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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
for the quarterly period ended: MARCH 31, 2005
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from:____________to____________
Commission file number: 0-26366
ROYAL BANCSHARES OF PENNSYLVANIA, INC.
----------------------------------------------------------
(Exact name of the registrant as specified in its charter)
PENNSYLVANIA 23-2812193
------------------------------- -------------------
(State or other jurisdiction of (IRS Employer
incorporated or organization) identification No.)
732 MONTGOMERY AVENUE, NARBERTH, PA 19072
-----------------------------------------
(Address of principal Executive Offices)
(610) 668-4700
----------------------------------------------------
(Registrant's telephone number, including area code)
N/A
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the bank (1) has filed all reports required to be
filed by Section 13 of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the bank was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act 12b-2).
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class A Common Stock Outstanding at April 30, 2005
-------------------- -----------------------------
$2.00 PAR VALUE 10,484,595
Class B Common Stock Outstanding at April 30, 2005
-------------------- -----------------------------
$.10 PAR VALUE 1,978,347
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share data)
MAR 31, 2005 DEC 31, 2004
------------ ------------
(UNAUDITED)
ASSETS
Cash and due from banks $ 19,322 $ 26,109
Federal funds sold 8,850 1,000
------------ ------------
Total cash and cash equivalents 28,172 27,109
------------ ------------
Investment securities held to maturity (HTM) (fair value of $217,052 at
March 31, 2005 and $211,865 at December 31, 2004) 219,459 212,227
Investment securities available for sale (AFS) - at fair value 367,165 372,034
Loans held for sale 1,469 2,204
Loans 491,805 467,294
Less allowance for loan losses 12,495 12,519
------------ ------------
Net loans 479,310 454,775
Premises and equipment, net 70,913 72,433
Accrued interest and other assets 64,538 64,492
------------ ------------
Total assets $ 1,231,026 $ 1,205,274
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposits
Non-interest bearing $ 56,990 $ 64,371
Interest bearing (includes certificates of deposit in excess
of $100 of $96,762 at March 31, 2005 and
$90,596 at December 31, 2004) 613,782 678,011
------------ ------------
Total deposits 670,772 742,382
Accrued interest payable 5,584 5,602
Borrowings 401,815 304,023
Other liabilities 10,822 8,736
------------ ------------
Total liabilities 1,088,993 1,060,743
------------ ------------
MINORITY INTEREST 2,892 3,655
Stockholders' equity
Common stock
Class A, par value $2 per share; authorized, 18,000,000 shares; issued,
10,484,595 at March 31, 2005 and 10,276,672 at December 31, 2004 20,969 20,553
Class B, par value $.10 per share; authorized, 2,000,000 shares; issued,
1,978,347 at March 31, 2005 and 1,939,490 at December 31, 2004 198 194
Additional paid in capital 98,741 92,037
Retained earnings 20,686 26,558
Accumulated other comprehensive income 812 3,799
------------ ------------
141,406 143,141
Treasury stock - at cost, shares of Class A, 215,388 at March 31, 2005,
and December 31, 2004 (2,265) (2,265)
------------ ------------
Total stockholders' equity 139,141 140,876
------------ ------------
Total liabilities and stockholders' equity $ 1,231,026 $ 1,205,274
============ ============
The accompanying notes are an integral part of these statements.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
----------------------------
(in thousands, except per share data) 2005 2004
- ----------------------------------------------- ------------ ------------
Interest income
Loans, including fees $ 10,126 $ 10,634
Investment securities held to maturity 2,248 1,174
Investment securities available for sale 4,789 5,556
Deposits in banks 23 141
Federal funds sold 18 23
------------ ------------
TOTAL INTEREST INCOME 17,204 17,528
------------ ------------
Interest expense
Deposits 4,010 4,367
Borrowings 3,356 2,363
------------ ------------
TOTAL INTEREST EXPENSE 7,366 6,730
------------ ------------
NET INTEREST INCOME 9,838 10,798
Provision for loan losses 1 1
------------ ------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 9,837 10,797
------------ ------------
Other income
Service charges and fees 293 352
Net gains on sales of investment securities 250 193
Income related to equity investments 1,443 1,858
Gains on sales of other real estate 289 332
Gains on sales of loans 125 176
Other income 213 272
------------ ------------
2,613 3,183
------------ ------------
Other expenses
Salaries and wages 2,314 2,090
Employee benefits 576 512
Occupancy and equipment 409 383
Expenses related to equity investments 1,064 1,728
Other operating expenses 1,997 1,863
------------ ------------
6,360 6,576
------------ ------------
INCOME BEFORE INCOME TAXES 6,090 7,404
Income taxes 1,769 2,240
------------ ------------
NET INCOME $ 4,321 $ 5,164
============ ============
Per share data
Net income - basic $ .34 $ .41
============ ============
Net income - diluted $ .34 $ .41
============ ============
The accompanying notes are an integral part of these statements.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
THREE MONTHS ENDED MARCH 31, 2005
(UNAUDITED)
CLASS A COMMON STOCK CLASS B COMMON STOCK
----------------------------- -----------------------------
(in thousands) SHARES AMOUNT SHARES AMOUNT
- ------------------------------------------------ ------------- ------------- ------------- -------------
Balance, January 1, 2005 10,277 $ 20,553 1,939 $ 194
Net income for the three months ended Mar 31, - - - -
Conversion of Class B common stock to
Class A Common stock - - - -
Purchase of treasury stock - - - -
2% stock dividend declared 201 402 39 4
Cash dividends on common stock
(per share: Class A $0.25 and Class B $0.2875) - - - -
Cash in lieu of fractional shares - - - -
Stock options exercised 7 14 - -
Other comprehensive loss, net of
Reclassifications and taxes - - - -
------------- ------------- ------------- -------------
Comprehensive income
Balance, March 31, 2005 10,485 $ 20,969 1,978 $ 198
============= ============= ============= =============
ACCUMULATED
ADDITIONAL OTHER
PAID IN RETAINED TREASURY COMPREHENSIVE COMPREHENSIVE
(in thousands) CAPITAL EARNINGS STOCK INCOME (LOSS) INCOME
- ------------------------------------------------ ------------- ------------- ------------- ------------- -------------
Balance, January 1, 2005 $ 92,037 $ 26,558 $ (2,265) $ 3,799
Net income for the three months ended Mar 31, - 4,321 - - $ 4,321
Conversion of Class B common stock to
Class A Common stock - -- - - -
Purchase of treasury stock - - - - -
2% stock dividend declared 6,640 (7,046) - -
Cash dividends on common stock
(per share: Class A $0.25 and Class B $0.2875) - (3,135) - - -
Cash in lieu of fractional shares - (12) - - -
Stock options exercised 64 - - - -
Other comprehensive loss, net of
Reclassifications and taxes - - - (2,987) (2,987)
------------- ------------- ------------- ------------- -------------
Comprehensive income $ 1,334
=============
Balance, March 31, 2005 $ 98,741 $ 20,686 $ (2,265) $ 812
============= ============= ============= =============
The accompanying notes are an integral part of the financial statement.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
THREE MONTHS ENDED MARCH 31, 2004
(UNAUDITED)
CLASS A COMMON STOCK CLASS B COMMON STOCK
----------------------------- -----------------------------
(in thousands) SHARES AMOUNT SHARES AMOUNT
- ------------------------------------------------ ------------- ------------- ------------- -------------
Balance, January 1, 2004 10,027 $ 20,054 1,909 $ 191
Net income for the three months ended Mar 31, - - - -
Conversion of Class B common stock to
Class A Common stock 3 6 (3) (1)
Purchase of treasury stock - - - -
2% stock dividend declared 196 392 39 5
Cash dividends on common stock
(per share: Class A $0.25 and Class B $0.2875) - - - -
Cash in lieu of fractional shares - - - -
Stock options exercised 3 6 - -
Other comprehensive income, net of
Reclassifications and taxes - - - -
------------- ------------- ------------- -------------
Comprehensive income
Balance, March 31, 2004 $ 10,229 $ 20,458 1,945 $ 195
============= ============= ============= =============
ACCUMULATED
ADDITIONAL OTHER
PAID IN RETAINED TREASURY COMPREHENSIVE COMPREHENSIVE
(in thousands) CAPITAL EARNINGS STOCK INCOME (LOSS) INCOME
- ------------------------------------------------ ------------- ------------- ------------- ------------- -------------
Balance, January 1, 2004 $ 85,448 $ 24,989 $ (2,265) $ 6,415
Net income for the three months ended Mar 31, - 5,164 - - $ 5,164
Conversion of Class B common stock to
Class A Common stock - (5) - - -
Purchase of treasury stock - - - - -
2% stock dividend declared 5,842 (6,237) - -
Cash dividends on common stock
(per share: Class A $0.25 and Class B $0.2875) - (3,001) - - -
Cash in lieu of fractional shares - (11) - - -
Stock options exercised 45 - - - -
Other comprehensive income, net of
Reclassifications and taxes - - - 1,778 1,778
------------- ------------- ------------- ------------- -------------
Comprehensive income $ 6,942
=============
Balance, March 31, 2004 $ 91,335 $ 20,899 $ (2,265) $ 8,193
============= ============= ============= =============
The accompanying notes are an integral part of the financial statement
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED MARCH 31,
(in thousands)
2005 2004
------------ ------------
Cash flows from operating activities
Net income $ 4,321 $ 5,164
Adjustments to reconcile net income to
net cash provided by operating activities
Depreciation 587 203
Provision for loan losses 1 1
Net accretion of discounts and premiums
on loans, mortgage-backed securities and investments 1,788 3,200
Provision for deferred income taxes (1,007) 916
Gains on other real estate (289) (332)
Gains on sales of loans (125) (176)
Net gains on sales of investment securities (250) (193)
Changes in assets and liabilities:
Increase(decrease) in accrued interest receivable (1,056) 1,421
(Increase) in other assets 1,709 (3,269)
Increase(decrease) in accrued interest payable (18) 13
Increase in other liabilities 1,323 4,464
------------ ------------
Net cash provided by operating activities 6,984 11,412
Cash flows from investing activities
Proceeds from calls/maturities of HTM investment securities 32,750 89,285
Proceeds from calls/maturities of AFS investment securities 3,970 37,917
Proceeds from sales of AFS investment securities 6,345 890
Purchase of AFS investment securities (5,137) (83,932)
Purchase of HTM investment securities (40,025) --
Redemption(purchase) of FHLB Stock (4,825) 704
Net (increase) decrease in loans (23,018) 25,529
Purchase of premises and equipment 933 (62,458)
------------ ------------
Net cash (used in) investing activities (29,007) 7,935
Cash flows from financing activities:
Net (decrease) increase in non-interest bearing and
interest bearing demand deposits and savings accounts (77,263) 1,925
Net (decrease) increase in certificates of deposit 5,655 (3,469)
Mortgage payments (15) (16)
Net increase in FHLB borrowings 96,500 --
Obligations through equity investments 1,292 53,846
Cash dividends (3,135) (3,002)
Cash in lieu of fractional shares (12) (11)
Issuance of common stock under stock option plans 64 45
------------ ------------
Net cash provided by financing activities 23,086 49,318
NET INCREASE IN CASH AND CASH EQUIVALENTS 1,063 68,665
Cash and cash equivalents at beginning of year 27,109 25,070
------------ ------------
Cash and cash equivalents at end of year $ 28,172 $ 93,735
============ ============
The accompanying notes are an integral part of these statements.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The accompanying unaudited consolidated financial statements include the
accounts of Royal Bancshares and its wholly-owned subsidiaries, Royal
Investments of Delaware, Inc. and Royal Bank, including Royal Bank's
subsidiaries, Royal Real Estate of Pennsylvania, Inc., Royal Investment America,
LLC, and 60% ownership of Crusader Servicing Corporation. The two recently
formed Delaware trusts, Royal Bancshares Capital Trust I and Royal Bancshares
Capital Trust II are not consolidated per requirements under FIN 46(R). These
financial statements reflect the historical information of the Company. All
significant inter-company transactions and balances have been eliminated.
1. The accompanying unaudited condensed financial statements have been
prepared in accordance with accounting principles generally accepted in
the United States of America (US GAAP) for interim financial
information. The financial information included herein is unaudited;
however, such information reflects all adjustments (consisting solely of
normal recurring adjustments) that are, in opinion of management,
necessary to present a fair statement of the results for the interim
periods. These interim financial statements should be read in
conjunction with the consolidated financial statements and footnotes
thereto included in our Annual Report on Form 10-K for the year ended
December 31, 2004. The results of operations for the three-month period
ended March 31, 2005, are not necessarily indicative of the results to
be expected for the full year.
2. Segment Information
Royal Bancshares' Community Banking segment consists of commercial and
retail banking. The community banking business segment is managed as a
single strategic unit which generates revenue from a variety of products
and services provided by Royal Bank. For example, commercial lending is
dependent upon the ability of Royal Bank to fund itself with retail
deposits and other borrowings and to manage interest rate and credit
risk. This situation is also similar for consumer and residential
mortgage lending.
Royal Bancshares' Tax Lien Operation does not meet the quantitative
thresholds for requiring disclosure, but has different characteristics
than the community banking operation. Royal Bancshares' tax lien
operation consists of purchasing delinquent tax certificates from local
municipalities at auction. The tax lien segment is managed as a single
strategic unit which generates revenue from a nominal interest rate
achieved at the individual auctions along with periodic penalties
imposed.
As a result of the adoption of FIN 46(R), Royal Bancshares is reporting
on a consolidated basis its interest in four Equity Investments as
Variable Interest Entities ("VIE") which have different characteristics
than the community banking segment. Royal Bancshares has investments in
two apartment complexes and two buildings leased as commercial office
space.
THREE MONTHS ENDED MARCH 31, 2005
----------------------------------------------------------
COMMUNITY TAX LIEN EQUITY
(in thousands) BANKING OPERATION INVESTMENTS CONSOLIDATED
------------------------- ------------ ------------ ------------ ------------
Total assets $ 1,117,768 $ 46,400 $ 66,858 $ 1,231,026
============ ============ ============ ============
Total deposits 670,772 -- -- 670,772
============ ============ ============ ============
Net interest income $ 9,718 $ 674 $ (554) $ 9,838
Provision for loan losses -- 1 -- 1
Other income 1,079 91 1,443 2,613
Other expense 4,632 664 1,064 6,360
Income tax expense 1,720 49 -- 1,769
------------ ------------ ------------ ------------
Net income $ 4,445 $ 51 $ (175) $ 4,321
============ ============ ============ ============
THREE MONTHS ENDED MARCH 31, 2004
----------------------------------------------------------
COMMUNITY TAX LIEN EQUITY
(in thousands) BANKING OPERATION INVESTMENTS CONSOLIDATED
------------------------- ------------ ------------ ------------ ------------
Total assets $ 1,105,289 $ 45,697 $ 64,819 $ 1,215,805
============ ============ ============ ============
Total deposits 789,517 -- -- 789,517
============ ============ ============ ============
Net interest income $ 10,188 $ 881 $ (271) $ 10,798
Provision for loan losses -- 1 -- 1
Other income 1,001 325 1,857 3,183
Other expense 3,901 947 1,728 6,576
Income tax expense 2,118 122 -- 2,240
------------ ------------ ------------ ------------
Net income $ 5,170 $ 136 $ (142) $ 5,164
============ ============ ============ ============
Interest paid to the Community Banking segment by the Tax Lien Operation
was approximately $617 thousand and $455 thousand for the three-months
period ending March 31, 2005, and 2004, respectively.
3. Per Share Information
The Company follows the provisions of Statement of Financial Accounting
Standards No. 128, "Earnings Per Share". 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. December 15, 2004 the Company declared a 2%
stock dividend payable on January 12, 2005. All share and per share
information has been restated to reflect this dividend. Basic and
diluted EPS are calculated as follows (in thousands, except per share
data):
THREE MONTHS ENDED MARCH 31, 2005
------------------------------------------------
Income Average shares Per share
(numerator) (denominator) Amount
-------------- -------------- --------------
Basic EPS
Income available to common shareholders $ 4,321 12,541 $ 0.34
Effect of dilutive securities Stock options 91 --
-------------- -------------- --------------
Diluted EPS
Income available to common shareholders
plus assumed exercise of options $ 4,321 12,632 $ 0.34
THREE MONTHS ENDED MARCH 31, 2004
------------------------------------------------
Income Average shares Per share
(numerator) (denominator) Amount
-------------- -------------- --------------
Basic EPS
Income available to common shareholders $ 5,164 12,494 $ 0.41
Effect of dilutive securities Stock options 61 --
-------------- -------------- --------------
Diluted EPS
Income available to common shareholders
plus assumed exercise of options $ 5,164 12,555 $ 0.41
4. Investment Securities:
The carrying value and approximate market value of investment securities
at March 31, 2005 are as follows:
AMORTIZED GROSS GROSS APPROXIMATE
PURCHASED UNREALIZED UNREALIZED FAIR CARRYING
(in thousands) COST GAINS LOSSES VALUE VALUE
---------------------- ------------ ------------ ------------ ------------ ------------
HELD TO MATURITY:
Mortgage Backed $ 218 $ -- $ -- $ 218 $ 218
US Agencies 195,000 -- (3,124) 191,876 195,000
Other Securities 24,241 717 -- 24,958 24,241
------------ ------------ ------------ ------------ ------------
$ 219,459 $ 717 $ (3,124) $ 217,052 $ 219,459
============ ============ ============ ============ ============
AVAILABLE FOR SALE:
Federal Home Loan
Bank Stock - at cost $ 15,925 $ -- $ -- $ 15,925 $ 15,925
Mortgage Backed 49,123 36 (559) 48,600 48,600
CMO's 28,128 42 -- 28,170 28,170
US Agencies 94,977 -- (3,019) 91,958 91,958
Other securities 177,763 5,992 (1,243) 182,512 182,512
------------ ------------ ------------ ------------ ------------
$ 365,916 $ 6,070 $ (4,821) $ 367,165 $ 367,165
============ ============ ============ ============ ============
5. Allowance for Loan Losses: Changes in the allowance for credit losses
were as follows:
THREE MONTHS ENDED MARCH 31,
----------------------------
(in thousands) 2005 2004
----------------------------------- ------------ ------------
BALANCE AT BEGINNING OF PERIOD, $ 12,519 $ 12,426
Loans charged-off (33) (57)
Recoveries 8 97
------------ ------------
Net charge-offs and recoveries 25 40
Provision for loan losses 1 1
------------ ------------
BALANCE AT END OF PERIOD $ 12,495 $ 12,467
============ ============
6. Non-performing loans
Loans on which the accrual of interest has been discontinued or reduced
amounted to approximately $13.0 million and $10.0 million at March 31,
2005 and 2004, respectively. Although the Company has non-performing
loans of approximately $13.0 million at March 31, 2005, management
believes it has adequate collateral to limit its credit risk with these
loans.
The balance of impaired loans, which included the loans on which the
accrual of interest has been discontinued, was approximately $13.0
million and $10.0 million at March 31, 2005 and 2004, respectively. The
Company identifies a loan as impaired when it is probable that interest
and principal will not be collected according to the contractual terms
of the loan agreements. Although the Company recognizes the balances of
impaired loans when analyzing its loan loss reserve, the allowance for
loan loss associated with impaired loans was $2.3 million at March 31,
2005. The income that was recognized on impaired loans during the
three-month period ended March 31, 2005 was $-0-. The cash collected on
impaired loans during the same period was $170,000 all of which was
credited to the principal balance outstanding on such loans. The
Company's policy for interest income recognition on impaired loans is to
recognize income on currently performing restructured loans under the
accrual method. The Company recognizes income on non-accrual loans under
the cash basis when the principal payments on the loans become current
and the collateral on the loan is sufficient to cover the outstanding
obligation to the Company. If these factors do not exist, the Company
does not recognize income.
7. 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
consecutive years during the last 10 years of employment. The Company's
policy is to fund pension costs allowable for income tax purposes.
Net periodic defined benefit pension expense for the three months ended
March 31, 2005 and 2004 included the following components:
Three months ended
March 31,
----------------------------
(in thousands) 2005 2004
------------------------- ------------ ------------
Service cost 206 108
Interest cost 65 63
------------ ------------
Net periodic benefit cost 271 171
8. Stock-based Compensation
At March 31, 2005, the Company had both a director and employee
stock-based compensation plan. The Company accounts for the plan under
the recognition and measurement provisions of Accounting Principals
Board No. 25, "Accounting for Stock Issued to Employee," and related
interpretations. Stock-based employee compensation costs 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 Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 148 "Accounting for Stock-Based
Compensation--Transition and Disclosure" ("SFAS No. 148") in December
2002. SFAS No. 148 amends the disclosure and certain transition
provisions of SFAS No. 123 "Accounting for Stock-Based Compensation".
The new disclosure provisions are effective for financial statements for
fiscal years ending after December 15, 2002 and financial reports
containing condensed financial statements for interim periods beginning
after December 15, 2002.
The following table provides the disclosure required by SFAS No. 148 and
illustrates the effect on net income and earnings per share if the
Company had applied the fair value recognition provisions of SFAS No.
123 to stock-based employee compensation.
THREE MONTHS ENDED
MARCH 31,
----------------------------
(in thousands, except per share data) 2005 2004
------------------------------------------ ------------ ------------
Net income, as reported $ 4,321 $ 5,164
Less: Stock-based compensation costs
under fair value based method for
all awards, net of related tax effect (123) (106)
------------ ------------
Pro forma net income $ 4,198 $ 5,058
============ ============
Earnings per share - Basic As reported $ 0.34 $ 0.41
Pro forma $ 0.33 $ 0.40
Earnings per share - Diluted As reported $ 0.34 $ 0.41
Pro forma $ 0.33 $ 0.40
9. Interest Rate Swaps
For asset/liability management purposes, Royal Bancshares uses interest
rate swap agreements to hedge various exposures or to modify interest
rate characteristics of various balance sheet accounts. Such derivatives
are used as part of the asset/liability management process and are
linked to specific liabilities which have a high correlation between the
contract and the underlying item being hedged, both at inception and
throughout the hedge period.
Royal Bancshares currently utilizes interest rate swap agreements to
convert a portion of its fixed rate time deposits to a variable rate
(fair value hedge) to fund variable rate loans. Interest rate swaps are
contracts in which a series of interest flows are exchanged over a
prescribed period. The notional amount ($25 million) on which interest
payments are based is not exchanged.
10. Variable Interest Entities ("VIE")
The Company, together with a real estate development company, formed
Brook View Investors, L.L.C. ("Brook View") in May 2001. Brook View was formed
to construct 13 apartment buildings with a total of 116 units in a gated
apartment community. The development company is the general partner of the
project. The Company invested 60% of initial capital contributions with the
development company holding the remaining equity interest. Upon the repayment of
the initial capital contributions and a preferred return, distributions will
convert to 50% for the Company and 50% for the development company. At March 31,
2005, Brook View had total assets of $13.0 million and total borrowings of $12.8
million of which $0 is guaranteed by the Company. The Company has determined
that Brook View is a VIE and it is the primary beneficiary. The Company's
exposure to loss due to its investment in and receivables due from Brook View is
$124,000.
The Company, together with a real estate development company, formed
Burrough's Mill Apartment, L.L.C. ("Burrough's Mill") in December 2001.
Burrough's Mill was formed to construct 32 apartment buildings with a total of
308 units in a gated apartment community. The development company is the general
partner of the project. The Company invested 72% of initial capital
contributions with the development company holding the remaining equity
interest. Upon the repayment of the initial capital contributions and a
preferred return, distributions will convert to 50% for the Company and 50% for
the development company. At March 31, 2005, Burrough's Mill had total assets of
$36.1 million and total borrowings of $30.0 million of which $0 is guaranteed by
the Company. The Company has determined that Burrough's Mill is a VIE and it is
the primary beneficiary. The Company's exposure to loss due to its investment in
and receivables due from Burrough's Mill is $3.6 million.
The Company, together with a real estate development company, formed
Main Street West Associates, L.P. ("Main Street") in February 2002. Main Street
was formed to acquire, maintain, improve, and operate office space located in
Norristown, Pennsylvania. The development company is the general partner of the
project. The Company invested 90% of initial capital contributions with the
development company holding the remaining equity interest. Upon the repayment of
the initial capital contributions and a preferred return, distributions will
convert to 50% for the Company and 50% for the development company. At March 31,
2005, Main Street had total assets of $4.1 million and total borrowings of $2.9
million of which $0 is guaranteed by the Company. The Company has determined
that Main Street is a VIE and it is the primary beneficiary. The Company's
exposure to loss due to its investment in and receivables due from Main Street
is $674,000.
The Company, together with a real estate investment company, formed 212
C Associates, L.P. ("212 C") in May 2002. 212 C was formed to acquire, hold,
improve, and operate office space located in Lansdale, Pennsylvania. The
investment company is the general partner of the project. The Company invested
90% of initial capital contributions with the investment company holding the
remaining equity interest. Upon the repayment of the initial capital
contributions and a preferred return, distributions will convert to 50% for the
Company and 50% for the investment company. At March 31, 2005, 212 C had total
assets of $13.7 million and total borrowings of $11.8 million of which $0 is
guaranteed by the Company. The Company has determined that 212 C is a VIE and it
is the primary beneficiary. The Company's exposure to loss due to its investment
in and receivables due from 212 C is $1.5 million.
Trust Preferred Securities
Management has determined that Royal Bancshares Capital Trust I/II ("the
Trusts") qualify as VIE's under FASB Interpretation 46 (FIN 46), "Consolidation
of Variable Interest Entities," as revised. The Trusts issued mandatory
redeemable preferred stock to investors and loaned the proceeds to Royal
Bancshares.
The Company adopted the provision under the revised interpretation, FIN 46(R),
in the first quarter of 2004. Accordingly, Royal Bancshares does not consolidate
the Trust. FIN 46(R) precludes consideration of the call option embedded in the
preferred stock when determining if the Company has the right to a majority of
the Trusts' expected residual returns. The deconsolidation resulted in the
investment in the common stock of the Trusts to be included in other assets as
of March 31, 2005 and the corresponding increase in outstanding debt of
$774,000. In addition, income received on the Company's stock investment is
included in other income.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULT
OF OPERATIONS
The following discussion and analysis is intended to assist in
understanding and evaluating the changes in the financial condition and earnings
performance of the Company and its subsidiaries for the three-month period ended
March 31, 2005.
From time to time, the Company may include forward-looking statements
relating to such matters as anticipated financial performance, business
prospects, technological developments, new products, research and development
activities, and similar matters in this and other filings with the Securities
Exchange Commission. The Private Securities Litigation Reform Act of 1995
provides safe harbor for forward-looking statements. In order to comply with the
terms of the safe harbor, the Company notes that a variety of factors could
cause the Company's actual results and experience to differ materially from the
anticipated results or other expectations expressed in the Company's
forward-looking statements. The risks and uncertainties that may affect the
operations, performance development, and results of the Company's business
include the following: general economic conditions, including their impact on
capital expenditures; 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.
CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES
The accounting and reporting policies of the Company conform with
accounting principals generally accepted in the United States of America and
general practices within the financial services industry. The preparation of the
financial statements in conformity with accounting principles generally accepted
in the United States of America requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and the
accompanying notes. Actual results could differ from those estimates.
Allowance for Loan Losses
The Company considers that the determination of the allowance for loan
losses involves a higher degree of judgment and complexity than its other
significant accounting policies. The balance in the allowance for loan losses is
determined based on management's review and evaluation of the loan portfolio in
relation to past loss experience, the size and composition of the portfolio,
current economic events and conditions, and other pertinent factors, including
management's assumptions as to future delinquencies, recoveries and losses. All
of these factors may be susceptible to significant change. To the extent actual
outcomes differ from management's estimates, additional provisions for loan
losses may be required that would adversely impact earnings in future periods.
Income Taxes
Under the liability method, deferred tax assets and liabilities are
determined based on the difference between the financial statement and tax basis
of assets and liabilities. Deferred tax assets are subject to management's
judgment based upon available evidence that future realization is more likely
than not. If management determines that the company may be unable to realize all
or part of the net
deferred tax assets in the future, a direct charge to income tax expense may be
required to reduce the recorded value of net deferred tax assets to the expected
realizable amount.
FINANCIAL CONDITION
Total consolidated assets as of March 31, 2005 were $1.23 billion, an
increase of $26 million from the $1.21 billion reported at year-end, December
31, 2004. This increase is primarily due to a $25 million increase in the loan
balance during the first three months of 2005.
Total loans increased $24.5 million from the $467.3 million level at
December 31, 2004 to $491.8 million at March 31, 2005. This increase is
attributed to loans generated by our Royal Asian Bank Division along with being
more competitive within our local markets. The year-to-date average balance of
loans was $480.2 million at March 31, 2005.
The allowance for loan loss decreased $24,000 to $12.5 million at March
31, 2005 from $12.5 million at December 31, 2004. The level of allowance for
loan loss reserve represents approximately 2.5% of total loans at March 31, 2005
versus 2.7% at December 31, 2004. While management believes that, based on
information currently available, the allowance for loan loss is sufficient to
cover losses inherent in the Company's loan portfolio at this time, no
assurances can be given that the level of allowance will be sufficient to cover
future loan losses or that future adjustments to the allowance will be
sufficient to cover future loan losses or that future adjustments to the
allowance will not be necessary if economic and/or other conditions differ
substantially from the economic and other conditions considered by management in
evaluating the adequacy of the current level of the allowance.
The $2.4 million increase in total investment securities is primarily
attributable to the redeployment of excess cash held during the period offset by
principal payments received during the quarter.
Total cash and cash equivalents increased $1.1 million from the $27.1
million level at December 31, 2004 to $28.2 million at March 31, 2005. This
increase is primarily due to holding funds for anticipated funding needs in the
lending area.
Total deposits, the primary source of funds, decreased $71.6 million to
$670.8 million at March 31, 2005, from $742.4 million at December 31, 2004. The
balance of brokered deposits was $67.3 million, representing approximately 10%
of total deposits at March 31, 2005. Generally, these brokered deposits cannot
be redeemed prior to the stated maturity, except in the event of the death or
adjudication of incompetence of the deposit holder.
Total borrowings increased $97.8 million to $401.8 million at March 31,
2005, from $304.0 million at December 31, 2004. This increase is primarily
attributed to the utilization of FHLB borrowings for funding of loan volume and
covering the decline in the balance of higher yielding deposits.
Consolidated stockholders' equity decreased $1.8 million to $139.1
million at March 31, 2005 from $140.9 million at December 31, 2004. This
decrease is primarily due to a decline in market value from the available for
sale investment portfolio.
RESULTS OF OPERATIONS
Results of operations depend primarily on net interest income, which is
the difference between interest income on interest earning assets and interest
expense on interest bearing liabilities. Interest earning assets consist
principally of loans and investment securities, while interest bearing
liabilities consist primarily of deposits and borrowings. Net income is also
effected by the provision for loan losses and the level of non-interest income
as well as by non-interest expenses, including salary and employee benefits,
occupancy expenses and other operating expenses.
Consolidated net income for the three months ended, March 31, 2005 was
$4.3 million or $0.34 basic earnings per share, as compared to net income of
$5.2 million or $0.41 basic earnings per share for the same three month period
in 2004.
For the first quarter 2005, net interest income was $9.8 million as
compared to $10.8 million for the same quarter in 2004, a decrease of $1.0
million. This decrease is primarily due to an increase in the non-performing
loans balance and an increase in borrowing cost from issuing subordinated debt
during the fourth quarter in 2004.
Provision for loan losses was $1,000 for the first quarter of 2005 and
$1,000 for the same three-month period in 2004. Charge-offs and recoveries for
the first quarter of 2005 were $33,000 and $8,000, respectively. Overall,
management considers the current level of allowance for loan loss to be adequate
at March 31, 2005.
Total non-interest income for the three-month period ended March 31,
2005 was $2.6 million as compared to $3.2 million for the same three-month
period in 2004. The $600,000 decrease in 2005 is primarily due to a decrease of
$414,000 relating to non-interest income derived from equity investments.
Total non-interest expense for the three months ended March 31, 2005 was
$6.4 million, as compared to $6.6 million for the same period in 2004, a
decrease of $216,000. The decrease is primarily attributed to the $664,000
thousand decline in non-interest expense attributed to equity investments.
CAPITAL ADEQUACY
The company is required to maintain minimum amounts of capital to total
"risk weighted" assets and a minimum Tier 1 leverage ratio, as defined by the
banking regulators. At March 31, 2005, the Company was required to have a
minimum Tier 1 and total capital ratios of 4% and 8%, respectively, and a
minimum Tier 1 leverage ratio of 3% plus an additional 100 to 200 basis points.
The table below provides a comparison of Royal Bancshares of
Pennsylvania's and Royal Bank risk-based capital ratios and leverage ratios:
ROYAL BANCSHARES ROYAL BANK
--------------------------- --------------------------
MARCH 31, DEC 31, MARCH 31, DEC 31,
2005 2004 2005 2004
---------- ---------- ---------- ----------
CAPITAL LEVELS
Tier 1 leverage ratio 13.4% 13.9% 9.3% 9.6%
Tier 1 risk-based ratio 18.7% 19.2% 13.1% 13.3%
Total risk-based ratio 20.0% 20.4% 14.4% 14.6%
CAPITAL PERFORMANCE
Return on average assets 1.4%(1) 1.7%(1) 1.5%(1) 1.7%(1)
Return on average equity 12.5%(1) 14.6%(1) 15.8%(1) 18.0%(1)
(1) annualized
The Company's ratios compare favorably to the minimum required amounts
of Tier 1 and total capital to "risk weighted" assets and the minimum Tier 1
leverage ratio, as defined by banking regulators. The Company currently meets
the criteria for a well-capitalized institution, and management believes that
the Company will continue to meet its minimum capital requirements. At present,
the Company has no commitments for significant capital expenditures.
The Company is not under any agreement with regulatory authorities nor
is the Company aware of any current recommendations by the regulatory
authorities that, if such recommendations were implemented, would have a
material effect on liquidity, capital resources or operations of the Company.
LIQUIDITY & INTEREST RATE SENSITIVITY
Liquidity is the ability to ensure that adequate funds will be available
to meet its financial commitments as they become due. In managing its liquidity
position, all sources of funds are evaluated, the largest of which is deposits.
Also taken into consideration is the repayment of loans. These sources provide
alternatives to meet its short-term liquidity needs. Longer liquidity needs may
be met by issuing longer-term deposits and by raising additional capital. The
liquidity ratio is calculated by adding total cash and investments less reserve
requirements divided by deposits and short-term liabilities which is generally
maintained equal to or greater than 25%.
The liquidity ratio of the Company remains strong at approximately 26%
and exceeds the Company's target ratio set forth in the Asset/Liability Policy.
The Company's level of liquidity is provided by funds invested primarily in
corporate bonds, capital trust securities, US Treasuries and agencies, and to a
lesser extent, federal funds sold. The overall liquidity position is monitored
on a monthly basis.
Interest rate sensitivity is a function of the repricing characteristics
of the Company's assets and liabilities. These include the volume of assets and
liabilities repricing, the timing of the repricing, and the interest rate
sensitivity gaps is a continual challenge in a changing rate environment. The
following table shows separately the interest sensitivity of each category of
interest earning assets and interest bearing liabilities as of March 31, 2005:
INTEREST RATE SENSITIVITY
DAYS
----------------------- 1 TO 5 OVER 5 NON-RATE
(IN MILLIONS) 0 - 90 91 - 365 YEARS YEARS SENSITIVE TOTAL
- ---------------------------------------- ---------- ---------- ---------- ---------- ---------- ----------
ASSETS
Interest-bearing deposits in banks $ 4.8 $ 0.0 $ 0.0 $ 0.0 $ 14.5 $ 19.3
Federal funds sold 8.9 0.0 0.0 0.0 0.0 8.9
Investment securities:
Available for sale 8.9 38.1 235.1 83.9 1.2 367.2
Held to maturity 3.9 10.2 205.4 0.0 0.0 219.5
---------- ---------- ---------- ---------- ---------- ----------
Total investment securities 12.8 48.3 440.5 83.9 1.2 586.7
Loans:
Fixed rate 15.9 15.0 82.6 18.9 0.0 132.4
Variable rate 197.0 78.2 85.6 0.0 (12.5) 348.3
---------- ---------- ---------- ---------- ---------- ----------
Total loans 212.9 93.2 168.2 18.9 (12.5) 480.7
Other assets 0.0 0.0 0.0 0.0 135.4 135.4
---------- ---------- ---------- ---------- ---------- ----------
Total Assets $ 239.4 $ 141.5 $ 608.7 $ 102.8 $ 138.6 $ 1,231.0
========== ========== ========== ========== ========== ==========
LIABILITIES & CAPITAL
Deposits:
Non interest bearing deposits $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 56.9 $ 56.9
Interest bearing deposits 46.5 159.5 240.7 0.0 0.0 446.7
Certificate of deposits 48.8 51.6 62.9 3.9 0.0 167.2
---------- ---------- ---------- ---------- ---------- ----------
Total deposits 95.3 211.1 303.6 3.9 56.9 670.8
Borrowings (1) 149.4 37.5 77.9 79.5 57.5 401.8
Other liabilities 0.0 0.0 0.3 0.0 19.0 19.3
Capital 0.0 0.0 0.0 0.0 139.1 139.1
---------- ---------- ---------- ---------- ---------- ----------
Total liabilities & capital $ 244.7 $ 248.6 $ 381.8 $ 83.4 $ 272.5 $ 1,231.0
========== ========== ========== ========== ========== ==========
Net interest rate GAP $ (5.3) $ (107.1) $ 226.9 $ 19.4 $ (133.9)
========== ========== ========== ========== ==========
Cumulative interest rate GAP $ (5.3) $ (112.4) $ 114.5 $ 133.9
========== ==========
GAP to total assets 0% -9%
========== ==========
GAP to total equity -4% -77%
========== ==========
Cumulative GAP to total assets 0% -9%
========== ==========
Cumulative GAP to total equity -4% -81%
========== ==========
(1) The $57.5 in borrowings classified as non-rate sensitive are related to
variable interest entities and are not obligations of the Company.
The Company's exposure to interest rate risk is mitigated somewhat by a
portion of the Company's loan portfolio consisting of floating rate loans, which
are tied to the prime lending rate but which have interest rate floors and no
interest rate ceilings. Although the Company is originating fixed rate loans, a
portion of the loan portfolio continues to be comprised of floating rate loans
with interest rate floors.
ITEM 4 - CONTROLS AND PROCEDURES
i) Management's Report on Controls and Procedures
Company management evaluated, with the participation of the Chief
Executive Officer and Chief Financial Officer, the effectiveness of the
Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period
covered by this quarterly report. Based on such evaluation, the Chief Executive
Officer and Chief Financial Officer have concluded that the Company's disclosure
controls and procedures are designed to ensure that information required to be
disclosed by the Company in the reports it files or submits under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the
time period specified in the Securities and Exchange Commission's rules and
regulations and are operating in an effective manner.
ii) Change in Internal Controls.
In connection with the ongoing review of the Company's internal controls
over financial reporting as defined in rule 13a-15(f) and 15(d)(f) under the
Securities Exchange Act 1934, as amended , and in response to the material
weakness identified in the Annual Report on Form 10-K for the fiscal year ended
December 31, 2004, the Company has implemented the documentation required under
SAB No.102 relating to the Company's allowance for loan losses.
RECENT DEVELOPMENTS
None
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board (FASB) issued
Statement No. 123(R), "Share-Based Payment." Statement No. 123(R) replaces
Statement No. 123, "Accounting for Stock-Based Compensation," and supersedes APB
Opinion No. 25, "Accounting for Stock Issued to Employees." Statement No. 123(R)
requires compensation costs related to share-based payment transactions to be
recognized in the financial statements over the period that an employee provides
service in exchange for the award. Public companies are required to adopt the
new standard using a modified prospective method and may elect to restate prior
periods using the modified retrospective method. Under the modified prospective
method, companies are required to record compensation cost for new and modified
awards over the related vesting period of such awards prospectively and record
compensation cost prospectively for the unvested portion, at the date of
adoption, of previously issued and outstanding awards over the remaining vesting
period of such awards. No change to prior periods presented is permitted under
the modified prospective method. Under the modified retrospective method,
companies record compensation costs for prior periods retroactively through
restatement of such periods using the exact pro forma amounts disclosed in the
companies' footnotes. Also, in the period of adoption and after, companies
record compensation cost based on the modified prospective method.
On April 14, 2005, the Securities and Exchange Commission ("SEC") adopted a new
rule that amends the compliance dates for FASB's Statement of Financial
Accounting Standards No. 123 (revised 2004), "Share-Based Payment" ("SFAS No.
123R"). Under the new rule, the Company is required to adopt SFAS No. 123R in
the first annual period beginning after June 15, 2005. The Company has not yet
determined the method of
adoption or the effect of adopting SFAS No. 123R, and it has not determined
whether the adoption will result in amounts that are similar to the current pro
forma disclosures under SFAS No. 123.
In December 2003, the Accounting Standards Executive Committee issued Statement
of Position 03-3 (SOP 03-3), "Accounting for Certain Loans or Debt Securities
Acquired in a Transfer." SOP 03-3 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 acquired in a
transfer, including business combinations, if those differences are
attributable, at least in part, to credit quality. SOP 03-3 is effective for
loans for debt securities acquired in fiscal years beginning after December 15,
2004. The Company adopted the provisions of SOP 03-3 on January 1, 2005.
In March 2005, the SEC issued Staff Accounting Bulletin No. 107 ("SAB No. 107"),
"Share-Based Payment", providing guidance on option valuation methods, the
accounting for income tax effects of share-based payment arrangements upon
adoption of SFAS No. 123(R), and the disclosures in MD&A subsequent to the
adoption. The Company will provide SAB No. 107 required disclosures upon
adoption of SFAS No. 123(R) on January 1, 2006.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULT AND UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO VOTE SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
(a)
31.1 Section 302 Certification Pursuant to Section 13(a) or
15(d) of the Securities and Exchange Act of 1934 signed
by Joseph P. Campbell, Chief Executive Officer of Royal
Bancshares of Pennsylvania on May 9, 2005.
31.2 Section 302 Certification Pursuant to Section 13(a) or
15(d) of the Securities and Exchange Act of 1934 signed
by Jeffrey T. Hanuscin, Chief Financial Officer of Royal
Bancshares of Pennsylvania on May 9, 2005.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002, signed by Joseph P.
Campbell, Chief Executive Officer of Royal Bancshares of
Pennsylvania on May 9, 2005.
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002, signed by Jeffrey T. Hanuscin, Chief
Financial Officer of Royal Bancshares of Pennsylvania on
May 9, 2005.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ROYAL BANCSHARES OF PENNSYLVANIA, INC.
(Registrant)
Dated: May 9, 2005 /s/ Jeffrey T. Hanuscin
-----------------------
Jeffrey T. Hanuscin
Chief Financial Officer