form10k.htm

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.

Royal Bancshares of Pennsylvania, Inc. (the “Company”), is a Pennsylvania business corporation and a bank holding company registered under the Federal Bank Holding Company Act of 1956, as amended (the “Holding Company Act”). The Company is supervised by the Board of Governors of the Federal Reserve System (“Federal Reserve Board”). The Company’s legal headquarters are located at 732 Montgomery Avenue, Narberth, Pennsylvania, 19072. 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 banking subsidiary of the Company, 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, Delaware, 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, 2011, the Company had consolidated total assets of approximately $848.4 million, total deposits of approximately $575.9 million and shareholders’ equity of approximately $75.9 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 two reportable operating segments, “Community Banking” and “Tax Liens”.

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 Pennsylvania Department of Banking (the “Department”). The material terms of the Orders were identical and required Royal Bank among other items to 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%. The FDIC and the Department replaced the Orders in the fourth quarter of 2011 with an informal agreement, known as a memorandum of understanding. Included in the informal agreement is the continued requirement of maintaining a leverage ratio equal to or greater than 8% and a total risk-based capital ratio equal to or greater than 12%.

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; (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.

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. Royal Bank’s business and services are 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 Gloucester County, 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, Delaware and Berks counties and Gloucester County, 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.

Deposits: At December 31, 2011, total deposits of Royal Bank were distributed among demand deposits (10%), money market deposit, savings and NOW accounts (42%) and time deposits (48%). At year-end 2011, deposits decreased $115.0 million to $582.2 million, from year-end 2010, or 16.5%. Demand deposits increased $4.6 million and NOW and money market accounts increased $4.3 million while time deposits decreased $124.3 million primarily due to the redemption of brokered CDs. Included in Royal Bank’s deposits are approximately $6.3 million of intercompany deposits that are eliminated through consolidation.

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 was an insured bank by the FDIC. Royal Asian derived its income principally from interest charged on loans and fees received in connection with other services. Royal Asian’s principal expenses were interest expense on deposits and operating expenses. Operating revenues, deposit growth, and the repayment of outstanding loans provided the majority of funds for activities. The sale of all of the outstanding common stock of Royal Asian owned by the Company was completed on December 30, 2010.

On June 30, 1995, the Company established a special purpose Delaware investment company, Royal Investment of Delaware (“RID”), as a wholly owned subsidiary. RID’s legal headquarters is 1105 N. Market Street, Suite 1300, Wilmington, Delaware 19899. RID buys, holds and sells investment securities. At December 31, 2011, total assets of RID were $30.0 million, of which $1.2 million was held in cash and cash equivalents and $6.0 million was held in investment securities. RID had net interest income of $673,000 and $779,000 for 2011 and 2010, respectively. Non-interest income, which is solely related to sales of investment securities, was $619,000 for 2011 compared to a loss of $158,000 for 2010.

The Company, through its wholly owned subsidiary Royal Bank, holds a 60% ownership interest in Crusader Servicing Corporation (“CSC”). CSC’s legal headquarters is located at 732 Montgomery Avenue, Narberth, Pennsylvania 19072. CSC acquired, 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. In the first quarter of 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. At December 31, 2011, total assets of CSC were $9.0 million. Included in total assets is $1.0 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 2010, CSC charged-off $3.0 million related to this loan. Additional charge-offs of $587,000 related to SMI were recorded in 2011. The outstanding SMI loan balance was $1.0 million at December 31, 2011. In 2011, CSC’s net interest income declined $355,000 from $368,000 for 2010 to $13,000 due to the continued liquidation of the portfolio. The 2011 provision for lien losses was $619,000 compared to $59,000 for 2010. The provision is mainly related to the SMI impairments mentioned above. For 2011 and 2010 other income was $289,000 and $338,000, respectively. Other income is mostly comprised of gain on sale of real estate owned (“REO”) properties. Other expense was $285,000 and $512,000 for 2011 and 2010, respectively. CSC recorded a net loss of $361,000 in 2011 compared to net income of $81,000 in 2010. The 2011 loss was impacted by the increase in the provision for lien 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. RIA’s legal headquarters is located at 732 Montgomery Avenue, Narberth, Pennsylvania 19072. RIA was formed to invest in equity real estate ventures subject to limitations imposed by regulation. At December 31, 2011, total assets of RIA were $5.9 million, which included $5.0 million in cash. During 2011, RIA had net income of $1.9 million compared to a net loss of $4.5 million for 2010. 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 July 25, 2005, the Company, through its wholly owned subsidiary Royal Bank, formed Royal Bank America Leasing, LP (“Royal Leasing”). Royal Bank holds a 60% ownership interest in Royal Leasing. Royal Leasing’s legal headquarters is located at 550 Township Line Road, Blue Bell, Pennsylvania 19422. Royal Leasing was formed to originate small business 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. From time to time Royal Leasing will sell small lease portfolios to third-parties and will, on occasion, purchase lease portfolios from other originators. During 2011 and 2010, neither sales nor purchases of lease portfolios were material. At December 31, 2011, total assets of Royal Leasing were $36.5 million. For 2011, Royal Leasing had net interest income of $2.3 million compared to $2.5 million for 2010. For 2011 provision for lease losses was $504,000 compared to $834,000 for 2010. The decrease in the provision was primarily related to improvement in the credit quality of the leasing portfolio year over year. Other income increased $193,000 from $365,000 for 2010 to $558,000 for 2011. Other expense was $1.0 million and $803,000 for 2011 and 2010, respectively. The increase in other expense was related to an increase of $294,000 in distribution of management fees. Royal Leasing recorded net income of $479,000 for the year ended December 31, 2011 compared to a $547,000 for the year ended December 31, 2010.

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, 2011, total assets of RTL of which the majority was held in tax liens were $61.8 million compared to $89.1 million at December 31, 2010. Tax certificates decline $19.2 million from $63.7 million at December 31, 2010 to $44.5 million at December 31, 2011. For 2011, RTL had net interest income of $4.8 million compared to $5.8 million for 2010 due to the reduction in average tax liens outstanding for RTL over the past year. Provision for lien losses was $464,000 compared to $70,000 for 2011 and 2010, respectively. Other expense was $1.2 million for both 2011 and 2010. Net income for 2011 declined $874,000 from $2.9 million for 2010 to $2.0 million for 2011.

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.

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.

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 43%, 40% and 9%, respectively of the $51.3 million in non-accrual loans held at December 31, 2011. The business of the Company and its subsidiaries is not seasonal in nature.

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.

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.

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.

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.

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.

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 informal agreement 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 informal agreement. Royal Bank has met all of the capital ratio requirements under the informal agreement.

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.

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.

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.

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

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.

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.

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.

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.

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.

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 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.

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:

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 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.

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 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 began in the second quarter of 2011, but did not affect Royal Bank. Under the Dodd-Frank Act, the FDIC is authorized to make reimbursements from the insurance fund to banks if the reserve ratio exceeds 1.50%, but the FDIC has adopted the “designated reserve ratio” of 2.0%. In lieu of reimbursements, the FDIC has set lower base assessment rates if the reserve ratio for the prior assessment period is equal to or exceeds 2.0%.

In addition to deposit insurance, Royal Bank is also subject to assessments to pay the interest on Financing Corporation bonds. The Financing Corporation was created by Congress to issue bonds to finance the resolution of failed thrift institutions. Commercial banks and thrifts are subject to the same assessment for Financing Corporation bonds. The FDIC sets the Financing Corporation assessment rate every quarter. For the first quarter of 2012, the Financing Corporation’s assessment for Royal Bank (and all other banks), is an annual rate of $.0066 for each $100 of deposits. The Financing Corporation bonds are expected to be paid off between 2017 and 2019.

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. Basel III also includes two newly required liquidity ratios. 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 draft final rules by the first quarter of 2012 with implementation and adoption of Basel III regulations later in 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 overall should benefit Royal Bank, the individual provisions of this law are not considered currently material to Royal Bank when considered alone.

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

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.

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.

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 informal agreement 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 informal agreement 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 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, is subject to prior written consent of the FDIC and Department. 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 informal agreement. Attracting new management talent is critical to the success of our business and could be potentially impacted due to the existence of the informal agreement and the Federal Reserve Agreement.

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 non-residential real estate and construction and land development loan portfolio held for investment was $236.7 million at December 31, 2011 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 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.

Like all financial institutions, we maintain an allowance for loan and lease losses to provide for loan and lease 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.

We are required by regulatory authorities to maintain adequate capital levels to support our operations. We anticipate that our current capital will satisfy our regulatory requirements for the foreseeable future. However, in order to maintain our well-capitalized status and to support future growth we may need to raise capital. Our ability to raise additional capital will depend, in part, on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Under the informal agreement 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 informal agreement. 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.

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.

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, 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. 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. Royal Bank must receive prior written 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.

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, peer to peer lenders and governmental organizations which may offer more favorable terms. Some of our non-bank competitors are not subject to the same extensive regulations that govern our banking operations. As a result, such non-bank competitors may have advantages over 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.

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. 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.

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.

We are exposed to downturns in the U. S. housing market. Dramatic declines in the housing market over the past few years, with decreasing home prices and increasing delinquencies and foreclosures, have negatively impacted 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. Financial institutions have also experienced decreased access to borrowings. While the economy and market conditions have improved, the current economic recovery has been much weaker than recent economic recoveries post recession and unemployment, despite recent improvement, remains high. The existing 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. A worsening of current economic conditions would likely exacerbate the adverse effects of existing market conditions on us and others in the industry. In particular, we may face the following risks in connection with these events:

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.

As described under “Supervision and Regulation” 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.

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

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 29, 2012. As a result of their ownership, the directors, executive officers and principal shareholders will have the ability, by voting their shares in concert, to influence the outcome of any matter submitted to our shareholders for approval, including the election of directors. The directors and executive officers may vote to cause the Company to take actions with which the other shareholders do not agree or that are not beneficial to all shareholders.

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)	Fairmount Office (1)	Grant Avenue Office (1)
6331 Castor Avenue	401 Fairmount Avenue	1650 Grant Avenue
Philadelphia, PA 19149	Philadelphia, PA 19123	Philadelphia, PA 19115

Henderson Road Office	Jenkintown Office (1)	King of Prussia Office (1)
Beidler 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

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 holders, including mortgage lien holders. On March 4, 2009, each of CSC and RTL received grand jury subpoenas 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 subpoenas sought certain documents and information relating to an ongoing investigation being conducted by the DOJ relating to alleged bid-rigging at tax lien auctions in New Jersey. Royal Bank, CSC and RTL have produced to the DOJ documents responsive to the subpoenas and have been cooperating with the DOJ throughout the investigation. On February 23, 2012, the former President of CSC and RTL entered a plea of guilty to one count of bid-rigging at certain auctions for tax liens in New Jersey from 1998 until approximately the spring of 2009. The former President’s employment with CSC and RTL effectively terminated in November 2010. As previously disclosed, Royal Bank had been advised that neither CSC nor RTL were targets of the DOJ investigation, but they were subjects of the investigation. It is possible, particularly in light of the plea entered by the former President of CSC and RTL, 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. No proceedings have been instituted by the DOJ or any other governmental authority against CSC or RTL as of the date of this filing.

As a result of the plea agreements of the former President of CSC and RTL and others resulting from the DOJ investigation, on March 13, 2012, the former president of RTL and CSC, RTL, CSC, the Company and certain other parties were named as defendants in a putative class action lawsuit filed in the Superior Court of New Jersey, Chancery Division on behalf of a proposed class of taxpayers who became delinquent in paying their municipal tax obligations (Boyer v. Robert W. Stein, Crusader Servicing Corp. Royal Tax Lien Services LLC, Royal Bancshares of Pennsylvania, Inc., et al., Superior Court of New Jersey, Chancery Division, Docket No. C-14007/12). On March 28, 2012, CSC, RTL and the Company removed this case to the U.S. District Court for the District of New Jersey. The lawsuit alleges violations of the New Jersey Antitrust Act and unjust enrichment, and seeks treble damages, attorney fees and injunctive relief.

Under the Pennsylvania Business Corporation Law, the Company may pay dividends only if, after giving effect to the dividend payment, the total assets of the Company would exceed the total liabilities of the Company plus the amount necessary to satisfy preferential rights of holders of senior shareholders, and the Company is solvent and would not be rendered insolvent by the dividend payment. There are also restrictions set forth in the Pennsylvania Banking Code of 1965 (the “Code”) and in the Federal Deposit Insurance Act (“FDIA”) concerning the payment of dividends by the Company. Under the Code, no dividends may be paid except from “accumulated net earnings” (generally retained earnings). Under the FDIA, no dividend may be paid if a bank is in arrears in the payment of any insurance assessment due to the FDIC. In addition, dividends paid by Royal Bank to the Company would be prohibited if the effect thereof would cause Royal Bank’s capital to be reduced below applicable minimum capital requirements. Therefore, the restrictions on Royal Bank’s dividend payments are directly applicable to the Company. See “Note 14 – Shareholder’s Equity” of the Notes to Consolidated Financial Statements in Item 8 of this Report.

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, this decision better supports the capital position of Royal Bank, a wholly owned subsidiary of the Company. As of December 31, 2011, the Series A Preferred stock dividend in arrears was $4.1 million and has not been recognized in the consolidated financial statements. As a consequence of missing the sixth dividend payment in the fourth quarter of 2010, the Treasury had the right to appoint two directors to our board of directors until all accrued but unpaid dividends have been paid. The Treasury exercised its right and appointed two directors to the Company’s board of directors during 2011.

At December 31, 2011, as a result of significant losses within Royal Bank and cash and stock dividends declared and paid in previous years, the Company had negative retained earnings and therefore would not have been able to declare and pay any cash dividends. 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 as described under “Regulatory Actions” in “Item 1 – Business” of this Report, 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.

Additionally, as a result of the CPP completed between the Treasury and the Company 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 and any repurchases of Company common stock. These restrictions on the payment of dividends and the repurchases of common stock by the Company became effective immediately upon closing 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.

Statement of Operations Data	For the years ended December 31,
(In thousands, except share data)	2011			2010			2009			2008			2007
Interest income	$	39,377		$	57,262		$	66,043		$	72,764		$	86,736
Interest expense		14,086			25,994			37,439			38,109			48,873
Net interest income		25,291			31,268			28,604			34,655			37,863
Provision for loan and lease losses		7,728			22,140			20,605			21,841			13,026
Net interest income after loan and lease losses		17,563			9,128			7,999			12,814			24,837
Gains (loss) on investment securities		1,782			1,290			1,892			(1,313	)		5,358
Gains on sales related to real estate joint ventures		1,750			-			-			1,092			350
Net gains on sales of other real estate owned		1,638			1,019			294			429			1,111
Service charges and fees		1,128			1,266			1,419			1,186			1,348
Income from bank owned life insurance		391			379			1,099			1,233			875
Gains on sale of loans and leases		337			666			914			190			404
Income related to real estate owned via equity investments		478			564			1,302			965			1,384
Gain on sale of security claim		-			1,656			-			-			-
Gain on sale of premises & equipment related to real estate owned via equity investments		-			667			1,817			1,679			1,860
Gain on sale of premises & equipment		-			-			-			1,991			-
Other income		1,110			737			578			148			198
Total other than-temporary-impairment losses on investment securities		(1,796	)		(566	)		(13,431	)		(23,388	)		-
Portion of loss recognized in other comprehensive loss		-			87			2,390			-			-
Net impairment losses recognized in earnings		(1,796	)		(479	)		(11,041	)		(23,388	)		-
Total other income (loss)		6,818			7,765			(1,726	)		(15,788	)		12,888
Income (loss) before other expenses & income taxes		24,381			16,893			6,273			(2,974	)		37,725
Non-interest expense
Salaries and benefits		10,920			11,591			12,235			15,044			12,215
Impairment related to OREO		5,522			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
Impairment related to real estate joint venture		-			1,552			-			-			5,927
Other		15,627			17,097			19,977			15,023			11,800
Total other expense		32,069			40,743			37,656			32,533			40,032
Loss before tax expense (benefit)		(7,688	)		(23,850	)		(31,383	)		(35,507	)		(2,307	)
Income tax expense (benefit)		-			-			474			2,643			(1,568	)
Net loss	$	(7,688	)	$	(23,850	)	$	(31,857	)	$	(38,150	)	$	(739	)
Less net income (loss) attributable to noncontrolling interest		875			243			1,402			(68	)		(1,303	)
Net (loss) income attributable to Royal Bancshares		(8,563	)		(24,093	)		(33,259	)		(38,082	)		564
Less Series A Preferred stock accumulated dividend and accretion		(2,003	)		(1,970	)		(1,672	)		-			-
Net (loss) income available to common shareholders		(10,566	)		(26,063	)		(34,931	)		(38,082	)		564

Basic and diluted (loss) earnings per common share	$	(0.80	)	$	(1.97	)	$	(2.64	)	$	(2.86	)	$	0.04

Balance Sheet Data	For the years ended December 31,
(In thousands)	2011			2010			2009			2008			2007
Total Assets		848,449			980,626			1,292,726			1,175,586			1,278,475
Total average assets (2)		906,502			1,177,922			1,295,126			1,189,518			1,314,361
Loans, net		397,863			475,725			656,533			671,814			625,193
Total deposits		575,916			693,913			881,755			760,068			770,152
Total average deposits		621,709			791,026			857,742			724,384			869,884
Total borrowings (1)		173,774			180,723			283,601			313,805			339,251
Total average borrowings (1)		177,517			256,688			307,225			307,597			254,757
Total shareholders' equity (3)		75,946			84,093			101,156			79,687			146,367
Total average shareholders' equity		81,184			103,895			107,511			131,155			158,695
Return on average assets		(0.94	%)		(2.04	%)		(2.57	%)		(3.20	%)		0.04	%
Return on average equity		(10.55	%)		(23.19	%)		(30.94	%)		(29.04	%)		0.36	%
Average equity to average assets		8.96	%		8.82	%		8.30	%		11.03	%		12.07	%
Dividend payout ratio		0.00	%		0.00	%		0.00	%		(10.52	%)		2743.40	%

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.

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 did not hold trading securities at December 31, 2011 and 2010. 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.

The Company evaluates securities for other-than-temporary impairment (“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”.

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 Company considers that the determination of the allowance for loan and lease losses (“allowance”) involves a higher degree of judgment and complexity than its other significant accounting policies. The allowance is calculated with the objective of maintaining a reserve level believed by management to be sufficient to absorb estimated credit losses. 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.

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 $8.6 million in 2011, which represented an improvement of $15.5 million, or 64.5%, from loss recorded in 2010 of $24.1 million. The improved results were primarily related to a reduction in the provision for loan and lease losses of $14.4 million and a decline of $8.7 million in total other expense. The favorable change in the provision resulted primarily from a decrease in the outstanding loan balances year over year as well as a decline in the level of non-performing loans. Loan balances, including loans held for sale, amounted to $410.4 million at year end 2011, which amounted to a decline of $94.9 million from balance at the end of 2010 due to charge-offs, loan sales, pay-downs, pay offs and transfers to other real estate owned (“OREO”). Other expenses of $32.1 million resulted in a year over year decline of $8.7 million, or 21.3%, and was attributed to an overall reduction of expenses related to the sale of Royal Asian at year end 2010, which amounted to $3.8 million; a reduction of $1.9 million in OREO impairment charges; lower FDIC and state assessments of $1.1 million associated with reduced deposit balances, mainly brokered CDs and deposits of Royal Asian; and the absence of impairment on real estate joint ventures which was $1.6 million in 2010 and the VIE related to real estate owned via equity investments being deconsolidated in 2011. The impairment related to the VIE in 2010 was $2.6 million.

Partially offsetting these favorable changes were a decline in both net interest income and other income year over year. Net interest income, which amounted to $25.3 million in 2011, decreased by $6.0 million, or 19.1%, from the prior year’s results of $31.3 million. The decline in loan balances negatively impacted net interest income during the past year. In addition, a reduction in the yields on loans and investments and a 2010 non-recurring adjustment amounting to $905,000 also contributed to the decline in net interest income. The nonrecurring adjustment was related to the correction of previously reversed interest income on a participation loan from a previous year. The overall decline in net interest income was partially mitigated by the continued reduction in interest expense related to lower interest rates principally associated with the re-pricing of maturing retail CDs and the redemption of brokered deposits and FHLB advances. Other income of $6.8 million in 2011 was $947,000 below the result for 2010 mainly due to impairment on investment securities of $1.8 million, resulting primarily from a complete write-down of one trust preferred security in the amount of $1.7 million.

Total non-performing loans at December 31, 2011 were $51.3 million and were comprised of $38.7 million in loans held for investment (“LHFI”) and $12.6 million in loans held for sale (“LHFS”), which amounted to an improvement of $14.5 million from the level at December 31, 2010 resulting from charge-offs, transfers to OREO and improved credit quality. 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, 2011, amounted to $21.0 million versus $29.2 million at year end 2010. As a consequence of the continued weak housing market and slow growth economy, the Company continued to experience a high level of non-performing assets despite the continued progress in reducing the level of those assets. Impaired and non-accrual loans and OREO assets are reviewed in the “Credit Quality” section of this report. Basic and diluted losses per common share were both $0.80 for 2011 compared to basic and diluted losses per common share of $1.97 in 2010.

The Company recorded a net loss of $24.1 million in 2010, which represented a $9.2 million improvement from 2009. 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. 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 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 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. 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 2010. The increase in other expense was mainly associated with increased OREO impairment charges of $2.8 million, 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 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.

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 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 amounted to $25.3 million in 2011 as compared to $31.3 million in 2010, which resulted in a decline of $6.0 million, or 19.1%. The decrease was attributed mainly to a decline in interest-earning assets, both loans and investments, primarily attributable to the de-leveraging of the balance sheet, a decline on the yields of those interest-earning assets, again principally loans and investments, and a nonrecurring favorable adjustment of $905,000 for interest income in 2010. The decline was partially offset by a reduction of the average balances and the average rate paid on interest bearing liabilities associated with the redemption of brokered CDs and lower rates paid on maturing retail CDs. (See the “Average Balance” table included in this discussion.) Net interest income in 2010 of $31.3 million increased $2.7 million, or 9.3%, from the level recorded in 2009 of $28.6 million. The increase resulted from lower rates paid on maturing retail certificates of deposit, the redemption of brokered deposits and 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. The favorable results were partially offset by a decline in the yield on average interest earning assets, primarily investment securities.

Interest income of $39.4 million in 2011 amounted to a reduction of $17.9 million, or 31.2%, from the level of $57.3 million in 2010. The decline was attributable to a lower yield on interest earning assets year over year for loans and investment securities, and a lower level of average interest earning assets again related to both loans and investment securities. The reduction in loan balances and investment securities was driven in part by the Company’s strategic capital initiative of de-leveraging the balance sheet. Interest income for loans declined by $13.0 million, or 30.5%, and was mainly attributed to the reduction of average total loans but was also related to a decline in the yield on the loan portfolio. Average balance of total loans amounted to $475.0 million during 2011 versus $643.5 million during 2010, which amounted to a decline of $168.5 million, or 26.2%, year over year. The reduction was comprised of charge-offs, pay downs, payoffs, the sale of Royal Asian Bank (“RAB”) at year end 2010 and transfers to OREO that was accompanied by minimal new loan growth. The sale of RAB accounted for almost 40% of the overall decline. The interest income on investment securities amounted to $9.6 million and declined $4.8 million, or 33.3%, resulting from a decline in average investment securities coupled with a decline in the yield on the investment securities. Average investment securities of $320.4 million in 2011 amounted to a decline of $61.4 million, or 16.1%, from the average in 2010.

The decline in the yield on average interest earning assets contributed to the decline in interest income year over year (4.76% in 2011 versus 5.29% in 2010). The 53 basis point reduction was comprised of a decline of 78 basis points on investment securities and a 39 basis point decrease in total loans. The decline in the yield on investment securities was mainly related to the replacement of sold investment securities and principal payments and prepayments on government agency investment securities with comparable investment securities at lower interest rates. The yield decrease on average total loans primarily resulted from the $905,000 favorable adjustment to interest income in 2010 as previously mentioned, the lower yields on new loans booked during the past year and a change in the composition of the loans within the portfolio during 2011. The loan composition change was related to a decrease in the percentage of tax liens, which have the highest yields within the loan portfolio. At year end 2011, the variable rate portfolio represented approximately 40% 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.

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, which was driven in part by the Company’s strategic capital initiative of de-leveraging the balance sheet. 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.

For the full year ended December 31, 2011, interest expense amounted to $14.1 million, which resulted in a decline of $11.9 million, or 45.8%, from the level recorded in the previous year. The favorable change was attributed to a reduced level of average interest bearing liabilities year over year and a decline in the interest rates paid on those liabilities. Average interest bearing liabilities amounted to $742.0 million in 2011, which represented a decline of $243.3 million, or 24.7%, from the previous year and was primarily related to the previously noted de-leveraging strategy and compliance with the Orders. Average time deposits, which included brokered CDs, amounted to $327.6 million in 2011 and represented a decrease of $175.6 million, or 34.9%, from the average level of 2010 due mainly to the redemption of higher cost brokered CDs over the past two years. Average borrowings amounted to $151.7 million during 2011 and declined $77.8 million, or 33.9%, primarily due to the redemption of FHLB advances at the end of 2010.

Average rates paid on all major liability categories declined year over year due to the re-pricing of maturing retail certificates of deposit and the redemption of higher cost brokered CDs during the past two years; the redemption of higher cost FHLB advances during 2010; and the reduction of rates paid on NOW, money market accounts, and savings accounts primarily during 2011. The average interest rate paid on average interest-bearing liabilities in 2011 of 1.90% amounted to a reduction of 74 basis points from the prior year as the Company was able to take advantage of the current lower interest rate environment and the maturity of retail and brokered CDs as well as FHLB borrowings during the past two years. Significant declines in average interest rates paid on interest bearing liabilities year over year included certificates of deposits of 81 basis points and borrowings of 70 basis points.

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 the previous Orders.

The net interest margin for the full year 2011 amounted to 3.06%, which represented an increase of 17 basis points from 2010. The improved margin was attributed to lower interest rates for all major categories of interest bearing liabilities for the Company. The redemption of $83.2 million of higher cost brokered CDs, the retention of most of the $273 million maturing retail CDs at reduced rates of interest during 2011 and improved borrowings costs associated with the pay off of $57.5 million of FHLB advances at year end 2010 accounted for a majority of the improved net interest margin. The overall improvement was partially offset by a decline of 53 basis points on the yield on average interest earning assets, which resulted from a decline in yields on both loans and investment securities. The decline in the yield on investment securities was associated with a lower reinvestment rate on sold securities and payments and prepayments of cash-flowing agency investments due to the lower interest rates throughout 2011. The decline for loan yields was related to a reduction of higher yielding tax liens within the loan portfolio during 2011, the pay off of higher yielding loans, lower interest rates on new loans and a nonrecurring favorable adjustment of $905,000 that positively impacted the loan yield in 2010.

The net interest margin of 2.89% for the full year 2010 amounted to an increase of 50 basis points from the 2009 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 2009, and to redeem higher cost funding sources throughout 2010. During 2010 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.

	For the years ended December 31,
	2011								2010								2009
(Dollars in thousands)	Average Balance			Interest		Yield / Rate			Average Balance			Interest		Yield / Rate			Average Balance			Interest		Yield / Rate
Assets
Interest bearing deposits	$	29,016		$	78		0.27	%	$	57,377		$	154		0.27	%	$	51,578		$	164		0.32	%
Federal funds		2,822			3		0.11	%		562			1		0.13	%		553			1		0.18	%
Investment securities
Held to maturity		-			-		0.00	%		-			-		0.00	%		-			-		0.00	%
Available for sale		320,362			9,645		3.01	%		381,804			14,464		3.79	%		426,829			20,121		4.71	%
Total investment securities		320,362			9,645		3.01	%		381,804			14,464		3.79	%		426,829			20,121		4.71	%
Loans & Leases
Commercial demand loans		219,554			10,044		4.57	%		307,515			15,857		5.16	%		384,831			18,439		4.79	%
Real estate secured		213,737			16,268		7.61	%		291,205			23,195		7.97	%		294,414			24,285		8.25	%
Other loans and leases		41,756			3,339		8.00	%		44,730			3,591		8.03	%		36,276			3,032		8.36	%
Total loans		475,047			29,651		6.24	%		643,450			42,643		6.63	%		715,521			45,756		6.39	%
Total interest earnings assets		827,247			39,377		4.76	%		1,083,193			57,262		5.29	%		1,194,481			66,042		5.53	%
Non interest earnings assets
Cash & due from banks		11,725								16,465								11,752
Other assets		87,729								105,013								115,173
Allowance for loan loss		(19,567	)							(25,919	)							(25,061	)
Unearned discount		(632	)							(830	)							(1,219	)
Total non-interest earning assets		79,255								94,729								100,645
Total assets	$	906,502							$	1,177,922							$	1,295,126
Liabilities & Shareholders' Equity
Deposits
Savings	$	15,727		$	86		0.55	%	$	15,959		$	90		0.56	%	$	14,802		$	83		0.56	%
NOW		42,488			236		0.56	%		42,990			395		0.92	%		46,046			478		1.04	%
Money market		178,670			1,722		0.96	%		166,386			1,754		1.05	%		153,146			2,797		1.83	%
Time deposits		327,583			6,906		2.11	%		503,217			14,683		2.92	%		581,202			21,984		3.78	%
Total interest bearing deposits		564,468			8,950		1.59	%		728,552			16,922		2.32	%		795,196			25,342		3.19	%
Borrowings		151,743			4,493		2.96	%		229,515			8,403		3.66	%		271,000			10,717		3.95	%
Obligation through VIE equity investments		-			-		0.00	%		1,399			22		1.57	%		10,451			243		2.33	%
Subordinated debt		25,774			643		2.49	%		25,774			647		2.51	%		25,774			1,136		4.41	%
Total interest bearing liabilities		741,985			14,086		1.90	%		985,240			25,994		2.64	%		1,102,421			37,438		3.40	%
Non interest bearing deposits		57,241								62,474								62,546
Other liabilities		26,092								26,313								22,648
Total liabilities		825,318								1,074,027								1,187,615
Shareholders' equity		81,184								103,895								107,511
Total liabilities and shareholders' equity	$	906,502							$	1,177,922							$	1,295,126
Net interest income				$	25,291							$	31,268							$	28,604
Net interest margin							3.06	%							2.89	%							2.39	%

	2011 versus 2010									2010 versus 2009
	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	$	(76	)	$	-		$	(76	)	$	16		$	(26	)	$	(10	)
Federal funds sold		2			-			2			-			-			-
Total short term earning assets		(74	)		-			(74	)		16			(26	)		(10	)
Investments securities
Held to maturity		-			-			-			-			-			-
Available for sale		(2,260	)		(2,559	)		(4,819	)		(1,730	)		(3,927	)		(5,657	)
Total Investments securities		(2,260	)		(2,559	)		(4,819	)		(1,730	)		(3,927	)		(5,657	)
Loans
Commercial demand loans		(3,768	)		(1,704	)		(5,472	)		(3,536	)		1,180			(2,356	)
Commercial mortgages		(3,810	)		(342	)		(4,152	)		(156	)		(724	)		(880	)
Residential and home equity loans		(56	)		(11	)		(67	)		(95	)		(103	)		(198	)
Lease receivables		(200	)		(21	)		(221	)		693			(135	)		558
Real estate tax liens		(1,541	)		(1,140	)		(2,681	)		127			(160	)		(33	)
Other loans		(30	)		-			(30	)		5			(5	)		-
Loan fees		(369	)		-			(369	)		(205	)		-			(205	)
Total loans		(9,774	)		(3,218	)		(12,992	)		(3,167	)		53			(3,114	)

Total decrease in interest income	$	(12,108	)	$	(5,777	)	$	(17,885	)	$	(4,881	)	$	(3,900	)	$	(8,781	)
Interest expense
Deposits
NOW and money market	$	117		$	(307	)	$	(190	)	$	160		$	(1,286	)	$	(1,126	)
Savings		(1	)		(3	)		(4	)		6			1			7
Time deposits		(4,336	)		(3,442	)		(7,778	)		(2,699	)		(4,602	)		(7,301	)
Total deposits		(4,220	)		(3,752	)		(7,972	)		(2,533	)		(5,887	)		(8,420	)
Borrowings
Borrowings		(2,498	)		(1,412	)		(3,910	)		(1,558	)		(757	)		(2,315	)
Trust preferred		-			(4	)		(4	)		-			(489	)		(489	)
Total Borrowings		(2,498	)		(1,416	)		(3,914	)		(1,558	)		(1,246	)		(2,804	)
Total decrease in interest expense		(6,718	)		(5,168	)		(11,886	)		(4,091	)		(7,133	)		(11,224	)
Total (decrease) increase in net interest income	$	(5,390	)	$	(609	)	$	(5,999	)	$	(790	)	$	3,233		$	2,443

Other income includes service charges on depositors’ accounts, safe deposit rentals and various services such issuing money orders and traveler’s checks. In addition, other forms of non-interest income are derived from changes in the cash value of bank owned life insurance (“BOLI”), income related to income producing properties within other real estate owned 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 in 2011 amounted to $6.8 million resulting in a decline of $947,000, or 12.2%, from the previous year, which was primarily attributable to an increase of $1.3 million in OTTI charges on AFS securities ($1.8 million in 2011 versus $479,000 in 2010). This was mainly associated with the impairment of one trust preferred security within the Company’s investment portfolio which was completely written off in 2011. Other unfavorable fluctuations year over year in other income amounted to a $329,000 decrease in gain on the sales of loans and leases ($337,000 in 2011 compared to $666,000 in 2010), and decreases in both 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 of $86,000 and $667,000, respectively. The decline in 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 investment is attributable to the deconsolidation of the VIE as a result of the substantial completion of the real estate partnership project. As a result of deconsolidation, income of $278,000 is reflected in income related to real estate owned via equity investments.

Partially offsetting these decreases was a $619,000 increase in net gains on the sale of other real estate owned ($1.6 million in 2011 versus $1.0 million in 2010), a $492,000 increase in net gains on the sale of available for sale investment securities ($1.8 million in 2011 versus $1.3 million in 2010), a $1.8 million increase in income from real estate joint ventures related to a partial recovery of a fully impaired real estate joint venture and an increase in other income of $373,000. The improvement in other income was mostly attributed to rental income associated with two OREO properties acquired through foreclosures.

Total other income of $7.8 million in 2010 amounted to an improvement of $9.5 million from 2009 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 while 2009 impairment losses totaled $11.0 million. 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 2009. 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.

For the period ended December 31, 2011 non-interest expense of $32.1 million amounted to a decrease of $8.7 million, or 21.3%, from the results in 2010. The improvement in expenses was primarily attributable to a decrease of $3.5 million related to the sale of Royal Asian at the end of 2010 that impacted most expense categories, a $1.9 million decrease in OREO impairments, a $2.6 million decrease in impairments on real estate owned via equity investments, a $1.6 million decrease in impairments of real estate joint ventures, and an $1.1 million decrease in FDIC Insurance and Pennsylvania Department of Banking assessments, mainly a result of a reduction in deposits, most notably brokered CDs and Royal Asian deposits. The VIE was deconsolidated in 2011. During 2010 impairments of real estate joint ventures was the net impact of a $2.6 million impairment, which was the entire amount of an 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 and a recovery of $968,000 from another investment in a real estate joint venture that was written off in 2007.

Salaries and benefits of $10.9 million in 2011, which declined $671,000, or 5.8%, also contributed to the favorable results for other expense. The improvement was comprised of a reduction associated with the sale of Royal Asian amounting to $1.1 million and a partially offsetting increase of $417,000 mainly related to annual merit raises for most employees, the reinstatement of the 401K match and increased benefit costs. The $888,000 decline in occupancy and equipment expense in 2011 was primarily associated with the reduction of expenses related to the Royal Asian retail branch network. While professional and legal fees of $4.1 million in 2011 and OREO and loan collection expenses of $2.6 million in the current year were relatively flat year over year, they represent significant increases from historical levels due to credit quality issues, which have improved but remain elevated. 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 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 impairment of real estate owned via equity investments was due to lower projected operating cash flows resulting from a significant decline in unit sales, which was primarily related to the expiration of the new home buyers’ tax credit. During 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 non-controlling 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.

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 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 mainly to a reduction in the number of directors 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.

As of December 31, 2011 and December 31, 2010, 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, 2010 and 2011, the Company established additional valuation allowances of $10.2 million, $7.7 million, and $3.0 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 2011. As of December 31, 2011 the valuation allowance for deferred tax assets totaled $36.4 million.

Under FASB ASC Topic 280, “Segment Reporting” (“ASC Topic 280”), management of the Company has identified two reportable operating segments, “Community Banking” and “Tax Liens”. In previous years, the Company reflected “Equity Investments” and “Leasing” as operating segments. Management has determined that the operating results and assets related to Equity Investments and Leasing should be reflected under the Community Banking segment. The determination related to Equity Investments was based on the deconsolidation of the VIE as a result of the substantial completion of the project and minimal assets remaining. The determination related to Leasing was based on not meeting the quantitative thresholds for requiring disclosure.

Community Bank segment: At December 31, 2011, the Community Bank segment had total assets of $777.6 million, a decrease of $102.5 million or 11.6% from $880.0 million at December 31, 2010. Total deposits declined $118.0 million or 17.0% from $693.9 million at December 31, 2010 to $575.9 million at December 31, 2011. Net interest income for 2011 was $20.3 million compared to $24.4 million for 2010 representing a decrease of $4.2 million, or 17.1%. The decrease in net interest income was primarily related to a reduction in the average balance of loans which have a higher yield than investments. In addition, the yield earned on the investment securities declined in 2011 as a result of the market rates being significantly lower in 2011. The interest rates paid on deposits declined in 2011 largely due to the maturities of brokered and retail certificates of deposits. The loan loss provision was $6.6 million for 2011 compared to $22.0 million for 2010 primarily as a result of the reduction of non-performing loans. For 2011, total other income was $6.3 million compared to a total other income of $7.4 million for 2010. The decline is mostly attributed to a $1.3 million increase in impairment charges recorded on the available-for-sale investment portfolio in 2011 compared to 2010. In 2011, total other expense was $30.4 million, a decrease of $8.4 million, or 21.6%, from $38.8 million in 2010. The decrease is mostly associated with decreases in OREO impairment charges of $1.9 million, impairment in real estate joint ventures of $1.6 million and a decline in the FDIC assessment of $1.1 million. The net loss for 2011 was $9.6 million compared to a net loss of $25.9 million for 2010, which represents an improvement of $16.3 million, or 63.0%.

Tax Lien segment: At December 31, 2011, the Tax Lien segment had total assets of $70.9 million compared to $100.6 million at December 31, 2010 representing a decrease of $29.7 million, or 30%. Net interest income decreased $1.7 million, or 26%, from $6.5 million in 2010 to $4.8 million in 2011. The provision for losses increased from $129,000 in 2010 to $1.1 million in 2011. The 2011 provision was mostly related to charge-offs on a non-accrual loan with a tax lien portfolio located in Alabama. Total other income was $548,000 in 2011 compared to $389,000 in 2010. Total other income is derived mostly from the gains on sale of OREO property. Total other expense decreased $203,000 from $1.7 million for 2010 to $1.5 million for 2011. The decrease in other total expense was related to a decline in management fees. Net income was $1.0 million in 2011 compared to $1.8 million for 2010.

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 $27.2 million from $51.7 million at December 31, 2010 to $24.5 million at December 31, 2011. The average balance of cash and cash equivalents was approximately $43.6 million for 2011 versus $74.4 million for 2010. The high level of cash for 2010 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 $29.0 million in 2011.

Investment Securities Available for Sale (“AFS”): AFS investment securities represented 39% of average interest earning assets during 2011 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, 2011, AFS investment securities were $329.0 million as compared to $315.6 million at December 31, 2010, an increase of $13.4 million. The increase was primarily due to the purchase of liquid, cash-flowing mortgage backed securities and U. S. government agency CMOs. The purchase of these investments was partially offset by the sale of debt securities and government agencies to reduce credit risk and extension risk within the investment portfolio.

Loans: The Company’s primary earning assets are loans, representing approximately 57% of average earning assets during 2011. 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 2011, total loans held for investment decreased $82.6 million to $414.2 million at December 31, 2011 from $496.8 million at December 31, 2010. The decline was primarily due to net pay downs or payoffs, loan charge-offs of $13.2 million, transfers to OREO of approximately $6.4 million in non-performing construction and land development, non-residential, and residential real estate loans, and transfers to LHFS of $2.9 million.

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, 2011 compared to 55% of total loans at December 31, 2010. Management believes our current loan loss reserve is adequate at December 31, 2011 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 to absorb losses in the loan and lease portfolio. The allowance is based on the review and evaluation of the loan and lease portfolio, along with ongoing, quarterly assessments of the probable losses inherent in that portfolio. The allowance represents an estimation made pursuant to FASB ASC Topic 450, “Contingencies” (“ASC Topic 450”) or FASB ASC Topic 310, “Receivables” (“ASC Topic 310”). The adequacy of the allowance is determined through evaluation of the credit portfolio, and involves consideration of a number of factors, as outlined below, to establish a prudent level. Determination of the allowance is inherently subjective and requires significant estimates, including estimated losses on pools of homogeneous loans and leases based on historical loss experience and consideration of current economic trends, which may be susceptible to significant change. Loans and leases deemed uncollectible are charged against the allowance, while recoveries are credited to the allowance. Management adjusts the level of the allowance through the provision for loan and lease losses, which is recorded as a current period expense. 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 calculation.

The specific reserves are determined utilizing standards required under ASC Topic 310. A loan is considered impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. Non-accrual loans and loans restructured under a troubled debt restructuring 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 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.

	For the years ended December 31,
(In thousands)	2011		2010		2009		2008		2007
Total Loans	$	414,243	$	496,854	$	686,864	$	700,722	$	644,475
Daily average loan balance	$	475,047	$	643,450	$	715,521	$	676,761	$	636,612
Allowance for loan and lease losses:
Balance at the beginning of the year	$	21,129	$	30,331	$	28,908	$	19,282	$	11,455
Charge-offs by loan type:
Real Estate – non-residential		1,685		7,352		7,404		1,330		294
Real Estate – non-residential-mezzanine		-		-		1,132		1,675		-
Construction and land development		5,755		13,413		6,231		3,852		2,408
Construction and land develop-mezzanine		-		-		2,756		1,540		1,579
Commercial and industrial		2,901		5,930		258		1,009		704
Real Estate – multi-family		328		787		-		-		-
Real Estate – residential		635		731		1,361		37		195
Real Estate - residential-mezzanine		-		2,480		-		2,220		-
Leases		868		972		676		642		286
Tax certificates		1,039		49		-		22		-
Total charge-offs		13,211		31,714		19,818		12,327		5,466
Recoveries by loan type:
Real Estate – non-residential		357		684		431		-		4
Construction and land development		196		116		-		-		34
Commercial and industrial		22		81		15		106		201
Real Estate – multi-family		-

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)

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)

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	%

Closing Prices
2011	High		Low
First Quarter	$	1.92	$	1.52
Second Quarter		1.84		1.28
Third Quarter		1.45		0.95
Fourth Quarter		1.54		0.82

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

Title of Class	Number of record holders
Class A Common stock		269
Class B Common stock		135

			Period Ending
Index	12/31/06		12/31/07		12/31/08		12/31/09		12/31/10		12/31/11
Royal Bancshares of Pennsylvania, Inc.		100.00		44.21		13.75		5.37		5.78		5.16
NASDAQ Composite		100.00		110.66		66.42		96.54		114.06		113.16
SNL Bank and Thrift		100.00		76.26		43.85		43.27		48.30		37.56
RBPAA Peer Group Index*		100.00		78.20		59.81		52.70		59.80		58.91