pennsylvania Department of Banking and Securities (the “Department”).  We also have a wholly-owned non-bank subsidiary, Royal Investments of Delaware, Inc., which is engaged in investment activities. 

At December 31, 2016, we had consolidated total assets of approximately $832.5 million, total deposits of approximately $629.5 million and shareholders’ equity of approximately $51.6 million. The Company’s 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”).  We have two reportable operating segments, “Community Banking” and “Tax Liens”.

On  January 30, 2017, the Company and Bryn Mawr Bank Corporation (“Bryn Mawr”) entered into an Agreement and Plan of Merger (the “Merger Agreement”).  The Merger Agreement provides that, upon the terms and subject to the conditions set forth therein, the Company will merge with and into Bryn Mawr, with Bryn Mawr as the surviving corporation (the “Merger”).  Immediately following the Merger, Royal Bank will merge with the Bryn Mawr Trust Company, the wholly owned subsidiary of Bryn Mawr.  Upon completion of the Merger, holders of Class A common stock of the Company will receive 0.1025 shares of Bryn Mawr common stock, par value of $1.00 per share (the “Bryn Mawr common stock”) for each share of Class A common stock they hold, and holders of Class B common stock of the Company will receive 0.1179 shares of Bryn Mawr common stock for each share of Class B common stock they hold.  The Merger, which is subject to a number of closing conditions including receipt of required regulatory approvals and approval by the Company’s shareholders, is expected to be completed in the third quarter of 2017.

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Regulatory Actions

Federal Reserve Memorandum of Understanding (“MOU”)

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, a memorandum of understanding (“MOU”), with the Federal Reserve Bank.  The MOU was terminated in writing by the Federal Reserve Bank in February 2017.

Royal Bank America

Royal Bank was incorporated in the Commonwealth of Pennsylvania on July 30, 1963, was chartered by the Department, 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.  Royal Bank’s subsidiaries include 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.

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 principal amortization payments, maturities and sales, loan and other real estate owned (“OREO”) sales and the repayment of outstanding loans provide the majority of funds for activities.

Royal Bank conducts business operations as a commercial bank offering traditional consumer and business deposit products and services (excluding trust) and commercial and consumer loans, including home equity and small business loans.  Fee income services such as a suite of cash management products, remote deposit capture, mobile deposits, and payroll and merchant services have been greatly improved or expanded.  Services may be added or deleted from time to time.  Royal Bank’s business and services are not subject to significant seasonal fluctuations.

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.  We lease Royal Bank’s Customer Center, which includes a loan production office, in Bala Cynwyd, Pennsylvania and a loan production office in Princeton, New Jersey.  In February 2017, Royal Bank closed one branch location and intends to sell the building during the first quarter of 2017. 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 16 states and Washington, D.C. via loan originations with service area borrowers 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.

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.

Many bank holding companies have elected to become financial holding companies under the Gramm-Leach-Bliley Act of 1999, and such companies may provide a broader range of products and services with which Royal Bank must compete.  Management believes this statute further narrowed the differences and intensified competition among commercial banks, investment banks, insurance firms and other financial services companies.  We have not elected financial holding company status.

Employees:  Royal Bank employed approximately 117 persons on a full-time equivalent basis as of December 31, 2016.

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Deposits: At December 31, 2016, total deposits of Royal Bank were distributed among demand deposits (16%), money market deposit, savings and NOW accounts (47%) and time deposits (37%).  At year-end 2016, deposits increased $43.0 million to $631.9 million from year-end 2015, or 7.3%, and reflected a change in the composition. Savings accounts grew $31.3 million, or 58.2% from December 31, 2015.  Additionally, certificates of deposits and demand deposits increased $25.7 million and $5.7 million, respectively.  NOW and money market accounts decreased $19.7 million. Included in Royal Bank’s deposits are approximately $2.3 million of intercompany deposits that are eliminated through consolidation.

Lending:  At December 31, 2016, Royal Bank had a total net loan portfolio of $591.6 million, representing 71.4% of total assets.  The loan portfolio is categorized into commercial demand, commercial mortgages, residential mortgages (including home equity lines of credit), construction, tax lien certificates, small business leases and installment loans.  At year-end 2016, net loans grew $102.2 million from year end 2015. 

Non-Bank Subsidiaries

On June 30, 1995, we established a special purpose Delaware investment company, Royal Investment of Delaware (“RID”), as a wholly-owned subsidiary. RID’s legal headquarters is 1105 N. Market Street, Suite 1300, Wilmington, Delaware 19899.  RID buys, holds and sells investment securities. At December 31, 2016, total assets of RID were $5.5 million, of which $4.8 million was held in cash and cash equivalents and $1.1 million was held in investment securities.  RID had net interest income of $587 thousand and $666 thousand for 2016 and 2015, respectively.  Non-interest income for 2016 and 2015 was $516 thousand and $316 thousand, respectively, and was comprised of net gains on sale of investment securities.  RID recorded net income of $1.0 million for 2016 compared to $781 thousand for 2015.  Royal Bank has previously extended loans to RID, secured by securities, as per the provisions of Regulation W.  At December 31, 2016, no loans were outstanding.  The amounts above include the activity related to RID’s wholly-owned subsidiary Royal Preferred LLC.

The Company, through its wholly-owned subsidiary Royal Bank, has an 80% ownership interest in CSC.  CSC acquired, through auction, delinquent property tax certificates 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 state law.  Royal Bank and a majority of  other CSC shareholders, voted to liquidate CSC under an orderly, long term plan adopted by CSC management.  CSC’s legal headquarters is located at 732 Montgomery Avenue, Narberth, Pennsylvania 19072. At December 31, 2016 and 2015, total assets of CSC were $1.4 million and $4.7 million, respectively. Included in total assets was OREO of $225 thousand and $3.2 million at December 31, 2016 and 2015, respectively.  For 2016, CSC recorded net interest expense of $213 thousand compared to $297 thousand for 2015 due to the continued liquidation of CSC’s tax lien certificate portfolio.  The 2016 credit for lien losses was $49 thousand compared to $2 thousand for 2015.  For 2016 and 2015, non-interest income was $0 thousand and $62 thousand, respectively.  Non-interest expense was a credit of $566 thousand compared to an expense of $125 thousand for 2016 and 2015, respectively.  Included in non-interest expense is net gains on the sale of OREO of $645 thousand and $101 thousand for 2016 and 2015, respectively. During 2016, CSC sold its largest tax lien property and received net proceeds of $3.8 million.  CSC recorded net income of $402 thousand in 2016 compared to a net loss of $357 thousand in 2015. 

On June 23, 2003, the Company, through its wholly-owned subsidiary Royal Bank, established Royal Investments America, LLC (“RIA”) as a wholly-owned subsidiary.  RIA’s legal headquarters is located at 732 Montgomery Avenue, Narberth, Pennsylvania 19072.  RIA was formed to invest in equity real estate ventures subject to limitations imposed by regulation.  At December 31, 2016 and 2015, total assets of RIA were $6.5 million and $6.1 million, which included $6.3 million and $5.8 million in cash, respectively. For 2016, RIA recorded net income of $483 thousand compared to $170 thousand for 2015.  Net income was directly impacted by gains on the sale of investment securities of $447 thousand and $182 thousand in 2016 and 2015, respectively.

On October 27, 2004, we 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 trust preferred securities.

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. Royal Leasing’s legal headquarters is located at 550 Township Line Road, Blue Bell, Pennsylvania 19422.  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 hold in its portfolio individual leases in amounts of up to $250 thousand. Leases originated in amounts in excess of that are sold to other leasing companies.  At December 31, 2016 and 2015, total assets of Royal Leasing were $61.6 million and $65.1 million, respectively.  For 2016 and 2015, Royal Leasing

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had net interest income of $3.3 million and $3.2 million, respectively.  For 2016, the provision for lease losses was $1.4 million compared to $906 thousand for 2015.  The 2016 provision was primarily attributable to specific reserves on the leasing and net charge-off activity.  Total net leases were $61.4 million at December 31, 2016 compared to $65.0 million at December 31, 2015.  Non-interest income for 2016 was $680 thousand compared to $473 thousand for 2015.  Non-interest expense, which includes management distribution fees, was $1.3 million and $1.2 million for 2016 and 2015, respectively. Royal Leasing recorded net income of $1.3 million for the year ended December 31, 2016 compared to $1.5 million for the year ended December 31, 2015.  

On November 17, 2006, the Company, through its wholly-owned subsidiary Royal Bank, formed RTL to purchase and service delinquent tax certificates.  RTL typically acquired delinquent property tax certificates 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 state law. RTL ceased acquiring tax certificates at public auctions in 2010.  RTL’s legal headquarters is located at 732 Montgomery Avenue, Narberth, Pennsylvania 19072.  At December 31, 2016, total assets of RTL, of which the majority was held in tax certificates and OREO, were $7.3 million compared to $9.4 million at December 31, 2015.  Tax certificates were $2.6 million at December 31, 2016 compared to $3.3 million at December 31, 2015.  OREO was $3.1 million at December 31, 2016 compared to $4.0 million at December 31, 2015.  For 2016, RTL had net interest expense of $131 thousand compared to net interest income of $116 thousand for 2015 due to the reduction in average tax certificates outstanding over the past year.  Provision for lien losses was $69 thousand compared to $100 thousand for 2016 and 2015, respectively.  Non-interest income was $59 thousand for 2016 compared to $209 thousand for 2015. Non-interest expense was $1.1 million for 2016 and 2015. RTL recorded a net loss of $1.1 million for 2016 compared to $885 thousand for 2015. 

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. During 2016, the subordinated debenture was redeemed.  At December 31, 2016 and 2015, Royal Preferred LLC had total assets of approximately $0 and $21.2 million, respectively. 

Website Access to Company Reports

We post publicly available reports required to be filed with the SEC on our website, www.royalbankamerica.com, as soon as reasonably practicable after filing such reports with the SEC.  The required reports are available free of charge through our website.  Information available on our website is not part of or incorporated by reference into this Report or any other report filed by us with the SEC.

Products and Services with Reputation Risk

We offer a diverse range of financial and banking products and services.  In the event one or more customers and/or governmental agencies become dissatisfied or object to any product or service offered by us or any of our subsidiaries, whether legally justified or not, the resulting negative publicity with respect to any such product or service could have an adverse impact on our reputation. The discontinuance of any product or service, whether or not any customer or governmental agency has challenged any such product or service, could have an unfavorable impact on our reputation.

Concentrations, Seasonality

We do not have any portion of our business dependent on a single or limited number of customers, the loss of which would have a material adverse effect on our business.  No substantial portion of loans or investments is concentrated within a single industry or group of related industries, but a significant majority of loans are secured by real estate.  The business of the Company and its subsidiaries is not seasonal in nature.

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Environmental Compliance

The Company and its subsidiaries’ compliance with federal, state and local environment protection laws had no material effect on their capital expenditures, earnings or competitive position in 2016, and is not expected to have a material effect on such expenditures, earnings or competitive position in 2017.

Supervision and Regulation

Bank holding companies and banks operate in a highly regulated environment and are regularly examined by federal and state regulatory authorities.  The following discussion concerns various federal and state laws and regulations and the potential impact of such laws and regulation on us and our subsidiaries.  To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory or regulatory provisions themselves.  Proposals to change laws and regulations are frequently introduced in Congress, the state legislatures, and before the various bank regulatory agencies.  We cannot determine the likelihood or timing of any such proposals or legislations or the impact they may have on us and our subsidiaries.  A change in law, regulations or regulatory policy may have a material effect on our business.

Holding Company

We are subject to the jurisdiction of the Securities and Exchange Commission (the “SEC”) and of state securities commissions for matters relating to the offering and sale of our securities.  Accordingly, if we wish to issue additional shares of our Common Stock, in order, for example, to raise capital or to grant stock options, we will have to comply with the registration requirements of the Securities Act of 1933 as amended, or find an applicable exemption from registration.

We are subject to the provisions of the BHCA and to supervision, regulation and examination by the Federal Reserve Board.  The BHCA requires us to secure the prior approval of the Federal Reserve Board before we own or control, directly or indirectly, more than 5% of the voting shares of any corporation, including another bank.  A bank holding company also is prohibited from engaging in or acquiring direct or indirect control of more than 5% of the voting shares of any such company engaged in non-banking activities unless the Federal Reserve Board, by order or regulation, has found such activities to be closely related to banking or managing or controlling banks as to be a proper incident thereto.  In making this determination, the Federal Reserve Board considers whether the performance of these activities by a bank holding company would offer benefits to the public that outweigh possible adverse effects.

As a bank holding company, we are required to file an annual report with the Federal Reserve Board and any additional information that the Federal Reserve Board may require pursuant to the BHCA. The Federal Reserve Board may also make examinations of the Company and any or all of its subsidiaries.  Further, under the BHCA and the Federal Reserve Board’s regulations, a bank holding company and its subsidiaries are prohibited from engaging in certain tying arrangements in connection with any extension of credit or provision of credit of any property or services.  The so called “anti-tying” provisions state generally that a bank may not extend credit, lease, sell property or furnish any service to a customer on the condition that the customer obtain additional credit or services from the bank, its bank holding company or any other subsidiary of its bank holding company, or on the condition that the customer not obtain other credit or services from a competitor of the bank, its bank holding company or any subsidiary of its bank holding company.  Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve Act and by state banking laws on any extensions of credit to the bank holding company or any of the holding company’s subsidiaries, on investments in the stock or other securities of the bank holding company and on taking stock or securities of the bank holding company as collateral for loans to any borrower.

Under the Pennsylvania Banking Code of 1965, as amended, the (“Code”), we are permitted to control an unlimited number of banks.  However, we would be required under the BHCA to obtain the prior approval of the Federal Reserve Board before we could acquire all or substantially all of the assets of any bank, or acquire ownership or control of any voting shares of any bank other than Royal Bank, if, after such acquisition, we would own or control more than 5% of the voting shares of such bank.  A bank holding company located in Pennsylvania, another state, the District of Columbia or a territory or possession of the United States may control one or more banks, bank and trust companies, national banks, interstate banks and, with the prior written approval of the Department, may acquire control of a bank and trust company or a national bank located in Pennsylvania.  A Pennsylvania-chartered institution may maintain a bank, branches in any other state, the District of Columbia, or a territory or possession of the United States upon the written approval of the Department.

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Federal law also prohibits the acquisition of control of a bank holding company without prior notice to certain federal bank regulators.  Control is defined for this purpose as the power, directly or indirectly, to direct the management or policies of a bank or bank holding company or to vote 25% or more of any class of voting securities of a bank or bank holding company.

Royal Bank

The Department and the FDIC routinely examine Pennsylvania state-chartered, non-member banks such as Royal Bank in areas such as reserves, loans, investments, management practices, and other aspects of operations. These examinations are designed for the protection of depositors rather than the Company’s shareholders.  The deposits of Royal Bank are insured by the FDIC to the maximum amount permitted by law. 

In addition, Royal Bank is subject to a variety of state and federal laws that affect its operation.  Federal and state banking laws and regulations govern, among other things, the scope of a bank’s business, the investments a bank may make, the reserves against deposits a bank must maintain, the types and terms of loans a bank may make and the collateral it may take, the activities of banks with respect to mergers and consolidations, and the establishment of branches. 

Under the Federal Deposit Insurance Act (“FDIC Act”), the FDIC possesses the power to prohibit institutions regulated by it (such as Royal Bank) from engaging in any activity that would be an unsafe and unsound banking practice or in violation of applicable law.  Moreover, the FDIC Act: (i) empowers the FDIC to issue cease-and-desist or civil money penalty orders against Royal Bank or its executive officers, directors and/or principal shareholders based on violations of law or unsafe and unsound banking practices; (ii) authorizes the FDIC to remove executive officers who have participated in such violations or unsound practices; (iii) restricts lending by Royal Bank to its executive officers, directors, principal shareholders or related interests thereof; and (iv) restricts management personnel of a bank from serving as directors or in other management positions with certain depository institutions whose assets exceed a specified amount or which have an office within a specified geographic area.  Additionally, the FDIC Act provides that no person may acquire control of Royal Bank unless the FDIC has been given 60-days prior written notice and within that time has not disapproved the acquisition or extended the period for disapproval.

Under the Community Reinvestment Act (“CRA”), the FDIC uses a five-point rating scale to assign a numerical score for a bank’s performance in each of three areas: lending, service and investment.  Under the CRA, the FDIC is required to:  (i) assess the records of all financial institutions regulated by it to determine if these institutions are meeting the credit needs of the community (including low-and moderate-income neighborhoods) which they serve, and (ii) take this record into account in its evaluation of any application made by any such institutions for, among other things, approval of a branch or other deposit facility, office relocation, a merger or an acquisition of another bank.  The CRA also requires the federal banking agencies to make public disclosures of their evaluation of each bank’s record of meeting the credit needs of its entire community, including low-and moderate-income neighborhoods. This evaluation will include a descriptive rating (“outstanding,” “satisfactory,” “needs to improve” or “substantial noncompliance”) and a statement describing the basis for the rating. 

The Federal Reserve Act and Federal Reserve Board regulations also place certain limitations and reporting requirements on extensions of credit by a bank to principal shareholders of its parent holding company, among others, and to related interests of such principal shareholders. In addition, such legislation and regulations may affect the terms upon which any person who becomes a principal shareholder of a holding company may obtain credit from banks with which the subsidiary bank maintains a correspondent relationship.

From time to time, various types of federal and state legislation have been proposed that could result in additional regulation of, and restrictions on, the business of Royal Bank.  It cannot be predicted whether any such legislation will be adopted or how such legislation would affect the business of Royal Bank. As a consequence of the extensive regulation of commercial banking activities in the United States, Royal Bank’s business is particularly susceptible to being affected by federal legislation and regulations that may increase the costs of doing business.

Under the Bank Secrecy Act (“BSA”), banks and other financial institutions are required to report to the Internal Revenue Service currency transactions of more than $10 thousand or multiple transactions in any one day of which the banks are aware that exceed $10 thousand in the aggregate.  Civil and criminal penalties are provided under the BSA for failure to file a required report, for failure to supply information required by the BSA or for filing a false or fraudulent report.

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Capital Requirements and Basel III:  In order to minimize losses to the deposit insurance funds, the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), established a format to monitor FDIC-insured institutions and to enable “prompt corrective action” by the appropriate federal supervisory agency if an institution begins to experience any difficulty. FDICIA established five capital categories for insured depository institutions under the prompt corrective action regulations. 

An “undercapitalized” institution is one that fails to meet one or more of the required minimum capital levels for an adequately capitalized institution.  An “undercapitalized institution” must file a capital restoration plan and is automatically subject to restrictions on dividends, management fees and asset growth.  In addition, the institution is prohibited from making acquisitions, opening new branches, and engaging in new lines of business without the prior approval of its primary federal regulator and other restrictions may be imposed.

A “significantly undercapitalized” institution is subject to similar regulatory requirements and restrictions as an “undercapitalized institution.  Additional regulatory directives include mandated capital raising activities, restrictions on interest rates paid and transactions with affiliates, removal of management and other restrictions.

A “critically undercapitalized” institution is prohibited from taking the following actions without the prior written approval of its primary federal supervisory agency:  engaging in any material transactions other than in the usual course of business; extending credit for highly leveraged transactions; amending its charter or bylaws; making any material changes in accounting methods; engaging in certain transactions with affiliates; paying excessive compensation or bonuses; and paying interest on liabilities exceeding the prevailing rates in the institution’s market area.  In addition, a “critically undercapitalized” institution is prohibited from paying interest or principal on its subordinated debt and is subject to being placed in conservatorship or receivership if its tangible equity capital level is not increased within certain mandated time frames.

The overall goal of these capital measures is to impose scrutiny and operational restrictions on banks as they descend the capital categories from well capitalized to critically undercapitalized.  Federal bank regulators may set capital requirements for a particular banking organization that are higher than the minimum ratios when circumstances warrant.

The Basel Committee on Banking Supervision and the Financial Stability Board (“Basel Committee”), which was established by the Group of 20 (“G-20”) Finance Ministers and Central Bank Governors to take action to strengthen regulation and supervision of the financial system with greater international consistency, cooperation and transparency, have both committed to raise capital standards and liquidity buffers within the banking system. In December 2010 and January 2011, the Basel Committee published the final reforms on capital and liquidity generally referred to as “Basel III”. 

In July 2013, the federal bank regulatory agencies adopted final rules with the aim to improve the quality and increase the quantity of capital for all banks as well as set higher standards for large internationally active banks. The agencies view the new capital requirements as a better reflection of banking organizations’ risk profiles, thereby improving the overall resiliency of the banking system. The rules generally implement higher minimum capital requirements, add a new common equity tier 1 capital requirement or “CET1”, and establish criteria that instruments must meet to be considered common equity tier 1 capital, additional tier 1 capital, or tier 2 capital.  Basel III also introduces a non-risk adjusted tier 1 leverage ratio of 3%, based on a measure of total exposure rather than total assets, and new liquidity requirements.  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 CET1 above its minimum risk-based capital requirements in an amount greater than 2.5% of total risk-weighted assets.   The new minimum capital requirements became effective on January 1, 2015.  The capital conservation buffer requirements phase in over a three-year period beginning January 1, 2016. 

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The following table shows the required capital ratios with the conservation buffer over the phase-in period. 

	Basel III Community Banks
	Minimum Capital Ratio Requirements
	2015		2016		2017		2018		2019
Common equity tier 1 capital (CET1)	4.500	%	5.125	%	5.750	%	6.375	%	7.000	%
Tier I capital (to risk-weighted assets)	6.000	%	6.625	%	7.250	%	7.875	%	8.500	%
Total capital (to risk-weighted assets)	8.000	%	8.625	%	9.250	%	9.876	%	10.500	%
Tier I capital (to average assets, leverage)	4.000	%	4.000	%	4.000	%	4.000	%	6.500	%

Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010: On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) was enacted into law.  The Dodd-Frank Act significantly changed the regulation of financial institutions and the financial services industry and includes provisions that, among other things:

· create the Financial Services Oversight Council to identify emerging systemic risks and improve interagency cooperation;

· centralize the responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau, which will be responsible for implementing, examining and enforcing compliance with federal consumer financial laws;

· permanently raise the current standard maximum deposit insurance amount to $250 thousand;

· establish strengthened capital standards for banks, and disallowing trust preferred securities as qualifying as Tier 1 capital (subject to certain exceptions and grandfather provisions for existing trust preferred securities);

· amend the Truth in Lending Act with respect to mortgage originations and establishing new minimum mortgage underwriting standards;

· strengthen the SEC’s powers to regulate securities markets;

· grant the Federal Reserve Board the power to regulate debit card interchange fees;

· allow the FDIC to raise the ratio of reserves to deposits from 1.15% to 1.35% for deposit insurance purposes by December 31, 2020 and to offset the effect of increased assessments on insured depository institutions with assets of less than $10 billion;

· allow financial institutions to pay interest on business checking accounts; and

· implement provisions that affect corporate governance and executive compensation at all publicly traded companies.

Additionally the Dodd-Frank Act amended the BHCA to require the federal financial regulatory agencies to adopt rules that prohibit banks and their affiliates from engaging in proprietary trading in designated types of financial instruments and investing in covered funds. This statutory provision, commonly known as the “Volcker Rule,” defines covered funds as hedge funds or private equity funds.  The Volcker rule places a number of limitations on a community bank were it to retain an ownership interest in a covered fund that it organized and offered. In particular, the community bank (including all its affiliates) must limit its total interest in each covered fund to no more than 3% of the ownership interests issued by the covered fund, and to no more than 3% of the value of the entire covered fund. In addition, the aggregate of all interests the community bank (together with its affiliates) has in all covered funds may not exceed 3 percent of the community bank’s tier 1 capital.  At December 31, 2016, the Company had $1.8 million invested in private equity funds, of which $203 thousand is invested by Royal Bank.  The Volker Rule did not have a material impact on the operations of the Company and/or Royal Bank.

Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such requirements will have on the Company’s and Royal Bank’s operations is presently unclear. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make necessary changes in order to comply with new statutory and regulatory requirements.

FDIC Insurance Assessments:  Royal Bank is a member of the FDIC.  The FDIC assigns each depository institution to one of several supervisory groups based on both capital adequacy and the FDIC's judgment of the institution's strength in light of

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supervisory evaluations, including examination reports, statistical analyses and other information relevant to measuring the risk posed by the institution.  Each depositor is insured to at least $250 thousand.

The assessment base used to calculate insurance premiums is a bank’s average assets minus average tangible equity.  The FDIC is required under the Dodd-Frank Act to establish assessment rates that will allow the Deposit Insurance Fund to achieve a reserve ratio of 1.35% of insured deposits by September 2020.  In attempting to achieve the mandated 1.35% ratio, the FDIC implemented assessment formulas that charge banks over $10 billion in asset size more than banks under that size.  Those new formulas do not affect Royal Bank.  Under the Dodd-Frank Act, the FDIC is authorized to make reimbursements from the insurance fund to banks if the reserve ratio exceeds 1.50%, but the FDIC has adopted the “designated reserve ratio” of 2.0%.  In lieu of reimbursements, the FDIC has set lower base assessment rates if the reserve ratio for the prior assessment period is equal to or exceeds 2.0%.

In addition to deposit insurance, Royal Bank is also subject to assessments to pay the interest on Financing Corporation bonds.  The Financing Corporation was created by Congress to issue bonds to finance the resolution of failed thrift institutions.  Commercial banks and thrifts are subject to the same assessment for Financing Corporation bonds.  The FDIC sets the Financing Corporation assessment rate every quarter.  For the fourth quarter of 2016, the Financing Corporation’s assessment for Royal Bank (and all other banks), is an annual rate of $.0056 for each $100 of deposits.  The Financing Corporation bonds are expected to be paid off between 2018 and 2019.

Sarbanes-Oxley Act of 2002: The primary aims of the Sarbanes-Oxley Act of 2002 (“SOX”) was to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. SOX addresses, among other matters, requirements for audit committee membership and responsibilities, requirements of management to evaluate our disclosure controls and procedures and its internal control over financial reporting, including certification of financial statements and the effectiveness of internal controls by the primary executive officer and primary financial officer; established standards for auditors and regulation of audits, including independence provisions that restrict  non-audit services that accountants may provide to their audit clients; and expanded the disclosure requirements for our Company insiders; and increased various civil and criminal penalties for fraud and other violations of securities laws.

USA Patriot Act of 2001: A major focus of governmental policy in recent years that impacts financial institutions has been combating money laundering and terrorist financing. The Patriot Act broadened anti-money laundering regulations to apply to additional types of financial institutions and strengthened the ability of the U. S. Government to help prevent and prosecute international money laundering and the financing of terrorism.  The potential impact of the Patriot Act on financial institutions of all kinds is significant and wide ranging.  The Patriot Act requires regulated financial institutions, among other things, to establish an anti-money laundering program that includes training and auditing components, to take additional precautions with non-U.S. owned accounts, and to comply with regulations related to verifying client identification at account opening. The Patriot Act also provides rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering. Failure of a financial institution to comply with the requirements of the Patriot Act could have serious legal and reputational consequences for the institution. We have implemented systems and procedures to meet the requirements of the regulation and will continue to revise and update policies, procedures and necessary controls to reflect changes required by the Patriot Act.

Gramm-Leach-Bliley Act of 1999: The Gramm-Leach-Bliley Act of 1999 (“GLBA”), also known as the Financial Services Modernization Act, repeals the two anti-affiliation provisions of the Glass-Steagall Act.  GLBA establishes a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers.  It revises and expands the framework of the Holding Company Act to permit a holding company to engage in a full range of financial activities through a new entity known as a financial holding company.  “Financial activities” is broadly defined to include not only banking, insurance and securities activities, but also merchant banking and additional activities that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to such financial activities, or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally.

In addition, GLBA provides a uniform framework for the functional regulation of the activities of banks, savings institutions and their holding companies; broadens the activities that may be conducted by national banks, banking subsidiaries of bank holding companies, and their financial subsidiaries; and adopts a number of provisions related to the capitalization, membership, corporate governance, and other measures designed to modernize the Federal Home Loan Bank system.

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Privacy provision: GLBA provides an enhanced framework for protecting the privacy of consumer information.  The FDIC and other banking regulatory agencies, as required under GLBA, have adopted rules limiting the ability of banks and other financial institutions to disclose nonpublic information about consumers to nonaffiliated third parties. Among other things, these provisions require banks and other financial institutions to have in place safeguards to ensure the security and confidentiality of customer records and information, to protect against anticipated threats or hazards to the security or integrity of such records, and to protect against unauthorized access to or use of such records that could result in substantial harm or inconvenience to a customer. GLBA also requires financial institutions to provide customers at the outset of the relationship and annually thereafter written disclosures concerning the institution’s privacy policies.  In 2015, GLBA was amended to eliminate the annual notification of written privacy policies by financial institutions, such as Royal Bank, that limit information sharing and post their privacy policies on their website.

GLBA also expressly preserves the ability of a state bank to retain all existing subsidiaries.  Because Pennsylvania permits commercial banks chartered by the state to engage in any activity permissible for national banks, Royal Bank will be permitted to form subsidiaries to engage in the activities authorized by GLBA to the same extent as a national bank.  In order to form a financial subsidiary, Royal Bank must be well-capitalized, and would be subject to the same capital deduction, risk management and affiliate transaction rules as applicable to national banks.

To the extent that GLBA permits banks, securities firms, and insurance companies to affiliate, the financial services industry may experience further consolidation.  GLBA is intended to grant to community banks certain powers as a matter of right that larger institutions have accumulated on an ad hoc basis.  Nevertheless, this act may have the result of increasing the amount of competition that the Company and Royal Bank face from larger institutions and other types of companies offering financial products, many of which may have substantially more financial resources than the Company and Royal Bank.

Regulation W: Transactions between a bank and its “affiliates” are quantitatively and qualitatively restricted under Sections 23A and 23B of Federal Reserve Act.  The FDIC Act applies Sections 23A and 23B to insured nonmember banks in the same manner and to the same extent as if they were members of the Federal Reserve System.  The Federal Reserve Board also issued Regulation W, which codifies prior regulations under Sections 23A and 23B of the Federal Reserve Act and interpretative guidance with respect to affiliate transactions.  Regulation W incorporates the exemption from the affiliate transaction rules but expands the exemption to cover the purchase of any type of loan or extension of credit from an affiliate.  Affiliates of a bank include, among other entities, the bank’s holding company and companies that are under common control with the bank.  We are considered to be an affiliate of Royal Bank.  In general, subject to certain specified exemptions, a bank or its subsidiaries are limited in their ability to engage in “covered transactions” with affiliates:

· To an amount equal to 10% of Royal Bank’s capital and surplus, in the case of covered transactions with any one affiliate; and

· To an amount equal to 20% of Royal Bank’s capital and surplus, in the case of covered transactions with all affiliates.

In addition, a bank and its subsidiaries may engage in covered transactions and other specified transactions only on terms and under circumstances that are substantially the same, or at least as favorable to the bank or its subsidiary, as those prevailing at the time for comparable transactions with nonaffiliated companies.  A “covered transaction” includes:

· A loan or extension of credit to an affiliate;

· A purchase of, or an investment in, securities issued by an affiliate;

· A purchase of assets from an affiliate, with some exceptions;

· The acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any party; and

· This issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate.

In addition, under Regulation W:

· A bank and its subsidiaries may not purchase a low-quality asset from an affiliate;

· Covered transactions and other specified transactions between a bank or its subsidiaries and an affiliate must be on terms and conditions that are consistent with safe and sound banking practices; and

· With some exceptions, each loan or extension of credit by a bank to an affiliate must be secured by collateral with a market value ranging from 100% to 130%, depending on the type of collateral, of the amount of the loan or extension of credit.

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Regulation W generally excludes all non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve Board decides to treat these subsidiaries as affiliates.

Concurrently with the adoption of Regulation W, the Federal Reserve Board has proposed a regulation which would further limit the amount of loans that could be purchased by a bank from an affiliate to not more than 100% of Royal Bank’s capital and surplus.

Truth in Savings Act: The Truth in Savings Act (“Act”) was implemented in 1993.  The purpose of this Act is to require the clear and uniform disclosure of the rates of interest that are payable on deposit accounts by Royal Bank and the fees that are assessable against deposit accounts, so that consumers can make a meaningful comparison between the competing claims of banks with regard to deposit accounts and products.  This Act requires Royal Bank to include, in a clear and conspicuous manner, the following information with each periodic statement of a deposit account:  (1) the annual percentage yield earned; (2) the amount of interest earned; (3) the amount of any fees and charges imposed; and (4) the number of days in the reporting period. This Act allows for civil lawsuits to be initiated by customers if Royal Bank violates any provision or regulation under this Act.

Real Estate Lending Guidelines: Pursuant to the FDICIA, the FDIC issued real estate lending guidelines that establish loan-to-value (“LTV”) ratios for different types of real estate loans.  An LTV ratio is generally defined as the total loan amount divided by the appraised value of the property at the time the loan is originated.  If a bank does not hold a first lien position, the total loan amount would be combined with the amount of all senior liens when calculating the ratio.  In addition to establishing the LTV ratios, the FDIC’s real estate guidelines require all real estate loans to be based upon proper loan documentation and a recent independent appraisal of the property.

The FDIC’s guidelines establish the following limits for LTV ratios:

Loan Category	LTV limit
Raw land	65	%
Land development	65	%
Construction:
Commercial, multifamily (includes condos and co-ops) and other nonresidential	80	%
Improved property	85	%
Owner occupied 1-4 family and home equity (without credit enhancements)	90	%

The guidelines provide exceptions to the LTV ratios for government-backed loans; loans facilitating the sale of real estate acquired by the lending institution in the normal course of business; loans where Royal Bank’s decision to lend is not based on the offer of real estate as collateral and such collateral is taken only out of an abundance of caution; and loans renewed, refinanced, or restructured by the original lender to the same borrower, without the advancement of new money.  The regulation also allows institutions to make a limited amount of real estate loans that do not conform to the proposed LTV ratios.  Under this exception, Royal Bank would be allowed to make real estate loans that do not conform to the LTV ratio limits, up to an amount not to exceed 100% of its total capital.

Other Legislation/Regulatory Requirements: Congress and the federal banking agencies routinely propose new regulations.  The Company cannot predict how any new legislation, or new rules adopted by the federal banking agencies, may affect its business or the business of Royal Bank in the future.

Monetary Policy

The earnings of Royal Bank are affected by the policies of regulatory authorities including the Federal Reserve Board.  An important function of the Federal Reserve System is to influence the money supply and interest rates.  Among the instruments used to implement those objectives are open market operations in United States government securities, changes in reserve requirements against member bank deposits and limitations on interest rates that member banks may pay on time and savings deposits.  These instruments are used in varying combinations to influence overall growth and distribution of bank loans and investments and deposits.  Their use may also affect rates charged on loans or paid for deposits.

The policies and regulations of the Federal Reserve Board have had and will probably continue to have a significant effect on its reserve requirements, deposits, loans and investment growth, as well as the rate of interest earned and paid, and are

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expected to affect Royal Bank’s operations in the future.  The effect of such policies and regulations upon the future business and earnings of Royal Bank cannot be predicted.

Effects of Inflation

Inflation can impact the country’s overall economy, which in turn can impact the business and revenues of the Company and our subsidiaries.  Inflation has some impact on our operating costs.  Unlike many industrial companies, however, substantially all of our assets and liabilities are monetary in nature.  As a result, interest rates have a more significant impact on our performance than the general level of inflation.  Over short periods of time, interest rates may not necessarily move in the same direction or in the same magnitude as prices of goods and services.

Available Information

Upon a shareholder’s written request, a copy of the Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, as required to be filed with the SEC pursuant to Exchange Act Rule 13a-1, may be obtained without charge from our Chief Financial Officer, Royal Bancshares of Pennsylvania, Inc. One Bala Plaza, Suite 522, 231 St. Asaph’s Road, Bala Cynwyd, Pennsylvania 19004 or on our website www.royalbankamerica.com.

ITEM 1A. RISK FACTORS

An investment in our common stock involves risks. Before making an investment decision, investors should carefully consider the risks described below in conjunction with the other information in this Report, including our consolidated financial statements and related notes. If any of the following risks or other risks, which have not been identified or which we may believe are immaterial or unlikely, actually occurs, our business, financial condition and results of operations could be harmed. In such a case, the trading price of our common stock could decline, and investors may lose all or part of their investment.

Risks Related to Our Business

Our business is subject to the success of the local economies and real estate markets in which we operate.

Our earnings are significantly generated from net interest income which is heavily reliant on the interest and fees we earn on loans.  If prevailing economic conditions locally or nationally are unfavorable, our business may be adversely affected.  Unfavorable economic conditions in our targeted market areas, specifically depressed or declining real estate values could affect the ability of customers to repay their loans, impede our growth, and generally affect our financial condition and results of operations through potential increases in credit losses.  We are less able than a larger institution to spread the risks of unfavorable local economic conditions across broader and more diverse economies.

Our concentration of commercial real estate and construction loans is subject to unique risks that could adversely affect our earnings.

Our commercial real estate, including multi-family, and construction and land development loan portfolios were $368.3 million at December 31, 2016 comprising 61% of total loans.  Commercial real estate and construction and development loans are often riskier and tend to have significantly larger balances than home equity loans or residential mortgage loans to individuals. While we believe that the commercial real estate concentration risk is mitigated by diversification among the types and characteristics of real estate collateral properties, sound underwriting practices, and ongoing portfolio monitoring and market analysis, the repayments of these loans usually depends on the successful operation of a business or the sale of the underlying property.  As a result, these loans are more likely to be unfavorably affected by adverse conditions in the real estate market or the economy in general.  Commercial and industrial loans comprise 18% of the loan portfolio. These loans are collateralized by various business assets the value of which may decline during adverse market and economic conditions.  Adverse conditions in the real estate market and the economy may result in increasing levels of loan charge-offs and non-performing assets and the reduction of earnings.  When we take collateral in foreclosures and similar proceedings, we are required to mark the related asset to the then fair market value of the collateral, which may ultimately result in a loss.

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Our allowance for loan and lease losses may not be adequate to cover actual losses.

Like all financial institutions, we maintain an allowance for loan and lease losses (“allowance”) to provide for loan and lease defaults and non-performance.  Our allowance is based on our historical loss experience as well as an evaluation of the risks associated with our loan portfolio, including the size and composition of the loan portfolio, current economic conditions and geographic concentrations within the portfolio.  Our allowance may not be adequate to cover actual loan and lease losses.  Bank regulators periodically review our allowance and may require us to increase the allowance or recognize additional charge-offs.  Material increases to the allowance for loan and lease losses could materially decrease out net income.

The Financial Accounting Standards Board has adopted Accounting Standards Update No. 2016-13, “Financial Instruments-Credit Losses (Topic 326) Measurement of Credit Losses on Financial Instruments”, which is commonly referred to as CECL.  CECL will be effective in the first quarter of 2020. The CECL guidelines require us to gather and review additional data and types of data to determine the appropriate level for the allowance.New or changes to accounting or regulatory guidance could impact the need for additional reserves and future provisions for loan and lease losses could materially and adversely affect our financial results. We believe that expected credit losses under the CECL model will generally result in earlier loss recognition on our loans and lease portfolio. We are currently evaluating the impact of the amendments in this new standard on our consolidated financial statements.

Our future growth may require us to raise additional capital but, that capital may not always be available.

We are required by regulatory authorities to maintain adequate capital levels to support our operations. We anticipate that our current capital will satisfy our regulatory requirements for the foreseeable future. However, in order to maintain our well-capitalized status and to support future growth we may need to raise capital. Our ability to raise additional capital will depend, in part, on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Basel III introduced new minimum capital requirements that became effective on January 1, 2015, with the capital conservation buffer requirements phased in over a three-year period beginning January 1, 2016.  In addition, if we decide to raise additional capital, the existing shareholders are subject to dilution and a potential capital raise could adversely impact our deferred tax asset. If we cannot raise additional capital when required, our ability to further expand operations through both internal growth and acquisitions could be materially impaired.

We may suffer losses in our loan portfolio despite our underwriting practices.

We seek to mitigate the risks inherent in our loan portfolio by adhering to specific underwriting practices.  These practices often include: analysis of a borrower’s credit history, financial statements, tax returns and cash flow projections; valuation of collateral based on reports of independent appraisers; and verification of liquid assets.  Although we believe that our underwriting criteria are appropriate for the various kinds of loans we make, we may incur losses on loans that meet these criteria.

Our ability to pay dividends depends primarily on dividends from our banking subsidiary, which are subject to regulatory limits. 

We are a bank holding company and our operations are conducted by our direct and indirect subsidiaries, each of which is a separate and distinct legal entity.  Substantially all of our assets are held by such subsidiaries; and our ability to pay dividends depends on our receipt of dividends from our direct and indirect subsidiaries.  Royal Bank is our primary source of dividends.  Dividend payments from Royal Bank are subject to legal and regulatory limitations, generally based on net profits and retained earnings, imposed by the various banking regulatory agencies. The ability of Royal Bank to pay dividends is also subject to its profitability, financial condition, capital expenditures and other cash flow requirements. At December 31, 2016, as a result of significant losses within Royal Bank from prior years, we had an accumulated deficit and therefore would not have been able to declare and pay any cash dividends.  There is no assurance that our subsidiaries will be able to pay dividends in the future, or that we will generate adequate cash flow to pay dividends in the future.  Failure to pay dividends on our stock could have a material adverse effect on the market price of our Class A Common Stock. 

Our ability to use net operating loss carryforwards to reduce future tax payments may be limited.

As of December 31, 2016, we had federal net operating loss (“NOL”) carryforwards of approximately $57.7 million and state NOL carryforwards of $136.8 million, which are available to be carried forward to future tax years.  The federal NOL carryforwards will begin to expire in 2028 and the state NOLs will begin to expire in 2026 if not fully utilized.

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The ability to use NOLs will be dependent on our ability to generate taxable income. The NOLs may expire before we generate sufficient taxable income. There was a $4.0 million NOL carryover from the acquisition of Knoblauch State Bank that expired in 2015.  There were no NOLs that expired in 2016.  Refer to “Accounting for Income Tax Expense” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Report.

We may not be able to fully recover our deferred tax asset valuation allowance and a reduction in future enacted tax rates could have a material impact on the value of our deferred tax assets.

We recognize deferred tax assets (“DTA”) and liabilities based on differences between the financial statement carrying amounts and the tax bases of assets and liabilities. We are required to establish a valuation allowance for DTA and record a charge to income or shareholders' equity if management determines, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized.  Management evaluates the DTA for recoverability using a consistent approach which considers the relative impact of negative and positive evidence, including historical profitability and projections of future reversals of temporary differences and future taxable income. These determinations are inherently subjective and dependent upon estimates and judgments concerning management’s evaluation of both positive and negative evidence.

Based on the analysis of the DTA at December 31, 2016, management concluded that it is more likely than not that a portion of the net DTA will be realized by the Company in the future.As a result of this conclusion, we released $1.9 million of our valuation allowance previously recorded on the net DTA and credited income tax expense. In 2015, we released $5.4 million of our valuation allowance previously recorded on the net DTA. The ability to recognize the remaining deferred tax assets that continue to be subject to a valuation allowance will be evaluated on a quarterly basis to determine if there are any significant events that would affect the ability to utilize these deferred tax assets. The release of the remaining valuation allowance would have a positive impact on future earnings. There can be no assurance, however, as to when we could be in a position to recapture the remaining DTA valuation allowance. The deferred tax assets, net of valuation allowances, totaled $7.9 million and $5.7 million at December 31, 2016 and 2015, respectively.  The deferred tax asset valuation allowance was $26.6 million and $30.6 million at December 31, 2016 and 2015, respectively. Refer to “Accounting for Income Tax Expense” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Report.

Our net DTA are measured using the tax rates under the current enacted tax law expected to apply to taxable income in future years. The effects of future changes in tax laws or rates are not anticipated in the determination of the value of our deferred tax assets and liabilities. The U.S. Congress and the current administration have indicated an interest in, among other changes to federal tax laws, lowering the federal corporate tax rate from the current 35%. If these plans ultimately result in the enactment of new laws lowering the corporate income tax rate and/or eliminating the corporate alternative minimum tax, our net DTA would need to be re-calculated. It is difficult to predict whether any change to the federal corporate tax rate will occur, or if any change to the federal corporate tax rate did occur, the magnitude or timing of any change.

Although any reduction in the corporate tax rate would reduce the amount of taxes we would pay in the future, the reduction also would result in a decrease in the value of our DTA, and thus a reduction in our net income and total equity, during the period in which any such tax rate change is enacted. This reduction in our net income and total equity could materially and adversely affect our results of operations and financial condition. There is no assurance that any potential tax savings from a reduction in corporate tax rates, if enacted, would be realized to the extent anticipated or at all.

Competition from other financial institutions may adversely affect our profitability.

We face substantial competition in originating commercial and consumer loans. This competition comes principally from other banks, savings institutions, mortgage banking companies and other lenders.  Many of our competitors enjoy advantages, including greater financial resources and higher lending limits, a wider geographic presence, more accessible branch office locations, the ability to offer a wider array of services or more favorable pricing alternatives, as well as lower origination and operating costs. This competition could reduce our net income by decreasing the number and size of loans that we originate and the interest rates we may charge on these loans.

In attracting business and consumer deposits, Royal Bank faces substantial competition from other insured depository institutions such as banks, savings institutions and credit unions, as well as institutions offering uninsured investment alternatives, including money market funds.  Many of our competitors enjoy advantages, including greater financial resources,

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more aggressive marketing campaigns, better brand recognition and more branch locations.  These competitors may offer higher interest rates than we do, which could decrease the deposits that we attract or require us to increase our rates to retain existing deposits or attract new deposits.  Increased deposit competition could adversely affect our ability to generate the funds necessary for lending operations. As a result, we may need to seek other sources of funds that may be more expensive to obtain and could increase our cost of funds.

Our banking and non-banking subsidiaries also compete with non-bank providers of financial services, such as brokerage firms, consumer finance companies, credit unions, insurance agencies, peer to peer lenders and governmental organizations which may offer more favorable terms.  Some of our non-bank competitors are not subject to the same extensive regulations that govern our banking operations.  As a result, such non-bank competitors may have advantages over our banking and non-banking subsidiaries in providing certain products and services.  This competition may reduce or limit our margins on banking and non-banking services, reduce our market share, and adversely affect our earnings and financial condition.

Our ability to manage liquidity is always critical in our operation, but more so today given the uncertainty within the capital markets.

We monitor and manage our liquidity position on a regular basis to insure that adequate funds are in place to manage the day to day operations and to cover routine fluctuations in available funds. However, our funding decisions can be influenced by unplanned events. These unplanned events 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. We have a liquidity contingency plan in the event liquidity falls below an acceptable level, however in today’s economic environment, we are not certain that those sources of liquid funds will be available in the future when required. As a result, loan growth may be curtailed to maintain adequate liquidity.  Additionally, loans may need to be sold in the secondary market, investments may need to be sold or deposits may need to be raised at above market interest rates to maintain liquidity.

Negative publicity could damage our reputation and adversely impact our business and financial results.

Reputation risk, or the risk to our earnings and capital from negative publicity, is inherent in our business.  Negative publicity can result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance, acquisitions, cyber-attacks, breach in security, and actions taken by government regulators and community organizations in response to those activities.  Negative publicity can adversely affect our ability to keep and attract customers and can expose us to litigation and regulatory action.  Although we take steps to minimize reputation risk in dealing with customers and other constituencies, as a larger diversified financial services company with a high industry profile, we are inherently exposed to this risk. 

Risks Related to Our Industry

Difficult real estate market conditions and economic trends can adversely affect our industry and our business.

We have exposure to downturns in both the commercial and residential real estate markets.  Dramatic declines in the housing market can lead to decreasing home prices and increasing delinquencies and foreclosures.  This negative market condition can adversely impact the credit performance of mortgage, consumer, commercial and construction loan portfolios, resulting in significant impairments of assets held by many financial institutions.  General downward economic trends, reduced availability of commercial credit and sustained unemployment may negatively impact the credit performance of commercial and consumer credit, resulting in write-downs of real estate collateral supporting many loans.  Concerns over the stability of the financial markets and the economy may result in decreased lending by financial institutions to their customers and to each other.  This type of market turmoil and tightening of credit can lead to increased commercial and consumer deficiencies, lack of customer confidence, increased market volatility and widespread reduction in general business activity. Financial institutions can also experience decreased access to borrowings.

A decline in current economic conditions would likely put pressure on consumers and businesses and may adversely affect our business, financial condition, results of operations and stock price.  In particular, as the result of a deteriorating economy we may face the following risks:

· We could face increased regulation of our industry.  Compliance with such regulation may increase our costs and limit our ability to pursue business opportunities.

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· Our ability to assess the creditworthiness of customers and to accurately estimate the losses inherent in our credit portfolio could be more complex.

· We may be required to pay higher Federal Deposit Insurance Corporation premiums because financial institution failures resulting from the depressed market conditions have depleted and may continue to deplete the deposit insurance fund and reduce its ratio of reserves to insured deposits.

· Our ability to borrow from other financial institutions or the Federal Home Loan Bank on favorable terms or at all could be adversely affected by disruptions in the capital markets or other events.

· We may experience increases in foreclosures, delinquencies and customer bankruptcies.

· We may experience difficulty in liquidating our OREO portfolio at favorable prices.

Our business is subject to interest rate risk, and variations in interest rates may negatively affect our financial performance.

Changes in the interest rate environment may reduce profits. The primary source of our income is the differential or “spread” between the interest earned on loans, securities and other interest-earning assets, and interest paid on deposits, borrowings and other interest-bearing liabilities.  As prevailing interest rates change, net interest spreads are affected by the difference between the maturities and re-pricing characteristics of interest-earning assets and interest-bearing liabilities.  In addition, loan volume and yields are affected by market interest rates on loans, and rising interest rates generally are associated with a lower volume of loan originations.  An increase in the general level of interest rates may also adversely affect the ability of certain borrowers to pay the interest on and principal of their obligations.  Accordingly, changes in levels of market interest rates could materially adversely affect our net interest spread, asset quality, loan origination volume, pre-payment speeds and overall profitability.

Recent and future governmental regulation and legislation could limit our future growth and adversely impact our results of operations.

As described under “Supervision and Regulation” we are subject to extensive state and federal regulation, supervision and legislation that govern almost all aspects of our operations.  These laws may change from time to time and are primarily intended for the protection of consumers, depositors, and the deposit insurance fund.  Any changes to these laws may negatively affect our ability to expand our services and to increase the value of our business.  While we cannot predict what effect any presently contemplated or future changes in the laws or regulations or their interpretations would have on our business, these changes could be materially adverse to shareholders. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on our operations.

Changes in consumers’ use of banks and changes in consumers’ spending and saving habits could adversely affect the Company’s financial results.

Technology and other changes now allow many consumers to complete financial transactions without using banks. For example, consumers can pay bills and transfer funds directly without going through a bank. This disintermediation could result in the loss of fee income, as well as the loss of customer deposits and income generated from those deposits.  In addition, changes in consumer spending and saving habits could adversely affect our operations, and we may be unable to timely develop competitive new products and services in response to these changes that are accepted by new and existing customers.

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Our information systems may experience an interruption or breach in security.

We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer-relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or  limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur; or, if they do occur, that they will be adequately addressed.  The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny or expose us to civil litigation and possible financial liability; any of which could have a material adverse effect on our financial condition and results of operations.

We face the risk of cyber-attack to our computer systems.

Our computer systems, software and networks have been and will continue to be vulnerable to unauthorized access, loss, or destruction of data (including confidential client information), account takeovers, unavailability of service, computer viruses or other malicious code, cyber-attacks and other events. These threats may derive from human error, fraud, or malice on the part of employees or third parties, or may result from accidental technological failure. If one or more of these events occurs, it could result in the disclosure of confidential client information,  damage to our reputation with our clients and the market, additional costs to us (such as repairing systems or adding new personnel or protection technologies), regulatory penalties and financial losses, to both us and our clients and customers. Such events could also cause interruptions or malfunctions in our operations (such as the lack of availability of our online banking system), as well as the operations of our clients, customers or other third parties. Although we maintain safeguards to protect against these risks, there can be no assurance that we will not suffer losses in the future that may be material in amount.

Acts or threats of terrorism and political or military actions taken by the United States or other governments could adversely affect general economic or industry conditions.

Geopolitical conditions may also affect our earnings.  Acts or threats or terrorism and political or military actions taken by the United States or other governments in response to terrorism, or similar activity, could adversely affect general economic or industry conditions.

Other Risks

Our directors, executive officers and principal shareholders own a significant portion of our common stock and can influence shareholder decisions.

Our directors, executive officers and principal shareholders, as a group, beneficially owned approximately 32% of our Class A common stock and 87% of our Class B common stock outstanding as of February 28, 2017. As a result of their ownership, the directors, executive officers and principal shareholders will have the ability, by voting their shares in concert, to influence the outcome of any matter submitted to our shareholders for approval, including the election of directors. The directors and executive officers may vote to cause the Company to take actions with which the other shareholders do not agree or that are not beneficial to all shareholders.

Risks Relating to Our Pending Merger

The Company will be subject to business uncertainties and contractual restrictions while the merger is pending.

On January 30, 2017, the Company and Bryn Mawr Bank Corporation (“Bryn Mawr”) entered into a merger agreement that provides that the Company will merge with and into Bryn Mawr, with Bryn Mawr remaining as the surviving entity (the “Merger”).  Immediately following the Merger, Royal Bank America, the wholly owned banking subsidiary of the Company, will merge with The Bryn Mawr Trust Company, the wholly owned banking subsidiary of Bryn Mawr.  The merger agreement restricts the Company from taking certain actions until the merger occurs without the consent of Bryn Mawr. These restrictions may prevent the Company from pursuing attractive business opportunities that may arise prior to the completion of the Merger. See the Current Report on Form 8-K filed with the SEC by the Company on February 2, 2017 for a description of the restrictive covenants to which the Company is subject.

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Termination of the merger agreement could negatively affect the Company.

If the merger agreement is terminated, there may be various consequences, including the fact that the Company’s businesses may have been adversely impacted by the failure to pursue other beneficial opportunities due to the focus of management on the merger, without realizing any of the anticipated benefits of completing the Merger. If the merger agreement is terminated and the Company’s board of directors seeks another merger or business combination, the Company shareholders cannot be certain that the Company will be able to find a party willing to offer equivalent or more attractive consideration than the consideration Bryn Mawr has agreed to provide in the Merger. If the merger agreement is terminated and a different business combination is pursued, the Company may be required to pay a termination fee of $5.0 million to Bryn Mawr under certain circumstances.  If Bryn Mawr terminates the merger agreement under certain circumstances, the Company may be required to pay liquidated damages in the sum of $1.8 million. 

Failure to complete the Merger could negatively impact the stock price and the future business and financial results of the Company.

If the Merger is not completed for any reason, the Company will be subject to a number of material risks, including the following:

· the market price of the Company’s Class A common stock may decline to the extent that the current market prices of the Class A common stock already reflect a market assumption that the Merger will be completed;

· costs relating to the Merger, such as legal and accounting and, in specified circumstances, additional reimbursement and termination fees, must be paid even if the Merger is not completed; and

· the diversion of management’s attention from the day-to-day business operations and the potential disruption to each of the Company’s employees and business relationships during the period before the completion of the Merger may make it difficult to regain financial and market positions if the merger does not occur.

Because the market price of Bryn Mawr shares of common stock will fluctuate, the Company’s shareholders cannot be sure of the value of the Merger consideration they may receive.

Upon completion of the Merger, holders of the Company’s Class A common stock will receive 0.1025 shares of Bryn Mawr common stock, par value $1.00 per share for each share of Class A common stock they hold, and holders of the Company’s Class B common stock will receive 0.1179 shares of Bryn Mawr common stock for each share of Class B common stock they hold.  The sale prices for shares of Bryn Mawr common stock may vary from the sale prices of Bryn Mawr common stock on the date we announced the merger, on the date the joint proxy statement/prospectus will be mailed to the Company’s shareholders and on the date of the special meeting of the Company shareholders. Any change in the market price of Bryn Mawr shares of common stock prior to closing the Merger may affect the value of the Merger consideration that the Company shareholders will receive upon completion of the Merger.  The Company is not permitted to resolicit the vote of the Company shareholders solely because of changes in the market price of Bryn Mawr common stock. Stock price changes may result from a variety of factors, including general market and economic conditions, changes in our respective businesses, operations and prospects and regulatory considerations. Many of these factors are beyond our control.

ITEM 1B.  UNRESOLVED STAFF COMMENTS

None.

ITEM 2.  PROPERTIES

At December 31, 2016, Royal Bank was headquartered and had a retail office at 732 Montgomery Avenue, Narberth, Pennsylvania.  Royal Bank had thirteen additional retail banking locations and administrative offices situated in Pennsylvania and New Jersey.  Royal Bank’s Customer Center, which includes a loan production office, is located in Bala Cynwyd, Pennsylvania. All non-branch personnel are co-located at the Bala Cynwyd location.  We also lease a loan production office in Princeton, New Jersey and Royal Leasing’s office in Blue Bell, Pennsylvania.

Royal Bank owns six of the branch properties.  In February 2017, we closed one branch location and intend to sell the building this year.  Our customers’ deposits were moved to other retail locations.  In 2015, we sold a Company owned building and

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recorded a gain of $324 thousand. The Company’s leased properties have lease expiration dates between 2017 and 2024.  During both 2016 and 2015, Royal Bank made aggregate lease payments of approximately $1.3 million.  We believe that all of our properties are sufficiently insured, maintained and are adequate for Royal Bank’s purposes.

ITEM 3.  LEGAL PROCEEDINGS

Prior to December 31, 2013, Royal Bank held a 60% equity interest in each of CSC and RTL.  CSC and RTL acquired, through public auction, delinquent tax liens in various jurisdictions thereby assuming a superior lien position to most other lien holders, including mortgage lien holders.   In 2012, the former President of CSC and RTL, CSC, RTL and the Company were named defendants, among others, in a Consolidated Master Class Action Complaint (the “Complaint”) filed in the U.S. District Court for the District of New Jersey (“Court”) on behalf of a proposed class of taxpayers who became delinquent in paying their municipal tax obligations.  The Complaint alleged a conspiracy to rig bids in municipal tax lien auctions.   

During 2013, the Company, Royal Bank, CSC, and RTL reached a settlement agreement with plaintiffs to settle the litigation for $1.65 million and other terms and conditions, including an opportunity for members of the proposed settlement class whose tax liens are currently held by CSC or RTL to redeem those liens for a one-time cash payment equaling 85% of the redemption amount by making such payment within 35 days of the date of written notice.  The proposed settlement class does not include, and therefore the offer to redeem does not apply to, tax liens acquired at 0% interest or at a premium. The settlement amount has already been paid into an escrow account. In 2016, the Court approved the settlement after notice and a hearing.  The plaintiffs are appealing the Court’s decision. It is expected to be resolved in the third or fourth quarter of 2017.

ITEM 4.  MINE SAFETY DISCLOSURES

Not applicable.

PART II

ITEM 5.   MARKET FOR REGISTRANT’S COMMON EQUITY, AND RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES

Our Class A Common Stock trades on the NASDAQ Global Market under the symbol RBPAA.  There is no market for our 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.

The following table shows the range of high and low closing sale prices for our stock as reported by NASDAQ during each quarter of 2016 and 2015.

Closing Prices
2016		High		Low
First Quarter	$	2.16	$	1.86
Second Quarter		3.20		2.11
Third Quarter		2.65		2.25
Fourth Quarter		4.15		2.28
2015		High		Low
First Quarter	$	1.90	$	1.61
Second Quarter		2.32		1.70
Third Quarter		2.14		1.91
Fourth Quarter		2.29		2.01

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The approximate number of record holders of our Class A and Class B Common Stock, as of February 28, 2017, is shown below:

Title of Class	Number of record holders
Class A Common stock	213
Class B Common stock	105

Dividends

Subject to certain limitations imposed by law or our articles of incorporation, the Board of Directors of the Company may declare a dividend on shares of Class A or Class B Common Stock.

We did not pay cash dividends on our common stock in 2016 and 2015.  Future dividends depend upon net income, capital requirements, and appropriate legal restrictions and other factors relevant at the time the Board of Directors of the Company considers dividend policy.  Cash necessary to fund dividends available for dividend distributions to the shareholders of the Company must initially come primarily from dividends paid by its direct and indirect subsidiaries, including Royal Bank, to the Company.    

Under the Pennsylvania Business Corporation Law, we may pay dividends only if, after giving effect to the dividend payment, our total assets would exceed our total liabilities plus the amount necessary to satisfy preferential rights of holders of senior shareholders, and we are 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 (“FDIC Act”) concerning the payment of dividends by Royal Bank.  Under the Code, no dividends may be paid except from “accumulated net earnings” (generally retained earnings).  Under the FDIC Act, no dividend may be paid if a bank is in arrears in the payment of any insurance assessment due to the FDIC.  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.  Therefore, the restrictions on Royal Bank’s dividend payments are directly applicable to the Company.  See “Note 15 – Shareholder’s Equity” of the Notes to Consolidated Financial Statements in Item 8 of this Report.

COMMON STOCK PERFORMANCE GRAPH

The performance graph shows cumulative investment returns to shareholders based on the assumption that an investment of $100 was made on December 31, 2011, (with all dividends reinvested), in each of the following:

· Royal Bancshares of Pennsylvania, Inc. Class A common stock;

· The stock of all United States companies trading on the NASDAQ Global Market;

· Common stock of a 2016 Peer Group consisting of 26 banks headquartered in the Mid-Atlantic region, that trade on a major exchange and have total assets between $700 million and $1.5 billion; and

· SNL Bank and Thrift Index.

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Royal Bancshares of Pennsylvania, Inc.

	Period Ending
Index	12/31/11	12/31/12	12/31/13	12/31/14	12/31/15	12/31/16
Royal Bancshares of Pennsylvania, Inc.	100.00	95.99	110.40	128.80	167.20	332.00
NASDAQ Composite	100.00	117.45	164.57	188.84	201.98	219.89
SNL Bank and Thrift	100.00	131.52	176.69	193.53	193.50	238.66
RBPAA Peer Group Index*	100.00	121.82	153.16	157.06	165.21	229.76

Securities Authorized for Issuance Under Equity Compensation Plans

The following tables provide certain information regarding securities issued or issuable under our equity compensation plans as of December 31, 2016:

Long Term Incentive Plan	Number of Securities to be issued upon exercise of outstanding options, warrants and rights	Weighted average exercise price of outstanding options, warrants and rights		Number of securities remaining available for issuance under equity plans (excluding securities reflected in first column)
Equity compensation plan approved by security holders	242,139	$	3.71	732,861
Equity compensation plan not approved by security holders	—		—	—
Total	242,139	$	3.71	732,861

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ITEM 6.  SELECTED FINANCIAL DATA

The following selected consolidated financial and operating information for the Company should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and accompanying notes in Item 8 of this Report:

Statement of Operations Data	For the years ended December 31,
(In thousands, except share data)	2016		2015		2014		2013		2012
Interest income	$	33,416	$	29,993	$	28,784	$	27,524	$	31,981
Interest expense		7,315		6,484		6,484		7,357		9,899
Net interest income		26,101		23,509		22,300		20,167		22,082
Provision (credit) for loan and lease losses		1,242		(748)		(867)		(872)		5,997
Net interest income after loan and lease losses		24,859		24,257		23,167		21,039		16,085
Non-interest income
Gain on sale of premises & equipment		-		324		107		2,524		-
Service charges and fees		1,361		1,126		1,032		1,323		1,218
Gains on sale of loans and leases		165		-		232		686		2,057
Income from bank owned life insurance		1,166		497		512		539		553
Net gains on investment securities		1,431		900		377		158		1,030
Other income		374		280		573		207		747
Total other than-temporary-impairment losses on investment securities		(190)		(14)		(41)		-		(2,359)
Total non-interest income		4,307		3,113		2,792		5,437		3,246
Non-interest expense
Salaries and benefits		10,398		10,441		10,164		10,276		11,576
Net OREO expenses		77		504		216		1,358		8,038
Other expenses		9,522		10,040		10,741		13,269		16,347
Total non-interest expense		19,997		20,985		21,121		24,903		35,961
Income (loss) before tax expense		9,169		6,385		4,838		1,573		(16,630)
Income tax (benefit) expense		(1,796)		(5,139)		(654)		42		-
Net income (loss)	$	10,965	$	11,524	$	5,492	$	1,531	$	(16,630)
Less net income (loss) attributable to noncontrolling interest		590		531		382		(578)		(1,005)
Net income (loss) attributable to Royal Bancshares		10,375		10,993		5,110		2,109		(15,625)
Less Series A Preferred stock accumulated dividend and accretion		1,133		1,721		2,078		2,075		2,038
Net income (loss) to common shareholders		9,242		9,272		3,032		34		(17,663)
Basic and diluted earnings (loss) per common share	$	0.31	$	0.31	$	0.14	$	-	$	(1.33)

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Balance Sheet Data	For the years ended December 31,
(In thousands)	2016			2015			2014			2013			2012
Total assets	$	832,485		$	788,283		$	732,553		$	732,254		$	769,455
Total average assets		805,553			739,921			731,245			740,324			819,211
Loans, net		591,589			489,414			403,424			352,810			326,904
Total deposits		629,546			577,892			530,425			528,964			554,917
Total average deposits		592,527			536,034			522,428			527,452			573,233
Total borrowings		129,774			116,744			118,200			133,655			134,107
Total average borrowings		121,301			116,547			128,628			133,261			149,416
Total shareholders' equity (1)		51,648			71,904			62,219			47,534			53,568
Total average shareholders' equity (1)		68,289			65,405			56,498			50,533			67,794
Return on average assets		1.29	%		1.49	%		0.70	%		0.28	%		(1.91)	%
Return on average equity		15.19	%		16.81	%		9.04	%		4.17	%		(23.05)	%
Average equity to average assets		8.48	%		8.84	%		7.73	%		6.83	%		8.28	%
Royal Bank America-Total capital (to risk-weighted assets) (2)		12.41	%		16.11	%		16.44	%		16.49	%		17.57	%
Royal Bank America-Tier 1 capital (to average assets, leverage) (2)		8.75	%		10.82	%		10.52	%		9.73	%		9.45	%
Royal Bancshares-Total capital (to risk-weighted assets) (2)		13.30	%		18.57	%		19.20	%		18.09	%		19.33	%
Royal Bancshares-Tier 1 capital (to average assets, leverage) (2)		8.49	%		12.44	%		11.88	%		9.79	%		9.80	%
Non-performing assets to total assets (3)		1.15	%		1.64	%		2.67	%		2.70	%		4.53	%
Non-performing loans to total loans (3)		1.00	%		1.10	%		2.36	%		2.77	%		6.23	%

(1)  Excludes noncontrolling interest.

(2) Capital ratios are presented in accordance with GAAP.  Refer to “Capital Adequacy” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Report.

(3)  Excludes non-performing loans held for sale in 2012.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements of the Company and the related Notes in Item 8 of this Report.

Critical Accounting Policies, Judgments and Estimates

In preparing the consolidated financial statements in accordance with United States generally accepted accounting principles (“U.S. GAAP”), management is required 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 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.  Critical accounting policies, judgments and estimates relate to other-than-temporary impairment losses on investment securities, allowance for loan and lease losses, the valuation of other real estate owned (“OREO”), the valuation of deferred tax assets, fair value measurements, net periodic pension costs and the pension benefit obligation. The policies which significantly affect the determination of the Company’s financial position, results of operations and cash flows are summarized in “Note 1 - Summary of Significant Accounting Polices” to the Consolidated Financial Statements and are discussed in the section captioned “Recent Accounting Pronouncements” of Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in Items 7 and 8 of this Report, each of which is incorporated herein by reference.

Investment Securities

We evaluate securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis.  We assess whether OTTI is present when the fair value of a security is less than its amortized cost.  All investment securities are evaluated for OTTI

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under FASB ASC Topic 320, “Investments-Debt & Equity Securities” (“ASC Topic 320”).  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.  In addition, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell or will more likely than not be required to sell the security.  If an entity intends to sell the security or will be required to sell the security, the OTTI shall be 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 shall be 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.

Allowance for Loan and Lease Losses

The allowance for loan and lease losses (the “allowance”) represents management’s estimate of losses inherent in the loan and lease portfolio as of the statement of financial condition date and is recorded as a reduction to loans and leases. The allowance is increased by the provision for loan and lease losses, and decreased by charge-offs, net of recoveries. We consider that the determination of the allowance involves a higher degree of judgment and complexity than our other significant accounting policies.  The allowance is calculated with the objective of maintaining a reserve level believed by management to be sufficient to absorb estimated credit losses. 

The allowance is based on our past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, the composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available. All of these factors may be susceptible to significant change.  While management uses the best information available to make loan loss allowance evaluations, adjustments to the allowance may be necessary based on changes in economic and other conditions or changes in accounting guidance. In addition, the FDIC, as an integral part of its examination processes, periodically reviews our allowance for loan and lease losses. The FDIC may require the recognition of adjustments to the allowance for loan losses based on their judgment of information available to them at the time of their examinations. To the extent actual outcomes differ from management estimates, additional provisions for loan and lease losses may be required that would adversely impact earnings in future periods. We also have a reserve for unfunded lending commitments, which represents management’s estimate of losses inherent in those commitments.  The reserve for unfunded loan commitments is adjusted by a provision for credit losses on off-balance sheet credit exposures and is recorded in other liabilities on the consolidated statement of financial condition. See “Note 1 - Summary of Significant Accounting Policies” to the Consolidated Financial Statements included in Item 8 of this report.

Other Real Estate Owned

Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less costs to sell at the date of foreclosure, establishing a new cost basis.  Foreclosed real estate properties acquired through the tax certificate portfolio are transferred at the lower of cost or fair value principally due to uncertainty around the fair value of the foreclosed properties.  Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount recorded at acquisition date or fair value less costs to sell.  Third-party appraisals or agreements of sale are utilized to determine fair value of the loan collateral while BPOs, agreements of sale, or in some cases, third-party appraisals are utilized to value properties from the tax certificate portfolio.  Revenue and expenses from operations and changes in the valuation allowance are included in other expenses.  For fair value measurement, OREO is included in level 3 assets.

Deferred Tax Assets

We recognize deferred tax assets and liabilities for the future tax consequences related to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets are subject to management’s judgment based upon available evidence that future realization is more likely than not.  We are required to establish a valuation allowance for deferred tax assets and record a charge to income or shareholders' equity if management determines, based on all available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. These estimates and judgments are inherently subjective. Management evaluates the DTAs for recoverability using a consistent approach which considers the relative impact of

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negative and positive evidence, including historical profitability and projections of future reversals of temporary differences and future taxable income. In evaluating our ability to recover deferred tax assets, management considers all available positive and negative evidence, including our past operating results and our forecast of future taxable income. In determining future taxable income, assumptions are made for the amount of taxable income, the reversal of temporary differences and potentially the implementation of feasible and prudent tax planning strategies. These assumptions are consistent with the plans and estimates management uses to manage our business.

Based on the analysis of the DTAs at December 31, 2016, management concluded that it is more likely than not that a portion of the net DTA will be realized by the Company in the future.  As a result of this conclusion, we released an additional $1.9 million of our valuation allowance previously recorded on the net DTAs and credited income tax expense, which was partially offset by the current income expense for the year. The ability to recognize the remaining deferred tax assets that continue to be subject to a valuation allowance will be evaluated on a quarterly basis to determine if there are any significant events that would affect the ability to utilize these deferred tax assets.  Based on the analysis of the DTAs at December 31, 2015, we released $5.4 million of our valuation allowance previously recorded on the net DTAs and credited income tax expense. There can be no assurance, however, as to when we could be in a position to recapture the remaining DTA valuation allowance.  At December 31, 2016, the DTA valuation allowance was $26.6 million compared to $30.6 million at December 31, 2015.  For more information refer to “Note 12 - Income Taxes” to the Consolidated Financial Statements in Item 8 of this Report.

Fair Value Measurements

We use fair value measurements to record fair value adjustments to certain assets to determine fair value disclosures. Investment and mortgage-backed securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other assets on a nonrecurring basis, such as impaired loans, real estate owned and certain other assets. These nonrecurring fair value adjustments typically involve application of lower-of-cost-or-market accounting or write-downs of individual assets. FASB ASC Topic 820 “Fair Value Measurements and Disclosures” (“ASC Topic 820”), establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value.  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).

Under ASC Topic 820, we base our fair values 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. It is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy in FASB ASC Topic 820. Fair value measurements for assets where there exists limited or no observable market data and, therefore, are based primarily upon our or other third-party’s estimates, are often calculated based on the characteristics of the asset, the economic and competitive environment and other such factors. Management uses its best judgment in estimating the fair value of our 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 we 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. Additionally, changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future valuations.

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Benefit Plans

We have a noncontributory nonqualified defined benefit pension plan (“Pension Plan”) covering certain eligible employees.  Our 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.  We account for our pension plan in accordance with FASB ASC Topic 715 “Compensation-Retirement Benefits” (“ASC Topic 715”).  ASC Topic 715 requires the recognition of a plan’s over-funded or under-funded status as an asset or liability with an offsetting adjustment to AOCI.  ASC Topic 715 requires the determination of the fair values of plans assets at a company’s year-end and recognition of actuarial gains and losses, prior service costs or credits, and transition assets or obligations as a component of AOCI.  These amounts will be subsequently recognized as components of net periodic benefits cost.  Further, actuarial gains and losses that arise in subsequent periods that are not initially recognized as a component of net periodic benefit cost will be recognized as a component of AOCI.  Those amounts will subsequently be recognized as a component of net periodic benefit cost as they are amortized during future periods.  Net pension expense consists of service costs and interest costs.  We accrue pension costs as incurred. Benefit payments are expected to be substantially made from insurance policies owned by the Company.

We have a capital accumulation and salary reduction plan under Section 401(k) of the Internal Revenue Code of 1986, as amended.  Under the plan, all employees are eligible to contribute up to the maximum allowed by Internal Revenue Service (“IRS”) regulation, with the Company matching 100% of any contribution between 1% and 5% subject to a $2,500 per employee annual limit.  The 401(k) matching contribution was $135 thousand and $134 thousand for 2016 and 2015, respectively.

Recent Accounting Pronouncements

See “Note 1 - Summary Of Significant Accounting Policies” to the Consolidated Financial Statements included in Item 8 of this Report.

Results of Operations

Financial Highlights and Business Results

Our results of operations depend primarily on net interest income.  Its level is a function of the average balance of interest-earning assets, the average balance of interest-bearing liabilities, and the spread between the yield on assets and liabilities. In turn, these factors are influenced by the pricing and mix of our interest-earning assets and funding sources.  Additionally, net interest income is affected by market and economic conditions, which influence rates on loan and deposit growth. 

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 below for additional information on interest yield and cost.  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 employee benefits, occupancy expenses and other operating expenses.

Consistent quality loan growth and expense discipline were key to the increase in net income before taxes. Loan growth in commercial, consumer, and leasing segments and more economical delivery channels, including our loan production office, are helping drive customer growth.  We continued to modernize the ways customers can access our products and services.  During 2016, we introduced a tablet version of our consumer mobile app as well a mobile app for our corporate customers, which includes our cash management suite of products.  We introduced enhancements to our website which improved navigation and functionality.  We added first position residential mortgages through a new arrangement with a local mortgage company experienced in providing and servicing residential mortgages for community banks. Additionally, we completed extensive renovations of our Narberth retail location.  These results and continued progress come at a time when competition, current interest rates, regulatory requirements and domestic and global markets greatly challenge the banking industry.  Our ability to generate consistent earnings led to the partial reversal of the valuation allowance on the deferred tax assets.  For further discussion on the deferred tax assets see “Accounting for Income Taxes.” 

In 2014, we 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”).  We repurchased 11,551 shares of Series A Preferred stock in July 2014 as

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part of Treasury’s auction of its holdings of Series A Preferred Stock.  We repurchased the remaining 18,856 shares of Series A preferred stock from time to time during 2016 as shares became available for purchase and we received the required regulatory approvals to repurchase such shares. 

Consolidated Net Income

Net income attributable to the Company for the year ended December 31, 2016 amounted to $10.4 million, or $0.31 per diluted common share, compared to $11.0 million, or $0.31 per diluted common share, for the year ended December 31, 2015. Net interest income grew $2.6 million, or 11.0%, from 2015 and the provision for unfunded loan commitments declined $758 thousand from 2015.  Additionally, net gains on the sales of investment securities increased $531 thousand and net OREO expenses declined $427 thousand from 2015. 

In 2016 we recorded a $1.9 million reversal of the valuation allowance for the net deferred tax assets, which contributed to the $1.8 million tax benefit compared to a $5.4 million reversal of the valuation allowance for the net deferred tax assets which contributed to the $5.1 million tax benefit in 2015.  The provision for loan and lease losses increased $2.0 million from a credit of $748 thousand in 2015 to an expense of $1.2 million in 2016. Additionally, professional and legal fees, communications and data processing, and OTTI on investment securities increased $246 thousand, $206 thousand, and $176 thousand, respectively.

At December 31, 2016, loans and leases totaled $602.0 million, which represents an increase of $102.9 million, or 20.6%, from 2015. New business relationships continue to stimulate the growth of the loan portfolio, which also improved the composition of interest earning assets.  As part of the continued planned reduction of the tax lien portfolio, tax lien certificates declined $1.1 million, or 22.1%, from 2015.  Investment securities declined $54.2 million, or 24.2%, from the level at December 31, 2015 due to the reinvestment of cash flows from sales, calls, and principal payments into loans.  Cash and cash equivalents decreased $4.2 million to $21.2 million at December 31, 2016.  The decrease in cash was primarily the result of funding new loan originations.

Total deposits grew $51.6 million, or 8.9%, from $577.9 million at December 31, 2015 to $629.5 million at December 31, 2016. The increase in deposits reflects a focused change in the deposit mix with a successful savings promotion.  Savings accounts and non-interest bearing deposits increased $31.3 million and $14.3 million, respectively. During the third quarter of 2016, the $25.0 million brokered checking deposit arrangement with a regional financial institution was terminated. We partially replaced these funds with $21.5 million in brokered certificates of deposit through Promontory Interfinancial Network’s CDARS program.  NOW and money market accounts and non-brokered certificates of deposit increased $5.3 million and $4.2 million, respectively.

Total borrowings increased $13.0 million.  Short-term borrowings increased $10.0 million and was due to the rollover strategy of an FHLB advance tied to an interest rate swap agreement. Long-term borrowings increased $3.0 million.

Interest Income

Total interest income of $33.4 million for 2016 grew $3.4 million, or 11.4%, from $30.0 million for 2015.  The increase was primarily driven by an increase of $4.5 million in the interest income earned on average loan balances and was predominantly due to the growth in such assets.  Partially offsetting the increase in loan interest income was a $1.1 million decline in the interest income earned on average investments which was largely due to a drop in the average balance of such assets.  Average interest-earning assets grew $62.6 million, or 9.0%, from $695.1 million for 2015 to $757.7 million for 2016.  During 2016, average loans and leases grew $101.1 million, or 22.5%, to $551.2 million, while average investment securities declined  $34.7 million, or 15.2%, to $194.1 million.  Average interest-earning deposits decreased $3.8 million year over year.   During the past year, we sold investment securities with lower yields or extension risk in a rising rate environment. We also had $26.1 million in government agency bonds called during 2016, which impacted the year over year comparison. The cash flows from these transactions along with principal and interest payments on the investment portfolio were reinvested in loans and leases,  government sponsored mortgage-backed securities andcollateralized mortgage obligations (“CMOs”).  Average loan and investment balances for 2015 were $450.1 million and $228.8 million, respectively.

For 2016, the yield on average interest-earning assets was 4.41% and increased nine basis points from 4.32% for the comparable period of 2015.  While the average loan balances significantly increased, the average yield on loans decreased 18 basis points (5.23% in 2016 versus 5.41% in 2015).  The decline in loan yield reflects the competitive pricing environment

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we are experiencing for originating and retaining high quality loans. The average yield on investments declined 13 basis points (2.33% in 2016 versus 2.46% in 2015).

Interest Expense

For 2016 total interest expense was $7.3 million and increased $831 thousand, or 12.8%, from $6.5 million for 2015. The increase in interest expense was primarily associated with an increase in interest expense on average savings accounts and average borrowings. Average interest-bearing liabilities for 2016 were $630.6 million and increased $55.1 million, or 9.6%, year-over-year. Average interest-bearing deposits of $509.3 million increased $50.3 million, or 11.0%, and included increases of $44.5 million and $11.4 million in savings accounts and NOW and money market accounts, respectively.  Partially offsetting these increases was a $5.5 million decrease in average certificates of deposits. Average borrowings increased $4.8 million, or 4.1%, to $121.3 million.  Interest costs associated with average deposit balances increased $519 thousand from 2015.  Interest expense associated with average savings balances accounted for $409 thousand of the increase.  Average non-interest bearing demand deposits grew $6.2 million, or 8.0%. Average interest-bearing deposits for 2015 were $459.0 million.

The interest paid on average borrowings increased $312 thousand, or 11.7% from 2015.  We have one interest rate swap that was tied to a rollover strategy of an FHLB advance that matured on June 24, 2016. We have and will continue to rollover the FHLB advance every three months through the swap expiration of June 2021. The interest expense associated with the swap was $148 thousand for 2016.  Additionally, in the third quarter of 2016, we chose to benefit from the flattening yield curve and borrowed a $15.0 million FHLB advance for five years.  This advance will allow us to guarantee an interest rate spread on $15.0 million in five year fixed rate loans. Average borrowings were $116.5 million for 2015.

The average interest rate paid on interest-bearing liabilities amounted to 1.16% for 2016 and increased three basis points from 1.13% for 2015. The average interest rate paid on interest-bearing deposits in 2016 amounted to 0.85% and increased two basis points from 0.83% for 2015.  During the third quarter of 2015 and throughout 2016, we ran a successful savings account promotion. As a result, the average rates paid on savings accounts increased 31 basis points (0.71% in 2016 versus 0.40% in 2015). Despite the decline in average balances for CDs year over year, the average rate paid on this deposit classification increased five basis points (1.41% in 2016 versus 1.36% in 2015).  The interest rate paid on average NOW and money market accounts increased two basis points (0.36% in 2016 versus 0.34% in 2015).  The increases in the average rates paid on average interest-bearing deposits reflect the competitive pricing in our market area for all deposit product types and our retail savings promotion. The average rate paid on average borrowings increased 16 basis points (2.46% for 2016 versus 2.30% for 2015).Short-term borrowing rates and the subordinated debt rate were directly impacted by the Federal Reserve Bank’s rate increase in December 2015. Additionally, the average borrowing rate paid was negatively impacted by the interest rate swap and the new $15.0 million advance mentioned previously.

Net Interest Income and Margin 

Net interest income for 2016 increased $2.6 million, or 11.0%, to $26.1 million from $23.5 million for 2015. The growth in 2016 was attributed to an increase in interest income due to the growth and change in the composition of average interest-earning assets. Year-over-year average loans increased $101.1 million with growth recognized in multiple commercial loan classes. Average investments and average interest-earning deposits declined $34.7 million and $3.8 million, primarily to fund the growth in loans. Partially mitigating the improvement in interest income was an $831 thousand increase in interest expense.  The $50.3 million net growth in average interest-bearing deposits led to a $519 thousand increase in interest expense on those deposits.  We experienced increases in interest expense across all interest-bearing deposit types.  The $4.8 million increase in average borrowings resulted in a $312 thousand increase in interest expense year over year. 

For 2016, the net interest margin was 3.44%, a six basis point increase from 3.38% for 2015. The nine basis point increase in the yield on average interest-earning assets (4.41% in 2016 versus 4.32% in 2015) was partially offset by a three basis point increase in funding costs (1.16% in 2016 versus 1.13% in 2015). The 18 basis point decrease in average loan yield (5.23% in 2016 versus 5.41% in 2015) reflects the competitive pricing for new loan originations. Average interest rates paid on average interest-bearing deposits grew two basis points from 0.83% for 2015 to 0.85% for 2016. The increase in average interest rates paid occurred in all interest-bearing segments or products. We have been experiencing competitive pricing pressure in our market area to retain deposits.  Additionally, the average rate paid on average borrowings increased 16 basis points due to an $4.8 million increase in the average balance coupled with higher rates paid. Short-term deposit rates paid and the subordinated debt rate were directly impacted by the flattening of the yield curve throughout most of 2016

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and the Federal Reserve Bank’s rate increase in December 2015.  Additionally, the average borrowing rate paid was negatively impacted by the interest rate swap and the new $15.0 million advance mentioned previously. The average rates paid on average borrowings, other than subordinated debt, were 2.35% in 2016 versus 2.25% in 2015, and the average rates paid on subordinated debt were 2.88% in 2016 versus 2.48% in 2015.

Average Balances

The following table represents the average daily balances of assets, liabilities and shareholders’ equity and the respective interest earned and paid on interest-bearing assets and interest-bearing liabilities, as well as average rates for the periods indicated:

	For the year ended						For the year ended						For the year ended
	December 31, 2016						December 31, 2015						December 31, 2014
(In thousands, except percentages)	Average Balance		Interest		Yield			Average Balance		Interest	Yield			Average Balance		Interest	Yield
Assets
Interest-earning deposits	$	12,416	$	63	0.51	%	$	16,197	$	32	0.20	%	$	9,897	$	22	0.22	%
Investment securities available for sale		194,108		4,528	2.33	%		228,779		5,617	2.46	%		292,208		7,191	2.46	%
Loans and leases (1)
Commercial demand loans		165,369		8,413	5.09	%		120,460		5,882	4.88	%		117,943		5,825	4.94	%
Real estate secured		318,834		14,916	4.68	%		268,919		13,443	5.00	%		217,660		11,622	5.34	%
Other loans and leases		66,958		5,496	8.21	%		60,715		5,019	8.27	%		47,979		4,124	8.60	%
Total loans		551,161		28,825	5.23	%		450,094		24,344	5.41	%		383,582		21,571	5.62	%
Total interest-earning assets		757,685		33,416	4.41	%		695,070		29,993	4.32	%		685,687		28,784	4.20	%
Non-earning assets
Cash and due from banks		13,586						14,059						10,409
Other assets		44,313						41,317						47,312
Allowance for loan and lease losses		(10,031)						(10,525)						(12,163)
Total non-earning assets		47,868						44,851						45,558
Total average assets	$	805,553					$	739,921					$	731,245
Interest-bearing deposits
NOW and money markets	$	222,626	$	811	0.36	%	$	211,271	$	716	0.34	%	$	208,688	$	653	0.31	%
Savings		74,520		529	0.71	%		30,023		120	0.40	%		18,765		31	0.17	%
Time deposits		212,166		2,985	1.41	%		217,688		2,970	1.36	%		228,754		2,920	1.28	%
Total interest-bearing deposits		509,312		4,325	0.85	%		458,982		3,806	0.83	%		456,207		3,604	0.79	%
Borrowings		95,527		2,248	2.35	%		90,773		2,039	2.25	%		102,854		2,257	2.19	%
Subordinated debt		25,774		742	2.88	%		25,774		639	2.48	%		25,774		623	2.42	%
Total interest-bearing liabilities		630,613		7,315	1.16	%		575,529		6,484	1.13	%		584,835		6,484	1.11	%
Non-interest bearing deposits		83,215						77,052						66,221
Other liabilities		23,436						21,935						23,691
Total average  liabilities		737,264						674,516						674,747
Shareholders' equity		68,289						65,405						56,498
Total average liabilities and equity	$	805,553					$	739,921					$	731,245
Net interest income			$	26,101					$	23,509					$	22,300
Net interest margin					3.44	%					3.38	%					3.25	%

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(1) Non-accrual loans have been included in the appropriate average loan balance category, but interest on these loans has not been included.

The following table sets forth a rate/volume analysis, which segregates in detail the major factors contributing to the change in net interest income for the years ended December 31, 2016 and 2015, as compared to respective previous periods, into amounts attributable to both rate and volume variances.

	For the year ended							For the year ended
	December 31,							December 31,
	2016 vs. 2015							2015 vs. 2014
	Increase (decrease)							Increase (decrease)
(In thousands)	Volume		Rate		Total			Volume		Rate		Total
Interest income
Interest-earning deposits	$	(20)	$	51	$	31	$	13	$	(3)	$	10
Total short term earning assets		(20)		51		31		13		(3)		10
Investment securities		(791)		(298)		(1,089)		(1,560)		(14)		(1,574)
Loans and leases
Commercial demand loans		2,276		255		2,531		123		(66)		57
Commercial mortgages		2,344		(535)		1,809		2,337		(180)		2,157
Residential and home equity loans		132		40		172		368		1		369
Leases receivables		534		(55)		479		1,003		(136)		867
Tax certificates		(136)		(267)		(403)		(517)		(169)		(686)
Consumer loans		(4)		2		(2)		31		(3)		28
Loan fees		(105)		—		(105)		(19)		—		(19)
Total loans and leases		5,041		(560)		4,481		3,326		(553)		2,773
Total increase (decrease) in interest income	$	4,230	$	(807)	$	3,423	$	1,779	$	(570)	$	1,209
Interest expense
Deposits
NOW and money market	$	39	$	56	$	95	$	8	$	54	$	62
Savings		269		140		409		27		62		89
Certificates of deposit		(76)		91		15		(146)		197		51
Total deposits		232		287		519		(111)		313		202
Borrowings
Borrowings		107		102		209		(270)		52		(218)
Subordinated debentures		—		103		103		—		16		16
Total borrowings		107		205		312		(270)		68		(202)
Total increase in interest expense	$	339	$	492	$	831	$	(381)	$	381	$	-
Total increase (decrease) in net interest income	$	3,891	$	(1,299)	$	2,592	$	2,160	$	(951)	$	1,209

Provision (Credit) for Loan and Lease Losses

For 2016 we recorded a provision for loan and lease losses of $1.2 million compared to a credit of $748 thousand in 2015. The 2016 provision was primarily attributable to loan growth, specific reserves on the leasing portfolio, and net charge-off activity within the leasing and tax certificate portfolios.  We recorded $1.3 million in gross charge-offs in 2016 compared to $2.5 million in 2015.  The charge-offs in both periods were primarily related to specific reserves.  Growth in the loan portfolio may require provisions to the allowance for loan and lease losses in future periods.

Non-interest Income

Non-interest income includes service charges on depositors’ accounts, leasing commissions, and fees for various services such as wire transfers, cash management and debit card processing.   In addition, other forms of non-interest income are derived from changes in the cash value of bank owned life insurance (“BOLI”) and company owned life insurance  (“COLI”).  Most components of non-interest income are a modest and stable source of income, with exceptions of one-time gains and losses from the sale of investment securities, loans, and premises and equipment. From period to period these sources of income may vary considerably.  Service charges on depositors’ accounts and other fees are periodically reviewed by management to remain competitive with other local banks.

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For 2016, total non-interest income was $4.3 million and increased $1.2 million, or 38.4%, from $3.1 million for 2015.  Income from Company owned life insurance policies grew $669 thousand from $497 thousand for 2015 to $1.2 million for 2016.  During 2016, we received $748 thousand in insurance proceeds related to a former employee covered by a BOLI policy.  We recorded $273 thousand in income from these proceeds.  Net gains on the sale of investment securities increased $531 thousand from $900 thousand in 2015 to $1.4 million for 2016. Included in the $1.4 million of net gains on investment securities were distributions from two private equity investments that resulted in net gains of $1.1 million. Service charges and fees increased $235 thousand to $1.4 million for 2016 and were mostly related to the leasing portfolio.

Partially offsetting these positive items was an increase in other-than-temporary impairment (“OTTI”) charges on the investment portfolio of $176 thousand related to investments in private equity real estate funds and a decline of $324 thousand in gains on the sale of premises and equipment. In 2015, we sold a Company owned building adjacent to our Narberth location and recorded a gain of $324 thousand.  There were no sales of premises and equipment in 2016. 

Non-interest Expense

Non-interest expense was $20.0 million for 2016 and decreased $988 thousand, or 4.7%, from $21.0 million for 2015.  During 2016, we recorded a credit for unfunded loan commitments of $333 thousand compared to a provision for unfunded loan commitments of $425 thousand for 2015.  The improvement of $758 thousand was due to a decline in the historical loss rates applied in the calculation of the reserve for unfunded loan commitments.  Net OREO expenses, which include property related expenses, net gains on sales, and impairment charges decreased $427 thousand ($77 thousand in 2016 versus $504 thousand in 2015).  Net gains on the sales of OREO decreased $241 thousand and was more than offset by decreases in OREO impairment charges and OREO expenses of  $442  thousand and $226 thousand, respectively.  We recorded net gains on the sale of OREO of $678 thousand in 2016 compared to $919 thousand in net gains on the sale of OREO in 2015.  In 2016, we sold an OREO tax lien property with a carrying value of $3.2 million and recorded a gain of $645 thousand. Additionally, in 2016 we reversed a $200 thousand contingency accrual related to an OREO property that was sold in a previous reporting period.  During 2016, Management determined that the contingency no longer exists and therefore was reversed. 

Partially offsetting the decrease in non-interest expense were increases in professional and legal fees and communications and data processing expenses. Professional and legal fees increased $246 thousand ($2.0 million in 2016 versus $1.7 million in 2015) and was largely due to leasing correspondant fees and the resolution of problem assets.  Communications and data processing expenses increased $206 thousand from $798 thousand for 2015 to $1.0 million for 2016 as a result of technology investments.

Accounting for Income Tax Expense

In 2016, we recorded a tax benefit of $1.8 million compared to $5.1 million for 2015.  We recognize deferred tax assets and liabilities for the future tax consequences related to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  We are required to establish a valuation allowance for DTAs and record a charge to income or shareholders' equity if management determines, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. Prior to 2015, a full valuation allowance was recorded against the DTA based on the available evidence at that time.  Management performs this analysis on an annual basis and quarterly monitors if significant events occur which would affect the ability to utilize these DTAs in the future.  Based on the analysis of the DTAs at December 31, 2016, management concluded that it is more likely than not that a portion of the net DTA will be realized by the Company in the future.  As a result of this conclusion, we released $1.9 million of our valuation allowance previously recorded on the net DTAs and credited income tax expense, which was partially offset by the current income expense for the year. In 2015, we released $5.4 million of our valuation allowance.  In accordance with ASC 740, we considered the following sources of income in reaching our conclusion:

· Future reversal of temporary differences

· Future taxable income exclusive of reversing temporary differences and carryforwards

· Taxable income in prior carryback year(s) if carryback is permitted under the tax law

· Potential tax-planning strategies

The positive evidence that outweighed the negative evidence in management’s assessment included, but was not limited to, the following:

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· Positive cumulative pre-tax earnings over the prior three year period ended December 31, 2016.

· Improvement in asset quality and net interest income.

· Management’s consistent ability to exceed annual forecasted financial results.

· Significant reductions in historical credit-related losses and investment impairment.

· Net operating loss carryforwards do not begin to expire until 2028.

As of December 31, 2016 and December 31, 2015 the valuation allowance for deferred tax assets totaled $26.6 million and $30.6 million, respectively.  The ability to recognize the remaining DTAs that continue to be subject to a valuation allowance will be evaluated on a quarterly basis to determine if there are any significant events that would affect the ability to utilize these deferred tax assets. There can be no assurance, however, as to when we could be in a position to reverse the remaining DTA valuation allowance. The deferred tax assets, net of valuation allowances, totaled $7.9 million and $5.7 million at December 31, 2016 and 2015, respectively. 

The Company’s effective tax rate is the provision for federal income taxes expressed as a percentage of income or loss before federal income taxes. The effective tax rate for the twelve months ended December 31, 2016 and 2015 was 2% and 0%, respectively.  In general our effective tax rate is different from the federal statutory rate primarily due to the valuation allowance, which was $26.6 million as of December 31, 2016. For more information refer to “Note 12 - Income Taxes” to the Consolidated Financial Statements in Item 8 of this Report.

Results of Operations by Business Segments

Under FASB ASC Topic 280, “Segment Reporting” (“ASC Topic 280”), management of the Company has identified two reportable operating segments, “Community Banking” and “Tax Liens”.  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.  Our chief operating decision makers are the Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”).    

· Community Bank segment: At December 31, 2016, the Community Bank segment had total assets of $823.8 million, an increase of $49.5 million, or 6.4%, from $774.3 million at December 31, 2015.  Total deposits increased $51.6 million, or 8.9%, from $577.9 million at December 31, 2015 to $629.5 million at December 31, 2016.  Net interest income for 2016 was $26.4 million compared to $23.7 million for 2015 representing an increase of $2.7 million, or 11.6%. The improvement in net interest income was primarily attributed to an increase in interest income due to the growth and change in the composition of average interest-earning assets. The provision for loan and lease losses was $1.2 million in 2016 compared to a credit of $846 thousand for 2015. The provision was due to loan growth, specific reserves on the leasing portfolio, and net charge-off activity within the leasing portfolio. For 2016, total non-interest income was $4.2 million compared to $2.8 million for 2015.  The increase was mostly attributed to increases of $669 thousand and $531 thousand in income from Company owned life insurance policies and in the net gains on the sale of investment securities, respectively.  Partially mitigating these improvements was an increase in OTTI charges on the investment portfolio of $176 thousand related to investments in private equity real estate funds and a decline of $324 thousand in gains on the sale of premises and equipment.   For 2016 and 2015, total non-interest expense was $19.5 million and $19.8 million, respectively. During 2016, we recorded a credit for unfunded loan commitments of $333 thousand compared to a provision for unfunded loan commitments of $425 thousand for 2015, which resulted in an  improvement of $758 thousand.  Partially offsetting this change was a $305 increase in professional and legal fees, which was largely due to leasing correspondant fees and the resolution of problem assets. In 2016 and 2015, we released $1.9 million and $5.4 million of our valuation allowance previously recorded on the net DTAs, respectively.  As a result of this transaction, the net tax benefit recorded for 2016 was $1.7 million compared to $5.1 million for 2015. Net income for 2016 was $11.1 million compared to $12.2 million for 2015.

· Tax Liens segment:  At December 31, 2016, the Tax Liens segment had total assets of $8.7 million compared to $14.0 million at December 31, 2015 representing a decrease of $5.3 million, or 37.9%.  The Tax Liens segment had net interest expense of $345 thousand in 2016 compared to $181 thousand for 2015.  The provision for lien losses decreased $78 thousand from $98 thousand in 2015 to $20 thousand in 2016.  The improvement in the 2016 provision was mostly related to the declining portfolio balance. Total non-interest income was $58 thousand in 2016 compared to $271 thousand in 2015.  Total non-interest expense decreased $731 thousand from $1.2 million in 2015 to $503 thousand for 2016. Net OREO expenses decreased $301 thousand while professional and legal fees declined $215 thousand in 2015.  Additionally, in 2016 the Tax Lien segmeent reversed a $200 thousand contingency accrual

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related to an OREO property that was sold in a previous reporting period.  During 2016, Management determined that the contingency no longer exists and therefore was reversed.  Net loss attributed to the tax liens segment was $700 thousand in 2016 compared to $1.2 million for 2015.

Financial Condition

Total assets grew $44.2 million to $832.5 million at December 31, 2016 from $788.3 million at year-end 2015.

Cash and Cash Equivalents

Cash and cash equivalents consist of cash on hand and cash in interest bearing and non-interest bearing accounts in banks.  Cash and cash equivalents declined $4.2 million from $25.4 million at December 31, 2015 to $21.2 million at December 31, 2016.  The average balance of cash and cash equivalents was approximately $26.0 million for 2016 versus $30.3 million for 2015. Almost half of this average balance was held in interest-bearing accounts with other financial institutions which were paying a higher interest rate than federal funds.  The excess cash is invested daily in money market funds.  The decrease in cash and cash equivalents was mainly associated with the funding of loan originations.

Investment Securities Available for Sale (“AFS”)

AFS investment securities represented 25.6% of average interest earning assets during 2016 and consisted of government secured agency bonds, government secured mortgage-backed securities, collateralized mortgage obligations (“CMOs”), municipal bonds, domestic corporate debt, and third party managed equity funds.  At December 31, 2016, AFS investment securities were $169.9 million with a net unrealized loss of $1.1 million compared to $224.1 million with a net unrealized loss of $41 thousand at December 31, 2015.  The $54.2 million reduction in investment securities was mostly due to the reinvestment of cash flows from sales, principal payments, and calls into loans.  The increase in net unrealized loss was predominantly impacted by a $1.1 million increase in the unrealized loss on agency CMOs.  Additionally, the net unrealized gain on other securities decreased $445 thousand as some of the funds were sold and gains realized as a result of these sales.  Our AFS securities carry lower coupons and their market value was negatively impacted by an increase in the 10-year Treasury yield from 2.27% at December 31, 2015 to 2.45% at December 31, 2016.  Refer to “Note 3- Investment Securities” to the Consolidated Financial Statements in Item 8 for more information.

The following tables present the consolidated amortized cost and approximate fair value at December 31, 2016 and 2015, respectively, for each major category of the Company’s AFS investment securities portfolio.

December 31, 2016
			Gross		Gross
		Amortized	unrealized		unrealized		Fair
(In thousands)	Cost		gains		loss		Value
U.S. government agencies	$	988	$	—	$	(22)	$	966
Mortgage-backed securities-residential		6,985		70		(17)		7,038
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		146,666		1,022		(2,129)		145,559
Non-agency		4,121		—		(86)		4,035
Corporate bonds		1,700		1		—		1,701
Municipal bonds		8,691		92		(75)		8,708
Other securities		1,821		—		—		1,821
Common stocks		26		—		—		26
Total available for sale	$	170,998	$	1,185	$	(2,329)	$	169,854

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December 31, 2015
			Gross		Gross
		Amortized	unrealized		unrealized		Fair
(In thousands)	Cost		gains		loss		Value
U.S. government agencies	$	26,127	$	—	$	(564)	$	25,563
Mortgage-backed securities-residential		11,002		106		(50)		11,058
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		170,764		1,524		(1,554)		170,734
Non-agency		2,729		1		(26)		2,704
Corporate bonds		1,500		56		—		1,556
Municipal bonds		9,910		73		(52)		9,931
Other securities		2,050		445		—		2,495
Common stocks		26		—		—		26
Total available for sale	$	224,108	$	2,205	$	(2,246)	$	224,067

The contractual maturity distribution and weighted average coupon rate of our AFS debt securities at December 31, 2016 are presented in the following table.  Mortgage-backed securities and collateralized mortgage obligations are presented within the category that represents the total weighted average expected maturity. 

		As of December 31, 2016
		Within one year				After one year, but within five years				After five years, but within ten years				After ten years				Total
(In thousands, except percentages)		Amount	Rate			Amount	Rate			Amount	Rate			Amount	Rate			Amount	Rate
U.S. government agencies	$	—	—	%	$	966	1.39	%	$	—	—	%	$	—	—	%	$	966	1.39	%
Mortgage-backed securities-residential		—	—	%		6,057	3.14	%		—	—	%		981	3.08	%		7,038	3.14	%
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		1,746	4.09	%		59,415	3.49	%		84,179	3.21	%		219	2.91	%		145,559	3.24	%
Non-agency		—	—	%		2,284	0.89	%		1,751	0.89	%		—	—	%		4,035	1.93	%
Corporate bonds		—	—	%		700	2.25	%		—	—	%		1,001	5.00	%		1,701	3.87	%
Municipal bonds		—	—	%		3,567	4.04	%		5,141	3.49	%		—	—	%		8,708	3.72	%
Total AFS debt securities	$	1,746	4.09	%	$	72,989	3.13	%	$	91,071	3.23	%	$	2,201	3.95	%	$	168,007	3.21	%

We assess 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 320 Subtopic 40, “Beneficial Interests in Securitized Financial Assets” under FASB ASC Topic 325, “Investments-Other”.  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) our 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.  If we intend to sell a security or will be required to sell a 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 we do not intend to sell a security and it is not more likely than not that we will be required to sell a security before the recovery of its amortized cost basis, the OTTI is separated into two amounts, the credit related loss and the loss related to other factors.  The credit related loss is based on the present value of the expected cash flows and is recognized in earnings. The noncredit-related loss is based on other factors such as illiquidity and is recognized in other comprehensive income. We recorded an OTTI charge of $190 thousand related to private equity investments in 2016 compared to $14 thousand in 2015.

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Loans and Lease Financing Receivables

Our primary earning assets are loans, representing approximately 72.7% of average interest-earning assets during 2016.  We originate loans primarily in the greater Philadelphia metropolitan area as well as selected locations throughout the Mid-Atlantic region. We also have participated with other financial institutions in selected construction and land development loans outside these geographic areas.  The loan portfolio consists primarily of commercial demand loans and commercial mortgages secured by real estate, leases, and to a significantly lesser extent, tax liens and residential loans comprised of one to four family residential and home equity loans.  We have a concentration of credit risk in commercial real estate and construction and land development loans, which represented 57.3% of total loans at December 31, 2016 compared to 54.8% of total loans at December 31, 2015.

During 2016, total loans grew $102.9 million from $499.1 million at December 31, 2015 to $602.0 million at December 31, 2016.  The growth was attributed to new loan originations partially offset by balances being paid down, payoffs, charge-offs, and transfers to OREO. 

The loans receivable portfolio is segmented into commercial loans, construction and development loans, residential loans, leases, tax certificates, and consumer loans. The commercial loan segment consists of the following classes: commercial real estate loans, multi-family real estate loans, and other commercial loans, which are also generally known as commercial and industrial loans or commercial business loans. The construction and development loan segment consists of the following classes: residential construction and commercial construction loans. Residential construction loans are made for the acquisition of and/or construction on a lot or lots on which a residential dwelling is to be built. Commercial construction loans are made for the purpose of acquiring, developing and/or constructing a commercial structure. The residential loan segment consists of the following classes: one- to four-family first lien residential mortgage loans, home equity lines of credit, and home equity loans.  We classify our leases as finance leases, in accordance with FASB ASC Topic 840, “Leases”. The difference between our 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 tax certificate segment includes delinquent property tax certificates that have been acquired through public auctions in various jurisdictions.  The tax certificates assume a lien position that is generally superior to any mortgage liens that are on the property and have certain foreclosure rights as defined by state law. The tax certificates are predominantly in New Jersey. We ceased acquiring new tax certificates in 2010.  Consumer loans includes cash secured and unsecured loans and lines of credit.

Commercial Loans: The commercial real estate loan portfolio consists primarily of loans secured by office buildings, retail and industrial use buildings, strip shopping centers, mixed-use and other properties used for commercial purposes primarily located in our market area. Although terms for commercial real estate and multi-family loans vary, the underwriting standards generally allow for terms up to 10 years with the interest rate being reset in the sixth year and with monthly amortization not greater than 25 years and loan-to-value ratios of not more than 80%. Interest rates are either fixed or adjustable and are predominantly based upon the prime rate or a borrowing rate from the Federal Home Loan Bank of Pittsburgh plus a margin. Prepayment fees are charged on most loans in the event of early repayment. Generally, the personal guarantees of the principals are obtained as additional collateral for commercial real estate and multi-family real estate loans.

Commercial and multi-family real estate loans generally present a higher level of risk than loans secured by one- to four-family residences. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effect of general economic conditions on income producing properties and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by commercial and multi-family real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed, a bankruptcy court modifies a lease term, or a major tenant is unable to fulfill its lease obligations), the borrower’s ability to repay the loan may be impaired.

Our commercial business loans generally have been made to small to mid-sized businesses predominantly located in our market area. The commercial business loans are either a revolving line of credit or for a fixed term of generally 10 years or less. Interest rates are adjustable, indexed to a published prime rate of interest, or fixed. Generally, equipment, machinery, real property or other corporate assets secure such loans. Personal guarantees from the business principals are

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generally obtained as additional collateral. Generally, commercial business loans are characterized as having higher risks associated with them than single-family residential loans.

Our underwriting procedures include evaluations of the stability of the property’s cash flow history, future operating projections, current and projected occupancy levels, location and physical condition. Generally, we require a debt service ratio (the ratio of net cash flows from operations before the payment of debt service to debt service) of not less than 120%. We also evaluate the credit and financial condition of the borrower, and if applicable, the guarantor. Appraisal reports prepared by independent appraisers are obtained on each loan to substantiate the property’s market value, and are reviewed prior to the closing of the loan.

Construction and Development Loans: We originate construction loans to builders and developers predominantly in our market area. Construction and development loans are riskier than other loan types because they are more speculative in nature. Deteriorating economic or environmental conditions can negatively affect a project. Construction loans are also more difficult to evaluate and monitor.  In order to mitigate some of the risks inherent in construction lending, limits are placed on the number of units that can be built on a speculative basis based upon the reputation and financial position of the builder, his/her present obligations, the location of the property and prior sales in the development and the surrounding area. Additionally, the construction budget is reviewed prior to loan origination and the properties under construction are inspected. During the construction phase of a real estate project, the loan requires interest payments only.  Construction loans generally are for 12 to 18 months with loan-to-value ratios of not more than 75%.  Most construction loans are assigned an initial risk rating of pass-watch due to the riskier nature of the loan.

Residential Loans: Our residential mortgages were acquired in recent years in pool purchases and are secured primarily by properties located in our primary market and surrounding areas.  We originate home equity loans and home equity lines of credit in our market area with a maximum amount of $1.25 million. The collateral must be the borrower’s primary residence and the loan-to-value does not exceed 80%. Home equity lines of credit are variable rate and are indexed to the prime rate.  Our home equity loans are either first or second liens and have a fixed rate.We have originated some home equity lines of credit or home equity loans for second homes.  In financing second homes, we must have a first lien position, the LTV does not exceed 65%, and the maximum amount is $750 thousand.

Consumer Loans: We originate cash-secured and unsecured loans and lines of credit to individuals.  Unsecured loans and lines of credit have a maximum amount of $15 thousand.  Unsecured consumer loans generally have a higher interest rate than residential loans because they have additional credit risk associated with them.

In the past we have made loans to the officers and directors of the Company and to their associates.  In accordance with Regulation O related party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than normal risk of collectability.  There were no related party loans outstanding at December 31, 2016 and 2015. 

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The following table reflects the composition of the loan portfolio and the percent of gross loans outstanding represented by each category at the dates indicated.

		As of December 31,
(Dollars in thousands)		2016				2015				2014				2013				2012
Commercial real estate	$	261,561	43.4	%	$	225,679	45.2	%	$	175,038	42.2	%	$	148,293	40.5	%	$	167,115	48.5	%
Construction and land development		83,369	13.8	%		47,984	9.6	%		45,662	11.0	%		45,261	12.3	%		37,215	10.8	%
Commercial and industrial		108,146	18.0	%		85,980	17.2	%		76,489	18.4	%		79,589	21.7	%		40,560	11.8	%
Multi-family		23,389	3.9	%		16,249	3.3	%		13,823	3.3	%		11,737	3.2	%		11,756	3.4	%
Residential real estate		56,899	9.5	%		51,588	10.3	%		42,992	10.4	%		25,535	7.0	%		24,981	7.3	%
Leases		61,838	10.3	%		64,341	12.9	%		51,583	12.4	%		42,524	11.6	%		37,347	10.8	%
Tax certificates		3,705	0.6	%		4,755	1.0	%		7,191	1.7	%		12,716	3.5	%		24,569	7.1	%
Consumer		3,102	0.5	%		2,527	0.5	%		2,354	0.6	%		826	0.2	%		1,139	0.3	%
Total gross loans and leases	$	602,009	100.0	%	$	499,103	100.0	%	$	415,132	100.0	%	$	366,481	100.0	%	$	344,682	100.0	%
Unearned income*		—				—				—				—				(517)
Loans and leases	$	602,009			$	499,103			$	415,132			$	366,481			$	344,165
Allowance for loan and lease losses		(10,420)				(9,689)				(11,708)				(13,671)				(17,261)
Total net loans and leases	$	591,589			$	489,414			$	403,424			$	352,810			$	326,904

*For the 2013 through 2016 periods, unearned income was allocated among the various loan types.

Credit Classification Process and Credit Risk Management

We use a nine point grading risk classification system commonly used in the financial services industry.  The first four classifications are rated Pass.  The riskier classifications include Pass-Watch, Special Mention, Substandard, Doubtful and Loss.  During the underwriting process, the Underwriting and Credit Administration Officer (“UCAO”) 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 our 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 UCAO is the primary bank officer dealing with the third party vendor during the reviews.

Loans on our Special Assets Committee list are also subject to loan review even though they are receiving the daily attention of an assigned individual and the 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, CFO, UCAO, Chief Lending Officer

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(“CLO”), and Chief Accounting Officer (“CAO”) 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 quarterly 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 our 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.

Non-performing assets

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

		As of December 31,
(Dollars in thousands)		2016			2015			2014			2013			2012
Non-accrual loans (1)	$	6,007		$	5,492		$	9,813		$	10,157		$	21,432
Other real estate owned		3,536			7,435			9,779			9,617			13,435
Total non-performing assets	$	9,543		$	12,927		$	19,592		$	19,774		$	34,867
Non-performing assets to total assets		1.15	%		1.64	%		2.67	%		2.70	%		4.53	%
Non-performing loans to total loans		1.00	%		1.10	%		2.36	%		2.77	%		6.23	%
Allowance for loan loss to non-accrual loans		173.46	%		176.42	%		119.31	%		134.60	%		80.54	%

(1) Generally, a loan is placed in non-accrual status when it has been delinquent for a period of 90 days or more, unless the loan is both well secured and in the process of collection.

Non-accrual loan activity for 2016 is set forth below:

	For the year ended December 31, 2016
					Payments
	Beginning				and other				Transfers to		Ending
(In thousands)	balance		Additions		decreases		Charge-offs		OREO		balance
Commercial real estate	$	1,495	$	343	$	(869)	$	(84)	$	—	$	885
Construction and land development		145		—		(1)		—		—		144
Commercial and industrial		751		189		(180)		(108)		—		652
Residential real estate		889		32		(283)		(40)		(28)		570
Leases		1,087		2,713		(1,022)		(929)		—		1,849
Tax certificates		1,125		1,743		(279)		(139)		(543)		1,907
Total non-accrual loans	$	5,492	$	5,020	$	(2,634)	$	(1,300)	$	(571)	$	6,007

Total non-accrual loans at December 31, 2016 were $6.0 million compared to $5.5 million at December 31, 2015.  The $515 thousand increase in non-accrual loans was the result of  $5.0 million in additions that was partially offset by a $2.6 million reduction in existing non-accrual loan balances through payments or payoffs, $1.3 million in charge-offs related to impairment, and transfers to OREO of $571 thousand. The majority of the new non-accrual activity and transfers to OREO originated from the leasing and tax certificate portfolios.  Tax certificates, leases and commercial real estate represented 31.7%, 30.8%, and 14.7%, respectively, of the total $6.0 million in non-accrual loans at December 31, 2016.  

Impaired Loans

We identify 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 TDRs. Excess proceeds received over the principal amounts due on impaired non-accrual loans are recognized as income on a cash basis. We

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recognize 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, we do not recognize interest income. If interest had accrued on these loans, such income would have been approximately $583 thousand and $703 thousand for the years ended December 31, 2016 and 2015, respectively. At December 31, 2016, the Company had no loans past due 90 days or more on which interest continues to accrue.    Total cash collected on impaired loans during the year ended December 31, 2016 and 2015 was $1.8 million and $9.6 million respectively, of which $1.7 million and $8.4 million was credited to the principal balance outstanding on such loans, respectively.

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

	As of  December 31,
(In thousands)	2016		2015
Impaired loans and leases with a valuation allowance	$	2,509	$	2,414
Impaired loans and leases without a valuation allowance		4,446		4,777
Total impaired loans and leases	$	6,955	$	7,191
Valuation allowance related to impaired loans and leases	$	368	$	398

	For the year ended
	December 31,
(In thousands)	2016		2015
Average investment in impaired loans and leases	$	6,244	$	11,703
Interest income recognized on impaired loans and leases	$	111	$	279
Interest income recognized on a cash basis on impaired loans and leases	$	—	$	234

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 collectibility of the total contractual restructured principal and interest is no longer in doubt.  At December 31, 2016, the Company had five TDRs, with a total carrying value of $2.1 million compared to six TDRs with a total carrying value of $2.6 million at December 31, 2015.  The $465 thousand decline in TDRs was mainly due to principal payments and one payoff.  Our 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 a non-accrual status at December 31, 2016.

	As of December 31, 2016
				Non-
	Number of	Accrual		Accrual
(In thousands)	loans	Status		Status		Total TDRs
Commercial real estate	1	$	19	$	—	$	19
Construction and land development	1		—		144		144
Commercial and industrial	2		1,692		173		1,865
Residential real estate	1		83		—		83
Total	5	$	1,794	$	317	$	2,111

At December 31, 2016, there were no TDRs modified within the past 12 months, for which there was a payment default. At December 31, 2015, the one construction and land development TDR, cited in the above table, was not in compliance with its restructured terms due to payment defaults. We did not have any newly restructured loans that fit the criteria for classification as a TDR during the years ended December 31, 2016 and 2015.

We may obtain physical possession of real estate collateralizing residential mortgage loans or home equity loans through or in lieu of, foreclosure. As of December 31, 2016, we have a foreclosed residential real estate property with a carrying

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value of $28 thousand as a result of physical possession. However, as of December 31, 2016, we had residential mortgage loans with a carrying value of $104 thousand collateralized by residential real estate property for which formal foreclosure proceedings were in process.

Potential Problem Loans

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. Potential problem loans amounted to approximately $2.2 million and $3.3 million at December 31, 2016 and December 31, 2015, respectively.

Allowance for loan and lease losses (“allowance”)

Our loan and lease portfolio (the “credit portfolio”) is subject to varying degrees of credit risk. We maintain an 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. Our systematic methodology for assessing the appropriateness of the allowance includes: (1) general 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 classification.  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 TDR 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. We obtain third-party

42

appraisals to establish 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 balance and the net remaining balance will be used in the general and qualitative analysis. A specific reserve is established for an impaired loan for the amount that the carrying value exceeds its estimated fair value.

The amount of the allowance is reviewed and approved by the CLO, CFO, and the UCAO on at least a quarterly basis.  Management believes that the allowance for loan and lease losses at December 31, 2016 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.  These changes could be based in the credits comprising the portfolio and changes in the financial condition of borrowers, as the result of 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.

Analysis of the Allowance for Loan and Lease Losses:

	For the years ended
	December 31,
(In thousands, except percentages)	2016			2015			2014			2013			2012
Total Loans	$	602,009		$	499,103		$	415,132		$	366,481		$	344,165
Daily average loan balance	$	551,161		$	450,094		$	383,582		$	367,219		$	384,440
Allowance for loan and lease losses:
Balance at beginning of year	$	9,689		$	11,708		$	13,671		$	17,261		$	16,380
Charge-offs
Commercial real estate		(84)			(622)			(354)			(1,684)			(1,313)
Construction and land development		—			(264)			(172)			(820)			(2,452)
Commercial and industrial		(107)			(566)			(452)			(383)			(586)
Multi-family		—			—			—			—			(542)
Residential real estate		(40)			—			—			(46)			(111)
Leases		(930)			(612)			(793)			(382)			(465)
Tax certificates		(139)			(471)			(350)			(578)			(802)
Total charge-offs		(1,300)			(2,535)			(2,121)			(3,893)			(6,271)
Recoveries
Commercial real estate		201			380			—			600			3
Construction and land development		306			503			940			297			816
Commercial and industrial		174			282			27			17			67
Residential real estate		35			20			15			158			208
Leases		57			26			42			29			32
Tax certificates		14			53			1			74			29
Consumer		2			—			—			—			—
Total recoveries		789			1,264			1,025			1,175			1,155
Net charge offs		(511)			(1,271)			(1,096)			(2,718)			(5,116)
Provision (credit) for loan and lease losses		1,242			(748)			(867)			(872)			5,997
Balance at end of year	$	10,420		$	9,689		$	11,708		$	13,671		$	17,261
Net charge-offs to average loans		0.09	%		0.28	%		0.29	%		0.74	%		1.33	%
Allowance to total loans at end of year		1.73	%		1.94	%		2.82	%		3.73	%		5.02	%

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Analysis of the Allowance for Loan and Lease Losses by Loan Type:

		As of December 31,
		2016			2015			2014			2013			2012
(In thousands, except percentages)		Reserve Amount	Percent of outstanding loans in each category to total loans		Reserve Amount	Percent of outstanding loans in each category to total loans		Reserve Amount	Percent of outstanding loans in each category to total loans		Reserve Amount	Percent of outstanding loans in each category to total loans		Reserve Amount	Percent of outstanding loans in each category to total loans
Commercial real estate	$	3,295	43.4%	$	3,622	45.2%	$	4,452	42.2%	$	5,498	40.5%	$	8,750	48.5%
Construction and land development		2,294	13.8%		1,674	9.6%		2,292	11.0%		2,316	12.3%		2,987	10.8%
Commercial and industrial		1,346	18.0%		1,513	17.2%		1,780	18.4%		3,006	21.7%		1,924	11.8%
Multi-family		263	3.9%		171	3.3%		285	3.3%		402	3.2%		654	3.4%
Residential real estate		656	9.5%		586	10.3%		616	10.4%		473	7.0%		1,098	7.3%
Leases		2,295	10.3%		1,749	12.9%		1,429	12.4%		1,223	11.6%		1,108	10.8%
Tax certificates		242	0.6%		347	1.0%		667	1.7%		555	3.5%		472	7.1%
Consumer		29	0.5%		27	0.5%		38	0.6%		15	0.2%		29	0.3%
Unallocated		—	—		—	—		149	0.0%		183	0.0%		239	0.0%
Total	$	10,420	100.0%	$	9,689	100.0%	$	11,708	100.0%	$	13,671	100.0%	$	17,261	100.0%

For 2016 we recorded a provision for loan and lease losses of $1.2 million compared to a credit of $748 thousand in 2015. The 2016 provision was primarily attributable to loan growth, specific reserves on the leasing portfolio, and net charge-off activity within the leasing and tax certificate portfolios.  We recorded $511 thousand in net charge-offs in 2016 compared to $1.3 million in 2015.  The decline in net charge-offs was primarily related to a $1.2 million decrease in charge-offs year over year.  There were no significant changes in the impairment analyses of impaired loans collateralized by real estate, that required new or further write downs of the carrying value. Tax certificates, leases and commercial real estate, represented 31.8%, 30.8%, and 14.7%, respectively, of the total $6.0 million in non-accrual loans at December 31, 2016.  Commercial real estate, tax certificates and leases represented 27.2%, 20.5%, and 19.8%, respectively, of the total $5.5 million in non-accrual loans at December 31, 2015.  Total charge-offs recorded in 2016 related to leases and to construction and land development loans and commercial real estate loans were $930 thousand, or 71.5%, and $84 thousand, or 6.5%, respectively, of total charge-offs in 2016.  Total charge-offs recorded in 2015 related to leases and to construction and land development loans and commercial real estate loans were $612 thousand, or 24.1%, and $886 thousand, or 35.0%, respectively, of total charge-offs in 2015.

Other Real Estate Owned (“OREO”)

At December 31, 2016, OREO is comprised of two real estate properties acquired through, or in lieu of foreclosure in settlement of loans and 41 real estate properties acquired through foreclosure related to tax liens.  Set forth below is a table which detail the changes in OREO from December 31, 2015 to December 31, 2016.

	For the year ended December 31, 2016
(In thousands)	Loans		Tax Liens		Total
Beginning balance	$	220	$	7,215	$	7,435
Net proceeds from sales		(7)		(5,458)		(5,465)
Net gains on sales		1		677		678
Transfers in		28		831		859
Cash additions		—		290		290
Impairment charge		(6)		(255)		(261)
Ending balance	$	236	$	3,300	$	3,536

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At December 31, 2016, OREO was comprised of $208 thousand in land, $3.3 million in tax liens, and $28 thousand in residential real estate related to a single family home.  During 2016, we sold one residential condominium. We received $7 thousand in net proceeds and recorded a net gain of $1 thousand as a result of this sale.  During 2016, we recorded impairment charges of $6 thousand on the land parcel due to a recent appraisal.  In 2016, we foreclosed on one single family home. 

At December 31, 2016, OREO assets acquired through the tax lien portfolio were comprised of 41 properties, were valued at $3.3 million, and were primarily located in New Jersey.  In 2016, we transferred $831 thousand to OREO, which represented ten separate properties.  During 2016, the Company sold 28 of the tax lien properties, received proceeds of $5.5 million, and recorded net gains of $677 thousand as a result of these sales. Additionally, we recorded impairment charges of $255 thousand in 2016 related to the tax lien properties.  At December 31, 2015, OREO assets acquired through the tax lien portfolio were $7.2 million and were comprised of 60 properties.

The Company is working to satisfactorily sell the remaining OREO properties.  However, we recognize that the successful disposition of the properties, specifically the land, will likely take considerable time.

Other Assets

Other assets were $10.7 million and $9.1 million at December 31, 2016 and December 31, 2015, respectively.  The $1.5 million increase in other assets was mainly due to the $2.2 million increase in the net deferred tax asset at December 31, 2016.  Please see discussion under “Accounting for Income Taxes.”

Deposits

Our customer deposits are an important source of funding. Total deposits of $629.5 million at December 31, 2016 increased $51.6 million, or 8.9%, from $577.9 million at December 31, 2015.  Savings accounts grew $31.4 million, or 58.2%, from $53.8 million at December 31, 2015 to $85.2 million at December 31, 2016. Non-interest checking accounts grew $14.3 million, or 17.2%, to $97.8 million at December 31, 2016 from $83.5 million at December 31, 2015.  NOW and money market accounts increased $5.3 million while time deposit accounts of $207.7 million at December 31, 2015 grew $4.2 million to $211.9 million at December 31, 2016.  During 2016, we replaced our terminated $25.0 million brokered checking deposit arrangement with $21.5 million in brokered certificates of deposit.

The average balance of the Company’s deposits by major classifications for each of the last three years is presented in the following table.

		As of December 31,
		2016				2015				2014
(In thousands, except percentages)		Average Balance	Rate			Average Balance	Rate			Average Balance	Rate
Demand deposits
Non-interest  bearing	$	83,215	-		$	77,052	-		$	66,221	-
Interest-bearing (NOW)		62,773	0.27	%		50,570	0.18	%		42,443	0.11	%
Money market deposits		159,853	0.40	%		160,701	0.39	%		166,245	0.34	%
Savings deposits		74,520	0.71	%		30,023	0.40	%		18,765	0.17	%
Certificates of deposit		212,166	1.41	%		217,688	1.36	%		228,754	1.28	%
Total deposits	$	592,527			$	536,034			$	522,428

The remaining maturity of Certificates of Deposit of $100,000 or greater is presented below:

	As of December 31,
(In thousands)	2016		2015
Three months or less	$	14,226	$	10,795
Over three months through twelve months		47,621		28,436
Over twelve months through five years		53,455		45,973
Over five years		227		2,085
Total	$	115,529	$	87,289

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Short and Long Term Borrowings

		As of December 31,
(In thousands)		2016		2015		2014		2013		2012
Short term borrowings	$	19,000	$	9,000	$	—	$	10,000	$	—
Long term borrowings
Other borrowings		35,000		36,970		37,426		42,881		43,333
Subordinated debt		25,774		25,774		25,774		25,774		25,774
FHLB advances		50,000		45,000		55,000		55,000		65,000
Total borrowings	$	129,774	$	116,744	$	118,200	$	133,655	$	134,107

FHLB Borrowings

Borrowings consist of long-term borrowings (advances) and short-term borrowings (overnight borrowings, advances).  Total FHLB borrowings were $69.0 million and $54.0 million at December 31, 2016 and 2015, respectively.  The maturity dates of the FHLB borrowings range from 2017 through 2021.  The weighted average rate on the outstanding FHLB borrowings at December 31, 2016 was 1.36% compared to 1.35% at December 31, 2015.

Other Borrowings

We had a note payable with PNC Bank (“PNC”) in the amount of $2.0 million at December 31, 2015.  The note was paid on its maturity date of August 25, 2016.  The interest rate was a variable rate equal to one month LIBOR + 15 basis points and adjusted monthly. At December 31, 2016 and 2015, we had other borrowings of $35.0 million from PNC which will mature on January 7, 2018.  These borrowings are secured by government agencies and mortgaged-backed securities and have a weighted average interest rate of 3.65%.  As of December 31, 2016, investment securities with a market value of $39.5 million were pledged as collateral to secure all borrowings with PNC.

Royal Bank also has $20.0 million in lines of credit with two local financial institutions, of which $0 was outstanding,  at December 31, 2016 and December 31, 2015.

Subordinated Debentures

We have outstanding $25.8 million of trust preferred securities which have a maturity date of October 2034.  The interest rate resets quarterly at 3-month LIBOR plus 2.15% and was 3.11% at December 31, 2016.   

Other Liabilities

At December 31, 2016, other liabilities were $20.2 million.  The largest component of other liabilities is the $15.3 million in unfunded benefit obligation related to our pension plan. We plan to fund a substantial portion of this obligation through existing Company owned life insurance policies. For more information refer to “Note 17 - Pension Plan” to the Consolidated Financial Statements in Item 8 of this Report.

Shareholders’ Equity

Shareholders’ equity attributable to the Company declined $20.3 million, or 28.2%, from $71.9 million at December 31, 2015 to $51.6 million at December 31, 2016. We repurchased or redeemed the remaining 18,856 shares of Series A preferred stock from time to time during 2016 as shares became available for purchase and we received the required regulatory approvals to repurchase such shares. We paid $29.5 million to repurchase the outstanding shares and eliminated future dividends on these shares. Of lesser impact to shareholders’ equity attributable to the Company, was a $1.3 million increase in accumulatedother comprehensive loss. The other comprehensive loss was mostly related to a decline in the valuation of the investment portfolio.  Partially offsetting these factors was net income of $10.4 million for 2016.  The distributions to non-controlling interests of $359 thousand and $524 thousand for 2016 and 2015, respectively, were to the 40% owners of RBA Leasing and were for tax distributions.

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Asset Liability Management

The primary functions of asset-liability management are to ensure adequate liquidity and maintain an appropriate balance between interest-earning assets and interest-bearing liabilities.  This process is overseen by the Asset-Liability Committee (“ALCO”) which monitors and controls, among other variables, the liquidity, balance sheet structure and interest rate risk of the consolidated company within policy parameters established and outlined in the ALCO Policy which are reviewed by the Board of Directors at least annually. Additionally, the ALCO committee meets monthly and reports on liquidity and interest rate sensitivity and projects financial performance in various interest rate scenarios.

Liquidity: Liquidity is the ability to ensure that adequate funds will be available to meet our 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 our 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. 

We generally target liquidity ratios equal to or greater than 12% and 10% of total deposits and total liabilities, respectively. At December 31, 2016, liquidity as a percent of deposits was 57% and liquidity as a percent of total liabilities was 47%.  At December 31, 2015, liquidity as a percent of deposits was 67% and liquidity as a percent of total liabilities was 55%.  Management believes that our liquidity position continues to be adequate and meets or exceeds the liquidity target set forth in the Asset/Liability Management Policy.  Management believes that due to its financial position, it will be able to raise deposits as needed to meet liquidity demands.  However, any financial institution could have unmet liquidity demands at any time.

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. We have 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.  Our ALCO meets monthly to monitor liquidity management. 

Contractual Obligations and Other Commitments:  The following table sets forth contractual obligations and other commitments representing required and potential cash outflows as of December 31, 2016.  The allocation of the non-maturity deposits is based on an annual deposit decay study completed in 2016.

		As of December 31, 2016
(In thousands)		Total		Less than one  year		One to three years		Four to five years		More than five years
Operating leases	$	5,453	$	1,215	$	1,862	$	1,063	$	1,313
FHLB borrowings (1)		70,791		44,926		10,518		15,347		-
PNC Bank (1)		36,317		1,296		35,021		-		-
Subordinated debt		25,774		-		-		-		25,774
Benefit obligations		15,263		1,005		2,044		2,251		9,963
Standby letters of credit		37		37		-		-		-
Non-interest bearing deposits		97,859		97,859		-		-		-
Interest-bearing deposits		298,310		130,524		167,786		-		-
Certificates of deposit		233,377		115,673		75,605		40,194		1,905
Total	$	783,181	$	392,535	$	292,836	$	58,855	$	38,955

((1) Includes principal and expected interest payments

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Capital Adequacy

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 December 31, 2016 and the previous 25 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 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 Office of the Comptroller of the Currency (“OCC”).

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

	As of December 31,
	2016		2015
Total risk based capital ratio	12.185	%	15.802	%
Tier 1 risk based capital ratio	10.919	%	14.546	%
Leverage ratio	8.573	%	10.589	%
Common equity Tier 1 ratio	11.068	%	10.641	%

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

	For the year ended		For the year ended
(In thousands)	December 31, 2016		December 31, 2015
RAP net income	$	8,775	$	9,161
Tax lien adjustment, net of noncontrolling interest		1,544		1,973
U.S. GAAP net income	$	10,319	$	11,134

	At December 31, 2016				At December 31, 2015
	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)	12.185	%	12.405	%	15.802	%	16.109	%
Tier 1 capital (to risk-weighted assets)	10.919	%	11.139	%	14.546	%	14.853	%
Tier 1 capital (to average assets, leverage)	8.573	%	8.750	%	10.589	%	10.824	%
Common equity Tier 1 (to risk-weighted assets)	11.068	%	11.040	%	10.641	%	10.962	%

The tables below reflect the Company’s capital ratios and the Company’s performance ratios:

	As of December 31,
	2016		2015
Total risk based capital ratio	13.302	%	18.574	%
Tier 1 risk based capital ratio	10.812	%	17.129	%
Leverage ratio	8.488	%	12.444	%
Common equity Tier 1 ratio	7.992	%	9.366	%

Capital performance
Return on average assets	1.29	%	1.49	%
Return on average equity	15.19	%	16.81	%

We have filed the Consolidated Financial Statements for Bank Holding Companies-FR Y-9C (“FR Y-9C”) as of December 31, 2016 consistent with U.S. GAAP and the FR Y-9C instructions.  In the event that a similar adjustment for RAP

48

purposes would be required by the Federal Reserve on the holding company level, the adjusted ratios are shown in the table below. 

	For the year ended		For the year ended
(In thousands)	December 31, 2016		December 31, 2015
U.S. GAAP net income	$	10,375	$	10,993
Tax lien adjustment, net of noncontrolling interest		(1,544)		(1,973)
RAP net income	$	8,831	$	9,020

	At December 31, 2016				At December 31, 2015
	As reported		As adjusted		As reported		As adjusted
	under U.S. GAAP		for RAP		under U.S. GAAP		for RAP
Total capital (to risk-weighted assets)	13.302	%	13.084	%	18.574	%	18.277	%
Tier 1 capital (to risk-weighted assets)	10.812	%	10.512	%	17.129	%	16.710	%
Tier 1 capital (to average assets, leverage)	8.488	%	8.248	%	12.444	%	12.127	%
Common equity Tier 1 (to risk-weighted assets)	7.992	%	8.012	%	9.366	%	9.040	%

The capital ratios set forth above compare favorably to the minimum required amounts of Tier 1 and total capital to risk-weighted assets and the minimum Tier 1 leverage ratio, as defined by the banking regulators.  At December 31, 2016, the Company met the regulatory minimum capital requirements, and management believes that, under current regulations, the Company will continue to meet its minimum capital requirements in the foreseeable future.  Royal Bank met the criteria for a well-capitalized institution which is a leverage ratio of 5%, a Tier 1 ratio of 8%, and a total capital ratio of 10%. 

Management Options to Purchase Securities

The 2007 Long-Term Incentive Plan was approved by shareholders at the 2007 Annual Meeting.  All employees and non-employee directors of the Company and its designated subsidiaries are eligible participants. The plan includes 1,000,000 shares of Class A common stock (of which 250,000 shares may be issued as restricted stock), subject to customary anti-dilution adjustments, or approximately 4.0% of total outstanding shares of the Class A common stock.  As of December 31, 2016, options to purchase 217,139 shares from this plan have been granted. The option price is equal to the fair market value at the date of the grant.  The options are exercisable based on the vesting schedule of the specific grant and begin one year after the date of grant.  The options must be exercised within ten years of the grant.  At December 31, 2016, 217,139 of the options that have been granted are outstanding.  The restricted stock is granted with an estimated fair value equal to the market value of the Company closing stock price on the date of the grant.  Restricted stock will vest three years from the grant date, if we achieve specific goals set by the Compensation Committee and approved by the Board of Directors. At December 31, 2016, 25,000 shares of restricted stock were outstanding. 

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

An interest rate simulation model is used to estimate the impact of various changes, both upward and downward, in market interest rates and volumes of assets and liabilities on net interest income and net income.  This model produces an interest rate exposure report that forecasts changes in the economic value of equity (“EVE”) and net interest income under alternative interest rate environments.  This model assumes that the change in interest rates occurs immediately.  The EVE is the difference between the present value of the expected future cash flows from Royal Bank’s existing assets and the present value of the expected future cash flows from Royal Bank’s existing liabilities.  The assumptions used in evaluating the vulnerability of earnings and capital to changes in interest rates are based on management’s considerations of past experience, current position and anticipated future economic conditions.  The interest rate sensitivity of assets and liabilities as well as the estimated effect of changes in interest rates on the EVE and net interest income could vary substantially if different assumptions are used or actual experience differs from what the calculations may be based.

The simulation model indicates that we are outside of our policy limits in the EVE increasing rate scenarios for 200, 300 and 400 basis points but within policy limits for rates up 100 basis points.  We are within our policy limits for all changes in net interest income scenarios.  The cause of the EVE policy exceptions is primarily related to extension risk within the Company’s investment portfolio; the demand for fixed rate loans in this sustained low rate environment; the composition of deposits, and the lower capital from the transactions associated with the repurchase of the Series A Preferred Stock.  In a rising interest rate environment general expectations are for prepayments of principal to slow down which cause the life

49

of the our mortgage-backed and CMO securities to extend.  Management continues to work on changing the mix of interest-earning assets to mitigate this risk.

In December 2016, the Federal Reserve Bank raised short-term interest rates 25 basis points.  We do not expect this singular event to have a significant impact on net interest income in 2017.  Based on the simulation results below we expect to remain within our policy limits for changes in net interest income due to changes in rates.  The calculated estimates of changes in the EVE as of December 31, 2016 and net interest income for 2016 for Royal Bank are as follows:

(In thousands, except percentages)		As of December 31, 2016
Changes in Rates		Economic Value of Equity	Percent of Change	Policy Limits
+  400 basis points	$	26,857	(64.8%)	+/- 45%
+  300 basis points		38,181	(50.0%)	+/- 35%
+  200 basis points		50,443	(33.9%)	+/- 25%
+  100 basis points		63,397	(16.9%)	+/- 15%
Flat rate		76,326	0.0%	N/A
-  100 basis points		81,536	6.8%	+/- 15%
-  200 basis points		76,467	0.2%	+/- 25%

(In thousands, except percentages)		Net Interest Income for 2016
Changes in Rates		Net Interest Income	Percent of Change	Policy Limits
+  400 basis points	$	27,591	(3.5%)	+/- 40%
+  300 basis points		27,868	(2.5%)	+/- 30%
+  200 basis points		28,144	(1.6%)	+/- 20%
+  100 basis points		28,409	(0.6%)	+/- 10%
Flat rate		28,589	0.0%	N/A
-  100 basis points		27,972	(2.2%)	+/- 10%
-  200 basis points		26,739	(6.5%)	+/- 20%

Interest-Rate Sensitivity:   Interest rate sensitivity is a function of the re-pricing characteristics of our 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 our interest rate sensitivity positions, we seek 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 December 31, 2016, and the difference or “GAP” between them on an actual and cumulative basis for the periods indicated. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities.  During a period of falling interest rates, a positive gap would tend to adversely affect net interest income, while a negative gap would tend to result in an increase in net interest income.  During a period of rising interest rates, a positive gap would tend to result in an increase in net interest income while a negative gap would tend to affect net interest income adversely.  At December 31, 2016, we were in a liability sensitive position of $19.9 million, which indicates that within one year the re-pricing of liabilities is sooner than the re-pricing of assets.

50

		As of December 31, 2016
(In millions)		0 – 90 days		91 – 365 days		One to five years		Over five years		Non-rate sensitive		Total
Assets  (1)
Interest-earning deposits in banks	$	8.1	$	-	$	-	$	-	$	13.1	$	21.2
Investment securities		9.8		21.4		79.1		60.1		(0.5)		169.9
Loans: (2)
Fixed rate		22.5		54.1		230.1		136.0		(10.4)		432.3
Variable rate		159.3		-		-		-		-		159.3
Total loans		181.8		54.1		230.1		136.0		(10.4)		591.6
Other assets (3)		-		20.8		-		-		29.0		49.8
Total Assets	$	199.7	$	96.3	$	309.2	$	196.1	$	31.2	$	832.5
Liabilities & Capital
Deposits:
Non-interest bearing deposits		-		-		-		-		97.9		97.9
Interest-bearing deposits		32.6		97.9		167.8		-		-		298.3
Certificate of deposits		31.4		84.2		115.8		1.9		-		233.3
Total deposits		64.0		182.1		283.6		1.9		97.9		629.5
Borrowings (1)		59.8		10.0		60.0		-		-		129.8
Other liabilities		-		-		-		-		20.9		20.9
Capital		-		-		-		-		52.3		52.3
Total liabilities & capital	$	123.8	$	192.1	$	343.6	$	1.9	$	171.1	$	832.5
Net  interest rate  GAP	$	75.9	$	(95.8)	$	(34.4)	$	194.2	$	(139.9)
Cumulative interest rate  GAP	$	75.9	$	(19.9)	$	(54.3)	$	139.9
GAP to total  assets		9%		(12%)
GAP to total equity		145%		(183%)
Cumulative GAP to total assets		9%		(2%)
Cumulative GAP to total equity		145%		(38%)

(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 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.

51

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Report of Independent Registered Public Accounting Firm	53
Consolidated Balance Sheets.	54
Consolidated Statements of Income.	55
Consolidated Statements of Comprehensive Income.	56
Consolidated Statements of Changes in Shareholders’ Equity.	57
Consolidated Statement of Cash Flows.	58
Notes to Consolidated Financial Statements.	60

52

Report of Independent Registered Public Accounting Firm 

Board of Directors and Shareholders

Royal Bancshares of Pennsylvania, Inc. and Subsidiaries

Bala Cynwyd, Pennsylvania

We have audited the accompanying consolidated balance sheets of Royal Bancshares of Pennsylvania, Inc. and subsidiaries (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Royal Bancshares of Pennsylvania, Inc. and subsidiaries at December 31, 2016 and 2015, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

/s/ BDO USA, LLP

Philadelphia, Pennsylvania

March 22, 2017

53

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

	December 31,		December 31,
	2016		2015
ASSETS	(Dollars in thousands, except share data)
Cash and due from banks	$	13,146	$	10,394
Interest-earning deposits		8,084		15,026
Total cash and cash equivalents		21,230		25,420
Investment securities available for sale (“AFS”), at fair value		169,854		224,067
Other investment, at cost		2,250		2,250
Federal Home Loan Bank (“FHLB”) stock		3,216		2,545
Loans and leases (“LHFI”)		602,009		499,103
Less allowance for loan and lease losses		10,420		9,689
Net loans and leases		591,589		489,414
Company owned life insurance		20,781		19,899
Accrued interest receivable		3,968		4,149
Other real estate owned (“OREO”), net		3,536		7,435
Premises and equipment, net		5,398		3,959
Other assets		10,663		9,145
Total assets	$	832,485	$	788,283
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits
Non-interest bearing	$	97,859	$	83,529
Interest-bearing		531,687		494,363
Total deposits		629,546		577,892
Short-term borrowings		19,000		9,000
Long-term borrowings		85,000		81,970
Subordinated debentures		25,774		25,774
Accrued interest payable		711		709
Other liabilities		20,181		20,640
Total liabilities		780,212		715,985
Shareholders’ equity
Royal Bancshares of Pennsylvania, Inc. equity:
Preferred stock, Series A perpetual,  $1,000 liquidation value per share, 500,000 shares authorized, 0 and 18,856 shares outstanding at December 31, 2016 and  December 31, 2015, respectively		—		18,856
Class A common stock, par value $2 per share, authorized 40,000,000 shares; issued 28,242,055 and 28,204,182 at December 31, 2016 and  December 31, 2015, respectively, and outstanding of 27,887,024 and 27,828,849 at December 31, 2016 and  December 31, 2015, respectively		56,484		56,408
Class B common stock, par value $ 0.10 per share, authorized 3,000,000 shares; issued and outstanding, 1,924,629 and 1,928,289  at December 31, 2016 and  December 31, 2015, respectively		193		193
Additional paid in capital		99,667		110,494
Accumulated deficit		(94,512)		(104,879)
Accumulated other comprehensive loss		(5,219)		(3,919)
Treasury stock - at cost, shares of Class A, 355,031 and 375,333 at December 31, 2016 and  December 31, 2015, respectively		(4,965)		(5,249)
Total Royal Bancshares of Pennsylvania, Inc. shareholders’ equity		51,648		71,904
Noncontrolling interest		625		394
Total equity		52,273		72,298
Total liabilities and shareholders’ equity	$	832,485	$	788,283

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

54

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

Consolidated Statements of Income

	For the year ended
	December 31,
(In thousands, except per share data)	2016		2015
Interest Income
Loans and leases, including fees	$	28,825	$	24,344
Investment securities		4,528		5,617
Deposits in banks		63		32
Total Interest Income		33,416		29,993
Interest Expense
Deposits		4,325		3,806
Short-term borrowings		88		14
Long-term borrowings		2,902		2,664
Total Interest Expense		7,315		6,484
Net Interest Income		26,101		23,509
Provision (credit) for loan and lease losses		1,242		(748)
Net Interest Income after Provision (Credit) for Loan and Lease Losses		24,859		24,257
Non-interest Income
Service charges and fees		1,361		1,126
Net gains on sales of loans and leases		165		—
Income from company owned life insurance		1,166		497
Gains on sales of premises and equipment		—		324
Net gains on the sale of AFS investment securities		1,431		900
Total other-than-temporary impairment on AFS investment securities		(190)		(14)
Other income		374		280
Total Non-interest Income		4,307		3,113
Non-interest Expense
Employee salaries and benefits		10,398		10,441
Loss contingency		(200)		—
Occupancy and equipment		2,876		2,950
Professional and legal fees		1,977		1,731
Net OREO expenses		77		504
Pennsylvania shares tax expense		547		450
FDIC and state assessments		594		688
Communications and data processing		1,004		798
(Credit) provision for credit losses on off-balance sheet credit exposures		(333)		425
Directors’ fees		434		459
Marketing and advertising		243		190
Insurance		363		335
Loan collection expenses		216		422
Other operating expenses		1,801		1,592
Total Non-interest Expense		19,997		20,985
Income Before Tax Benefit		9,169		6,385
Income Tax Benefit		(1,796)		(5,139)
Net Income	$	10,965	$	11,524
Less Net Income Attributable to Noncontrolling Interest	$	590	$	531
Net Income Attributable to Royal Bancshares of Pennsylvania, Inc.	$	10,375	$	10,993
Less Preferred Stock Series A Accumulated Dividend and Accretion	$	1,133	$	1,721
Net Income Available to Common Shareholders	$	9,242	$	9,272
Per Common Share Data:
Net Income — Basic and Diluted	$	0.31	$	0.31

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

55

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

Statements of Consolidated Comprehensive Income  

	For the year ended
	December 31,
(In thousands)	2016		2015
Net income	$	10,965	$	11,524
Other comprehensive loss, net of tax
Unrealized (losses) gains on investment securities:
Unrealized holding gains (losses) arising during period, net of tax (1)		91		(824)
Less adjustment for impaired investments, net of tax (2)		(125)		(9)
Less reclassification adjustment for gains realized in net income, net of tax (3)		1,095		594
Unrealized losses on investment securities		(879)		(1,409)
Unrecognized benefit obligation:
Actuarial (loss) gain		(634)		73
Reclassification adjustment for amortization (4)		173		275
Unrecognized benefit obligation		(461)		348
Unrealized gain (loss) on derivative instrument, net of tax (5)		40		(366)
Other comprehensive loss		(1,300)		(1,427)
Comprehensive income		9,665		10,097
Less net income attributable to noncontrolling interest		590		531
Comprehensive income attributable to Royal Bancshares of Pennsylvania, Inc.	$	9,075	$	9,566

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

1. Net of $47 thousand tax expense and $603 thousand tax benefit for 2016 and 2015, respectively.

2. Amounts are included in total other-than-temporary impairment on AFS investment securities on the Consolidated Statements of Income in total non-interest income, net of a $65 thousand and $5 thousand tax benefit for 2016 and 2015, respectively.

3. Amounts are included in net gains on the sale of AFS investment securities on the Consolidated Statements of Income in total non-interest income, net of $336 thousand and $306 thousand in taxes for 2016 and 2015, respectively.

4. Amounts are included in salaries and benefits on the Consolidated Statements of Income in non-interest expense.

5. Net of $21 thousand tax expense and $189 thousand tax benefit for 2016 and 2015, respectively.

56

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders’ Equity

Years ended December 31, 2016 and 2015

													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 at January 1, 2015	$	18,856	28,200	$	56,400	1,932	$	193	$	110,697	$	(115,864)	$	(2,492)	$	(5,571)	$	387	$	62,606
Net income												10,993						531		11,524
Other comprehensive income, net of reclassifications and taxes														(1,427)						(1,427)
Distributions to noncontrolling interests																		(524)		(524)
Common stock conversion from Class B to Class A			4		8	(4)		—				(8)								—
Treasury shares issued for compensation (23,032 shares)										(281)						322				41
Stock compensation expense										78										78
Balance at December 31, 2015		18,856	28,204		56,408	1,928		193		110,494		(104,879)		(3,919)		(5,249)		394		72,298
Net income												10,375						590		10,965
Other comprehensive loss, net of reclassifications and taxes														(1,300)						(1,300)
Distributions to noncontrolling interests																		(359)		(359)
Common stock conversion from Class B to Class A			4		8	(3)		—				(8)								—
Repurchase of 18,856 shares of preferred stock		(18,856)								(10,653)										(29,509)
Treasury shares issued for compensation (20,302 shares)										(243)						284				41
Stock options exercised (33,666 shares)			34		68					(16)										52
Stock compensation expense										85										85
Balance at December 31, 2016	$	—	28,242	$	56,484	1,925	$	193	$	99,667	$	(94,512)	$	(5,219)	$	(4,965)	$	625	$	52,273

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

57

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

Year ended December 31,

(In thousands)	2016		2015
Cash flows from operating activities:
Net income	$	10,965	$	11,524
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		598		634
Stock compensation expense		85		78
Provision (credit) for loan and lease losses		1,242		(748)
(Credit) provision for credit losses on off-balance sheet credit exposures		(333)		425
Impairment charge for OREO		261		703
Net amortization of premiums on AFS investment securities		1,556		1,506
Net accretion of net deferred fees on loans		(626)		(613)
Benefit for deferred income taxes		(1,969)		(5,176)
Net gains on sales of premises and equipment		—		(324)
Gains on sales of loans and leases		(165)		—
Net gains on sales of OREO		(678)		(919)
Net gains on sales of investment securities		(1,431)		(900)
Income from company owned life insurance		(1,166)		(497)
Other-than-temporary impairment on AFS investment securities		190		14
Changes in assets and liabilities:
Decrease in accrued interest receivable		181		1,121
(Increase) decrease in other assets		(209)		364
Increase (decrease) in accrued interest payable		2		(17)
Decrease in other liabilities		(126)		(381)
Net cash provided by operating activities		8,377		6,794
Cash flows from investing activities:
Proceeds from maturities, calls and paydowns of AFS investment securities		62,267		35,585
Proceeds from sales of AFS investment securities		36,436		47,018
Purchase of AFS investment securities		(45,909)		(59,235)
(Purchase) redemption of Federal Home Loan Bank stock		(671)		77
Proceeds from sales of loans and leases		4,178		—
Net increase in loans		(107,663)		(87,976)
Additions to OREO		(290)		(558)
Proceeds from life insurance policies		748		1,420
Purchase of premises and equipment		(2,037)		(488)
Proceeds from sales of OREO		5,465		6,465
Net cash used in investing activities		(47,476)		(57,692)

58

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows- continued

Year ended ended December 31,

	2016		2015
Cash flows from financing activities:
Net (decrease) increase in demand and NOW accounts	$	(5,393)	$	30,907
Net increase in money market and savings accounts		31,391		34,139
Net increase (decrease) in certificates of deposit		25,656		(17,579)
Net increase in short-term borrowings		10,000		9,000
Repayments of long-term borrowings		(11,970)		(10,456)
Proceeds from long-term borrowings		15,000		—
Distributions to noncontrolling interest		(359)		(524)
Issuance of treasury stock		41		41
Repurchase of preferred stock		(29,509)		—
Proceeds from stock options exercised		52		—
Net cash provided by financing activities		34,909		45,528
Net decrease in cash and cash equivalents		(4,190)		(5,370)
Cash and cash equivalents at the beginning of the period		25,420		30,790
Cash and cash equivalents at the end of the period	$	21,230	$	25,420
Supplemental Disclosure:
Income taxes paid	$	135	$	—
Interest paid	$	7,313	$	6,501
Transfers from loans to OREO	$	859	$	4,342
Transfers from OREO to loans	$	—	$	995

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

59

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

1.  Basis of Financial Statement Presentation

Nature of Operations

Royal Bancshares of Pennsylvania, Inc. (“Royal Bancshares”, the “Company”, “We” or “Our”), through its wholly-owned subsidiary Royal Bank America (“Royal Bank”) offers a full range of banking services to individual and corporate customers primarily located in the Mid-Atlantic states.  Royal Bank competes with other banking and financial institutions in certain markets, including financial institutions with resources substantially greater than its own.  Commercial banks, savings banks, savings and loan associations, credit unions and brokerage firms actively compete for savings and time deposits and for various types of loans.  Such institutions, as well as consumer finance and insurance companies, may be considered competitors of Royal Bank with respect to one or more of the services it renders.

Principles of Consolidation

The accompanying audited consolidated financial statements include the accounts of Royal Bancshares of Pennsylvania, Inc. 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, 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. 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 in consolidation.

Use of Estimates

In preparing the consolidated financial statements in accordance with United States generally accepted accounting principles (“U.S. GAAP”), management is required 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 principal estimates that are particularly susceptible to significant change in the near term relate to the allowance for loan and lease losses, the valuation of other real estate owned, the valuation of deferred tax assets, fair value measurements, other-than-temporary impairment losses on investment securities, net periodic pension costs and the pension benefit obligation.  Descriptions of these estimates are in the following paragraphs.

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Significant Concentration of Credit Risk

Credit risk is one of our most significant risks. It is critical for consistent profitability that we effectively manage credit risk. Most of the Company’s activities are with customers located within the Mid-Atlantic region of the country.  “Note 3 – Investment Securities” to the Consolidated Financial Statements discusses the types of securities in which the Company invests.  “Note 4 – Loans and Leases” to the Consolidated Financial Statements discusses the types of lending in which we engage.  We do not have any portion of our business dependent on a single or limited number of customers, the loss of which would have a material adverse effect on our business.  We have 90% of our investment portfolio in securities issued by government sponsored entities.  Our tax certificate and other real estate owned portfolios have a geographic concentration in the State of New Jersey.

No substantial portion of loans is concentrated within a single industry or group of related industries, except a significant majority of loans are secured by real estate.  There are numerous risks associated with commercial and consumer lending that could impact the borrower’s ability to repay on a timely basis.  They include, but are not limited to: the owner’s business expertise, changes in local, national, and in some cases international economies, competition, government regulation, and the general financial stability of the borrowing entity. Our commercial real estate, commercial and industrial and construction and land development loans comprised 43%, 18% and 14%, respectively, of the loan portfolio.

We attempt to mitigate these risks through conservative underwriting policies and procedures which include an analysis of the borrower’s business and industry history, its financial position, as well as that of the business owner.  We will also require the borrower to provide current financial information on the operation of the business periodically over the life of the loan.  In addition, most commercial loans are secured by assets of the business or those of the business owner, which can be liquidated if the borrower defaults, along with the personal surety of the business owner.

U.S. GAAP RAP Difference

In connection with a prior bank regulatory examination, the Federal Deposit Insurance Company (“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 December 31, 2016 and the previous 25 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 our capital ratios as disclosed in “Note 2 - Regulatory Matters and Significant Risks And Uncertainties” and “Note 16 - 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 Office of the Comptroller of the Currency (“OCC”).

Reclassifications

Certain items in the 2015 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 for the periods presented herein as a result of the reclassification.

Cash and Cash Equivalents

For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, interest-bearing deposits and federal funds sold.  Generally, federal funds are purchased and sold for one-day periods.

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Investment Securities

Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each balance sheet date. Investments in debt securities that we have the positive intent and ability to hold to maturity are classified as held to maturity securities and reported at amortized cost.  Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized holding gains and losses included in earnings.  Debt and equity securities not classified as trading securities, nor as held to maturity securities, are classified as available for sale securities and reported at fair value, with unrealized holding gains or losses, net of deferred income taxes (when applicable), reported in the accumulated other comprehensive income (loss) (“AOCI”) component of shareholders’ equity.  We did not hold trading securities nor had securities classified as held to maturity at December 31, 2016 and 2015.  Discounts and premiums are accreted/amortized to income by use of the level-yield method.  Gain or loss on sales of securities available for sale is based on the specific identification method.

We evaluate declines in the fair value of securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis.  The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. All investment securities are evaluated for OTTI under FASB ASC Topic 320, “Investments-Debt & Equity Securities” (“ASC Topic 320”).  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) our 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.  Once a decline in value for a debt security is determined to be other-than-temporary, the other-than-temporary impairment is separated into (a) the amount of the total OTTI related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total OTTI related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total OTTI related to all other factors is recognized in other comprehensive income.  In determining our intent not to sell and whether it is more likely than not that we 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.

Other Investment

This investment includes the Solomon Hess SBA Loan Fund, which we invested in to partially satisfy our 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 a 60-day notice to the Fund.  The investment in this Fund is recorded at cost. 

Federal Home Loan Bank Stock

As a member of the Federal Home Loan Bank of Pittsburgh (“FHLB”), we are 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 December 31, 2016 and 2015, FHLB stock totaled $3.2 million and $2.5 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. We evaluate 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

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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 realized.  Accordingly, there is no impairment related to the carrying amount of the Company’s FHLB stock as of December 31, 2016.

Loans Held for Sale

At and during the year ended December 31, 2016 and December 31, 2015, we did not have any loans classified as loans held for sale (“LHFS”).  Generally, loans are transferred from loans held for investment (“LHFI”) to LHFS at fair market value using expected net sales proceeds or collateral values when there is an intent to sell.  Gains or losses on the sale of LHFS are recorded in non-interest income. Generally any subsequent credit losses on LHFS are recorded as a component of non-interest expense. During 2016, we received net proceeds of $4.2 million and recorded net gains of $165 thousand as a result of loan sales.

Loans and Leases

We originate 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. We also have participated with other financial institutions in selected construction and land development loans outside our geographic area. 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. We utilize the effective yield interest method for recognizing interest income as required under FASB ASC Topic 310-20, “Receivables” - “Nonrefundable Fees and Other Costs” (“ASC 310-20”).  ASC 310-20 also guides our accounting for nonrefundable fees and costs associated with lending activities such as discounts, premiums, and loan origination fees. 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. We are generally amortizing these amounts over the contractual life of the loan.  For loan modifications, any unamortized net fees or costs and any prepayment penalties from the original loan shall be recognized in interest income when the new loan is granted.

We have a concentration of credit risk in commercial real estate and construction and land development loans at December 31, 2016.  We originate mainly small business, commercial real estate, middle market business and consumer loans.  Additionally, after thorough due diligence, we have purchased specific commercial and commercial real estate loans and small residential loan pools. A substantial portion of our borrowers’ ability to honor their contracts is dependent upon the regional economy including unemployment and the regional commercial and residential real estate markets.

The loans receivable portfolio is segmented into commercial loans, construction and development loans, residential loans, leases, tax certificates, and consumer loans. The commercial loan segment consists of the following classes: commercial real estate loans, multi-family real estate loans, and other commercial loans, which are also generally known as commercial and industrial loans or commercial business loans. The construction and development loan segment consists of the following classes: residential construction and commercial construction loans. Residential construction loans are made for the acquisition of and/or construction on a lot or lots on which a residential dwelling is to be built. Commercial construction loans are made for the purpose of acquiring, developing and/or constructing a commercial structure. The residential loan segment consists of the following classes: one- to four-family first lien residential mortgage loans, home equity lines of credit, and home equity loans.  We classify our leases as finance leases, in accordance with FASB ASC Topic 840, “Leases”. The difference between our 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 tax certificate segment  includes delinquent property tax certificates that have been acquired through public auctions in various jurisdictions.  The tax certificates assume a lien position that is generally superior to any mortgage liens that are on the property and have certain foreclosure rights as defined by state law.  The tax certificates are predominantly in New Jersey. We ceased acquiring new tax certificates in 2010.  Consumer loans includes cash secured and unsecured loans and lines of credit.

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Commercial Loans: The commercial real estate loan portfolio consists primarily of loans secured by office buildings, retail and industrial use buildings, strip shopping centers, mixed-use and other properties used for commercial purposes primarily located in our market area. Although terms for commercial real estate and multi-family loans vary, the underwriting standards generally allow for terms up to 10 years with the interest rate being reset in the sixth year and with monthly amortization not greater than 25 years and loan-to-value ratios of not more than 80%. Interest rates are either fixed or adjustable and are predominantly based upon the prime rate or a borrowing rate from the Federal Home Loan Bank of Pittsburgh plus a margin. Prepayment fees are charged on most loans in the event of early repayment. Generally, the personal guarantees of the principals are obtained as additional collateral for commercial real estate and multi-family real estate loans.

Commercial and multi-family real estate loans generally present a higher level of risk than loans secured by one- to four-family residences. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effect of general economic conditions on income producing properties and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by commercial and multi-family real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed, a bankruptcy court modifies a lease term, or a major tenant is unable to fulfill its lease obligations), the borrower’s ability to repay the loan may be impaired.

Our commercial business loans generally have been made to small to mid-sized businesses predominantly located in our market area. The commercial business loans are either a revolving line of credit or for a fixed term of generally 10 years or less. Interest rates are adjustable, indexed to a published prime rate of interest, or fixed. Generally, equipment, machinery, real property or other corporate assets secure such loans. Personal guarantees from the business principals are generally obtained as additional collateral. Generally, commercial business loans are characterized as having higher risks associated with them than single-family residential loans.

Our underwriting procedures include evaluations of the stability of the property’s cash flow history, future operating projections, current and projected occupancy levels, location and physical condition. Generally, we require a debt service ratio (the ratio of net cash flows from operations before the payment of debt service to debt service) of not less than 120%. We also evaluate the credit and financial condition of the borrower, and if applicable, the guarantor. Appraisal reports prepared by independent appraisers are obtained on each loan to substantiate the property’s market value, and are reviewed prior to the closing of the loan.

Construction and Development Loans: We originate construction loans to builders and developers predominantly in our market area. Construction and development loans are riskier than other loan types because they are more speculative in nature. Deteriorating economic or environmental conditions can negatively affect a project. Construction loans are also more difficult to evaluate and monitor.  In order to mitigate some of the risks inherent in construction lending, limits are placed on the number of units that can be built on a speculative basis based upon the reputation and financial position of the builder, his/her present obligations, the location of the property and prior sales in the development and the surrounding area. Additionally, the construction budget is reviewed prior to loan origination and the properties under construction are inspected. During the construction phase of a real estate project, the loan requires interest payments only.  Construction loans generally are for 12 to 18 months with loan-to-value ratios of not more than 75%.  Most construction loans are assigned an initial risk rating of pass-watch due to the riskier nature of the loan.

Residential Loans: Our residential mortgages were acquired in recent years in pool purchases and are secured primarily by properties located in our primary market and surrounding areas. We originate home equity loans and home equity lines of credit in our market area with a maximum amount of $1.25 million. The collateral must be the borrower’s primary residence and the loan-to-value does not exceed 80%. Home equity lines of credit are variable rate and are indexed to the prime rate.  Our home equity loans are either first or second liens and have a fixed rate.We have originated some home equity lines of credit or home equity loans for second homes.  In financing second homes, we must have a first lien position, the LTV does not exceed 65%, and the maximum amount is $750 thousand.

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Consumer Loans: We originate cash-secured and unsecured loans and lines of credit to individuals.  Unsecured loans and lines of credit have a maximum amount of $15 thousand.  Unsecured consumer loans generally have a higher interest rate than residential loans because they have additional credit risk associated with them.

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. When a loan is placed on non-accrual all unpaid interest is reversed from interest income. Interest payments received on impaired nonaccrual loans are normally applied against principal. Excess proceeds received over the principal amounts due on impaired non-accrual loans are recognized as income on a cash basis.  We recognize 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, we do not recognize income. Generally, 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 collectibility of the total contractual principal and interest is no longer in doubt.  The past due status of all classes of loans receivable is determined based on contractual due dates for loan payments.  Tax certificates have no contractual maturity. Collection is dependent upon the tax payer’s redemption of the lien, which includes principal interest and fees.

A loan modification is deemed a troubled debt restructuring (“TDR”) when two conditions are met: 1) the borrower is experiencing financial difficulty and 2) a concession is made by us that would not otherwise be considered for a borrower 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 collectibility of the total contractual restructured principal and interest is no longer in doubt.  Our policy for TDRs is to recognize interest income on currently performing restructured loans under the accrual method. 

We account for guarantees in accordance with FASB ASC Topic 460 “Guarantees” (“ASC Topic 460”).  ASC Topic 460 requires a guarantor entity, at the inception of a guarantee covered by the measurement provisions of the interpretation, to record a liability for the fair value of the obligation undertaken in issuing the guarantee.  We issue financial and performance letters of credit.  Financial letters of credit require us to make a payment if the customer’s condition deteriorates, as defined in agreements.  Performance letters of credits require us to make payments if the customer fails to perform certain non-financial contractual obligations. 

Allowance for Loan and Lease Losses    

Our loan and lease portfolio (the “credit portfolio”) is subject to varying degrees of credit risk. The allowance for loan and lease losses (the “allowance”) represents management’s estimate of losses inherent in the loan and lease portfolio as of the statement of financial condition date and is recorded as a reduction to loans and leases. The allowance is increased by the provision for loan and lease losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectible are charged against the allowance, and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable are charged off to the allowance as soon as it is determined that the repayment or collateral recovery of all, or part, of the principal balance is highly unlikely.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. We consider that the determination of the allowance involves a higher degree of judgment and complexity than our other significant accounting policies. Our systematic methodology for assessing the appropriateness of the allowance includes: (1) general 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. We also have a reserve for unfunded lending commitments, which represents management’s estimate of losses inherent in those commitments.  The reserve for unfunded loan commitments is adjusted by a provision for credit losses on off-balance sheet credit exposures and is recorded in other liabilities on the consolidated statement of financial condition.

The loan portfolio is stratified into loan classifications that have similar risk characteristics. The general allowance is based upon historical loss rates using a three-year rolling average of the historical loss experienced within each loan segment. 

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The qualitative factors used to adjust the historical loss experience address various risk characteristics of the our 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, (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 allowance calculation methodology includes further segregation of loan classes into risk rating categories. The borrower’s overall financial condition, repayment sources, guarantors and value of collateral, if appropriate, are evaluated annually for commercial and construction and development loans or when credit deficiencies arise, such as delinquent loan payments, for all loans. Credit quality risk ratings include regulatory classifications of special mention, substandard, doubtful and loss. Loans classified as special mention have potential weaknesses that deserve management’s close attention.  If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects.  Loans classified as substandard have a well-defined weakness or weaknesses that jeopardize the repayment of the debt.  They include loans that are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any.  Loans classified as doubtful have all the weaknesses inherent in loans classified substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable.   Loans classified as a loss are considered uncollectible and are charged to the allowance.  Loans not classified as special mention, substandard, doubtful or loss are rated pass.

The specific reserves are determined utilizing standards required under ASC Topic 310.  We identify 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.  Non-accrual loans and loans restructured under a TDR 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). 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 our impaired loans are measured based on the estimated fair value of the loan’s collateral. We obtain third-party appraisals or real estate brokers’ opinions (“BPOs”) to establish the fair value of real estate collateral.  Appraised values or BPOs are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value less 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. A specific reserve is established for an impaired loan for the amount that the carrying value exceeds its estimated fair value. Once a loan is determined to be impaired it will be deducted from the portfolio balance and the net remaining balance of the portfolio will be used in the general and qualitative analysis. 

Based on management’s comprehensive analysis of the loan and lease portfolio, management believes the current level of the allowance is adequate at December 31, 2016. 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 the best information available to make allowance evaluations, adjustments to the allowance may be necessary based on changes in economic and other conditions or changes in accounting guidance. In addition, the FDIC,

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as an integral part of its examination processes, periodically reviews our allowance for loan and lease losses. The FDIC may require the recognition of adjustments to the allowance for loan and lease losses based on their judgment of information available to them at the time of their examinations. To the extent that actual outcomes differ from management’s estimates, additional provisions to the allowance for loan and lease losses may be required that would adversely impact earnings in future periods.

Other Real Estate Owned

Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less costs to sell at the date of foreclosure, establishing a new cost basis.  Foreclosed real estate properties acquired through the tax certificate portfolio are transferred at the lower of cost or fair value principally due to uncertainty around the fair value of the foreclosed properties.  Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount recorded at acquisition date or fair value less costs to sell.  Third-party appraisals or agreements of sale are utilized to determine fair value of the loan collateral while BPOs, agreements of sale, or in some cases, third-party appraisals are utilized to value properties from the tax certificate portfolio.  Revenue and expenses from operations and changes in the valuation allowance are included in non-interest expenses.  For fair value measurement, OREO is included in level 3 assets on a non-recurring basis.

Premises and Equipment

Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation, which is computed primarily using the modified accelerated cost recovery system (“MACRS”) over the estimated useful lives of the assets.  Leasehold improvements are depreciated over the shorter of the estimated useful lives of the improvements or the terms of the related leases.  Expected term includes lease options periods to the extent that the exercise of such options is reasonably assured.

Company and Bank-Owned Life Insurance

Royal Bank has purchased life insurance policies on certain employees.  These policies are reflected on the consolidated balance sheets at their cash surrender value, or the amount that can be realized.  Income from these policies and changes in the cash surrender value are recorded in non-interest income.  During the third quarter of 2016, we received $748 thousand in insurance proceeds related to a former employee covered by a BOLI policy.  We recorded $273 thousand in income from these proceeds. 

Advertising Costs

Advertising costs are expensed as incurred.  Our advertising costs were $243 thousand and $190 thousand for 2016 and 2015, respectively.

Benefit Plans

We have a noncontributory nonqualified, defined benefit pension plan covering certain eligible employees.  The 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. In accordance with ASC Topic 715, ”Compensation – Retirement Benefits” (“ASC Topic 715”), we recognize the Plan’s over-funded or under-funded status as an asset or liability with an offsetting adjustment to AOCI.  ASC Topic 715 requires the determination of the fair value of a plan’s assets at the company’s year-end and the recognition of actuarial gains and losses, prior service costs or credits, transition assets or obligations as a component of AOCI.  These amounts were previously netted against the plan’s funded status in our consolidated Balance Sheet. These amounts will be subsequently recognized as components of net periodic benefit costs.  Further, actuarial gains and losses that arise in subsequent periods that are not initially recognized as a component of net periodic benefit costs will be recognized as a component of AOCI.  Those amounts will subsequently be recorded as component of net periodic benefit costs as they are amortized during future periods.  Net pension expense consists of service costs and interest costs and are actually determined.  We accrue pension costs as

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incurred. The Plan does not have assets.  We plan to fund a substantial portion of the pension plan obligations through existing Company owned life insurance policies.

We have a capital accumulation and salary reduction plan under Section 401(k) of the Internal Revenue Code of 1986, as amended.  Under the plan, all employees are eligible to contribute up to the maximum allowed by Internal Revenue Service (“IRS”) regulation, with the Company matching 100% of any contribution between 1% and 5% subject to a $2,500 per employee annual limit.  During 2016 and 2015, we recorded a matching contribution expense of $135 thousand and $134 thousand, respectively.    

Stock Compensation

FASB ASC Topic 718, “Compensation-Stock Compensation” (“ASC Topic 718”) requires that the compensation cost relating to share-based payment transactions be recognized in consolidated financial statements.  The costs are measured based on the fair value of the equity or liability instruments issued.  ASC Topic 718 covers a wide range of share-based compensation arrangements including stock options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans.  The effect of ASC Topic 718 is to require entities to measure the cost of employee services received in exchange for stock options based on the grant-date fair value of the award, and to recognize the cost over the period the employee is required to provide services for the award.  ASC Topic 718 permits entities to use any option-pricing model that meets the fair value objective in the Statement.  We recorded compensation expense relating to stock options and restricted stock of $85 thousand and $78 thousand during 2016 and 2015, respectively.

At December 31, 2016, the Company had a long-term incentive compensation plan, which is more fully described in “Note 18 – Stock Compensation Plans” to the Consolidated Financial Statements. 

Trust Preferred Securities

Royal Bancshares Capital Trust I/II (“Trusts”) issued mandatory redeemable preferred stock to investors and loaned the proceeds to the Company.  The Trusts hold, as their sole asset, subordinated debentures issued by the Company in 2004.  We do not consolidate the Trusts as ASC Topic 810 precludes consideration of the call option embedded in the preferred stock when determining if the Company has the right to a majority of the Trusts expected returns.  The non-consolidation results in the investment in common stock of the Trusts to be included in other assets with a corresponding increase in outstanding debt of $774 thousand.  In addition, the income accrued on the Company’s common stock investments is included in other income.  Refer to “Note 10 – Borrowings and Subordinated Debentures” to the Consolidated Financial Statements for more information.

Derivatives and Hedging

In support of our asset liability management process, we will implement derivative hedging strategies with the intent of reducing interest rate risk and economic value of equity risk. We account for derivatives in accordance with FASB ASC Topic 815 “Derivatives and Hedging” (“ASC Topic 815”). We formally designate our derivatives as cash flow hedges and document the strategy for entering into the transactions and the method of assessing ongoing effectiveness.  Changes in the fair value of the derivative are recognized in other comprehensive income (loss) until the underlying forecasted transaction is recognized in earnings. The ineffective portion of a derivative’s change in fair value is recognized in earnings immediately. To determine fair value, we use third party pricing models that incorporate assumptions about market conditions and risks that are current at the reporting date.  We do not use derivative instruments for speculative purposes. 

Derivative instruments qualify for hedge accounting treatment only if they are designated as such on the date on which the derivative contracted is entered and are expected to be, and are, effective in substantially reducing interest rate risk arising from the assets and liabilities identified as exposing the Company to risk. Those derivative financial instruments that do not meet the hedging criteria discussed below would be classified as undesignated derivatives and would be recorded at fair value with changes in fair value recorded in income.

Derivative hedge contracts must meet specific effectiveness tests (i.e., over time the change in their fair values due to the designated hedge risk must be within 80 to 125 percent of the opposite change in the fair values of the hedged assets or

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liabilities). Changes in fair value of the derivative financial instruments must be effective at offsetting changes in the fair value of the hedged items due to the designated hedge risk during the term of the hedge.

We formally assess, both at the hedges’ inception, and on an on-going basis, whether derivatives used in hedging transactions have been highly effective in offsetting changes in cash flows of hedged items and whether those derivatives are expected to remain highly effective in subsequent periods. We discontinue hedge accounting when (a) it determines that a derivative is no longer effective in offsetting changes in cash flows of a hedged item; (b) the derivative expires or is sold, terminated or exercised; (c) probability exists that the forecasted transaction will no longer occur; or (d) management determines that designating the derivative as a hedging instrument is no longer appropriate. In all cases in which hedge accounting is discontinued and a derivative remains outstanding, we will carry the derivative at fair value in the consolidated financial statements, recognizing changes in fair value in current period income in the consolidated statement of income. Cash flows resulting from the derivative financial instruments that are accounted for as hedges of assets and liabilities are classified in the cash flow statement in the same category as the cash flows of the items being hedged.

Income Taxes

We account for income taxes in accordance with FASB ASC Topic 740-10, “Accounting for Uncertainty in Income Taxes”, (“ASC 740”) which includes guidance related to accounting for uncertainty in income taxes, which sets out a consistent framework to determine the appropriate level of tax reserves to maintain for uncertain tax positions. We had no material unrecognized tax benefits or accrued interest and penalties as of December 31, 2016 and 2015.  We classify interest and penalties as an element of tax expense.

The Company and its subsidiaries file a consolidated federal income tax return.  Income taxes are allocated to the Company and its subsidiaries based on the contribution of their income or use of their loss in the consolidated return.  Separate state income tax returns are filed by the Company and its subsidiaries. As of December 31, 2016, tax years 2013 through 2015 are subject to federal examination by the IRS and years 2012 through 2015 are subject to state examination by various state taxing authorities.  Tax regulations are subject to interpretation of the related tax laws and regulations and require significant judgment to apply.

Federal and state income taxes have been provided on the basis of reported income or loss.  The amounts reflected on the tax returns differ from these provisions principally due to temporary differences in the reporting of certain items for financial reporting and income tax reporting purposes. The tax effect of these temporary differences is accounted for as deferred taxes applicable to future periods. Deferred income tax expense or benefit is determined by recognizing deferred tax assets (“DTA”) and liabilities (“DTL”) for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect on deferred assets and liabilities of a change in tax rates is recognized in earnings in the period that includes the enactment date. 

We are required to establish a valuation allowance for DTAs and record a charge to income or shareholders' equity if management determines, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized in future periods. In evaluating our ability to recover deferred tax assets, we consider all available positive and negative evidence, including past operating results and projections of future taxable income. In determining future taxable income, assumptions are made for the amount of taxable income, the reversal of temporary differences and potentially the implementation of feasible and prudent tax planning strategies. This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws or variances between projected operating performance, actual results and other factors. While these estimates and judgments are inherently subjective, they are consistent with the plans and estimates management uses to manage our business.

In the fourth quarters of 2016 and 2015, we released portions of our valuation allowance previously recorded on the net DTAs.  In evaluating the need for a valuation allowance, we estimate future taxable income based on management approved business plans and potential tax planning strategies.  At December 31, 2016, the DTA valuation allowance was $26.6 million compared to $30.6 million at December 31, 2015. The net change in the valuation allowance of $4.0 million

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consists of a decrease of $4.3 million related to net DTAs for which the change impacted income tax expense and a $308 thousand increase associated with certain equity investments related to AOCI items.  The change in the valuation allowance for certain equity investments related to AOCI items is reflected in AOCI and not in income tax expense. The ability to recognize the remaining deferred tax assets that continue to be subject to a valuation allowance will be evaluated on a quarterly basis to determine if there are any significant events that would affect the ability to utilize these deferred tax assets. There can be no assurance, however, as to when we could be in a position to recapture the remaining DTA valuation allowance. Refer to “Note 12 – Income Taxes” to the Consolidated Financial Statements for more information.

We had no material unrecognized tax benefits (“UTB”) or accrued interest and penalties as of December 31, 2016. We do not expect the total amount of UTB to significantly increase in the next twelve months.  We monitor changes in tax statutes and regulations to determine if significant changes will occur over the next 12 months. As of December 31, 2016 no significant changes to UTB are projected; however, tax audit examinations are possible.

Treasury Stock

Shares of common stock repurchased are recorded as treasury stock at cost.

Earnings Per Share Information

Basic per share data excludes dilution and is computed by dividing income available to common shareholders by the weighted average common shares outstanding during the period.  Diluted per share data 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. 

The Class B shares of the Company may be converted to Class A shares at the rate of 1.15 to 1.

Comprehensive Income (Loss)

We report comprehensive income (loss) in accordance with FASB ASC Topic 220, “Comprehensive Income” (“ASC Topic 220”), which requires the reporting of all changes in equity during the reporting period except investments from and distributions to shareholders.  Net income is a component of comprehensive income (loss) with all other components referred to in the aggregate as other comprehensive income (loss).  Comprehensive income (loss) consists of net income and other comprehensive income (loss).  Other comprehensive income (loss) includes unrealized gains and losses on available for sale investment securities, non-credit related losses on other-than-temporarily impaired investment securities, adjustment to net periodic pension cost, and adjustment to the fair value of derivative instruments.

Fair Value of Financial Instruments

For information on the fair value of our financial instruments refer to “Note 21 - Fair Value of Financial Instruments” to the Consolidated Financial Statements. 

Restrictions on Cash and Amounts Due From Banks

Royal Bank is required to maintain average balances on hand with the Federal Reserve Bank.  At December 31, 2016 and 2015, these reserve balances amounted to $100 thousand.

2. Recent Accounting Pronouncements

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (“ASU 14-09”), which establishes a comprehensive revenue recognition standard for virtually all industries under U.S. GAAP, including those that previously followed industry-specific guidance such as the real estate, construction and software industries. The revenue standard’s core principle is built on the contract between a vendor and a customer for the provision of goods and services. It attempts to depict the exchange of rights and obligations between the parties in the pattern of revenue recognition based on the consideration to which the vendor is entitled. To accomplish this objective, the standard requires five basic steps: i) identify

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the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) the entity satisfies a performance obligation. The ASU is effective for public entities for annual periods beginning after December 15, 2016, including interim periods therein. Three basic transition methods are available – full retrospective, retrospective with certain practical expedients, and a cumulative effect approach. Under the third alternative, an entity would apply the new revenue standard only to contracts that are incomplete under legacy U.S. GAAP at the date of initial application (e.g. January 1, 2017) and recognize the cumulative effect of the new standard as an adjustment to the opening balance of retained earnings. That is, prior years would not be restated and additional disclosures would be required to enable users of the financial statements to understand the impact of adopting the new standard in the current year compared to prior years that are presented under legacy U.S. GAAP. Early adoption is prohibited under U.S. GAAP.  In August 2015, the FASB Issued ASU 2015-14 which deferred the effective date to December 31, 2017 and the initial application date (e.g. January 1, 2018.) The majority of our revenue is comprised of net interest income on financial assets and liabilities, which is explicitly excluded from the scope of of ASU 2014-09. We continue to analyze this update and do not believe that ASU 2014-09 will have a material effect on our financial statements.

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments – Overall (Topic 825-10): “Recognition and Measurement of Financial Assets and Financial Liabilities.” ASU 2016-01 amends the guidance on the classification and measurement of financial instruments.  Some of the amendments in ASU 2016-01 include the following: 1) requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; 2) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; 3) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; and 4) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value; among others.  ASU 2016-01 also clarifies that an entity should assess the need for a valuation allowance on a deferred tax asset related to unrealized losses of investments in debt instruments recognized in OCI in combination with the entity’s other deferred tax assets. Prior to this guidance, the alternative approach used in practice evaluated the need for a valuation allowance for a deferred tax asset related to unrealized losses on debt instruments recognized in other comprehensive income separately from other deferred tax assets. This alternative approach will no longer be acceptable. For public business entities, the amendments of ASU 2016-01 are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.  As of December 31, 2016 we do not hold a material amount of equity investments for which fair value is accounted through other comprehensive income.  Consequently, we continue to analyze ASU 2016-01 and do not believe that it will have a material effect on our financial statements.

In February 2016, the FASB issued Accounting Standards Update No. 2016-02, “Leases” (“ASU 2016-02”). From the lessee's perspective, the new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement for a lessees. From the lessor's perspective, the new standard requires a lessor to classify leases as either sales-type, finance or operating. A lease will be treated as a sale if it transfers all of the risks and rewards, as well as control of the underlying asset, to the lessee. If risks and rewards are conveyed without the transfer of control, the lease is treated as a financing lease. If the lessor doesn’t convey risks and rewards or control, an operating lease results.  The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. A modified retrospective transition approach is required for lessors for sales-type, direct financing, and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. Our leases are operating leases and ASU 2016-02 will require us to add them to our balance sheet.  Our operating leases are predominantly related to real estate. We are currently evaluating other  impacts of the pending adoption of the new standard on our consolidated financial statements.

In March 2016, FASB issued Accounting Standards Update No. 2016-09, “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”).  FASB is issuing ASU 2016-09

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as part of its initiative to reduce complexity in accounting standards. The areas for simplification in this ASU 2016-09 involve several aspects of the accounting for employee share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Some of the areas for simplification apply only to nonpublic entities. For public business entities, the amendments in ASU 2016-09 are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. We adopted ASU 2016-09 in the first quarter of 2017. ASU 2016-09 did not have a material effect on our financial statements.

In June 2016, FASB issued Accounting Standards Update No. 2016-13, “Financial Instruments-Credit Losses (Topic 326) Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13”).  The main objective of ASU 2016-13 is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in ASU 2016-13 replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates.  This new methodology is commonly referred to as the CECL model.  The amendments affect entities holding financial assets and net investment in leases that are not accounted for at fair value through net income. The amendments affect loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash.

The amendments in ASU 2016-13 affect an entity to varying degrees depending on the credit quality of the assets held by the entity, their duration, and how the entity applies current GAAP. There is diversity in practice in applying the incurredloss methodology, which means that before transition some entities may be more aligned, under current GAAP, than others to the new measure of expected credit losses.

The amendments in ASU 2016-13 require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset.  The income statement reflects the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period.  The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectibility of the reported amount. An entity must use judgment in determining the relevant information and estimation methods that are appropriate in its circumstances. The allowance for credit losses for purchased financial assets with a more-than insignificant amount of credit deterioration since origination (PCD assets) that are measured at amortized cost basis is determined in a similar manner to other financial assets measured at amortized cost basis; however, the initial allowance for credit losses is added to the purchase price rather than being reported as a credit loss expense. Only subsequent changes in the allowance for credit losses are recorded as a credit loss expense for these assets. Interest income for PCD assets should be recognized based on the effective interest rate, excluding the discount embedded in the purchase price that is attributable to the acquirer’s assessment of credit losses at acquisition.

Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses. Available-for-sale accounting recognizes that value may be realized either through collection of contractual cash flows or through sale of the security. Therefore, the amendments limit the amount of the allowance for credit losses to the amount by which fair value is below amortized cost because the classification as available for sale is premised on an investment strategy that recognizes that the investment could be sold at fair value, if cash collection would result in the realization of an amount less than fair value. The amendments in ASU 2016-13 require that credit losses be presented as an allowance rather than as a writedown. This approach is an improvement to current GAAP because an entity will be able to record reversals of credit losses (in situations in which the estimate of credit losses declines) in current period net income, which in turn should align the income statement recognition of credit losses with the reporting period in which changes occur. Current GAAP prohibits reflecting those improvements in current period earnings. 

For public business entities that are SEC filers, the amendments in ASU 2016-13 are effective for financial statements issued for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. All entities may

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adopt the amendments in ASU 2016-13 earlier as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.  An entity will apply the amendments in ASU 2016-13 through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (that is,  modified-retrospective approach).  A prospective transition approach is required for debt securities for which an other-than-temporary impairment had been recognized before the effective date. The effect of a prospective transition approach is to maintain the same amortized cost basis before and after the effective date of ASU 2016-13. Amounts previously recognized in accumulated other comprehensive income as of the date of adoption that relate to  improvements in cash flows expected to be collected should continue to be accreted into income over the remaining life of the asset. Recoveries of amounts previously written off relating to improvements in cash flows after the date of adoption should be recorded in earnings when received. We are reviewing our systems and data collection to determine the necessary changes to our current process. We are currently evaluating the impact of the amendments in ASU 2016-13 on our consolidated financial statements. We believe that expected credit losses under the CECL model will generally result in earlier loss recognition on our loans and lease portfolio.

In August 2016, FASB issued Accounting Standards Update No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments” (“ASU 2016-15”).  Stakeholders indicated that there is diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows under Topic 230, Statement of Cash Flows, and other Topics. The following eight specific cash flow issues are addressed in ASU 2016-15: Debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (“COLI”s) (including bank-owned life insurance policies (“BOLI”s)); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. For publicbusiness entities, the amendments in this ASU 2016-15 are effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The amendments in ASU 2016-15 should be applied using a retrospective transition method to each period presented. If it is impracticable to apply the amendments retrospectively for some of the issues, the amendments for those issues would be applied prospectively as of the earliest date practicable. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity that elects early adoption must adopt all of the amendments in the same period.  We intend to adopt ASU 2016-15 during the first quarter of 2018 and it will have no effect on our results of operations because it only impacts the presentation of certain information on the statement of cash flows.

In December 2016, FASB issued Accounting Standards Update No. 2016-19, “Technical Corrections and Improvements” (“ASU 2016-19”).  The amendments in ASU 2016-19 cover a wide range of Topics in the Accounting Standards Codification.  The amendments generally fall into one of four categories: (1) amendments related to differences between original guidance and the codification, (2) guidance clarification and reference corrections, (3) simplification, and (4) minor improvements. Most of the amendments in ASU 2016-19 do not require transition guidance and were effective upon issuance. The amendments that require transition guidance are not applicable to the Company.The amendments that require transition guidance are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016.FASB does not expect the changes to affect current accounting practice or result in any significant costs.  The adoption of ASU 2016-19 effective January 1, 2017, did not have a material impact on our consolidated financial statements.

Note 2.Regulatory Matters and Significant Risks or Uncertainties

Federal Reserve Memorandum of Understanding

In July 2013, the Company agreed to enter into an informal non-public agreement, a memorandum of understanding (“MOU”), with the Federal Reserve Bank of Philadelphia (the “Federal Reserve Bank”).  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 our capital stock, making interest payments related to our outstanding trust

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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 was terminated in writing by the Federal Reserve Bank in February 2017.

Note 3.  Investment Securities

The carrying value and fair value of investment securities available for sale (“AFS”) at December 31, 2016 and December 31, 2015 are as follows:

As of December 31, 2016
			Gross		Gross
	Amortized		unrealized		unrealized
(In thousands)	cost		gains		losses		Fair value
U.S. government agencies	$	988	$	—	$	(22)	$	966
Mortgage-backed securities-residential		6,985		70		(17)		7,038
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		146,666		1,022		(2,129)		145,559
Non-agency		4,121		—		(86)		4,035
Corporate bonds		1,700		1		—		1,701
Municipal bonds		8,691		92		(75)		8,708
Other securities		1,821		—		—		1,821
Common stocks		26		—		—		26
Total available for sale	$	170,998	$	1,185	$	(2,329)	$	169,854

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As of December 31, 2015
			Gross		Gross
	Amortized		unrealized		unrealized
(In thousands)	cost		gains		losses		Fair value
U.S. government agencies	$	26,127	$	—	$	(564)	$	25,563
Mortgage-backed securities-residential		11,002		106		(50)		11,058
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		170,764		1,524		(1,554)		170,734
Non-agency		2,729		1		(26)		2,704
Corporate bonds		1,500		56		—		1,556
Municipal bonds		9,910		73		(52)		9,931
Other securities		2,050		445		—		2,495
Common stocks		26		—		—		26
Total available for sale	$	224,108	$	2,205	$	(2,246)	$	224,067

The amortized cost and fair value of investment securities at December 31, 2016, 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 December 31, 2016
	Amortized
(In thousands)	cost		Fair value
Within 1 year	$	—	$	—
After 1 but within 5 years		5,282		5,233
After 5 but within 10 years		5,097		5,141
After 10 years		1,000		1,001
Mortgage-backed securities-residential		6,985		7,038
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		146,666		145,559
Non-agency		4,121		4,035
Total available for sale debt securities		169,151		168,007
No contractual maturity		1,847		1,847
Total available for sale securities	$	170,998	$	169,854

Proceeds from the sales of AFS investments during the year ended  December 31, 2016 and 2015 were $36.4 and $47.0 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 year ended
	December 31,
(In thousands)	2016		2015
Gross realized gains	$	1,475	$	925
Gross realized losses		(44)		(25)
Net realized gains	$	1,431	$	900

We recorded $190 thousand and $14 thousand in OTTI charges in 2016 and 2015, respectively, related to one private equity investment.  There was no non-credit related impairment losses on debt securities held at December 31, 2016 or December 31, 2015 for which a portion of OTTI was recognized in other comprehensive income.  As of December 31, 2016, investment securities with a market value of $74.8 million were pledged as collateral for borrowings.

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The tables below indicate the length of time individual AFS securities have been in a continuous unrealized loss position at December 31, 2016 and December 31, 2015:

December 31, 2016	Less than 12 months					12 months or longer					Total
			Gross		Number			Gross		Number			Gross		Number
			unrealized		of			unrealized		of			unrealized		of
(In thousands)	Fair value		losses		positions	Fair value		losses		positions	Fair value		losses		positions
U.S. government agencies	$	966	$	(22)	1	$	—	$	—	—	$	966	$	(22)	1
Mortgage-backed securities-residential		4,237		(17)	2		—		—	—		4,237		(17)	2
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		73,864		(1,630)	31		12,045		(499)	4		85,909		(2,129)	35
Non-agency		4,035		(86)	3		—		—	—		4,035		(86)	3
Municipal bonds		1,678		(45)	3		2,314		(30)	3		3,992		(75)	6
Total available for sale	$	84,780	$	(1,800)	40	$	14,359	$	(529)	7	$	99,139	$	(2,329)	47

December 31, 2015	Less than 12 months					12 months or longer					Total
			Gross		Number			Gross		Number			Gross		Number
			unrealized		of			unrealized		of			unrealized		of
(In thousands)	Fair value		losses		positions	Fair value		losses		positions	Fair value		losses		positions
U.S. government agencies	$	6,681	$	(57)	2	$	18,882	$	(507)	6	$	25,563	$	(564)	8
Mortgage-backed securities-residential		5,140		(5)	2		2,574		(45)	1		7,714		(50)	3
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		87,020		(994)	31		15,644		(560)	5		102,664		(1,554)	36
Non-agency		1,101		(26)	1		—		—	—		1,101		(26)	1
Municipal bonds		6,080		(52)	7		—		—	—		6,080		(52)	7
Total available for sale	$	106,022	$	(1,134)	43	$	37,100	$	(1,112)	12	$	143,122	$	(2,246)	55

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 December 31, 2016, we had one U.S. Agency security with a fair value of $966 thousand and a gross unrealized loss of $22 thousand.  The bond has been in an unrealized loss position for less than twelve months at December 31, 2016. Management believes that the unrealized loss on this debt security is a function of changes in investment spreads.  Management expects to recover the entire amortized cost basis of this security. We do not intend to sell this security before recovery of its cost basis and have not determined that it is not more likely than not that it will 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 December 31, 2016.

Mortgage-backed securities issued by U.S. government agencies and U.S. government sponsored enterprises: As of December 31, 2016, we had two mortgage-backed securities with a fair value of $4.2 million and gross unrealized losses of $17 thousand.  Both of the mortgage-backed securities 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. We do not intend to sell these securities before recovery of their cost basis and have 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 December 31, 2016.

U.S. government issued or sponsored collateralized mortgage obligations (“Agency CMOs”):  As of December 31, 2016, we had 35 Agency CMOs with a fair value of $85.9 million and gross unrealized losses of $2.1 million.  Four of the Agency CMOs had been in an unrealized loss position for twelve months or longer and the other 31 Agency CMOs 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

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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. We do not intend to sell these securities before recovery of their cost basis and have 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 December 31, 2016.

Non-agency collateralized mortgage obligations (“Non-agency CMOs”):  As of December 31, 2016, we had three non-agency CMOs with a fair value of $4.0 million and gross unrealized losses of $86 thousand.  The bonds have been in an unrealized loss position for less than twelve months.  We do not intend to sell these securities before recovery of their cost basis, and it is not more likely than not we will 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 December 31, 2016.

Municipal bonds:  As of December 31, 2016, we had six municipal bonds with a fair value $4.0 million and gross unrealized losses of $75 thousand.  Three of the municipal bonds had been in an unrealized loss position for less than twelve months and three of the municipal bonds had been in an unrealized loss position for twelve months or longer.   Because we do not intend to sell the bonds and it is not more likely than not that the we will be required to sell the bond before recovery of its amortized cost basis, which may be maturity, we do not consider the bonds to be other-than-temporarily impaired at December 31, 2016.

Other securities:  As of December 31, 2016, we had five investments in private equity funds which were predominantly invested in real estate.  In determining whether or not OTTI exists, we review the funds’ financials, asset values, and near-term projections.  During 2016, OTTI charges of $190 thousand were recorded on two of the private equity investments.  Management concluded that the impairment on this investment was other-than-temporary.

We 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.

Note 4.Loans and Leases

Major classifications of loans are as follows:

	December 31,		December 31,
(In thousands)	2016		2015
Commercial real estate	$	261,561	$	225,679
Construction and land development		83,369		47,984
Commercial and industrial		108,146		85,980
Multi-family		23,389		16,249
Residential real estate		56,899		51,588
Leases		61,838		64,341
Tax certificates		3,705		4,755
Consumer		3,102		2,527
Total loans, net of unearned income	$	602,009	$	499,103

We use 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;

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· Pass-watch: a classification which includes currently performing credits that are beginning to demonstrate above average risk through declining earnings, strained cash flows, increased leverage and/or weakening market fundamentals. This class may also include new loan originations which warrant approval but may contain certain risks that require closer than usual monitoring and supervision, such as construction loans;

· Special mention: includes credits that have potential weaknesses that if left uncorrected could weaken the credit or result in inadequate protection of our 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 are assigned an initial loan risk rating by the Underwriting and Credit Administration Officer (“UCAO”).  The initial loan risk rating is approved by another member of executive management or by the appropriate loan committee approving the loan request. 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 December 31, 2016 and December 31, 2015.

As of December 31, 2016
(In thousands)	Pass		Pass-Watch		Special Mention		Substandard		Non-accrual		Total
Commercial real estate	$	221,862	$	38,814	$	—	$	—	$	885	$	261,561
Construction and land development		9,643		73,582		—		—		144		83,369
Commercial and industrial		92,174		13,308		320		1,692		652		108,146
Multi-family		16,974		6,415		—		—		—		23,389
Residential real estate		56,225		104		—		—		570		56,899
Leases		59,641		348		—		—		1,849		61,838
Tax certificates		1,798		—		—		—		1,907		3,705
Consumer		2,891		211		—		—		—		3,102
Total loans, net of unearned income	$	461,208	$	132,782	$	320	$	1,692	$	6,007	$	602,009

As of December 31, 2015
(In thousands)	Pass		Pass-Watch		Special Mention		Substandard		Non-accrual		Total
Commercial real estate	$	191,320	$	31,994	$	870	$	—	$	1,495	$	225,679
Construction and land development		4,429		43,410		—		—		145		47,984
Commercial and industrial		68,998		13,971		195		2,065		751		85,980
Multi-family		15,982		267		—		—		—		16,249
Residential real estate		50,699		—		—		—		889		51,588
Leases		62,896		319		39		—		1,087		64,341
Tax certificates		3,630		—		—		—		1,125		4,755
Consumer		2,439		88		—		—		—		2,527
Total loans, net of unearned income	$	400,393	$	90,049	$	1,104	$	2,065	$	5,492	$	499,103

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The following tables present an aging analysis of past due payments for each loan portfolio classification at December 31, 2016 and December 31, 2015.

As of December 31, 2016	30-59 Days		60-89 Days		90+ Days*
(In thousands)	Past Due		Past Due		Past Due		Current		Total
Commercial real estate	$	—	$	507	$	886	$	260,168	$	261,561
Construction and land development		—		—		144		83,225		83,369
Commercial and industrial		416		367		173		107,190		108,146
Multi-family		—		—		—		23,389		23,389
Residential real estate		978		—		355		55,566		56,899
Leases		348		104		1,577		59,809		61,838
Tax certificates		—		—		1,907		1,798		3,705
Consumer		—		—		—		3,102		3,102
Total loans, net of unearned income	$	1,742	$	978	$	5,042	$	594,247	$	602,009

As of December 31, 2015	30-59 Days		60-89 Days		90+ Days*
(In thousands)	Past Due		Past Due		Past Due		Current		Total
Commercial real estate	$	96	$	—	$	1,495	$	224,088	$	225,679
Construction and land development		507		—		145		47,332		47,984
Commercial and industrial		1,092		592		509		83,787		85,980
Multi-family		—		—		—		16,249		16,249
Residential real estate		788		306		472		50,022		51,588
Leases		319		39		1,087		62,896		64,341
Tax certificates		—		—		1,125		3,630		4,755
Consumer		—		—		—		2,527		2,527
Total loans, net of unearned income	$	2,802	$	937	$	4,833	$	490,531	$	499,103

*All loans categorized as “90+ Days Past Due” are non-accrual.

Total non-accrual loans at December 31, 2016 were $6.0 million compared to $5.5 million at December 31, 2015.  If interest had accrued on these loans, such income would have been approximately $583 thousand and $703 thousand for the years ended December 31, 2016 and 2015, respectively. At December 31, 2016 and 2015, the Company had no loans past due 90 days or more on which interest continues to accrue. 

Impaired Loans

Total cash collected on impaired loans during the year ended  December 31, 2016 and 2015 was $1.8 million and $9.6 million respectively, of which $1.7 million and $8.4 million was credited to the principal balance outstanding on such loans, respectively.  We did not recognize interest income on a cash basis on impaired loans and leases for 2016.  Interest income recognized on a cash basis on impaired loans and leases was $234 thousand for 2015.

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Troubled Debt Restructurings

The following table details our TDRs that are on an accrual status and non-accrual status at December 31, 2016 and December 31, 2015.

	As of December 31, 2016
				Non-
	Number of	Accrual		Accrual
(In thousands)	loans	Status		Status		Total TDRs
Commercial real estate	1	$	19	$	—	$	19
Construction and land development	1		—		144		144
Commercial and industrial	2		1,692		173		1,865
Residential real estate	1		83		—		83
Total	5	$	1,794	$	317	$	2,111

	As of December 31, 2015
				Non-
	Number of	Accrual		Accrual
(In thousands)	loans	Status		Status		Total TDRs
Commercial real estate	1	$	24	$	—	$	24
Construction and land development	1		—		145		145
Commercial and industrial	3		2,315		—		2,315
Residential real estate	1		—		92		92
Total	6	$	2,339	$	237	$	2,576

At December 31, 2016, there were no TDRs modified within the past 12 months, for which there was a payment default. At December 31, 2015, the one construction and land development TDR, cited in the above table, was not in compliance with its restructured terms due to payment defaults. We did not have any newly restructured loans that fit the criteria for classification as a TDR during the years ended December 31, 2016 and 2015. 

We may obtain physical possession of real estate collateralizing residential mortgage loans or home equity loans through or in lieu of, foreclosure. As of December 31, 2016, we have a foreclosed residential real estate property with a carrying value of $28 thousand as a result of physical possession. However, as of December 31, 2016, we had residential mortgage loans with a carrying value of $104 thousand collateralized by residential real estate property for which formal foreclosure proceedings were in process.

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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 December 31, 2016 and December 31, 2015.

Allowance for Loan and Lease Losses and Loans Held for Investment

For the year ended December 31, 2016

			Construction
	Commercial		and land		Commercial		Multi-		Residential				Tax
(In thousands)	real estate		development		and industrial		family		real estate		Leases		certificates		Consumer		Unallocated		Total
Beginning balance	$	3,622	$	1,674	$	1,513	$	171	$	586	$	1,749	$	347	$	27	$	—	$	9,689
Charge-offs		(84)		—		(107)		—		(40)		(930)		(139)		—		—		(1,300)
Recoveries		201		306		174		—		35		57		14		2		—		789
(Credit) provision		(444)		314		(234)		92		75		1,419		20		—		—		1,242
Ending balance	$	3,295	$	2,294	$	1,346	$	263	$	656	$	2,295	$	242	$	29	$	—	$	10,420
Ending balance: related to loans individually evaluated for impairment	$	3	$	—	$	—	$	—	$	17	$	340	$	8	$	—	$	—	$	368
Ending balance: related to loans collectively evaluated for impairment	$	3,292	$	2,294	$	1,346	$	263	$	639	$	1,955	$	234	$	29	$	—	$	10,052
LHFI
Ending balance	$	261,561	$	83,369	$	108,146	$	23,389	$	56,899	$	61,838	$	3,705	$	3,102	$	—	$	602,009
Ending balance: individually evaluated for impairment	$	904	$	144	$	2,105	$	—	$	653	$	1,242	$	1,907	$	—	$	—	$	6,955
Ending balance: collectively evaluated for impairment	$	260,657	$	83,225	$	106,041	$	23,389	$	56,246	$	60,596	$	1,798	$	3,102	$	—	$	595,054

Allowance for Loan and Lease Losses and Loans Held for Investment

For the year ended December 31, 2015

			Construction
	Commercial		and land		Commercial		Multi-		Residential				Tax
(In thousands)	real estate		development		and industrial		family		real estate		Leases		certificates		Consumer		Unallocated		Total
Beginning balance	$	4,452	$	2,292	$	1,780	$	285	$	616	$	1,429	$	667	$	38	$	149	$	11,708
Charge-offs		(622)		(264)		(566)		—		—		(612)		(471)		—		—		(2,535)
Recoveries		380		503		282		—		20		26		53		—		—		1,264
(Credit) provision		(588)		(857)		17		(114)		(50)		906		98		(11)		(149)		(748)
Ending balance	$	3,622	$	1,674	$	1,513	$	171	$	586	$	1,749	$	347	$	27	$	—	$	9,689
Ending balance: related to loans individually evaluated for impairment	$	77	$	—	$	100	$	—	$	27	$	194	$	—	$	—	$	—	$	398
Ending balance: related to loans collectively evaluated for impairment	$	3,545	$	1,674	$	1,413	$	171	$	559	$	1,555	$	347	$	27	$	—	$	9,291
Loan Balances
Ending balance	$	225,679	$	47,984	$	85,980	$	16,249	$	51,588	$	64,341	$	4,755	$	2,527	$	—	$	499,103
Ending balance: individually evaluated for impairment	$	1,469	$	145	$	2,687	$	—	$	889	$	876	$	1,125	$	—	$	—	$	7,191
Ending balance: collectively evaluated for impairment	$	224,210	$	47,839	$	83,293	$	16,249	$	50,699	$	63,465	$	3,630	$	2,527	$	—	$	491,912

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The following tables detail the LHFI that were evaluated for impairment by loan classification at December 31, 2016 and December 31, 2015.

	At and for the year ended December 31, 2016
	Unpaid						Average		Interest		Interest income
	principal		Recorded		Related		recorded		income		recognized
(In thousands)	balance		investment		allowance		investment		recognized		cash basis
With no related allowance recorded:
Commercial real estate	$	362	$	362	$	—	$	923	$	—	$	—
Construction and land development		546		144		—		145		—		—
Commercial and industrial		2,209		2,105		—		2,296		107		—
Residential real estate		133		83		—		45		4		—
Tax certificates		2,165		1,752		—		1,019		—		—
Total:	$	5,415	$	4,446	$	—	$	4,428	$	111	$	—
With an allowance recorded:
Commercial real estate	$	936	$	542	$	3	$	168	$	—	$	—
Commercial and industrial		—		—		—		17		—		—
Residential real estate		668		570		17		695		—		—
Leases		1,242		1,242		340		910		—		—
Tax certificates		4,202		155		8		26		—		—
Total:	$	7,048	$	2,509	$	368	$	1,816	$	—	$	—

	At and for the year ended December 31, 2015
	Unpaid						Average		Interest		Interest income
	principal		Recorded		Related		recorded		income		recognized
(In thousands)	balance		investment		allowance		investment		recognized		cash basis
With no related allowance recorded:
Commercial real estate	$	1,323	$	931	$	—	$	4,144	$	101	$	233
Construction and land development		546		145		—		376		—		—
Commercial and industrial		2,662		2,576		—		4,314		178		1
Tax certificates		5,666		1,125		—		904		—		—
Total:	$	10,197	$	4,777	$	—	$	9,738	$	279	$	234
With an allowance recorded:
Commercial real estate	$	926	$	538	$	77	$	334	$	—	$	—
Construction and land development		—		—		—		90		—		—
Commercial and industrial		2,500		111		100		172		—		—
Residential real estate		1,033		889		27		938		—		—
Leases		876		876		194		243		—		—
Tax certificates		—		—		—		188		—		—
Total:	$	5,335	$	2,414	$	398	$	1,965	$	—	$	—

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Note 6.Other Real Estate Owned

At December 31, 2016, OREO is comprised of two properties acquired through, or in lieu of, foreclosure in settlement of loans and 41 real estate properties, primarily located in New Jersey, acquired through foreclosure related to tax liens.  Set forth below are tables which detail the changes in OREO from December 31, 2015 to December 31, 2016 and December 31, 2014 to December 31, 2015.

	For the year ended December 31, 2016
(In thousands)	Loans		Tax Liens		Total
Beginning balance	$	220	$	7,215	$	7,435
Net proceeds from sales		(7)		(5,458)		(5,465)
Net gains on sales		1		677		678
Transfers in		28		831		859
Cash additions		—		290		290
Impairment charge		(6)		(255)		(261)
Ending balance	$	236	$	3,300	$	3,536

	For the year ended December 31, 2015
(In thousands)	Loans		Tax Liens		Total
Beginning balance	$	349	$	9,430	$	9,779
Net proceeds from sales		(1,735)		(4,730)		(6,465)
Net gain on sales		60		859		919
Transfers in		1,671		2,671		4,342
Cash additions		—		558		558
Transfer to loans		—		(995)		(995)
Impairment charge		(125)		(578)		(703)
Ending balance	$	220	$	7,215	$	7,435

At December 31, 2016, OREO was comprised of $208 thousand in land, $3.3 million in tax liens, and $28 thousand in residential real estate related to a single family home.  At December 31, 2015, OREO assets acquired through the tax lien portfolio were comprised of 60 properties and were primarily located in New Jersey.

NOTE 7.  PREMISES AND EQUIPMENT

Premises and equipment are summarized as follows (in thousands):

		As of December 31,
(In thousands)	Estimated Useful Lives	2016		2015
Land		$	1,156	$	1,156
Buildings and leasehold improvements	5 - 39 years		6,993		5,433
Furniture, fixtures and equipment	3 - 7 years		5,647		7,796
Premises and equipment, gross			13,796		14,385
Less accumulated depreciation and amortization			(8,398)		(10,426)
Premises and equipment, net		$	5,398	$	3,959

Depreciation and amortization expense related to premises and equipment was approximately $598 thousand and $634 thousand, for the years ended 2016 and 2015, respectively.  In 2015, we sold a Company owned building.  We received $1.4 million in proceeds and recorded a gain of $324 thousand as a result of this sale. We did not sell any properties in 2016. During 2016, we retired fully depreciated assets that had an original cost basis of $2.6 million.

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NOTE 8.  LEASE COMMITMENTS

The Company leases various premises under operating lease agreements, which expire through 2024 and require minimum annual rentals.  Some of these leases are cancelable.  The approximate minimum rental commitments under the leases are as follows for the year ended December 31, 2016:

	As of
(In thousands)	December 31, 2016
2017	$	1,215
2018		1,195
2019		667
2020		559
2021		504
Thereafter		1,313
Total lease commitments	$	5,453

The leases contain options to extend for periods from one to ten years.  The cost of such lease extensions is not included in the above table.  Rental expense for all leases was approximately $1.3 million for the years ended December 31, 2016 and 2015, respectively.

Note 9.Deposits

The Company’s deposit composition as of December 31, 2016 and December 31, 2015 is presented below:

	December 31,		December 31,
(In thousands)	2016		2015
Non-interest bearing checking	$	97,859	$	83,529
NOW		47,835		42,558
Money Market		165,305		165,251
Savings		85,170		53,833
Time deposits ($250 and over)		19,520		18,066
Time deposits (less than $250)		192,368		189,655
Brokered deposits*		21,489		25,000
Total deposits	$	629,546	$	577,892

*Brokered deposits were time deposits in 2016 compared to an interest-bearing demand deposit in 2015.

Maturities of time deposits for the next five years and thereafter are as follows:

		As of
(In thousands)	December 31, 2016
2017		115,673
2018		47,886
2019		27,719
2020		20,040
2021		20,154
Thereafter		1,905
Total certificates of deposit	$	233,377

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Note 10.Borrowings and Subordinated Debentures

1. Advances from the Federal Home Loan Bank

As of December 31, 2016, Royal Bank had $300.8 million of available borrowing capacity at the FHLB, which is based on qualifying collateral.  Total advances from the FHLB were $69.0 million and had a weighted average rate of 1.36% at December 31, 2016 compared to $54.0 million and a weighted average rate of 1.35% at December 31, 2015.  The average balance of advances with the FHLB was $59.3 million and $53.6 million for 2016 and 2015, respectively. The advances and the line of credit are collateralized by FHLB stock, government agencies, mortgage-backed securities and accepted loans.  As of December 31, 2016, investment securities with a fair value of $20.1 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
	December 31, 2016				December 31, 2015
(Dollars in thousands)	Amount		Rate		Amount		Rate
Advances maturing in
2016	$	—	—	%	$	19,000	0.85	%
2017		44,000	1.19	%		25,000	1.46	%
2018		10,000	2.01	%		10,000	2.01	%
2021		15,000	1.40	%		—	—	%
Total FHLB borrowings	$	69,000			$	54,000

2. Other borrowings

We had a note payable with PNC Bank (“PNC”) in the amount of $2.0 million as of December 31, 2015.  The note was paid on its maturity date of August 25, 2016.  The interest rate was a variable rate equal to one month LIBOR + 15 basis points and adjusted monthly. 

At December 31, 2016 and 2015, we had additional borrowings of $35.0 million from PNC which will mature on January 7, 2018.  These borrowings have a weighted average interest rate of 3.65%. The borrowings are secured by government agencies and mortgage-backed securities. As of December 31, 2016, investment securities with a market value of $39.5 million were pledged as collateral to secure all borrowings with PNC.

Royal Bank also has $20.0 million in lines of credit, of which $0 was outstanding, with two local financial institutions at December 31, 2016 and December 31, 2015.

3. Subordinated debentures

We have outstanding $25.8 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”).  We 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 3.11% at December 31, 2016, 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 thousand of common securities bearing fixed and/or fixed/floating interest rates corresponding to the debt securities held by each trust to the Company.  We have fully and unconditionally guaranteed all of the obligations of the Trusts, including any distributions and payments on liquidation or redemption of the capital securities.

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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.  We received approval and paid the required interest payments in 2016 and 2015.The MOU was terminated in writing by the Federal Reserve Bank in February 2017.

NOTE 11. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITY

In 2014, we entered into a forward-starting interest rate swap agreement to hedge the risk of variability in our cash flowsattributable to changes in the 3 month LIBOR rate. This particular hedging objective was to reduce the interest rate risk associated with our forecasted issuances of 3 month fixed rate debt arising from a rollover strategy of an FHLB advance that matured in June 2016.  We have and will continue to rollover the FHLB advance through the swap expiration of June 2021. This derivative was used as part of the asset/liability management process, is linked to a specific liability, and has a high correlation between the contract and the underlying item being hedged, both at inception and throughout the hedge period. The derivative was designated as cash flow hedge with the change in fair value recorded as an adjustment through other comprehensive income (loss) until the underlying forecasted transactions occur, at which time the deferred gains and losses are recognized in earnings. As of December 31, 2016, an investment security with a fair value of $678 thousand was pledged as collateral to the counterparty of this transaction.

The effects of the derivative instrument on the Consolidated Financial Statements for December 31, 2016 and 2015 were as follows:

	As of December 31, 2016
	Notional
	Contract				Balance Sheet	Expiration
(In thousands)	Amount		Fair Value		Location	Date
Derivatives designated as hedging instruments
Interest rate swaps:
Effective June 24, 2016	$	15,000	$	(494)	Other liabilities	June 24, 2021
Total:	$	15,000	$	(494)

	As of December 31, 2015
	Notional
	Contract				Balance Sheet	Expiration
(In thousands)	Amount		Fair Value		Location	Date
Derivatives designated as hedging instruments
Interest rate swaps:
Effective June 24, 2016	$	15,000	$	(555)	Other liabilities	June 24, 2021
Total:	$	15,000	$	(555)

	For the year ended December 31, 2016
	Amount of Gain		Location of Loss	Amount of Loss
	Recognized		Recognized	Recognized
	in OCI		in Income	in Income
	on Derivatives		on Derivatives	on Derivatives
(In thousands)	(Effective Portion)		(Ineffective Portion)	(Ineffective Portion)
Derivatives designated as hedging instruments
Interest rate swaps:
Effective June 24, 2016	$	40	Not Applicable	$	—
Total:	$	40		$	—

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	For the year ended December 31, 2015
	Amount of Loss		Location of Loss	Amount of Loss
	Recognized		Recognized	Recognized
	in OCI		in Income	in Income
	on Derivatives		on Derivatives	on Derivatives
(In thousands)	(Effective Portion)		(Ineffective Portion)	(Ineffective Portion)
Derivatives designated as hedging instruments
Interest rate swaps:
Effective June 24, 2016	$	(366)	Not Applicable	$	—
Total:	$	(366)		$	—

NOTE 12. INCOME TAXES

The components of income tax benefit are stated below:

	For the years ended December 31,
(In thousands)	2016		2015
Income tax (benefit) expense
Current-federal	$	171	$	21
Current-state		2		16
Deferred		(1,969)		(5,176)
Income tax benefit	$	(1,796)	$	(5,139)

The income tax benefit for 2016 and 2015 is largely due to the release of a portion of the valuation allowance against the net deferred tax assets (“DTA”) during the fourth quarters of 2016 and 2015.

The difference between the income tax benefit and the amount computed by applying the statutory federal income tax rate of 34% in 2016 and 2015 is as follows:

	For the years ended December 31,
(In thousands)	2016		2015
Computed tax expense at statutory rate	$	3,116	$	2,169
Non-controlling interest		(263)		(205)
Alternative minimum tax ("AMT") expense		133		21
Stock options expense		43		20
Nondeductible expense		92		146
Bank owned life insurance		(489)		(169)
Federal net operating loss-KNBT*		—		1,368
State taxes (benefit) expense (net of federal benefit)		(49)		8
Adjustment to prior year items		(82)		67
Decrease in valuation allowance		(4,297)		(8,564)
Income tax benefit	$	(1,796)	$	(5,139)

*KNBT: Knoblauch State Bank

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Deferred tax assets and liabilities consist of the following:

	As of December 31,
(In thousands)	2016		2015
Deferred tax assets
Allowance for loan and lease losses and unfunded loan commitments	$	2,843	$	2,699
Net operating loss carryforwards		20,712		22,546
Security writedowns		1,085		1,020
OREO writedowns		94		139
Investment in partnerships		1,920		1,698
Pension obligation		3,782		3,858
Pension obligation-AOCI		1,407		1,250
Unrealized losses on debt securities		389		165
Share-based compensation cost		57		83
Non-accrual interest		203		366
Capital loss carryovers		1,258		1,618
Charitable contribution carryovers		12		24
Employee bonuses		238		184
Accrued liabilities		105		181
Alternative minimum tax credit carryforward		426		302
Derivative instruments		168		189
Other		73		311
Total deferred tax assets before valuation allowance		34,772		36,633
Less valuation allowance-AOCI		(1,407)		(1,099)
Less valuation allowance-Other		(25,177)		(29,474)
Deferred tax assets, net of valuation allowance		8,188		6,060
Deferred tax liabilities
Penalties on delinquent tax certificates		25		35
Unrealized gains on AFS equity securities		—		151
Prepaid deductions		121		43
Other		153		114
Total deferred tax liabilities		299		343
Net deferred tax asset, included in other assets	$	7,889	$	5,717

We recognize deferred tax assets and liabilities for the future tax consequences related to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.   We are required to establish a valuation allowance for DTAs and record a charge to income or shareholders' equity if management determines, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized.  Management evaluates the DTAs for recoverability using a consistent approach which considers the relative impact of negative and positive evidence, including historical profitability and projections of future reversals of temporary differences and future taxable income based on management approved business plans. These estimates and judgments are inherently subjective.  Based on the analysis of the DTAs at December 31, 2016, management concluded that it is more likely than not that a portion of the net DTA will be realized by the Company in the future. As a result of this assessment, we recorded an additional $1.9 million of DTA by reversing a portion of the valuation allowance and crediting income tax expense. In 2015, we released $5.4 million of our valuation allowance.  In accordance with ASC 740, we considered the following sources of income in reaching our conclusion:

· Future reversal of temporary differences

· Future taxable income exclusive of reversing temporary differences and carryforwards

· Taxable income in prior carryback year(s) if carryback is permitted under the tax law

· Tax-planning strategies

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The positive evidence that outweighed the negative evidence in management’s assessment included, but was not limited to, the following:

· Positive cumulative pre-tax earnings over the prior three year period ended December 31, 2016.

· Improvement in asset quality and net interest income.

· Management’s consistent ability to exceed annual forecasted financial results.

· Significant reductions in historical credit-related losses and investment impairment.

· Net operating loss carryforwards do not begin to expire until 2028.

The total change to our valuation allowance on the net DTAs was $4.0 million.  The change consisted of a decrease in the valuation allowance of $4.3 million related to items for which the change impacted income tax expense, offset by a $308 increase in the valuation allowance associated with certain equity investments related to AOCI items.  The change in the valuation allowance for certain equity investments related to AOCI items is reflected in AOCI and not in income tax expense. The ability to recognize the remaining DTAs that continue to be subject to a valuation allowance will be evaluated on a quarterly basis to determine if there are any significant events that would affect the ability to utilize these deferred tax assets. There can be no assurance, however, as to when we could be in a position to reverse the remaining DTA valuation allowance. The deferred tax assets, net of valuation allowances, totaled $7.9 million and $5.7 million at December 31, 2016 and 2015, respectively.

A significant component of the DTAs at December 31, 2016 is our federal NOL carryforwards of approximately $57.7 million and state NOL carryforwards of $136.8 million which are available to be carried forward to future tax years.  The federal loss carryforwards will begin to expire in 2028 and the state NOLs will begin to expire in 2026 if not fully utilized.

As of December 31, 2016, we have capital loss carryforwards of approximately $3.7 million which will begin to expire as of December 31, 2017 if not utilized. We also have charitable contribution carryovers of $35 thousand which will begin to expire as of December 31, 2019 if not utilized but would likely be converted to NOLs. We also have general business tax credit carryovers of $1 thousand that will begin to expire as of December 31, 2030 if not utilized and AMT tax credits of $426 thousand that have an indefinite life.

We had no material unrecognized tax benefits (“UTB”) or accrued interest and penalties as of December 31, 2016. We do not expect the total amount of UTB to significantly increase in the next twelve months.  As of December 31, 2016 no significant changes to UTB are projected; however, tax audit examinations are possible.  As of December 31, 2016, tax years 2013 through 2015 are subject to federal examination by the IRS and years 2012 through 2015 are subject to state examination by various state taxing authorities.

Note 13.FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF CREDIT RISK

We are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our 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 we have in particular classes of financial instruments.

Our 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.  We use the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

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The contract amounts are as follows:

	December 31,		December 31,
(In thousands)	2016		2015
Financial instruments whose contract amounts represent credit risk:
Open-end lines of credit	$	74,858	$	72,988
Commitments to extend credit		43,344		8,497
Standby letters of credit and financial guarantees written		37		515

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since many of the commitments are expected to expire without being drawn upon, and others are for staged construction, the total commitment amounts do not necessarily represent immediate cash requirements.

We evaluate each customer’s creditworthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation.  Collateral held varies but may include personal or commercial real estate, accounts receivable, inventory or equipment.

Standby letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party.  Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions.  Most guarantees extend for one year and expire in decreasing amounts through August 2017.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.  We hold personal or commercial real estate, accounts receivable, inventory or equipment as collateral supporting those commitments for which collateral is deemed necessary.  The extent of collateral held for those commitments is approximately 75%.

NOTE 14. LEGAL CONTINGENCIES

Royal Bank had a 60% equity interest in each of CSC and RTL.  CSC and RTL acquired, through public auction, delinquent tax liens in various jurisdictions thereby assuming a superior lien position to most other lien holders, including mortgage lien holders.  In 2012, the former President of CSC and RTL, CSC, RTL and the Company were named defendants, among others, in a Consolidated Master Class Action Complaint (the “Complaint”) filed in the U.S. District Court for the District of New Jersey (“Court”) on behalf of a proposed class of taxpayers who became delinquent in paying their municipal tax obligations. The Complaint alleged a conspiracy to rig bids in municipal tax lien auctions.  

During 2013, the Company, Royal Bank, CSC, and RTL reached a settlement agreement with plaintiffs to settle the litigation for $1.65 million and other terms and conditions, including an opportunity for members of the proposed settlement class whose tax liens are currently held by CSC or RTL to redeem those liens for a one-time cash payment equaling 85% of the redemption amount by making such payment within 35 days of the date of written notice. The proposed settlement class does not include, and therefore the offer to redeem does not apply to, tax liens acquired at 0% interest or at a premium. The settlement amount has already been paid into an escrow account. In 2016, the Court approved the settlement after notice and a hearing.  The plaintiffs are appealing the Court’s decision. It is expected to be resolved in the third or fourth quarter of 2017. 

Note 15. Shareholders’ Equity

1. Preferred Stock

On February 20, 2009, as part of the Capital Purchase Program (“CPP”) established by the Treasury, we 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 our Class A common stock.  The

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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 us at any time following consultation with our 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 our Class A common stock adjusted to 1,368,040 and the warrant exercise price decreased to $3.33 per share of the common stock.

In the second quarter of 2014, we 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 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. We were allocated 11,551 shares of Series A Preferred Stock for repurchase at the clearing price of $1,207.11.

From time to time in 2016, we received regulatory approval to repurchase or redeem the remaining 18,856 shares of the Series A Preferred Stock.  We utilized existing cash on-hand to complete the repurchase and paid approximately $29.5 million. At December 31, 2016, there are no outstanding shares of the Series A Preferred Stock.

2. Common Stock

Our Class A common stock trades on the NASDAQ Global Market under the symbol RBPAA.  There is no market for our 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.

3. 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. As mentioned previously, we retired all of the remaining shares of the Series A Preferred stock in 2016, thus eliminating future dividends.

Note 16.Regulatory Capital Requirements

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 our financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our 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. 

In July 2013, the federal bank regulatory agencies adopted the final reforms on capital and liquidity generally referred to as “Basel III”, which were published by the Basel Committee on Banking Supervision and the Financial Stability Board. The agencies view the new capital requirements as a better reflection of banking organizations’ risk profiles, thereby improving the overall resiliency of the banking system. The rules generally implement higher minimum capital requirements, add a new common equity tier 1 capital requirement or “CET1”, and establish criteria that instruments must meet to be considered common equity tier 1 capital, additional tier 1 capital, or tier 2 capital.  Basel III also introduced a non-risk adjusted tier 1 leverage ratio of 3%, based on a measure of total exposure rather than total assets, and new liquidity requirements.  Under the

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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 CET1 above its minimum risk-based capital requirements in an amount greater than 2.5% of total risk-weighted assets.   The new minimum capital requirements became effective on January 1, 2015.  The capital conservation buffer requirements phase in over a three-year period beginning January 1, 2016. As of December 31, 2016, the Company and Royal Bank met all capital adequacy requirements to which it is subject and Royal Bank met the criteria for a well-capitalized institution.

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 December 31, 2016 and the previous 25 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:

	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 December 31, 2016	$	76,716	12.185	%	$	54,301	8.625	%	$	62,957	10.000	%
At December 31, 2015	$	87,354	15.802	%	$	44,225	8.000	%	$	55,281	10.000	%
Tier 1 capital (to risk-weighted assets)
At December 31, 2016	$	68,743	10.919	%	$	41,709	6.625	%	$	50,366	8.000	%
At December 31, 2015	$	80,410	14.546	%	$	33,169	6.000	%	$	44,225	6.000	%
Tier 1 capital (to average assets, leverage)
At December 31, 2016	$	68,743	8.573	%	$	32,076	4.000	%	$	40,095	5.000	%
At December 31, 2015	$	80,410	10.589	%	$	30,374	4.000	%	$	37,968	5.000	%
Common equity Tier 1 (to risk-weighted assets)
At December 31, 2016	$	69,681	11.068	%	$	32,266	5.125	%	$	40,922	6.500	%
At December 31, 2015	$	58,824	10.641	%	$	24,876	4.500	%	$	35,933	6.500	%

*The 2016 ratios include the capital conservation buffer of 0.625%.

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 year ended		For the year ended
(In thousands)	December 31, 2016		December 31, 2015
RAP net income	$	8,775	$	9,161
Tax lien adjustment, net of noncontrolling interest		1,544		1,973
U.S. GAAP net income	$	10,319	$	11,134

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	At December 31, 2016				At December 31, 2015
	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)	12.185	%	12.405	%	15.802	%	16.109	%
Tier 1 capital (to risk-weighted assets)	10.919	%	11.139	%	14.546	%	14.853	%
Tier 1 capital (to average assets, leverage)	8.573	%	8.750	%	10.589	%	10.824	%
Common equity Tier 1 (to risk-weighted assets)	11.068	%	11.040	%	10.641	%	10.962	%

The tables below reflect the Company’s capital ratios:

	Actual				For capital adequacy purposes				To be well capitalized under the Federal Reserve's regulations
(Dollars in thousands)	Amount		Ratio		Amount		Ratio*		Amount		Ratio
Total capital (to risk-weighted assets)
At December 31, 2016	$	84,056	13.302	%	$	54,503	8.625	%	$	63,192	10.000	%
At December 31, 2015	$	103,355	18.574	%	$	44,516	8.000	%	$	55,645	10.000	%
Tier 1 capital (to risk-weighted assets)
At December 31, 2016	$	68,326	10.812	%	$	41,865	6.000	%	$	37,915	6.000	%
At December 31, 2015	$	95,316	17.129	%	$	33,387	6.000	%	$	33,387	6.000	%
Tier 1 capital (to average assets, leverage)
At December 31, 2016	$	68,326	8.488	%	$	32,199	4.000	%		N/A	N/A
At December 31, 2015	$	95,316	12.444	%	$	30,638	4.000	%		N/A	N/A
Common equity Tier 1 (to risk-weighted assets)
At December 31, 2016	$	50,502	7.992	%	$	32,386	4.500	%		N/A	N/A
At December 31, 2015	$	52,115	9.366	%	$	25,040	4.500	%		N/A	N/A

*The 2016 ratios include the capital conservation buffer of 0.625%.

The Company has filed the Consolidated Financial Statements for Bank Holding Companies-FR Y-9C (“FR Y-9C”) as of December 31, 2016 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 year ended		For the year ended
(In thousands)	December 31, 2016		December 31, 2015
U.S. GAAP net income attributable to Royal Bancshares	$	10,375	$	10,993
Tax lien adjustment, net of noncontrolling interest		(1,544)		(1,973)
RAP net income	$	8,831	$	9,020

	At December 31, 2016				At December 31, 2015
	As reported		As adjusted		As reported		As adjusted
	under U.S. GAAP		for RAP		under U.S. GAAP		for RAP
Total capital (to risk-weighted assets)	13.302	%	13.084	%	18.574	%	18.277	%
Tier 1 capital (to risk-weighted assets)	10.812	%	10.512	%	17.129	%	16.710	%
Tier 1 capital (to average assets, leverage)	8.488	%	8.248	%	12.444	%	12.127	%
Common equity Tier 1 (to risk-weighted assets)	7.992	%	8.012	%	9.366	%	9.040	%

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Note 17.Pension Plan

The following table sets forth our pension plan’s funded status and amounts recognized in our consolidated balance sheets within other liabilities:

	For the years ended December 31,
(In thousands)	2016		2015
Change in benefit obligation
Benefit obligation at beginning of year	$	15,024	$	15,438
Service cost		49		64
Interest cost		560		565
Benefits paid		(1,004)		(971)
Actuarial (gain) loss		634		(72)
Benefits obligation at end of year	$	15,263	$	15,024
Amounts recognized in accumulated other comprehensive income (loss)
Unrecognized actuarial loss		4,138		3,677
AOCI related to pension plan	$	4,138	$	3,677

We plan to fund a substantial portion of the pension plan obligations through existing Company owned life insurance policies. The accumulated benefit obligation at December 31, 2016 and 2015 was $15.2 million and $14.9 million, respectively.

The table below reflects the assumptions used to determine the benefit obligations:
	As of December 31,
	2016		2015
Discount rate	3.70	%	3.81	%
Rate of compensation increase	4.00	%	4.00	%

The table below reflects the assumptions used to determine the net periodic pension cost:

	As of December 31,
	2016		2015
Discount rate	3.70	%	3.81	%
Rate of compensation increase	4.00	%	4.00	%

Net periodic defined benefit pension expense for the years ended December 31, 2016 and 2015 included the following components:

	For the year ended
	December 31,
(In thousands)	2016		2015
Service cost	$	49	$	64
Interest cost		560		565
Amortization of prior service cost		—		90
Amortization of actuarial loss		173		185
Net periodic benefit cost	$	782	$	904

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Benefit payments to be made from the Non-qualified Pension Plan are as follows:

		As of December 31, 2016
		Non-Qualified
(In thousands)		Pension Plans
2017	$	1,005
2018		1,015
2019		1,029
2020		1,098
2021		1,153
Next  five years thereafter		5,821

A substantial portion of the benefit payments are expected to be made from insurance policies owned by the Company.  The cash surrender value for these policies was approximately $4.7 million and $3.8 million as of December 31, 2016 and 2015, respectively.    

Defined Contribution Plan

We have a capital accumulation and salary reduction plan under Section 401(k) of the Internal Revenue Code of 1986, as amended.  Under the plan, all employees are eligible to contribute up to the maximum allowed by IRS regulation, with the Company matching dollar for dollar of any contribution up to 5%, which is subject to a $2,500 per employee annual limit.  The 401(k) matching contribution was $135 thousand and $134 thousand for 2016 and 2015, respectively. 

NOTE 18. STOCK COMPENSATION PLANS

We recognized compensation expense for stock options in the amounts of $70 thousand and $64 thousand in 2016 and 2015, respectively. We granted 5,000 and 146,500 options to purchase common stock in 2016 and 2015, respectively. 

1. Outside Directors’ Stock Option Plan

We had a non-qualified outside Directors’ Stock Option Plan (the “Directors’ Plan”) which expired in 2006.  At December 31, 2016 all outstanding shares are expired.  The ability to grant new options under this plan has expired.

A summary of the Directors’ Plan activity is presented below:

	2016						2015
			Weighted	Weighted					Weighted
			Average	Average		Aggregate			Average
			Exercise	Remaining		Intrinsic			Exercise
	Options		Price	Term (yrs)		Value	Options		Price
Options outstanding at beginning of year	4,725	$	21.78	0.5			12,724	$	21.83
Forfeited	(1,575)		21.78				(3,181)		21.83
Expired	(3,150)		21.78				(4,818)		21.88
Options outstanding at the end of the year	—	$	—	—	$	—	4,725	$	21.78
Options exercisable at the end of the year	—	$	—	—	$	—	4,725	$	21.78

2.  Employee Stock Option and Appreciation Rights Plan

We had a Stock Option and Appreciation Rights Plan (the “Plan”) which expired in 2006.  At December 31, 2016 all outstanding shares are expired.  The ability to grant new options under this plan has expired.

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A summary of the Plan activity is presented below:

	2016						2015
			Weighted	Weighted					Weighted
			Average	Average		Aggregate			Average
			Exercise	Remaining		Intrinsic			Exercise
	Options		Price	Term (yrs)		Value	Options		Price
Options outstanding at beginning of year	19,061	$	21.78	0.5			35,612	$	21.82
Forfeited	(3,560)		21.78				(1,749)		21.81
Expired	(15,501)		21.78				(14,802)		21.88
Options outstanding at the end of the year	—	$	—	—	$	—	19,061	$	21.78
Options exercisable at the end of the year	—	$	—	—	$	—	19,061	$	21.78

3. Long-Term Incentive Plan

Our current share based payment plan is the 2007 Long-Term Incentive Plan (“LTI Plan”), which consists of stock option grants and restricted stock awards.  All employees and non-employee directors of the Company and its designated subsidiaries are eligible participants. The LTI Plan includes one million shares of Class A common stock (of which 250,000 shares may be issued as restricted stock), subject to customary anti-dilution adjustments, or approximately 4.0% of  the total outstanding shares of the Class A common stock.

As of December 31, 2016, 732,861 shares in the LTI plan are available for future grants. The ability to grant new options under this plan will expire in the second quarter of 2017. The option price is equal to the fair market value at the date of the grant. The employee options are exercisable based on the grant’s vesting schedule beginning one year after the date of grant and must be exercised within ten years of the grant date.  Directors’ options are exercisable on the one year anniversary of the date of grant and must be exercised within ten years of the grant date. Compensation expense for stock options is recognized over the requisite service period. During 2016 and 2015, we recognized $70 thousand and $64 thousand, respectively, in compensation expense for stock options.  At December 31, 2016, approximately $55 thousand remained to be recognized in compensation expense over a weighted-average period of 1.0 years.

The fair value of each stock option award is estimated on the date of the grant using the Black-Scholes option-pricing model.  The risk-free interest rate for the expected term of the stock option awarded is based on the U.S. Treasury yield curve in effect at the time of the grant. Average volatility is based on the historical volatility of our common stock. The average expected life represents the period of time that stock option grants are expected to be outstanding and are based on historical data. The following assumptions were used to estimate the fair value of the options granted during 2016 and 2015:

	2016		2015
Weighted average risk-free interest rate	1.14	%	1.57	%
Weighted average volatility	61.74	%	77.01	%
Expected dividend yield	—	%	—	%
Weighted average expected life	5.0 years		5.0 years

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A summary of the status of the stock options in the LTI Plan is presented below:

	2016						2015
			Weighted	Weighted		(1)			Weighted
			Average	Average		Aggregate			Average
			Exercise	Remaining		Intrinsic			Exercise
	Options		Price	Term (yrs)		Value	Options		Price
Options outstanding at beginning of year	271,869	$	3.59	3.7			130,709	$	5.60
Granted	5,000		2.16				146,500		1.78
Exercised	(33,666)		1.54				—		—
Forfeited	(26,064)		3.11				(5,340)		3.98
Options outstanding at the end of the year	217,139	$	3.93	6.3	$	48	271,869	$	3.59
Options exercisable at the end of the year	117,806	$	5.67	4.7	$	—	88,699	$	7.23
Weighted-average fair value of options granted during the year		$	1.13					$	1.14

(1) The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had they exercised their options on December 31, 2016. The intrinsic value varies based on the changes in the market value in the Company’s stock. Because the exercise price exceeded the total market value of the options, the aggregate intrinsic value was $0 for options exercisable at December 31, 2016.

Information pertaining to options outstanding at December 31, 2016 is as follows:

					Options issued and outstanding				Options exercisable
						Weighted		Weighted		Weighted		Weighted
						Average		Average		Average		Average
Range of					Number	Exercise		Remaining	Number	Exercise		Remaining
exercise prices					Outstanding	Price		Term (yrs)	Exercisable	Price		Term (yrs)
$	1.00	-	$	3.99	159,000	$	1.86	8.1	59,667	$	1.90	7.9
$	4.00	-	$	14.99	39,300		4.50	1.8	39,300		4.50	1.8
$	15.00	-	$	21.00	18,839		20.08	0.6	18,839		20.08	0.6
					217,139	$	3.93	6.3	117,806	$	5.67	4.7

The following table provides detail for non-vested stock options under the LTI Plan as of December 31, 2016:

			Weighted
			Average
			Exercise
	Options		Price
Non-vested options December 31, 2015	183,170	$	1.94
Granted	5,000		2.16
Forfeited	(21,334)		1.86
Vested	(67,503)		1.78
Non-vested options December 31, 2016	99,333	$	1.86

Under the aforementioned LTI Plan, we are authorized to grant share-based incentive compensation awards for corporate performance to employees. These awards may be granted in the form of performance restricted shares of our common

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stock.  The vesting of awards is contingent upon meeting performance goals stated in the specific awards when granted. The awards are not permitted to be transferred during the restricted time period from the date of the award and are subject to forfeiture to the extent that the performance restrictions are not satisfied. Awards are also forfeited if the employee terminates his or her service prior to the end of the restricted time period, unless such termination is in accordance with the Company’s mandatory retirement age. Vested awards are converted to shares of our common stock at the end of the restricted time period. The fair market value of each employee based award is estimated based on the fair market value of our common stock on the date of the grant and probable performance goals to be achieved and estimated forfeitures. If such goals are not met then no compensation cost would be recognized and any recognized compensation cost would be reversed. At December 31, 2016 of the 757,861 shares available for future grants, 225,000 shares are available for future restricted stock grants.  During 2016 and 2015, we recognized $15 thousand and $14 thousand, respectively, in compensation expense for restricted stock grants.  At December 31, 2016, approximately $16 thousand remained to be recognized in compensation expense over a weighted-average period of 1.0 years.

The following table details the restricted stock awards as of December 31, 2016

			Weighted
			Average
			Exercise
	Shares		Price
Non-vested restricted stock at December 31, 2015	25,000	$	1.80
Granted	—		—
Forfeited	—		—
Vested	—		—
Non-vested restricted stock at December 31, 2016	25,000	$	1.80

Note 19. Earnings Per Common Share

We follow 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.  We have 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 years ended December 31, 2016 and 2015, 68,139 and 96,655 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. 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:

	For the year ended December 31, 2016
	Income		Average shares	Per share
(In thousands, except for per share data)	(numerator)		(denominator)	Amount
Basic EPS
Income available to common shareholders	$	9,242	30,081	$	0.31
Diluted EPS
Income available to common shareholders	$	9,242	30,146	$	0.31

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	For the year ended December 31, 2015
	Income		Average shares	Per share
(In thousands, except for per share data)	(numerator)		(denominator)	Amount
Basic EPS
Income available to common shareholders	$	9,272	30,041	$	0.31
Diluted EPS
Income available to common shareholders	$	9,272	30,088	$	0.31

Note 20. 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 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.

	For the year ended December 31, 2016
			Tax
	Before tax		expense		Net of tax
(In thousands)	amount		(benefit)		amount
Unrealized losses on investment securities:
Unrealized holding losses arising during period	$	138	$	47	$	91
Less adjustment for impaired investments		(190)		(65)		(125)
Less reclassification adjustment for gains
realized in net income		1,431		336		1,095
Unrealized losses on investment securities		(1,103)		(224)		(879)
Unrecognized benefit obligation expense:
Actuarial loss		(634)		—		(634)
Reclassification adjustment for amortization		173		—		173
Unrecognized benefit obligation		(461)		—		(461)
Unrealized gain on derivative instrument		61		21		40
Other comprehensive loss, net	$	(1,503)	$	(203)	$	(1,300)

	For the year ended December 31, 2015
			Tax
	Before tax		expense		Net of tax
(In thousands)	amount		(benefit)		amount
Unrealized losses on investment securities:
Unrealized holding losses arising during period	$	(1,427)	$	(603)	$	(824)
Less adjustment for impaired investments		(14)		(5)		(9)
Less reclassification adjustment for gains
realized in net income		900		306		594
Unrealized losses on investment securities		(2,313)		(904)		(1,409)
Unrecognized benefit obligation expense:
Actuarial gain		73		—		73
Reclassification adjustment for amortization		275		—		275
Unrecognized benefit obligation		348		—		348
Unrealized loss on derivative instrument		(555)		(189)		(366)
Other comprehensive loss, net	$	(2,520)	$	(1,093)	$	(1,427)

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The other components of accumulated other comprehensive loss included in shareholders’ equity at December 31, 2016 and 2015 are as follows:

0f
	December 31,
(In thousands)	2016		2015
Unrecognized benefit obligation	$	(4,138)	$	(3,677)
Unrealized loss on AFS investments		(755)		124
Unrealized loss on derivative instrument		(326)		(366)
Accumulated other comprehensive loss	$	(5,219)	$	(3,919)

Note 21. 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, we use unobservable inputs to determine appropriate valuation adjustments using discounted cash flow methodologies.

Management uses its best judgment in estimating the fair value of our 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 we 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).

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.  We did not have transfers of financial instruments within the fair value hierarchy during the years ended December 31, 2016 and 2015.

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Items Measured on a Recurring Basis

Our 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 our mortgage-backed securities and CMOs issued by U.S. government and government-sponsored agencies, non-agency CMOs, and corporate and municipal bonds.  Additionally,  Level 2 includes derivative instruments whose valuations are based on observable market data.

Level 3 securities include investments in five 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.  We also review 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 December 31, 2016 and December 31, 2015 are as follows:

	Fair Value Measurements Using:
	Quoted Prices
	in Active		Significant
	Markets for		Other		Significant
	Identical		Observable		Unobservable
As of December 31, 2016	Assets		Inputs		Inputs
(In thousands)	Level 1		Level 2		Level 3		Fair Value
Assets:
Investment securities available for sale
U.S. government agencies	$	—	$	966	$	—	$	966
Mortgage-backed securities-residential		—		7,038		—		7,038
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		—		145,559		—		145,559
Non-agency		—		4,035		—		4,035
Corporate bonds		—		1,701		—		1,701
Municipal bonds		—		8,708		—		8,708
Other securities		—		—		1,821		1,821
Common stocks		26		—		—		26
Total investment securities available for sale	$	26	$	168,007	$	1,821	$	169,854
Liabilities:
Derivative instruments
Interest rate swaps	$	—	$	494	$	—	$	494

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	Fair Value Measurements Using:
	Quoted Prices
	in Active		Significant
	Markets for		Other		Significant
	Identical		Observable		Unobservable
As of December 31, 2015	Assets		Inputs		Inputs
(In thousands)	Level 1		Level 2		Level 3		Fair Value
Assets:
Investment securities available for sale
U.S. government agencies	$	—	$	25,563	$	—	$	25,563
Mortgage-backed securities-residential		—		11,058		—		11,058
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		—		170,734		—		170,734
Non-agency		—		2,704		—		2,704
Corporate bonds		—		1,556		—		1,556
Municipal bonds		—		9,931		—		9,931
Other securities		—		—		2,495		2,495
Common stocks		26		—		—		26
Total investment securities available for sale	$	26	$	221,546	$	2,495	$	224,067
Liabilities:
Derivative instruments
Interest rate swaps	$	—	$	555	$	—	$	555

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 year ended December 31, 2016 and 2015:

(In thousands)	Other securities
Investment Securities Available for Sale	2016		2015
Beginning balance January 1,	$	2,495	$	4,034
Total gains/(losses) - (realized/unrealized):
Included in earnings-net gains on sale and OTTI		983		484
Included in other comprehensive income		(445)		(905)
Purchases		111		19
Sales and calls		(1,323)		(1,137)
Transfers in and/or out of Level 3		—		—
Ending balance December 31,	$	1,821	$	2,495

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. 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.

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For financial assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at December 31, 2016 and December 31, 2015 are as follows:

	Fair Value Measurements Using:
	Quoted Prices
	in Active		Significant
	Markets for		Other		Significant
	Identical		Observable		Unobservable
As of December 31, 2016	Assets		Inputs		Inputs
(In thousands)	Level 1		Level 2		Level 3		Fair Value
Assets
Impaired loans and leases	$	—	$	—	$	6,102	$	6,102
Other real estate owned		—		—		1,471		1,471

	Fair Value Measurements Using:
	Quoted Prices
	in Active		Significant
	Markets for		Other		Significant
	Identical		Observable		Unobservable
As of December 31, 2015	Assets		Inputs		Inputs
(In thousands)	Level 1		Level 2		Level 3		Fair Value
Assets
Impaired loans and leases	$	—	$	—	$	5,946	$	5,946
Other real estate owned		—		—		2,384		2,384

The following tables present additional quantitative information about assets measured at fair value on a nonrecurring basis and for which we have utilized Level 3 inputs to determine fair value at December 31, 2016 and December 31, 2015:

	Qualitative Information about Level 3 Fair Value Measurements
As of December 31, 2016			Valuation		Range
(In thousands)	Fair Value		Techniques	Unobservable Input	(WeightedAverage)
Impaired loans and leases	$	6,102	Appraisal of	Appraisal adjustments	0.0%	-	-27.4%	(-12.3%)
			collateral (1)	Liquidation expenses	0.0%	-	-12.8%	(-5.2%)
Other real estate owned		1,471	Appraisal of	Appraisal adjustments	0.0%	-	-61.5%	(-32.5%)
			collateral (1)	Liquidation expenses	0.0%	-	-5.6%	(-5.6%)

	Qualitative Information about Level 3 Fair Value Measurements
As of December 31, 2015			Valuation		Range
(In thousands)	Fair Value		Techniques	Unobservable Input	(WeightedAverage)
Impaired loans and leases	$	5,946	Appraisal of	Appraisal adjustments	0.0%	-	-62.3%	(-13.7%)
			collateral (1)	Liquidation expenses	0.0%	-	-15.4%	(-6.5%)
Other real estate owned		2,384	Appraisal of	Appraisal adjustments	0.0%	-	-54.1%	(-17.1%)
			collateral (1)	Liquidation expenses	0.0%	-	-14.7%	(-6.0%)

(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 our financial instruments at December 31, 2016 and December 31, 2015. 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 our assets and liabilities.  Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between our 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.

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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, we use 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 we invested in to partially satisfy our 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.  We do 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.

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 we have 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.

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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.

Derivative instruments:

We have contracted with a third party vendor to provide periodic valuations for our interest rate derivatives to determine the fair value of our interest rate swaps. The vendor utilizes standard valuation methodologies applicable to interest rate derivatives such as discounted cash flow analysis and extensions of the Black-Scholes model. Such valuations are based upon readily observable market data and are therefore considered Level 2 valuations by the Company.

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

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

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The tables below indicate the fair value of our financial instruments at December 31, 2016 and December 31, 2015.

					Fair Value Measurements
					At December 31, 2016
					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	$	21,230	$	21,230	$	21,230	$	—	$	—
Investment securities available for sale		169,854		169,854		26		168,007		1,821
Other investment		2,250		2,250		—		—		2,250
Federal Home Loan Bank stock		3,216		3,216		—		—		3,216
Loans, net		591,589		578,732		—		—		578,732
Accrued interest receivable		3,968		3,968		—		3,968		—
Financial Liabilities:
Demand deposits		97,859		97,859		—		97,859		—
NOW and money markets		213,140		213,140		—		213,140		—
Savings		85,170		85,170		—		85,170		—
Time deposits and brokered funds		211,888		233,288		—		233,288		—
Short-term borrowings		19,000		19,000		19,000		—		—
Long-term borrowings		85,000		84,617		—		84,617		—
Subordinated debt		25,774		26,538		—		26,538		—
Accrued interest payable		711		711		—		711		—
Derivative Instruments (Liability):
Interest rate swaps		494		494		—		494		—

					Fair Value Measurements
					At December 31, 2015
					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	$	25,420	$	25,420	$	25,420	$	—	$	—
Investment securities available for sale		224,067		224,067		26		221,546		2,495
Other investment		2,250		2,250		—		—		2,250
Federal Home Loan Bank stock		2,545		2,545		—		—		2,545
Loans, net		489,414		484,961		—		—		484,961
Accrued interest receivable		4,149		4,149		—		4,149		—
Financial Liabilities:
Demand deposits		83,529		83,529		—		83,529		—
NOW and money markets		207,809		207,809		—		207,809		—
Interest-bearing brokered deposits		25,000		25,000		—		25,000		—
Savings		53,833		53,833		—		53,833		—
Time deposits		207,721		207,110		—		207,110		—
Short-term borrowings		9,000		9,000		9,000		—		—
Long-term borrowings		81,970		80,258		—		80,258		—
Subordinated debt		25,774		26,789		—		26,789		—
Accrued interest payable		709		709		—		709		—
Derivative Instruments (Liability):
Interest rate swaps		555		555		—		555		—

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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 22. Related party transactions

In the ordinary course of business, Royal Bank has had, and expects to have in the future, banking transactions with  officers, directors, and their affiliates, which involve substantially the same terms as those prevailing at the time for comparable transactions with other parties not related to the bank.  In the past we have originated loans to related parties. In accordance with Regulation O, related party loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than normal risk of collectability. The aggregate dollar amount of these loans and commitments was $0 at December 31, 2016 and 2015. During 2016, there were no new related party loans.

Related party deposits were $18.2 million and $12.6 million at December 31, 2016 and 2015, respectively.

The Company has had and intends to have business transactions in the ordinary course of business with directors, officers and associates on comparable terms as those prevailing from time to time for other non-affiliated vendors of the Company.  For these transactions, the expenses are not significant to the operations of the Company.

Note 23.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.  Our chief operating decision makers are the CEO and the CFO.  We have identified our reportable operating segments as “Community Banking” and “Tax Liens”.

Community banking

Our community banking segment consists of commercial and retail banking and equipment leasing. The community banking business segment includes Royal Bank and Royal Bank Leasing and generates revenue from a variety of products

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and services provided by those entities.  Royal Bank and Royal Bank Leasing have similar economic characterisitcs in that earnings are predominantly derived from net interest income.  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 December 31, 2016, Royal Bank’s tax liens segment includes its 80% and 100% ownership interest in CSC and RTL, respectively.  Prior to December 31, 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.

The following table presents selected financial information for reportable business segments for the years ended December 31, 2016 and 2015.

	For the year ended December 31, 2016
	Community
(In thousands)	Banking		Tax Liens		Consolidated
Total assets	$	823,779	$	8,706	$	832,485
Total deposits	$	629,546	$	—	$	629,546
Interest income	$	33,205	$	211	$	33,416
Interest expense		6,760		555		7,315
Net interest income (expense)	$	26,445	$	(344)	$	26,101
Provision for loan and lease losses		1,222		20		1,242
Total non-interest income		4,249		58		4,307
Total non-interest expense		19,494		503		19,997
Income tax benefit		(1,685)		(111)		(1,796)
Net income (loss)	$	11,662	$	(697)	$	10,965
Noncontrolling interest	$	510	$	80	$	590
Net income (loss) attributable to Royal Bancshares	$	11,153	$	(778)	$	10,375

	For the year ended December 31, 2015
	Community
(In thousands)	Banking		Tax Liens		Consolidated
Total assets	$	774,258	$	14,025	$	788,283
Total deposits	$	577,892	$	—	$	577,892
Interest income	$	29,379	$	614	$	29,993
Interest expense		5,689		795		6,484
Net interest income (expense)	$	23,690	$	(181)	$	23,509
(Credit) provision for loan and lease losses		(846)		98		(748)
Total non-interest income		2,842		271		3,113
Total non-interest expense		19,751		1,234		20,985
Income tax expense		(5,139)		—		(5,139)
Net income (loss)	$	12,766	$	(1,242)	$	11,524
Noncontrolling interest	$	602	$	(71)	$	531
Net income (loss) attributable to Royal Bancshares	$	12,164	$	(1,171)	$	10,993

Interest income earned by the community banking segment related to the tax liens segment was approximately $555 thousand and $795 thousand for the year ended December 31, 2016 and 2015, respectively.

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NOTE 24. CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY

Condensed financial information for the parent company only follows. 

CONDENSED BALANCE SHEETS

	As of December 31,
(In thousands)	2016		2015
Assets
Cash	$	1,027	$	10,152
Investment in non-bank subsidiaries		5,490		26,212
Investment in Royal Bank		70,856		61,309
Other assets		59		15
Total assets	$	77,432	$	97,688
Liabilities and Stockholders' Equity
Subordinated debentures	$	25,774	$	25,774
Other liabilities		10		10
Stockholders' equity		51,648		71,904
Total liabilities and stockholders' equity	$	77,432	$	97,688

CONDENSED STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME

	For the years ended December 31,
(In thousands)	2016		2015
Income
Other income	$	22	$	20
Total Income		22		20
Expenses
Other expenses		230		303
Interest on subordinated debentures		742		639
Total Expenses		972		942
Loss before income taxes and equity in undistributed net income		(950)		(922)
Equity in undistributed net income		11,325		11,915
Net income	$	10,375	$	10,993
Other comprehensive loss of subsidiaries		(1,300)		(1,427)
Comprehensive income	$	9,075	$	9,566

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CONDENSED STATEMENTS OF CASH FLOWS

	For the years ended December 31,
(In thousands)	2016		2015
Cash flows from operating activities
Net income	$	10,375	$	10,993
Adjustments to reconcile net income to net cash provided by operating activities:
Stock compensation expense		85		78
Undistributed income from subsidiaries		(11,325)		(11,915)
Dividend proceeds from non-banking subsidiaries		21,193		5,000
Other, net		56		(264)
Net cash provided by operating activities		20,384		3,892
Net cash provided by investing activities		—		—
Cash flows from financing activities
Redemption of preferred stock		(29,509)		—
Net cash used in financing activities		(29,509)		—
Net (decrease) increase in cash and cash equivalents		(9,125)		3,892
Cash and cash equivalents at beginning of period		10,152		6,260
Cash and cash equivalents at end of period	$	1,027	$	10,152

NOTE 25. SUMMARY OF QUARTERLY RESULTS (UNAUDITED)

The following summarizes the consolidated results of operations during 2016 and 2015, on a quarterly basis, for the Company:

	For the year ended December 31, 2016
(In thousands, except per share data)		Fourth Quarter		Third Quarter		Second Quarter		First    Quarter
Interest income	$	8,561	$	8,460	$	8,181	$	8,214
Interest expense		1,926		1,902		1,764		1,723
Net interest income		6,635		6,558		6,417		6,491
Provision for loan and lease losses		255		578		197		212
Net interest income after provision		6,380		5,980		6,220		6,279
Other income		838		1,189		1,073		1,207
Other expenses		4,729		5,001		5,046		5,221
Income before income tax		2,489		2,168		2,247		2,265
Income tax (benefit) expense		(1,881)		25		60		-
Net income	$	4,370	$	2,143	$	2,187	$	2,265
Less net income attributable to noncontrolling interest		248		113		153		76
Net income attributable to Royal Bancshares of Pennsylvania, Inc.	$	4,122	$	2,030	$	2,034	$	2,189
Net income available to common shareholders	$	4,003	$	1,688	$	1,696	$	1,855
Net income per common share
Basic and diluted	$	0.13	$	0.06	$	0.06	$	0.06

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		For the year ended December 31, 2015
(In thousands, except per share data)		Fourth Quarter		Third Quarter		Second Quarter		First    Quarter
Interest income	$	7,844	$	7,798	$	7,071	$	7,280
Interest expense		1,686		1,636		1,591		1,571
Net interest income		6,158		6,162		5,480		5,709
Provision (credit) for loan and lease losses		634		(216)		(586)		(580)
Net interest income after provision		5,524		6,378		6,066		6,289
Other income		1,202		700		1,283		847
Other expenses		5,427		5,365		5,737		5,375
Income before income tax		1,299		1,713		1,612		1,761
Income tax benefit		(5,139)		-		-		-
Net income	$	6,438	$	1,713	$	1,612	$	1,761
Less net income attributable to noncontrolling interest		31		179		151		170
Net income attributable to Royal Bancshares of Pennsylvania, Inc.	$	6,407	$	1,534	$	1,461	$	1,591
Net income available to common shareholders	$	5,973	$	1,100	$	1,032	$	1,167
Net income per common share
Basic and diluted	$	0.20	$	0.04	$	0.03	$	0.04

NOTE 26. SUBSEQUENT EVENTS

On  January 30, 2017, the Company and Bryn Mawr Bank Corporation (“Bryn Mawr”) entered into an Agreement and Plan of Merger (the “Merger Agreement”).  The Merger Agreement provides that, upon the terms and subject to the conditions set forth therein, the Company will merge with and into Bryn Mawr, with Bryn Mawr as the surviving corporation (the “Merger”).  Immediately following the Merger, Royal Bank will merge with the Bryn Mawr Trust Company, the wholly owned subsidiary of Bryn Mawr.  Upon completion of the Merger, holders of Class A common stock of the Company will receive 0.1025 shares of Bryn Mawr common stock, par value of $1.00 per share (the “Bryn Mawr common stock”) for each share of Class A common stock they hold, and holders of Class B common stock of the Company will receive 0.1179 shares of Bryn Mawr common stock for each share of Class B common stock they hold.  The Merger, which is subject to a number of closing conditions including receipt of required regulatory approvals and approval by the Company’s shareholders, is expected to be completed in the third quarter of 2017.

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ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A.   CONTROLS AND PROCEDURES

We maintain 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 and Exchange Commission’s rules and forms. As of the end of the period covered by this report, we 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 our CEO and CFO concluded that our disclosure controls and procedures were effective as of December 31, 2016.   

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting during the fourth quarter of 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act.  Our management, with the participation of our principal executive officer and principal financial officer, has assessed the effectiveness of our internal control over financial reporting based on the 2013 framework in “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). 

Based on its assessment under the COSO framework, our management concluded that the Company’s control over financial reporting was effective as of December 31, 2016.

There are inherent limitations to the effectiveness of any controls system.  A controls system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that its objectives are met. Further, the design of a control system must reflect the fact that there are limits on resources, and the benefits of controls must be considered relative to their costs and their impact on the business model.

This annual report does not include an attestation report of our registered accounting firm regarding internal control over financial reporting.  Management’s report was not subject to attestation by our registered public accounting firm pursuant to the Dodd-Frank Act, which permits smaller reporting companies, such as the Company, to provide only management’s report in this annual report.

ITEM 9B.   OTHER INFORMATION

None.

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PART III.

ITEM 10.  DIRECTORS,  EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE

Information concerning the directors and named executive officers of the Corporation and all directors and named executive officers as a group, is set forth in the following table, including the number of shares of common stock of the Corporation beneficially owned, as of February 28, 2017, by each of them.  The table includes options exercisable within 60 days of February 28, 2017. Unless otherwise indicated in a footnote, shares reported in this table are owned directly by the reporting person and such person holds sole voting and investment power with respect to such shares.  The percent of class assumes all options exercisable within 60 days of February 28, 2017, have been exercised and, therefore, on a pro forma basis, 27,999,233  shares of Class A common Stock would be outstanding.  The information is furnished as of February 28, 2017, on which date 1,924,629 Class B shares were issued and outstanding.

			Class A Shares			Class B Shares
		Director	Beneficially	Percent of		Beneficially	Percent of
Name	Age	Since	Owned	Class		Owned	Class
Class I Directors
Edward F. Bradley	73	2008	150,925	0.54	%	—	—	%
Linda Tabas Stempel (1) (2) (3)	65	2003	977,162	3.49	%	82,919	4.31	%
Howard Wurzak (2)	62	1987	1,011,468	3.61	%	76,336	3.97	%
Class II Directors
Murray Stempel, III (2) (3)	62	1997	1,015,910	3.63	%	82,919	4.31	%
Robert R. Tabas (1) (2)	61	1988	900,319	3.22	%	82,683	4.30	%
Gerard M. Thomchick	61	2011	16,960	0.06	%	—	—	%
Class III Directors
F. Kevin Tylus	62	2013	325,267	1.16	%	—	—	%
Michael J. Piracci	71	2010	24,436	0.09	%	—	—	%
Wayne R. Huey, Jr.	72	2011	42,694	0.15	%	—	—	%
Non-Director Executive Officer
Michael S. Thompson (4)	45	N/A	14,542	0.05	%	—	—	%
Lars B. Eller (5)	50	N/A	26,566	0.09	%	—	—	%
Mark W. Biedermann (6)	51	N/A	16,666	0.06	%	—	—	%
All directors and executive officers as a group (12 persons)			6,041,019	21.58	%	1,362,717	70.80	%
and Daniel M. Tabas Trust (7)

(1) Linda Tabas Stempel, Robert R. Tabas and Nicholas Randazzo share voting and dispositive control over 2,492,016 shares of Class A common stock and 1,120,779 shares of Class B common stock held in the Daniel M. Tabas Trust. These shares are not included in the share ownership reported in this table for Ms. Stempel or for Mr. Tabas (See footnote (1) on page 125).

(2) Robert R. Tabas, Murray Stempel, III, Linda Tabas Stempel, Howard Wurzak and members of their immediate families (including siblings) and their affiliates including the Daniel M. Tabas Trust, in the aggregate (excluding stock options), own 8,414,586 shares of Class A common stock (30.05% of Class A) and 1,677,098 shares of Class B common stock (87.14% of Class B) or 34.23% of Class A assuming the full conversion of Class B common stock at a current conversion rate of 1.15 shares of Class A common stock for each share of Class B common stock.  The Class B common stock has 10 to 1 voting rights.  Therefore, the Tabas family holds 53.31% of the voting rights of the Corporation’s common stock.

(3) Linda Tabas Stempel and Murray Stempel, III are married.  Mr. Stempel’s shares include 21,808 Class A shares related to shares for which he has the voting and dispositive power held in trust for two grandchildren of Evelyn Tabas.

(4) Mr. Thompson was appointed Executive Vice President and Chief Financial Officer of the Corporation and Royal Bank America in September 2012.  Mr. Thompson previously served as the Corporation’s Chief Accounting Officer.

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(5) Mr. Eller was appointed Executive Vice President and Chief Retail Officer of Royal Bank America in December 2013.  Prior to December 2013, Mr. Eller served as Head of Retail Banking in the Pennsylvania market for TD Bank and also previously served as Executive Vice President of Retail Banking at National City Bank.

(6) Mr. Biedermann was appointed Executive Vice President and Chief Lending Officer of Royal Bank America in January 2015.  Prior to January 2015, Mr. Biedermann served as Executive Vice President and Chief Lending Officer for Valley Green Bank. Mr. Biedermann previously served as Executive Vice President and Chief Credit Officer at Valley Green Bank from 2010 through the end of 2011.

(7) The number of shares included in total for directors, officers and the Daniel Tabas Trust has been reduced by 973,912 Class A shares and 82,919 Class B shares to eliminate the same shares beneficially held by both Linda Tabas Stempel and her husband, Murray Stempel, III.  Included in the percent of class calculation is 2,492,016 shares of Class A common stock and 1,120,779 shares of Class B common stock owned by the Daniel M. Tabas Trust.

The information in the preceding table was furnished by the beneficial owners or their representatives and includes direct and indirect ownership. For a description of certain voting agreements executed by the Corporation’s directors and executive officers and certain of their family members and affiliates, including the Daniel M. Tabas Trust, see “Item 12 – Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters/Merger Agreement/Voting Agreements.”

Set forth below as to each of the Class I, Class II and Class III directors, are descriptions of his or her principal occupation and business experience for the past five years, and where applicable, family relationships between each such person and the Corporation’s other directors and officers. In addition, we briefly describe the particular experience, qualifications, attributes or skills that led our board of directors to conclude that such director should serve as a director of the Corporation.

CLASS I DIRECTORS – TERMS EXPIRING IN 2018

Edward F. Bradley, CPA, is a Director of the Corporation, and is currently an adjunct professor at Philadelphia University.He was previously a partner at Grant Thornton, a public accounting firm in Philadelphia, Pennsylvania. Mr. Bradley’s many years of experience in public accounting, particularly in auditing financial institutions, is beneficial to the operations of the Corporation’s Audit Committee and his role as the Audit Committee’s Chairperson and financial expert.

Linda Tabas Stempel is a Director of the Corporation, and was previously Director of Investor Relations for the Corporation. She is the wife of Murray Stempel, III, the sister of Robert R. Tabas and the sister-in-law of Howard Wurzak. Her previous role as Director of Investor Relations provides assistance and expertise to the board of directors in managing shareholder communications.

Howard Wurzak is a Director of the Corporation, and is Chairman and CEO of the Wurzak Hotel Group, President and CEO of the Hilton Hotel Philadelphia, Sheraton Hotel King of Prussia, Home2 Suites Philadelphia, Homewood Suites City Avenue and JCB Management, LLC. He is the son-in-law of Evelyn R. Tabas, and the brother-in-law of Robert R. Tabas, Murray Stempel, III and Linda Tabas Stempel.  Mr. Wurzak’s real estate development expertise and ability to manage large organizations demonstrates that he possesses the knowledge regarding the industries we serve and the management skills that we value in the members of our board of directors.

CLASS II DIRECTORS – TERMS EXPIRING IN 2019

Murray Stempel, III is a Director of the Corporation, and was previously Vice Chairman of the Corporation from December 2008 (and, prior thereto, Executive Vice President of the Corporation and the Bank) until December 31, 2012.  Mr. Stempel is the husband of Linda Tabas Stempel and the brother-in-law of Robert R. Tabas and Howard Wurzak.  From 2004 until 2008, he served as Executive Vice President and Chief Lending Officer at the Bank.  Mr. Stempel, is a member of the board of trustees of RAIT Financial Trust (“RAIT”), a publicly traded, self-managed and self-advised real estate investment trust since December 2006 and is Chairman of their Nominating and Governance Committee. RAIT offers a set of debt financing options to the commercial real estate industry, fixed income trading and advisory services, owns and manages a portfolio of commercial real estate properties, and manages real estate-related assets for third parties. Mr. Stempel’s knowledge of the Bank’s lending practices and of commercial real estate investments generally, which remain

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a substantial portion of the Bank’s loan portfolio, are important to the board of directors’ oversight of the Bank’s lending relationships.

Robert R. Tabas is the Chairman of the Board and a Director of the Corporation, and was previously Chief Executive Officer of the Corporation from December 2008 (and prior thereto, Chairman of the Corporation and Executive Vice President of the Bank) until February 20, 2013.  Mr. Tabas is also the past president of Federation Housing, Inc. and currently serves on its board of directors and is chair of the board governance committee. He also serves on the board of the Montgomery County Development Corporation. He is the brother of Linda Tabas Stempel and the brother-in-law of Howard Wurzak and Murray Stempel, III.  For the board of directors to run efficiently and effectively, we believe that Mr. Tabas’ participation on the board of directors is necessary and assists the board of directors in overseeing management’s progress on corporate initiatives and strategic plans, given his previous experience within the Corporation as Chief Executive Officer.

Gerard M. Thomchick is a Director of the Corporation and is currently President of GMT, LLC, a consulting company. Previously he was Senior Executive Vice President and Chief Operating Officer of First Commonwealth Financial Corporation, a regional financial services company in western Pennsylvania from 1995-2007 and was President and CEO of First Commonwealth Bank, a regional bank and subsidiary of First Commonwealth Financial from 2005 to 2007. He has served the community during his career in various civic activities including Rotary President. He was previously a board member of the FHLB in Pittsburgh and was acting Chief Risk Officer and Chairman of the Credit Committee for the FHLB in 2009. He was also a member of the American Bankers Executive Council and served on the Financial Services Roundtable.  His prior leadership and banking experience in community banks and larger financial institutions provides critical skills required for the board of directors’ oversight of mergers and acquisitions, commercial lending, strategic planning, risk management, and treasury and investment management.

CLASS III DIRECTORS- TERMS EXPIRING IN 2017

F. Kevin Tylus is the Chief Executive Officer and President since February 20, 2013 and a Director of the Corporation; and is the Chief Executive Officer and President since December 18, 2012 of Royal Bank America (the “Bank”).  Mr. Tylus’ prior experience as a Regional President for PNC Bank, as President and member of the Board of Directors of Yardville Bank as well as numerous progressively-responsible leadership positions in the financial services, insurance, and healthcare industries provides critical skills for the board of directors’ oversight of capital management, retail banking, lending, corporate governance and strategic planning.  For the board of directors to run efficiently and effectively, we believe that Mr. Tylus’ participation on the board of directors is necessary and assists the board of directors in overseeing management’s progress on corporate initiatives and strategic plans.

Michael J. Piracci is a Director of the Corporation and is currently President of M. Piracci Consulting, Inc. an independent consulting company providing consulting services to financial institutions primarily related to banking regulations. He was previously the Assistant Regional Director of the New York Office of the FDIC and was an examiner for many years. Mr. Piracci’s prior experience as an examiner, manager and Assistant Regional Director of the FDIC is important for the board of directors’ oversight in dealing with the regulatory orders, banking regulations and banking operations.

Wayne R. Huey, Jr. is a Director of the Corporation, and was previously Executive Vice President of Montgomery Chemicals, a regional chemical manufacturer and supplier to specialty industries, and prior thereto was Senior Vice President of Private Banking at Nova Savings Bank, a local community bank from 2004 until 2005. From 1998 until 2004 he was Vice Chairman and Managing Director of Millennium Bank, a community bank that was merged into Harleysville National Corporation. He was also employed as an Executive Vice President by CoreStates Bank and Meridian Bancorp. He previously held executive positions within other community banks with significant experience in retail banking, administration, commercial lending and marketing. He is currently a board member of the Paoli Hospital Foundation.  Mr. Huey’s prior leadership and banking experience in community banks and larger financial institutions provides critical skills required for the board of directors’ oversight of retail banking, lending, and corporate governance.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the Corporation’s officers and directors, and

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persons who own more than 10% of the registered class of the Corporation’s equity securities, to file reports of ownership and changes in ownership with the SEC.  Officers, directors and greater than 10% shareholders are required by SEC regulation to furnish the Corporation copies of all Section 16(a) forms they file.

Based solely on its review of forms received from certain reporting persons, or written representations from reporting persons that no Forms 5 were required for those persons, the Corporation believes that during the period January 1, 2016 through December 31, 2016 its officers and directors were in compliance with all filing requirements applicable to them.

Audit Committee

The Audit Committee arranges examinations by the Corporation’s independent registered public accounting firm, reviews and evaluates the recommendations of the examinations, receives all reports of examination of the Corporation and the Bank by regulatory agencies, analyzes such reports and reports the results of its analysis of the regulatory reports to the Corporation’s board of directors. The committee receives reports directly from the Corporation’s internal auditors on a quarterly basis, and recommends any action to be taken. The committee is also responsible for, among other things, assisting the board of directors in monitoring (i) the integrity of the consolidated financial statements of the Corporation, (ii) the independent auditor's qualification and independence, (iii) the performance of the Corporation’s internal audit function and independent auditors, and (iv) compliance by the Corporation with legal and regulatory matters. The members of the Audit Committee are Edward F. Bradley, Chairperson, Michael J. Piracci and Gerard M. Thomchick. The board of directors has determined that Edward F. Bradley is an "Audit Committee Financial Expert" and is "Independent" under applicable SEC and NASDAQ Rules. The Audit Committee’s charter can be accessed on the Corporation’s website at www.royalbankamerica.com under the heading “Regulatory Filings” located under the “Investor Relations” page under the heading “About Us”.

ITEM 11.  EXECUTIVE COMPENSATION

This section covers the Corporation’s executive compensation philosophy, approach, guidelines and programs, and the factors impacting the compensation of the executive team.  It is presented to provide shareholders with an understanding of the components of the compensation program and its alignment with the Corporation’s performance. The Named Executive Officers (NEOs) for the fiscal year 2016 are:

· F. Kevin Tylus, President and Chief Executive Officer (“CEO”)

· Michael S. Thompson, EVP, Chief Financial Officer (“CFO”)

· Mark W. Biedermann, EVP, Chief Lending Officer (“CLO”) Hired on January 30, 2015

· Lars B. Eller,  EVP, Chief Retail Officer (“CRO”)

Role of the Committee

The primary purpose of the Corporation’s Compensation Committee (the “Committee”) is to periodically review and recommend to the independent directors of the Corporation the compensation for the Corporation’s directors and certain senior executive officers, including the named executive officers (the “Tier 1 Executives”), and to periodically review the compensation of the other executive officers and employees of the Corporation as determined by the Salary & Benefits Committee. The Committee also has overall responsibility for recommending, approving and evaluating the compensation plans, policies and programs of the Corporation and its subsidiaries.  The Compensation Committee’s charter can be accessed on the Corporation’s website at www.royalbankamerica.com under the heading “Regulatory Filings” located under the “Investor Relations” page under the heading “About Us”.  Direct responsibilities of the Committee include:

· At least annually reviewing and approving corporate goals and objectives relevant to the compensation of the Tier 1 Executives, evaluating the performance of Tier 1 Executives in light of such goals and objectives, and recommending to the independent directors the compensation levels of the Tier 1 Executives, including base salary, annual incentive opportunity level, long-term incentive opportunity level, and the terms of any agreements, based on such evaluation.  In recommending the long-term incentive component of the compensation of the Tier 1 Executives, the Committee considers the Corporation’s performance and relative shareholder return, the value of similar incentive awards to

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senior executive officers at comparable companies, the awards given to the Tier 1 Executives in past years, and other factors it deems appropriate.

· At least annually reviewing the material performance criteria used by the Salary & Benefits Committee in evaluating executive officers other than the Tier 1 Executives and the material criteria used in establishing appropriate compensation, retention, incentive, severance, and benefit policies and programs applicable to such executive officers.

· Periodically reviewing and making recommendations to the board of directors with respect to the adoption of or substantive changes in material employee benefit plans, bonus, incentive compensation, severance, equity-based or other compensation, or incentive plans of the Corporation and its subsidiaries.

· Administering and having authority to recommend awards, subject to approval of the board of directors, under the Corporation’s long-term incentive plans, subject to the terms of the applicable plans.

· Annually reviewing and determining the compensation of directors, subject to the approval of independent directors acting in executive session. 

· Ensuring that the Corporation uses sound compensation governance practices, which include compliance with all applicable regulations and laws, and ensuring that the compensation programs do not create any undue risk-taking.

Role of Management

The role of management is to provide the Committee with reviews and recommendations for the Committee’s consideration, and to manage the Corporation’s executive compensation programs, policies and governance (as they relate to compensation).  Direct responsibilities of management in this process include:

· Providing an ongoing review of the effectiveness of the compensation programs, including competitiveness, and alignment with the Corporation’s objectives.

· Recommending changes, if necessary, to ensure achievement of all program objectives.

· Recommending compensation levels and/or incentive awards for key executive officers other than the Tier 1 Executives.

In making compensation decisions, the Committee receives input from the CEO as it relates to his direct reports.  This information is considered; however, the Committee and/or Board make the final determinations.  The CEO is not present during deliberations concerning his own compensation, and the Committee and Board hold regular executive sessions where management is not present.

Executive Summary of Corporation Performance and Compensation Decisions

The successful performance during 2016 resulted from our management team’s efforts and abilities to execute on the Bank’s immediate priorities while holding to longer-term strategic objectives. During 2016 and 2015, we achieved a number of milestones including the partial recovery of a portion of the net deferred tax asset valuation allowance, which contributed to a net tax benefit of $1.8 million in 2016 and $5.1 million in 2015.  In addition, the Bank recorded net income of $10.4 million in 2016 ($8.6 million after adjusting for the net tax benefit) compared to $11.0 million ($5.9 million after adjusting for the net tax benefit) in net income during 2015.  Diluted earnings per share were $0.31 ($0.25 after adjusting for the net tax benefit) in 2016 compared to diluted earnings per share of $0.31 ($0.14 after adjusting for the net tax benefit) in 2015. Key financial highlights are shown below.

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Performance Metrics	2016			2015			2014
Net Income (in Millions)	$	10.4		$	11.0		$	5.1
Diluted EPS	$	0.31		$	0.31		$	0.14
ROAA		1.3	%		1.5	%		0.7	%
ROAE		15.2	%		16.8	%		9.0	%

Executive Management Compensation Program

Beginning in 2015, the Committee adopted the Executive Management Compensation Program (the “Program”), in which all Named Executive Officers (NEO’s) participate.  The Program is designed to recognize and reward executives for their annual contribution to the Corporation’s performance.

Eligibility is limited to Executive Vice President level positions that have a significant impact on the success of the Corporation.  The Program is a short-term cash incentive plan that directly ties annual cash awards to the Corporation’s performance as achieved across multiple performance measures.  The performance measures and goals are defined each year and approved by the Committee. 

The Plan includes a claw back provision.  In the event the Corporation is required to restate its financial statements, participants will be required to forfeit any incentive award earned or distributed during the period for which the restatement is required in excess of what they would have otherwise received based on restated results. The Committee has discretion in determining the application of claw-backs and the amounts to be reclaimed under this provision.

Each executive has a scorecard that identifies the appropriate measures, range of performance, and target compensation opportunities.  Performance Measures are broken into two groups: Corporation Performance Measures, which account for 70% of the incentive payout and Individual Performance Measures which account for 30% of the incentive payout.   Below is a table that shows the weighting of each of the Corporation Performance Measures:

Corporation Performance Measures 70%	Weighting
Net Income (excluding tax benefit)	28.00	%
Net Loan Growth	10.50	%
Net Core Deposit Growth	10.50	%
Non-Performing Asset Reduction	10.50	%
Non-Interest Income	10.50	%

Individual performance measures are made up of a combination of three qualitative and/or quantitative goals with equal weightings of 10% each for a total of 30% for each individual. These goals vary by individual and are primarily strategic in nature and based on improving overall efficiencies throughout the Corporation.  Each of the NEO’s achieved 100% of their individual performance goals which is equal to 30% of their targeted award.

At the beginning of each year, Threshold, Target and Stretch performance measures are established and approved by the Board of Directors for each of the Corporation Performance Measures.  During 2016, Stretch Performance measures were established for Net Income which the Corporation exceeded.  During 2015, there were no Stretch Performance measures established for the Corporation.  Performance against each range determines the payout opportunity for each factor, ranging from 0% (not achieving minimal performance) to 100% (achieving target performance) of the established target. The Compensation Committee determines an amount to be awarded to each of the NEO’s should the Stretch Performance measure be met.  The Compensation Committee reserves the right to use their discretion and may make additional compensation recommendations for exceptional performance that could exceed target awards. For 2016, the Board of Directors approved the Compensation Committee’s recommendations to award an additional $30,570 to Michael S. Thompson for exceptional performance.

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The following table shows fiscal year 2016 performance against goal for each Performance Factor: 

Corporation Performance Measures	Target Achievement
Net Income (excluding tax benefit)	137.22	%
Net Loan Growth	107.66	%
Net Deposit Growth	103.22	%
Non-Performing Asset Reduction	116.38	%
Non-Interest Income	153.57	%

The following table shows fiscal year 2016 overall performance compared to the targeted measures:

	Corporation		Individual		Total
Name	Performance 70%		Performance 30%		Payout
F. Kevin Tylus	70	%	30	%	100	%
Michael S. Thompson	70	%	30	%	100	%
Mark W. Biedermann	70	%	30	%	100	%
Lars B. Eller	70	%	30	%	100	%

For the fiscal year ending December 31, 2016, the incentive payouts to the named executives were as follows: 

	Target Payout		Incentive		Additional Payout		Additional		Total		% of
Name	Opportunity		Payout at Target		at Stretch		Bonus		Payout		Base Salary
F. Kevin Tylus	33	%	$	148,706	$	21,600	$	—	$	170,306	38.9	%
Michael S. Thompson	20	%	$	44,000	$	12,000	$	30,570	$	86,570	44.4	%
Mark W. Biedermann	25	%	$	57,938	$	14,400	$	—	$	72,338	32.2	%
Lars B. Eller	20	%	$	44,880	$	12,000	$	—	$	56,880	25.9	%

As noted above, for 2016, the Corporation exceeded the Stretch Performance measures, therefore the additional payments for exceeding this measure are shown in the table above.  In addition, the Board of Directors approved the Compensation Committee’s recommendation to award an additional $30,570 to Michael S. Thompson for exceptional performance.

Base pay increases were awarded to the following named executive officers, effective January 2017:

	2016		2017		$		%
Name	Base Salary		Base Salary		Increase		Increase
F. Kevin Tylus	$	450,625	$	464,144	$	13,519	3.0	%
Michael S. Thompson	$	220,000	$	226,600	$	6,600	3.0	%
Mark W. Biedermann	$	231,750	$	238,703	$	6,953	3.0	%
Lars B. Eller	$	224,400	$	231,132	$	6,732	3.0	%

No stock awards are contemplated for the NEOs.

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Based on the annual incentive plan that was approved, which is based on achieving selected financial performance and individual goals.  Target award percentages were established as a percentage of base salary as follows:

Name	Target %		Payout at Target
F. Kevin Tylus	33	%	$	153,168
Michael S. Thompson	20	%	$	45,320
Mark W. Biedermann	25	%	$	59,676
Lars B. Eller	20	%	$	46,226

The Committee reserves the right to use their discretion and may make additional compensation decisions for 2017, which includes rewarding exceptional performance through payments above the target percentages.  This action would reflect a strong desire to re-establish a pay-for-performance environment that will support our long term goals and strategies.  Our goal is to develop programs that align the executive team’s compensation with the Corporation’s performance and to create long-term value for its shareholders. 

Below is the “Summary Compensation Table” for the Corporation’s named executive officers for 2016.

							Nonqualified
						Non -Equity	Deferred	All Other
				Stock	Option	Incentive Plan	Compensation	Compensation	Total
Name and Principal		Salary	Bonus	Awards	Awards	Compensation	Earnings
Position	Year	($)	($)	($) (5)	($) (5)	($)	($)	($) (1)	($)
F. Kevin Tylus	2016	450,625	—	—	—	170,306	—	8,500	629,431
Principal Executive Officer	2015	437,500	—	—	28,000	150,375	—	2,500	618,375
President & CEO (2)	2014	525,000	74,350	—	—	—	—	2,500	601,850
Michael S. Thompson	2016	220,000	30,570	—	—	56,000	—	2,500	309,070
Principal Finanical Officer	2015	195,000	—	—	11,200	49,000	—	2,500	257,700
Executive Vice President &	2014	180,000	18,000	—	—	—	—	2,500	200,500
Chief Financial Officer (3)
Mark W. Biedermann	2016	231,750	—	—	—	72,338	—	2,500	306,588
Executive Vice President &	2015	208,558	—	45,000	26,750	56,250	—	2,500	339,058
Chief Lending Officer (4)
Lars B. Eller	2016	224,400	—	—	—	56,880	—	2,500	283,780
Executive Vice President &	2015	220,000	—	—	11,200	44,000	—	2,500	277,700
Chief Retail Officer (5)	2014	255,000	21,500	—	—	—	—	2,500	279,000

(1) Please see the table below for a breakdown of the terms and amounts comprising All Other Compensation.

(2) Mr. Tylus was appointed as President and Chief Executive Officer of the Corporation on February 20, 2013, and as President and Chief Executive Officer of the Bank on December 18, 2012.  Included in Mr. Tylus’ salary for 2014 is $100,000 that was paid in the form of Class A common stock of the Corporation.

(3) Mr. Thompson was appointed Executive Vice President and Chief Financial Officer of the Corporation and Royal Bank America in September 2012.  Mr. Thompson previously served as the Corporation’s Chief Accounting Officer.

(4) Mr. Biedermann has served as Executive Vice President and Chief Lending Officer since January 30, 2015.  Mr. Biedermann’s salary for 2015 represents the amount paid in 2015 based on an annual salary of $225,000 for 2015.

(5) Mr. Eller has served as Executive Vice President and Chief Retail Officer of the Bank since December 2013.  Included in Mr. Eller’s salary for 2014 is $40,000 that was paid in the form of Class A common stock of the Corporation.

(6) The amount in these columns reflects the grant date fair value in accordance with ASC Topic 718 for equity awards under the Long-Term Incentive Plan.

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The following table sets forth information identifying the items and amounts that comprise All Other Compensation reflected in the “Summary Compensation Table” above.

			401 (k)
		Automobile	Employer	Director	Club dues	Other
		Benefit	Contribution	Fees	Allowance	Compensation	Total
Name	Year	($)	($)	($)	($)	($) (1)	($)
F. Kevin Tylus	2016	—	2,500	—	—	6,000	8,500
	2015	—	2,500	—	—	—	2,500
	2014	—	2,500	—	—	—	2,500
Michael S. Thompson	2016	—	2,500	—	—	—	2,500
	2015	—	2,500	—	—	—	2,500
	2014	—	2,500	—	—	—	2,500
Mark W. Biedermann	2016	—	2,500	—	—	—	2,500
	2015	—	2,500	—	—	—	2,500
Lars B. Eller	2016	—	2,500	—	—	—	2,500
	2015	—	2,500	—	—	—	2,500
	2014	—	2,500	—	—	—	2,500

(1) For Mr. Tylus, the Other Compensation for 2016 reflects the value of the benefit for the use of a company leased apartment for November and December 2016.

The table does not include benefits generally available to all salaried employees such as medical health coverage, disability coverage, life insurance and benefits made available under cafeteria plans.

Outstanding Equity Awards Table

The table that follows provides information on outstanding stock options and restricted shares awarded to the named executives as of February 28, 2017.  The stock option grants shown below that expire in 2025 vests 33 1/3% each year beginning on the first anniversary date of the grant date.  All other stock option grants listed below have fully vested as of December 31, 2016.  Each restricted stock award vests three years from the grant date.  Mr. Biedermann was issued 25,000 shares of restricted stock in 2015 that does not vest until January 2018. There were no other restricted stock awards outstanding for any of the named executive officers as of December 31, 2016.

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Outstanding Equity Awards Table
	Option Awards						Stock Awards
			Equity Incentive
			Plan Awards
	Number of	Number of	Number of				Number of		Market Value
	Securities	Securities	Securities				Shares or Units		of Shares or
	Underlying	Underlying	Underlying	Option			of Stock That		Units of Stock
	Unexercised	Unexercised	Unexercised	Exercise		Option	Have Not		That Have
Name and Principal	Options (#)	Options (#)	Unearned	Price		Expiration	Vested		Not Vested
Position	Exercisable	Unexercisable	Options(#)	($)		Date	(#)		($) (1)
F. Kevin Tylus	16,666	8,334	—	$	1.83	02/18/25	—	$	—
Principal Executive Officer
President & CEO
Michael S. Thompson	1,109	—	—	$	20.08	07/18/17	—	$	—
Principal Financial Officer	4,700	—	—	$	4.50	10/07/18	—	$	—
Executive Vice President &	6,666	3,334	—	$	1.83	02/18/25	—	$	—
Chief Financial Officer			—
Mark W. Biedermann	16,666	8,334	—	$	1.71	02/27/25	25,000	$	101,750
Executive Vice President &
Chief Lending Officer (1)
Lars B. Eller	6,666	3,334	—	$	1.83	02/18/25	—	$	—
Executive Vice President &
Chief Retail Officer

(1) Based on closing price of $4.07 per share on February 28, 2017.

Option Exercises and Stock Vested Table

There were no stock options exercised by any of the named executive officers, and no stock awards vested for any of the named executive officers during 2016.

Employment Agreement and Change in Control Agreements

On March 4, 2015, Royal Bank America (the “Bank”) entered into an amended and restated employment agreement with F. Kevin Tylus.  The amended and restated employment agreement supersedes the employment agreement with Mr. Tylus, dated November 20, 2013.  The amended and restated agreement for Mr. Tylus is currently subject to annual renewals absent notice of nonrenewal by either party at least 90 days prior to an annual renewal date.

Under the amended and restated agreement, Mr. Tylus is entitled to receive an annual cash base salary of $464,144 which is based on his current base salary.  The amended and restated employment agreement also provides for participation in employee benefit plans and programs maintained by the Corporation and the Bank for the benefit of their executive officers, including participation in cash bonus programs, participation in health, disability benefit, life insurance, pension, profit sharing, retirement and stock-based compensation plans and certain fringe benefits described in the agreements.

Following a “change in control” of the Corporation, if Mr. Tylus’ employment is terminated other than for cause or disability, or if Mr. Tylus resigns after the occurrence of specified events of “good reason” following a change in control, he will receive a lump-sum cash payment equal to three times his annual base salary.  In the event his employment is terminated other than for cause or disability, or if Mr. Tylus resigns after the occurrence of specified events of “good reason” absent a change in control of the Corporation, he would receive a lump-sum cash payment equal to two times his

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base salary.  The agreement provides for the reduction of any severance payments to the extent necessary to ensure that Mr. Tylus will not receive “excess parachute payments” under Section 280G of the Internal Revenue Code. 

The Bank also entered into change in control agreements in March 2015 with each of Michael S. Thompson, Executive Vice President and Chief Financial Officer of the Corporation and the Bank, Lars B. Eller, Executive Vice President and Chief Retail Officer of the Bank, and Mark W. Biedermann, Executive Vice President and Chief Lending Officer of the Bank.  The change in control agreements are currently subject to annual renewals absent notice of nonrenewal by either party at least 60 days prior to an annual renewal date. Under each of these agreements, if, following a “change in control” of the Corporation, the employment of the officer is terminated other than for cause or disability, or if the officer resigns after the occurrence of specified events of “good reason” following a change in control, he or she will receive a lump-sum cash payment equal to two times his highest annual base salary during the three preceeding calendar years.  Each of the agreements provides for the reduction of any payments to the applicable officer to the extent necessary to ensure that he will not receive “excess parachute payments” under Section 280G of the Internal Revenue Code.  The prior employment agreements between the Corporation and the Bank and each of Mr. Thompson and Mr. Eller have either expired or been superseded and replaced with the change in control agreement described in this paragraph, so that, at the date hereof, the only employment agreement to which the Corporation or the Bank is a party with an executive officer of the Corporation is the amended and restated employment agreement with Mr. Tylus.

Director Compensation Table

Director compensation is based on analysis conducted by the Corporation’s management and the Committee, and focuses on director compensation practices of its peers, especially those peers of similar asset size as the Corporation.  Fees paid to non-employee board members are as follows:

a) Annual retainer of $10,000. (This retainer is paid quarterly and each director has the opportunity to take the cash equivalent in shares of the Corporation’s Class A common stock in lieu of the cash payment.)  Should a board member miss three meetings during a calendar year, any unpaid quarterly retainer is forfeited; and

b) A board meeting attendance fee of $1,250 per meeting.  The board member must be present in person at the meeting in order to be entitled to receive the fee.  In the event a board member attends via teleconference, the fee paid will be 50% of the regular fee for attendance.

In previous years, board members received annual grants of stock options.  The exercise price for each option grant is set in the same manner as under the LTIP, detailed above.  However, no stock options have been granted for board service since 2008.

In addition, fees are paid to non-employee directors for service on committees and sub-committees of the board.  The Chair of the respective sub-committee is paid $750 per meeting.  The other directors, outside of the Chair, attending the meetings are paid $500 per meeting.  The principal committees and sub-committees of the board are the (i) Executive Loan Committee; (ii) Audit Committee; (iii) Compensation Committee; (iv) Board Risk Committee; (v) Nominating and Governance Committee; (vi) Special Assets Committee; and (vii) Board Capital and Strategy Committee.  Independent directors also receive fees for meetings of the independent directors which they attend.  Outside directors are compensated at the reduced per meeting rates of $300 for teleconference committee meetings and $400 for web-based meetings. The Chair of the Audit Committee is paid a monthly retainer of $1,000. The presiding director for meetings of the independent directors is paid $750 per meeting.

The following table provides information on payments made to all directors by the Corporation and subsidiaries during 2016, except for Mr. Tylus whose compensation is reported in the “Summary Compensation Table” and related tables.

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										Change in
										Pension
										Value and
		Fees						Non-Equity		Nonqualified
		Earned						Incentive		Deferred		All
		or Paid		Stock		Option		Plan		Compensation		Other
		in Cash		Awards		Awards		Compensation		Earnings		Compensation		Total
Director Name		($)		($) (1)		($) (1)		($)		($)		($) (2)		($)
Edward F. Bradley	$	49,863	$	3,015	$	—	$	—	$	—	$	—	$	52,878
Wayne R. Huey, Jr.	$	44,812	$	3,015	$	—	$	—	$	—	$	—	$	47,827
Michael J. Piracci	$	32,513	$	3,015	$	—	$	—	$	—	$	—	$	35,528
Linda Tabas Stempel	$	27,513	$	3,015	$	—	$	—	$	—	$	—	$	30,528
Murray Stempel, III	$	41,163	$	3,015	$	—	$	—	$	—	$	—	$	44,178
Robert R. Tabas	$	43,613	$	3,015	$	—	$	—	$	—	$	81,350	$	127,978
Gerard M. Thomchick	$	35,663	$	3,015	$	—	$	—	$	—	$	—	$	38,678
Howard Wurzak	$	37,388	$	3,015	$	—	$	—	$	—	$	—	$	40,403

(1) In January 2016, each director was awarded 1,500 shares of the Corporation’s stock as part of their compensation. The price of the stock on the date of the award was $2.01.

(2) For Mr. Tabas represents annual stipend for serving as Chairman of the Board.

Outstanding Stock Options Held by Directors

The following table provides information on total outstanding stock options held by outside directors at February 28, 2017:

Director Stock Options Table
			Number of
	Number of	Number of	Securities
	Securities	Securities	Underlying
	Underlying	Underlying	Unexercised
	Unexercised	Unexercised	Options (#)
	Options (#)	Options (#)	Total
Director Name	Exercisable	Unexercisable	Outstanding
Edward F. Bradley	—	—	—
Wayne R. Huey, Jr.	—	—	—
Michael J. Piracci	—	—	—
Linda Tabas Stempel	3,250	—	3,250
Murray Stempel, III	12,400	—	12,400
Robert R. Tabas	14,836	—	14,836
Gerard M. Thomchick	—	—	—
Howard Wurzak	3,250	—	3,250

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERS MATTERS

Principal Shareholders

The following table shows as of February 28, 2017, the amount of outstanding common stock beneficially owned by each shareholder (including any “group” as the term is used in Section 13(d)(3) of the Securities Exchange Act of 1934) known by the Corporation to be the beneficial owner of more than 5% of such stock.  Each share of Class A common stock is

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entitled to one vote per share.  Each share of Class B common stock is entitled to ten votes per share and may be converted into shares of Class A common stock at the current rate of 1.15 shares of Class A common stock for each share of Class B common stock.  Beneficial ownership is determined in accordance with applicable regulations of the Securities and Exchange Commission, and the information is not necessarily indicative of beneficial ownership for any other purpose.  For purposes of the table set forth below, beneficial ownership includes any shares as to which the individual has sole or shared voting power or investment power and any shares that the individual has the right to acquire within 60 days of February 28, 2017.  In addition, a person is deemed to beneficially own any stock for which he, directly or indirectly, through any contact, arrangement, understanding, relationship or otherwise has or shares voting or investment power.

Unless otherwise indicated in a footnote, shares reported in this table are owned directly by the reporting person.  The percent of class assumes all options exercisable within 60 days of February 28, 2017, have been exercised and, therefore, on a pro forma basis, 27,999,233 shares of Class A common stock would be outstanding, net of treasury stock.

	Class A Shares			Class B Shares
Name and Address of	Beneficially	Percent of		Beneficially	Percent of
Beneficial Owner	Owned	Class		Owned	Class
Daniel M. Tabas, Trust (1)	2,492,016	8.90	%	1,120,779	58.23	%
543 Mulberry Lane
Haverford, PA 19041
Lee Evan Tabas (2)	1,370,679	4.90	%	149,662	7.78	%
355 W. Lancaster Avenue
Haverford, PA 19041
Carol Tabas (3)	889,321	3.18	%	82,041	4.26	%
39 Rosemont Lane
Pittsburgh, PA 15217
Ithan Creek Master Investors (Cayman), LP (4)	2,265,949	8.09	%	—	—	%
c/o Wellington Management Company LLP
280 Congress Street
Boston, MA 02210
FJ Capital Management LLC (5)	1,944,803	6.95	%	—	—	%
1313 Dolly Madison Blvd.
McLean, VA  22101

(1) The trustees for the Daniel M. Tabas Trust are, Robert R. Tabas, Linda Tabas Stempel and Nicholas Randazzo, who as a group have voting rights and dispositive control of these shares.

(2) The shares beneficially owned by Lee Evan Tabas consist of: (a) 604,995 Class A shares acquired pursuant to the 2008 Irrevocable Agreement of Trust for the Family of Lee E. Tabas from Evelyn R. Tabas of which he has sole voting power and dispositivepower subject to the terms of the trust agreement; (b) 5,177 Class A and 58,887 Class B shares held by his wife, Nancy Freeman Tabas in her name over which she holds voting and dispositive power; (c) 282,461 Class A shares held by Lee Evan Tabas and Nancy Freeman Tabas as joint tenants in common; and (d) 193,482 Class A and 5,918 Class B shares owned collectively by the Samuel Bradford Tabas Trust, the Elizabeth Rebecca Tabas Trust, the Theodore Herschel Tabas Trust and the Melissa Tamara Tabas Trust. Samuel, Elizabeth, Theodore, and Melissa are the adult children of Lee and Nancy Tabas. Lee and Nancy Tabas share voting and dispositive power over the shares they hold jointly and for the shares held in the trusts in the names of their adult children.  In addition, Lee Tabas also has the power to vote and dispose of 284,564 Class A and 84,857 Class B shares held in the Lee Evan Tabas Trust.

(3) The shares beneficially owned by Carol Tabas consist of:  (a) 604,995 Class A shares acquired pursuant to the 2008 Irrevocable Agreement of Trust for Carol Tabas from Evelyn R. Tabas of which she has sole voting and dispositive power subject to the terms of the trust agreement; and (b) 36,606 Class A shares in the Lily Ashley

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Stofman Trust of which she has sole voting power; (c) 16,802 Class A shares in the Gregory Rome Stofman Trust of which she has sole voting power; and (d) 11,844 Class A shares in the Maxwell Hunter Stofman Trust of which she has sole voting power.  In addition, Carol Tabas has the power to vote and dispose of 219,074 Class A and 82,041 Class B shares held in the Carol Tabas Trust.

(4) This information is based on Amendment No. 2 to a Schedule 13G filed by Ithan Creek Master Investors (Cayman) L.P. with the Securities and Exchange Commission on February 9, 2017.

(5) Includes shares held by certain affiliates of FJ Capital Management LLC, including affiliated entities for which FJ Capital Management LLC may serve as managing member or sub-investment advisor.  This information is based on a Schedule 13G filed with the Securities and Exchange Commission on February 21, 2017.

Merger Agreement/Voting Agreements

As previously disclosed, on January 30, 2017, the Corporation and Bryn Mawr Bank Corporation (“Bryn Mawr”) entered into an agreement and plan of merger (the “Merger Agreement”) providing that, upon the terms and subject to the conditions set forth in the Merger Agreement, the Corporation will merge with and into Bryn Mawr, with Bryn Mawr as the surviving corporation (the “Merger”).  As a condition and inducement to Bryn Mawr’s willingness to enter into the Merger Agreement, Bryn Mawr entered into voting agreements with certain shareholders of the Corporation, including all directors and executive officers of the Corporation and certain of their family members or affiliates, including the Daniel M. Tabas Trust.  Under the voting agreements, the signing shareholders have agreed to, among other things, vote all shares of the Corporation’s common stock owned by them in favor of approval of the Merger Agreement, and against any competing takeover proposal to acquire the Corporation.  The voting agreements also prohibit each signing shareholder from soliciting or participating in discussions or negotiations with respect to competing takeover proposals, subject to certain exceptions, and restrict each signing shareholder’s ability to sell, transfer or otherwise dispose of, grant any proxy to or permit to exist any pledge or any other encumbrance of any nature with respect to shares of the Corporation’s common stock covered by the voting agreement.  The voting agreements cover an aggregate of 5,954,810 shares of Class A common stock and 1,362,717 shares of Class B common stock (representing approximately 41% of the total voting power of all outstanding shares of the Corporation’s common stock) owned by the Corporation’s directors and executive officers and certain of their family members or affiliates, including the Daniel M. Tabas Trust.  The voting agreements will terminate upon the earliest of (i) the effective date of the Merger; (ii) the date on which the Merger Agreement is terminated in accordance with its terms; or (iii) the date of any mutual modification, waiver, or amendment of the Merger Agreement that adversely affects the consideration payable to shareholders pursuant to the Merger Agreement.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

Interest of Management and Others in Certain Transactions

NASDAQ Marketplace Rule 4350(h) requires that we conduct an appropriate review of related party transactions for potential conflict of interest situations on an ongoing basis, and all such transactions must be approved by our Audit Committee or another independent body of the board of directors.

Our Code of Ethics requires all directors, officers and employees who may have a potential or apparent conflict of interest to notify our Chief Executive Officer.  A conflict exists any time one faces a choice between what is in a person’s own personal interest (financial or otherwise) and the interest of the Corporation.  Prior to consideration, full disclosure of all material facts concerning the relationship and financial interest of the relevant individuals in the transaction is required.

To identify related party transactions, each year, we submit and require our directors and officers to complete Director and Officer Questionnaires identifying any transaction with us or any of our subsidiaries in which the officer or director or their family members have an interest.

In the ordinary course of business, Royal Bank America, the Corporation’s wholly owned banking subsidiary, has had, and expects to have in the future, banking transactions with directors, officers of the Bank, principal shareholders of the Corporation and their associates which involve substantially the same terms, including interest rates, collateral and

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repayment terms as those prevailing at the time for comparable transactions with other parties not related to the bank, and no more than the normal risk of collectability or other unfavorable features. 

The largest aggregate amount of indebtedness to the Corporation and Royal Bank America during the year 2016, by all directors (as of December 31, 2016) and officers of the Corporation and Bank as a group, and their affiliates, was $0. The total of such outstanding loans at December 31, 2016, was $0 as there are no remaining loans to directors or executive officers of the Corporation or the bank.

The Corporation has had and intends to have business transactions in the ordinary course of business with directors, officers and associates on comparable terms as those prevailing from time to time for other non-affiliated vendors of the Corporation.  During 2016, the Corporation used the services and banquet facilities of the Hilton Philadelphia Hotel for some of its board of directors meetings.  The Hilton Philadelphia Hotel complex is managed by Howard Wurzak and owned by Stout Road Hotel Development, 37.5% of which is owned by Evelyn R. Tabas, 37.5% of which is owned by the Daniel M. Tabas Trust, and 25% of which is owned by Howard and Joanne Wurzak.  In addition, the Corporation used the services and banquet facilities of the Sheraton Valley Forge for some of its board of director meetings and the annual shareholders meeting in 2016.  The Sheraton Valley Forge is managed by Howard Wurzak and owned 33% by the Daniel M. Tabas Trust and 17% by Howard Wurzak and other members of his immediate family.

A copy of our Code of Ethics is available on our website at www.royalbankamerica.com under  the “Regulatory Filings” link located under the “Investor Relations” page under the heading “About Us” and any shareholder may obtain a printed copy of the Code of Ethics by writing to Investor Relations, Royal Bancshares of Pennsylvania, Inc., 231 St. Asaph’s Road Suite 522, Bala Cynwyd, Pennsylvania 19004, or by calling Investor Relations, Michael Thompson, at (610) 677-2216. There were no waivers of the provisions of our Code of Ethics for any director or any other executive officer in 2016 or through the date of this filing.  In the unlikely event that there is a waiver of our Code of Ethics, the waiver will be described on our website at www.royalbankamerica.com under the “Regulatory Filings” link located under the “Investor Relations” page under the heading “About Us”.

The board of directors has affirmatively determined that Edward F. Bradley, Wayne Huey, Jr., Michael J. Piracci, Gerard M. Thomchick, Robert R. Tabas, Howard Wurzak, Linda Tabas Stempel and Murray Stempel III are independent within the meaning of the NASDAQ listing standards.  In addition, all members of the board of directors serving on the Audit and Compensation Committees are independent within the meaning of the NASDAQ listing standards applicable to each committee.  The board of directors determined that F. Kevin Tylus, President and Chief Executive Officer of the Corporation, is not independent within the meaning of the NASDAQ listing standards. Due to an exemption as a “Controlled Company” under NASDAQ Rules, we are not required to meet certain NASDAQ independence standards for our board of directors. NASDAQ Rules define a “Controlled Company” as one in which more than 50% of the voting power is held by an individual, group or another company. As shown in the stock ownership table included in Item 12, through its ownership of Class A and Class B common stock, the Daniel Tabas Trust and immediate family members control more than 50% of the voting power of the Corporation.

ITEM 14.  PRINCIPAL ACCOUNTING FEES AND SERVICES

Fees pertaining to services rendered to the Corporation by BDO USA, LLP during the year ended December 31, 2016 and the year ended December 31, 2015 were as follows:

	Year ended December 31,
		2016		2015
Audit fees	$	211,185	$	203,124
Audit related fees		14,322		14,384
Tax fees		—		—
All other fees		—		—
Total fees:	$	225,507	$	217,508

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Audit Fees include fees billed (or estimated to be billed) for professional services rendered for the audit of the annual consolidated financial statements and fees billed for the review of financial statements, including expenses, included in the Corporation's Forms 10-K and 10-Q and services that are normally provided by BDO USA, LLP for 2016 and for 2015 in connection with statutory and regulatory filings or engagements. 

Audit Related Fees for 2016 and 2015 include fees billed for assurance and related services that are reasonably related to the performance of the audit or review of the registrant’s financial statements and are not reported under the Audit Fees section of the table above.  Audit Related Fees are related to audit of the Corporation's 401(k) Plan.

 The Audit Committee maintains a policy requiring that it pre-approves all audit and permitted non-audit services provided by BDO USA, LLP.  All non-audit services provided in 2016 were pre-approved by the Audit Committee. The Audit Committee has considered whether, and determined that, the provision of the non-audit services reflected above is compatible with maintaining BDO USA, LLP’s independence.

PART IV

ITEM 15.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a.)	1.	Financial Statements
		The following financial statements are included by reference in Part II, Item 8 hereof.
		Report of Independent Registered Public Accounting Firm
		Consolidated Balance Sheets.
		Consolidated Statements of Income.
		Consolidated Statements of Comprehensive Income (Loss).
		Consolidated Statements of Changes in Shareholders’ Equity.
		Consolidated Statement of Cash Flows.
		Notes to Consolidated Financial Statements.
	2.	Financial Statement Schedules
		Financial Statement Schedules are omitted because the required information is either not applicable, not required or is shown in the respective financial statements or in the notes thereto.

(b.)	The following Exhibits are filed herewith or incorporated by reference as a part of this Annual Report.
	2.1	Agreement and Plan of Merger dated as of January 30, 2017 by and between the Company and Bryn Mawr Bank Corporation (Incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on February 2, 2017.)
	3.1	Articles of Incorporation of the Company.  (Incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2013.)
	3.2	Bylaws of the Company.  (Incorporated by reference to Exhibit 3.2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.)
	4.1	Junior Subordinated Debt Security Due 2034 issued by Royal Bancshares of Pennsylvania, Inc. to JPMorgan Chase Bank, as Institutional Trustee, dated October 27, 2004.  (Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K (included as Exhibit A to Exhibit 10.1) filed with the Commission on November 1, 2004.)

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4.2	Junior Subordinated Debt Security Due 2034 issued by Royal Bancshares of Pennsylvania, Inc. to JPMorgan Chase Bank, as Institutional Trustee, dated October 27, 2004.  (Incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K (included as Exhibit A to Exhibit 10.2) filed with the Commission on November 1, 2004.)
4.3	Indenture by and between Royal Bancshares of Pennsylvania, Inc. and JPMorgan Chase Bank, as Trustee, dated October 27, 2004.  (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Commission on November 1, 2004.)
4.4	Indenture by and between Royal Bancshares of Pennsylvania, Inc. and JPMorgan Chase Bank, as Trustee, dated October 27, 2004.  (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the Commission on November 1, 2004.)
4.5	Guarantee Agreement by and between Royal Bancshares of Pennsylvania, Inc. and JPMorgan Chase Bank, as Guarantee Trustee, dated October 27, 2004.  (Incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed with the Commission on November 1, 2004.)
4.6	Guarantee Agreement by and between Royal Bancshares of Pennsylvania, Inc. and JPMorgan Chase Bank, as Guarantee Trustee, October 27, 2004.  (Incorporated by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed with the Commission on November 1, 2004.)
10.1	Royal Bancshares of Pennsylvania, Inc. 2007 Long-Term Incentive Plan.  (Incorporated by reference to Exhibit A to the Company’s definitive Proxy Statement dated April 6, 2007.)*
10.2	Letter Agreement, including Securities Purchase Agreement - Standard Terms, dated December 19, 2008, between Royal Bancshares of Pennsylvania, Inc. and the United States Department of the Treasury.  (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Commission on February 26, 2009.)
10.3	Side Letter Agreement, dated February 20, 2009, between Royal Bancshares of Pennsylvania, Inc. and the United States Department of the Treasury.  (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the Commission on February 26, 2009.)
10.4	Employment Agreement, dated March 4, 2015, between the Company, Royal Bank America and F. Kevin Tylus.  (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on March 11, 2015.)*
10.5	Change in Control Agreement between the Company, Royal Bank America and Michael S. Thompson dated March 10, 2015 (incorporated by reference to Exhibit 99.2 to the Company’s Current Report on Form 8-K filed on March 11, 2015.)*
10.6	Change in Control Agreement between the Company, Royal Bank America and Lars Eller dated March 10, 2015 (incorporated by reference to Exhibit 99.2 to the Company’s Current Report on Form 8-K filed on March 11, 2015.)*

10.7	Change in Control Agreement between the Company, Royal Bank America and Mark Beidermann dated March 10, 2015 (incorporated by reference to Exhibit 99.2 to the Company’s Current Report on Form 8-K filed on March 11, 2015.)*
10.8	Royal Bank America Supplemental Executive Retirement Plan.  (Incorporated by reference to Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q filed on November 13, 2009.)*
10.9	SERP Participation Agreement, as amended — Robert Tabas.  (Incorporated by reference to Exhibit 10.6 to the Company’s Quarterly Report on Form 10-Q filed on November 13, 2009.)*
10.10	SERP Participation Agreement, as amended — Murray Stempel.  (Incorporated by reference to Exhibit 10.8 to the Company’s Quarterly Report on Form 10-Q filed on November 13, 2009.)*
11.	Statement re: Computation of Earnings Per Share.  (Included at Item 8, hereof, Note 19, “Earnings Per Common Share”.)

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21.	Subsidiaries of Registrant.
23.	Consents of Independent Registered Public Accounting Firm.
31.1	Rule 13a-14(a)/15-d-14(a) Certification of Principal Executive Officer
31.2	Rule 13a-14(a)/15-d-14(a) Certification of Principal Financial Officer
32.1	Section 1350 Certification of Principal Executive Officer.
32.2	Section 1350 Certification of Principal Financial Officer.
101	Interactive Data File

* Denotes compensation plan or arrangement.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

ROYAL BANCSHARES OF PENNSYLVANIA, INC.

By: /s/ F. Kevin Tylus	By: /s/ Michael S. Thompson
F. Kevin Tylus	Michael S. Thompson
President and Chief Executive Officer	Chief Financial Officer
(Principal Executive Officer)	(Principal Financial Officer and Principal Accounting Officer)
March 22, 2017	March 22, 2017

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

SIGNATURES

By: /s/ Robert R. Tabas	By: /s/ F. Kevin Tylus
Robert R. Tabas	F. Kevin Tylus
Chairman of the Board	President and Chief Executive Officer/Director
March 22, 2017	March 22, 2017
By: /s/ Edward F. Bradley	By: /s/ Wayne R. Huey, Jr.
Edward F. Bradley	Wayne R. Huey, Jr
Director	Director
March 22, 2017	March 22, 2017
By: /s/ Michael Piracci	By: /s/ Linda Tabas Stempel
Michael Piracci	Linda Tabas Stempel
Director	Director
March 22, 2017	March 22, 2017
By: /s/ Murray Stempel, III	By: /s/ Gerard M. Thomchick
Murray Stempel, III	Gerard M. Thomchick
Director	Director
March 22, 2017	March 22, 2017
By: /s/ Howard Wurzak
Howard Wurzak
Director
March 22, 2017

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