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