UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

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

		for the quarterly period ended: March 31, 2011

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

Commission file number: 0-26366

ROYAL BANCSHARES OF PENNSYLVANIA, INC.

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

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

732 Montgomery Avenue, Narberth, PA 19072
(Address of principal Executive Offices)

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 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 whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12-b-2 of the Exchange Act.

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

Applicable only to corporate issuers:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class A Common Stock		Outstanding at April 30, 2011
$2.00 par value		10,863,023

Class B Common Stock		Outstanding at April 30, 2011
$0.10 par value		2,081,431

 

 

PART I — FINANCIAL STATEMENTS

Item 1.		Financial Statements

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(unaudited)

		March 31,				December 31,
		2011				2010
		(In thousands, except share data)
ASSETS
Cash and due from banks		$	10,593			$	26,811
Interest bearing deposits			41,553				24,922
Total cash and cash equivalents			52,146				51,733
Investment securities available-for-sale (“AFS”)			305,349				317,155
Federal Home Loan Bank (“FHLB”) stock			9,884				10,405
Loans and leases held for sale			27,088				29,621
Loans and leases			463,853				496,854
Less allowance for loan and lease losses			23,048				21,129
Net loans and leases			440,805				475,725
Bank owned life insurance			8,736				8,642
Real estate owned via equity investment			7,300				6,794
Accrued interest receivable			16,867				16,864
Other real estate owned (“OREO”), net			30,681				29,244
Premises and equipment, net			5,658				5,735
Other assets			24,860				28,708
Total assets		$	929,374			$	980,626
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits
Non-interest bearing		$	54,985			$	52,872
Interest bearing			590,084				641,041
Total deposits			645,069				693,913
Short-term borrowings			22,000				22,000
Long-term borrowings			131,233				132,949
Subordinated debentures			25,774				25,774
Accrued interest payable			4,470				3,983
Other liabilities			18,318				17,914
Total liabilities			846,864				896,533
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 March 31, 2011 and December 31, 2010			28,513				28,395
Class A common stock, par value $2.00 per share, authorized 18,000,000 shares; issued, 11,361,511 and 11,355,466 at March 31, 2011 and December 31, 2010, respectively			22,723				22,711
Class B common stock, par value $0.10 per share; authorized 3,000,000 shares; issued, 2,081,431 and 2,086,689 at March 31, 2011 and December 31, 2010, respectively			208				209
Additional paid in capital			126,175				126,152
Accumulated deficit			(93,386	)			(91,746	)
Accumulated other comprehensive income			1,470				1,942
Treasury stock — at cost, shares of Class A, 498,488 at March 31, 2011 and December 31, 2010			(6,971	)			(6,971	)
Total Royal Bancshares of Pennsylavania, Inc. shareholders’ equity			78,732				80,692
Noncontrolling interest			3,778				3,401
Total equity			82,510				84,093
Total liabilities and shareholders’ equity		$	929,374			$	980,626

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

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Consolidated Statements of Operations — (unaudited)

		For the three months ended
		March 31,
(In thousands, except per share data)		2011				2010
Interest income
Loans and leases, including fees		$	8,094			$	11,119
Investment securities available-for-sale:			2,459				4,469
Deposits in banks			21				35
Total Interest Income			10,574				15,623
Interest expense
Deposits			2,725				5,007
Short-term borrowings			44				1,280
Long-term borrowings			1,250				1,302
Obligations related to real estate owned via equity investments			—				14
Total Interest Expense			4,019				7,603
Net Interest Income			6,555				8,020
Provision for loan and lease losses			2,084				1,903
Net Interest Income after Provision for Loan and Lease Losses			4,471				6,117
Other income
Service charges and fees			257				291
Income from bank owned life insurance			95				95
Income related to real estate owned via equity investments			50				197
Gains on sales of loans and leases			12				504
Income from real estate joint ventures			250				—
Net gains on sales of other real estate owned			394				157
Net gains on the sale of AFS investment securities			8				167
Other income			298				70
Total other-than-temporary impairment losses on investment securities			—				(176	)
Less: Portion of loss recognized in other comprehensive loss			—				—
Net impairment losses recognized in earnings			—				(176	)
Total Other Income			1,364				1,305
Other expenses
Employee salaries and benefits			2,654				2,961
FDIC and state assessments			525				864
Professional and legal fees			1,071				803
OREO impairment			393				802
Occupancy and equipment			605				799
OREO and loan collection expenses			642				688
Pennsylvania shares tax			312				369
Expenses related to real estate owned via equity investments			48				125
Directors’ fees			76				81
Stock option expense (benefit)			23				(72	)
Other operating expenses			620				633
Total Other Expenses			6,969				8,053
Loss Before Tax Benefit			(1,134	)			(631	)
Income tax benefit			—				—
Net Loss		$	(1,134	)		$	(631	)
Less net income attributable to noncontrolling interest		$	377			$	442
Net loss attributable to Royal Bancshares of Pennsylvania, Inc.		$	(1,511	)		$	(1,073	)
Less Preferred stock Series A accumulated dividend and accretion		$	498			$	490
Net loss available to common shareholders		$	(2,009	)		$	(1,563	)
Per common share data
Net loss — basic and diluted		$	(0.15	)		$	(0.12	)

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

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Consolidated Statement of Changes in Shareholders’ Equity and Comprehensive Loss
Three months ended March 31, 2011
(unaudited)

																														Accumulated
																						Additional								other												Total
		Preferred stock				Class A common stock								Class B common stock								paid in				Accumulated				comprehensive				Treasury				Noncontrolling				Shareholders’
(In thousands, except share data)		Series A				Shares				Amount				Shares				Amount				capital				deficit				income				stock				Interest				Equity
Balance January 1, 2011		$	28,395				11,355			$	22,711				2,087			$	209			$	126,152			$	(91,746	)		$	1,942			$	(6,971	)		$	3,401			$	84,093
Comprehensive income
Net (loss) income																											(1,511	)											377				(1,134	)
Other comprehensive loss, net of reclassifications and taxes																															(472	)							—				(472	)
Total comprehensive loss																																										$	(1,606	)
Common stock conversion from Class B to Class A							6				12				(5	)			(1	)							(11	)															—
Accretion of discount on preferred stock			118																								(118	)															—
Stock option expense																							23																				23
Balance March 31, 2011		$	28,513				11,361			$	22,723				2,082			$	208			$	126,175			$	(93,386	)		$	1,470			$	(6,971	)		$	3,778			$	82,510

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Consolidated Statement of Changes in Shareholders’ Equity and Comprehensive Income
Three months ended March 31, 2010
(unaudited)

																														Accumulated
																						Additional								other												Total
		Preferred stock				Class A common stock								Class B common stock								paid in				Accumulated				comprehensive				Treasury				Noncontrolling				Shareholders’
(In thousands, except share data)		Series A				Shares				Amount				Shares				Amount				capital				deficit				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																											(1,073	)											442				(631	)
Other comprehensive income, net of reclassification and taxes																															2,578												2,578
Total comprehensive income																																										$	1,947
Accretion of discount on preferred stock			110																								(110	)															—
Common stock conversion from Class B to Class A							3				6				(2	)			—								(6	)															—
Stock option benefit																							(72	)																			(72	)
Balance March 31, 2010		$	28,055				11,355			$	22,711				2,087			$	209			$	126,045			$	(68,386	)		$	926			$	(6,971	)		$	3,600			$	106,189

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

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (unaudited)
Three months ended March 31,

(In thousands)		2011				2010
Cash flows from operating activities:
Net loss		$	(1,511	)		$	(1,073	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation and amortization			118				172
Stock compensation expense (benefit)			23				(72	)
Provision for loan and lease losses			2,084				1,903
Impairment charge for other real estate owned			393				802
Net amortization of investment securities			802				599
Net accretion on loans			(77	)			(155	)
Net gains on sales of other real estate			(394	)			(157	)
Proceeds from sales of loans and leases			118				2,691
Gains on sales of loans and leases			(12	)			(504	)
Net gains on sales of investment securities			(8	)			(167	)
Distribution from investments in real estate			(50	)			(50	)
Gain from sale of premises of real estate owned via equity investment			—				(27	)
Income from real estate joint ventures			(250	)			—
Income from bank owned life insurance			(95	)			(95	)
Impairment of available-for-sale investment securities			—				176
Changes in assets and liabilities:
Increase in accrued interest receivable			(3	)			(590	)
Decrease in other assets			3,968				12,304
Increase in accrued interest payable			487				492
Increase in other liabilities			859				246
Net cash provided by operating activities			6,452				16,495
Cash flows from investing activities:
Proceeds from call/maturities of available-for-sale (“AFS”) investment securities			17,408				32,394
Proceeds from sales of AFS investment securities			43,549				55,754
Purchase of AFS investment securities			(50,793	)			(54,058	)
Redemption of Federal Home Loan Bank stock			521				—
Net decrease in loans			32,233				23,796
Purchase of premises and equipment			(41	)			(33	)
Net proceeds from sale of premises of real estate owned via equity investments			—				820
Distribution from investments in real estate			50				50
Net increase in real estate owned via equity investments			—				(793	)
Proceeds from sales of foreclosed real estate			1,594				4,391
Net cash provided by investing activities			44,521				62,321
Cash flows from financing activities:
Increase (decrease) in demand and NOW accounts			2,980				(1,429	)
Decrease in money market and savings accounts			(11,266	)			(3,156	)
Decrease in certificates of deposit			(40,558	)			(50,943	)
Repayments of short-term borrowings			—				(15,000	)
Repayments of long-term borrowings			(1,716	)			(1,662	)
Repayment of mortgage debt of real estate owned via equity investments			—				(609	)
Net cash used in financing activities			(50,560	)			(72,799	)
Net increase in cash and cash equivalents			413				6,017
Cash and cash equivalents at the beginning of the period			51,733				58,298
Cash and cash equivalents at the end of the period		$	52,146			$	64,315
Supplemental Disclosure
Interest paid		$	3,532			$	7,111
Transfers to other real estate owned		$	3,030			$	500

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

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Note 1. Summary of Significant Accounting Policies

Basis of Financial Presentation

The accompanying unaudited consolidated financial statements include the accounts of Royal Bancshares of Pennsylvania, Inc. (“Royal Bancshares” or the “Company”) and its wholly-owned subsidiaries, Royal Investments of Delaware, Inc., including Royal Investments of Delaware, Inc.’s wholly owned subsidiary, Royal Preferred, LLC, and Royal Bank America (“Royal Bank”), including Royal Bank’s subsidiaries, Royal Real Estate of Pennsylvania, Inc., Royal Investments America, LLC, RBA Property LLC, Narberth Property Acquisition LLC, Rio Marina LLC, and its three 60% ownership interests in Crusader Servicing Corporation, Royal Tax Lien Services, LLC, and Royal Bank America Leasing, LP. During the fourth quarter of 2010, the Company’s wholly-owned subsidiary, Royal Captive Insurance, was dissolved. 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 recorded a loss of $995,000 in the first quarter of 2010. The two Delaware trusts, Royal Bancshares Capital Trust I and Royal Bancshares Capital Trust II are not consolidated per requirements under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 810, “Consolidation” (“ASC Topic 810”). These consolidated financial statements reflect the historical information of the Company. All significant intercompany transactions and balances have been eliminated.

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information. Applications of the principles in the Company’s preparation of the consolidated financial statements in conformity with U.S. GAAP require management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and the accompanying notes. These estimates and assumptions are based on information available as of the date of the consolidated financial statements; therefore, actual results could differ from those estimates. The interim financial information included herein is unaudited; however, such information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, necessary to present a fair statement of the results for the interim periods. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2010. The results of operations for the three month period ended March 31, 2011 are not necessarily indicative of the results to be expected for the full year.

Accounting Policies Recently Adopted and Pending Accounting Pronouncements

In January 2010, the FASB issued Accounting Standard Update (“ASU”) No. 2010-06, “Improving Disclosures about Fair Value Measurements” (“ASU 2010-06”), which updates ASC Topic 820 “Fair Value Measurements and Disclosures”. ASU 2010-06 is intended to provide a greater level of disaggregated information and more robust disclosures about valuation techniques and inputs to fair value measurements. A reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers. Additionally, a reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. Those disclosures are required for fair value measurements that fall in either Level 2 or Level 3. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009. The disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements were effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of ASU 2010-06 did not have a significant impact on the Company’s consolidated financial statements.

In July 2010, the FASB issued ASU No. 2010-20, “Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses” (“ASU 2010-20”), which is intended to help

investors assess the credit risk of a company’s receivables portfolio and the adequacy of its allowance for credit losses held against the portfolios by expanding credit risk disclosures. (“ASU 2010-20”) requires more information about the credit quality of financing receivables in the disclosures to financial statements, such as aging information and credit quality indicators. Both new and existing disclosures must be disaggregated by portfolio segment or class. The disaggregation of information is based on how a company develops its allowance for credit losses and how it manages its credit exposure. The disclosure requirements as of December 31, 2010 are included in “Note 4 — Loans and Leases” and “Note 5 — Allowance for Loan and Lease Losses” to the Consolidated Financial Statements. Disclosures about activity that occurs during a reporting period were effective in the interim reporting period ending March 31, 2011.

In April 2011, the FASB issued ASU 2011-002, “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring” (“ASU 2011-002”) which is intended to amend guidance related to troubled debt restructurings (“TDRs”). ASU 2011-002 provides additional guidance to assist creditors in concluding whether the restructuring has granted a concession to the borrower and that the borrower is experiencing financial difficulties. ASU 2011-002 is effective for public entities for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. The adoption of ASU 2011-002 is not expected to have a significant impact on the Company’s consolidated financial statements.

Note 2. Regulatory Matters and Significant Risks or Uncertainties

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 Federal Deposit Insurance Corporation (“FDIC”) and the Commonwealth of Pennsylvania Department of Banking (“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 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 materially 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.

Royal Bank created a Regulatory Compliance Committee comprised of outside directors and management in the third quarter of 2009. The purpose of the Committee is to monitor compliance with the Orders. Royal Bank has submitted an internal assessment of senior management’s qualifications report to the FDIC and the Department. Additionally Royal Bank has submitted plans for reducing classified assets, reducing delinquencies, reducing commercial real estate concentrations, liquidity and funds management, and reducing non-core deposits and whole-sale funding sources. Royal Bank had submitted a 2010 budget plan, a 2010 strategic plan and a compensation plan. All plans have been approved by the FDIC and the Department where required. In the first quarter of 2011, Royal Bank submitted a strategic plan and a budget plan for 2011 to the FDIC and the Department for their review.

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 the Banks, the adequacy of the Banks’ 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 the Banks’ future capital requirements; supervisory requests for additional capital at the Banks or the requirements of any supervisory action imposed on the Banks by federal or state regulators; and applicable legal requirements that the Company serve as a source of strength to the Banks; (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 30 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. Royal Bancshares has submitted all progress reports and responses required under the Federal Reserve Agreement as of the date of this Report. In April 2011, with respect to the capital plan submissions by the Company to the Reserve Bank, the Reserve Bank has advised the Company that it will not approve a capital plan until such time as the Company is able to successfully raise additional capital and/or substantially reduce its risk profile, or is able to offer credible assurances that the Company will be able to raise capital or reduce its risk profile.

Our success as a Company is dependent upon pursuing various alternatives in not only achieving the growth and expansion of our banking franchise but also in managing our day to day operations. The existence of the Orders and the Federal Reserve Agreement may limit or impact our ability to pursue all previously available alternatives in the management of the Company. Our ability to retain existing retail and commercial customers as well as the ability to attract potentially new customers may be impacted by the existence of the 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 is limited. The Company’s ability to raise capital in the current economic environment could be potentially limited or impacted as a result of the 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. At March 31, 2011, the Company and Royal Bank met all capital adequacy requirements to which it is subject.

Continued Losses

Over the past thirteen quarters, the Company has recorded significant losses totaling $96.9 million ($1.5 million for the three months ended March 31, 2011 and $24.1 million, $33.2 million and $38.1 million for the years ended December 31, 2010, 2009, and 2008, respectively) which were primarily related to charge-offs on the loan and lease portfolio, impairment charges on investment securities, and the establishment of a deferred tax valuation allowance. The year-over-year decrease in losses was mainly related to the reduction in other-than-temporary impairment (“OTTI”) on investment securities. As a result of these losses, the Company has negative retained earnings of $93.4 million at March 31, 2011. Also contributing to the negative retained earnings were the cash and stock dividends declared and paid in previous years. In addition to reducing the total shareholders’ equity, the continued losses and negative retained earnings impact the Company’s ability to pay cash dividends to its shareholders now and in future years.

The deterioration of the real estate market over the past few years has significantly impacted the Company’s loan portfolio which has a high concentration of real estate secured loans. Net loan charge-offs were $165,000 and $3.6 million for the three months ended March 31, 2011 and 2010, respectively, and $30.4 million, $19.2 million, and $12.2 million for the years ended 2010, 2009, and 2008, respectively. The $2.1 million provision for loan and lease losses for the first quarter of 2011 was primarily attributable to a $2.6 million increase in specific reserves on impaired loans. The provision for loan and lease losses for the first quarter of 2010 was $1.9 million, of which $1.0 million was attributable to Royal Asian. The level of charge-offs was the primary reason for the significant provision for loan and lease losses of $22.1 million, $20.6 million, and $21.8 million that were recorded in 2010, 2009, and 2008, respectively. Non-performing loans held for investment (“LHFI”) totaled $43.5 million at March 31, 2011 compared to $43.2 million at December 31, 2010, $73.7 million at December 31, 2009 and $85.8 million at December 31, 2008. Total non-performing loans at March 31, 2011 and December 31, 2010 were $65.1 million and $65.8 million, respectively, and include $21.6 million and $22.6 million in loans held for sale (“LHFS”), respectively.

For the three months ended March 31, 2011 the Company did not record OTTI losses on the investment portfolio. OTTI losses were $176,000 for the three months ended March 31, 2010. The investment impairment charges totaled $479,000, $11.0 million, and $23.4 million in 2010, 2009, and 2008, respectively. As evidenced by the significant reduction in impairment charges, the Company has reduced the credit risk within its investment portfolio. This was accomplished by taking advantage of opportunities to sell investments that had potential credit risk for minimal losses as well as instituting new policy guidelines regarding types of investments, as well as limits on the amount of each type of investment.

The establishment of a deferred tax valuation allowance resulted in a $15.5 million non-cash charge to the consolidated statement of operations in 2008. This was a result of management’s conclusion 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. Subsequent additions to the allowance have resulted in a deferred tax valuation allowance of $33.5 million at March 31, 2011.

In addition to the losses mentioned above, the Company has experienced an increase in other operating expenses over the past three years. These increased expenses include OREO impairment charges, OREO expenses, and legal and other expenses related to credit quality. Impairment charges related to real estate owned via equity investments totaled $2.6 million, $0, and $1.5 million in 2010, 2009, and 2008 respectively. There was no further impairment in the first quarter of 2011. Also included in other operating expenses are FDIC and state assessments which totaled $3.0 million, $3.8 million, and $658,000 in 2010, 2009, and 2008, respectively. As a result of the reduction of deposits in 2010, largely related to

the decline in brokered deposits, the FDIC assessment decreased in 2010. The FDIC assessment for the first quarter of 2011 amounted to $503,000, which results in a decline year over year on an annualized basis.

Credit Quality

The Company’s 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 could reduce our growth rate, affect the ability of customers to repay their loans and generally affect our financial condition and results of operations. Many industries have been impacted by the effects of the economic conditions over the past three years, with financial services, housing and commercial real estate being hit particularly hard. The Company’s loan and investment portfolios were directly affected. The Company’s commercial real estate loans, including construction and land development loans, have seen a decline in the collateral values, and a reduction in the borrowers’ ability to meet the payment terms of their loans due to reduced cash flow. Further declines in collateral values and borrowers’ liquidity with sustained unemployment at current levels may lead to increases in foreclosures, delinquencies and customer bankruptcies. 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 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 trends in delinquencies and non-performing loans 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.

The Company had non-performing loans of $65.1 million ($43.5 million in LHFI and $21.6 million in LHFS) at March 31, 2011. Non-performing loans were $65.8 million ($43.2 million in LHFI and $22.6 million in LHFS), $73.7 million, and $85.8 million at December 31, 2010, 2009 and 2008, respectively. The Company recorded $177,000 in charge-offs for the first quarter of 2011 compared to $3.7 million in charge-offs for the first quarter of 2010. Charge-offs recorded for the years ended 2010, 2009, and 2008 were $31.7 million, $19.8 million, and $12.3 million, respectively. OREO balances were $30.7 million at March 31, 2011 and $29.2 million, $30.3 million, and $10.3 million at December 31, 2010, 2009, and 2008, respectively.

The Company signed a letter of intent in the first quarter of 2011 to sell a pool of $54.1 million of classified assets in a bulk sale, which included $30.3 million of non-performing loans, $10.8 million of classified accruing loans and $13.0 million of OREO properties. The proposed 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 LHFS was $29.6 million, which included $22.6 million in non-performing loans and $7.0 million in classified loans, 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 pending sale was expected to close in the second quarter of 2011; however, the Company was unable to arrive at a mutually satisfactory purchase and sale agreement with the prospective purchaser and recently terminated negotiations. The Company has initiated plans to market and sell the assets within the pool to other bulk and individual buyers to facilitate the reduction of classified assets and improve the credit quality of the loan portfolio.

In accordance with the Orders, Royal Bank has eliminated from the balance sheet via charge-off all assets classified as “Loss”. Royal Bank was successful in reducing classified assets, which includes LHFS and OREO, from $149.6 million at June 30, 2009 to $109.1 million at March 31, 2011. Royal Bank’s delinquent loans (30 to 90 days) amounted to $36.3 million at June 30, 2009 versus $9.7 million at March 31, 2011. No material advances were made on any classified or delinquent loan unless approved by the board of directors and determined to be in Royal Bank’s best interest. The Company has restructured the investment portfolio to reduce credit risk by selling corporate debt securities and equity securities and replacing their maturities with U.S. government issued or sponsored securities. For the three months ended March 31, 2011 the Company did not record OTTI losses on the investment portfolio compared to $176,000 for the three months ended March 31, 2010. Year-

over-year OTTI losses have decreased from $23.4 million at December 31, 2008 to $11.0 million at December 31, 2009 to $479,000 at December 31, 2010.

Commercial Real Estate Concentrations

As mentioned previously the adverse economic conditions have primarily impacted the real estate secured loan portfolio. 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 the Company believes 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 depend 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 fair market value of the collateral, which may ultimately result in a loss. 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 the Bank’s commercial real estate loans, which may require the Company to obtain additional capital.

Management has been working diligently to reduce the concentration in commercial real estate loans (“CRE loans”). Our non-residential real estate and construction and land development loan portfolio held for investment was $272.7 million at March 31, 2011 comprising 59% of total loans compared to $284.1 million or 57% of total loans at December 31, 2010. Royal Bank was successful in reducing the CRE concentration, which includes loans held for sale from $289.1 million at June 30, 2009 to $204.7 million at March 31, 2011, which amounted to 200.9% of total capital and 218.2% of Tier 1 capital. At March 31, 2011, total construction/land loans (“CL loans”) including loans held for sale amounted to $87.7 million, or 86.1%, of total capital and 93.5% of Tier 1 capital. Based on capital levels calculated under U.S. GAAP, Royal Bank no longer has a concentration of commercial real estate loans as defined in the Guidance. Based on capital levels calculated under regulatory accounting principles (“RAP”) (see discussion under “Note 11 — Regulatory Capital Requirements” to the Consolidated Financial Statements), CRE loans and CL loans as a percentage of total capital and Tier 1 capital, respectively, are 232.5%, 255.4%, 99.6% and 109.4%. Under RAP, Royal Bank does not have a concentration in CL loans as defined in the Guidance. Included in the figures above are loans held for sale as of March 31, 2011.

Balance Sheet Reduction (Deleveraging)

During the past 21 months, Royal Bank has continued to record losses in earnings, which have negatively impacted its capital ratios. The Company implemented a strategy to mitigate this impact to the capital ratios through the reduction of the balance sheet (deleveraging). The balance sheet deleveraging was accomplished primarily through the run off of maturing brokered certificates of deposit (“CDs”) and FHLB borrowings as required under the Orders by reducing the balances of cash, investment securities and loans. This strategy of reducing the size of the balance sheet has provided greater use of the existing capital despite the continued loss of income by maintaining that capital ratio as a percentage of the remaining reduced level of assets in order to achieve capital ratios at required regulatory levels. The Company recognizes that deleveraging will also potentially have a negative impact on future earnings, but will provide a short-term benefit to capital levels.

The deleveraging of the balance sheet over the past 21 months resulted from paying off FHLB advances and the run off of brokered CDs totaling $300.3 million within Royal Bank. The Company does not plan to roll over maturing brokered CDs during the remainder of 2011. As part of the restructuring of the investment portfolio, the Company also reduced the investment portfolio by approximately $122 million during 2010, which is almost entirely within Royal Bank and an additional $12.3 million during the first quarter of 2011. At year end 2010, loans had declined by approximately $116 million, with an additional decline of $35.5 million in the first quarter of 2011 due to pay downs of principal, payoffs, charge-offs and transfers to OREO.

Liquidity and Funds Management

Royal Bank may not accept new brokered deposits and has limited capacity to borrow additional funds in the event it is needed for liquidity purposes. However, Royal Bank has continued to maintain liquidity measures that are more than two times the target levels. As discussed in “Note 8 — Borrowings and Subordinated Debentures” to the Consolidated Financial Statements, Royal Bank has an over collateralized delivery requirement of 105% with the Federal Home Loan Bank (“FHLB”) as a result of the level of non-performing assets and the losses that have been experienced over the past three years. The ability to borrow additional funds is based on the amount of collateral that is available to be pledged. As of March 31, 2011, Royal Bank had approximately $32 million of available borrowing capacity at the FHLB as a result of excess collateral that has been pledged. In addition, Royal Bank has approximately $97 million of unpledged agency securities that are available to be pledged as collateral if needed. Royal Bank also has limited availability to borrow from the Federal Reserve Discount Window. The availability, which is approximately $7 million at March 31, 2011, is based on collateral pledged.

At March 31, 2011, Royal Bank had $52.1 million in cash on hand and $97.3 million in unpledged agency securities. At March 31, 2011, the liquidity to deposits ratio was 32.4% compared to Royal Bank’s 12% policy target and the liquidity to total liabilities ratio was 24.7% compared to Royal Bank’s 10% policy target. Since entering the Orders Royal Bank has not renewed, accepted, or rolled over any maturing brokered CDs; nor has Royal Bank issued new brokered CDs. Brokered CDs declined $171.3 million from $226.9 million at June 30, 2009 to $55.6 million at March 31, 2011. Borrowings declined $130.7 million from $283.9 million at June 30, 2009 to $153.2 million at March 31, 2011.

The Company also has unfunded pension plan obligations of $12.6 million as of March 31, 2011 which potentially could impact liquidity. The Company plans to fund the pension plan obligations through existing Company owned life insurance policies.

Dividend and Interest Restrictions

Due to the Orders and the Federal Reserve Agreement, our ability to obtain lines of credit, to receive attractive collateral treatment from funding sources, and to pursue all attractive funding alternatives in this current low interest rate environment could be impacted and thereby limit liquidity alternatives. On August 13, 2009, the Company’s board of directors determined to suspend regular quarterly cash dividends on the $30.4 million in Series A Preferred Stock and to suspend interest payments on the $25.8 million in trust preferred securities. As of March 31, 2011, the Series A Preferred stock dividend in arrears was $2.8 million and has not been recognized in the consolidated financial statements. As of March 31, 2011 the trust preferred interest payment in arrears was $1.3 million and has been recorded in interest expense and accrued interest payable. The decision to suspend the preferred cash dividends and the trust preferred interest payments better supports the capital position of Royal Bank. As a consequence of missing the sixth dividend payment in the fourth quarter of 2010, the Treasury has the right to appoint two directors to our board of directors until all accrued but unpaid dividends have been paid.

At March 31, 2011, as a result of significant losses within Royal Bank, the Company had negative retained earnings and therefore would not have been able to declare and pay any cash dividends. Under the Orders, Royal Bank must receive prior approval from the FDIC and the Department before declaring and paying a dividend to the Company. Under the Federal Reserve Agreement the Company may not declare or pay any dividends 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.

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 RAP, that income from Royal Bank’s tax lien business should be recognized on a cash basis, not an accrual basis. Royal Bank’s current accrual method is in accordance with U.S. GAAP. Royal Bank disagrees with the FDIC’s conclusion and filed the Call Report for March 31, 2011, December 31, 2010, and September 30, 2010 in accordance with U.S. GAAP. However, the change in the manner of revenue recognition for the tax lien business for regulatory accounting

purposes affects Royal Bank’s and the Company’s capital ratios as disclosed in “Note 11 - Regulatory Capital Requirements” to the Consolidated Financial Statements. Royal Bank is in discussions with the FDIC to resolve the difference of opinion.

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 March 31, 2011, based on capital levels calculated under RAP, Royal Bank’s total risk-based capital and Tier 1 leverage ratios were 14.25% and 8.65%, respectively. As of March 31, 2011, the Company and Royal Bank met all capital adequacy requirements to which it is subject.

Department of Justice Investigation (“DOJ”)

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 DOJ. The subpoena sought 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 and therefore the Company has concluded that it is unlikely that a contingent liability exists. Royal Bank, CSC and RTL are cooperating in the investigation.

Management Plans

The Company was successful during the past year in reducing the cost of funds, which improved the net interest margin; in completing the sale of Royal Asian, which permitted the Company to contribute additional capital of $10.3 million to Royal Bank; in minimizing investment impairment, recouping $1.7 million of the $5.0 million collateral loss associated with the collapse of Lehman in 2008; and in addressing the matters set forth in the Orders, which included maintaining required capital ratios and liquidity measures. During the first quarter of 2011, the Company signed a letter of intent to sell approximately $54 million of classified assets in a bulk sale; however, the Company was unable to arrive at a mutually satisfactory purchase and sale agreement with the prospective purchaser and recently terminated negotiations. The Company has initiated plans to market and sell the assets within the pool to other bulk and individual buyers to facilitate the reduction of classified assets and improve the credit quality of the loan portfolio.

In addition to increased board oversight and the creation of a Regulatory Compliance Committee in response to the Orders, the Company has enhanced the board through the addition of experienced directors with diverse backgrounds. The new members are comprised of the following: the CEO of a public company who has legal and consulting experience, a former regulator with consulting experience, a former CEO of a much larger financial institution who has bank turnaround experience and a former senior partner of a public accounting firm.

The board and management have developed a contingency plan to maintain capital ratios at required levels under the Orders that expands the deleveraging beyond the run off of maturing brokered CDs and FHLB advances, which includes the potential securitization or sale of a significant portion of the tax lien portfolio. The Company will also consider the following measures as part of the contingency plan, if required, to insure that capital ratios continue to meet the requirements of the Orders. These additional measures, if required, include the following: sales of selected branches with high concentrations of retail CDs, sales of performing loans or specific segments of the loan portfolio, a shareholder rights offering, a reduction in the level of investment securities, and allow maturing CDs to selectively run off. It is extremely unlikely that all of the above alternatives would be initiated. The Company recognizes that some of these measures will also potentially have a negative impact on future earnings due to the loss of earning assets, but they also can potentially provide a short-term benefit to capital levels. The board of directors and management of the Company remain committed to meeting the capital level requirements for Royal Bank as set forth in the Orders.

The Company’s strategic plan includes compliance with the Orders and the Federal Reserve Agreement discussed above, reducing the level of classified loans within the loan portfolio and improving the overall level of credit quality, maintaining reduced credit risk within the investment portfolio and returning to profitability. In concert with

these efforts, the Company will transition more toward a community bank focus within its geographic footprint and adjacent markets. This will be achieved through the continued diversification of the loan portfolio, increased emphasis on the growth of core deposits, the utilization of enterprise risk management for reviewing strategic initiatives and maintenance of improved underwriting standards. The strategic plan provides a framework for maintaining required capital ratios while also reducing the risk profile of the Company and Royal Bank.

Note 3. Investment Securities

The carrying value and fair value of investment securities available-for-sale (“AFS”) at March 31, 2011 are as follows:

						Included in Accumulated Other
						Comprehensive Income (AOCI)
										Gross unrealized losses
														Non-credit
						Gross								related
		Amortized				unrealized				Non-OTTI				OTTI in
(In thousands)		cost				gains				in AOCI				AOCI				Fair value
Mortgage-backed securities-residential		$	12,950			$	292			$	—			$	—			$	13,242
U.S. government agencies			30,492				—				(959	)			—				29,533
Common stocks			381				146				(45	)			—				482
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies			215,718				2,466				(597	)			—				217,587
Non-agency			6,181				163				(3	)			—				6,341
Corporate bonds			10,473				—				(310	)			—				10,163
Municipal bonds			1,025				—				—				—				1,025
Trust preferred securities			16,147				2,463				—				(2	)			18,608
Other securities			7,808				560				—				—				8,368
Total available for sale		$	301,175			$	6,090			$	(1,916	)		$	—			$	305,349

The carrying value and fair value of investment securities AFS at December 31, 2010 are as follows:

						Included in Accumulated Other
						Comprehensive Income (AOCI)
										Gross unrealized losses
														Non-credit
						Gross								related
		Amortized				unrealized				Non-OTTI				OTTI in
(In thousands)		cost				gains				in AOCI				AOCI				Fair value
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		$	312,131			$	6,820			$	(1,709	)		$	(87	)		$	317,155

The amortized cost and fair value of investment securities at March 31, 2011, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

		As of March 31, 2011
		Amortized
(In thousands)		cost				Fair value
Within 1 year		$	100			$	100
After 1 but within 5 years			12,812				12,528
After 5 but within 10 years			15,017				14,549
After 10 years			30,208				32,152
Mortgage-backed securities-residential			12,950				13,242
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies			215,718				217,587
Non-agency			6,181				6,341
Total available for sale debt securities			292,986				296,499
No contractual maturity			8,189				8,850
Total available for sale securities		$	301,175			$	305,349

Proceeds from the sales of investments AFS during the three months ended March 31, 2011 and 2010 were $43.5 million and $56.2 million, respectively. The following table summarizes gross realized gains and losses realized on the sale of securities recognized in earnings in the periods indicated:

		For the three months
		ended March 31,
(In thousands)		2011				2010
Gross realized gains		$	587			$	253
Gross realized losses			(579	)			(86	)
Net realized gains		$	8			$	167

The Company evaluates securities for OTTI at least on a quarterly basis. The Company assesses whether OTTI is present when the fair value of a security is less than its amortized cost. All investment securities are evaluated for OTTI under FASB ASC Topic 320, “Investments-Debt & Equity Securities” (“ASC Topic 320”). 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.

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

The following table summarizes OTTI losses on securities recognized in earnings in the periods indicated:

		For the three months
		ended March 31,
(In thousands)		2011				2010
Corporate bonds		$	—			$	58
Trust preferred securities			—				55
Other securities			—				63
Total OTTI charges		$	—			$	176

The following table presents a roll-forward of the balance of credit-related impairment losses on debt securities held at March 31, 2011 and 2010 for which a portion of OTTI was recognized in other comprehensive income:

(In thousands)		2011				2010
Balance at January 1,		$	924			$	1,896
Reductions for securities sold during the period (realized)			—				(573	)
Reductions for securities for which the amount previously recognized in other comprehensive income was recognized in earnings because the Company intends to sell the security			—				(113	)
Balance at March 31,		$	924			$	1,210

The tables below indicate the length of time individual AFS securities have been in a continuous unrealized loss position at March 31, 2011 and December 31, 2010:

March 31, 2011		Less than 12 months								12 months or longer								Total
						Gross								Gross								Gross
						unrealized								unrealized								unrealized
(In thousands)		Fair value				losses				Fair value				losses				Fair value				losses
U.S. government agencies		$	29,522			$	(959	)		$	—			$	—			$	29,522			$	(959	)
Common stocks			101				(45	)			—				—				101				(45	)
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies			43,263				(585	)			4,239				(12	)			47,502				(597	)
Non-agency			857				(3	)			—				—				857				(3	)
Corporate bonds			9,863				(310	)			—				—				9,863				(310	)
Trust preferred securities			—				—				1,747				(2	)			1,747				(2	)
Total available-for-sale		$	83,606			$	(1,902	)		$	5,986			$	(14	)		$	89,592			$	(1,916	)

December 31, 2010		Less than 12 months								12 months or longer								Total
						Gross								Gross								Gross
						unrealized								unrealized								unrealized
(In thousands)		Fair value				losses				Fair value				losses				Fair value				losses
U.S. government agencies		$	29,737			$	(755	)		$	—			$	—				29,737				(755	)
Common stocks			96				(50	)			—				—				96				(50	)
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies			73,169				(687	)			4,429				(17	)			77,598				(704	)
Non-agency			918				(3	)			—				—				918				(3	)
Corporate bonds			8,986				(197	)			—				—				8,986				(197	)
Trust preferred securities			—				—				1,662				(87	)			1,662				(87	)
Total available-for-sale		$	112,906			$	(1,692	)			6,091			$	(104	)		$	118,997				(1,796	)

The AFS portfolio had gross unrealized losses of $1.9 million at March 31, 2011, which slightly increased from gross unrealized losses of $1.8 million at December 31, 2010. Increases in gross unrealized losses on U.S. government agencies securities and corporate bonds were slightly offset by decreases in gross unrealized losses on collateralized mortgage obligations and trust preferred securities. In determining the Company’s intent not to sell and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, management considers the following factors: current liquidity and availability of other non-pledged assets that permits the investment to be held for an extended period of time but not necessarily until maturity, capital planning, and any specific investment committee goals or guidelines related to the disposition of specific investments.

Common stocks: As of March 31, 2011, the Company had one common stock of a financial institution with a total fair value of $100,000 and an unrealized loss of $45,000, or 31.0% of its aggregate cost. The Company recorded an OTTI charge to earnings of $220,000 related to this common stock during the second quarter of 2009. Because the Company does not intend to sell this stock before recovery of its cost basis and will not more likely than not be required to sell this stock before recovery of its cost basis, it does not consider the unrealized loss to be other-than-temporary at March 31, 2011.

For all debt security types discussed below the fair value is based on prices provided by brokers and safekeeping custodians with the exception of trust preferred securities which are described below.

U.S. government-sponsored agencies (“U.S. Agencies”): As of March 31, 2011, the Company had eight U.S. Agencies with a fair value of $29.5 million and gross unrealized losses of $959,000, or 3.1%, of their aggregate cost. All of these U.S. Agencies have been in an unrealized loss position for six months or less. Management believes that the unrealized losses on these debt securities are a function of changes in investment spreads. Management expects to recover the entire amortized cost basis of these securities. The Company does not intend to sell these securities before recovery of their cost basis and will not more likely than not be required to sell these securities before recovery of their cost basis. Therefore, management has determined that these securities are not other-than-temporarily impaired at March 31, 2011.

U.S. government issued or sponsored collateralized mortgage obligations (“Agency CMOs”): As of March 31, 2011, the Company had fourteen Agency CMOs with a fair value of $47.5 million and gross unrealized losses of $597,000, or 1.2% of their aggregate cost. Thirteen of the Agency CMOs have been in an unrealized loss position for less than twelve months. The one Agency CMO that has been in an unrealized loss position for more than twelve months has a fair market value of $4.2 million and an unrealized loss of $12,000 at March 31, 2011. The unrealized loss is attributable to a combination of factors, including relative changes in interest rates since the time of purchase. The contractual cash flows for these securities are guaranteed by U.S. government agencies and U.S. government-sponsored enterprises. Based on its assessment of these factors, management believes that the unrealized losses on these debt securities are a function of changes in investment spreads and interest rate movements and not changes in credit quality. Management expects to recover the entire amortized cost basis of these securities. The Company does not intend to sell these securities before recovery of their cost basis and will not more likely than not be required to sell these securities before recovery of their cost basis. Therefore, management has determined that these securities are not other-than-temporarily impaired at March 31, 2011.

Non-agency collateralized mortgage obligations (“Non-agency CMOs”): As of March 31, 2011, the Company had one non-agency CMO with a fair value of $857,000 and gross unrealized losses of $3,000, or less than 1.0% of the aggregate cost. The non-agency CMO bond has been in an unrealized loss position for less than twelve months. The Company evaluated the impairment to determine if it could expect to recover the entire amortized cost basis of the non-agency CMO bond by considering numerous factors including credit default rates, conditional prepayment rates, current and expected loss severities, delinquency rates, and geographic concentrations. The bond is rated AAA. The Company does not intend to sell the non-agency CMO and it is not more likely than not that the Company will be required to sell the investment before recovery of the amortized cost basis. Therefore, the Company does not consider the bond to be other-than-temporarily impaired as of March 31, 2011.

Corporate bonds: As of March 31, 2011, the Company had ten corporate bonds with a fair value of $9.9 million and gross unrealized losses of $310,000, or 3.1% of their aggregate cost. All ten bonds have been in an unrealized loss position for less than six months and are above investment grade. The Company’s unrealized losses in investments in corporate bonds represent interest rate risk and not credit risk of the underlying issuers. As previously mentioned management also considered (1) the length of time and the extent to which the fair value is less than the amortized cost, (2) the Company’s intent to hold or sell the security, (3) the financial condition and results of the issuer including changes in capital, (4) the credit rating of the issuer, (5) analysts earnings estimate, (6) industry trends specific to the security, and (7) timing of debt maturity and status of debt payments. Management utilized discounted cash flow analysis based upon the credit ratings of the securities, liquidity risk premiums, and the recent corporate spreads for similar securities to arrive at the credit risk component as required under ASC Topic 320 to determine the credit risk component of the corporate bonds. Based on these analyses, there was no credit-related loss on the ten bonds. Because the Company does not intend to sell the corporate bonds and it is not more likely than not that the Company will be required to sell the bonds before recovery of their amortized cost basis, which may be maturity, the Company does not consider the ten bonds to be other-than-temporarily impaired at March 31, 2011.

Trust preferred securities: At March 31, 2011, the Company had seven trust preferred securities issued by five individual name companies (reflecting, where applicable the impact of mergers and acquisitions of issuers subsequent to original purchase) in the financial services/banking industry. The valuations of trust preferred securities were based upon the fair market values of active trades for one of the securities and ASC Topic 320 using cash flow analysis for the remaining six securities. Contractual cash flows and a market rate of return were used to derive fair value for each of these securities. Factors that affected the market rate of return included (1) any uncertainty about the amount and timing of the cash flows, (2) the credit risk, (3) liquidity of the instrument, and (4) observable yields from trading data and bid/ask indications. Credit risk spreads and liquidity premiums were analyzed to derive the appropriate discount rate. As of March 31, 2011, the Company has one trust preferred security with a fair value of $1.7 million and gross unrealized losses of $2,000, or less than 1.0% of the aggregate cost. The trust preferred security has been in an unrealized loss position for longer than twelve months and was deemed other-than-temporarily impaired at June 30, 2009. The security is not rated.

The unrealized loss in the trust preferred security reflects the credit concerns related to the financial institution that issued this long term financial obligation. The recent financial losses and reductions of capital coupled with bank failures and the overall market uncertainty within the financial services industry has resulted in a lower value. Management applied a discounted cash flow analysis based upon the liquidity risk premiums and the recent corporate spreads for similar securities to arrive at the credit risk component of the unrealized loss as required by ASC Topic 320. As a result, there was no additional credit-related loss on the bond. The total gross unrealized loss of $2,000 recognized in comprehensive income is the noncredit-related loss on the security.

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

Note 4. Loans and Leases

Major classifications of loans held for investment (“LHFI”) are as follows:

		March 31,				December 31,
(In thousands)		2011				2010
Commercial and industrial		$	57,103			$	74,027
Construction			27,637				29,044
Land Development			46,139				50,594
Real Estate — residential			29,101				29,299
Real Estate — non-residential			188,800				194,203
Real Estate — multi-family			10,168				10,277
Tax certificates			65,804				70,443
Leases			38,697				38,725
Other			909				793
Total gross loans		$	464,358			$	497,405
Deferred fees, net			(505	)			(551	)
Total loans and leases		$	463,853			$	496,854

The Company grants commercial and real estate loans, including construction and land development loans primarily in the greater Philadelphia metropolitan area as well as selected locations throughout the mid-Atlantic region. The Company also has participated with other financial institutions in selected construction and land development loans outside our geographic area. The Company has a concentration of credit risk in commercial real estate, construction and land development loans at March 31, 2011. A substantial portion of its debtors’ ability to honor their contracts is dependent upon the housing sector specifically and the economy in general.

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

The Company’s policy for income recognition on troubled debt restructurings (“TDRs”) is to recognize income on currently performing restructured loans under the accrual method. At March 31, 2011, the Company had one TDR which is classified as a multi-family real estate non-accrual loan in the amount of $1.8 million.

At March 31, 2011 and December 31, 2010, the Company had $27.1 million and $29.6 million; respectively, in loans held for sale (“LHFS”). LHFS at March 31, 2011 are comprised of $21.6 million in non-accrual loans and $5.5 million in classified loans. These loans were transferred from LHFI in the fourth quarter of 2010 at the lower of cost or fair market value.

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

	•		Pass: includes credits that demonstrate a low probability of default;
	•		Watch: a warning classification which includes credits that are beginning to demonstrate above average risk through declining earnings, strained cash flows, increased leverage and/or weakening market fundamentals;
	•		Special mention: includes credits that have potential weaknesses that if left uncorrected could weaken the credit or result in inadequate protection of the Company’s position at some future

date. While potentially weak, credits in this classification are marginally acceptable and loss of principal or interest is not anticipated;

	•		Substandard accrual—includes credits that exhibit a well-defined weakness which currently jeopardizes the repayment of debt and liquidation of collateral even though they are currently performing. These credits are characterized by the distinct possibility that the Company may incur a loss in the future if these weaknesses are not corrected;
	•		Non-accrual (substandard non-accrual, doubtful, loss)-includes credits that demonstrate serious problems to the point that it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement.

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

The following tables present risk ratings for each loan portfolio segment at March 31, 2011 and December 31, 2010, excluding LHFS.

March 31, 2011										Special
(In thousands)		Pass				Watch				Mention				Substandard				Non-accrual				Total
Construction		$	994			$	3,781			$	5,284			$	—			$	17,578			$	27,637
Land development			3,137				17,609				22,266				—				3,127				46,139
Real Estate-non-residential			96,803				44,607				37,527				—				9,863				188,800
Commercial & industrial			20,136				314				22,801				8,317				5,535				57,103
Residential real estate			19,024				7,340				199				—				2,538				29,101
Multi-family			2,766				4,092				895				—				2,415				10,168
Leasing			37,598				290				138				—				671				38,697
Consumer			819				90				—				—				—				909
Tax certificates			64,014				—				—				—				1,790				65,804
Subtotal LHFI			245,291				78,123				89,110				8,317				43,517				464,358
Less: Deferred loan fees																							(505	)
Total LHFI																						$	463,853

December 31, 2010										Special
(In thousands)		Pass				Watch				Mention				Substandard				Non-accrual				Total
Construction		$	992			$	10,089			$	5,491			$	—			$	12,472			$	29,044
Land development			6,921				13,967				22,420				—				7,286				50,594
Real Estate-non-residential			97,142				49,278				37,723				—				10,060				194,203
Commercial & industrial			27,864				6,488				25,400				8,317				5,958				74,027
Residential real estate			19,272				7,430				198				—				2,399				29,299
Multi-family			2,804				4,117				903				—				2,453				10,277
Leasing			37,731				252				10				—				732				38,725
Consumer			768				25				—				—				—				793
Tax certificates			68,641				—				—				—				1,802				70,443
Subtotal LHFI			262,135				91,646				92,145				8,317				43,162				497,405
Less: Deferred loan fees																							(551	)
Total LHFI																						$	496,854

The following tables present an aging analysis of past due payments for each loan portfolio segment at March 31, 2011 and December 31, 2010, excluding LHFS.

March 31, 2011		30-59 Days				60-89 Days				Accruing				Total
(In thousands)		Past Due				Past Due				90+ Days				Non-accrual				Current				Total
Construction		$	—			$	—			$	—			$	17,578			$	10,059			$	27,637
Land development			—				—				—				3,127				43,012				46,139
Real Estate-non-residential			191				—				—				9,863				178,746				188,800
Commercial & industrial			190				8,317				—				5,535				43,061				57,103
Residential real estate			484				43				—				2,538				26,036				29,101
Multi-family			—				—				—				2,415				7,753				10,168
Leasing			290				138				—				671				37,598				38,697
Consumer			—				—				—				—				909				909
Tax certificates			—				—				—				1,790				64,014				65,804
Subtotal LHFI			1,155				8,498				—				43,517				411,188				464,358
Less: Deferred loan fees																							(505	)
Total LHFI																						$	463,853