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EX-21 - EX-21 - ROYAL BANCSHARES OF PENNSYLVANIA INCw82200exv21.htm
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EX-31.1 - EX-31.1 - ROYAL BANCSHARES OF PENNSYLVANIA INCw82200exv31w1.htm
EX-99.2 - EX-99.2 - ROYAL BANCSHARES OF PENNSYLVANIA INCw82200exv99w2.htm
EX-99.1 - EX-99.1 - ROYAL BANCSHARES OF PENNSYLVANIA INCw82200exv99w1.htm
EX-32.2 - EX-32.2 - ROYAL BANCSHARES OF PENNSYLVANIA INCw82200exv32w2.htm
EX-31.2 - EX-31.2 - ROYAL BANCSHARES OF PENNSYLVANIA INCw82200exv31w2.htm
EX-32.1 - EX-32.1 - ROYAL BANCSHARES OF PENNSYLVANIA INCw82200exv32w1.htm
 
 
UNITED STATES SECURITIES AND EXCHANGE
COMMISSION
WASHINGTON, D. C. 20549
 
FORM 10-K
(Mark One)
     
þ   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2010
or
     
o   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 registrant as specified in its charter)
     
Pennsylvania   23-2812193
     
(State of other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
     
732 Montgomery Avenue, Narberth, Pennsylvania   19072
     
(Address of principal executive offices)   (Zip Code)
(610) 668-4700
(Issuer’s telephone number, including area code)
(Former name, former address and former year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
     
Name of Each Exchange on Which Registered   Title of Each Class
 
   
The NASDAQ Stock Market, LLC
  Class A Common Stock ($2.00 par value)
Securities registered pursuant to Section 12(g) of the Act:
     
Name of Each Exchange on Which Registered   Title of Each Class
 
   
None
  Class B Common Stock ($0.10 par value)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. o Yes þ No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. o Yes þ No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 of 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding twelve months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer o   Accelerated filer o   Non-accelerated filer o   Small reporting company þ
        (Do not check if a smaller reporting company)    
Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act) Yes o No þ
The aggregate market value of the Registrant’s Common Stock held by non-affiliates is $15,428,819 based on the June 30, 2010 closing price of the Registrant’s Common Stock of $3.00 per share.
As of February 28, 2011, the Registrant had 11,359,788 and 2,082,930 shares outstanding of Class A and Class B common stock, respectively.
Documents Incorporated by Reference
Portions of the following documents are incorporated by reference: the definitive Proxy Statement of the Registrant relating to Registrant’s Annual meeting of Shareholders to be held on May 18, 2011—Part III.
 
 

 


 

Forward Looking Statements
From time to time, Royal Bancshares of Pennsylvania, Inc. (the “Company”) may include forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new products, research and development activities and similar matters in this and other filings with the Securities and Exchange Commission. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. When we use words such as “believes,” “expects,” “anticipates” or similar expressions, we are making forward-looking statements. In order to comply with the terms of the safe harbor, the Company notes that a variety of factors could cause the Company’s actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company’s forward-looking statements. The risks and uncertainties that may affect the operations, performance development and results of the Company’s business include the following: general economic conditions, including their impact on capital expenditures; interest rate fluctuations; business conditions in the banking industry; the regulatory environment: the nature, extent, and timing of governmental actions and reforms, including the rules of participation for the Troubled Asset Relief Program voluntary Capital Purchase Plan under the Emergency Economic Stabilization Act of 2008, which may be changed unilaterally and retroactively by legislative or regulatory actions; 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.

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PART I
ITEM 1. BUSINESS
Royal Bancshares of Pennsylvania, Inc.
Royal Bancshares of Pennsylvania, Inc. (the “Company”), is a Pennsylvania business corporation and a two bank holding company registered under the Federal Bank Holding Company Act of 1956, as amended (the “Holding Company Act”). The Company is supervised by the Board of Governors of the Federal Reserve System (“Federal Reserve Board”). Its legal headquarters are located at 732 Montgomery Avenue, Narberth, Pennsylvania 19072. On June 29, 1995, pursuant to the plan of reorganization approved by the shareholders of Royal Bank America, formerly Royal Bank of Pennsylvania (“Royal Bank”), all of the outstanding shares of common stock of Royal Bank were acquired by the Company and were exchanged on a one-for-one basis for common stock of the Company. On July 17, 2006, Royal Asian Bank (“Royal Asian”) was chartered by the Commonwealth of Pennsylvania Department of Banking (the “Department”) and commenced operation as a Pennsylvania state-chartered bank. Prior to obtaining a separate charter, the business of Royal Asian was operated as a division of Royal Bank. On December 30, 2010, the Company completed the sale of all of the outstanding common stock of Royal Asian to an ownership group led by the President and Chief Executive Officer of Royal Asian.
The principal activities of the Company are supervising Royal Bank which engages in general banking business principally in Montgomery, Chester, Bucks, Philadelphia and Berks counties in Pennsylvania, southern New Jersey, and Delaware. The Company also has a wholly owned non-bank subsidiary, Royal Investments of Delaware, Inc., which is engaged in investment activities. On November 21, 2007, the Company established Royal Captive Insurance Company, a wholly owned subsidiary. Royal Captive Insurance was formed to insure commercial property and provide comprehensive umbrella liability coverage for the Company and its affiliates. During the fourth quarter of 2010, Royal Captive Insurance was dissolved. The investments were sold for a gain of approximately $8,000, $2.0 million was paid to the Company as a dividend, and the remaining funds, in the approximate amount of $500,000, were transferred to the Company.
At December 31, 2010, the Company had consolidated total assets of approximately $980.6 million, total deposits of approximately $693.9 million and shareholders’ equity of approximately $84.1 million. The Company’s two Delaware trusts, Royal Bancshares Capital Trust I and Royal Bancshares Capital Trust II, are not consolidated per requirements under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 810, “Consolidation” (“ASC Topic 810”).
The Company has three reportable operating segments, “Community Banking”, “Tax Liens” and “Equity Investments”; and one operating segment that does not meet the quantitative thresholds for requiring disclosure, but has different characteristics than the Community Banking, Tax Liens and Equity Investments segments, “Leasing”. The Equity Investments are consolidated under ASC Topic 810 as described in “Note 20 — Segment Information” of the Notes to Consolidated Financial Statements in Item 8 of this Report.
Regulatory Actions
FDIC Orders
On July 15, 2009, Royal Bank agreed to enter into a Stipulation and Consent to the Issuance of an Order to Cease and Desist (the “Orders”) with each of the FDIC and the Department. The material terms of the Orders are identical and require Royal Bank to: (i) have and retain qualified management, and notify the FDIC and the Department of any changes in Royal Bank’s board of directors or senior management; (ii) increase participation of Royal Bank’s board of directors in Royal Bank’s affairs by having the board assume full responsibility for approving Royal Bank’s policies and objectives and for supervising Royal Bank’s management; (iii) eliminate all assets classified as “Loss” and formulate a written plan to reduce assets classified as “Doubtful” and “Substandard” at its regulatory examination; (iv) develop a written plan to reduce delinquent loans, and restrict additional advances to borrowers with existing credits classified as “Loss,” “Doubtful” or “Substandard”; (v) develop a written plan to reduce Royal Bank’s commercial real estate loan concentration; (vi) maintain, after establishing an adequate allowance for loan and lease losses, a ratio of Tier 1 capital to total assets (“leverage ratio”) equal to or greater than 8% and a ratio of qualifying total capital to risk-weighted assets (total risk-based capital ratio) equal to or greater than 12%; (vii) formulate and implement written profit plans and

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comprehensive budgets for each year during which the Orders are in effect; (viii) formulate and implement a strategic plan covering at least three years, to be reviewed quarterly and revised annually; (ix) revise the liquidity and funds management policy and update and review the policy annually; (x) refrain from increasing the amount of brokered deposits held by Royal Bank and develop a plan to reduce the reliance on non-core deposits and wholesale funding sources; (xi) refrain from paying cash dividends without prior approval of the FDIC and the Department; (xii) refrain from making payments to or entering contracts with Royal Bank’s Holding Company or other Royal Bank affiliates without prior approval of the FDIC and the Department; (xiii) submit to the FDIC for review and approval an executive compensation plan that incorporates qualitative as well as profitability performance standards for Royal Bank’s executive officers; (xiv) establish a compliance committee of the board of directors of Royal Bank with the responsibility to ensure Royal Bank’s compliance with the Orders; and (xv) prepare and submit quarterly reports to the FDIC and the Department detailing the actions taken to secure compliance with the Orders. The Orders will remain in effect until modified or terminated by the FDIC and the Department.
The Orders do not restrict Royal Bank from transacting its normal banking business. Royal Bank continues to serve its customers in all areas including making loans, establishing lines of credit, accepting deposits and processing banking transactions. Customer deposits remain fully insured to the highest limits set by the FDIC. The FDIC and the Department did not impose or recommend any monetary penalties in connection with the Orders.
Following are the actions Royal Bank has taken to respond to and comply with the Orders as of the date of this Report:
  1.   Board Oversight and Senior Management
 
      A Regulatory Compliance Committee comprised of outside directors and management was created in the third quarter of 2009. The purpose of the Committee is to monitor compliance with the Orders. Royal Bank had previously completed an internal assessment of senior management’s qualifications and had submitted the report to the FDIC and the Department for their review.
 
  2.   Reduction of Classified Assets
 
      Royal Bank has eliminated from its books via charge-off all assets classified as “Loss”. Royal Bank submitted to the FDIC and the Department a “Plan for the Reduction of Classified Assets” (“classified assets plan”) required under the Orders. The FDIC and the Department approved the classified assets plan. No material advances were made on any classified loan unless approved by the board of directors and determined to be in Royal Bank’s best interest. Royal Bank was successful in reducing classified loans, which includes loans held for sale, and OREO from $149.6 million at June 30, 2009 to $109.9 million at December 31, 2010.
 
  3.   Reduction of Delinquencies
 
      Royal Bank submitted to the FDIC and the Department a “Plan for the Reduction of Delinquencies” (“delinquency reduction plan”) required under the Orders. The FDIC and the Department approved the delinquency reduction plan. No advances were made on any delinquent loan unless approved by the board of directors and determined to be in Royal Bank’s best interest. Royal Bank’s delinquent loans (30 to 90 days) amounted to $36.3 million at June 30, 2009 versus $12.2 million at December 31, 2010. Royal Bank’s non-accrual loans held for investment were $80.8 million and $43.2 million at June 30, 2009 and December 31, 2010, respectively.
 
  4.   Reduction of Commercial Real Estate Concentrations
 
      Royal Bank submitted to the FDIC and the Department a “Plan for the Reduction of Commercial Real Estate Concentrations” (“CRE concentration plan”) required under the Orders. The FDIC and the Department approved the CRE concentration plan. Management has been working diligently to reduce the concentration in commercial real estate loans (“CRE loans”). Royal Bank was successful in reducing the CRE concentration, which includes loans held for sale, from $289.1 million at June 30, 2009 to $214.1 million at December 31, 2010, which amounted to 207.7% of total capital and 225.9% of Tier 1 capital,

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      respectively as of such dates. At December 31, 2010, total construction/land loans (“CL loans”), which includes loans held for sale, amounted to $93.2 million, or 90.5%, of total capital and 98.4% of Tier 1 capital. CL loans were approximately $20 million less than what was projected under the CRE concentration plan at year end 2010. Based on capital levels calculated under US GAAP, Royal Bank no longer has a concentration of commercial real estate loans as defined in the joint agency “Guidance on Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices” issued on December 12, 2006 (“Guidance”). Based on capital levels calculated under regulatory accounting principles (“RAP”), (see discussion under “Capital Adequacy” in “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations.”), CRE loans and CL loans as a percentage of total capital and Tier 1 capital, respectively, are 239.6%, 263.5%, 104.3% and 114.8%. Under RAP, Royal Bank would have a concentration in CL loans as defined in the Guidance.
 
  5.   Capital Maintenance
 
      Under the Orders, Royal Bank must maintain a minimum total risk-based capital ratio and a minimum Tier 1 leverage ratio of 12% and 8%, respectively. At December 31, 2010, based on capital levels calculated under RAP, Royal Bank’s total risk-based capital and Tier 1 leverage ratios were 13.76% and 8.03%, respectively. At December 31, 2010, based on capital levels calculated under US GAAP, Royal Bank’s total risk-based capital and Tier 1 leverage ratios were 15.86% and 9.24%, respectively. Please see discussion in “Capital Adequacy” in “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 
  6.   Budget Plan
 
      Royal Bank submitted to the FDIC and the Department a revised 2010 budget and profit plan required under the Orders. The FDIC and the Department approved the 2010 budget and profit plan. In addition, Royal Bank has submitted to the FDIC and the Department a 2011 budget and profit plan.
 
  7.   Strategic Plan
 
      Royal Bank submitted to the FDIC and the Department a three-year strategic plan required under the Orders. The FDIC and the Department approved the three-year strategic plan. The Board of Directors and senior management are executing the strategic plan and will incorporate any modifications as deemed necessary by our regulators. Additionally, Royal Bank submitted a three-year strategic plan to the FDIC and Department covering 2011 through 2013.
 
  8.   Liquidity and Funds Management
 
      Royal Bank submitted to the FDIC and the Department a liquidity and funds management plan (“liquidity plan”) required under the Orders. The FDIC and the Department have approved the liquidity plan. At December 31, 2010, Royal Bank had $51.7 million in cash on hand and $95.0 million in unpledged agency securities. At December 31, 2010, the liquidity to deposits ratio was 31.4% compared to Royal Bank’s 12% target and the liquidity to total liabilities ratio was 24.2% compared to Royal Bank’s 10% target.
 
  9.   Brokered Deposits and Borrowings
 
      Royal Bank submitted to the FDIC and the Department a plan for reduction of reliance on non-core deposits and wholesale funding sources plan (“brokered deposit plan”) required under the Orders. The FDIC and the Department approved the brokered deposit plan. Since entering the Orders Royal Bank has not renewed, accepted, or rolled over any maturing brokered certificates of deposit (“CDs”); nor has Royal Bank issued new brokered CDs. Brokered CDs declined $137.8 million from $226.9 million at June 30, 2009 to $89.1 million at December 31, 2010. Borrowings declined $129.0 million from $283.9 million at June 30, 2009 to $154.9 million at December 31, 2010.

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  10.   Cash Dividends and other Payments to the Company
 
      Royal Bank will seek approval from the FDIC and the Department prior to declaring a cash dividend to the Company and prior to making payments or entering into new contracts with our affiliates.
 
  11.   Executive Compensation
 
      Royal Bank submitted to the FDIC an executive compensation plan (“compensation plan”) required under the Orders. The FDIC approved the compensation plan. Royal Bank was not required to submit the compensation plan to the Department.
Royal Bank has submitted all required quarterly reports to the FDIC and the Department detailing the actions taken to maintain compliance with the Orders as of the date of this Report.
Federal Reserve Agreement
On March 17, 2010, the Company agreed to enter into a written agreement (“the Federal Reserve Agreement”) with the Federal Reserve Bank of Philadelphia (the “Reserve Bank”). The material terms of the Federal Reserve Agreement provide that: (i) the Company’s board of directors will take appropriate steps to fully utilize the Company’s financial and managerial resources to serve as a source of strength to its subsidiary banks, including taking steps to ensure that Royal Bank complies with the Orders previously entered into with the FDIC and the Department on July 15, 2009; (ii) the Company’s board of directors will, within 60 days of the Federal Reserve Agreement, submit to the Reserve Bank a written plan to strengthen board oversight of the management and operations of the consolidated operation; (iii) the Company will not declare or pay any dividends without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System; (iv) the Company and its non-bank subsidiaries will not make any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without the prior approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System; (v) the Company and its nonbank subsidiaries will not, directly or indirectly, incur, increase, or guarantee any debt without the prior written approval of the Reserve Bank; (vi) the Company will not, directly or indirectly, purchase or redeem any shares of its stock without the prior written approval of the Reserve Bank; (vii) the Company will, within 60 days of the Federal Reserve Agreement, submit to the Reserve Bank an acceptable written capital plan to maintain sufficient capital at the Company on a consolidated basis, which plan will at a minimum address: regulatory requirements for the Company and Royal Bank, the adequacy of Royal Bank’s capital taking into account the volume of classified credits, the allowance for loan and lease losses, current and projected asset growth, and projected retained earnings; the source and timing of additional funds necessary to fulfill the consolidated organization’s and Royal Bank’s future capital requirements; supervisory requests for additional capital at Royal Bank or the requirements of any supervisory action imposed on Royal Bank by federal or state regulators; and applicable legal requirements that the Company serve as a source of strength to Royal Bank; (viii) the Company will, within 60 days of the Federal Reserve Agreement, submit to the Reserve Bank cash flow projections for 2010 showing planned sources and uses of cash for debt service, operating expenses, and other purposes, and will submit similar cash flow projections for each subsequent calendar year at least one month prior to the beginning of such year; (ix) the Company will comply with applicable legal notice provisions in advance of appointing any new director or senior executive officer or changing the responsibilities of any senior executive officer such that the officer would assume a different senior executive officer position, and comply with restrictions on indemnification and severance payments imposed by the Federal Deposit Insurance Act; and (x) the Company’s board of directors will, within 45 days after the end of each quarter, submit progress reports to the Reserve Bank detailing the form and manner of all actions taken to secure compliance with the Agreement and the results thereof, together with a parent company-level balance sheet, income statement, and, as applicable, report of changes in shareholders’ equity.
The Federal Reserve Agreement will remain in effect and enforceable until stayed, modified, terminated or suspended by the Reserve Bank. The Company has submitted all progress reports and responses required under the Federal Reserve Agreement as of the date of this Report.

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Royal Bank America
Royal Bank was incorporated in the Commonwealth of Pennsylvania on July 30, 1963, was chartered by the Commonwealth of Pennsylvania Department of Banking and commenced operation as a Pennsylvania state-chartered bank on October 22, 1963. Royal Bank is the successor of the Bank of King of Prussia, the principal ownership of which was acquired by The Tabas Family in 1980. The deposits of Royal Bank are insured by the FDIC.
During the fourth quarter of 2006, Royal Bank formed a subsidiary, Royal Tax Lien Services, LLC, to purchase and service delinquent tax liens. Royal Bank owns 60% of the subsidiary.
During the fourth quarter of 2006, Royal Bank formed a subsidiary, RBA Capital, LP, to originate structured debt. Royal Bank owns 60% of the subsidiary. During the fourth quarter of 2008, management decided to wind down the operation of RBA Capital. During 2009, the operations of the subsidiary were folded into Royal Bank.
On October 17, 2008, Royal Bank established RBA Property LLC, a wholly owned subsidiary. RBA Property was formed to hold other real estate owned acquired through foreclosure of collateral associated with non-performing loans.
On December 1, 2008, Royal Bank established Narberth Property Acquisition LLC, a wholly owned subsidiary. Narberth Property Acquisition was formed to hold other real estate owned acquired through foreclosure of collateral associated with non-performing loans.
On November 4, 2009, Royal Bank established Rio Marina LLC, a wholly owned subsidiary. Rio Marina LLC was formed to hold other real estate owned acquired through foreclosure of collateral associated with non-performing loans.
Royal Bank derives its income principally from interest charged on loans, interest earned on investment securities, and fees received in connection with the origination of loans and other services. Royal Bank’s principal expenses are interest expense on deposits and operating expenses. Operating revenues, deposit growth, investment maturities, loan sales and the repayment of outstanding loans provide the majority of funds for activities.
Royal Bank conducts business operations as a commercial bank offering checking 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.
Service Area: Royal Bank’s primary service area includes Pennsylvania, primarily Montgomery, Chester, Bucks, Delaware, Berks and Philadelphia counties, and New Jersey. This area includes residential areas and industrial and commercial businesses of the type usually found within a major metropolitan area. Royal Bank serves this area from fifteen branches located throughout Montgomery, Philadelphia and Berks counties and New Jersey. Royal Bank also considers New York, Maryland, and Delaware as a part of its service area for certain products and services. In the past, Royal Bank had frequently conducted business with clients located outside of its service area. Royal Bank has loans in twenty-four states via loan originations and/or participations with other lenders who have broad experience in those respective markets. Royal Bank’s headquarters are located at 732 Montgomery Avenue, Narberth, Pennsylvania 19072.
Competition: The financial services industry in our service area is extremely competitive. Competitors within our service area include banks and bank holding companies with greater resources. Many competitors have substantially higher legal lending limits.
In addition, savings banks, savings and loan associations, credit unions, money market and other mutual funds, brokerage firms, mortgage companies, leasing companies, finance companies and other financial services companies offer products and services similar to those offered by Royal Bank, on competitive terms.

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Many bank holding companies have elected to become financial holding companies under the Gramm-Leach-Bliley Act of 1999, which give a broader range of products with which Royal Bank must compete. Management believes this statute further narrowed the differences and intensified competition among commercial banks, investment banks, insurance firms and other financial services companies. The Company has not elected financial holding company status.
Employees: Royal Bank employed approximately 155 persons on a full-time equivalent basis as of December 31, 2010.
Deposits: At December 31, 2010, total deposits of Royal Bank were distributed among demand deposits (8%), money market deposit, savings and Super NOW accounts (34%) and time deposits (58%). At year-end 2010, deposits decreased $125.1 million to $697.3 million, from year-end 2009, or 15%. NOW and money market accounts decreased $3.6 million while time deposits decreased $120.0 million. Included in Royal Bank’s deposits are approximately $3.3 million of intercompany deposits that are eliminated through consolidation.
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.
Lending: At December 31, 2010, Royal Bank had a total net loan portfolio of $475.7 million, representing 49% of total assets. The loan portfolio is categorized into commercial demand, commercial mortgages, residential mortgages (including home equity lines of credit), construction, real estate tax liens, asset based loans, small business leases and installment loans. At year-end 2010, loans decreased $116.1 million from year end 2009.
Royal Asian Bank
Royal Asian was incorporated in the Commonwealth of Pennsylvania on October 4, 2005, and was chartered by the Commonwealth of Pennsylvania Department of Banking and commenced operation as a Pennsylvania state-chartered bank on July 17, 2006. Royal Asian is an insured bank by the FDIC. Royal Asian derives its income principally from interest charged on loans and fees received in connection with other services. Royal Asian’s principal expenses are interest expense on deposits and operating expenses. Operating revenues, deposit growth, and the repayment of outstanding loans provide the majority of funds for activities.
Royal Asian 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 Asian also offers collections, internet banking, safe deposit boxes and bill payment along with other customary bank services (excluding trust) to its customers. Drive-up, ATM, and night depository facilities are available. Certain international services are offered via a SWIFT machine which provides international access to transfer information through a secured web based system. This system is for informational purposes only and no funds are transferred through SWIFT. Services may be added or deleted from time to time. The services offered and the business of Royal Asian is not subject to significant seasonal fluctuations. Royal Asian through its affiliation with Royal Bank is a member of the Federal Reserve FedLine Wire Transfer System.
On August 26, 2010, the Company announced that it had entered into a stock purchase agreement with an investment group to purchase all of the outstanding common stock of Royal Asian owned by the Company. The sale of Royal Asian was completed on December 30, 2010.
Non-Bank Subsidiaries
On June 30, 1995, the Company established a special purpose Delaware investment company, Royal Investment of Delaware (“RID”), as a wholly owned subsidiary. Its legal headquarters is 1105 N. Market Street, Suite 1300, Wilmington, Delaware 19899. RID buys, holds and sells investment securities. At December 31, 2010, total assets of RID were $29.1 million, of which $606,000 was held in cash and cash equivalents and $6.0 million was held in investment securities. RID had net interest income of $779,000 and $1.2 million for 2010 and 2009, respectively. Non-interest

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income for 2010 was a loss of $158,000 compared to a loss of $5.8 million for 2009. During 2010, RID recorded a $158,000 loss on the sale of investment securities.
During 2009, RID recorded $5.5 million in impairment charges on investment securities of which $3.8 million was related to a managed common stock portfolio, and recorded investment losses of $353,000. During the third quarter of 2009, the Company sold the managed common stock portfolio and minimized additional losses to $130,000, or 1% of their aggregate cost. RID’s net income for 2010 was $382,000  compared to a net loss of $5.1 million in 2009. Royal Bank has previously extended loans to RID, secured by securities and as per the provisions of Regulation W. During the third quarter of 2009, RID paid off the $9.4 million loan from Royal Bank. In addition, RID paid a $2.5 million dividend to Royal Bancshares in the third quarter of 2010 and a $10.0 million dividend to Royal Bancshares during the third quarter of 2009. The amounts above include the activity related to RID’s wholly owned subsidiary Royal Preferred LLC.
The Company, through its wholly owned subsidiary Royal Bank, holds a 60% ownership interest in Crusader Servicing Corporation (“CSC”). Its legal headquarters is located at 732 Montgomery Avenue, Narberth, Pennsylvania 19072. 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. On February 2, 2007, due to a change in CSC management, Royal Bank and other shareholders, constituting a majority of CSC shareholders, voted to liquidate CSC under an orderly, long term plan adopted by CSC management. Royal Bank continues acquiring tax liens through its subsidiary, Royal Tax Lien Services, LLC (“RTL”) which was formed in November 2006. At December 31, 2010, total assets of CSC were $11.5 million. Included in total assets is $1.8 million for the Strategic Municipal Investments (“SMI”) portfolio, which is comprised of residential, commercial, and land tax liens, primarily in Alabama. In 2005, the Company entered into a partnership with SMI, ultimately acquiring a 50% ownership interest in SMI. In connection with acquiring this ownership interest, CSC extended an $18 million line of credit to SMI, which was used by SMI to purchase tax lien portfolios at a discount. As a result of the deterioration in residential, commercial and land values principally in Alabama, management concluded that the loan was impaired based on an analysis of the portfolio in the fourth quarter of 2008. Through 2009, CSC charged-off $3.0 million related to this loan. There were no charge-offs related to SMI in 2010. The outstanding SMI loan balance was $1.8 million at December 31, 2010. In 2010, CSC had net interest income of $368,000 compared to $468,000 for 2009. The 2010 provision for loan and lease losses was $59,000 compared to $624,000 for 2009. The provision is mainly related to the SMI impairments mentioned above. For 2010 and 2009 other income was $338,000 and $179,000, respectively. Other income is mostly comprised of gain on sale of real estate owned (“REO”) properties. Other expense was $512,000 and $693,000 for 2010 and 2009, respectively. CSC recorded net income of $81,000 in 2010 compared to a net loss of $402,000 in 2009. The 2009 loss was impacted by the increase in the provision for loan and lease losses.
On June 23, 2003, the Company, through its wholly owned subsidiary Royal Bank, established Royal Investments America, LLC (“RIA”) as a wholly owned subsidiary. Its legal headquarters is located at 732 Montgomery Avenue, Narberth, Pennsylvania 19072. RIA was formed to invest in equity real estate ventures subject to limitations imposed by regulation. At December 31, 2010, total assets of RIA prior to consolidation under ASC Topic 810 were $4.0 million. During 2010, RIA had a net loss of $4.5 million compared to net income of $709,000 for 2009. The net loss in 2010 was primarily a result of a $2.6 million impairment recorded on an equity real estate investment and a $2.5 million impairment recorded on a real estate joint venture.
On October 27, 2004, the Company formed two Delaware trust affiliates, Royal Bancshares Capital Trust I and Royal Bancshares Capital Trust II, in connection with the sale of an aggregate of $25.0 million of trust preferred securities.
On July 25, 2005, the Company, through its wholly owned subsidiary Royal Bank, formed Royal Bank America Leasing, LP (“Royal Leasing”). Royal Bank holds a 60% ownership interest in Royal Leasing. Its legal headquarters is located at 550 Township Line Road, Blue Bell, Pennsylvania 19422. Royal Leasing was formed to originate small business leases. Royal Leasing originates small ticket leases through its internal sales staff and through independent brokers located throughout its business area. In general, Royal Leasing will portfolio individual small ticket leases in amounts of up to $250,000. Leases originated in amounts in excess of that are sold for a profit to other leasing companies. On occasion, Royal Bank will purchase municipal leases originated by Royal Leasing for its own portfolio. These purchases are at market based pricing and terms that Royal Leasing would expect to receive from unrelated third-parties. From time to time Royal Leasing will sell small lease portfolios to third-parties and will, on

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occasion, purchase lease portfolios from other originators. During 2010 and 2009, neither sales nor purchases of lease portfolios were material. At December 31, 2010, total assets of Royal Leasing were $38.0 million. For 2010, Royal Leasing had net interest income of $2.5 million, a 39% increase from $1.8 million for 2009. For 2010 provision for lease losses was $834,000 million compared to $1.3 million for 2009. The decrease in the provision was primarily related to improvement in the leasing portfolio year over year. Other income decreased $25,000 from $390,000 for 2009 to $365,000 for 2010. Other expense was $803,000 and $335,000 for 2010 and 2009, respectively. The increase in other expense was related to $472,000 in distribution of management fees. Royal Leasing recorded net income of $547,000 for the year ended December 31, 2010 compared to a $382,000 for the year ended December 31, 2009.
On October 1, 2006, the Company, through its wholly owned subsidiary Royal Bank, formed RBA Capital, LP (“RBA Capital”). Royal Bank held a 60% ownership interest in RBA Capital and its legal headquarters was located at 150 North Radnor Chester Road, Radnor, Pennsylvania 19087. RBA Capital was formed to lend to lenders on a re-discounted basis, which indicates the main business line of RBA Capital was the extension of loans to other lenders. These other lenders were not typically financial institutions, but rather individuals, smaller corporations, or partnerships that make small loans including, but not limited to, loans to contractors, home buyers or the purchasers of smaller, owner occupied, commercial real estate buildings. RBA Capital on occasion referred loans to Royal Bank, or for certain larger loans it originated, participated with Royal Bank in the loan. Royal Bank paid RBA Capital a referral fee for loans referred from RBA Capital or for loans participated with RBA Capital. All transactions between Royal Bank and RBA Capital were on commercially reasonable terms at market rates and terms that would be paid, received or granted by unrelated third-parties. During the fourth quarter of 2008, management decided to wind down the operation of RBA Capital and during 2009 took 100% ownership of the Company, which is currently managed as a separate division of Royal Bank.
On November 17, 2006, the Company, through its wholly owned subsidiary Royal Bank, formed Royal Tax Lien Services, LLC (“RTL”). Royal Bank holds a 60% ownership interest in RTL. Its legal headquarters is located at 732 Montgomery Avenue, Narberth, Pennsylvania 19072. RTL was formed to purchase and service delinquent tax certificates. RTL typically acquires delinquent property tax liens through public auctions in various jurisdictions, assuming a lien position that is generally superior to any mortgage liens that are on the property, and obtaining certain foreclosure rights as defined by local statute. At December 31, 2010, total assets of RTL were $89.1 million compared to $88.9 million at December 31, 2009. Tax certificates outstanding slightly increased $600,000 from $63.1 million at December 31, 2009 to $63.7 million at December 31, 2010. For 2010, RTL had net interest income of $5.8 million compared to $5.0 million for 2009. Provision for loan and lease losses was $70,000 compared to $0 for 2010 and 2009, respectively. Other expense decreased $1.0 million from $2.2 million for 2009 to $1.2 million for 2010 primarily due to a decline in legal and professional fees. Net income for 2010 grew $839,000 from $2.1 million for 2009 to $2.9 million for 2010. During the fourth quarter of 2010, the President of RTL resigned from his position with the Company. He presently retains his equity interest in the Company and continues on the board of managers of RTL. The duties of the President of RTL have been assumed by another officer of the Company.
On November 21, 2007, the Company established Royal Captive Insurance Company, a wholly owned subsidiary. Royal Captive Insurance was formed to insure commercial property and comprehensive umbrella liability for the Company and its affiliates. During the fourth quarter of 2010, Royal Captive Insurance was dissolved. The investments were sold for a gain of approximately $8,000, $2.0 million was paid to the Company as a dividend, and the remaining funds, in the approximate amount of $500,000, were transferred to the Company.
On June 16, 2006, the Company, through its wholly owned subsidiary RID, established Royal Preferred LLC as a wholly owned subsidiary. Royal Preferred LLC was formed to purchase a subordinated debenture from Royal Bank. At December 31, 2010, Royal Preferred LLC had total assets of approximately $21 million.
Website Access to Company Reports
We post publicly available reports required to be filed with the SEC on our website, www.royalbankamerica.com, as soon as reasonably practicable after filing such reports with the SEC. The required reports are available free of charge through our website. Information available on our website is not part or incorporated by reference into this Report or any other report filed by this Company with the SEC.

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Products and Services with Reputation Risk
The Company 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 the Company 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 the Company’s reputation.
Future Acquisitions
The Company’s acquisition strategy consists of identifying financial institutions, insurance agencies and other financial companies with business philosophies that are similar to our business philosophies, which operate in strong markets that are geographically compatible with our operations, and which can be acquired at an acceptable cost. In evaluating acquisition opportunities, we generally consider potential revenue enhancements and operating efficiencies, asset quality, interest rate risk, and management capabilities. The Company currently has no formal commitments with respect to future acquisitions.
Concentrations, Seasonality
The Company 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. The Company has seen a deterioration in economic conditions as it pertains to real estate loans. Construction and land, non-residential real estate, and commercial loans represent 46%, 23% and 14%, respectively of the $43.2 million in non-accrual loans held for investment at December 31, 2010. The business of the Company and its subsidiaries is not seasonal in nature.
Environmental Compliance
The Company 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 2010, and are not expected to have a material effect on such expenditures, earnings or competitive position in 2011.
Supervision and Regulation
Bank holding companies and banks operate in a highly regulated environment and are regularly examined by federal and state regulatory authorities.
The following discussion concerns various federal and state laws and regulations and the potential impact of such laws and regulation on the Company 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 the Company and its subsidiaries. A change in law, regulations or regulatory policy may have a material effect on the Company’s business.
Holding Company
The Company, 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 the Company wishes to issue additional shares of its Common Stock, in order, for example, to raise

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capital or to grant stock options, the Company will have to comply with the registration requirements of the Securities Act of 1933 as amended, or find an applicable exemption from registration.
The Company is subject to the provisions of the Holding Company Act, and to supervision, regulation and examination by the Federal Reserve Board. The Holding Company Act requires the Company 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 the Company 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, the Company 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 its subsidiaries. Further, under the Holding Company Act and the Federal Reserve Board’s regulations, a bank holding company and its subsidiaries are prohibited from engaging in certain tying arrangements in connection with any extension of credit or provision of credit of any property or services. The so called “anti-tying” provisions state generally that a bank may not extend credit, lease, sell property or furnish any service to a customer on the condition that the customer obtain additional credit or service from the banks, 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 banks, its bank holding company or any subsidiary of its bank holding company.
Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve Act and by state banking laws on any extensions of credit to the bank holding company or any of the holding company’s subsidiaries, on investments in the stock or other securities of the bank holding company and on taking of such stock or securities as collateral for loans to any borrower.
Under the Pennsylvania Banking Code of 1965, as amended, the (“Code”), the Company is permitted to control an unlimited number of banks. However, the Company 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.
A bank holding company located in Pennsylvania, another state, the District of Columbia or a territory or possession of the United States may control one or more banks, bank and trust companies, national banks, interstate banks and, with the prior written approval of the Department, may acquire control of a bank and trust company or a national bank located in Pennsylvania. A Pennsylvania-chartered institution may maintain a bank, branches in any other state, the District of Columbia, or a territory or possession of the United States upon the written approval of the Department.
Federal law also prohibits the acquisition of control of a bank holding company without prior notice to certain federal bank regulators. Control is defined for this purpose as the power, directly or indirectly, to direct the management or policies of a bank or bank holding company or to vote 25% or more of any class of voting securities of a bank or bank holding company.
Royal Bank
As previously mentioned under “Regulatory Actions”, Royal Bank is operating under the Orders with the FDIC and the Department. The deposits of Royal Bank are insured by the FDIC. Royal Bank is subject to supervision, regulation and examination by the Department and by the FDIC. In addition, Royal Bank is subject to a variety of local, state and federal laws that affect its operation.

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The Department and the FDIC routinely examine Pennsylvania state-chartered, non-member banks such as Royal Bank in areas such as reserves, loans, investments, management practices and other aspects of operations. These examinations are designed for the protection of depositors rather than the Company’s shareholders.
Federal and state banking laws and regulations govern, among other things, the scope of a bank’s business, the investments a bank may make, the reserves against deposits a bank must maintain, the types and terms of loans a bank may make and the collateral it may take, the activities of banks with respect to mergers and consolidations, and the establishment of branches. Pennsylvania law permits statewide branching.
Under the Federal Deposit Insurance Act (“FDIC Act”), the FDIC possesses the power to prohibit institutions regulated by it (such as Royal Bank) from engaging in any activity that would be an unsafe and unsound banking practice or in violation of applicable law. Moreover, the FDIC Act: (i) empowers the FDIC to issue cease-and-desist or civil money penalty orders against Royal Bank or its executive officers, directors and/or principal shareholders based on violations of law or unsafe and unsound banking practices; (ii) authorizes the FDIC to remove executive officers who have participated in such violations or unsound practices; (iii) restricts lending by Royal Bank to its executive officers, directors, principal shareholders or related interests thereof; and (iv) restricts management personnel of a bank from serving as directors or in other management positions with certain depository institutions whose assets exceed a specified amount or which have an office within a specified geographic area. Additionally, the FDIC Act provides that no person may acquire control of Royal Bank unless the FDIC has been given 60-days prior written notice and within that time has not disapproved the acquisition or extended the period for disapproval.
Under the Community Reinvestment Act (“CRA”), the FDIC uses a five-point rating scale to assign a numerical score for a bank’s performance in each of three areas: lending, service and investment. Under the CRA, the FDIC is required to: (i) assess the records of all financial institutions regulated by it to determine if these institutions are meeting the credit needs of the community (including low-and moderate-income neighborhoods) which they serve, and (ii) take this record into account in its evaluation of any application made by any such institutions for, among other things, approval of a branch or other deposit facility, office relocation, a merger or an acquisition of another bank. The CRA also requires the federal banking agencies to make public disclosures of their evaluation of each bank’s record of meeting the credit needs of its entire community, including low-and moderate-income neighborhoods. This evaluation will include a descriptive 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.
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.
From time to time, various types of federal and state legislation have been proposed that could result in additional regulation of, and restrictions on, the business of Royal Bank. It cannot be predicted whether any such legislation will be adopted or how such legislation would affect the business of Royal Bank. As a consequence of the extensive regulation of commercial banking activities in the United States, Royal Bank’s business is particularly susceptible to being affected by federal legislation and regulations that may increase the costs of doing business.
Under the Bank Secrecy Act (“BSA”), banks and other financial institutions are required to report to the Internal Revenue Service currency transactions of more than $10,000 or multiple transactions in any one day of which the banks are 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.

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Federal Deposit Insurance Corporation Improvement Act of 1991
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 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 capital measures is to impose 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 is 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. Under the Orders as described in “Regulatory Action” under “Item 1 — Business” of this Report, Royal Bank is required to maintain a minimum Tier 1 leverage ratio of 8% and a Total risk-based capital ratio of 12% during the term of the Orders. Royal Bank has met all of the capital ratio requirements under the Orders.
An “adequately capitalized” institution is 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 is measured 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.
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.

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The FDIC’s guidelines establish the following limits for LTV ratios:
         
Loan Category   LTV limit
Raw land
    65 %
Land development
    65 %
Construction:
       
Commercial, multifamily (includes condos and co-ops) and other nonresidential
    80 %
Improved property
    85 %
Owner occupied 1-4 family and home equity (without credit enhancements)
    90 %
The guidelines provide exceptions to the LTV ratios for government-backed loans; loans facilitating the sale of real estate acquired by the lending institution in the normal course of business; loans where Royal Bank’s decision to lend is not based on the offer of real estate as collateral and such collateral is taken only out of an abundance of caution; and loans renewed, refinanced, or restructured by the original lender to the same borrower, without the advancement of new money. The regulation also allows institutions to make a limited amount of real estate loans that do not conform to the proposed LTV ratios. Under this exception, Royal Bank would be allowed to make real estate loans that do not conform to the LTV ratio limits, up to an amount not to exceed 100% of their 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 fees and charges imposed; and (4) the number of days in the reporting period. This Act allows for civil lawsuits to be initiated by customers if Royal Bank violates any provision or regulation under this Act.
Gramm-Leach-Bliley Act of 1999
The Gramm-Leach-Bliley Act of 1999 (“GLBA”), also known as the Financial Services Modernization Act repeals the two anti-affiliation provisions of the Glass-Steagall Act. GLBA establishes a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers. It revises and expands the framework of the Holding Company Act to permit a holding company to engage in a full range of financial activities through a new entity known as a Financial Holding Company. “Financial activities” is broadly defined to include not only banking, insurance and securities activities, but also merchant banking and additional activities that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to such financial activities, or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally.
In addition, GLBA provides a uniform framework for the functional regulation of the activities of banks, savings institutions and their holding companies; broadens the activities that may be conducted by national banks, banking subsidiaries of bank holding companies, and their financial subsidiaries; and adopts a number of provisions related to the capitalization, membership, corporate governance, and other measures designed to modernize the Federal Home Loan Bank system.
Privacy provision: GLBA provides an enhanced framework for protecting the privacy of consumer information. The FDIC and other banking regulatory agencies, as required under GLBA, have adopted rules limiting the ability of banks and other financial institutions to disclose nonpublic information about consumers to nonaffiliated third parties. Among other things, these provisions require banks and other financial institutions to have in place safeguards to ensure the security and confidentiality of customer records and information, to protect against anticipated threats or hazards to the security or integrity of such records, and to protect against unauthorized access to or use of such records that could result in substantial harm or inconvenience to a customer. GLBA also requires

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financial institutions to provide customers at the outset of the relationship and annually thereafter written disclosures concerning the institution’s privacy policies.
GLBA also expressly preserves the ability of a state bank to retain all existing subsidiaries. Because Pennsylvania permits commercial banks chartered by the state to engage in any activity permissible for national banks, Royal Bank will be permitted to form subsidiaries to engage in the activities authorized by GLBA to the same extent as a national bank. In order to form a financial subsidiary, Royal Bank must be well-capitalized and would be subject to the same capital deduction, risk management and affiliate transaction rules as applicable to national banks.
To the extent that GLBA permits banks, securities firms, and insurance companies to affiliate, the financial services industry may experience further consolidation. GLBA is intended to grant to community banks certain powers as a matter of right that larger institutions have accumulated on an ad hoc basis. Nevertheless, this act may have the result of increasing the amount of competition that the Company and Royal Bank face from larger institutions and other types of companies offering financial products, many of which may have substantially more financial resources than the Company and Royal Bank.
USA Patriot Act of 2001
A major focus of governmental policy in recent years that impacts financial institutions has been combating money laundering and terrorist financing. The Patriot Act broadened anti-money laundering regulations to apply to additional types of financial institutions and strengthened the ability of the U. S. Government to help prevent and prosecute international money laundering and the financing of terrorism. The potential impact of the Patriot Act on financial institutions of all kinds is significant and wide ranging. The Patriot Act requires regulated financial institutions, among other things, to establish an anti-money laundering program that includes training and auditing components, to take additional precautions with non-U.S. owned accounts, and to comply with regulations related to verifying client identification at account opening. The Patriot Act also provides rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering. Failure of a financial institution to comply with the requirements of the Patriot Act could have serious legal and reputational consequences for the institution. The Company has implemented systems and procedures to meet the requirements of the regulation and will continue to revise and update policies, procedures and necessary controls to reflect changes required by the Patriot Act.
Sarbanes-Oxley Act of 2002
The primary aims of the Sarbanes-Oxley Act of 2002 (“SOX”) was to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. SOX addresses, among other matters, requirements for audit committee membership and responsibilities, requirements of management to evaluate the Company’s disclosure controls and procedures and its internal control over financial reporting, including certification of financial statements and the effectiveness of internal controls by the primary executive officer and primary financial officer; established standards for auditors and regulation of audits, including independence provisions that restrict non-audit services that accountants may provide to their audit clients; and expanded the disclosure requirements for our Company insiders; and increased various civil and criminal penalties for fraud and other violations of securities laws.
Emergency Economic Stabilization Act of 2008
The Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted on October 3, 2008. EESA was designed to enable the federal government, under terms and conditions developed by the Secretary of the Treasury, to insure troubled assets, including mortgage-backed securities, and collect premiums from participating financial institutions. EESA includes, among other provisions: (a) the $700 billion Troubled Asset Relief Program (“TARP”), under which the Secretary of the Treasury was authorized to purchase, insure, hold, and sell a wide variety of financial instruments, particularly those that are based on or related to residential or commercial mortgages originated or issued on or before March 14, 2008; and (b) an increase in the amount of deposit insurance provided by the FDIC.

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Under the TARP, the United States Department of Treasury (“Treasury”) authorized a voluntary Capital Purchase Program (“CPP”) to purchase up to $250 billion of senior preferred shares of qualifying financial institutions that elected to participate by November 14, 2008. On February 20, 2009, the Company issued to Treasury, 30,407 shares of Series A Preferred Stock and a warrant to purchase 1,104,370 shares of Class A common stock for an aggregate purchase price of $30.4 million under the TARP CPP. (See “Note 14 — Shareholders’ Equity” of the Notes to Consolidated Financial Statements in Item 8 of this Report.) Companies participating in the TARP CPP were required to adopt certain standards relating to executive compensation. The terms of the TARP CPP also limit certain uses of capital by the issuer, including with respect to repurchases of securities and increases in dividends.
American Recovery and Reinvestment Act of 2009
On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (“ARRA”) was enacted. ARRA is intended to provide a stimulus to the U.S. economy in the wake of the economic downturn brought about by the subprime mortgage crisis and the resulting credit crunch. The bill included federal tax cuts, expansion of unemployment benefits and other social welfare provisions, and domestic spending in education, healthcare, and infrastructure, including the energy structure.
Under ARRA, an institution that received funds under TARP, such as the Company, is subject to certain restrictions and standards throughout the period in which any obligation arising under TARP remains outstanding (except for the time during which the federal government holds only warrants to purchase common stock of the issuer). The following summarizes the significant requirements of ARRA and applicable Treasury regulations:
  §   Limits on compensation incentives for risks by senior executive officers;
 
  §   A requirement for recovery of any compensation paid based on inaccurate financial information;
 
  §   A prohibition on “golden parachute payments” to specified officers or employees, which term is generally defined as any payment for departure from a company for any reason;
 
  §   A prohibition on compensation plans that would encourage manipulation of reported earnings to enhance the compensation of employees;
 
  §   A prohibition on bonus, retention award, or incentive compensation to designated employees, except in the form of long-term restricted stock;
 
  §   A requirement that the board of directors adopt a luxury expenditures policy;
 
  §   A requirement that shareholders be permitted a separate nonbinding vote on executive compensation;
 
  §   A requirement that the chief executive officer and the chief financial officer provide a written certification of compliance with the standards, when established, to the SEC.
Under ARRA, subject to consultation with the appropriate federal banking agency, Treasury is required to permit a recipient of TARP funds to repay any amounts previously provided to or invested in the recipient by Treasury without regard to whether the institution has replaced the funds from any other source or to any waiting period.
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) was enacted into law. The Dodd-Frank Act significantly changes regulation of financial institutions and the financial services industry, including: creating a Financial Services Oversight Council to identify emerging systemic risks and improve interagency cooperation; centralizing the responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau, which will be responsible for implementing, examining and enforcing compliance with federal consumer financial laws; permanently raising the current standard maximum deposit insurance amount to $250,000; establishing strengthened capital standards for banks, and

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disallowing trust preferred securities as qualifying as Tier 1 capital (subject to certain exceptions and grandfather provisions for existing trust preferred securities); amending the Truth in Lending Act with respect to mortgage originations and establishing new minimum mortgage underwriting standards; strengthening the SEC’s powers to regulate securities markets; granting the Federal Reserve Board the power to regulate debit card interchange fees; allowing the FDIC to raise the ratio of reserves to deposits from 1.15% to 1.35% for deposit insurance purposes by September 30, 2020 and to offset the effect of increased assessments on insured depository institutions with assets of less than $10 billion; allowing financial institutions to pay interest on business checking accounts; and implementing provisions that affect corporate governance and executive compensation at all publicly traded companies.
It is difficult to predict at this time the specific impact the Dodd-Frank Act and the yet to be written implementing rules and regulations will have on community banks. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such requirements will have on financial institutions’ operations is presently unclear. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage ratio requirements or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make necessary changes in order to comply with new statutory and regulatory requirements.
Regulation W
Transactions between a bank and its “affiliates” are quantitatively and qualitatively restricted under the Sections 23A and 23B of Federal Reserve Act. The FDIC Act applies Sections 23A and 23B to insured nonmember banks in the same manner and to the same extent as if they were members of the Federal Reserve System. The Federal Reserve Board has also recently issued Regulation W, which codifies prior regulations under Sections 23A and 23B of the Federal Reserve Act and interpretative guidance with respect to affiliate transactions. Regulation W incorporates the exemption from the affiliate transaction rules but expands the exemption to cover the purchase of any type of loan or extension of credit from an affiliate. Affiliates of a bank include, among other entities, the bank’s holding company and companies that are under common control with the bank. The Company 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 Royal Bank’s capital and surplus, in the case of covered transactions with any one affiliate; and
 
  §   To an amount equal to 20% of Royal Bank’s capital and surplus, in the case of covered transactions with all affiliates.
In addition, a bank and its subsidiaries may engage in covered transactions and other specified transactions only on terms and under circumstances that are substantially the same, or at least as favorable to the bank or its subsidiary, as those prevailing at the time for comparable transactions with nonaffiliated companies. A “covered transaction” includes:
  §   A loan or extension of credit to an affiliate;
 
  §   A purchase of, or an investment in, securities issued by an affiliate;
 
  §   A purchase of assets from an affiliate, with some exceptions;
 
  §   The acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any party; and
 
  §   This issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate.
In addition, under Regulation W:
  §   A bank and its subsidiaries may not purchase a low-quality asset from an affiliate;

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  §   Covered transactions and other specified transactions between a bank or its subsidiaries and an affiliate must be on terms and conditions that are consistent with safe and sound banking practices; and
 
  §   With some exceptions, each loan or extension of credit by a bank to an affiliate must be secured by collateral with a market value ranging from 100% to 130%, depending on the type of collateral, of the amount of the loan or extension of credit.
Regulation W generally excludes all non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve Board decides to treat these subsidiaries as affiliates.
Concurrently with the adoption of Regulation W, the Federal Reserve Board has proposed a regulation which would further limit the amount of loans that could be purchased by a bank from an affiliate to not more than 100% of Royal Bank’s capital and surplus.
FDIC Insurance Assessments
The Federal Deposit Insurance Reform Act of 2005 (the “Reform Act”), which was signed into law in 2006, resulted in a number of changes to how banks are assessed deposit premiums. Under the new risk-related premium schedule established by the Reform Act, the FDIC assigns each depository institution to one of several supervisory groups based on both capital adequacy and the FDIC’s judgment of the institution’s strength in light of supervisory evaluations, including examination reports, statistical analyses and other information relevant to measuring the risk posed by the institution.
The Reform Act merged the former BIF and SAIF into a single Deposit Insurance Fund (“DIF”), increased deposit insurance coverage for IRAs to $250,000, provides for the future increase of deposit insurance on all other accounts (presently limited to $250,000 per account) by indexing the coverage to the rate of inflation, authorizes the FDIC to set the reserve ratio of the combined DIF at a level between 1.15% and 1.50%, and permits the FDIC to establish assessments to be paid by insured banks to maintain the minimum ratios. The required reserve ratio will depend upon the growth of insured deposits at all banks in the U.S., the number and size of any bank failures, and the FDIC’s assessment of the risk in the banking industry at any given time.
On October 14, 2008, the FDIC announced its temporary “Transaction Account Guarantee Program” (“TAGP”) which provides full coverage for non-interest bearing deposit accounts. Royal Bank was participating in the program which guaranteed all personal and business non-interest bearing checking accounts. This unlimited coverage expired on December 31, 2010. Additionally the FDIC temporarily raised the insurance limit from $100,000 to $250,000 per depositor until December 31, 2013. Participation in the TAGP added an additional twenty-five basis points to the Company’s total FDIC assessment for 2010.
On February 27, 2009, the FDIC’s Board of Directors voted to amend the restoration plan for DIF. Failures of FDIC-insured institutions had caused the reserve ratio of DIF to decline from 1.19 percent as of March 30, 2008, to 0.76 percent as of September 30, 2008. Consequently, the 2009 DIF assessment rates reflected an increase of seven to nine basis points and range from $0.07 for those institutions with the least risk, up to $0.775 for every $100 of insured deposits for institutions deemed to have the highest risk. In May 2009, the Board imposed a five basis point emergency special assessment for every $100 of insured deposits on June 30, 2009. Royal Bank’s emergency special assessment was $601,000 and was collected on September 30, 2009. Additionally, in November 2009, the FDIC adopted a final rule imposing a 13-quarter prepayment of FDIC insurance premiums payable on December 30, 2009. The FDIC exempted Royal Bank from making this prepayment of approximately $11.8 million.
Beginning with the second quarter of 2011, as mandated by the recently enacted Dodd-Frank Act, the assessment base that the FDIC will use to calculate assessment premiums will be a bank’s average assets minus average tangible equity. As the asset base of the banking industry is larger than the deposit base, the range of assessment rates will change to a low or 2.5 basis points to a high of 45 basis points, per $100 of assets; however, the dollar amount of the actual premiums is expected to be roughly the same.

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The FDIC is required under the Dodd-Frank Act to establish assessment rates that will allow the Deposit Insurance Fund to achieve a reserve ratio of 1.35% of Insurance Fund insured deposits by September 2020. In addition, the FDIC has established a “designated reserve ratio” of 2.0%, a target ratio that, until it is achieved, will not likely result in the FDIC reducing assessment rates. In attempting to achieve the mandated 1.35% ratio, the FDIC is required to implement assessment formulas that charge banks over $10 billion in asset size more than banks under that size. Those new formulas begin in the second quarter of 2011, but do not affect Royal Bank. Under the Dodd-Frank Act, the FDIC is authorized to make reimbursements from the insurance fund to banks if the reserve ratio exceeds 1.50%, but the FDIC has adopted the “designated reserve ratio” of 2.0% and has announced that any reimbursements from the fund are indefinitely suspended.
In addition to deposit insurance, Royal Bank is also subject to assessments to pay the interest on Financing Corporation bonds. The Financing Corporation was created by Congress to issue bonds to finance the resolution of failed thrift institutions. Commercial banks and thrifts are subject to the same assessment for Financing Corporation bonds. The FDIC sets the Financing Corporation assessment rate every quarter. For the first quarter of 2011, the Financing Corporation’s assessment for Royal Bank (and all other banks), is an annual rate of $.0102 for each $100 of deposits. The Financing Corporation bonds are expected to be paid off between 2017 and 2019.
Other Legislation/Regulatory Requirements
Capital Framework and Basel III
The Basel Committee on Banking Supervision and the Financial Stability Board, which was established by the Group of 20 (“G-20”) Finance Ministers and Central Bank Governors to take action to strengthen regulation and supervision of the financial system with greater international consistency, cooperation and transparency, have both committed to raise capital standards and liquidity buffers within the banking system. On September 12, 2010, the G-20 Governors and Heads of Supervision agreed to the phase-in of Basel III with full implementation by January 2015 of the following minimum capital requirements: minimum tier 1 equity ratio of 6% (subject to an additional capital conservation buffer of potentially of 2.5% and 5% with implementation by January 2019 imposed by regulatory agencies during periods of excess aggregate credit growth), and minimum total capital to risk-weighted assets of 8%, subject to new deductions and adjustments to Tier 1 common equity. The G-20 endorsed Basel III on November 12, 2010. The U.S. financial regulatory agencies have indicated informally that they generally support Basel III and expect to propose regulations implementing Basel III in mid 2011 with final adoption of implementing regulations in mid 2012. Additionally, the Basel Committee is considering further amendments beyond the final framework that include more stringent capital requirements for “globally systemically important financial institutions”. The Company believes that our current capital levels already exceed the Basel III capital requirements.
In addition to the Federal Deposit Insurance Reform Act described above, the Financial Services Regulatory Relief Act of 2006 was also enacted. This legislation is a wide ranging law that affects many previously enacted financial regulatory laws. The overall intent of the law is to simplify regulatory procedures and requirements applicable to all banks, and to conform conflicting provisions. The Relief Act conforms a number of separate statutes to provide equal definitions and treatment for national banks, state banks, and for federal savings banks in a number of respects. The law streamlines certain reporting requirements, and provides for bank examinations on an 18 month schedule for smaller banks that qualify. The law also authorizes the Federal Reserve to pay interest to banks for the required deposit reserves maintained by banks at the Federal Reserve, but such interest would not begin to be paid until 2012. While this law has many facets that should benefit Royal Bank overall, the individual provisions of this law are not considered currently material to Royal Bank when considered alone.
Congress is currently considering major financial industry legislation, and the federal banking agencies routinely propose new regulations. The Company cannot predict how any new legislation, or new rules adopted by the federal banking agencies, may affect its business or the business of Royal Bank in the future.
Monetary Policy
The earnings of Royal Bank are affected by the policies of regulatory authorities including the Federal Reserve Board. An important function of the Federal Reserve System is to influence the money supply and interest rates. Among the

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instruments used to implement those objectives are open market operations in United States government securities, changes in reserve requirements against member bank deposits and limitations on interest rates that member banks may pay on time and savings deposits. These instruments are used in varying combinations to influence overall growth and distribution of bank loans and investments and deposits. Their use may also affect rates charged on loans or paid for deposits.
The policies and regulations of the Federal Reserve Board have had and will probably continue to have a significant effect on its reserve requirements, deposits, loans and investment growth, as well as the rate of interest earned and paid, and are expected to affect Royal Bank’s operations in the future. The effect of such policies and regulations upon the future business and earnings of Royal Bank cannot be predicted.
Effects of Inflation
Inflation can impact the country’s overall economy, which in turn can impact the business and revenues of the Company and its subsidiaries. Inflation has some impact on the Company’s operating costs. Unlike many industrial companies, however, substantially all of the Company’s assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on the Company’s performance than the general level of inflation. Over short periods of time, interest rates may not necessarily move in the same direction or in the same magnitude as prices of goods and services.
Available Information
Upon a shareholder’s written request, a copy of the Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, as required to be filed with the SEC pursuant to Exchange Act Rule 13a-1, may be obtained without charge from our Chief Executive Officer, Royal Bancshares of Pennsylvania, Inc. 732 Montgomery Avenue, Narberth, Pennsylvania 19072 or on our website www.royalbankamerica.com.
ITEM 1A. RISK FACTORS
An investment in our common stock involves risks. Before making an investment decision, investors should carefully consider the risks described below in conjunction with the other information in this Report, including our consolidated financial statements and related notes. If any of the following risks or other risks, which have not been identified or which we may believe are immaterial or unlikely, actually occurs, our business, financial condition and results of operations could be harmed. In such a case, the trading price of our common stock could decline, and investors may lose all or part of their investment.
Risks Related to Our Business
Our business may be impacted by the existence of the Orders for Royal Bank and the Federal Reserve Agreement with the Federal Reserve Bank of Philadelphia.
Our success as a business is dependent upon pursuing various alternatives in not only achieving the growth and expansion of our banking franchise but also in managing our day to day operations. The existence of the Orders and the Federal Reserve Agreement limits and impacts our ability to pursue all previously available alternatives in the management of the Company. Our ability to retain existing retail and commercial customers as well as the ability to attract potentially new customers may be impacted by the existence of the Orders and the Federal Reserve Agreement. The Company has been successful in commercial real estate lending; however, our ability to expand into potentially attractive commercial real estate or construction loans at this time would most likely be limited. Our ability to obtain lines of credit, to receive attractive collateral treatment from funding sources, and to pursue all attractive funding alternatives in this current low interest rate environment could be potentially impacted and thereby limit liquidity alternatives. Royal Bank’s ability to pay dividends to the Company, which provides funding for cash dividends to the Company’s shareholders, will be limited as a result of the Orders. Moreover, the Company is prohibited from paying cash dividends without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System. Our ability to raise capital in the current economic environment could be potentially limited or impacted as a result of the

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Orders. Attracting new management talent is critical to the success of our business and could be potentially impacted due to the existence of the Orders and the Federal Reserve Agreement.
Our business is subject to the success of the local economies and real estate markets in which we operate.
Our success significantly depends on the growth in population, income levels, loans and deposits and on the continued stability in real estate values in our markets. If the communities in which we operate do not grow or if prevailing economic conditions locally or nationally are unfavorable, our business may be adversely affected. Adverse economic conditions in our specific market areas, specifically decreases in real estate property values due to the nature of our loan portfolio, over 80% of which is secured by real estate, could reduce our growth rate, affect the ability of customers to repay their loans and generally affect our financial condition and results of operations. The Company is less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of more diverse economies.
Our concentration of non-residential real estate and construction loans is subject to unique risks that could adversely affect our earnings.
Our non-residential real estate and construction and land development loan portfolio held for investment was $284.1 million at December 31, 2010 comprising 57% of total loans. Non-residential real estate and construction and development loans are often riskier and tend to have significantly larger balances than home equity loans or residential mortgage loans to individuals. While we believe that the commercial real estate concentration risk is mitigated by diversification among the types and characteristics of real estate collateral properties, sound underwriting practices, and ongoing portfolio monitoring and market analysis, the repayments of these loans usually depends on the successful operation of a business or the sale of the underlying property. As a result, these loans are more likely to be unfavorably affected by adverse conditions in the real estate market or the economy in general. The remaining loans in the portfolio are commercial or industrial loans. These loans are collateralized by various business assets the value of which may decline during adverse market and economic conditions. Adverse conditions in the real estate market and the economy may result in increasing levels of loan charge-offs and non-performing assets and the reduction of earnings. When we take collateral in foreclosures and similar proceedings, we are required to mark the related asset to the then fair market value of the collateral, which may ultimately result in a loss.
Further, under guidance adopted by the federal banking regulators, banks which have concentrations in construction, land development or commercial real estate loans (other than loans for majority owner occupied properties) would be expected to maintain higher levels of risk management and, potentially, higher levels of capital. It is possible that Royal Bank may be required to maintain higher levels of capital than it would be otherwise be expected to maintain as a result of Royal Bank’s commercial real estate loans, which may require the Company to obtain additional capital sooner than it would otherwise seek it, which may reduce shareholder returns.
Our allowance for loan and lease losses may not be adequate to cover actual losses.
Like all financial institutions, we maintain an allowance for loan and lease losses to provide for loan defaults and non-performance. Our allowance for loan and lease losses is based on our historical loss experience as well as an evaluation of the risks associated with our loan portfolio, including the size and composition of the loan portfolio, current economic conditions and geographic concentrations within the portfolio. Our allowance for loan and lease losses may not be adequate to cover actual loan and lease losses and future provisions for loan and lease losses could materially and adversely affect our financial results.
Our current level of non-performing loans and future growth may require us to raise additional capital but that capital may not be available.
We are required by regulatory authorities to maintain adequate capital levels to support our operations. We anticipate that our current capital will satisfy our regulatory requirements for the foreseeable future. However, in order to maintain our well-capitalized status and to support future growth we may need to raise capital. Our ability to raise additional capital will depend, in part, on conditions in the capital markets at that time, which are outside our

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control, and on our financial performance. Under the Orders as described in “Regulatory Actions” under “Item 1 — Business” of this Report, Royal Bank is required to maintain a minimum Tier 1 leverage ratio of 8% and a Total risk-based capital ratio of 12% during the term of the Orders. In addition, on February 20, 2009, we issued 30,407 shares of Fixed Rate Cumulative Preferred Stock, Series A, to the United States Department of Treasury under its TARP Capital Purchase Program, The Series A Preferred Stock issued to Treasury has a liquidation preference of $1,000 per share and contains other provisions, including restrictions on the payment of dividends on common stock and on repurchases of any shares of preferred stock ranking equal to or junior to the Series A Preferred Stock or common stock while the Series A Preferred Stock is outstanding, which provisions may make it more difficult to raise additional capital on favorable terms while the Series A Preferred Stock is outstanding. Therefore, we may be unable to raise additional capital, or to raise capital on terms acceptable to us. If we cannot raise additional capital when required, our ability to further expand operations through both internal growth and acquisitions could be materially impaired. In addition, if we decide to raise additional capital, the existing shareholders are subject to dilution.
We may suffer losses in our loan portfolio despite our underwriting practices.
The Company seeks to mitigate the risks inherent in its loan portfolio by adhering to specific underwriting practices. These practices often include: analysis of a borrower’s credit history, financial statements, tax returns and cash flow projections; valuation of collateral based on reports of independent appraisers; and verification of liquid assets. Although we believe that our underwriting criteria are appropriate for the various kinds of loans we make, the Company may incur losses on loans that meet these criteria.
Holders of our Series A Preferred Stock have certain voting rights that may adversely affect our common shareholders, and the holders of the Series A Preferred Stock may have interests different from our common shareholders.
Since the Company has failed to pay dividends on the Series A Preferred Stock for a total of six quarterly dividend periods (whether or not consecutive), the Treasury currently has the right to appoint two directors to our Board of Directors until all accrued but unpaid dividends have been paid. Otherwise, except as required by law, holders of the Series A Preferred Stock have limited voting rights.
For as long as shares of the Series A Preferred Stock are outstanding, in addition to any other vote or consent of the shareholders required by law or our Articles of Incorporation, the vote or consent of holders of at least 66 2/3% of the shares of the Series A Preferred Stock outstanding is required for any authorization or issuance of shares ranking senior to the Series A Preferred Stock; any amendments to the rights of the Series A Preferred Stock so as to adversely affect the rights, privileges, or voting power of the Series A Preferred Stock; or initiation and completion of any merger, share exchange or similar transaction unless the shares of Series A Preferred Stock remain outstanding, or if we are not the surviving entity in such transaction, are converted into or exchanged for preference securities of the surviving entity and the shares of Series A Preferred Stock remaining outstanding or such preference securities have the rights, preferences, privileges and voting power of the Series A Preferred Stock.
The holders of our Series A Preferred Stock, including the Treasury, may have different interests from the holders of our common stock, and could vote to block the forgoing transactions, even when considered desirable by, or in the best interests of the holders of our common stock.
Our ability to pay dividends depends primarily on dividends from our banking subsidiary, which are subject to regulatory limits and we are subject to other dividend limitations.
We are a bank holding company and our operations are conducted by direct and indirect subsidiaries, each of which is a separate and distinct legal entity. Substantially all of our assets are held by our direct and indirect subsidiaries. Our ability to pay dividends depends on our receipt of dividends from our direct and indirect subsidiaries. Our banking subsidiary, Royal Bank is our primary source of dividends. Dividend payments from our banking subsidiary are subject to legal and regulatory limitations, generally based on net profits and retained earnings, imposed by the various banking regulatory agencies. The ability of Royal Bank to pay dividends is also subject to its profitability, financial condition, capital expenditures and other cash flow requirements. At December 31, 2010, as a result of significant losses within Royal Bank, the Company had negative retained earnings and therefore would not

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have been able to declare and pay any cash dividends. There is no assurance that our subsidiaries will be able to pay dividends in the future or that we will generate adequate cash flow to pay dividends in the future. Under the Orders as described in “Regulatory Actions” under “Item 1 — Business” of this Report, Royal Bank must receive prior approval from the FDIC and the Department before declaring and paying a dividend to the Company.
As a result of our participation in the Treasury’s TARP CPP on February 20, 2009, we are required to receive Treasury’s approval for any increases in the dividend above the amount of the last regular quarterly common stock dividend paid prior to October 14, 2008 ($0.15 per Class A share and $0.1725 per Class B share) and any repurchases of common stock. These restrictions on the payment of dividends and the repurchases of common stock will remain in effect until the earlier date of the third anniversary of the closing date of the preferred shares and the date of the redemption of the preferred shares. In addition, under the terms of the TARP CPP, we are not permitted to declare or pay cash dividends on, or redeem or otherwise acquire, stock that is junior to or on parity with the Series A Preferred Stock issued to Treasury at any time when we have not declared and paid full dividends on the Series A Preferred Stock. We suspended regular quarterly cash dividends on the Series A Preferred Stock in August 2009 and, accordingly, are not permitted at this time to pay dividends on our Class A or Class B Common Stock.
Under the terms of the Federal Reserve Agreement, we are prohibited from paying any dividends on shares of our stock without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System.
Failure to pay dividends on our stock could have a material adverse effect on the market price of our Class A Common Stock.
Competition from other financial institutions may adversely affect our profitability.
We face substantial competition in originating loans, both commercial and consumer. This competition comes principally from other banks, savings institutions, mortgage banking companies and other lenders. Many of our competitors enjoy advantages, including greater financial resources and higher lending limits, a wider geographic presence, more accessible branch office locations, the ability to offer a wider array of services or more favorable pricing alternatives, as well as lower origination and operating costs. This competition could reduce our net income by decreasing the number and size of loans that we originate and the interest rates we may charge on these loans.
In attracting business and consumer deposits, Royal Bank faces substantial competition from other insured depository institutions such as banks, savings institutions and credit unions, as well as institutions offering uninsured investment alternatives, including money market funds. Many of our competitors enjoy advantages, including greater financial resources, more aggressive marketing campaigns, better brand recognition and more branch locations. These competitors may offer higher interest rates than we do, which could decrease the deposits that we attract or require us to increase our rates to retain existing deposits or attract new deposits. Increased deposit competition could adversely affect our ability to generate the funds necessary for lending operations. As a result, we may need to seek other sources of funds that may be more expensive to obtain and could increase our cost of funds.
The Company’s banking and non-banking subsidiaries also compete with non-bank providers of financial services, such as brokerage firms, consumer finance companies, credit unions, insurance agencies and governmental organizations which may offer more favorable terms. Some of our non-bank competitors are not subject to the same extensive regulations that govern our banking operations. As a result, such non-bank competitors may have advantages over the Company’s banking and non-banking subsidiaries in providing certain products and services. This competition may reduce or limit our margins on banking and non-banking services, reduce our market share, and adversely affect our earnings and financial condition.
The Company has a lower level of “core deposits” and a higher level of wholesale funding relative to our peer institutions.
The Company achieved significant growth in the loan portfolio until two years ago. Because the Company’s retail deposits had not grown at similar rates, our funding sources were supplemented to include the national market (brokered CDs) to attract additional funds. During an environment when interest rates are rising and the related U.S.

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Treasury interest rate curve is flattening, the use of this funding source may result in an increase in interest costs disproportionate to loan yields. This could result in reduced net interest income. During the past 18 months, loan balances have declined and the Company has reduced the outstanding amount of brokered CDs by $138 million, or 61%, in order to reduce this risk.
Our ability to manage liquidity is always critical in our operation, but more so today given the uncertainty within the capital markets.
We monitor and manage our liquidity position on a regular basis to insure that adequate funds are in place to manage the day to day operations and to cover routine fluctuations in available funds. However, our funding decisions can be influenced by unplanned events. These unplanned events include, but are not limited to, the inability to fund asset growth, difficulty renewing or replacing funds that mature, the ability to maintain or draw down lines of credit with other financial institutions, significant customer withdrawals of deposits, and market disruptions. The Federal Home Loan Bank of Pittsburgh had imposed an over collateralized delivery requirement of 105% on Royal Bank as a result of Royal Bank’s level of non-performing assets and losses incurred in 2009. The available amount for future borrowings will be based on the amount of collateral to be pledged. We have a liquidity contingency plan in the event liquidity falls below an acceptable level, however in today’s economic environment, we are not certain that those sources of liquid funds will be available in the future when required. As a result, loan growth may be curtailed to maintain adequate liquidity, loans may need to be sold in the secondary market, investments may need to be sold or deposits may need to be raised at above market interest rates to maintain liquidity.
Negative publicity could damage our reputation and adversely impact our business and financial results.
Reputation risk, or the risk to the Company’s earnings and capital from negative publicity, is inherent in our business. Negative publicity can result from the Company’s actual or alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions, and actions taken by government regulators and community organizations in response to those activities. Negative publicity can adversely affect our ability to keep and attract customers and can expose the Company to litigation and regulatory action. Although the Company takes steps to minimize reputation risk in dealing with customers and other constituencies, the Company, as a larger diversified financial services company with a high industry profile, is inherently exposed to this risk.
Risks Related to Our Industry
Recent legislative and regulatory initiatives to address difficult market and economic conditions may not stabilize the U.S. banking system.
On July 21, 2010, the Dodd-Frank Act was enacted into law. The Dodd-Frank Act significantly changes regulation of financial institutions and the financial services industry, including the creation of a Financial Services Oversight Council to identify emerging systemic risks and improve interagency cooperation and the Consumer Financial Protection Bureau, which will be responsible for implementing, examining and enforcing compliance with federal consumer financial laws. The regulatory changes include, among other things, permanently raising the current standard maximum deposit insurance amount to $250,000; establishing strengthened capital standards for banks, and disallowing trust preferred securities as qualifying as Tier 1 capital (subject to certain grandfather provisions for existing trust preferred securities); establishing new minimum mortgage underwriting standards; strengthening the SEC’s powers to regulate securities markets; granting the Federal Reserve Board the power to regulate debit card interchange fees; allowing financial institutions to pay interest on business checking accounts; and implementing provisions that affect corporate governance at all publicly traded companies. These changes are expected to impact our compliance costs resulting from significant changes in our policies and procedures. Many aspects of the Dodd-Frank Act are subject to rulemaking that will take effect over several years, thus making it difficult to assess the impact of the statute on the Company, at this time.
On October 3, 2008, EESA became law. EESA, among other measures, authorizes Treasury to purchase from financial institutions and their holding companies up to $700 billion in mortgage loans, mortgage-related securities and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies, under TARP. The purpose of TARP is to restore confidence and stability to the U.S. banking

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system and to encourage financial institutions to increase their lending to customers and to each other. Under the TARP Capital Purchase Program, Treasury is purchasing equity securities from participating institutions. EESA also increased federal deposit insurance on most deposit accounts from $100,000 to $250,000. This increase is not covered by deposit insurance premiums paid by the banking industry.
EESA followed, and has been followed by, numerous actions by the Board of Governors of the Federal Reserve System, the U.S. Congress, Treasury, the FDIC, the SEC and others to address the current liquidity and credit crisis that has followed the sub-prime meltdown that commenced in 2007. These measures include homeowner relief that encourage loan restructuring and modification; the establishment of significant liquidity and credit facilities for financial institutions and investment banks; the lowering of the federal funds rate; emergency action against short selling practices; a temporary guarantee program for money market funds; the establishment of a commercial paper funding facility to provide back-stop liquidity to commercial paper issuers; and coordinated international efforts to address illiquidity and other weaknesses in the banking sector. Additional similar actions may be forthcoming.
The purpose of these legislative and regulatory actions is to stabilize the U.S. banking system. EESA and the other regulatory initiatives described above may not have their desired effects. If the volatility in the markets continues and economic conditions fail to improve or worsen, our business, financial condition, results of operations and cash flows could be materially and adversely affected.
Difficult market conditions and economic trends have adversely affected our industry and our business.
We are exposed to downturns in the U. S. housing market. Dramatic declines in the housing market over the past year, with decreasing home prices and increasing delinquencies and foreclosures, may have a negative impact on the credit performance of mortgage, consumer, commercial and construction loan portfolios resulting in significant write-downs of assets by many financial institutions. In addition, the values of real estate collateral supporting many loans have declined and may continue to decline. General downward economic trends, reduced availability of commercial credit and increasing unemployment may negatively impact the credit performance of commercial and consumer credit, resulting in additional write-downs. Concerns over the stability of the financial markets and the economy have resulted in decreased lending by financial institutions to their customers and to each other. This market turmoil and tightening of credit has led to increased commercial and consumer deficiencies, lack of customer confidence, increased market volatility and widespread reduction in general business activity. Competition among depository institutions for deposits has increased significantly. Financial institutions have experienced decreased access to deposits or borrowings. The resulting economic pressure on consumers and businesses and the lack of confidence in the financial markets may adversely affect our business, financial condition, results of operations and stock price. We do not expect that the difficult market conditions will improve in the immediate future. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the industry. In particular, we may face the following risks in connection with these events:
  §   We expect to face increased regulation of our industry. Compliance with such regulation may increase our costs and limit our ability to pursue business opportunities.
 
  §   Our ability to assess the creditworthiness of customers and to estimate the losses inherent in our credit exposure is made more complex by these difficult market and economic conditions.
 
  §   We also may be required to pay even higher Federal Deposit Insurance Corporation premiums than the recently increased level, because financial institution failures resulting from the depressed market conditions have depleted and may continue to deplete the deposit insurance fund and reduce its ratio of reserves to insured deposits.
 
  §   Our ability to borrow from other financial institutions or the Federal Home Loan Bank on favorable terms or at all could be adversely affected by further disruptions in the capital markets or other events.
 
  §   We may experience a prolonged decrease in dividend income from our investment in Federal Home Loan Bank stock.

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  §   We may experience increases in foreclosures, delinquencies and customer bankruptcies, as well as more restricted access to funds.
 
  §   The unrealized losses in our investment portfolio may increase or be deemed other than temporary.
Our business is subject to interest rate risk and variations in interest rates may negatively affect our financial performance.
Changes in the interest rate environment may reduce profits. The primary source of our income is the differential or “spread” between the interest earned on loans, securities and other interest-earning assets, and interest paid on deposits, borrowings and other interest-bearing liabilities. As prevailing interest rates change, net interest spreads are affected by the difference between the maturities and re-pricing characteristics of interest-earning assets and interest-bearing liabilities. In addition, loan volume and yields are affected by market interest rates on loans, and rising interest rates generally are associated with a lower volume of loan originations. An increase in the general level of interest rates may also adversely affect the ability of certain borrowers to pay the interest on and principal of their obligations. Accordingly, changes in levels of market interest rates could materially adversely affect our net interest spread, asset quality, loan origination volume and overall profitability.
Future governmental regulation and legislation could limit our future growth.
The Company and our subsidiaries are subject to extensive state and federal regulation, supervision and legislation that govern almost all aspects of the operations of the Company and our subsidiaries. These laws may change from time to time and are primarily intended for the protection of consumers, depositors and the deposit insurance funds. Any changes to these laws may negatively affect our ability to expand our services and to increase the value of our business. While we cannot predict what effect any presently contemplated or future changes in the laws or regulations or their interpretations would have on the Company, these changes could be materially adverse to shareholders.
Changes in consumer use of banks and changes in consumer spending and saving habits could adversely affect the Company’s financial results.
Technology and other changes now allow many consumers to complete financial transactions without using banks. For example, consumers can pay bills and transfer funds directly without going through a bank. This “disintermediation” could result in the loss of fee income, as well as the loss of customer deposits and income generated from those deposits. In addition, changes in consumer spending and saving habits could adversely affect our operations, and may be unable to timely develop competitive new products and services in response to these changes that are accepted by new and existing customers.
Acts or threats of terrorism and political or military actions taken by the United States or other governments could adversely affect general economic or industry conditions.
Geopolitical conditions may also affect our earnings. Acts or threats or terrorism and political or military actions taken by the United States or other governments in response to terrorism, or similar activity, could adversely affect general economic or industry conditions.
Other Risks
Our directors, executive officers and principal shareholders own a significant portion of our common stock and can influence shareholder decisions.
Our directors, executive officers and principal shareholders, as a group, beneficially owned approximately 57% of Class A common stock and 87% of Class B common stock as of February 28, 2011. As a result of their ownership, the directors, executive officers and principal shareholders will have the ability, by voting their shares in concert, to influence the outcome of any matter submitted to our shareholders for approval, including the election of directors.

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The directors and executive officers may vote to cause the Company to take actions with which the other shareholders do not agree or that are not beneficial to all shareholders.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
Royal Bank has fifteen banking offices, which are located in Pennsylvania and New Jersey.
         
15th Street Office
  Bala Plaza Office (3)   Bridgeport Office (1)
30 South Street
  231 St. Asaph's Road   105 W. 4th Street
Philadelphia, PA 19102
  Bala Cynwyd, PA 19004   Bridgeport, PA 19406
 
       
Castor Office (1)
  Fairmont Office (1)   Grant Avenue Office (1)
6331 Castor Avenue
  401 Fairmont Avenue   1650 Grant Avenue
Philadelphia, PA 19149
  Philadelphia, PA 19123   Philadelphia, PA 19115
 
       
Henderson Road Office
  Jenkintown Office (1)   King of Prussia Office (1)
Biedler and Henderson Roads
  600 Old York Road   655 West DeKalb Pike
King of Prussia, PA 19406
  Jenkintown, PA 19046   King of Prussia, PA 19406
 
       
Narberth Office (1)
  Narberth Training Center (1)(2)   Phoenixville Office (1)
732 Montgomery Avenue
  814 Montgomery Avenue   808 Valley Forge Road
Narberth, PA 19072
  Narberth, PA 19072   Phoenixville, PA 19460
 
       
Shillington Office
  Trooper Office (1)   Turnersville Office
516 East Lancaster Avenue
  Trooper and Egypt Roads   3501 Black Horse Pike
Shillington, PA 19607
  Trooper, PA 19401   Turnersville, NJ 08012
 
       
Villanova Office
  Walnut Street Office   Storage Facility (1)
801 East Lancaster Avenue
  1230 Walnut Street   3836 Spring Garden Street
Villanova, PA 19085
  Philadelphia, PA 19107   Philadelphia, PA 19104
 
(1)   Owned
 
(2)   Used for employee training
 
(3)   Loan production office
Royal Bank owns eleven of the above properties. The remaining seven properties are leased with expiration dates between 2011 and 2021. During 2010, Royal Bank made aggregate lease payments of approximately $767,000. During 2010. Royal Asian made aggregate lease payments of approximately $501,000. The Company believes that all of its properties are attractive, adequately insured, and well maintained and are adequate for Royal Bank’s purposes.
ITEM 3. LEGAL PROCEEDINGS
Management is not aware of any litigation that would have a material adverse effect on the consolidated financial position or results of operations of the Company. There are no proceedings pending other than routine litigation incident to the business of the Company.
As described under “Item 1 — Business” of this Report, Royal Bank holds a 60% equity interest in each of Crusader Servicing Corporation (“CSC”) and Royal Tax Lien Services, LLC (“RTL”). CSC and RTL acquire, through public auction, delinquent tax liens in various jurisdictions thereby assuming a superior lien position to most other lien

28


 

holders, including mortgage lien holders. On March 4, 2009, each of CSC and RTL received a grand jury subpoena issued by the U.S. District Court for New Jersey upon application of the Antitrust Division of the U.S. Department of Justice (“DOJ”). The subpoena seeks certain documents and information relating to an ongoing investigation being conducted by the DOJ. It is possible that the outcome of the investigation could result in fines and penalties being assessed against both CSC and RTL, which could also result in reputational risk due to negative publicity. However, Royal Bank has been advised that neither CSC nor RTL are targets of the DOJ investigation, but they are subjects of the investigation. Royal Bank, CSC and RTL are cooperating in the investigation.
ITEM 4. (REMOVED AND RESERVED)
PART II
ITEM 5.   MARKET FOR REGISTRANT’S COMMON EQUITY, AND RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company’s Class A Common Stock commenced trading on the NASDAQ Global Market under the symbol RBPAA. There is no market for the Company’s Class B Common Stock. The Class B shares may not be transferred in any manner except to the holder’s immediate family. Class B shares may be converted to Class A shares at the rate of 1.15 to 1.
The following table shows the range of high and low closing prices for the Company’s stock as reported by NASDAQ.
                 
Closing Prices
2010   High   Low
First Quarter
  $ 2.77     $ 1.24  
Second Quarter
    4.17       2.46  
Third Quarter
    3.01       1.74  
Fourth Quarter
    2.04       1.29  
                 
2009   High   Low
First Quarter
  $ 4.25     $ 2.05  
Second Quarter
    2.65       1.71  
Third Quarter
    2.10       1.40  
Fourth Quarter
    1.80       1.05  
The approximate number of recorded holders of the Company’s Class A and Class B Common Stock, as of February 28, 2011, is shown below:
         
Title of Class   Number of record holders
Class A Common stock
    275  
Class B Common stock
    138  
Dividends
Subject to certain limitations imposed by law or the Company’s articles of incorporation, the Board of Directors of the Company may declare a dividend on shares of Class A or Class B Common Stock.

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Stock dividends: On December 20, 2006, the board of directors of the Company declared a 5% stock dividend on both its Class A Common Stock and Class B Common Stock shares payable on January 17, 2007, to shareholders of record on January 3, 2007. The stock dividend resulted in the issuance of 526,825 additional shares of Class A common stock and 100,345 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. There were no stock dividends declared since 2006.
Cash Dividends: The Company paid cash dividends in the first two quarters of 2008 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 $4.0 million. In July 2008, the Company suspended cash dividends on its common stock to preserve capital and maintain liquidity in response to current financial and economic trends. The Company did not pay cash dividends on its common stock in 2010 and 2009.
Future dividends depend upon net income, capital requirements, and appropriate legal restrictions and other factors relevant at the time the Board of Directors of the Company considers dividend policy. Cash necessary to fund dividends available for dividend distributions to the shareholders of the Company must initially come primarily from dividends paid by its direct and indirect subsidiaries, including Royal Bank to the Company. As a result of the Orders as described under “Regulatory Actions” in “Item 1 — Business” of this Report, Royal Bank must obtain approval from the FDIC and the Department prior to declaring a cash dividend to the Company. Therefore, the restrictions on Royal Bank’s dividend payments are directly applicable to the Company. 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, the Company may pay dividends only if after payment the Company 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 the Company 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 “Note 14 — Shareholder’s Equity” of the Notes to Consolidated Financial Statements in Item 8 of this Report.
As a result of the investment by Treasury under the TARP CPP on February 20, 2009, the Company is required to receive Treasury’s approval for any increases in the dividend above the amount of the last regular quarterly common stock dividend paid prior to October 14, 2008 ($0.15 per Class A share and $0.1725 per Class B share) and any repurchases of common stock. These restrictions on the payment of dividends and the repurchases of common stock by the Company become effective immediately and remain in effect until the earlier date of the third anniversary of the closing date of the preferred shares and the date of the redemption of the preferred shares.
On August 13, 2009, the Company’s board of directors determined to suspend regular quarterly cash dividends on the $30.4 million in Series A Preferred Stock. The Company’s board of directors took this action in consultation with the Federal Reserve Bank of Philadelphia as required by regulatory policy guidance. The Company currently has sufficient capital and liquidity to pay the scheduled dividends on the preferred stock; however, the Company believes this decision will better support the capital position of Royal Bank, a wholly owned subsidiary of the Company. As of December 31, 2010, the Series A Preferred stock dividend in arrears is $2.4 million, which has not been recognized in the consolidated financial statements.

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COMMON STOCK PERFORMANCE GRAPH
The performance graph shows cumulative investment returns to shareholders based on the assumption that an investment of $100 was made on December 31, 2005, (with all dividends reinvested), in each of the following:
  §   Royal Bancshares of Pennsylvania, Inc. Class A common stock;
 
  §   The stock of all United States companies trading on the NASDAQ Global Market;
 
  §   Common stock of 2010 Peer Group consists of twenty banks headquartered in the Mid-Atlantic region, trade on the major exchange and have total assets between $750 million and $1.5 billion.
 
  §   SNL Bank and Thrift Index
(PERFORMANCE GRAPH)
                                                                 
 
        Period Ending
  Index     12/31/05     12/31/06     12/31/07     12/31/08     12/31/09     12/31/10  
 
Royal Bancshares of Pennsylvania, Inc.
      100.00         124.45         55.01         17.11         6.68         7.19    
 
NASDAQ Composite
      100.00         110.39         122.15         73.32         106.57         125.91    
 
SNL Bank and Thrift
      100.00         116.85         89.10         51.24         50.55         56.44    
 
Royal Bancshares Peer Group*
      100.00         111.18         85.91         70.56         63.63         68.05    
 

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ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial and operating information for the Company should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and accompanying notes in Item 8 of this Report:
                                         
Statement of Operations Data   For the years ended December 31,  
(In thousands, except share data)   2010     2009     2008     2007     2006  
Interest income
  $ 57,262     $ 66,043     $ 72,764     $ 86,736     $ 93,006  
Interest expense
    25,994       37,439       38,109       48,873       46,372  
 
                             
Net interest income
    31,268       28,604       34,655       37,863       46,634  
Provision for loan and lease losses
    22,140       20,605       21,841       13,026       1,803  
 
                             
Net interest income after loan and lease losses
    9,128       7,999       12,814       24,837       44,831  
 
                             
Gain on sale of premises & equipment
    156             1,991              
Gain on sale of premises & equipment related to real estate owned via equity investments
    667       1,817       1,679       1,860       3,036  
Income from bank owned life insurance
    379       1,099       1,233       875       847  
Service charges and fees
    1,266       1,419       1,186       1,348       1,404  
Gains on sales related to real estate joint ventures
                1,092       350        
Income related to real estate owned via equity investments
    564       1,302       965       1,384       3,591  
Gains on sale of real estate
    1,019       294       429       1,111       2,129  
Gains on sale of loans
    510       914       190       404       379  
Gains (loss) on investment securities
    1,290       1,892       (1,313 )     5,358       383  
Gain on sale of security claim
    1,656                          
Other income
    737       578       148       198       202  
 
                             
Other income, excluding other-than-temporary impairment losses
    8,244       9,315       7,600       12,888       11,971  
 
                             
Total other than-temporary-impairment losses on investment securities
    (566 )     (13,431 )     (23,388 )            
Portion of loss recognized in other comprehensive loss
    87       2,390                    
 
                             
Net impairment losses recognized in earnings
    (479 )     (11,041 )     (23,388 )            
 
                             
Total other income (loss)
    7,765       (1,726 )     (15,788 )     12,888       11,971  
 
                             
(Loss) income before other expenses & income taxes
    16,893       6,273       (2,974 )     37,725       56,802  
Non-interest expense
                                       
Salaries and benefits
    11,591       12,235       15,044       12,215       13,451  
Impairment related to OREO
    7,374       4,537                    
Impairment related to real estate owned via equity investments
    2,600             1,500       8,500        
Expenses related to real estate owned via equity investments
    529       907       966       1,590       1,606  
Impairment related to real estate joint venture
    1,552                   5,927        
Other
    17,097       24,514       15,023       11,800       9,595  
 
                             
Total other expense
    40,743       42,193       32,533       40,032       24,652  
 
                             
(Loss) income before tax expense (benefit)
    (23,850 )     (35,920 )     (35,507 )     (2,307 )     32,150  
Income tax expense (benefit)
          474       2,643       (1,568 )     10,015  
 
                             
Net (loss) income
  $ (23,850 )   $ (36,394 )   $ (38,150 )   $ (739 )   $ 22,135  
 
                             
Less net income (loss) attributable to noncontrolling interest
    243       1,402       (68 )     (1,303 )     567  
Net (loss) income attributable to Royal Bancshares
    (24,093 )     (37,796 )     (38,082 )     564       21,568  
Less Series A Preferred stock accumulated dividend and accretion
    (1,970 )     (1,672 )                  
Net (loss) income available to common shareholders
    (26,063 )     (39,468 )     (38,082 )     564       21,568  
 
Basic (loss) earnings per common share
  $ (1.97 )   $ (2.64 )   $ (2.86 )   $ 0.04     $ 1.60  
 
                             
Diluted (loss) earnings per common share
  $ (1.97 )   $ (2.64 )   $ (2.86 )   $ 0.04     $ 1.59  
 
                             

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Balance Sheet Data   For the years ended December 31,
(In thousands)   2010   2009   2008   2007   2006
Total Assets
    980,626       1,292,726       1,175,586       1,278,475       1,356,311  
Total average assets (2)
    1,177,922       1,295,126       1,189,518       1,314,361       1,317,688  
Loans, net
    475,725       656,533       671,814       625,193       580,759  
Total deposits
    693,913       881,755       760,068       770,152       859,457  
Total average deposits
    791,026       857,742       724,384       869,884       761,267  
Total borrowings (1)
    180,723       283,601       313,805       339,251       301,203  
Total average borrowings (1)
    256,688       307,225       307,597       254,757       377,139  
Total shareholders’ equity (3)
    84,093       101,156       79,687       146,367       163,254  
Total average shareholders’ equity
    103,895       107,511       131,155       158,695       158,372  
Return on average assets
    2.04 %     (3.20 %)     0.04 %     1.64 %     1.68 %
Return on average equity
    (23.19 %)     (29.04 %)     0.36 %     13.62 %     22.01 %
Average equity to average assets
    8.82 %     8.30 %     11.03 %     12.10 %     12.02 %
Dividend payout ratio
    0.00 %     0.00 %     (10.52 %)     2743.40 %     66.10 %
 
(1)   Includes obligations through VIE equity investments and subordinated debt.
 
(2)   Includes premises and equipment of VIE.
 
(3)   Excludes noncontrolling interest
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 the Company and the related Notes in Item 8 of this Report.
Critical Accounting Policies, Judgments and Estimates
The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and general practices within the financial services industry. Critical accounting policies, judgments and estimates relate to investment securities, loans, allowance for loan and lease losses and deferred tax assets. The policies which significantly affect the determination of the Company’s financial position, results of operations and cash flows are summarized in “Note 1 — Summary of Significant Accounting Polices” to the Consolidated Financial Statements and are discussed in the section captioned “Recent Accounting Pronouncements” of Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in Items 7 and 8 of this Report, each of which is incorporated herein by reference.
Investment Securities
Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each balance sheet date.
Investments in debt securities that the Company has the positive intent and ability to hold to maturity are classified as held to maturity securities and reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized holding gains and losses included in earnings. Debt and equity securities not classified as trading securities, nor as held to maturity securities are classified as available for sale securities and reported at fair value, with unrealized holding gains or losses, net of deferred income taxes, reported in the accumulated other comprehensive income component of shareholders’ equity. The Company held no trading securities at December 31, 2010 and 2009. Discounts and premiums are accreted/amortized to income by use of the level-yield method. Gain or loss on sales of securities available for sale is based on the specific identification method.

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The Company adopted FASB guidance related to the recognition and presentation of other-than-temporary impairment effective June 30, 2009. This accounting guidance amends the recognition guidance for other-than-temporary impairments of debt securities and expands the financial statement disclosures for other-than-temporary impairment losses on debt and equity securities. The guidance replaced the “intent and ability” indication by specifying that (a) if a company does not have the intent to sell a debt security prior to recovery and, (b) it is more likely than not that it will not have to sell the debt security prior to recovery, the security would not be considered other-than-temporarily impaired unless there is a credit loss.
When an entity does not intend to sell the security, and it is more likely than not, the entity will not have to sell the security before recovery of its cost basis, it will recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. For held-to-maturity debt securities, the amount of an other-than-temporary impairment recorded in other comprehensive income for the noncredit portion of a previous other-than-temporary impairment should be amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security.
Prior to the adoption of the guidance on June 30, 2009, management considered, in determining whether other-than-temporary impairment exists (1) the length of time and the extent to which the fair value has been less than amortized cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain the investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
For more information on the fair value of the Company’s investment securities and other financial instruments refer to “Note 3 — Investment Securities” and “Note 20 - Fair Values of Financial Instruments” to the Consolidated Financial Statements included in Item 8 of this Report.
Allowance for Loan and Lease Losses
The Company considers that the determination of the allowance for loan and lease losses involves a higher degree of judgment and complexity than its other significant accounting policies. The allowance for loan and lease 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 and lease losses may be required that would adversely impact earnings in future periods. See “Note 1 — Summary of Significant Accounting Policies” to the Consolidated Financial Statements included in Item 8 of this report.
Deferred Tax Assets
The Company 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.
RECENT ACCOUNTING PRONOUNCEMENTS
See “Note 1 — Summary Of Significant Accounting Policies” to the Consolidated Financial Statements included in Item 8 of this Report.

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Results of Operations
General: The Company’s 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 affected by the provision for loan and lease losses and the level of non-interest income as well as by non-interest expenses, including salary and employee benefits, occupancy expenses and other operating expenses.
Net Loss: The Company recorded a net loss of $24.1 million in 2010, which represented a $9.2 million improvement from the previous year. The reduction in the net loss was primarily attributed to an increase in net interest income of $2.7 million, an improvement in other income of $9.5 million, which was mainly associated with a reduction of impairment losses on the investment portfolio, and a reduction in net income attributable to non-controlling interest of $1.2 million. The increase in net interest income was primarily related to the re-pricing of maturing retail CDs and the redemption of higher costing brokered CDs and FHLB advances. The increased other income was associated mainly with a reduction in investment impairment and the sale of the Company’s collateral claim related to a pending lawsuit against Lehman Brothers Special Financing (“LBSF”) for $1.7 million. Investment impairment, which amounted to $479,000 during 2010 as compared to $11.0 million during 2009, improved due to the restructuring of the investment portfolio during the past 18 months. During the fourth quarter of 2010 the Company sold its claim against LBSF for $1.7 million related to the collateral for an interest rate swap, which had previously been written off in 2008 in the amount of $5.0 million, due to the uncertainty surrounding the litigation and bankruptcy of Lehman Brothers Holdings, Inc., an affiliate of LBSF. Rather than wait for an indefinite period of time to recover an undetermined amount through the bankruptcy proceedings, the Company elected to sell its claim for its current fair market value. The reduced net income attributable to non-controlling interest was principally due to the partner’s 50% share of the impairment related to real estate owned via equity investments of $1.3 million being included in the Company’s other expense and then eliminated through a credit to non-controlling interest in the Company’s consolidated statement of operations in the current year.
Partially offsetting these favorable changes were an increase in the provision for loans and leases of $1.5 million and an increase in total other expense of $3.1 million. The increase in the provision was entirely associated with the pending classified asset pool sale, which amounts to $11.4 million, and is described below. The increase in other expense was mainly associated with increased OREO impairment charges of $2.8 million, which were almost entirely related to the asset pool sale previously noted, impairment of $2.6 million related to real estate owned via equity investments and impairment of real estate joint ventures of $1.6 million. The impairment related to real estate owned via equity investments was due to lower projected operating cash flows resulting from a significant decline in unit sales for a condo conversion project after the expiration of the new home buyers’ tax credit at the end of the second quarter. The real estate joint venture impairment was comprised of impairment on the entire investment of $2.5 million for an Ohio marina project due to a significant decline in the project’s value, which was partially offset by a recovery of $968,000 from a real estate joint venture investment that was written off in 2007. These expense increases were partially offset by reduced expenses in most of the other expense categories.
The Company has signed a letter of intent to sell a pool of $54.1 million of classified assets in a bulk sale, which includes $30.3 million of non-performing loans, $10.8 million of classified accruing loans and $13.0 million of OREO properties. The pending sale is expected to close in the second quarter. The asset pool sale resulted in an additional loss of $14.2 million during the fourth quarter of 2010. The lower of cost or fair market value of the loans transferred to loans held for sale (“LHFS”) was $29.6 million after recording credit losses of $11.4 million. In addition, the Company recorded an OREO impairment charge of $2.8 million to reflect the projected sales price of the properties included in the sale. The Company has been successful in selling OREO properties that have been acquired through foreclosure during the past year at prices higher than the pending pool sales approach provides. However, the pool sale allows for a significant reduction in classified assets and improves the credit quality of the Company’s loan portfolio and overall balance sheet while also maintaining capital ratios as required under the Orders. The Company has concluded that the non-GAAP financial measure, shown in the table below, is significant since the impact of the pending asset sale amounts to 59% of the total net loss of $24.1 million for the year ended December 31, 2010.

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The impact of the asset pool sale on the results of operations for 2010 is provided in the non-GAAP table below:
         
Net Loss for 2010
  $ (24.1) million  
Increased provision (loans)
  11.4   million  
Increased impairment charge (OREO)
  2.8   million  
 
     
Total asset sale impact
  14.2   million  
 
     
Loss for 2010 without asset pool sale (non-GAAP)
  $ (9.9)  million  
 
     
The net loss of $24.1 million excluding the effects of the loss of $14.2 million associated with the asset pool sale on the 2010 financial results would have resulted in a loss of $9.9 million, which is a non-GAAP measure, in 2010. The adjusted loss would have amounted to an improvement of $23.4 million above the 2009 results on a non-GAAP basis.
Total non-performing loans at December 31, 2010 were $65.8 million and were comprised of $43.2 million in LHFI and $22.6 million in LHFS. Non-performing loans were $73.7 million at December 31, 2009. OREO at December 31, 2010, amounted to $29.2 million versus $30.3 million at year end 2009. Basic and diluted losses per common share were both $1.97 for 2010 compared to basic and diluted losses per common share of $2.64 in 2009.
The Company sold Royal Asian on December 30, 2010 to an ownership group led by the President and CEO of Royal Asian, through the purchase of all of the outstanding common stock of Royal Asian owned by the Company. The sale was completed under an agreement signed in August 2010. Under the terms of the agreement, the purchase price for the stock was equal to the total shareholders’ equity of Royal Asian, determined in accordance with generally accepted accounting principles as of November 30, 2010, which amounted to $12.3 million. Originally launched in 2004, Royal Asian provided banking products and services to businesses and consumers in the Korean-American communities of Southeastern Pennsylvania, Northern New Jersey and Flushing, New York. As a result of the sale of Royal Asian, the Company’s consolidated assets declined by $86.6 million, loans declined by $63.5 million and deposits declined by $73.4 million.
The Company recorded a net loss of $33.3 million in 2009, which amounted to an improvement of $4.8 million from the net loss of $38.1 million recorded in 2008. The reduced net loss was attributed to a decrease in the provision for loan and lease losses of $1.2 million year over year, a reduced loss of $14.1 million in other income, an increase of $5.1 million in other expense and a reduction in income taxes due to the valuation allowance in 2008 which resulted in a non-cash charge of $15.5 million. The lower loss in other income was primarily the result of a reduction in the impairment losses on investment securities year over year. The impairment losses on investment securities amounted to $11.0 million in 2009 which declined from $23.3 million in 2008, which included the bankruptcy of Lehman Brothers Holdings and the FDIC seizure of Washington Mutual. Partially offsetting these positive changes was a decline in net interest income of $6.1 million, or 17.5%, associated with a higher level of non-performing loans throughout 2009 and the lagged re-pricing of the deposits and borrowings that fund earning assets coupled with an increase in other expense. The increase in other expense of $5.1 million, or 15.7%, was comprised mainly of OREO impairment charges of $4.5 million related to foreclosed properties, OREO expenses of $3.0 million to maintain the OREO properties and increased FDIC insurance of $3.1 million due to increased rates for insured deposits. Income taxes of $474,000 in 2009 was primarily due to the sale of the BOLI and declined $2.2 million from the prior year resulting from the establishment of the valuation allowance for the deferred tax assets in 2008.
Net Interest Income and Margin: Net interest income is the Company’s 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 the Company’s 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.
The Company utilizes the effective yield interest method for recognizing interest income as required by ASC Subtopic 20, “Nonrefundable Fees and Other Costs” (“ASC Subtopic 20”) under FASB ASC Topic 310, “Receivables” (“ASC Topic 310”). ASC Subtopic 20 also guides our accounting for nonrefundable fees and costs associated with lending activities such as discounts, premiums, and loan origination fees. In the case of loan restructurings, if the terms of the new loan resulting from a loan refinancing or restructuring other than a troubled debt restructuring are at least as

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favorable to the Company as the terms for comparable loans to other customers with similar collection risks who are not refinancing or restructuring a loan with the Company, the refinanced loan is accounted for as a new loan. This condition is met if the new loan’s effective yield is at least equal to the effective yield for such loans. Any unamortized net fees or costs and any prepayment penalties from the original loan shall be recognized in interest income when the new loan is granted.
Net interest income was $31.3 million in 2010 as compared to $28.6 million in 2009, which amounted to an improvement of $2.7 million, or 9.3%. The increase was attributed mainly to lower rates paid on deposits, primarily redeemed brokered deposits and maturing retail certificates of deposit, and redeemed borrowings, mainly FHLB advances and a nonrecurring adjustment of $905,000 in the second quarter of 2010 that was related to the correction of previously reversed interest income on a participation loan from a previous year. This increase was partially offset by a decline in the yield on interest earning assets, principally investment securities, and was accomplished despite an overall decline of $111.3 million, or 9.3%, in the average balance of interest earning assets. (See the “Average Balance” table included in this discussion.) Net interest income amounted to $28.6 million in 2009, which reflected a decline of $6.1 million, or 17.5%, from the level recorded in 2008 due primarily to the increased level of non-performing loans and reduced yields on interest earnings assets.
Interest income for 2010 of $57.3 million amounted to a reduction of $8.8 million, or 13.3%, from the level recorded in 2009. The decrease was attributable to a lower yield on interest earning assets year over year, mainly associated with investment securities, and a lower level of average interest earning assets related almost entirely to loans and investment securities. Interest income for loans declined by $3.1 million, or 6.8%, and was mostly attributed to the reduction of average total loans, which was related to charge-offs, pay downs and payoffs, that was accompanied by minimal new loan growth. The decline was partially offset by an increase in the loan yield due to an increased concentration of higher yielding loans within the loan portfolio and the $905,000 adjustment previously mentioned. Average balance of total loans amounted to $643.5 million during 2010, which amounted to a decline of $72.1 million, or 10.1%, from the average level during 2009. The interest income on investment securities of $14.5 million declined $5.7 million, or 28.1%, due to a decline in average investment securities, and a decline in the yield due to an increased concentration in lower yielding, government agency securities. Average investment securities of $381.8 million in 2010 represented a decline of $45.0 million, or 10.5%, from the prior year’s average. The actual reduction in the investment securities portfolio from year end 2009 to year end 2010 amounted to $122.1 million, which was more pronounced than the reduction in the average year over year decline. This resulted from the Company’s strategic capital initiative of de-leveraging the balance sheet coupled with the Orders funding requirement of reducing non-core deposits. Consequently brokered CDs, amounting to $117.9 million, and FHLB advances, amounting to $98.8 million, were redeemed at their respective maturity dates during 2010.
The decline in the yield on average interest earning assets also contributed to the decline in interest income year over year (5.29% in 2010 versus 5.53% in 2009). This 24 basis point reduction was comprised of a decline of 5 basis points on interest bearing deposits, a decline of 92 basis points on investment securities partially offset by a 24 basis point increase in total loans. The decline in the yield on interest bearing deposits year over year was attributed to a continued decline in short term market interest rates throughout most of 2010. The decline of the yield on investment securities was mainly related to the replacement of sold investment securities and principal payments and prepayments on investment securities with lower yielding and lower risk-weighted, government agency securities that resulted in the continued improvement of credit risk within the investment portfolio but potentially higher interest rate risk when interest rates rise. The yield increase on average total loans primarily resulted from the $905,000 adjustment to interest income as previously mentioned and the change in the composition of the loans within the portfolio during the past year. The 2010 loan composition change was comprised of an increase in the percentage of leases and tax liens accompanied by a reduction in the percentage of commercial real estate and construction loans. Leases and tax lien portfolios have the highest yields within the loan portfolio while commercial real estate and construction loans, which historically have had attractive but lower yields, are currently negatively impacted by non-performing loans. At year end 2010, the variable rate portfolio represented approximately 44% of total loans; however the Company has mitigated a portion of this negative impact through the utilization of rate floors in many of the commercial loan agreements that exceed the current prime rate.
At December 31, 2010, non-performing loans to total loans amounted to 8.9% of total loans, whereas the same ratio at December 31, 2009, amounted 10.7%. The year over year increase was primarily associated with the decline in

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the loan portfolio during 2010. The total interest income lost as a result of non-performing loans during 2010 amounted to $6.5 million, which amounted to an increase of $339,000, or 5.5%, from 2009.
For the full year ended December 31, 2009, total interest income amounted to $66.0 million versus $72.8 million for full year 2008 resulting in a decline of $6.7 million, or 9.2%. The decrease was attributable to a lower yield on average interest earning assets year over year of 108 basis points, which was partially offset by a higher level of interest earning assets. Yields on loans and investment securities declined year over year by 98 basis points and 90 basis points, respectively. Average interest earning assets for 2009 of $1.2 billion increased $94.0 million, or 8.5%, above the level of 2008. This increase was comprised of cash and cash equivalents of $27.0 million, investment securities of $28.2 million, and total loans of $38.8 million. The increased levels of interest bearing deposits and investment securities, which were entirely comprised of government agencies, were mainly due to increased retail deposits and the desire to maintain higher liquidity levels. The growth in average total loans during 2009 resulted from new business relationships, new advances under existing lines of credit and a lower level of loan payoffs resulting from the weak economy.
Interest expense of $26.0 million for the full year 2010 declined $11.4 million, or 30.6%, from the level recorded in 2009. The improvement in interest expense was attributed to a reduced level of average interest bearing liabilities year over year and a decrease in the interest rates paid on those liabilities. Average interest bearing liabilities amounted to $985.2 million in 2010, which represented a decline of $117.2 million, or 10.6%, from the previous year. The change was primarily related to the redemption of higher cost brokered CDs and FHLB advances during the past year as part of the previously noted deleveraging strategy and compliance with regulatory Orders.
Rates paid on all major liability categories declined year over year with the exception of savings accounts due to the re-pricing of maturing retail certificates of deposit, the redemption of higher cost brokered CDs and the redemption of higher cost FHLB advances. The interest rate paid on average interest-bearing liabilities in 2010 of 2.64% amounted to a reduction of 76 basis points. The most significant declines were as follows: certificates of deposits declined by 86 basis points, money market accounts declined by 78 basis points, borrowings declined by 29 basis points and subordinated debt declined by 190 basis points.
Interest expense of $37.4 million for the full year 2009 decreased $670,000, or 1.8%, from the level of $38.1 million in 2008. This change resulted from an increase in average interest-bearing liabilities, which was more than offset by a reduction in the interest rates paid on those liabilities. Average interest-bearing liabilities in 2009 amounted to $1.1 billion, which represented an increase of $127.7 million, or 13.1%, from the prior year’s average of $974.8 million. The majority of the change was attributed to an increase in average interest-bearing deposits of $128.0 million, or 19.2%. This increase was primarily related to new retail certificates of deposit to maintain and assure adequate liquidity coupled with a very high retention rate of maturing retail certificates of deposit.
The net interest margin of 2.89% for the full year 2010 amounted to an increase of 50 basis points from the prior year’s level of 2.39%. The improvement in the margin was primarily due to the ability to re-price the liability side of the balance sheet, which had lagged the re-pricing of the asset side in the previous year, and redeem higher cost funding sources throughout 2010. During the past year the Company was able to re-price and retain almost all of the $230 million maturing retail CDs at reduced interest rates while also redeeming $118 million of higher cost brokered CDs and $98.8 million of higher cost FHLB advances. This positive trend was partially offset by a decline of 24 basis points in the yield on average interest earning assets mainly attributable to a decline in the yield on investment securities. The previously noted nonrecurring adjustment to net interest income of $905,000 contributed 8 basis points of the overall 50 basis point improvement in the net interest margin for 2010.
During 2009 the net interest margin amounted to 2.39% which resulted in a reduction of 76 basis points from the level of 3.15% in 2008. The decline of 108 basis points in the yield on interest-earning assets was primarily due to lower yields on all major interest-earning asset categories due to lower market rates in 2008 and 2009 coupled with a higher level of average non-performing loans in 2009. This was partially offset by average lower rates paid on interest-bearing liabilities of 51 basis points. However the rates paid on interest-bearing liabilities lagged the decline in yields on interest-earning assets during 2009 since a significant portion of interest bearing liabilities, mainly the higher rate retail certificates of deposit, did not mature until the second half of 2009, and a significant portion of higher rate brokered deposits and FHLB advances didn’t mature until 2010. In addition, the Company added slightly higher cost certificates of deposits to maintain liquidity and reduce reliance on brokered certificates of deposit.

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Average Balances
The following table represents the average daily balances of assets, liabilities and shareholders’ equity and the respective interest earned and paid on interest bearing assets and interest bearing liabilities, as well as average rates for the periods indicated:
                                                                         
    For the years ended December 31,  
    2010     2009     2008  
    Average             Yield /     Average             Yield /     Average             Yield /  
(Dollars in thousands)   Balance     Interest     Rate     Balance     Interest     Rate     Balance     Interest     Rate  
Assets
                                                                       
Interest bearing deposits
  $ 57,377     $ 154       0.27 %   $ 51,578     $ 164       0.32 %   $ 23,788     $ 495       2.08 %
Federal funds
    562       1       0.13 %     553       1       0.18 %     1,323       24       1.81 %
Investment securities
                                                                       
Held to maturity
                0.00 %                 0.00 %     56,658       3,241       5.72 %
Available for sale
    381,804       14,464       3.79 %     426,829       20,121       4.71 %     341,982       19,141       5.60 %
 
                                                     
Total investment securities
    381,804       14,464       3.79 %     426,829       20,121       4.71 %     398,640       22,382       5.61 %
Loans & Leases
                                                                       
Commercial demand loans
    307,515       15,857       5.16 %     384,831       18,439       4.79 %     395,109       25,270       6.40 %
Real estate secured
    291,205       23,195       7.97 %     294,414       24,285       8.25 %     256,124       22,153       8.65 %
Other loans and leases
    44,730       3,591       8.03 %     36,276       3,032       8.36 %     25,528       2,440       9.56 %
 
                                                     
Total loans
    643,450       42,643       6.63 %     715,521       45,756       6.39 %     676,761       49,863       7.37 %
 
                                                     
 
                                                                       
Total interest earnings assets
    1,083,193       57,262       5.29 %     1,194,481       66,042       5.53 %     1,100,512       72,764       6.61 %
 
                                                     
 
Non interest earnings assets
                                                                       
Cash & due from banks
    16,465                       11,752                       7,552                  
Other assets
    105,013                       115,173                       106,447                  
Allowance for loan loss
    (25,919 )                     (25,061 )                     (23,301 )                
Unearned discount
    (830 )                     (1,219 )                     (1,692 )                
 
                                                                 
Total non-interest earning assets
    94,729                       100,645                       89,006                  
 
                                                                 
Total assets
  $ 1,177,922                     $ 1,295,126                     $ 1,189,518                  
 
                                                                 
 
                                                                       
Liabilities & Shareholders’ Equity
                                                                       
Deposits
                                                                       
Savings
  $ 15,959     $ 90       0.56 %   $ 14,802     $ 83       0.56 %   $ 15,125     $ 76       0.50 %
NOW
    42,990       395       0.92 %     46,046       478       1.04 %     48,414       894       1.85 %
Money market
    166,386       1,754       1.05 %     153,146       2,797       1.83 %     168,972       4,947       2.93 %
Time deposits
    503,217       14,683       2.92 %     581,202       21,984       3.78 %     434,662       19,497       4.49 %
 
                                                     
Total interest bearing deposits
    728,552       16,922       2.32 %     795,196       25,342       3.19 %     667,173       25,414       3.81 %
Borrowings
    229,515       8,403       3.66 %     271,000       10,717       3.95 %     266,284       11,008       4.13 %
Obligation through VIE equity investments
    1,399       22       1.57 %     10,451       243       2.33 %     15,539       251       1.62 %
Subordinated debt
    25,774       647       2.51 %     25,774       1,136       4.41 %     25,774       1,436       5.57 %
 
                                                                       
 
                                                     
Total interest bearing liabilities
    985,240       25,994       2.64 %     1,102,421       37,438       3.40 %     974,770       38,109       3.91 %
 
                                                     
 
                                                                       
Non interest bearing deposits
    62,474                       62,546                       57,211                  
Other liabilities
    26,313                       22,648                       26,382                  
 
                                                                 
Total liabilities
    1,074,027                       1,187,615                       1,058,363                  
Shareholders’ equity
    103,895                       107,511                       131,155                  
 
                                                                 
Total liabilities and shareholders’ equity
  $ 1,177,922                     $ 1,295,126                     $ 1,189,518                  
 
                                                           
Net interest income
          $ 31,268                     $ 28,604                     $ 34,655          
 
                                                                 
Net interest margin
                    2.89 %                     2.39 %                     3.15 %
 
(1)   Non-accrual loans have been included in the appropriate average loan balance category, but interest on these loans has not been included.
 
(2)   Portions of interest related to obligations through VIE are capitalized on the VIE’s books.
The following table sets forth a rate/volume analysis, which segregates in detail the major factors contributing to the change in net interest income exclusive of interest on obligation through VIE, for the years ended December 31, 2010 and 2009, as compared to respective previous periods, into amounts attributable to both rate and volume variances.

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    2010 versus 2009     2009 versus 2008  
    Changes due to:     Changes due to:  
(In thousands)   Volume     Rate     Total     Volume     Rate     Total  
Interest income
                                               
Short term earning assets
                                               
Interest bearing deposits in banks
  $ 16     $ (26 )   $ (10 )   $ 88     $ (419 )   $ (331 )
Federal funds sold
                      (1 )     (22 )     (23 )
 
                                   
Total short term earning assets
    16       (26 )     (10 )     87       (441 )     (354 )
 
                                   
 
                                               
Investments securities
                                               
Held to maturity
                      (3,241 )           (3,241 )
Available for sale
    (1,730 )     (3,927 )     (5,657 )     4,023       (3,043 )     980  
 
                                   
Total Investments securities
    (1,730 )     (3,927 )     (5,657 )     782       (3,043 )     (2,261 )
 
                                   
 
                                               
Loans
                                               
Commercial demand loans
    (3,536 )     1,180       (2,356 )     (551 )     (4,339 )     (4,890 )
Commercial mortgages
    (156 )     (724 )     (880 )     1,250       (1,223 )     27  
Residential and home equity loans
    (95 )     (103 )     (198 )     (77 )     (127 )     (204 )
Lease receivables
    693       (135 )     558       987       (366 )     621  
Real estate tax liens
    127       (160 )     (33 )     2,945       (637 )     2,308  
Other loans
    5       (5 )           (15 )     (14 )     (29 )
Loan fees
    (205 )           (205 )     (1,939 )           (1,939 )
 
                                   
Total loans
    (3,167 )     53       (3,114 )     2,600       (6,706 )     (4,106 )
 
                                   
 
                                               
Total (decrease) increase in interest income
  $ (4,881 )   $ (3,900 )   $ (8,781 )   $ 3,469     $ (10,190 )   $ (6,721 )
 
                                   
 
                                               
Interest expense
                                               
Deposits
                                               
NOW and money market
  $ 160     $ (1,286 )   $ (1,126 )   $ (456 )   $ (2,109 )   $ (2,565 )
Savings
    6       1       7       (2 )     9       7  
Time deposits
    (2,699 )     (4,602 )     (7,301 )     5,871       (3,385 )     2,486  
 
                                   
Total deposits
    (2,533 )     (5,887 )     (8,420 )     5,413       (5,485 )     (72 )
 
                                   
 
                                               
Borrowings
                                               
Borrowings
    (1,558 )     (757 )     (2,315 )     192       (482 )     (290 )
Trust preferred
          (489 )     (489 )           (300 )     (300 )
 
                                   
Total Borrowings
    (1,558 )     (1,246 )     (2,804 )     192       (782 )     (590 )
 
                                   
 
                                               
Total (decrease) increase in interest expense
    (4,091 )     (7,133 )     (11,224 )     5,605       (6,267 )     (662 )
 
                                   
 
                                               
Total (decrease) increase in net interest income
  $ (790 )   $ 3,233     $ 2,443     $ (2,136 )   $ (3,923 )   $ (6,059 )
 
                                   
Provision for Loan and Lease Losses
The provision for loan and lease losses was $22.1 million in 2010 compared to $20.6 million in 2009. The Company recorded $30.4 million in net charge-offs of which $11.4 million was associated with the mark to market of loans at December 31, 2010 that are expected to sell during the second quarter that are part of the asset sale as described under the caption “Net Loss” in the “Results of Operations”. The remaining 2010 provision was based on the formula allowance reflecting historical losses and adjustments to qualitative factors.
The provision for loan and lease losses was $20.6 million in 2009. Included in the 2009 provision was $11.0 million in specific reserves for individual loans that became impaired during 2009. The Company recorded $19.2 million in net charge-offs in 2009.
The Company recorded a $21.8 million provision for loan and lease losses in 2008. The 2008 provision included $12.9 million in specific reserves for impaired loans. The Company recorded $12.2 million in net charge-offs in 2008.
Total Other (Loss) Income
Other income (loss) 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 addition, other forms of non-

40


 

interest income are derived from changes in the cash value of bank owned life insurance (“BOLI”), and income relating to real estate owned via equity investment. Most components of other income are a modest and stable source of income, with exceptions of one-time gains and losses from the sale of investment securities, other real estate owned, and real estate owned via equity investments. 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.
Total other income of $7.8 million in 2010 amounted to an improvement of $9.5 million from the previous year due primarily to a reduction of $10.6 million in net impairment losses on AFS investment securities, a one-time gain of $1.7 million on the sale of the Company’s LBSF claim and increased gains of $725,000 on the sale of other real estate, primarily related to the favorable disposition in 2010 of two properties acquired through foreclosure. The 2010 impairment losses were isolated to two real estate investments that amounted to $479,000 and reflected the restructuring of the investment portfolio during the previous year. The 2009 impairment losses of $11.0 million included five trust preferred securities totaling $3.0 million, various common stocks amounting to $4.3 million, three corporate bonds amounting to $1.4 million, a preferred stock of $1.1 million, two real estate funds totaling $769,000 and two private label CMOs in the amount of $459,000. The sale of the LBSF claim resulted in a gain of a previous impairment charge of $5.0 million in 2008 for the value of a CMO pledged as collateral for an interest rate swap with LBSF as previously mentioned under the caption “Net Loss” in the “Results of Operations”.
Offsetting these favorable year over year results were a reduction of $720,000 in BOLI income, a reduction of $602,000 in investment security gains ($1.3 million in 2010 versus $1.9 million in 2009), a decline in service fees of $153,000, a decline of $404,000 in gains on the sale of loans and leases, mainly related to fewer SBA loan sales. Additionally, lower other income was associated with reduced gains of $1.2 million on the sale of premises and equipment related to real estate owned via equity investments ($667,000 versus $1.8 million) and a decrease of $738,000 in income related to real estate owned via equity investments. The decline in BOLI income was due to the sale of approximately $23 million of BOLI insurance in the second half of 2009 to reduce the level of risk-weighted assets to enhance the risk-based capital ratio of Royal Bank. The reduction of income related to real estate owned via equity investments and gains on the sale of premises and equipment related to real estate owned via equity investments was primarily attributed to a slowdown in unit sales for the real estate partnership project due to the expiration of the new home buyers’ tax credit at the end of the second quarter.
Total other income (loss) amounted to a loss of $1.7 million in 2009 which equated to an improvement of $14.1 million from the loss of $15.8 million in 2008. The change was mainly associated with higher service charges and fees of $233,000, increased income of $337,000 related to real estate owned via equity investment, increased gains of $724,000 on the sale of loans and leases, net gains of $1.9 million on the sales of investment securities versus a loss of $1.3 million in 2008, increased other income of $430,000 and a reduction in net impairment losses on AFS investment securities amounting to $12.3 million. Offsetting these favorable changes was a reduction of gains on the sale of premises ($2.0 million in 2008 versus none in 2009), a decline of $134,000 in BOLI income associated with the sale of approximately $23 million of BOLI insurance and gains on the sales related to real estate joint ventures ($1.1 million in 2008 versus none in 2009). The increase in gains on the sale of loans was mainly attributed to SBA loan sales within Royal Asian during the past year. Net impairment losses on AFS investment securities amounted to $11.0 million in 2009, which included five trust preferred securities totaling $3.0 million, various common stocks amounting to $4.3 million, three corporate bonds amounting to $1.4 million, a preferred stock of $1.1 million, two real estate funds totaling $769,000 and two private label CMOs in the amount of $459,000. Refer to “Note 3 — Investment Securities” to the consolidated financial statements for more information on the impairment charges.
Total Other Expense
Total other expense amounted to $40.7 million in 2010, which represented an increase of $3.1 million, or 8.2%, above the level of 2009. The increase was principally related to an increase in OREO impairment charges of $2.8 million, impairment of $2.6 million related to real estate owned via equity investments and impairment of $1.6 million in real estate joint ventures. The OREO impairment charges of $7.4 million was comprised of a $4.6 million reduction in value of seven OREO properties during 2010 based upon updated annual appraisals and the December 31, 2010 increased valuation allowance associated with the pending sales value of OREO properties within the loan and OREO sale discussed in “Results of Operations” that amounted to $2.8 million. The impairment of real estate owned via equity investments was due to lower projected operating cash flows resulting from a significant decline in unit

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sales, which was primarily related to the expiration of the new home buyers’ tax credit at the end of the second quarter. During the second quarter of 2010, the Company recorded a $2.5 million impairment of real estate joint ventures, which amounted to the entire amount of the investment in which the Company had a subordinate debt position due to the reduction in the collateral value as a consequence of a significant decline in the cash flows generated from the property. The entire amount of the partnership’s impairment, including the partner’s share, is posted as a charge to expense and included in the Company’s other expense. The partner’s share of the losses is then eliminated through a credit to noncontrolling interest on the Company’s consolidated statement of operations. Partially offsetting this impairment loss was a recovery of $968,000 from an investment in a real estate joint venture that was written off in 2007 resulting in a $1.6 million net impairment expense for real estate joint ventures in 2010. Total other expense, after adjusting for the OREO impairment charge of $2.8 million related to the pending loan/OREO sale, would have been $38.0 million and would have amounted to an increase of $312,000, or 0.8%.
Offsetting these expense increases during 2010 was a reduction of $644,000 in employee salaries and benefits due to reduced headcount and the closing of the Blue Bell loan production office in 2009; a decline of $754,000 in FDIC and state assessment expense due to lower deposit balances in 2010 and a change in the accounting method from a prepaid basis to an accrual method in the third quarter of 2009; reduced OREO and loan collection expense of $682,000 mainly attributed to the successful auction of an OREO property in 2010 and the resulting recovery of expenses; and a decrease in directors’ fees of $321,000 due to a reduction in the number of directors, fewer meetings and the elimination of inside directors’ fees. Additionally, reductions were experienced in occupancy and equipment, stock option expense, professional and legal fees, expenses related to real estate owned via equity investments, and other operating expense, which collectively represented an expense decrease of $1.5 million. Other operating expense is comprised of data processing, postage, telephone, travel and entertainment, advertising, printing and supplies, dues and subscriptions and other miscellaneous expense.
Total other expense of $37.7 million increased $5.2 million, or 15.7%, in 2009 above the prior year’s results. While management was able to reduce selected expense categories throughout 2009, expense increases primarily associated with FDIC insurance rate increase, OREO costs related to foreclosed properties and legal expense increases associated with non-performing loans more than offset management’s expense reduction initiatives. Employee salaries and benefits of $12.2 million during 2009 declined $2.8 million from the level of 2008 due to a modest reduction in headcount, the temporary elimination of selected benefits within 2009 and the contractual payout to the former Company president in 2008 of $2.1 million. Professional and legal fees of $4.4 million in the current year increased $584,000, or 15.4%, above the previous year due mainly to increased legal fees associated with non-performing loans and an internal investigation related to the U.S Department of Justice investigation described in “Item 3-Legal Proceedings” of this Report which was partially offset by a decline in professional fees related to reduced consulting and recruiting expense. Occupancy and equipment amounted to $3.4 million, which represented an increase of $521,000, or 18.2%, due primarily to increased rental rates for leased facilities and additional leased space for the lending and credit departments. Impairment of real estate owned via equity investment, which amounted to $1.5 million in 2008 due to lower projected operating cash flows, experienced significant improvement during the second half of 2009 due to increased sales and related cash flows and resulted in no further impairment. FDIC and state assessments expense of $3.8 million in 2009 increased $3.1 million from the prior year almost entirely due to higher FDIC insurance rates during the past year. Both Royal Bank and Royal Asian Bank were charged higher rates in 2009 due to recent and expected future failures of financial institutions.
The OREO impairment charges of $4.5 million reflected a reduction in value of five OREO properties based upon updated appraisals during 2009 while there was no corresponding expense in 2008. OREO and loan collection expense of $3.2 million in 2009 amounted to an increase of $3.0 million year over year and was mainly due to ongoing costs to maintain the OREO properties, such as (tax payments, insurance, maintenance costs, utilities and other related expenses) due to the level of OREO properties increasing by $20.0 million to $30.3 million at year end 2009. Other operating expense of $3.0 million in 2009 declined $1.8 million, or 37.1%, from the previous year. The reduction was primarily due to gains associated with the real estate partnership investment of $1.2 million associated with the sales of the converted condominium partnership project previously noted above whereas in 2008 a loss of $254,000 was posted due to much slower sales activity. The Company’s portion of the net gains from the partnership investment is recorded as a reduction to expenses while losses are posted as a charge to expense.

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Accounting for Income Tax Expense (Benefit)
In 2010, the Company recorded no tax expense as compared to $474,000 in 2009. The Company did not record a tax benefit despite the net loss for 2010 since it concluded at December 31, 2010 that it was more likely than not that the Company would not generate sufficient taxable income to realize all of the deferred tax assets. The 2009 tax expense was entirely related to a 10% excise tax on the surrender of approximately $23.0 million in BOLI. Although the Company recorded a $35.4 million net loss for 2008, the tax expense was the result of the Company establishing a $15.5 million valuation allowance for the deferred tax asset.
As of December 31, 2010 and December 31, 2009, management concluded that it was more likely than not that the Company would not generate sufficient future taxable income to realize all of the deferred tax assets. Management’s conclusion was based on consideration of the relative weight of the available evidence and the uncertainty of future market conditions on results of operations. The Company recorded a non-cash charge of $15.5 million in the consolidated statements of operations in the period ended December 31, 2008 related to the establishment of a valuation allowance for the deferred tax asset for the portion of the future tax benefit that more likely than not will not be utilized in the future. During 2009 and 2010, the Company established additional valuation allowances of $10.2 million and $7.7 million, respectively, which was a result of the net operating losses for each year and the portion of the future tax benefit that more likely than not will not be utilized in the future. The additional valuation allowance did not impact the net loss as no tax benefit was recorded during 2010. As of December 31, 2010 the valuation allowance for deferred tax assets totaled $33.5 million. The net deferred tax asset of $414,000 relates to projected reversals of temporary differences in 2011 that are projected to be carried back to a prior year.
The Company’s effective tax rate is the provision (benefit) for federal income taxes, excluding the tax effect of extraordinary items, expressed as a percentage of income or loss before federal income taxes. The effective tax rate for the twelve months ended December 31, 2010 and 2009 was 0% and 1.5%, respectively. In general our effective tax rate is different from the federal statutory rate of 35% primarily due to the benefits related to certain insurance that is non-taxable and the establishment of a valuation allowance which was $32.1 million as of December 31, 2010.
Results of Operations by Business Segments
Under FASB ASC Topic 280, “Segment Reporting” (“ASC Topic 280”), management of the Company has identified three reportable operating segments, “Community Banking”, “Tax Liens” and “Equity Investments”; and one operating segment that does not meet the quantitative thresholds for requiring disclosure, but has different characteristics than the Community Banking, Tax Liens and Equity Investments segments, “Leasing”.
  §   Community Bank segment: At December 31, 2010, the Community Bank segment had total assets of $836.4 million, a decrease of $304.9 million or 27% from $1.1 billion at December 31, 2009. Total deposits declined $187.8 million or 21% from $881.8 million at December 31, 2009 to $693.9 million at December 31, 2010. Net interest income for 2010 was $22.3 million compared to $21.1 million for 2009 representing an increase of $1.2 million, or 6%. The improvement in net interest income was primarily related to lower rates paid on deposits due to the maturities of brokered and retail certificates of deposits, redeemed FHLB advances, and a non-recurring adjustment to net interest income. The loan loss provision was $21.2 million for 2010 compared to $18.7 million for 2009. For 2010, total other income was $6.2 million compared to a total other loss of $4.8 million for 2009. The improvement is mostly attributed to a $10.5 million reduction in impairment charges recorded on the available-for-sale investment portfolio in 2010 compared to 2009. In 2010 total other expense was $35.1 million, an increase of $1.6 million, or 5%, from $33.5 million in 2009. The increase is mostly associated with an increase in OREO impairment charges of $2.8 million and impairment of $1.6 million in real estate joint ventures. The net loss for 2010 was $25.1 million compared to a net loss of $34.7 million for 2009.
 
  §   Tax Lien segment: At December 31, 2010, the Tax Lien segment had total assets of $100.6 million compared to $105.0 million at December 31, 2009 representing a decrease of $4.4 million, or 4%. Net interest income increased $536,000, or 9%, from $6.0 million in 2009 to $6.5 million in 2010. The provision for losses declined from $624,000 in 2009 to $129,000 in 2010. The 2009

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      provision was related to a specific reserve for a non-accrual loan with a tax lien portfolio located in Alabama. Total other income was $389,000 in 2010 compared to $313,000 in 2009. Total other income is derived mostly from the gains on sale of OREO property. Total other expense decreased $1.2 million, or 42%, from $2.9 million for 2009 to $1.7 million for 2010. The decrease in other total expense was related to a decline in legal and professional fees. Net income was $1.8 million in 2010 compared to $1.0 million for 2009.
 
  §   Equity Investment segment: At December 31, 2010 the Equity Investment segment had total assets of $5.6 million compared to $8.7 million at December 31, 2009 representing a decline of $3.1 million, or 35%. The decline was primarily related to a $2.6 million impairment charge as a result of a slow-down in condominium unit sales following the end of the tax credit incentive that was being offered by the government. The measurement and recognition of the impairment was based on estimated future discounted operating cash flows. As a result of the impairment charge, the net loss for 2010 was $1.2 million compared to net income for 2009 of $179,000.
Financial Condition
Total assets decreased $312.1 million, or 24.1%, to $980.6 million at December 31, 2010 from $1.3 billion at year-end 2009.
Cash and Cash Equivalents: Cash and cash equivalents consist of cash on hand, and cash in interest bearing and non-interest bearing accounts in banks, in addition to federal funds sold. Cash and cash equivalents decreased $6.6 million from $58.3 million at December 31, 2009 to $51.7 million at December 31, 2010. The average balance of cash and cash equivalents was approximately $74.4 million for 2010 versus $63.9 million for 2009. The high level of cash for 2010 and 2009 was primarily related to maintaining strong liquidity during this current economic environment. The majority of this average balance was held in interest-bearing accounts with other financial institutions which were paying a higher interest rate than federal funds. The excess cash is invested daily in overnight and federal funds. The average balance of these funds that earn interest was $57.4 million in 2010.
Investment Securities Available for Sale (“AFS”): AFS investment securities represented 35% of average interest earning assets during 2010 and consisted of government secured agency bonds, government secured mortgage-backed securities, collateralized mortgage obligations (“CMOs”), capital trust security issues of regional banks, domestic corporate debt and third party managed equity funds. At December 31, 2010, AFS investment securities were $317.2 million as compared to $438.7 million at December 31, 2009, a decrease of $121.5 million. The decrease was primarily due to the sale of debt securities and government agencies to reduce credit risk and extension risk within the investment portfolio and provide funds for the payoff of maturing retail CDs, brokered CDs and FHLB advances. The sale of these investments was partially offset by the purchase of liquid, cash-flowing mortgage backed securities and U. S. government agency CMOs.
Loans: The Company’s primary earning assets are loans, representing approximately 59% of average earning assets during 2010. The loan portfolio consists primarily of business demand loans and commercial mortgages secured by real estate, real estate tax liens, lease receivables, and to a significantly lesser extent, residential loans comprised of one to four family residential and home equity loans. During 2010, total loans held for investment decreased $190.0 million to $496.9 million at December 31, 2009 from $686.9 million at December 31, 2009. The decline was primarily due to a reduction of $63.5 million related to the Royal Asian sale, loan charge-offs of $31.7 million,

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transfers to LHFS of $29.6 million, and transfers to OREO of approximately $16.8 million in non-performing construction and land development, non-residential, and residential real estate loans.
Non-residential real estate, construction loans and land development make up a significant portion of our loan portfolio and represented 57% of total loans at December 31, 2010, which amounted to a 4% decline from 61% of total loans at December 31, 2009. Management believes our current loan loss reserve is adequate at December 31, 2010 to cover losses arising from these loan categories as well as all others within the portfolio. We continue to monitor these loans, with emphasis on construction, land development and non-residential real estate loans, due to the continuing deterioration in market conditions to evaluate the impact these loans will have on our loan loss reserve.
Allowance for loan and lease losses: The Company’s loan and lease portfolio (the “credit portfolio”) is subject to varying degrees of credit risk. The Company maintains an allowance for loan and lease losses (the “allowance”) to absorb possible losses in the loan and lease portfolio. The allowance is based on the review and evaluation of the loan and lease portfolio, along with ongoing, quarterly assessments of the probable losses inherent in that portfolio. The allowance represents an estimation made pursuant to FASB ASC Topic 450, “Contingencies” (“ASC Topic 450”) or FASB ASC Topic 310, “Receivables” (“ASC Topic 310”). The adequacy of the allowance is determined through evaluation of the credit portfolio, and involves consideration of a number of factors, as outlined below, to establish a prudent level. Determination of the allowance is inherently subjective and requires significant estimates, including estimated losses on pools of homogeneous loans and leases based on historical loss experience and consideration of current economic trends, which may be susceptible to significant change. Loans and leases deemed uncollectible are charged against the allowance, while recoveries are credited to the allowance. Management adjusts the level of the allowance through the provision for loan and lease losses, which is recorded as a current period expense. The Company’s systematic methodology for assessing the appropriateness of the allowance includes: (1) general reserves reflecting historical loss rates by loan type, (2) specific reserves for risk-rated credits based on probable losses on an individual or portfolio basis and (3) qualitative reserves based upon current economic conditions and other risk factors.
The loan portfolio is stratified into loan segments that have similar risk characteristics. The general allowance is based upon historical loss rates using a three-year rolling average of the historical loss experienced within each loan segment. The qualitative factors used to adjust the historical loss experience address various risk characteristics of the Company’s loan and lease portfolio include evaluating: (1) trends in delinquencies and other non-performing loans, (2) changes in the risk profile related to large loans in the portfolio, (3) changes in the growth trends of categories of loans comprising the loan and lease portfolio, (4) concentrations of loans and leases to specific industry segments, and (5) changes in economic conditions on both a local and national level, (6) quality of loan review and board oversight, (7) changes in lending policies and procedures, and (8) changes in lending staff. Each factor is assigned a value to reflect improving, stable or declining conditions based on management’s best judgment using relevant information available at the time of the evaluation. Adjustments to the factors are supported through documentation of changes in conditions in a report accompanying the allowance for loan loss calculation.
The specific reserves are determined utilizing standards required under ASC Topic 310. A loan is considered impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. Non-accrual loans are evaluated for impairment on an individual basis considering all known relevant factors that may affect loan collectability such as the borrower’s overall financial condition, resources and payment record, support available from financial guarantors and the sufficiency of current collateral values (current appraisals or rent rolls for income producing properties), and risks inherent in different kinds of lending (such as source of repayment, quality of borrower and concentration of credit quality). Non-accrual loans that experience insignificant payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and industrial loans, commercial real estate loans and commercial construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent. An allowance for loan losses is established for an impaired loan if its carrying value exceeds its estimated fair value. The estimated fair values of substantially all of the Company’s impaired loans are measured based on the estimated fair value of the loan’s collateral. The

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Company obtains third-party appraisals on the fair value of real estate collateral. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property. For commercial and industrial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Once a loan is determined to be impaired it will be deducted from the portfolio and the net remaining balance will be used in the general and qualitative analysis.
Analysis of the Allowance for Loan and Lease Losses:
                                         
    For the years ended December 31,  
(In thousands)   2010     2009     2008     2007     2006  
Total Loans
  $ 496,854     $ 686,864     $ 700,722     $ 644,475     $ 602,958  
 
                             
 
                                       
Daily average loan balance
  $ 643,450     $ 715,521     $ 676,761     $ 636,612     $ 618,591  
 
                             
 
                                       
Allowance for loan and lease losses:
                                       
Balance at the beginning of the year
  $ 30,331     $ 28,908     $ 19,282     $ 11,455     $ 10,276  
Charge-offs by loan type:
                                       
Real Estate — residential
    731       1,361       37       195       631  
Real Estate — residential-mezzanine
    2,480             2,220              
Construction and land development
    13,413       6,231       3,852       2,408        
Construction and land develop-mezzanine
          2,756       1,540       1,579        
Real Estate — non-residential
    7,352       7,404       1,330       294       5  
Real Estate — non-residential-mezzanine
          1,132       1,675              
Real Estate — multi-family
    787                          
Leases
    972       676       642       286       11  
Commercial and industrial
    5,930       258       1,009       704        
Tax certificates
    49             22             25  
Other
                            73  
     
Total charge-offs
    31,714       19,818       12,327       5,466       745  
Recoveries by loan type:
                                       
Construction and land development
    116                   34        
Real Estate — residential
    313       190       6       28       100  
Real Estate — non-residential
    684       431             4       14  
Real Estate — multi-family
    18                          
Commercial and industrial
    81       15       106       201       2  
Leases
    51                          
Other
    37                         5  
     
Total recoveries
    1,300       636       112       267       121  
     
Net loan charge-offs
    (30,414 )     (19,182 )     (12,215 )     (5,199 )     (624 )
Provision for loan and lease losses
    22,140       20,605       21,841       13,026       1,803  
 
                             
 
                                       
Allowance related to disposed assets
    (928 )                        
 
                                       
Balance at end of year
  $ 21,129     $ 30,331     $ 28,908     $ 19,282     $ 11,455  
 
                             
 
                                       
Net charge-offs to average loans
    (4.73 %)     (2.68 %)     (1.80 %)     (0.82 %)     (0.10 %)
 
                             
 
                                       
Allowance to total loans at year-end
    4.25 %     4.42 %     4.13 %     2.99 %     1.90 %
 
                             

46


 

Analysis of the Allowance for Loan and Lease Losses by Loan Type:
                                                                                 
    As of December 31,
    2010   2009   2008   2007   2006
            Percent of           Percent of           Percent of           Percent of           Percent of
            outstanding           outstanding           outstanding           outstanding           outstanding
            loans in each           loans in each           loans in each           loans in each           loans in each
    Reserve   category to   Reserve   category to   Reserve   category to   Reserve   category to   Reserve   category to
(In thousands, except percentages)   Amount   total loans   Amount   total loans   Amount   total loans   Amount   total loans   Amount   total loans
Commercial and industrial
  $ 3,797       14.9 %   $ 6,542       15.1 %   $ 2,403       12.3 %   $ 2,124       12.0 %   $ 559       7.0 %
Construction
    1,117       5.8 %     4,713       7.6 %     11,548       23.8 %     7,674       14.4 %     4,117       29.0 %
Land development (1)
    2,859       10.2 %     3,182       9.7 %     2,359       10.6 %           12.2 %           0.0 %
Construction and land development - mezzanine
          0.0 %           0.0 %     1,415       0.3 %     2,493       1.0 %     409       1.0 %
Real Estate — residential
    1,106       5.9 %     2,762       7.1 %     747       3.9 %     1,014       6.5 %     845       7.0 %
Real Estate — residential — mezzanine
          0.0 %     1,000       0.4 %           0.0 %           0.0 %           0.0 %
Real Estate — non-residential
    9,534       39.0 %     9,824       40.3 %     5,172       33.4 %     4,746       40.5 %     4,941       46.0 %
Real Estate — non-residential - mezzanine
          0.0 %           0.0 %     1,188       0.6 %     204       1.4 %     224       1.0 %
Real Estate — multi-family
    652       2.1 %     215       3.2 %     133       2.0 %     59       1.1 %     36       1.0 %
Real Estate — multi-family — mezzanine
          0.0 %           0.0 %           0.0 %     6       0.5 %     20       1.0 %
Tax certificates
    380       14.2 %     290       10.6 %     2,735       9.1 %     185       7.1 %           5.0 %
Lease financing
    1,670       7.8 %     1,757       5.7 %     1,183       3.7 %     763       3.1 %     293       2.0 %
Other
    12       0.2 %     25       0.3 %     15       0.2 %     14       0.2 %     11       0.0 %
Unallocated
    2       0.0 %     21       0.0 %     10       0.0 %           0.0 %           0.0 %
                     
Total
  $ 21,129       100.0 %   $ 30,331       100.0 %   $ 28,908       100.0 %   $ 19,282       100.0 %   $ 11,455       100.0 %
                     
 
(1)   Beginning in 2008, the Company began segregating land development loans from the rest of the loan portfolio.
The amount of the allowance is reviewed and approved by the Chief Operating Officer (“COO”), Chief Financial Officer (“CFO”) and the Chief Accounting Officer (“CAO”) on at least a quarterly basis. The provision for loan and lease losses was $22.1 million in 2010 compared to $20.6 million in 2009. Included in the 2010 provision was $11.4 million in charge-offs on loans transferred to LHFS. The historical loss calculation of the allowance for loan and lease losses has been specifically impacted by the recent charge-off history of the Company. The deterioration of the real estate market these past few years has significantly impacted construction and real estate loans throughout the banking industry. This weakened sales market has affected land development, construction and real estate loans of the Company. Construction and land, non-residential real estate, and commercial loans represent 46%, 23% and 14%, respectively of the $43.2 million in non-accrual loans held for investment at December 31, 2010. Non-accrual loans classified as LHFS were $22.6 million at December 31, 2010. Total charge-offs recorded in 2010 related to construction and land development loans and non-residential real estate loans were $20.8 million, or 66%, of total charge-offs in 2010.
The provision for loan and lease losses was $20.6 million in 2009 compared to $21.8 million in 2008. The 2009 provision was the result of $11.0 million in required specific reserves based on the Company’s impairment analysis in accordance with ASC Topic 310 and net charge-offs of $19.2 million recorded in 2009. The remaining 2009 provision was based on the formula allowance reflecting historical losses. The historical loss calculation of the allowance for loan and lease losses had been specifically impacted by the recent charge-off history of the Company. The deteriorating real estate market that continued from 2008 into 2009 has negatively impacted construction and real estate loans throughout the banking industry. This weak sales market had affected land development, construction and mezzanine loans of the Company. Construction and land loans, non-residential and residential real estate loans represent 33%, 27% and 20%, respectively of the $73.7 million in non-accrual loans at December 31, 2009. Total charge-offs recorded in 2009 related to construction and land development loans and non-residential real estate loans were $17.5 million, or 88%, of total charge-offs in 2009.
The provision for loan and lease losses was $21.8 million in 2008, which included an $8.3 million increase in specific reserves on impaired loans. The 2008 provision for loan and lease losses was a reflection of the deteriorating real estate market that continued from 2007 into 2008. It had caused housing sales to slow and negatively impacted construction loans throughout the banking industry. The weak sales market had affected land development, construction and mezzanine loans of the Company. Consequently, non-accrual loans increased $60.4 million to $85.8 million at December 31, 2008. Construction, commercial and non-residential real estate loans represented 64%, 14% and 11%, of the total December 31, 2008 non-accrual loans, respectively. The downturn in

47


 

the real estate market was also reflected in the charge-offs of construction and land development loans and construction and land development mezzanine loans. Those two loan categories represented $6.5 million, or 53%, of total charge-offs in 2008.
Management believes that the allowance for loan and lease losses at December 31, 2010 is adequate. However, its determination requires significant judgment, and estimates of probable losses inherent in the credit portfolio can vary significantly from the amounts actually observed. While management uses available information to recognize probable losses, future changes to the allowance may be necessary based on changes in the credits comprising the portfolio and changes in the financial condition of borrowers, such as may result from changes in economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the credit portfolio and the allowance. Such review may result in additional provisions based on their judgment of information available at the time of each examination. During 2010, there were changes in assumptions that affected the allowance. These changes included increasing the qualitative risk factors related to economic conditions on both a local and national level and the trends in delinquencies and other non-performing loans.
Deposits: The Company’s deposits are an important source of funding. Total deposits of $693.9 million at December 31, 2010 decreased $187.8 million, or 21.3%, from $881.8 million at December 31, 2009. The decrease was partially related to an $89.3 million reduction as a result of the disposition of Royal Asian. Brokered deposits declined $117.9 million, or 57%, from $206.9 million at December 31, 2009 to $89.0 million at December 31, 2010 as the Company redeemed all maturing brokered deposits as required under the Orders. Time deposit accounts of $314.3 million at December 31, 2010 decreased $67.9 million, or 18%, from $382.2 million at December 31, 2009 primarily as a result of the reduction of $65.8 million related to Royal Asian time deposits. Money market accounts of $180.9 million increased $12.0 million (which includes a reduction of $11.2 million related to Royal Asian money market accounts), or 7%, mainly due to the increased desire of customers to shift money to liquid accounts in the event of rising interest rates in the near future. Demand deposits decreased $10.3 million, or 16%, which was primarily due to a $9.4 million reduction related to Royal Asian demand deposits.
FHLB Borrowings: Borrowings consist of long-term borrowings (advances) and short-term borrowings (overnight borrowings, advances). Total FHLB borrowings, which include $22.0 million in overnight borrowings, declined from $209.5 million at year end 2009 to $110.7 million at December 31, 2010 due to pay downs of maturing advances to reduce our reliance on non-core funding sources. Short term borrowings amounted to $22.0 million at December 31, 2010 versus $114.5 million at December 31, 2009 while long term advances for the periods ending December 31, 2010 and 2009 were $88.7 million and $95.0 million, respectively.
Other Borrowings: During 2004, the Company completed a private placement of trust preferred securities in the aggregate amount of $25.0 million for a term of 30 years with a call feature of 5 years. These securities were eligible to be called in October 2009 by the Company. The maturity date of these securities is October 2034. On August 13, 2009, the Company’s Board of Directors determined to suspend interest payments on the trust preferred securities. The Company’s Board of Directors took this action in consultation with the Federal Reserve Bank of Philadelphia as required by recent regulatory policy guidance. The Company currently has sufficient capital and liquidity to pay the scheduled interest payments; however, the Company believes this decision better supports the capital position of Royal Bank, a wholly owned subsidiary of the Company. As of December 31, 2010 the trust preferred interest payment in arrears was $1.2 million and has been recorded in interest expense and accrued interest payable.
At December 31, 2010, the Company has an amortizing loan outstanding with PNC Bank in the amount of $4.2 million. The Company also has $40.0 million in repurchase agreements with PNC. These repurchase agreements are callable between 2011 and 2013 and have a final maturity date of January 7, 2018.
Other Liabilities: At December 31, 2010, other liabilities of $17.9 million increased $1.0 million from December 31, 2009. This was principally due to an increase of $1.0 million related to unfunded pension plan obligations.
Shareholders’ Equity: Shareholders’ equity decreased $20.5 million, or 20.2%, in 2010 to $80.7 million primarily due net losses of $24.1 million which was partially offset by an increase in accumulated other comprehensive income of $3.6 million due to improvements in valuations in both the bond and stock markets that positively impacted the investment portfolio.

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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 ALCO Policy 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.
The Company generally targets liquidity ratios equal to or greater than 12% and 10% of total deposits and total liabilities, respectively, effective in 2010. The liquidity ratios are specifically defined as the ratio of net cash, available FHLB and other lines of credit, and unpledged marketable securities relative to both total deposits and total liabilities. At December 31, 2010, liquidity as a percent of deposits was 31% and liquidity as a percent of total liabilities was 24%. At December 31, 2009, liquidity as a percent of deposits was 33% and liquidity as a percent of total liabilities was 24%. Management believes that the Company’s liquidity position continues to be adequate and meets or exceeds the liquidity target set forth in the Asset/Liability Management Policy. Management believes that due to its financial position, it will be able to raise deposits as needed to meet liquidity demands. However, any financial institution could have unmet liquidity demands at any time.
Our funding decisions can be influenced by unplanned events, which include, but are not limited to, the inability to fund asset growth, difficulty renewing or replacing funds that mature, the ability to maintain or draw down lines of credit with other financial institutions, significant customer withdrawals of deposits, and market disruptions. Royal Bank is on an overcollateralization status, with a 105% pledged collateral requirement, with the FHLB. The available amount for future borrowings will be based on the amount of collateral to be pledged. The Company has a liquidity contingency plan in the event liquidity falls below an acceptable level, however in today’s economic environment, events could arise that may render sources of liquid funds unavailable in the future when required. The Company’s liquidity committee meets monthly to increase the oversight role of liquidity management during this challenging economic environment.
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, 2010.
                                         
    For the year ended December 31, 2010  
            Less than one     One to three     Four to five     More than five  
(In thousands)   Total     year     years     years     years  
FHLB advances
  $ 110,719     $ 22,000     $ 88,719     $     $  
Operating leases
    3,135       771       1,286       495       583  
PNC Bank
    44,230                         44,230  
Benefit obligations
    9,346       583       1,307       1,660       5,796  
Standby letters of credit
    2,755       2,755                    
Subordinated debt
    25,774                         25,774  
Non-interest bearing deposits
    52,872       52,872                    
Interest bearing deposits
    237,668       103,943       133,725              
Time deposits
    403,373       273,414       108,616       9,926       11,417  
 
                             
 
                                       
Total
  $ 889,872     $ 456,338     $ 333,653     $ 12,081     $ 87,800  
 
                             

49


 

Interest-Rate Sensitivity: Interest rate sensitivity is a function of the re-pricing characteristics of the financial institution’s assets and liabilities. These include the volume of assets and liabilities re-pricing, the timing of re-pricing, and the relative levels of re-pricing. Attempting to minimize the interest rate sensitivity gaps is a continual challenge in a changing rate environment. The interest rate sensitivity report examines the positioning of the interest rate risk exposure in a changing interest rate environment. Ideally, the rate sensitive assets and liabilities will be maintained in a matched position to minimize interest rate risk.
The interest rate sensitivity analysis is an important management tool; however, it does have some inherent shortcomings. It is a “static” analysis. Although certain assets and liabilities may have similar maturities or re-pricing, they may react in different degrees to changes in market interest rates. Additionally, re-pricing characteristics of certain assets and liabilities may vary substantially within a given period.
The following table summarizes re-pricing intervals for interest earning assets and interest bearing liabilities as of December 31, 2010, 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, 2010, the Company is in a liability sensitive position of $17.0 million, which indicates that within one year the re-pricing of liabilities is sooner than the re-pricing of assets.

50


 

                                                 
    For the year ended December 31, 2010
            91 – 365   One to five   Over five   Non-rate    
(In millions)   0 – 90 days   days   years   years   sensitive   Total
               
Assets (1)
                                               
Interest-bearing deposits in banks
  $ 24.9     $     $     $     $ 26.8     $ 51.7  
Federal funds sold
                                   
Investment securities
    20.8       36.4       166.7       87.3       6.0       317.2  
Loans: (2)
                                               
Fixed rate
    87.5       22.8       162.2       11.9             284.4  
Variable rate
    169.4       38.1       22.6       11.9       (21.1 )     220.9  
               
Total loans
    256.9       60.9       184.8       23.8       (21.1 )     505.3  
Other assets (3)
          19.0                   87.4       106.4  
               
Total Assets
  $ 302.6     $ 116.3     $ 351.5     $ 111.1     $ 99.1     $ 980.6  
               
 
                                               
Liabilities & Capital
                                               
Deposits:
                                               
Non interest bearing deposits
  $     $     $     $     $ 52.9     $ 52.9  
Interest bearing deposits
    26.0       78.0       133.6                   237.6  
Certificate of deposits
    66.3       207.1       118.6       11.4             403.4  
               
Total deposits
    92.3       285.1       252.2       11.4       52.9       693.9  
Borrowings (1)
    53.6       4.9       82.2       40.0             180.7  
Other liabilities
                            21.9       21.9  
Capital
                            84.1       84.1  
               
Total liabilities & capital
  $ 145.9     $ 290.0     $ 334.4     $ 51.4     $ 158.9     $ 980.6  
               
 
                                               
Net interest rate GAP
  $ 156.7     $ (173.7 )   $ 17.1     $ 59.7     $ (59.8 )        
                     
 
                                               
Cumulative interest rate GAP
  $ 156.7     $ (17.0 )   $ 0.1     $ 59.8                  
                           
GAP to total assets
    16 %     (18 %)                                
                                       
GAP to total equity
    186 %     (207 %)                                
                                       
Cumulative GAP to total assets
    16 %     (2 %)                                
                                       
Cumulative GAP to total equity
    186 %     (20 %)                                
                                       
 
(1)   Interest earning assets are included in the period in which the balances are expected to be repaid and/or re-priced as a result of anticipated prepayments, scheduled rate adjustments, and contractual maturities.
 
(2)   Reflects principal maturing within the specified periods for fixed and re-pricing for variable rate loans; includes non-performing loans.
 
(3)   Includes FHLB stock.
The method of analysis of interest rate sensitivity in the table above has a number of limitations. Certain assets and liabilities may react differently to changes in interest rates even though they re-price or mature in the same time periods. The interest rates on certain assets and liabilities may change at different times than changes in market interest rates, with some changes in advance of changes in market rates and some lagging behind changes in market rates. Also, certain assets have provisions, which limit changes in interest rates each time the interest rate changes and for the entire term of the loan. 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.
Interest Rate Swaps: For asset/liability management purposes, the Company has used interest rate swaps which are agreements between the Company and another party (known as counterparty) where one stream of future interest payments is exchanged for another based on a specified principal amount (known as notional amount). The

51


 

Company will use interest rate swaps 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, are linked to specific liabilities, and have a high correlation between the contract and the underlying item being hedged, both at inception and throughout the hedge period.
The Company had utilized interest rate swap agreements to convert a portion of its fixed rate time deposits to a variable rate (fair value hedge) to fund variable rate loans and investments as well as convert a portion of variable rate borrowings (cash flow hedge) to fund fixed rate loans. Interest rate swap contracts represent a series of interest flows exchanged over a prescribed period. Each quarter the Company used the Volatility Reduction Measure (“VRM”) to determine the effectiveness of their fair value hedges.
As a consequence of the 2008 Lehman Brothers Holdings, Inc. (“Lehman”) bankruptcy filing, the swap agreements and cash flow hedge that existed at the time of the bankruptcy filing were terminated. The Company had an agency mortgage-backed security (approximately $5.0 million) that was pledged as collateral at Lehman for our swap agreements. In October 2008, the Company sued Lehman Brothers Special Financing, Inc. (“LBSF”) to recover possession of its collateral. Because of the uncertainty surrounding the litigation and the Lehman bankruptcy, the Company classified the collateral as other-than-temporarily impaired for the entire amount as of December 31, 2008. In the fourth quarter of 2010, the Company sold its claim and recorded a gain of $1.7 million. The Company did not have any interest rate swaps agreements at December 31, 2010 and 2009.
Capital Adequacy
In connection with a recent bank regulatory examination, the FDIC concluded, based upon its interpretation of the Consolidated Reports of Condition and Income (the “Call Report”) instructions and under regulatory accounting principles (“RAP”), that income from Royal Bank’s tax lien business should be recognized on a cash basis, not an accrual basis. Royal Bank’s current accrual method is in accordance with US GAAP. Royal Bank disagrees with the FDIC’s conclusion and filed the Call Report for September 30, 2010 and December 31, 2010 in accordance with US GAAP. However, a change in the manner of revenue recognition for the tax lien business for regulatory accounting purposes affects Royal Bank’s capital ratios as shown below. Royal Bank is in discussions with the FDIC to resolve the difference of opinion.
The table below sets forth Royal Bank’s capital ratios under RAP, based on the FDIC’s interpretation of the Call Report instructions:
                         
    For the years ended December 31,
    2010   2009   2008
Royal Bank
                       
Leverage ratio
    8.03 %     8.09 %     7.81 %
Risk based capital ratio:
                       
Tier 1
    12.49 %     12.09 %     8.99 %
Total
    13.76 %     13.37 %     10.26 %
The tables below reflect the adjustments to the net loss as well as the capital ratios under US GAAP:
         
    For the year ended  
(In thousands)   December 31, 2010  
RAP net loss
  $ (30,011 )
Tax lien adjustment, net of noncontrolling interest
    8,126  
 
     
US GAAP net loss
  $ (21,885 )
 
     

52


 

                 
    As reported   As adjusted
    under RAP   for US GAAP
Total capital (to risk-weighted assets)
    13.76 %     15.54 %
Tier I capital (to risk-weighted assets)
    12.49 %     14.27 %
Tier I capital (to average assets, leverage)
    8.03 %     9.24 %
The tables below reflect the Company’s capital ratios and the Company’s performance ratios:
                         
    For the years ended December 31,
    2010   2009   2008
Company
                       
Leverage ratio
    9.68 %     9.78 %     10.30 %
Risk based capital ratio:
                       
Tier 1
    15.93 %     14.18 %     11.77 %
Total
    17.21 %     15.45 %     13.04 %
 
                       
Capital performance
                       
Return on average assets
    (2.04 %)     (2.57 %)     (3.20 %)
Return on average equity
    (23.19 %)     (30.94 %)     (29.04 %)
The Company has filed the Consolidated Financial Statements for Bank Holding Companies-FR Y-9C (“FR Y-9C”) as of December 31, 2010 consistent with GAAP and the FR Y-9C instructions. In the event that a similar adjustment for RAP purposes would be required by the Federal Reserve on the holding company level, the adjusted ratios are shown in the table below.
         
    For the year ended  
(In thousands)   December 31, 2010  
US GAAP net loss
  $ (24,093 )
Tax lien adjustment, net of noncontrolling interest
    (8,126 )
 
     
RAP net loss
  $ (32,219 )
 
     
                 
    As reported   As adjusted
    under US GAAP   for RAP
Total capital (to risk-weighted assets)
    17.21 %     15.48 %
Tier I capital (to risk-weighted assets)
    15.93 %     14.20 %
Tier I capital (to average assets, leverage)
    9.68 %     8.56 %
The capital ratios set forth above compare favorably to the minimum required amounts of Tier 1 and total capital to risk-weighted assets and the minimum Tier 1 leverage ratio, as defined by the banking regulators. At December 31, 2010, the Company was required to have minimum Tier 1 and total capital ratios of 4.0% and 8.0%, respectively, and a minimum Tier 1 leverage ratio of 4.0%. At December 31, 2010, the Company met the regulatory minimum capital requirements, and management believes that, under current regulations, the Company will continue to meet its minimum capital requirements in the foreseeable future. Under the Orders as described in “Regulatory Action” under “Item 1 — Business” in this Report, Royal Bank is required to maintain a minimum Tier 1 leverage ratio of 8% and a Total risk-based capital ratio of 12% during the term of the Orders. Royal Bank met those requirements at December 31, 2010. See “Note 15 — Regulatory Capital Requirements” of the Notes to Consolidated Financial Statements in Item 8 of this Report. While Royal Bank met the criteria for a well capitalized institution which is a

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leverage ratio of 5%, a Tier 1 ratio of 8%, and a total capital ratio of 10%, Royal Bank, as a party to the Orders, must classify itself as adequately capitalized.
On February 20, 2009, as part of the Capital Purchase Program (“CPP”) established by the United States Department of Treasury (“Treasury”), the Company issued to Treasury 30,407 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, without par value per share (the “Series A Preferred Stock”), and a liquidation preference of $1,000 per share. In conjunction with the purchase of the Series A Preferred Stock, Treasury received a warrant to purchase 1,104,370 shares of the Company’s Class A common stock. The aggregate purchase price for the Series A Preferred Stock and Warrant was $30.4 million in cash. The Series A Preferred Stock qualifies as Tier 1 capital and pays cumulative dividends at a rate of 5% per annum for the first five years, and 9% per annum thereafter. The Series A Preferred Stock may generally be redeemed by the Company at any time following consultation with its primary banking regulators. The warrant issued to Treasury has a 10-year term and is immediately exercisable upon its issuance, with an exercise price, subject to anti-dilution adjustments, equal to $4.13 per share of the common stock.
Management Options to Purchase Securities
The 2007 Long-Term Incentive Plan was approved by shareholders at the 2007 Annual Meeting. All employees and non-employee directors of the Company and its designated subsidiaries are eligible participants. The plan includes 1,000,000 shares of Class A common stock (of which 250,000 shares may be issued as restricted stock), subject to customary anti-dilution adjustments, or approximately 9.0% of total outstanding shares of the Class A common stock. As of December 31, 2010, 191,072 shares from this plan have been granted. The option price is equal to the fair market value at the date of the grant. The options are exercisable at 20% per year beginning one year after the date of grant and must be exercised within ten years of the grant. The restricted stock is granted with an estimated fair value equal to the market value of the Company closing stock price on the date of the grant. Restricted stock will vest three years from the grant date, if the Company achieves specific goals set by the Compensation Committee and approved by the Board of Directors. These goals include a three year average return on assets compared to peers, a three year average return on equity compared to peers and a minimum return on both assets and equity over the three year period.
In May 2001, the directors of the Company 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 re-approved 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 1,800,000 shares of the Company’s Class A common stock (but not in excess of 19% of outstanding shares). In May 2006, the shareholders approved an increase of the number of shares of Class A Common Stock available for issuance under the Plan by 150,000 to 1,800,000 and extended the plan for an additional year At the time a stock option is granted, a stock appreciation right for an identical number of shares may also be granted. The option price is equal to the fair market value at the date of the grant. At December 31, 2010, 385,005 of the options that have been granted are outstanding, which are exercisable at 20% per year. At December 31, 2010, options covering 369,448 shares were exercisable. The ability to grant new options under this plan has expired.
In May 2001, the directors of the Company approved an amended non-qualified Outside Directors’ Stock Option Plan. The shareholders in connection with the formation of the Holding Company re-approved this Plan. Under the terms of the plan, 250,000 shares of Class A stock are authorized for grants. Each director is entitled to a grant of an option to purchase 1,500 shares of stock annually, which is exercisable one year from the grant date. The options are granted at the fair market value at the date of the grant. At December 31, 2010, 74,086 of the options that have been granted are outstanding, and all are exercisable. The ability to grant new options under this plan has expired.

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Loans
The following table reflects the composition of the loan portfolio and the percent of gross loans outstanding represented by each category at the dates indicated.
                                                                                 
    As of December 31,  
(Dollars in thousands)   2010     2009     2008             2007             2006          
Commercial and industrial
  $ 74,027       14.9 %   $ 104,063       15.1 %   $ 86,278       12.3 %   $ 77,856       12.1 %   $ 43,019       7.2 %
Construction
    29,044       5.8 %     52,196       7.6 %     167,204       23.8 %     92,779       14.4 %     172,745       29.1 %
Construction and land development — mezzanine
          0.0 %           0.0 %     2,421       0.3 %     6,443       1.0 %     5,177       0.9 %
Land development (1)
    50,594       10.2 %     66,878       9.7 %     74,168       10.6 %     78,874       12.2 %           0.0 %
Real Estate — residential
    29,299       5.9 %     48,498       7.1 %     27,480       3.9 %     42,286       6.5 %     43,338       7.3 %
Real Estate — non-residential
    194,203       39.0 %     277,234       40.3 %     234,573       33.4 %     261,350       40.5 %     268,162       45.2 %
Real Estate — non-residential — mezzanine
          0.0 %           0.0 %     4,111       0.6 %     8,749       1.4 %     8,283       1.4 %
Real Estate — multi-family
    10,277       2.1 %     22,017       3.2 %     14,059       2.0 %     6,887       1.1 %     3,953       0.7 %
Real Estate — residential — mezzanine
          0.0 %     2,480       0.4 %     335       0.0 %     3,504       0.5 %     2,129       0.4 %
Tax certificates
    70,443       14.2 %     73,106       10.6 %     64,168       9.1 %     46,090       7.1 %     32,235       5.4 %
Lease financing
    38,725       7.8 %     39,097       5.7 %     26,123       3.7 %     19,778       3.1 %     13,404       2.3 %
Other
    793       0.2 %     2,173       0.3 %     1,243       0.2 %     1,424       0.2 %     1,333       0.2 %
                               
Total gross loans
  $ 497,405       100 %   $ 687,742       100 %   $ 702,163       100 %   $ 646,020       100 %   $ 593,778       100 %
Unearned income
    (551 )             (878 )             (1,441 )             (1,545 )             (1,564 )        
 
                                                                     
 
  $ 496,854             $ 686,864             $ 700,722             $ 644,475             $ 592,214          
Allowance for loan loss
    (21,129 )             (30,331 )             (28,908 )             (19,282 )             (11,455 )        
 
                                                                     
Total net loans
  $ 475,725             $ 656,533             $ 671,814             $ 625,193             $ 580,759          
 
                                                                     
 
(1)   Land development balances were not segregated from construction and land development for 2006.
Credit Quality
The following table presents the principal amounts of non-accrual loans held for investment and other real estate:
                                         
    For the years ended December 31,  
(Dollars in thousands)   2010     2009     2008     2007     2006  
Non-accrual loans (1)
  $ 43,162     $ 73,679     $ 85,830     $ 25,401     $ 6,748  
Other real estate owned
    29,244       30,317       10,346       1,048       924  
 
                             
Total non-performing assets
  $ 72,406     $ 103,996     $ 96,176     $ 26,449     $ 7,672  
 
                             
 
                                       
Non-performing assets to total assets
    7.38 %     8.04 %     8.18 %     2.07 %     0.57 %
 
                             
 
                                       
Non-performing loans to total loans
    8.69 %     10.73 %     12.25 %     3.94 %     1.14 %
 
                             
 
                                       
Allowance for loan loss to non-accrual loans
    48.95 %     41.17 %     33.68 %     75.91 %     169.75 %
 
                             
 
                                       
Total Loans
    496,854       686,864       700,722                  
Total Assets
    980,626       1,292,726       1,175,586                  
Allowance for loan and lease losses
    21,129       30,331       28,908                  
 
                                       
ALL / Loans & Leases (MD & A)
    4.25 %     4.42 %     4.13 %                
 
(1)   Generally, a loan is placed in non-accrual status when it has been delinquent for a period of 90 days or more, unless the loan is both well secured and in the process of collection.

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Non-accrual loan activity for LHFI for each of the four quarters in 2010 is set forth below:
                                                 
            1st Quarter Actvity  
    Balance at             Payments and                      
    December 31,             other             Transfer to     Balance at  
(In thousands)   2009     Additions     decreases     Charge-offs     OREO     March 31, 2010  
Construction
  $ 18,316     $ 2,130     $ (1,543 )   $ (55 )   $     $ 18,848  
Land development
    5,908       7,480       (2,857 )                 10,531  
Real Estate-non-residential
    19,584       3       (420 )                 19,167  
Commercial & industrial
    11,779       236       (637 )     (2,031 )           9,347  
Residential real estate
    12,445       1,190       (427 )                 13,208  
Residential real estate — mezzanine
    2,480                   (1,463 )           1,017  
Multi-family
          8,311                         8,311  
Leasing
    627       466             (179 )           914  
Tax certificates
    2,540             (221 )                 2,319  
 
                                   
 
                                               
Total
  $ 73,679     $ 19,816     $ (6,105 )   $ (3,728 )   $     $ 83,662  
 
                                   
                                                         
            2nd Quarter Actvity        
                    Payments and                              
    Balance at             other                     Transfer to     Balance at  
(In thousands)   March 31, 2010     Additions     decreases     Reclassed     Charge-offs     OREO     June 30, 2010  
Construction
  $ 18,848     $ 137     $ (1,932 )   $ 12,540     $ (4,119 )   $     $ 25,474  
Land development
    10,531       7,910       (73 )     300       (1,485 )           17,183  
Real Estate-non-residential
    19,167       5,192       (1,250 )     (4,000 )     (1,156 )     (47 )     17,906  
Commercial & industrial
    9,347       96       (109 )           (2,152 )     (499 )     6,683  
Residential real estate
    13,208       187       (14 )     (8,840 )                 4,541  
Residential real estate — mezzanine
    1,017                         (1,017 )            
Multi-family
    8,311       21                   (457 )     (7,875 )      
Leasing
    914       112                   (427 )           599  
Tax certificates
    2,319       10       (268 )           (10 )           2,051  
 
                                         
Total
  $ 83,662     $ 13,665     $ (3,646 )   $     $ (10,823 )   $ (8,421 )   $ 74,437  
 
                                         
                                                 
            3rd Quarter Actvity        
                    Payments and                     Balance at  
    Balance at             other             Transfer to     September 30,  
(In thousands)   June 30, 2010     Additions     decreases     Charge-offs     OREO     2010  
Construction
  $ 25,474     $ 4,540     $ (293 )   $     $     $ 29,721  
Land development
    17,183       229       (1,024 )     (61 )     (1,649 )     14,678  
Real Estate-non-residential
    17,906       3,846       (352 )     (42 )     (911 )     20,447  
Commercial & industrial
    6,683       25       (478 )                 6,230  
Residential real estate
    4,541       620       (747 )                 4,414  
Multi-family
          4,992                         4,992  
Leasing
    599       315             (310 )           604  
Tax certificates
    2,051             (127 )                 1,924  
 
                                   
Total
  $ 74,437     $ 14,567     $ (3,021 )   $ (413 )   $ (2,560 )   $ 83,010  
 
                                   

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            4th Quarter Actvity        
    Balance at             Payments and                             Royal Asian non-     Balance at  
    September 30,             other             Transfer to     Loans transferred     accrual loans     December 31,  
(In thousands)   2010     Additions     decreases     Charge-offs     OREO     to LHFS     sold     2010  
Construction
  $ 29,721     $     $ (730 )   $ (4,263 )   $ (3,883 )   $ (8,373 )   $     $ 12,472  
Land development
    14,678       1,210       (126 )     (3,212 )     (266 )     (4,998 )           7,286  
Real Estate-non-residential
    20,447       6,065       (1,000 )     (4,011 )     (486 )     (8,370 )     (2,585 )     10,060  
Commercial & industrial
    6,230       100       (251 )     (121 )                       5,958  
Residential real estate
    4,414       240       (228 )     (483 )     (642 )     (902 )           2,399  
Multi-family
    4,992       2,573       (4,811 )     (301 )                       2,453  
Leasing
    604       261             (133 )                       732  
Consumer
                                               
Tax certificates
    1,924             (84 )     (38 )                       1,802  
 
                                               
Total
  $ 83,010     $ 10,449     $ (7,230 )   $ (12,562 )   $ (5,277 )   $ (22,643 )   $ (2,585 )   $ 43,162  
 
                                               
Total non-accrual loans at December 31, 2010 were $65.8 million and were comprised of $43.2 million in LHFI and $22.6 million in LHFS. Non-accrual loans were $73.7 million at December 31, 2009. The $7.9 million decline in total non-accrual loans was the result of $19.9 million in charge-offs related to impairment analysis and transfers to OREO, a $7.6 million charge to the allowance for loan and lease losses on the $30.3 million carrying value of non-accrual loans transferred to LHFS, $20.0 million reduction in existing non-accrual loan balances through payments or loans becoming current and placed back on accrual, $16.3 million transferred to other real estate owned, and a $2.6 million reduction related to the Royal Asian disposition which collectively were offset by $58.5 million in additions.
The following is a detail listing of the significant additions to non-accrual loans during 2010:
First Quarter 2010 new non-accrual loans:
    A $16.1 million participation loan for a student housing rental apartment complex comprised of twelve 2-story townhouse type buildings located in Cumberland County, Pennsylvania became non-accrual during the first quarter of 2010. The project consists of 182 units. Royal Bank is the lead bank and had sold 48% to one local bank. During the second quarter of 2010, Royal Bank received a deed in lieu of foreclosure and transferred the collateral to OREO.
 
    A $12.5 million participation acquisition and development loan to a regional real estate developer to fund environmental remediation, site improvement and soft costs activities on parcels in Montgomery County, Pennsylvania became non-accrual during the first quarter of 2010. The project has final land development approvals for two office buildings with an approved floor area ratio of 300,790 square feet. Royal Bank is the lead bank and had sold 44% to one local bank. In the fourth quarter of 2010, the Company included this loan in the asset pool sale and transferred the loan to LHFS from LHFI.
 
    Three loans totaling $2.6 million to fund acquisition and soft development costs to develop a 100,000 square foot retail project located in Bucks County, Pennsylvania became non-accrual during the first quarter of 2010. The loan has matured by its terms. There is a signed land lease for a 10,000 square foot stand alone retail store to a national drug store chain which can be developed separate from the remaining 90,000 square foot planned for an in-line shopping center. During the third quarter the loans were restructured under market rates and terms and the two smaller loans were paid off. In the fourth quarter of 2010, the Company included the remaining loan in the asset pool sale and transferred the loan to LHFS from LHFI.
 
    A $1.2 million construction project in Worcester County, Maryland, in which the Company is a participant, became non-accrual during the first quarter of 2010. The project consists of 120.7 acres of which 86.5 acres are zoned for agricultural use. The borrower was unable to obtain county approval to have the land use reclassified to general commercial. The borrower is pursuing annexation through the town but the process will take time. During the fourth quarter the Company recorded a charged-off of $715,000 through the allowance for loan and lease losses.

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Second Quarter 2010 new non-accrual loans:
    A $5.9 million loan which was originally used for purchase money acquisition and to fund ongoing predevelopment activity associated with a residential project in Philadelphia, Pennsylvania became non-accrual during the second quarter of 2010. The project consists of interconnected buildings containing 73,050 square feet of gross area. After acquisition, the borrowers’ original plan was for the development of a 157,000 square foot, 97 unit condo project. The borrowers pursued and received approvals as well as made substantial progress in the engineering and design. This was to be ground-up construction requiring some demolition of the existing structure. In 2009, the sponsors made the decision to reposition the project to apartments given the downturn in the for-sale residential market. Ultimately, the economic climate and the deterioration of the sponsors’ financial condition led to a default in payment which has resulted in a foreclosure action being commenced. During 2010, the Company recorded total charge-offs of $1.9 million through the allowance for loan and lease losses.
 
    A $4.5 million non-residential real estate loan became non-accrual during the second quarter of 2010. The project is a hotel located in Monroe County, Pennsylvania. As a result of deteriorating economic conditions, the loan was placed in default as a result of non-payment. During the third quarter, the Company finalized a forbearance agreement with the borrower and the loan is currently performing under the agreement. A current appraisal did not indicate impairment in accordance with ASC Topic 310.
 
    A $1.6 million construction loan in Talbot County, Maryland which is collateralized by two commercial building lots became non-accrual during the second quarter of 2010. Both lots are approved and site improvements have been completed. The loan has matured and the borrower failed to put forth a realistic forbearance proposal. The Company recorded a $76,000 charge-off against the loan during the second quarter of 2010. During the third quarter of 2010, Royal Bank foreclosed on the borrower and transferred the collateral to OREO.
Third Quarter 2010 new non-accrual loans:
    A $5.0 million participation in a $10.1 million loan used to finance the purchase and renovation of a 156 unit apartment complex located in New Castle County, Delaware became non-accrual during the third quarter of 2010. The loan is an interest only loan for two years, with one 12-month extension option. The project is approximately 75% occupied and unable to service interest only debt service. The original strategy of the project was to renovate, lease up, and ultimately refinance with long term institutional financing, which at this time, is unavailable. In the fourth quarter the Company negotiated with the borrower to payoff the loan and recorded an $181,000 charge-off through the allowance for loan and lease losses.
 
    A project consisting of 38 whole ownership condominiums and 396 1/8th fractional ownership interests located in Routt County, Colorado became non-accrual during the third quarter of 2010. To date there have been 14 whole ownership sales and 82 fractional sold. The original balance of the loan was $165.0 million, with approximately $100.0 million outstanding. Royal Bank’s participation rate in the loan is 4.24%. The loan entered default status in October 2010 due to non-payment of a loan fee; the appropriate lien waivers have not been received; and an appraisal not having been delivered, with a value that does not exceed 70% loan to value. The current carrying value of the loan is $4.2 million. The most recent appraisal did not indicate impairment in accordance with ASC Topic 310.
Fourth Quarter 2010 new non-accrual loans:
    A $1.9 million condominium development project in Philadelphia, Pennsylvania, in which the Company is a participant, became non-accrual during the fourth quarter of 2010. The project consists of 48 residential units and one commercial unit. The lead bank renegotiated the loan and as a result the Company has classified the loan as a troubled debt restructuring (“TDR”). The Company recorded a $120,000 charge-off through the allowance for loan and lease losses.

58


 

    A $5.8 million participation in an $11.6 million loan became non-accrual in the fourth quarter of 2010. The loan is for a 207 acre site that consists of a golf course and club house in Montgomery County, Pennsylvania. The lead bank has begun collection proceedings. A current appraisal indicated impairment in accordance with ASC Topic 310. Consequently, the Company established a specific reserve of $1.4 million for this loan.
The Company identifies a loan as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. The Company recognizes income under the accrual basis when the principal payments on the loans become current and the collateral on the loan is sufficient to cover the outstanding obligation to the Company. If these factors do not exist, the Company does not recognize income.
The following is a summary of information pertaining to impaired loans and leases held for investment:
                 
    As of December 31,  
(In thousands)   2010     2009  
Impaired loans and leases with a valuation allowance
  $ 9,620     $ 46,670  
Impaired loans and leases without a valuation allowance
    32,805       27,009  
 
           
Total impaired loans and leases
  $ 42,425     $ 73,679  
 
           
 
               
Valuation allowance related to impaired loans and leases
  $ 1,907     $ 10,958  
                         
    For the years ended December 31,
(In thousands)   2010   2009   2008
Average investment in impaired loans and leases
  $ 78,225     $ 79,754     $ 55,134  
Interest income recognized on impaired loans and leases
  $ 335     $ 242     $ 302  
Interest income recognized on a cash basis on impaired loans and leases
  $ 335     $ 242     $ 302  
Total cash collected on impaired loans and leases during 2010, 2009, and 2008 was $21.7 million, $21.6 million, and $7.6 million, respectively, of which $21.4 million, $21.3 million, and $7.3 million was credited to the principal balance outstanding on such loans, respectively.
Potential problem loans are loans not currently classified as non-accrual loans that management has doubt as to the borrower’s ability to comply with present repayment terms. Potential problems loans were $20.5 million at December 31, 2010. Most of these loans were past due 30 days but less than 90 days.
The Company granted loans to the officers and directors of the Company and to their associates. In accordance with Regulation O related party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than normal risk of collectability. The aggregate dollar amount of these loans was $3.9 million and $4.8 million at December 31, 2010 and 2009. During 2010 no new related party loans were approved. Total payments received on related party loans in 2010 were $444,000.
The Company classifies its leases as finance leases, in accordance to FASB ASC Topic 840, “Leases”. The difference between the Company’s gross investment in the lease and the cost or carrying amount of the leased property, if different, is recorded as unearned income, which is amortized to income over the lease term by the interest method.
The Company’s policy for income recognition on troubled debt restructurings (“TDRs”) is to recognize income on currently performing TDRs under the accrual method. As of December 31, 2010, the Company had one TDR classified as a multi-family real estate non-accrual loan in the amount of $1.8 million.

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The Company grants commercial and real estate loans, including construction and land development primarily in the greater Philadelphia metropolitan area as well as selected locations throughout the Mid-Atlantic region. The Company also has participated with other financial institutions in selected construction and land development loans outside these geographic areas. The Company has a concentration of credit risk in commercial real estate, construction and land development loans at December 31, 2010. A substantial portion of its debtors’ ability to honor these contracts is dependent upon the housing sector specifically and the economy in general.
Other Real Estate Owned (“OREO”): OREO slightly decreased from $30.3 million at December 31, 2009 to $29.2 million at December 31, 2010. Set forth below is a table which details the changes in OREO from December 31, 2009 to December 31, 2010.
                                 
    2010  
(In thousands)   First Quarter     Second Quarter     Third Quarter     Fourth Quarter  
Beginning balance
  $ 30,317     $ 25,781     $ 30,795     $ 27,525  
Capital improvements
          697       545        
Net proceeds from sales
    (4,391 )     (3,403 )     (5,021 )     (504 )
Net gain on sales
    157       174       404       284  
Assets acquired on non-accrual loans
          8,421       2,873       5,490  
Other
    500       85       (10 )      
Impairment charge
    (802 )     (960 )     (2,061 )     (3,551 )
 
                       
Ending balance
  $ 25,781     $ 30,795     $ 27,525     $ 29,244  
 
                       
During the fourth quarter of 2010, the Company had five collateral acquisitions. The first foreclosure was on 87 improved residential lots which were collateral for a $3.9 million construction loan for an age-restricted community in Bucks County, Pennsylvania. The second foreclosure was on a two-story 13,000 square foot commercial building in Camden County, New Jersey. The third foreclosure was on seven single-family rental properties in Philadelphia, Pennsylvania that were collateral for a residential loan. The fourth foreclosure was on 18 single-family residential properties in Philadelphia, Pennsylvania that were collateral for a residential participation loan. The Company is entitled to 50% of the collateral. The Company recorded total charge-offs of $402,000 to the allowance for loan and lease losses when the collateral for these four lending relationships was transferred to OREO. The fifth foreclosure was on a 14.5 acre parcel, of which the developable area is 1.6 acres, in Burlington County, New Jersey. The parcel was collateral for a land development loan. A recent appraisal indicated an as-is value of $600,000. Consequently the Company recorded a gain of $271,000 when the collateral was transferred to OREO. During the fourth quarter, the Company recorded an impairment charge of $2.8 million on six properties included in the asset pool sale. Additionally the Company recorded a total impairment charge of $776,000 related to three previously foreclosed properties.
Also in the fourth quarter the Company sold portions of collateral associated with four separate OREO properties. The Company received proceeds of $477,000 and recorded a net gain of $11,000 as a result of these sales. Additionally the Company sold two properties acquired through the tax lien portfolio. The Company received proceeds of $27,000 and recorded gains of $2,000 as a result of these sales.
During the third quarter of 2010, the Company had two significant collateral acquisitions related to two different lending relationships. The first foreclosure was on two commercial building lots which were collateral for a $1.6 million construction loan in Maryland. The second foreclosure was on a three-story commercial building in Florida that was collateral for a $1.0 million commercial real estate loan. The Company is entitled to 95% of the collateral value. The Company recorded total charge-offs of $96,000 to the allowance for loan and lease losses when the collateral for these two lending relationships was transferred to OREO. During the third quarter the Company sold collateral associated with two notable projects. The first sale was related to a condominium project in Wildwood, New Jersey described below. The Company sold 25 units and received net proceeds of $3.0 million while recording a gain of $338,000 as a result of the sale of these units. The second sale was related to collateral acquired in the fourth quarter of 2009. The Company received proceeds of $1.4 million and recorded a gain of $59,000. During the third quarter of 2010, the Company recorded impairment charges of $2.1 million related to three separate projects

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and tax liens. In addition to the sales mentioned above the Company sold four properties acquired through the tax lien portfolio. The Company received proceeds of $240,000 and recorded gains of $45,000 as a result of these sales.
During the second quarter of 2010, the Company received a deed in lieu of foreclosure for a rental community consisting of 182 dwelling units which was collateral for a $16.1 million participation loan. The Company is entitled to 52% of the collateral value. The Company recorded a charge-off of $457,000 to the allowance for loan and lease losses when the collateral was transferred to OREO. Also during the second quarter, the Company sold collateral associated with four different projects. The first sale was related to a condominium project in Raleigh, North Carolina that the Company foreclosed on during the fourth quarter of 2008. The Company sold three units during the second quarter of 2010. The second sale was related to a condominium project in Wildwood, New Jersey that the Company foreclosed on during the fourth quarter of 2009. During the second quarter of 2010, the Company completed the renovations to the project and held an auction of 28 units. At June 30, 2010, the Company had settled on ten of the condominium units. The third sale was related to a commercial building that was the collateral for a loan transferred to OREO during the second quarter of 2009. The last sale was related to 3 homes and 14 residential lots located in North Carolina and South Carolina that the Company foreclosed on during the second quarter of 2010. During the second quarter the Company sold one home and one lot. As a result of these sales, the Company received net proceeds of $2.9 million and recorded a loss of $15,000. In addition to the sales mentioned above the Company sold five properties acquired through the tax lien portfolio. The Company received proceeds of $427,000 and recorded gains of $189,000 as a result of these sales.
During the second quarter of 2010, the Company recorded impairment charges of $960,000 which were primarily related to an apartment building in Luzerne County, Pennsylvania foreclosed on in the second quarter of 2009 and also the tax lien portfolio.
During the first quarter of 2010, the Company sold collateral related to three loans. The Company sold 19 condominium units in Raleigh, North Carolina. The second sale was a commercial building in Gloucester County, New Jersey that was collateral for a loan transferred to OREO in the third quarter of 2009. The third sale was a residential building in Philadelphia, Pennsylvania that was collateral for a loan transferred to OREO in the fourth quarter of 2009. As a result of these sales, the Company received net proceeds of $4.3 million and recorded an $87,000 gain. In addition to the sales mentioned above the Company sold one property acquired through the tax lien portfolio. The Company received proceeds of $139,000 and recorded gains of $70,000 as a result of these sales. During the first quarter of 2010, the Company recorded an impairment charge of $802,000 related to three lots in Ocean City, Maryland which were transferred to OREO in the first quarter of 2009.
The Company is working to satisfactorily sell the remaining OREO properties using existing relationships and possible future auctions. However the Company recognizes that due to the continued weak housing and commercial real estate markets the successful disposition of the properties will likely take considerable time.
Loans and Lease Financing Receivables
The following table summarizes the loan portfolio by loan category and amount that corresponds to the appropriate regulatory definitions.

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    As of December 31,  
(In thousands)   2010     2009     2008  
Loans secured by real estate:
                       
Construction and land development
  $ 29,044     $ 52,196     $ 167,204  
Construction and land development — mezzanine
                2,421  
Land development
    50,594       66,878       74,168  
Secured by 1-4 family residential properties:
                       
Revolving, open-end loans secured by 1-4 family residential properties and extended under lines of credit
    1,252       1,272       1,322  
All other loans secured by 1-4 family residential properties:
                       
Secured by first liens
    26,166       44,053       21,607  
Secured by junior liens
    1,881       3,173       4,551  
Secured by junior liens — mezzaninie
          2,480        
Secured by multi family (5 or more) residential properties
    10,277       22,017       14,059  
Secured by multi family (5 or more) res. Properties — mezzanine
                335  
Secured by non-farm nonresidential properties
    194,203       277,234       234,573  
Secured by non-farm nonresidential properties — mezzanine
                4,111  
Tax certificates
    70,443       73,106       64,168  
Commercial and industrial loans
    74,027       104,063       86,278  
Loans to individuals for household, family, and other personal expenditures
    768       1,514       1,031  
Obligations of state and political subdivisions in the U.S.
                47  
Lease financing receivables (net of unearned income)
    38,725       39,097       26,123  
All other loans
    25       659       165  
Less: Net deferred loan fees
    (551 )     (878 )     (1,441 )
 
                 
Total loans and leases, net of unearned income
  $ 496,854     $ 686,864     $ 700,722  
 
                 
Credit Classification Process
The loan review function is outsourced to a third party vendor which applies the Company’s loan rating system to specific credits. The Company uses a nine point grading risk classification system commonly used in the financial services industry. The first four classifications are rated Pass. The riskier classifications include Watch, Special Mention, Substandard, Doubtful and Loss. Upon completion of a loan review, a copy of any review receiving an adverse classification by the reviewer is presented to the Loan Review Committee for discussion. Minutes outlining in detail the Committee’s findings and recommendations are issued after each meeting for follow-up by individual loan officers. The Committee is comprised of the voting members of the Officers’ Loan Committee. The CCO is the primary bank officer dealing with the third party vendor during the reviews.
All loans are subject to initial loan review. Additional review is undertaken with respect to loans providing potentially greater exposure. This is accomplished by:
    100% of construction loans regardless of loan size;
 
    100% of loans/relationships with balances of $1 million or greater;
 
    50% of loans with balances from $500,000 up to $1 million;
 
    25% of loans with balances from $250,000 to $499,999;
 
    5% of loans with balances up to $250,000; and
 
    Loans requested specifically by the Company’s management

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Loans on the Company’s Special Assets Committee list are also subject to loan review even though they are receiving the daily attention of the assigned officer and monthly attention of the Special Assets Committee.
A watch list is maintained and reviewed at each meeting of the Loan Review Committee. Loans are added to the watch list, even though the loans may be current or less than 30 days delinquent if they exhibit elements of substandard creditworthiness. The watch list contains a statement for each loan as to why it merits special attention, and this list is distributed to the Board of Directors on a monthly basis. Loans may be removed from the watch list if the Loan Review Committee determines that exception items have been resolved or creditworthiness has improved. Additionally, if loans become serious collection matters and are listed on the Company’s monthly delinquent loan or Special Assets Committee lists, they may be removed from the watch list. During the third quarter of 2009, as a result of the level of classified assets within the loan portfolio, the Company established the CCIC Committee (Classified, Charge-off and Impairment Committee) to formalize the process and documentation required to classify, remove from classification, impair or charge-off a loan. The Committee, which is comprised of the President, Vice Chairman, Chief Financial Officer, Chief Credit Officer, Chief Lending Officer and Chief Risk Officer, meets as required and provides regular updated reports to the Board of Directors.
All loans, at the time of presentation to the appropriate loan committee, are given an initial loan “risk” rating by the CCO. From time to time, and at the general direction of any of the various loan committees, the ratings may be changed based on the findings of that committee. Items considered in assigning ratings include the financial strength of the borrower and/or guarantors, the type of collateral, the collateral lien position, the type of loan and loan structure, any potential risk inherent in the specific loan type, higher than normal monitoring of the loan or any other factor deemed appropriate by any of the various committees for changing the rating of the loan. Any such change in rating is reflected in the minutes of that committee.
Investment Securities
The following tables present the consolidated book values and approximate fair value at December 31, 2010, 2009 and 2008, respectively, for each major category of the Company’s AFS investment securities portfolio.
                                         
            Included in Accumulated Other        
            Comprehensive Income (AOCI)        
                    Gross unrealized losses        
            Gross             Non-credit        
As of December 31, 2010           unrealized     Non-OTTI     related OTTI        
(In thousands)   Amortized cost     gains     in AOCI     in AOCI     Fair value  
Investment securities available-for-sale
                                       
Mortgage-backed securities-residential
  $ 8,492     $ 348     $     $     $ 8,840  
U.S. government agencies
    30,492             (755 )           29,737  
Common stocks
    381       152       (50 )           483  
Collateralized mortgage obligations:
                                       
Issued or guaranteed by U.S. government agencies
    231,717       3,640       (704 )           234,653  
Non-agency
    7,026       114       (3 )           7,137  
Corporate bonds
    9,483             (197 )           9,286  
Trust preferred securities
    16,566       2,135             (87 )     18,614  
Other securities
    7,974       431                   8,405  
 
                             
Total available-for-sale investment securities
  $ 312,131     $ 6,820     $ (1,709 )   $ (87 )   $ 317,155  
 
                             

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            Included in Accumulated Other        
            Comprehensive Loss (AOCL)        
                    Gross Unrealized Losses        
            Gross             Non-credit        
As of December 31, 2009           unrealized     Non-OTTI     related OTTI        
(In thousands)   Amortized cost     gains     in AOCL     in AOCL     Fair value  
Investment securities available-for-sale
                                       
Mortgage-backed securities-residential
  $ 21,393     $ 234     $ (26 )   $     $ 21,601  
U.S. government agencies
    1,150       3       (2 )           1,151  
Preferred stocks
    2,500             (270 )           2,230  
Common stocks
    381       71       (8 )           444  
Collateralized mortgage obligations:
                                       
Issued or guaranteed by U.S. government agencies
    316,911       2,871       (1,281 )           318,501  
Non-agency
    23,010       145       (875 )     (1,082 )     21,198  
Collateralized debt obligations
    24,825                         24,825  
Corporate bonds
    7,911       9       (423 )     (630 )     6,867  
Trust preferred securities
    32,926       2,064       (177 )     (678 )     34,135  
Other securities
    7,892       8       (133 )           7,767  
 
                             
Total available-for-sale investment securities
  $ 438,899     $ 5,405     $ (3,195 )   $ (2,390 )   $ 438,719  
 
                             
                                         
            Included in Accumulated Other        
            Comprehensive Loss (AOCL)        
                    Gross Unrealized Losses        
            Gross             Non-credit        
As of December 31, 2008           unrealized     Non-OTTI     related OTTI        
(In thousands)   Amortized cost     gains     in AOCL     in AOCL     Fair value  
Investment securities available-for-sale
                                       
Mortgage-backed securities-residential
  $ 53,871     $ 1,190     $     $     $ 55,061  
U.S. government agencies
    48,109       82                   48,191  
Preferred stocks
    4,000             (1,703 )           2,297  
Common stocks
    19,907       8       (7,208 )           12,707  
Collateralized mortgage obligations:
                                       
Issued or guaranteed by U.S. government agencies
    77,848       1,649       (72 )           79,425  
Non-agency
    43,711             (6,221 )           37,490  
Collateralized debt obligations
    35,000             (8,840 )           26,160  
Corporate bonds
    57,445       641       (6,748 )           51,338  
Trust preferred securities
    36,316       606       (6,778 )           30,144  
Other securities
    7,631       54       (196 )           7,489  
 
                             
Total available-for-sale investment securities
  $ 383,838     $ 4,230     $ (37,766 )   $     $ 350,302  
 
                             
The contractual maturity distribution and weighted average rate of the Company’s AFS debt securities at December 31, 2010 are presented in the following table. Mortgage-backed securities and collateralized mortgage obligations are presented within the category that represents the total weighted average expected maturity.
                                                                                 
    As of December 31, 2010  
                    After one year, but     After five years, but              
    Within one year     within five years     within ten years     After ten years     Total  
(In thousands, except percentages)   Amount     Rate     Amount     Rate     Amount     Rate     Amount     Rate     Amount     Rate  
Mortgage-backed securities-residential
  $           $ 8,840       4.97 %   $           $           $ 8,840       4.97 %
U.S. government agencies
                10,376       1.80 %     7,713       1.87 %     11,648       2.00 %     29,737       1.90 %
Collateralized mortgage obligations:
                                                                               
Issued or guaranteed by U.S. government agencies
    17,664       4.78 %     216,989       4.54 %                             234,653       4.57 %
Non-agency
    554       5.25 %     6,583       4.46 %                             7,137       4.52 %
Corporate bonds
    100       1.72 %     6,183       2.51 %     1,978       5.13 %     1,025       3.10 %     9,286       3.12 %
Trust preferred securities
                                        18,614       10.22 %     18,614       10.22 %
 
                                                           
Total AFS debt securities
  $ 18,318       4.24 %   $ 248,971       4.78 %   $ 9,691       4.13 %   $ 31,287       9.53 %   $ 308,267       5.02 %
 
                                                           

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The Company assesses whether other-than-temporary impairment (“OTTI”) is present when the fair value of a security is less than its amortized cost. All investment securities are evaluated for OTTI under FASB ASC Topic 320, “Investments-Debt & Equity Securities” (“ASC Topic 320”). The non-agency collateralized mortgage obligations that are rated below AA are evaluated under FASB ASC Topic 320 Subtopic 40, “Beneficial Interests in Securitized Financial Assets” under FASB ASC Topic 325, “Investments-Other”. In determining whether OTTI exists, management considers numerous factors, including but not limited to: (1) the length of time and the extent to which the fair value is less than the amortized cost, (2) the Company’s intent to hold or sell the security, (3) the financial condition and results of the issuer including changes in capital, (4) the credit rating of the issuer, (5) analysts earnings estimate, (6) industry trends specific to the security, and (7) timing of debt maturity and status of debt payments. If the Company intends to sell a security or will be required to sell a security, the OTTI is recognized in earnings equal to the entire difference between the fair value and the amortized cost basis at the balance sheet date. If the Company does not intend to sell a security and it is not more likely than not that the entity will be required to sell a security before the recovery of its amortized cost basis, the OTTI is separated into two amounts, the credit related loss and the loss related to other factors. The credit related loss is based on the present value of the expected cash flows and is recognized in earnings. The noncredit-related loss is based on other factors such as illiquidity and is recognized in other comprehensive income.
At December 31, 2010 investment securities were $317.2 million with a net unrealized gain of $5.0 million compared to $438.7 million with a net unrealized loss of $180,000 at December 31, 2009. The improvement in gross unrealized losses is related to the overall improvement in the fair values of the securities in the Company’s investment portfolio slightly offset by $479,000 in impairment charges, including $193,000 on two trust preferred securities, $165,000 on a preferred stock and $58,000 on one bond that the Company decided to sell before recovery of its cost basis. Refer to “Note 3- Investment Securities” to the Consolidated Financial Statements in Item 8 for more information.
Deposits
The average balance of the Company’s deposits by major classifications for each of the last three years is presented in the following table.
                                                 
    As of December 31,  
    2010     2009     2008      
    Average             Average             Average        
(In thousands, except percentages)   Balance     Rate     Balance     Rate     Balance     Rate  
Demand deposits
                                               
Non interest bearing
  $ 62,474           $ 62,546           $ 57,211        
Interest bearing (NOW)
    42,990       0.92 %     46,046       1.04 %     48,414       1.85 %
Money market deposits
    166,386       1.05 %     153,146       1.83 %     168,972       2.93 %
Savings deposits
    15,959       0.56 %     14,802       0.56 %     15,125       0.50 %
Certificate of deposit
    503,217       2.92 %     581,202       3.78 %     434,662       4.49 %
 
                                         
Total deposits
  $ 791,026             $ 857,742             $ 724,384          
 
                                         
The remaining maturity of Certificates of Deposit of $100,000 or greater:
                 
    As of December 31,  
(In thousands)   2010     2009  
Three months or less
  $ 9,483     $ 19,960  
Over three months through twelve months
    52,969       78,985  
Over twelve months through five years
    38,265       40,790  
Over five years
    5,071       1,917  
 
           
Total
  $ 105,788     $ 141,652  
 
           

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Short and Long Term Borrowings
                                         
    For the years ended December 31,  
(In thousands)   2010     2009     2008     2007     2006  
Short term borrowings
  $ 22,000     $ 114,500     $ 37,000     $ 102,000     $ 53,000  
Long term borrowings
                                       
Other borrowings
    44,230       44,674       45,112       5,411       5,587  
Obligations through RE owned via equity invest(1)
          3,652       12,350       18,566       29,342  
Subordinated debt
    25,774       25,774       25,774       25,774       25,774  
FHLB advances
    88,719       95,001       193,569       187,500       187,500  
 
                             
Total borrowings
  $ 180,723     $ 283,601     $ 313,805     $ 339,251     $ 301,203  
 
                             
 
(1)   This obligation is consolidated from requirements under ASC Topic 810 of which $0 is guaranteed by the Company.
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 for Royal Bank are as follows:
                 
(In thousands, except percentages)   As of December 31, 2010
    Market Value of   Percent of
Changes in Rates   Portfolio Equity   Change
+ 300 basis points
  $ 52,466       (42.1 %)
+ 200 basis points
    66,793       (26.2 %)
+ 100 basis points
    79,662       (12.0 %)
Flat rate
    90,541       0.0 %
- 100 basis points
    86,989       (3.9 %)
- 200 basis points
    82,396       (9.0 %)
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.

66


 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders
Royal Bancshares of Pennsylvania, Inc.
     We have audited the accompanying consolidated balance sheets of Royal Bancshares of Pennsylvania, Inc. and subsidiaries as of December 31, 2010 and 2009, and the related consolidated statements of operations, changes in shareholders’ equity and comprehensive loss, and cash flows for each of the years in the three-year period ended December 31, 2010. These financial statements are the responsibility of Royal Bancshares of Pennsylvania, Inc.’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
     We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
     In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Royal Bancshares of Pennsylvania, Inc. and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America.
/s/ ParenteBeard LLC
ParenteBeard LLC
Philadelphia, Pennsylvania
March 31, 2011

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ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
                 
    December 31,  
    2010     2009  
    (In thousands, except share data)  
ASSETS
               
Cash and due from banks
  $ 26,811     $ 25,289  
Interest bearing deposits
    24,922       33,009  
 
           
Total cash and cash equivalents
    51,733       58,298  
 
               
Investment securities available-for-sale (“AFS”) at fair value
    317,155       438,719  
Federal Home Loan Bank (“FHLB”) stock, at cost
    10,405       10,952  
 
               
Loans held for sale, at lower of cost or fair market value
    29,621       2,254  
 
               
Loans and leases
    496,854       686,864  
Less allowance for loan and lease losses
    21,129       30,331  
 
           
Net loans and leases
    475,725       656,533  
 
               
Bank owned life insurance
    8,642       8,263  
Real estate owned via equity investment
    6,794       12,492  
Accrued interest receivable
    16,864       14,942  
Other real estate owned (“OREO”), net
    29,244       30,317  
Premises and equipment, net
    5,735       6,306  
Investment in real estate joint ventures
          2,520  
Other assets
    28,708       51,130  
 
           
Total assets
  $ 980,626     $ 1,292,726  
 
           
 
               
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
Liabilities
               
Deposits
               
Non-interest bearing
  $ 52,872     $ 63,168  
Interest bearing
    641,041       818,587  
 
           
Total deposits
    693,913       881,755  
Accrued interest payable
    3,983       6,150  
Short-term borrowings
    22,000       114,500  
Long-term borrowings
    132,949       139,675  
Obligations related to real estate owned via equity investment
          3,652  
Subordinated debentures
    25,774       25,774  
Other liabilities
    17,914       16,906  
 
           
Total liabilities
    896,533       1,188,412  
 
               
Shareholders’ equity
               
Royal Bancshares of Pennsylvania, Inc. equity:
               
Preferred stock, Series A perpetual, $1,000 liquidation value, 500,000 shares authorized, 30,407 shares issued and outstanding at December 31, 2010 and 2009
    28,395       27,945  
Common stock Class A, par value $2.00 per share, authorized 18,000,000 shares; issued, 11,355,466 and 11,352,482 at December 31, 2010 and 2009, respectively
    22,711       22,705  
Common stock Class B, par value $0.10 per share, authorized 3,000,0000 shares; issued, 2,086,689 and 2,089,284 at December 31, 2010 and 2009, respectively
    209       209  
Additional paid in capital
    126,152       126,117  
Accumulated deficit
    (91,746 )     (67,197 )
Accumulated other comprehensive income (loss)
    1,942       (1,652 )
Treasury stock — at cost, shares of Class A, 498,488 at December 31, 2010 and 2009
    (6,971 )     (6,971 )
 
           
Total Royal Bancshares of Pennsylvania, Inc. shareholders’ equity
    80,692       101,156  
Noncontrolling interest
    3,401       3,158  
Total shareholders’ equity
    84,093       104,314  
 
           
Total liabilities and shareholders’ equity
  $ 980,626     $ 1,292,726  
 
           
The accompanying notes are an integral part of these consolidated financial statements.

68


 

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
                         
    Year ended December 31,  
    2010     2009     2008  
    (In thousands, except per share data)  
Interest income
                       
Loans and leases, including fees
  $ 42,643     $ 45,757     $ 49,863  
Investment securities held to maturity, taxable
                3,241  
Investment securities available for sale:
                       
Taxable interest
    14,464       20,102       19,066  
Tax exempt interest
          19       75  
Deposits in banks
    154       164       495  
Federal funds sold
    1       1       24  
 
                 
Total Interest Income
    57,262       66,043       72,764  
 
                 
Interest expense
                       
Deposits
    16,922       25,342       25,414  
Short-term borrowings
    3,835       169       674  
Long-term borrowings
    5,215       11,685       11,770  
Obligations related to real estate owned via equity investments
    22       243       251  
 
                 
Total Interest Expense
    25,994       37,439       38,109  
 
                 
Net Interest Income
    31,268       28,604       34,655  
Provision for loan and lease losses
    22,140       20,605       21,841  
 
                 
Net Interest Income after Provision for Loan and Lease Losses
    9,128       7,999       12,814  
 
                 
Other income (loss)
                       
Gains on sales of premises and equipment
                1,991  
Gains on sale of premises and equipment related to real estate owned via equity investments
    667       1,817       1,679  
Income from bank owned life insurance
    379       1,099       1,233  
Service charges and fees
    1,266       1,419       1,186  
Gains on sales related to real estate joint ventures
                1,092  
Income related to real estate owned via equity investments
    564       1,302       965  
Gains on sales of other real estate owned
    1,019       294       429  
Gains on sales of loans and leases
    666       914       190  
Gain on sale of security claim
    1,656              
Net gains (losses) on investment securities available for sale
    1,290       1,892       (1,313 )
Other income
    737       578       148  
 
                 
Other income,excluding other than temporary impairment losses
    8,244       9,315       7,600  
 
                 
Total other than temporary impairment losses on investment securities
    (566 )     (13,431 )     (23,388 )
Portion of loss recognized in other comprehensive loss
    87       2,390        
 
                 
Net impairment losses recognized in earnings
    (479 )     (11,041 )     (23,388 )
 
                 
Total Other Income (Loss)
    7,765       (1,726 )     (15,788 )
 
                 
Other expenses
                       
Employee salaries and benefits
    11,591       12,235       15,044  
OREO impairment charge
    7,374       4,537        
Professional and legal fees
    4,237       4,367       3,783  
Occupancy and equipment
    3,216       3,381       2,860  
FDIC and state assessments
    3,047       3,801       658  
Impairment related to real estate owned via equity investments
    2,600             1,500  
OREO and loan collection expenses
    2,536       3,218       188  
Impairment of real estate joint ventures
    1,552              
Pennsylvania shares tax
    1,320       1,299       1,369  
Expenses related to real estate owned via equity investments
    529       907       966  
Directors fees
    355       676       675  
Stock option expense
    35       226       703  
Other operating expenses
    2,351       3,009       4,787  
 
                 
Total Other Expenses
    40,743       37,656       32,533  
 
                 
Loss Before Income Tax
    (23,850 )     (31,383 )     (35,507 )
Income tax expense
          474       2,643  
 
                 
Net Loss
  $ (23,850 )   $ (31,857 )   $ (38,150 )
 
                 
Less net income (loss) attributable to noncontrolling interest
    243       1,402       (68 )
 
                 
Net Loss Attributable to Royal Bancshares of Pennsylvania, Inc.
  $ (24,093 )   $ (33,259 )   $ (38,082 )
 
                 
Less Preferred stock Series A accumulated dividend and accretion
  $ 1,970     $ 1,672     $  
Net Loss to Common Shareholders
  $ (26,063 )   $ (34,931 )   $ (38,082 )
Per common share data
                       
Net loss — basic
  $ (1.97 )   $ (2.64 )   $ (2.86 )
 
                 
Net loss — diluted
  $ (1.97 )   $ (2.64 )   $ (2.86 )
 
                 
Cash dividends— Class A shares
  $     $     $ 0.30  
 
                 
Cash dividends— Class B shares
  $     $     $ 0.35  
 
                 
The accompanying notes are an integral part of these consolidated financial statements.

69


 

ROYAL BANCSHARES OF PENNSYLVANIA INC. AND SUBSIDIARIES
Consolidated Statement of Changes in Shareholders’ Equity and Comprehensive Loss
For the year ended December 31, 2010
                                                                                         
                                                            Accumulated                        
                                            Additional             other                     Total  
    Preferred stock     Class A common stock     Class B common stock     paid in     Accumulated     comprehensive     Treasury     Noncontrolling     Shareholders’  
(In thousands, except preferred share data)   Series A     Shares     Amount     Shares     Amount     capital     deficit     income     stock     Interest     Equity  
                         
Balance January 1, 2010
  $ 27,945       11,352     $ 22,705       2,089     $ 209     $ 126,117     $ (67,197 )   $ (1,652 )   $ (6,971 )   $ 3,158     $ 104,314  
Comprehensive loss
                                                                                       
Net (loss) income
                                                    (24,093 )                     243       (23,850 )
Other comprehensive income, net of reclassifications and taxes
                                                            3,594                       3,594  
 
                                                                                     
Total comprehensive loss
                                                                                  $ (20,256 )
 
                                                                                     
Common stock conversion from Class B to Class A
            3       6       (2 )                   (6 )                              
Accretion of discount on preferred stock
    450                                               (450 )                              
Stock option expense
                                            35                                       35  
     
Balance December 31, 2010
  $ 28,395       11,355     $ 22,711       2,087     $ 209     $ 126,152     $ (91,746 )   $ 1,942     $ (6,971 )   $ 3,401     $ 84,093  
                         
The accompanying notes are an integral part of these consolidated financial statements.

70


 

ROYAL BANCSHARES OF PENNSYLVANIA INC. AND SUBSIDIARIES
Consolidated Statement of Changes in Shareholders’ Equity and Comprehensive Loss
For the year ended December 31, 2009
                                                                                         
                                                            Accumulated                        
                                            Additional             other                     Total  
    Preferred stock     Class A common stock     Class B common stock     paid in     Accumulated     comprehensive     Treasury     Noncontrolling     Shareholders’  
(In thousands, except preferred share data)   Series A     Shares     Amount     Shares     Amount     capital     deficit     loss     stock     Interest     Equity  
                         
Balance January 1, 2009
  $       11,345     $ 22,690       2,096     $ 210     $ 123,425     $ (33,561 )   $ (26,106 )   $ (6,971 )   $ 1,898     $ 81,585  
Comprehensive loss
                                                                                       
Net (loss) income
                                                    (33,259 )                     1,402       (31,857 )
Transfer of noncontrolling interest related to RBA Capital
                                                                            (142 )     (142 )
Other comprehensive income, net of reclassifications and taxes
                                                            24,454                       24,454  
 
                                                                                     
Total comprehensive loss
                                                                                  $ (7,545 )
 
                                                                                     
Common stock conversion from Class B to Class A
            7       15       (7 )     (1 )             (14 )                              
Dividends paid on preferred stock
                                            (359 )                                     (359 )
Issuance of Series A perpetual preferred stock (30,407 shares) and warrants to purchase common stock (1,140,307 shares)
    27,582                                       2,825                                       30,407  
Accretion of discount on preferred stock
    363                                               (363 )                              
Stock option expense
                                            226                                       226  
     
Balance December 31, 2009
  $ 27,945       11,352     $ 22,705       2,089     $ 209     $ 126,117     $ (67,197 )   $ (1,652 )   $ (6,971 )   $ 3,158     $ 104,314  
                         
The accompanying notes are an integral part of these consolidated financial statements.

71


 

ROYAL BANCSHARES OF PENNSYLVANIA INC. AND SUBSIDIARIES
Consolidated Statement of Changes in Shareholders’ Equity and Comprehensive Loss
For the year ended December 31, 2008
                                                                                         
                                                    Retained     Accumulated                        
                                            Additional     earnings     other                     Total  
    Preferred stock     Class A common stock     Class B common stock     paid in     (accumulated     comprehensive     Treasury     Noncontrolling     Shareholders’  
(In thousands, except dividend per share data)   Series A     Shares     Amount     Shares     Amount     capital     deficit)     loss     stock     Interest     Equity  
                         
Balance, January 1, 2008
  $       11,329     $ 22,659       2,097     $ 210     $ 122,578     $ 8,527     $ (1,582 )   $ (6,025 )   $ 1,867     $ 148,234  
Comprehensive loss
                                                                                       
Net loss
                                                    (38,082 )                     31       (38,051 )
Other comprehensive loss, net of reclassifications and taxes
                                                            (24,524 )                     (24,524 )
 
                                                                                     
Total comprehensive loss
                                                                                  $ (62,575 )
 
                                                                                     
Common stock conversion from Class B to Class A
            1       2       (1 )                   (1 )                             1  
Cash dividends on common stock (Class A $0.30; Class B $0.345)
                                                    (4,005 )                             (4,005 )
Purchase of treasury stock (100 shares)
                                                                    (946 )             (946 )
Stock options exercised
            15       29                       144                                       173  
Stock option expense
                                            703                                       703  
     
 
                                                                                       
Balance December 31, 2008
  $       11,345     $ 22,690       2,096     $ 210     $ 123,425     $ (33,561 )   $ (26,106 )   $ (6,971 )   $ 1,898     $ 81,585  
                         
The accompanying notes are an integral part of these consolidated financial statements.

72


 

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
                         
    Year ended December 31,  
(In thousands)   2010     2009     2008  
Cash flows from operating activities
                       
Net loss
  $ (24,093 )   $ (33,259 )   $ (38,082 )
Adjustments to reconcile net loss to net cash provided by operating activities:
                       
Depreciation and amortization
    686       907       1,059  
Stock compensation expense
    35       226       703  
Impairment charge for other real estate owned
    7,374       4,537        
Provision for loan and lease losses
    22,140       20,605       21,841  
Net amortization (accretion) of discounts and premiums on loans, mortgage-backed securities and investments
    2,444       518       (2,242 )
(Benefit) provision for deferred income taxes
          (174 )     10,462  
Gains on sales of other real estate owned
    (1,019 )     (294 )     (429 )
Gain on sales of real estate joint ventures
                (1,092 )
Proceeds from sales of loans and leases
    4,145       10,844       2,613  
Gains on sales of premises and equipment
                (1,991 )
Gains on sales of loans and leases
    (666 )     (914 )     (190 )
Gains on sales of security claim
    (1,656 )            
Net (gains) losses on sales of investment securities
    (1,290 )     (1,892 )     1,313  
Distributions from investments in real estate
    (210 )     (200 )     (241 )
Gain from sale of premises of real estate owned via equity investment
    (667 )     (1,817 )     (1,679 )
Impairment of real estate owned via equity investments
    2,600             1,500  
Impairment of available-for-sale investment securities
    479       11,041       23,388  
Income from bank owned life insurance
    (379 )     (1,099 )     (1,233 )
Impairment of real estate joint venture
    1,552              
Changes in assets and liabilities:
                       
(Increase) decrease in accrued interest receivable
    (1,922 )     (1,362 )     1,676  
Decrease (increase) in other assets
    29,646       (5,225 )     (10,766 )
(Decrease) increase in accrued interest payable
    (2,167 )     48       (2,498 )
Increase in other liabilities
    1,669       5,292       3,364  
 
                 
Net cash provided by operating activities
    38,701       7,782       7,476  
 
                 
Cash flows from investing activities
                       
Proceeds from calls/maturities of held-to-maturity investment securities
                105,265  
Proceeds from calls/maturities of investment securities available-for-sale
    118,056       148,268       169,901  
Proceeds from sales of investment securities available-for-sale
    181,334       184,226       15,775  
Purchase of investment securities available-for-sale
    (174,167 )     (398,312 )     (179,257 )
Redemption of Federal Home Loan Bank stock
    547             2,510  
Net decrease (increase) in loans
    109,221       (49,260 )     (81,207 )
Capital improvements to foreclosed assets
    (1,242 )     (2,431 )      
Proceeds from sale of foreclosed assets
    13,319       7,877       1,186  
Net cash received in connection with the sale of Royal Asian Bank
    224              
Proceeds from sale of premises and equipment
                2,065  
Purchase of premises and equipment
    (115 )     (287 )     (692 )
Purchase of life insurance
                (5,000 )
Proceeds from surrender of life insurance
          22,628        
Net proceeds from sale of premises of real estate owned via equity investments
    6,682       11,354       9,064  
Distributions from real estate owned via equity investments
    210       200       241  
Net decrease in real estate joint ventures
                5,219  
Net decrease in real estate owned via equity investments
    (8,615 )     (9,537 )     (8,885 )
 
                 
Net cash provided by (used in) investing activities
    245,454       (85,274 )     36,185  
 
                 

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ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Continued)
                         
    Year ended December 31,  
    2010     2009     2008  
Cash flows from financing activities:
                       
(Decrease) increase in non-interest bearing and interest bearing demand deposits and savings accounts
    (2,105 )     32,719       (65,443 )
(Decrease) increase in certificates of deposit
    (185,737 )     88,968       55,359  
Net decrease in short-term borrowings
    (92,500 )           (80,000 )
Proceeds from long-term borrowings
                65,000  
Repayments of long-term borrowings
    (6,726 )     (21,506 )     (4,230 )
Repayment of mortgage debt of real estate owned via equity investments
    (3,652 )     (8,698 )     (6,216 )
Proceeds from the issuance of preferred stock
          30,407        
Cash dividends paid
          (359 )     (4,005 )
Purchase of treasury stock
                (946 )
Issuance of common stock under stock option plans
                174  
 
                 
Net cash (used in) provided by financing activities
    (290,720 )     121,531       (40,307 )
 
                       
Net (decrease) increase in cash and cash equivalents
    (6,565 )     44,039       3,354  
 
                       
Cash and cash equivalents at beginning of period
    58,298       14,259       10,905  
 
                 
 
                       
Cash and cash equivalents at end of period
  $ 51,733     $ 58,298     $ 14,259  
 
                 
 
                       
Supplemental Disclosure
                       
Interest
  $ 28,161     $ 37,391     $ 40,607  
 
                 
 
                       
Income taxes
  $     $     $  
 
                 
 
                       
Transfers to other real estate owned
  $ 18,797     $ 29,660     $ 10,055  
 
                 
 
                       
Carrying value of loans included in the sale of Royal Asian Bank
  $ 57,556     $     $  
Carrying value of investments included in the sale of Royal Asian Bank
    13,999              
Carrying value of other assets included in the sale of Royal Asian Bank
    2,546              
 
                 
Total carrying value of assets included in the sale of Royal Asian Bank
  $ 74,101     $     $  
 
                 
 
                       
Carrying value of deposits included in the sale of Royal Asian Bank
  $ (73,374 )   $     $  
Carrying value of other liabilities included in the sale of Royal Asian Bank
    (503 )            
 
                 
Total carrying value of liabilities included in the sale of Royal Asian Bank
  $ (73,877 )   $     $  
 
                 
The accompanying notes are an integral part of these consolidated financial statements.

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ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
1. Basis of Financial Statement Presentation
Nature of Operations
Royal Bancshares of Pennsylvania, Inc. (the “Company”), through its wholly owned subsidiaries Royal Bank America (“Royal Bank”) offers a full range of banking services to individual and corporate customers primarily located in the Mid-Atlantic states. Royal Bank competes with other banking and financial institutions in certain markets, including financial institutions with resources substantially greater than its own. Commercial banks, savings banks, savings and loan associations, credit unions and brokerage firms actively compete for savings and time deposits and for various types of loans. Such institutions, as well as consumer finance and insurance companies, may be considered competitors of Royal Bank with respect to one or more of the services it renders.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Royal Investments of Delaware, Inc., Royal Captive Insurance Company, Royal Preferred, LLC, and Royal Bank, including Royal Bank’s subsidiaries, Royal Real Estate of Pennsylvania, Inc., Royal Investment America, LLC, RBA Property LLC, Narberth Property Acquisition LLC, Rio Marina LLC. In addition the following are owned 60% by Royal Bank: Royal Bank America Leasing, LP, Crusader Servicing Corporation and Royal Tax Lien Services, LLC. During the fourth quarter of 2010, Royal Captive Insurance was dissolved. The investments were sold for a gain of approximately $8,000, $2.0 million was paid to the Company as a dividend, and the remaining funds, in the approximate amount of $500,000, were transferred to the Company. On December 30, 2010 the Company completed the sale of all of the outstanding common stock of Royal Asian Bank (“Royal Asian”), a wholly-owned subsidiary, to an investor group led by Royal Asian’s President and Chief Executive Officer. Royal Asian’s net loss of $953,000 through December 29, 2010 is consolidated into the Company’s consolidated financial statements. Both of the Company’s Trusts are not consolidated as further discussed below in “Variable Interest Entities”. All significant intercompany transactions and balances have been eliminated.
Use of Estimates
In preparing the consolidated financial statements in accordance with U.S. generally accepted accounting principles (“GAAP”), 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 estimates that are particularly susceptible to significant change in the near term relate to the allowance for loan and lease losses, loans held for sale, the valuation of other real estate owned, the valuation of deferred tax assets, real estate owned via equity investments, investment in real estate joint ventures, and other-than-temporary impairment losses on investment securities. In connection with the allowance for loan and lease losses 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 and lease losses. In addition, regulatory agencies, as an integral part of their examination process, periodically review the credit portfolio and the allowance. Such review may result in additional provisions based on their judgment of information available at the time of each examination.

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ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES — Continued
Significant Concentration of Credit Risk
Most of the Company’s activities are with customers located within the Mid-Atlantic region of the country. “Note 3 — Investment Securities” to the Consolidated Financial Statements discusses the types of securities in which the Company invests. “Note 4 — Loans and Leases” to the Consolidated Financial Statements discusses the types of lending in which the Company engages. The Company 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. The Company has 86% of its investment portfolio in securities issued by government sponsored entities. The Company’s tax lien portfolio has a geographic concentration in the State of New Jersey.
No substantial portion of loans is concentrated within a single industry or group of related industries, except a significant majority of loans are secured by real estate. There are numerous risks associated with commercial and consumer lending that could impact the borrower’s ability to repay on a timely basis. They include, but are not limited to: the owner’s business expertise, changes in local, national, and in some cases international economies, competition, governmental regulation, and the general financial stability of the borrowing entity. The Company has seen a deterioration in economic conditions as it pertains to real estate loans. Construction and land loans, non-residential real estate, and commercial loans represent 46% 23%, and 14%, respectively, of the $43.2 million in non-accrual loans held for investment at December 31, 2010.
The Company attempts to mitigate these risks by making an analysis of the borrower’s business and industry history, its financial position, as well as that of the business owner. The Company will also require the borrower to provide financial information on the operation of the business periodically over the life of the loan. In addition, most commercial loans are secured by assets of the business or those of the business owner, which can be liquidated if the borrower defaults, along with the personal surety of the business owner.
Variable Interest Entities (“VIE”)
Real estate owned via equity investments: The Company, together with third party real estate development companies, forms variable interest entities (“VIEs”) to construct various real estate development projects. These VIEs account for acquisition, development and construction costs of the real estate development projects in accordance with FASB ASC Topic 970, “Real Estate-General”, and account for capitalized interest on those projects in accordance with FASB ASC Topic 835, “Interest". Due to the present economic conditions, management has made a decision to curtail new equity investments.
In accordance with ASC Topic 976, the full accrual method is used to recognize profit on real estate sales. Profits on the sales of this real estate are recorded when cash in excess of the amount of the original investment is received, and calculation of same is made in accordance with the terms of the partnership agreement, the Company is no longer obligated to perform significant activities after the sale to earn profits, there is no continuing involvement with the property and; finally, the usual risks and rewards of ownership in the transaction had passed to the acquirer.
At December 31, 2010, the Company had one VIE which is consolidated into the Company’s financial statements. This VIE met the requirements for consolidation under FASB ASC Topic 810, “Consolidation” (“ASC Topic 810”) based on Royal Investments America being the primary financial beneficiary. In June 2009, the FASB issued ASU No. 2009-17 “Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities” (“ASU 2009-17”) which updates ASC Topic 810. The purpose of ASU 2009-17 is to improve financial reporting by enterprises involved with variable interest entities. The FASB undertook this project to address (1) the effects on certain provisions in ASC Topic 860 as a result of the elimination of the qualifying special-purpose entity concept in ASC Topic 860, and (2) constituent concerns about the application of certain key provisions of ASC Topic 810, including those in which the accounting and disclosures do not always provide timely and useful information about an enterprise’s involvement in a variable interest entity. ASU 2009-17 became effective on January 1, 2010. Earlier application was prohibited. The adoption of ASU 2009-17 had no impact on the Company’s consolidated financial statements.

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ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES — Continued
Consolidation of this VIE was determined based on the amount invested by Royal Investments America compared to the Company’s partners. In September 2005, the Company, together with a real estate development company, formed a limited partnership. Royal Investments America is a limited partner in the partnership (the “Partnership”). The Partnership was formed to convert an apartment complex into condominiums. The development company is the general partner of the Partnership. The Company invested 66% of the initial capital contribution, or $2.5 million, with the development company investing the remaining equity of $1.3 million. The Company is entitled to earn a preferred return on the $2.5 million capital contribution. In addition, the Company made two mezzanine loans totaling $9.2 million at market terms and interest rates. As shown on the consolidated balance sheet of the Company as of December 31, 2010, the Partnership no longer has senior debt with another bank. The remainder of the senior debt was paid off in June 2010. Upon the repayment of the mezzanine loan interest and principal and the initial capital contributions and preferred return, the Company and the development company will both receive 50% of the remaining distribution, if any.
On August 13, 2009, the Company received a Senior Loan Default Notice from the Senior Lender as a result of the Partnership not making the required repayment by July 9, 2009. The Company signed a forbearance agreement and an inter-creditor agreement between the Company and the Senior Lender on October 23, 2009 which extended the loan until December 9, 2010. On October 25, 2009, the Senior Lender filed for bankruptcy protection, which has not impacted the relationship between the Partnership and the Senior Lender. As part of the agreement to extend the loan for 14 months, the Senior Lender required the Partnership to provide additional funds to cover current and potential future cash requirements for capital improvements, operating expenses and marketing costs. As mentioned above the Senior Lender has been repaid in full. Through December 31, 2010, Royal Bank has loaned $2.4 million to the Partnership and is obligated to fund up to $2.7 million if required for the remaining costs associated with capital improvements, operating and marketing expenses. This loan has begun to be repaid from the cash flows since the Senior Lender has now been paid in full. The outstanding balance as of December 31, 2010 is $418,000. The outstanding balance along with any additional advances to the Partnership will be repaid in full prior to any other payments to partners.
In accordance with ASC Topic 360, the Partnership assesses the recoverability of fixed assets based on estimated future operating cash flows. The Company had recognized $10.0 million in impairment charges related to this asset through December 31, 2008. No further impairment of this asset occurred in 2009. During 2010 an additional impairment of $2.6 million was recorded as a result of a slow-down of unit sales following the end of the tax credit incentive that was being offered by the government. The measurement and recognition of the impairment was based on estimated future discounted operating cash flows.
At December 31, 2010, the Partnership had total assets of $9.0 million of which $6.8 million is real estate as reflected on the consolidated balance sheet and total borrowings of $9.6 million, of which $9.6 million relates to the Company’s loans discussed above. The Company has made an investment of $13.6 million in this Partnership ($2.5 million capital contribution and $11.6 million of loans). The impairments mentioned above along with the repayment of advances that started in June 2010 have contributed to an overall reduction in the Company’s investment. At December 31, 2010, the remaining amount of the investment in and receivables due from the Partnership totaled $6.6 million.

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ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES — Continued
Trust Preferred Securities: Royal Bancshares Capital Trust I/II (“Trusts”) issued mandatory redeemable preferred stock to investors and loaned the proceeds to the Company. The Trusts hold, as their sole asset, subordinated debentures issued by the Company in 2004. The Company does not consolidate the Trusts as ASC Topic 810 precludes consideration of the call option embedded in the preferred stock when determining if the Company has the right to a majority of the Trusts expected returns. The non-consolidation results in the investment in common stock of the Trusts to be included in other assets with a corresponding increase in outstanding debt of $774,000. In addition, the income received on the Company’s common stock investments is included in other income. The Federal Reserve Bank has issued final guidance on the regulatory treatment for the trust-preferred securities issued by the Trusts as a result of the adoption of ASC Topic 810. The final rule would retain the current maximum percentage of total capital permitted for trust preferred securities at 25%, but would enact other changes to the rules governing trust preferred securities that affect their use as a part of the collection of entities known as “restricted core capital elements.” The final adoption of the rule is effective on March 31, 2011 and will not have a material impact on its capital ratios. Refer to “Note 10 — Borrowings and Subordinated Debentures” to the Consolidated Financial Statements for more information.
US GAAP RAP Difference
In connection with a recent bank regulatory examination, the FDIC concluded, based upon its interpretation of the Consolidated Reports of Condition and Income (the “Call Report”) instructions and under regulatory accounting principles (“RAP”), that income from Royal Bank’s tax lien business should be recognized on a cash basis, not an accrual basis. Royal Bank’s current accrual method is in accordance with US GAAP. Royal Bank disagrees with the FDIC’s conclusion and filed the Call Report for September 30, 2010 and December 31, 2010 in accordance