10-K 1 rbpa-20161231x10k.htm 10-K rbpaa_Current_Folio_10K

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC  20549

FORM 10-K

 

 

[X]

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

 

For the fiscal year ended:          December 31, 2016         

 

 

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

 

For the transition period from:           to          

Commission file number:  0-26366

ROYAL BANCSHARES OF PENNSYLVANIA, INC.

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

 

 

 

PENNSYLVANIA

 

23-2812193

(State or other jurisdiction of incorporation or organization)

 

(IRS  Employer identification No.)

One Bala Plaza, Suite 522, 231 St. Asaph’s Road, Bala Cynwyd, PA 19004

(Address of principal Executive Offices)

Registrant’s telephone number, including area code: (610)  668-4700

Securities registered pursuant to Section 12(b) of the Act:

 

 

Name of Each Exchange on Which Registered

Title of Each Class

The NASDAQ Stock Market, LLC

Class A Common Stock ($2.00 par value)

Securities registered pursuant to Section 12(g) of the Act:

 

 

Name of Each Exchange on Which Registered

Title of Each Class 

None

Class B Common Stock ($0.10 par value)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. [ ] Yes [X] No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act.
[ ] Yes [X] No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 of 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes [ X ]   No [  ]

Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding twelve months (or for such shorter period that the registrant was required to submit and post such files).  Yes [ X ]    No [   ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   Yes [  ]  No [ X ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ___     Accelerated filer ___    Non-accelerated filer ____     Small reporting company __X__

Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act) Yes [  ]   No [ X ]

The aggregate market value of the Registrant’s Common Stock held by non-affiliates is $43,485,825 based on the June 30, 2016 closing price of the Registrant’s Common Stock of $2.26 per share.

As of February 28, 2017, the Registrant had 27,913,024 and 1,924,629 shares outstanding of Class A and Class B common stock, respectively.

Documents Incorporated by Reference:

None.

 

 

 

 


 

 

Table of Contents

 

 

 

Page

FORWARD LOOKING STATEMENTS 

 

PART I

 

ITEM 1.  BUSINESS 

ITEM 1A.  RISK FACTORS 

14 

ITEM 1B.  UNRESOLVED STAFF COMMENTS 

20 

ITEM 2.  PROPERTIES 

20 

ITEM 3.  LEGAL PROCEEDINGS 

21 

ITEM 4.  MINE SAFETY DISCLOSURES 

21 

 

PART II

 

ITEM 5.   MARKET FOR REGISTRANT’S COMMON EQUITY, AND RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES 

21 

ITEM 6.  SELECTED FINANCIAL DATA 

24 

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 

25 

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK 

49 

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 

52 

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 

112 

ITEM 9A.  CONTROLS AND PROCEDURES 

112 

ITEM 9B.   OTHER INFORMATION 

112 

 

PART III.

 

ITEM 10.  DIRECTORS,  EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE 

113 

ITEM 11.  EXECUTIVE COMPENSATION 

116 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERS MATTERS 

124 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE 

126 

ITEM 14.  PRINCIPAL ACCOUNTING FEES AND SERVICES 

127 

 

PART IV

 

ITEM 15.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K 

128 

SIGNATURES 

131 

 

 

 

 

 

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FORWARD LOOKING STATEMENTS

From time to time, Royal Bancshares of Pennsylvania, Inc. (the “Company”, “We”, or “Our”) 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”, “could”, “may”, “plan”, or similar expressions, we are making forward-looking statements.

In order to comply with the terms of the safe harbor, we note that a variety of factors could cause our actual results and experience to differ materially from the anticipated results or other expectations expressed in our forward-looking statements. The risks and uncertainties that may affect the operations, performance, development and results of our 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; 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.

All forward-looking statements contained in this report are based on information available as of the date of this report.  These statements speak only as of the date of this report, even if subsequently made available by us on our website, or otherwise.  We expressly disclaim any obligation to update any forward-looking statement to reflect future statements to reflect future events or developments.

PART I

ITEM 1.  BUSINESS

Royal Bancshares of Pennsylvania, Inc.

Royal Bancshares of Pennsylvania, Inc. (the “Company”, “We”, or “Our”), is a Pennsylvania business corporation and a bank holding company registered under the Federal Bank Holding Company Act of 1956, as amended (the “BHCA”). We are supervised by the Board of Governors of the Federal Reserve System (“Federal Reserve Board”).  Our legal headquarters are located at One Bala Plaza, Suite 522, 231 St. Asaph’s Road, Bala Cynwyd, Pennsylvania, 19004. 

The principal activities of the Company are supervising Royal Bank America (“Royal Bank”) which engages in general banking business principally in Montgomery, Delaware, Chester, Bucks, Philadelphia and Berks counties in Pennsylvania, central and southern New Jersey, and Delaware.  Royal Bank is subject to supervision, regulation and examination by the Federal Deposit Insurance Corporation (“FDIC”) and by the Pennsylvania Department of Banking and Securities (the “Department”).  We also have a wholly-owned non-bank subsidiary, Royal Investments of Delaware, Inc., which is engaged in investment activities. 

At December 31, 2016, we had consolidated total assets of approximately $832.5 million, total deposits of approximately $629.5 million and shareholders’ equity of approximately $51.6 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”).  We have two reportable operating segments, “Community Banking” and “Tax Liens”.

On  January 30, 2017, the Company and Bryn Mawr Bank Corporation (“Bryn Mawr”) entered into an Agreement and Plan of Merger (the “Merger Agreement”).  The Merger Agreement provides that, upon the terms and subject to the conditions set forth therein, the Company will merge with and into Bryn Mawr, with Bryn Mawr as the surviving corporation (the “Merger”).  Immediately following the Merger, Royal Bank will merge with the Bryn Mawr Trust Company, the wholly owned subsidiary of Bryn Mawr.  Upon completion of the Merger, holders of Class A common stock of the Company will receive 0.1025 shares of Bryn Mawr common stock, par value of $1.00 per share (the “Bryn Mawr common stock”) for each share of Class A common stock they hold, and holders of Class B common stock of the Company will receive 0.1179 shares of Bryn Mawr common stock for each share of Class B common stock they hold.  The Merger, which is subject to a number of closing conditions including receipt of required regulatory approvals and approval by the Company’s shareholders, is expected to be completed in the third quarter of 2017.

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Regulatory Actions

Federal Reserve Memorandum of Understanding (“MOU”)

As previously disclosed, in March 2010, the Company agreed to enter into a written agreement (the “Federal Reserve Agreement”) with the Federal Reserve Bank of Philadelphia (the “Federal Reserve Bank”).  Effective July 17, 2013, the Board of Governors of the Federal Reserve System terminated the enforcement action under the Federal Reserve Agreement, and it was replaced with an informal non-public agreement, a memorandum of understanding (“MOU”), with the Federal Reserve Bank.  The MOU was terminated in writing by the Federal Reserve Bank in February 2017.

Royal Bank America

Royal Bank was incorporated in the Commonwealth of Pennsylvania on July 30, 1963, was chartered by the Department, and commenced operation as a Pennsylvania state-chartered bank on October 22, 1963.  Royal Bank is the successor of the Bank of King of Prussia, the principal ownership of which was acquired by the Tabas family in 1980.  The deposits of Royal Bank are insured by the FDIC.  Royal Bank’s subsidiaries include Royal Real Estate of Pennsylvania, Inc., Royal Investments America, LLC, RBA Property LLC, Narberth Property Acquisition LLC, Rio Marina LLC, and Royal Tax Lien Services, LLC (“RTL”). Royal Bank also has an 80% and 60% ownership interest in Crusader Servicing Corporation (“CSC”) and Royal Bank America Leasing, LP, respectively.

Royal Bank derives its income principally from interest charged on loans and leases, interest earned on investment securities, and fees received in connection with the origination of loans and other services.  Royal Bank’s principal expenses are interest expense on deposits and borrowings and operating expenses.  Operating revenues, deposit growth, investment principal amortization payments, maturities and sales, loan and other real estate owned (“OREO”) sales and the repayment of outstanding loans provide the majority of funds for activities.

Royal Bank conducts business operations as a commercial bank offering traditional consumer and business deposit products and services (excluding trust) and commercial and consumer loans, including home equity and small business loans.  Fee income services such as a suite of cash management products, remote deposit capture, mobile deposits, and payroll and merchant services have been greatly improved or expanded.  Services may be added or deleted from time to time.  Royal Bank’s business and services are not subject to significant seasonal fluctuations.

Service Area:  Royal Bank’s primary service area includes Pennsylvania, primarily Montgomery, Chester, Bucks, Delaware, Berks and Philadelphia counties, and central and southern  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 thirteen retail branches located throughout Montgomery, Philadelphia, Delaware and Berks counties and Camden County, New Jersey.  We lease Royal Bank’s Customer Center, which includes a loan production office, in Bala Cynwyd, Pennsylvania and a loan production office in Princeton, New Jersey.  In February 2017, Royal Bank closed one branch location and intends to sell the building during the first quarter of 2017. 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 16 states and Washington, D.C. via loan originations with service area borrowers and/or participations with other lenders who have broad experience in those respective markets. Royal Bank’s headquarters are located at 732 Montgomery Avenue, Narberth, Pennsylvania 19072.

Competition:  The financial services industry in our service area is extremely competitive.  Competitors within our service area include banks and bank holding companies with greater resources.  Many competitors have substantially higher legal lending limits.  In addition, savings banks, savings and loan associations, credit unions, money market and other mutual funds, brokerage firms, mortgage companies, leasing companies, finance companies and other financial services companies offer products and services similar to those offered by Royal Bank, on competitive terms.

Many bank holding companies have elected to become financial holding companies under the Gramm-Leach-Bliley Act of 1999, and such companies may provide a broader range of products and services with which Royal Bank must compete.  Management believes this statute further narrowed the differences and intensified competition among commercial banks, investment banks, insurance firms and other financial services companies.  We have not elected financial holding company status.

Employees:  Royal Bank employed approximately 117 persons on a full-time equivalent basis as of December 31, 2016.

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Deposits: At December 31, 2016, total deposits of Royal Bank were distributed among demand deposits (16%), money market deposit, savings and NOW accounts (47%) and time deposits (37%).  At year-end 2016, deposits increased $43.0 million to $631.9 million from year-end 2015, or 7.3%, and reflected a change in the composition. Savings accounts grew $31.3 million, or 58.2% from December 31, 2015.  Additionally, certificates of deposits and demand deposits increased $25.7 million and $5.7 million, respectively.  NOW and money market accounts decreased $19.7 million. Included in Royal Bank’s deposits are approximately $2.3 million of intercompany deposits that are eliminated through consolidation.

Lending:  At December 31, 2016, Royal Bank had a total net loan portfolio of $591.6 million, representing 71.4% of total assets.  The loan portfolio is categorized into commercial demand, commercial mortgages, residential mortgages (including home equity lines of credit), construction, tax lien certificates, small business leases and installment loans.  At year-end 2016, net loans grew $102.2 million from year end 2015. 

Non-Bank Subsidiaries

On June 30, 1995, we 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, 2016, total assets of RID were $5.5 million, of which $4.8 million was held in cash and cash equivalents and $1.1 million was held in investment securities.  RID had net interest income of $587 thousand and $666 thousand for 2016 and 2015, respectively.  Non-interest income for 2016 and 2015 was $516 thousand and $316 thousand, respectively, and was comprised of net gains on sale of investment securities.  RID recorded net income of $1.0 million for 2016 compared to $781 thousand for 2015.  Royal Bank has previously extended loans to RID, secured by securities, as per the provisions of Regulation W.  At December 31, 2016, no loans were outstanding.  The amounts above include the activity related to RID’s wholly-owned subsidiary Royal Preferred LLC.

The Company, through its wholly-owned subsidiary Royal Bank, has an 80% ownership interest in CSC.  CSC acquired, through auction, delinquent property tax certificates 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 state law.  Royal Bank and a majority of  other CSC shareholders, voted to liquidate CSC under an orderly, long term plan adopted by CSC management.  CSC’s legal headquarters is located at 732 Montgomery Avenue, Narberth, Pennsylvania 19072. At December 31, 2016 and 2015, total assets of CSC were $1.4 million and $4.7 million, respectively. Included in total assets was OREO of $225 thousand and $3.2 million at December 31, 2016 and 2015, respectively.  For 2016, CSC recorded net interest expense of $213 thousand compared to $297 thousand for 2015 due to the continued liquidation of CSC’s tax lien certificate portfolio.  The 2016 credit for lien losses was $49 thousand compared to $2 thousand for 2015.  For 2016 and 2015, non-interest income was $0 thousand and $62 thousand, respectively.  Non-interest expense was a credit of $566 thousand compared to an expense of $125 thousand for 2016 and 2015, respectively.  Included in non-interest expense is net gains on the sale of OREO of $645 thousand and $101 thousand for 2016 and 2015, respectively. During 2016, CSC sold its largest tax lien property and received net proceeds of $3.8 million.  CSC recorded net income of $402 thousand in 2016 compared to a net loss of $357 thousand in 2015. 

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, 2016 and 2015, total assets of RIA were $6.5 million and $6.1 million, which included $6.3 million and $5.8 million in cash, respectively. For 2016, RIA recorded net income of $483 thousand compared to $170 thousand for 2015.  Net income was directly impacted by gains on the sale of investment securities of $447 thousand and $182 thousand in 2016 and 2015, respectively.

On October 27, 2004, we formed two Delaware trust affiliates, Royal Bancshares Capital Trust I and Royal Bancshares Capital Trust II, in connection with the sale of an aggregate of $25.0 million of trust preferred securities.

On July 25, 2005, the Company, through its wholly-owned subsidiary Royal Bank, formed Royal Bank America Leasing, LP (“Royal Leasing”). Royal Bank holds a 60% ownership interest in Royal Leasing. Royal Leasing’s legal headquarters is located at 550 Township Line Road, Blue Bell, Pennsylvania 19422.  Royal Leasing was formed to originate small business financing leases.  Royal Leasing originates the leases through its internal sales staff and through independent brokers located throughout its business area. In general, Royal Leasing will hold in its portfolio individual leases in amounts of up to $250 thousand. Leases originated in amounts in excess of that are sold to other leasing companies.  At December 31, 2016 and 2015, total assets of Royal Leasing were $61.6 million and $65.1 million, respectively.  For 2016 and 2015, Royal Leasing

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had net interest income of $3.3 million and $3.2 million, respectively.  For 2016, the provision for lease losses was $1.4 million compared to $906 thousand for 2015.  The 2016 provision was primarily attributable to specific reserves on the leasing and net charge-off activity.  Total net leases were $61.4 million at December 31, 2016 compared to $65.0 million at December 31, 2015.  Non-interest income for 2016 was $680 thousand compared to $473 thousand for 2015.  Non-interest expense, which includes management distribution fees, was $1.3 million and $1.2 million for 2016 and 2015, respectively. Royal Leasing recorded net income of $1.3 million for the year ended December 31, 2016 compared to $1.5 million for the year ended December 31, 2015.  

On November 17, 2006, the Company, through its wholly-owned subsidiary Royal Bank, formed RTL to purchase and service delinquent tax certificates.  RTL typically acquired delinquent property tax certificates 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 state law. RTL ceased acquiring tax certificates at public auctions in 2010.  RTL’s legal headquarters is located at 732 Montgomery Avenue, Narberth, Pennsylvania 19072.  At December 31, 2016, total assets of RTL, of which the majority was held in tax certificates and OREO, were $7.3 million compared to $9.4 million at December 31, 2015.  Tax certificates were $2.6 million at December 31, 2016 compared to $3.3 million at December 31, 2015.  OREO was $3.1 million at December 31, 2016 compared to $4.0 million at December 31, 2015.  For 2016, RTL had net interest expense of $131 thousand compared to net interest income of $116 thousand for 2015 due to the reduction in average tax certificates outstanding over the past year.  Provision for lien losses was $69 thousand compared to $100 thousand for 2016 and 2015, respectively.  Non-interest income was $59 thousand for 2016 compared to $209 thousand for 2015. Non-interest expense was $1.1 million for 2016 and 2015. RTL recorded a net loss of $1.1 million for 2016 compared to $885 thousand for 2015. 

On June 16, 2006, the Company, through its wholly-owned subsidiary RID, established Royal Preferred LLC as a wholly-owned subsidiary. Royal Preferred LLC was formed to purchase a subordinated debenture from Royal Bank. During 2016, the subordinated debenture was redeemed.  At December 31, 2016 and 2015, Royal Preferred LLC had total assets of approximately $0 and $21.2 million, respectively. 

Website Access to Company Reports

We post publicly available reports required to be filed with the SEC on our website, www.royalbankamerica.com, as soon as reasonably practicable after filing such reports with the SEC.  The required reports are available free of charge through our website.  Information available on our website is not part of or incorporated by reference into this Report or any other report filed by us with the SEC.

Products and Services with Reputation Risk

We offer 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 us or any of our subsidiaries, whether legally justified or not, the resulting negative publicity with respect to any such product or service could have an adverse impact on our 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 an unfavorable impact on our reputation.

Concentrations, Seasonality

We do not have any portion of our business dependent on a single or limited number of customers, the loss of which would have a material adverse effect on our business.  No substantial portion of loans or investments is concentrated within a single industry or group of related industries, but a significant majority of loans are secured by real estate.  The business of the Company and its subsidiaries is not seasonal in nature.

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Environmental Compliance

The Company and its subsidiaries’ compliance with federal, state and local environment protection laws had no material effect on their capital expenditures, earnings or competitive position in 2016, and is not expected to have a material effect on such expenditures, earnings or competitive position in 2017.

Supervision and Regulation

Bank holding companies and banks operate in a highly regulated environment and are regularly examined by federal and state regulatory authorities.  The following discussion concerns various federal and state laws and regulations and the potential impact of such laws and regulation on us and our 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.  We cannot determine the likelihood or timing of any such proposals or legislations or the impact they may have on us and our subsidiaries.  A change in law, regulations or regulatory policy may have a material effect on our business.

Holding Company

We are subject to the jurisdiction of the Securities and Exchange Commission (the “SEC”) and of state securities commissions for matters relating to the offering and sale of our securities.  Accordingly, if we wish to issue additional shares of our Common Stock, in order, for example, to raise capital or to grant stock options, we will have to comply with the registration requirements of the Securities Act of 1933 as amended, or find an applicable exemption from registration.

We are subject to the provisions of the BHCA and to supervision, regulation and examination by the Federal Reserve Board.  The BHCA requires us to secure the prior approval of the Federal Reserve Board before we own or control, directly or indirectly, more than 5% of the voting shares of any corporation, including another bank.  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, we are 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 BHCA. The Federal Reserve Board may also make examinations of the Company and any or all of its subsidiaries.  Further, under the BHCA 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 services from the bank, its bank holding company or any other subsidiary of its bank holding company, or on the condition that the customer not obtain other credit or services from a competitor of the bank, its bank holding company or any subsidiary of its bank holding company.  Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve Act and by state banking laws on any extensions of credit to the bank holding company or any of the holding company’s subsidiaries, on investments in the stock or other securities of the bank holding company and on taking stock or securities of the bank holding company as collateral for loans to any borrower.

Under the Pennsylvania Banking Code of 1965, as amended, the (“Code”), we are permitted to control an unlimited number of banks.  However, we would be required under the BHCA to obtain the prior approval of the Federal Reserve Board before we could acquire all or substantially all of the assets of any bank, or acquire ownership or control of any voting shares of any bank other than Royal Bank, if, after such acquisition, we would own or control more than 5% of the voting shares of such bank.  A bank holding company located in Pennsylvania, another state, the District of Columbia or a territory or possession of the United States may control one or more banks, bank and trust companies, national banks, interstate banks and, with the prior written approval of the Department, may acquire control of a bank and trust company or a national bank located in Pennsylvania.  A Pennsylvania-chartered institution may maintain a bank, branches in any other state, the District of Columbia, or a territory or possession of the United States upon the written approval of the Department.

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Federal law also prohibits the acquisition of control of a bank holding company without prior notice to certain federal bank regulators.  Control is defined for this purpose as the power, directly or indirectly, to direct the management or policies of a bank or bank holding company or to vote 25% or more of any class of voting securities of a bank or bank holding company.

Royal Bank

The Department and the FDIC routinely examine Pennsylvania state-chartered, non-member banks such as Royal Bank in areas such as reserves, loans, investments, management practices, and other aspects of operations. These examinations are designed for the protection of depositors rather than the Company’s shareholders.  The deposits of Royal Bank are insured by the FDIC to the maximum amount permitted by law. 

In addition, Royal Bank is subject to a variety of state and federal laws that affect its operation.  Federal and state banking laws and regulations govern, among other things, the scope of a bank’s business, the investments a bank may make, the reserves against deposits a bank must maintain, the types and terms of loans a bank may make and the collateral it may take, the activities of banks with respect to mergers and consolidations, and the establishment of branches. 

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 rating (“outstanding,” “satisfactory,” “needs to improve” or “substantial noncompliance”) and a statement describing the basis for the rating. 

The Federal Reserve Act and Federal Reserve Board regulations also place certain limitations and reporting requirements on extensions of credit by a bank to principal shareholders of its parent holding company, among others, and to related interests of such principal shareholders. In addition, such legislation and regulations may affect the terms upon which any person who becomes a principal shareholder of a holding company may obtain credit from banks with which the subsidiary bank maintains a correspondent relationship.

From time to time, various types of federal and state legislation have been proposed that could result in additional regulation of, and restrictions on, the business of Royal Bank.  It cannot be predicted whether any such legislation will be adopted or how such legislation would affect the business of Royal Bank. As a consequence of the extensive regulation of commercial banking activities in the United States, Royal Bank’s business is particularly susceptible to being affected by federal legislation and regulations that may increase the costs of doing business.

Under the Bank Secrecy Act (“BSA”), banks and other financial institutions are required to report to the Internal Revenue Service currency transactions of more than $10 thousand or multiple transactions in any one day of which the banks are aware that exceed $10 thousand in the aggregate.  Civil and criminal penalties are provided under the BSA for failure to file a required report, for failure to supply information required by the BSA or for filing a false or fraudulent report.

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Capital Requirements and Basel III:  In order to minimize losses to the deposit insurance funds, the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), established 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. FDICIA established five capital categories for insured depository institutions under the prompt corrective action regulations. 

An “undercapitalized” institution is one that fails to meet one or more of the required minimum capital levels for an adequately capitalized institution.  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, and engaging in new lines of business without the prior approval of its primary federal regulator and other restrictions may be imposed.

A “significantly undercapitalized” institution is subject to similar regulatory requirements and restrictions as an “undercapitalized institution.  Additional regulatory directives include mandated capital raising activities, restrictions on interest rates paid and transactions with affiliates, removal of management and other restrictions.

A “critically undercapitalized” institution 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.

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.  Federal bank regulators may set capital requirements for a particular banking organization that are higher than the minimum ratios when circumstances warrant.

The Basel Committee on Banking Supervision and the Financial Stability Board (“Basel Committee”), 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. In December 2010 and January 2011, the Basel Committee published the final reforms on capital and liquidity generally referred to as “Basel III”. 

In July 2013, the federal bank regulatory agencies adopted final rules with the aim to improve the quality and increase the quantity of capital for all banks as well as set higher standards for large internationally active banks. The agencies view the new capital requirements as a better reflection of banking organizations’ risk profiles, thereby improving the overall resiliency of the banking system. The rules generally implement higher minimum capital requirements, add a new common equity tier 1 capital requirement or “CET1”, and establish criteria that instruments must meet to be considered common equity tier 1 capital, additional tier 1 capital, or tier 2 capital.  Basel III also introduces a non-risk adjusted tier 1 leverage ratio of 3%, based on a measure of total exposure rather than total assets, and new liquidity requirements.  Under the new rules, in order to avoid limitations on capital distributions (including dividend payments and certain discretionary bonus payments to executive officers), a banking organization must hold a capital conservation buffer comprised of CET1 above its minimum risk-based capital requirements in an amount greater than 2.5% of total risk-weighted assets.   The new minimum capital requirements became effective on January 1, 2015.  The capital conservation buffer requirements phase in over a three-year period beginning January 1, 2016. 

9


 

The following table shows the required capital ratios with the conservation buffer over the phase-in period. 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basel III Community Banks

 

 

 

Minimum Capital Ratio Requirements

 

 

    

2015

    

2016

    

2017

    

2018

    

2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common equity tier 1 capital (CET1)

 

4.500

%

 

5.125

%

 

5.750

%

 

6.375

%

 

7.000

%

Tier I capital (to risk-weighted assets)

 

6.000

%

 

6.625

%

 

7.250

%

 

7.875

%

 

8.500

%

Total capital (to risk-weighted assets)

 

8.000

%

 

8.625

%

 

9.250

%

 

9.876

%

 

10.500

%

Tier I capital (to average assets, leverage)

 

4.000

%

 

4.000

%

 

4.000

%

 

4.000

%

 

6.500

%

 

 

Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010: On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) was enacted into law.  The Dodd-Frank Act significantly changed the regulation of financial institutions and the financial services industry and includes provisions that, among other things:

·

create the Financial Services Oversight Council to identify emerging systemic risks and improve interagency cooperation;

·

centralize 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 raise the current standard maximum deposit insurance amount to $250 thousand;

·

establish 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);

·

amend the Truth in Lending Act with respect to mortgage originations and establishing new minimum mortgage underwriting standards;

·

strengthen the SEC’s powers to regulate securities markets;

·

grant the Federal Reserve Board the power to regulate debit card interchange fees;

·

allow the FDIC to raise the ratio of reserves to deposits from 1.15% to 1.35% for deposit insurance purposes by December 31, 2020 and to offset the effect of increased assessments on insured depository institutions with assets of less than $10 billion;

·

allow financial institutions to pay interest on business checking accounts; and

·

implement provisions that affect corporate governance and executive compensation at all publicly traded companies.

Additionally the Dodd-Frank Act amended the BHCA to require the federal financial regulatory agencies to adopt rules that prohibit banks and their affiliates from engaging in proprietary trading in designated types of financial instruments and investing in covered funds. This statutory provision, commonly known as the “Volcker Rule,” defines covered funds as hedge funds or private equity funds.  The Volcker rule places a number of limitations on a community bank were it to retain an ownership interest in a covered fund that it organized and offered. In particular, the community bank (including all its affiliates) must limit its total interest in each covered fund to no more than 3% of the ownership interests issued by the covered fund, and to no more than 3% of the value of the entire covered fund. In addition, the aggregate of all interests the community bank (together with its affiliates) has in all covered funds may not exceed 3 percent of the community bank’s tier 1 capital.  At December 31, 2016, the Company had $1.8 million invested in private equity funds, of which $203 thousand is invested by Royal Bank.  The Volker Rule did not have a material impact on the operations of the Company and/or Royal Bank.

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 the Company’s and Royal Bank’s 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, 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.

FDIC Insurance Assessments:  Royal Bank is a member of the FDIC.  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

10


 

supervisory evaluations, including examination reports, statistical analyses and other information relevant to measuring the risk posed by the institution.  Each depositor is insured to at least $250 thousand.

The assessment base used to calculate insurance premiums is a bank’s average assets minus average tangible equity.  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 insured deposits by September 2020.  In attempting to achieve the mandated 1.35% ratio, the FDIC implemented assessment formulas that charge banks over $10 billion in asset size more than banks under that size.  Those new formulas do not affect Royal Bank.  Under the Dodd-Frank Act, the FDIC is authorized to make reimbursements from the insurance fund to banks if the reserve ratio exceeds 1.50%, but the FDIC has adopted the “designated reserve ratio” of 2.0%.  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 fourth quarter of 2016, the Financing Corporation’s assessment for Royal Bank (and all other banks), is an annual rate of $.0056 for each $100 of deposits.  The Financing Corporation bonds are expected to be paid off between 2018 and 2019.

Sarbanes-Oxley Act of 2002: The primary aims of the Sarbanes-Oxley Act of 2002 (“SOX”) was to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. SOX addresses, among other matters, requirements for audit committee membership and responsibilities, requirements of management to evaluate our 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.

USA Patriot Act of 2001: A major focus of governmental policy in recent years that impacts financial institutions has been combating money laundering and terrorist financing. The Patriot Act broadened anti-money laundering regulations to apply to additional types of financial institutions and strengthened the ability of the U. S. Government to help prevent and prosecute international money laundering and the financing of terrorism.  The potential impact of the Patriot Act on financial institutions of all kinds is significant and wide ranging.  The Patriot Act requires regulated financial institutions, among other things, to establish an anti-money laundering program that includes training and auditing components, to take additional precautions with non-U.S. owned accounts, and to comply with regulations related to verifying client identification at account opening. The Patriot Act also provides rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering. Failure of a financial institution to comply with the requirements of the Patriot Act could have serious legal and reputational consequences for the institution. We have 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.

Gramm-Leach-Bliley Act of 1999: The Gramm-Leach-Bliley Act of 1999 (“GLBA”), also known as the Financial Services Modernization Act, repeals the two anti-affiliation provisions of the Glass-Steagall Act.  GLBA establishes a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers.  It revises and expands the framework of the Holding Company Act to permit a holding company to engage in a full range of financial activities through a new entity known as a financial holding company.  “Financial activities” is broadly defined to include not only banking, insurance and securities activities, but also merchant banking and additional activities that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to such financial activities, or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally.

In addition, GLBA provides a uniform framework for the functional regulation of the activities of banks, savings institutions and their holding companies; broadens the activities that may be conducted by national banks, banking subsidiaries of bank holding companies, and their financial subsidiaries; and adopts a number of provisions related to the capitalization, membership, corporate governance, and other measures designed to modernize the Federal Home Loan Bank system.

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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.  In 2015, GLBA was amended to eliminate the annual notification of written privacy policies by financial institutions, such as Royal Bank, that limit information sharing and post their privacy policies on their website.

GLBA also expressly preserves the ability of a state bank to retain all existing subsidiaries.  Because Pennsylvania permits commercial banks chartered by the state to engage in any activity permissible for national banks, Royal Bank will be permitted to form subsidiaries to engage in the activities authorized by GLBA to the same extent as a national bank.  In order to form a financial subsidiary, Royal Bank must be well-capitalized, and would be subject to the same capital deduction, risk management and affiliate transaction rules as applicable to national banks.

To the extent that GLBA permits banks, securities firms, and insurance companies to affiliate, the financial services industry may experience further consolidation.  GLBA is intended to grant to community banks certain powers as a matter of right that larger institutions have accumulated on an ad hoc basis.  Nevertheless, this act may have the result of increasing the amount of competition that the Company and Royal Bank face from larger institutions and other types of companies offering financial products, many of which may have substantially more financial resources than the Company and Royal Bank.

Regulation W: Transactions between a bank and its “affiliates” are quantitatively and qualitatively restricted under 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 also 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.  We are considered to be an affiliate of Royal Bank.  In general, subject to certain specified exemptions, a bank or its subsidiaries are limited in their ability to engage in “covered transactions” with affiliates:

·

To an amount equal to 10% of Royal Bank’s capital and surplus, in the case of covered transactions with any one affiliate; and

·

To an amount equal to 20% of Royal Bank’s capital and surplus, in the case of covered transactions with all affiliates.

In addition, a bank and its subsidiaries may engage in covered transactions and other specified transactions only on terms and under circumstances that are substantially the same, or at least as favorable to the bank or its subsidiary, as those prevailing at the time for comparable transactions with nonaffiliated companies.  A “covered transaction” includes:

·

A loan or extension of credit to an affiliate;

·

A purchase of, or an investment in, securities issued by an affiliate;

·

A purchase of assets from an affiliate, with some exceptions;

·

The acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any party; and

·

This issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate.

In addition, under Regulation W:

·

A bank and its subsidiaries may not purchase a low-quality asset from an affiliate;

·

Covered transactions and other specified transactions between a bank or its subsidiaries and an affiliate must be on terms and conditions that are consistent with safe and sound banking practices; and

·

With some exceptions, each loan or extension of credit by a bank to an affiliate must be secured by collateral with a market value ranging from 100% to 130%, depending on the type of collateral, of the amount of the loan or extension of credit.

12


 

Regulation W generally excludes all non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve Board decides to treat these subsidiaries as affiliates.

Concurrently with the adoption of Regulation W, the Federal Reserve Board has proposed a regulation which would further limit the amount of loans that could be purchased by a bank from an affiliate to not more than 100% of Royal Bank’s capital and surplus.

Truth in Savings Act: The Truth in Savings Act (“Act”) was implemented in 1993.  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.

Real Estate Lending Guidelines: Pursuant to the FDICIA, the FDIC issued real estate lending guidelines that establish loan-to-value (“LTV”) ratios for different types of real estate loans.  An LTV ratio is generally defined as the total loan amount divided by the appraised value of the property at the time the loan is originated.  If a bank does not hold a first lien position, the total loan amount would be combined with the amount of all senior liens when calculating the ratio.  In addition to establishing the LTV ratios, the FDIC’s real estate guidelines require all real estate loans to be based upon proper loan documentation and a recent independent appraisal of the property.

The FDIC’s guidelines establish the following limits for LTV ratios:

 

 

 

 

 

Loan Category

    

LTV limit

    

 

 

 

 

Raw land

 

65

%

Land development

 

65

%

Construction:

 

 

 

Commercial, multifamily (includes condos and co-ops) and other nonresidential

 

80

%

Improved property

 

85

%

Owner occupied 1-4 family and home equity (without credit enhancements)

 

90

%

 

The guidelines provide exceptions to the LTV ratios for government-backed loans; loans facilitating the sale of real estate acquired by the lending institution in the normal course of business; loans where Royal Bank’s decision to lend is not based on the offer of real estate as collateral and such collateral is taken only out of an abundance of caution; and loans renewed, refinanced, or restructured by the original lender to the same borrower, without the advancement of new money.  The regulation also allows institutions to make a limited amount of real estate loans that do not conform to the proposed LTV ratios.  Under this exception, Royal Bank would be allowed to make real estate loans that do not conform to the LTV ratio limits, up to an amount not to exceed 100% of its total capital.

Other Legislation/Regulatory Requirements: Congress and the federal banking agencies routinely propose new regulations.  The Company cannot predict how any new legislation, or new rules adopted by the federal banking agencies, may affect its business or the business of Royal Bank in the future.

Monetary Policy

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

The policies and regulations of the Federal Reserve Board have had and will probably continue to have a significant effect on its reserve requirements, deposits, loans and investment growth, as well as the rate of interest earned and paid, and are

13


 

expected to affect Royal Bank’s operations in the future.  The effect of such policies and regulations upon the future business and earnings of Royal Bank cannot be predicted.

Effects of Inflation

Inflation can impact the country’s overall economy, which in turn can impact the business and revenues of the Company and our subsidiaries.  Inflation has some impact on our operating costs.  Unlike many industrial companies, however, substantially all of our assets and liabilities are monetary in nature.  As a result, interest rates have a more significant impact on our performance than the general level of inflation.  Over short periods of time, interest rates may not necessarily move in the same direction or in the same magnitude as prices of goods and services.

Available Information

Upon a shareholder’s written request, a copy of the Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, as required to be filed with the SEC pursuant to Exchange Act Rule 13a-1, may be obtained without charge from our Chief Financial Officer, Royal Bancshares of Pennsylvania, Inc. One Bala Plaza, Suite 522, 231 St. Asaph’s Road, Bala Cynwyd, Pennsylvania 19004 or on our website www.royalbankamerica.com.

ITEM 1A. RISK FACTORS

An investment in our common stock involves risks. Before making an investment decision, investors should carefully consider the risks described below in conjunction with the other information in this Report, including our consolidated financial statements and related notes. If any of the following risks or other risks, which have not been identified or which we may believe are immaterial or unlikely, actually occurs, our business, financial condition and results of operations could be harmed. In such a case, the trading price of our common stock could decline, and investors may lose all or part of their investment.

Risks Related to Our Business

Our business is subject to the success of the local economies and real estate markets in which we operate.

Our earnings are significantly generated from net interest income which is heavily reliant on the interest and fees we earn on loans.  If prevailing economic conditions locally or nationally are unfavorable, our business may be adversely affected.  Unfavorable economic conditions in our targeted market areas, specifically depressed or declining real estate values could affect the ability of customers to repay their loans, impede our growth, and generally affect our financial condition and results of operations through potential increases in credit losses.  We are less able than a larger institution to spread the risks of unfavorable local economic conditions across broader and more diverse economies.

Our concentration of commercial real estate and construction loans is subject to unique risks that could adversely affect our earnings.

Our commercial real estate, including multi-family, and construction and land development loan portfolios were $368.3 million at December 31, 2016 comprising 61% of total loans.  Commercial 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.  Commercial and industrial loans comprise 18% of the loan portfolio. 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.

14


 

Our allowance for loan and lease losses may not be adequate to cover actual losses.

Like all financial institutions, we maintain an allowance for loan and lease losses (“allowance”) to provide for loan and lease defaults and non-performance.  Our allowance 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 may not be adequate to cover actual loan and lease losses.  Bank regulators periodically review our allowance and may require us to increase the allowance or recognize additional charge-offs.  Material increases to the allowance for loan and lease losses could materially decrease out net income.

The Financial Accounting Standards Board has adopted Accounting Standards Update No. 2016-13, “Financial Instruments-Credit Losses (Topic 326) Measurement of Credit Losses on Financial Instruments”, which is commonly referred to as CECL.  CECL will be effective in the first quarter of 2020. The CECL guidelines require us to gather and review additional data and types of data to determine the appropriate level for the allowance.New or changes to accounting or regulatory guidance could impact the need for additional reserves and future provisions for loan and lease losses could materially and adversely affect our financial results. We believe that expected credit losses under the CECL model will generally result in earlier loss recognition on our loans and lease portfolio. We are currently evaluating the impact of the amendments in this new standard on our consolidated financial statements.

Our future growth may require us to raise additional capital but, that capital may not always be available.

We are required by regulatory authorities to maintain adequate capital levels to support our operations. We anticipate that our current capital will satisfy our regulatory requirements for the foreseeable future. However, in order to maintain our well-capitalized status and to support future growth we may need to raise capital. Our ability to raise additional capital will depend, in part, on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Basel III introduced new minimum capital requirements that became effective on January 1, 2015, with the capital conservation buffer requirements phased in over a three-year period beginning January 1, 2016.  In addition, if we decide to raise additional capital, the existing shareholders are subject to dilution and a potential capital raise could adversely impact our deferred tax asset. If we cannot raise additional capital when required, our ability to further expand operations through both internal growth and acquisitions could be materially impaired.

We may suffer losses in our loan portfolio despite our underwriting practices.

We seek to mitigate the risks inherent in our loan portfolio by adhering to specific underwriting practices.  These practices often include: analysis of a borrower’s credit history, financial statements, tax returns and cash flow projections; valuation of collateral based on reports of independent appraisers; and verification of liquid assets.  Although we believe that our underwriting criteria are appropriate for the various kinds of loans we make, we may incur losses on loans that meet these criteria.

Our ability to pay dividends depends primarily on dividends from our banking subsidiary, which are subject to regulatory limits. 

We are a bank holding company and our operations are conducted by our direct and indirect subsidiaries, each of which is a separate and distinct legal entity.  Substantially all of our assets are held by such subsidiaries; and our ability to pay dividends depends on our receipt of dividends from our direct and indirect subsidiaries.  Royal Bank is our primary source of dividends.  Dividend payments from Royal Bank 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, 2016, as a result of significant losses within Royal Bank from prior years, we had an accumulated deficit 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.  Failure to pay dividends on our stock could have a material adverse effect on the market price of our Class A Common Stock. 

Our ability to use net operating loss carryforwards to reduce future tax payments may be limited.

 

As of December 31, 2016, we had federal net operating loss (“NOL”) carryforwards of approximately $57.7 million and state NOL carryforwards of $136.8 million, which are available to be carried forward to future tax years.  The federal NOL carryforwards will begin to expire in 2028 and the state NOLs will begin to expire in 2026 if not fully utilized.

15


 

The ability to use NOLs will be dependent on our ability to generate taxable income. The NOLs may expire before we generate sufficient taxable income. There was a $4.0 million NOL carryover from the acquisition of Knoblauch State Bank that expired in 2015.  There were no NOLs that expired in 2016.  Refer to “Accounting for Income Tax Expense” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Report.

 

We may not be able to fully recover our deferred tax asset valuation allowance and a reduction in future enacted tax rates could have a material impact on the value of our deferred tax assets.

We recognize deferred tax assets (“DTA”) and liabilities based on differences between the financial statement carrying amounts and the tax bases of assets and liabilities. We are required to establish a valuation allowance for DTA and record a charge to income or shareholders' equity if management determines, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized.  Management evaluates the DTA for recoverability using a consistent approach which considers the relative impact of negative and positive evidence, including historical profitability and projections of future reversals of temporary differences and future taxable income. These determinations are inherently subjective and dependent upon estimates and judgments concerning management’s evaluation of both positive and negative evidence.

Based on the analysis of the DTA at December 31, 2016, management concluded that it is more likely than not that a portion of the net DTA will be realized by the Company in the future.    As a result of this conclusion, we released $1.9 million of our valuation allowance previously recorded on the net DTA and credited income tax expense. In 2015, we released $5.4 million of our valuation allowance previously recorded on the net DTA. The ability to recognize the remaining deferred tax assets that continue to be subject to a valuation allowance will be evaluated on a quarterly basis to determine if there are any significant events that would affect the ability to utilize these deferred tax assets. The release of the remaining valuation allowance would have a positive impact on future earnings. There can be no assurance, however, as to when we could be in a position to recapture the remaining DTA valuation allowance. The deferred tax assets, net of valuation allowances, totaled $7.9 million and $5.7 million at December 31, 2016 and 2015, respectively.  The deferred tax asset valuation allowance was $26.6 million and $30.6 million at December 31, 2016 and 2015, respectively. Refer to “Accounting for Income Tax Expense” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Report.

Our net DTA are measured using the tax rates under the current enacted tax law expected to apply to taxable income in future years. The effects of future changes in tax laws or rates are not anticipated in the determination of the value of our deferred tax assets and liabilities. The U.S. Congress and the current administration have indicated an interest in, among other changes to federal tax laws, lowering the federal corporate tax rate from the current 35%. If these plans ultimately result in the enactment of new laws lowering the corporate income tax rate and/or eliminating the corporate alternative minimum tax, our net DTA would need to be re-calculated. It is difficult to predict whether any change to the federal corporate tax rate will occur, or if any change to the federal corporate tax rate did occur, the magnitude or timing of any change.

Although any reduction in the corporate tax rate would reduce the amount of taxes we would pay in the future, the reduction also would result in a decrease in the value of our DTA, and thus a reduction in our net income and total equity, during the period in which any such tax rate change is enacted. This reduction in our net income and total equity could materially and adversely affect our results of operations and financial condition. There is no assurance that any potential tax savings from a reduction in corporate tax rates, if enacted, would be realized to the extent anticipated or at all.

Competition from other financial institutions may adversely affect our profitability.

We face substantial competition in originating commercial and consumer loans. 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,

16


 

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.

Our 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 our 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.

Our ability to manage liquidity is always critical in our operation, but more so today given the uncertainty within the capital markets.

We monitor and manage our liquidity position on a regular basis to insure that adequate funds are in place to manage the day to day operations and to cover routine fluctuations in available funds. However, our funding decisions can be influenced by unplanned events. These unplanned events include, but are not limited to, the inability to fund asset growth, difficulty renewing or replacing funds that mature, the ability to maintain or draw down lines of credit with other financial institutions, significant customer withdrawals of deposits, and market disruptions. 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.  Additionally, loans may need to be sold in the secondary market, investments may need to be sold or deposits may need to be raised at above market interest rates to maintain liquidity.

Negative publicity could damage our reputation and adversely impact our business and financial results.

Reputation risk, or the risk to our earnings and capital from negative publicity, is inherent in our business.  Negative publicity can result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance, acquisitions, cyber-attacks, breach in security, 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 us to litigation and regulatory action.  Although we take steps to minimize reputation risk in dealing with customers and other constituencies, as a larger diversified financial services company with a high industry profile, we are inherently exposed to this risk. 

Risks Related to Our Industry

Difficult real estate market conditions and economic trends can adversely affect our industry and our business.

We have exposure to downturns in both the commercial and residential real estate markets.  Dramatic declines in the housing market can lead to decreasing home prices and increasing delinquencies and foreclosures.  This negative market condition can adversely impact the credit performance of mortgage, consumer, commercial and construction loan portfolios, resulting in significant impairments of assets held by many financial institutions.  General downward economic trends, reduced availability of commercial credit and sustained unemployment may negatively impact the credit performance of commercial and consumer credit, resulting in write-downs of real estate collateral supporting many loans.  Concerns over the stability of the financial markets and the economy may result in decreased lending by financial institutions to their customers and to each other.  This type of market turmoil and tightening of credit can lead to increased commercial and consumer deficiencies, lack of customer confidence, increased market volatility and widespread reduction in general business activity. Financial institutions can also experience decreased access to borrowings.

A decline in current economic conditions would likely put pressure on consumers and businesses and may adversely affect our business, financial condition, results of operations and stock price.  In particular, as the result of a deteriorating economy we may face the following risks:

·

We could face increased regulation of our industry.  Compliance with such regulation may increase our costs and limit our ability to pursue business opportunities.

17


 

·

Our ability to assess the creditworthiness of customers and to accurately estimate the losses inherent in our credit portfolio could be more complex.

·

We may be required to pay higher Federal Deposit Insurance Corporation premiums because financial institution failures resulting from the depressed market conditions have depleted and may continue to deplete the deposit insurance fund and reduce its ratio of reserves to insured deposits.

·

Our ability to borrow from other financial institutions or the Federal Home Loan Bank on favorable terms or at all could be adversely affected by disruptions in the capital markets or other events.

·

We may experience increases in foreclosures, delinquencies and customer bankruptcies.

·

We may experience difficulty in liquidating our OREO portfolio at favorable prices.

Our business is subject to interest rate risk, and variations in interest rates may negatively affect our financial performance.

Changes in the interest rate environment may reduce profits. The primary source of our income is the differential or “spread” between the interest earned on loans, securities and other interest-earning assets, and interest paid on deposits, borrowings and other interest-bearing liabilities.  As prevailing interest rates change, net interest spreads are affected by the difference between the maturities and re-pricing characteristics of interest-earning assets and interest-bearing liabilities.  In addition, loan volume and yields are affected by market interest rates on loans, and rising interest rates generally are associated with a lower volume of loan originations.  An increase in the general level of interest rates may also adversely affect the ability of certain borrowers to pay the interest on and principal of their obligations.  Accordingly, changes in levels of market interest rates could materially adversely affect our net interest spread, asset quality, loan origination volume, pre-payment speeds and overall profitability.

Recent and future governmental regulation and legislation could limit our future growth and adversely impact our results of operations.

As described under “Supervision and Regulation” we are subject to extensive state and federal regulation, supervision and legislation that govern almost all aspects of our operations.  These laws may change from time to time and are primarily intended for the protection of consumers, depositors, and the deposit insurance fund.  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 our business, these changes could be materially adverse to shareholders. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on our operations.

Changes in consumers’ use of banks and changes in consumers’ spending and saving habits could adversely affect the Company’s financial results.

Technology and other changes now allow many consumers to complete financial transactions without using banks. For example, consumers can pay bills and transfer funds directly without going through a bank. This disintermediation could result in the loss of fee income, as well as the loss of customer deposits and income generated from those deposits.  In addition, changes in consumer spending and saving habits could adversely affect our operations, and 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.

18


 

Our information systems may experience an interruption or breach in security.

We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer-relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or  limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur; or, if they do occur, that they will be adequately addressed.  The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny or expose us to civil litigation and possible financial liability; any of which could have a material adverse effect on our financial condition and results of operations.

We face the risk of cyber-attack to our computer systems.

Our computer systems, software and networks have been and will continue to be vulnerable to unauthorized access, loss, or destruction of data (including confidential client information), account takeovers, unavailability of service, computer viruses or other malicious code, cyber-attacks and other events. These threats may derive from human error, fraud, or malice on the part of employees or third parties, or may result from accidental technological failure. If one or more of these events occurs, it could result in the disclosure of confidential client information,  damage to our reputation with our clients and the market, additional costs to us (such as repairing systems or adding new personnel or protection technologies), regulatory penalties and financial losses, to both us and our clients and customers. Such events could also cause interruptions or malfunctions in our operations (such as the lack of availability of our online banking system), as well as the operations of our clients, customers or other third parties. Although we maintain safeguards to protect against these risks, there can be no assurance that we will not suffer losses in the future that may be material in amount.

Acts or threats of terrorism and political or military actions taken by the United States or other governments could adversely affect general economic or industry conditions.

Geopolitical conditions may also affect our earnings.  Acts or threats or terrorism and political or military actions taken by the United States or other governments in response to terrorism, or similar activity, could adversely affect general economic or industry conditions.

Other Risks

Our directors, executive officers and principal shareholders own a significant portion of our common stock and can influence shareholder decisions.

Our directors, executive officers and principal shareholders, as a group, beneficially owned approximately 32% of our Class A common stock and 87% of our Class B common stock outstanding as of February 28, 2017. 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.

Risks Relating to Our Pending Merger

 

The Company will be subject to business uncertainties and contractual restrictions while the merger is pending.

 

On January 30, 2017, the Company and Bryn Mawr Bank Corporation (“Bryn Mawr”) entered into a merger agreement that provides that the Company will merge with and into Bryn Mawr, with Bryn Mawr remaining as the surviving entity (the “Merger”).  Immediately following the Merger, Royal Bank America, the wholly owned banking subsidiary of the Company, will merge with The Bryn Mawr Trust Company, the wholly owned banking subsidiary of Bryn Mawr.  The merger agreement restricts the Company from taking certain actions until the merger occurs without the consent of Bryn Mawr. These restrictions may prevent the Company from pursuing attractive business opportunities that may arise prior to the completion of the Merger. See the Current Report on Form 8-K filed with the SEC by the Company on February 2, 2017 for a description of the restrictive covenants to which the Company is subject.

 

19


 

Termination of the merger agreement could negatively affect the Company.

 

If the merger agreement is terminated, there may be various consequences, including the fact that the Company’s businesses may have been adversely impacted by the failure to pursue other beneficial opportunities due to the focus of management on the merger, without realizing any of the anticipated benefits of completing the Merger. If the merger agreement is terminated and the Company’s board of directors seeks another merger or business combination, the Company shareholders cannot be certain that the Company will be able to find a party willing to offer equivalent or more attractive consideration than the consideration Bryn Mawr has agreed to provide in the Merger. If the merger agreement is terminated and a different business combination is pursued, the Company may be required to pay a termination fee of $5.0 million to Bryn Mawr under certain circumstances.  If Bryn Mawr terminates the merger agreement under certain circumstances, the Company may be required to pay liquidated damages in the sum of $1.8 million. 

 

Failure to complete the Merger could negatively impact the stock price and the future business and financial results of the Company.

 

If the Merger is not completed for any reason, the Company will be subject to a number of material risks, including the following:

 

·

the market price of the Company’s Class A common stock may decline to the extent that the current market prices of the Class A common stock already reflect a market assumption that the Merger will be completed;

·

costs relating to the Merger, such as legal and accounting and, in specified circumstances, additional reimbursement and termination fees, must be paid even if the Merger is not completed; and

·

the diversion of management’s attention from the day-to-day business operations and the potential disruption to each of the Company’s employees and business relationships during the period before the completion of the Merger may make it difficult to regain financial and market positions if the merger does not occur.

Because the market price of Bryn Mawr shares of common stock will fluctuate, the Company’s shareholders cannot be sure of the value of the Merger consideration they may receive.

 

Upon completion of the Merger, holders of the Company’s Class A common stock will receive 0.1025 shares of Bryn Mawr common stock, par value $1.00 per share for each share of Class A common stock they hold, and holders of the Company’s Class B common stock will receive 0.1179 shares of Bryn Mawr common stock for each share of Class B common stock they hold.  The sale prices for shares of Bryn Mawr common stock may vary from the sale prices of Bryn Mawr common stock on the date we announced the merger, on the date the joint proxy statement/prospectus will be mailed to the Company’s shareholders and on the date of the special meeting of the Company shareholders. Any change in the market price of Bryn Mawr shares of common stock prior to closing the Merger may affect the value of the Merger consideration that the Company shareholders will receive upon completion of the Merger.  The Company is not permitted to resolicit the vote of the Company shareholders solely because of changes in the market price of Bryn Mawr common stock. Stock price changes may result from a variety of factors, including general market and economic conditions, changes in our respective businesses, operations and prospects and regulatory considerations. Many of these factors are beyond our control.

 

ITEM 1B.  UNRESOLVED STAFF COMMENTS

None.

ITEM 2.  PROPERTIES

At December 31, 2016, Royal Bank was headquartered and had a retail office at 732 Montgomery Avenue, Narberth, Pennsylvania.  Royal Bank had thirteen additional retail banking locations and administrative offices situated in Pennsylvania and New Jersey.  Royal Bank’s Customer Center, which includes a loan production office, is located in Bala Cynwyd, Pennsylvania. All non-branch personnel are co-located at the Bala Cynwyd location.  We also lease a loan production office in Princeton, New Jersey and Royal Leasing’s office in Blue Bell, Pennsylvania.

Royal Bank owns six of the branch properties.  In February 2017, we closed one branch location and intend to sell the building this year.  Our customers’ deposits were moved to other retail locations.  In 2015, we sold a Company owned building and

20


 

recorded a gain of $324 thousand. The Company’s leased properties have lease expiration dates between 2017 and 2024.  During both 2016 and 2015, Royal Bank made aggregate lease payments of approximately $1.3 million.  We believe that all of our properties are sufficiently insured, maintained and are adequate for Royal Bank’s purposes.

ITEM 3.  LEGAL PROCEEDINGS

Prior to December 31, 2013, Royal Bank held a 60% equity interest in each of CSC and RTL.  CSC and RTL acquired, through public auction, delinquent tax liens in various jurisdictions thereby assuming a superior lien position to most other lien holders, including mortgage lien holders.   In 2012, the former President of CSC and RTL, CSC, RTL and the Company were named defendants, among others, in a Consolidated Master Class Action Complaint (the “Complaint”) filed in the U.S. District Court for the District of New Jersey (“Court”) on behalf of a proposed class of taxpayers who became delinquent in paying their municipal tax obligations.  The Complaint alleged a conspiracy to rig bids in municipal tax lien auctions.   

During 2013, the Company, Royal Bank, CSC, and RTL reached a settlement agreement with plaintiffs to settle the litigation for $1.65 million and other terms and conditions, including an opportunity for members of the proposed settlement class whose tax liens are currently held by CSC or RTL to redeem those liens for a one-time cash payment equaling 85% of the redemption amount by making such payment within 35 days of the date of written notice.  The proposed settlement class does not include, and therefore the offer to redeem does not apply to, tax liens acquired at 0% interest or at a premium. The settlement amount has already been paid into an escrow account. In 2016, the Court approved the settlement after notice and a hearing.  The plaintiffs are appealing the Court’s decision. It is expected to be resolved in the third or fourth quarter of 2017.

ITEM 4.  MINE SAFETY DISCLOSURES

Not applicable.

 

PART II

ITEM 5.   MARKET FOR REGISTRANT’S COMMON EQUITY, AND RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES

Our Class A Common Stock trades on the NASDAQ Global Market under the symbol RBPAA.  There is no market for our Class B Common Stock.  The Class B shares may not be transferred in any manner except to the holder’s immediate family.  Class B shares may be converted to Class A shares at the rate of 1.15 to 1.

The following table shows the range of high and low closing sale prices for our stock as reported by NASDAQ during each quarter of 2016 and 2015.

 

 

 

 

 

 

 

 

Closing Prices

2016

    

 

High

    

 

Low

First Quarter

 

$

2.16

 

$

1.86

Second Quarter

 

 

3.20

 

 

2.11

Third Quarter

 

 

2.65

 

 

2.25

Fourth Quarter

 

 

4.15

 

 

2.28

 

 

 

 

 

 

 

2015

    

 

High

    

 

Low

First Quarter

 

$

1.90

 

$

1.61

Second Quarter

 

 

2.32

 

 

1.70

Third Quarter

 

 

2.14

 

 

1.91

Fourth Quarter

 

 

2.29

 

 

2.01

 

21


 

The approximate number of record holders of our Class A and Class B Common Stock, as of February 28, 2017, is shown below:

 

 

 

 

 

Title of Class

    

 

Number of record holders

Class A Common stock

 

 

213

Class B Common stock

 

 

105

 

 

Dividends

Subject to certain limitations imposed by law or our articles of incorporation, the Board of Directors of the Company may declare a dividend on shares of Class A or Class B Common Stock.

We did not pay cash dividends on our common stock in 2016 and 2015.  Future dividends depend upon net income, capital requirements, and appropriate legal restrictions and other factors relevant at the time the Board of Directors of the Company considers dividend policy.  Cash necessary to fund dividends available for dividend distributions to the shareholders of the Company must initially come primarily from dividends paid by its direct and indirect subsidiaries, including Royal Bank, to the Company.    

Under the Pennsylvania Business Corporation Law, we may pay dividends only if, after giving effect to the dividend payment, our total assets would exceed our total liabilities plus the amount necessary to satisfy preferential rights of holders of senior shareholders, and we are 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 (“FDIC Act”) concerning the payment of dividends by Royal Bank.  Under the Code, no dividends may be paid except from “accumulated net earnings” (generally retained earnings).  Under the FDIC Act, 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 15 – Shareholder’s Equity” of the Notes to Consolidated Financial Statements in Item 8 of this Report.

COMMON STOCK PERFORMANCE GRAPH

The performance graph shows cumulative investment returns to shareholders based on the assumption that an investment of $100 was made on December 31, 2011, (with all dividends reinvested), in each of the following:

·

Royal Bancshares of Pennsylvania, Inc. Class A common stock;

·

The stock of all United States companies trading on the NASDAQ Global Market;

·

Common stock of a 2016 Peer Group consisting of 26 banks headquartered in the Mid-Atlantic region, that trade on a major exchange and have total assets between $700 million and $1.5 billion; and

·

SNL Bank and Thrift Index.

22


 

Royal Bancshares of Pennsylvania, Inc.

 

Picture 4

 

 

 

 

 

 

 

 

 

Period Ending

Index

12/31/11

12/31/12

12/31/13

12/31/14

12/31/15

12/31/16

Royal Bancshares of Pennsylvania, Inc.

100.00
95.99
110.40
128.80
167.20
332.00

NASDAQ Composite

100.00
117.45
164.57
188.84
201.98
219.89

SNL Bank and Thrift

100.00
131.52
176.69
193.53
193.50
238.66

RBPAA Peer Group Index*

100.00
121.82
153.16
157.06
165.21
229.76

 

 

 

Securities Authorized for Issuance Under Equity Compensation Plans

The following tables provide certain information regarding securities issued or issuable under our equity compensation plans as of December 31, 2016:

 

 

 

 

 

 

 

 

 

Long Term Incentive Plan

  

Number of Securities to be issued upon exercise of outstanding options, warrants and rights

  

Weighted average exercise price of outstanding options, warrants and rights

  

Number of securities remaining available for issuance under equity plans (excluding securities reflected in first column)

 

 

 

 

 

 

 

 

Equity compensation plan approved by security holders

 

242,139 

 

$

3.71 

 

732,861

Equity compensation plan not approved by security holders

 

 —

 

 

 —

 

 —

Total

 

242,139 

 

$

3.71 

 

732,861 

 

 

 

 

 

23


 

 

 

ITEM 6.  SELECTED FINANCIAL DATA

The following selected consolidated financial and operating information for the Company should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and accompanying notes in Item 8 of this Report:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Statement of Operations Data

 

For the years ended December 31,

(In thousands, except share data)

    

2016

 

    

2015

    

 

2014

    

 

2013

    

 

2012

Interest income

 

$

33,416

 

 

$

29,993

 

 

$

28,784

 

 

$

27,524

 

 

$

31,981

Interest expense

 

 

7,315

 

 

 

6,484

 

 

 

6,484

 

 

 

7,357

 

 

 

9,899

Net interest income

 

 

26,101

 

 

 

23,509

 

 

 

22,300

 

 

 

20,167

 

 

 

22,082

Provision (credit) for loan and lease losses

 

 

1,242

 

 

 

(748)

 

 

 

(867)

 

 

 

(872)

 

 

 

5,997

Net interest income after loan and lease losses

 

 

24,859

 

 

 

24,257

 

 

 

23,167

 

 

 

21,039

 

 

 

16,085

Non-interest income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gain on sale of premises & equipment

 

 

 -

 

 

 

324

 

 

 

107

 

 

 

2,524

 

 

 

 -

Service charges and fees

 

 

1,361

 

 

 

1,126

 

 

 

1,032

 

 

 

1,323

 

 

 

1,218

Gains on sale of loans and leases

 

 

165

 

 

 

 -

 

 

 

232

 

 

 

686

 

 

 

2,057

Income from bank owned life insurance

 

 

1,166

 

 

 

497

 

 

 

512

 

 

 

539

 

 

 

553

Net gains on investment securities

 

 

1,431

 

 

 

900

 

 

 

377

 

 

 

158

 

 

 

1,030

Other income

 

 

374

 

 

 

280

 

 

 

573

 

 

 

207

 

 

 

747

Total other than-temporary-impairment losses on investment securities

 

 

(190)

 

 

 

(14)

 

 

 

(41)

 

 

 

 -

 

 

 

(2,359)

Total non-interest income

 

 

4,307

 

 

 

3,113

 

 

 

2,792

 

 

 

5,437

 

 

 

3,246

Non-interest expense

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Salaries and benefits

 

 

10,398

 

 

 

10,441

 

 

 

10,164

 

 

 

10,276

 

 

 

11,576

Net OREO expenses

 

 

77

 

 

 

504

 

 

 

216

 

 

 

1,358

 

 

 

8,038

Other expenses

 

 

9,522

 

 

 

10,040

 

 

 

10,741

 

 

 

13,269

 

 

 

16,347

Total non-interest expense

 

 

19,997

 

 

 

20,985

 

 

 

21,121

 

 

 

24,903

 

 

 

35,961

Income (loss) before tax expense

 

 

9,169

 

 

 

6,385

 

 

 

4,838

 

 

 

1,573

 

 

 

(16,630)

Income tax (benefit) expense

 

 

(1,796)

 

 

 

(5,139)

 

 

 

(654)

 

 

 

42

 

 

 

 -

Net income (loss)

 

$

10,965

 

 

$

11,524

 

 

$

5,492

 

 

$

1,531

 

 

$

(16,630)

Less net income (loss) attributable to noncontrolling interest

 

 

590

 

 

 

531

 

 

 

382

 

 

 

(578)

 

 

 

(1,005)

Net income (loss) attributable to Royal Bancshares

 

 

10,375

 

 

 

10,993

 

 

 

5,110

 

 

 

2,109

 

 

 

(15,625)

Less Series A Preferred stock accumulated dividend and accretion

 

 

1,133

 

 

 

1,721

 

 

 

2,078

 

 

 

2,075

 

 

 

2,038

Net income (loss) to common shareholders

 

 

9,242

 

 

 

9,272

 

 

 

3,032

 

 

 

34

 

 

 

(17,663)

Basic and diluted earnings (loss) per common share

 

$

0.31

 

 

$

0.31

 

 

$

0.14

 

 

$

 -

 

 

$

(1.33)

 

 

24


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance Sheet Data

 

For the years ended December 31,

(In thousands)

 

2016

 

2015

 

2014

 

2013

 

2012

Total assets

 

$

832,485

 

 

$

788,283

 

 

$

732,553

 

 

$

732,254

 

 

$

769,455

 

Total average assets

 

 

805,553

 

 

 

739,921

 

 

 

731,245

 

 

 

740,324

 

 

 

819,211

 

Loans, net

 

 

591,589

 

 

 

489,414

 

 

 

403,424

 

 

 

352,810

 

 

 

326,904

 

Total deposits

 

 

629,546

 

 

 

577,892

 

 

 

530,425

 

 

 

528,964

 

 

 

554,917

 

Total average deposits

 

 

592,527

 

 

 

536,034

 

 

 

522,428

 

 

 

527,452

 

 

 

573,233

 

Total borrowings

 

 

129,774

 

 

 

116,744

 

 

 

118,200

 

 

 

133,655

 

 

 

134,107

 

Total average borrowings

 

 

121,301

 

 

 

116,547

 

 

 

128,628

 

 

 

133,261

 

 

 

149,416

 

Total shareholders' equity (1)

 

 

51,648

 

 

 

71,904

 

 

 

62,219

 

 

 

47,534

 

 

 

53,568

 

Total average shareholders' equity (1)

 

 

68,289

 

 

 

65,405

 

 

 

56,498

 

 

 

50,533

 

 

 

67,794

 

Return on average assets

 

 

1.29

%

 

 

1.49

%

 

 

0.70

%

 

 

0.28

%

 

 

(1.91)

%

Return on average equity

 

 

15.19

%

 

 

16.81

%

 

 

9.04

%

 

 

4.17

%

 

 

(23.05)

%

Average equity to average assets

 

 

8.48

%

 

 

8.84

%

 

 

7.73

%

 

 

6.83

%

 

 

8.28

%

Royal Bank America-Total capital (to risk-weighted assets) (2)

 

 

12.41

%

 

 

16.11

%

 

 

16.44

%

 

 

16.49

%

 

 

17.57

%

Royal Bank America-Tier 1 capital (to average assets, leverage) (2)

 

 

8.75

%

 

 

10.82

%

 

 

10.52

%

 

 

9.73

%

 

 

9.45

%

Royal Bancshares-Total capital (to risk-weighted assets) (2)

 

 

13.30

%

 

 

18.57

%

 

 

19.20

%

 

 

18.09

%

 

 

19.33

%

Royal Bancshares-Tier 1 capital (to average assets, leverage) (2)

 

 

8.49

%

 

 

12.44

%

 

 

11.88

%

 

 

9.79

%

 

 

9.80

%

Non-performing assets to total assets (3)

 

 

1.15

%

 

 

1.64

%

 

 

2.67

%

 

 

2.70

%

 

 

4.53

%

Non-performing loans to total loans (3)

 

 

1.00

%

 

 

1.10

%

 

 

2.36

%

 

 

2.77

%

 

 

6.23

%

 

(1)  Excludes noncontrolling interest.

(2) Capital ratios are presented in accordance with GAAP.  Refer to “Capital Adequacy” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Report.

(3)  Excludes non-performing loans held for sale in 2012.

 

 

 

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements of the Company and the related Notes in Item 8 of this Report.

Critical Accounting Policies, Judgments and Estimates

In preparing the consolidated financial statements in accordance with United States generally accepted accounting principles (“U.S. GAAP”), management is required to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and the accompanying notes. These estimates and assumptions are based on information available as of the date of the consolidated financial statements; therefore, actual results could differ from those estimates.

The 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 other-than-temporary impairment losses on investment securities, allowance for loan and lease losses, the valuation of other real estate owned (“OREO”), the valuation of deferred tax assets, fair value measurements, net periodic pension costs and the pension benefit obligation. The policies which significantly affect the determination of the Company’s financial position, results of operations and cash flows are summarized in “Note 1 - Summary of Significant Accounting Polices” to the Consolidated Financial Statements and are discussed in the section captioned “Recent Accounting Pronouncements” of Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in Items 7 and 8 of this Report, each of which is incorporated herein by reference.

Investment Securities

We evaluate securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis.  We assess whether OTTI is present when the fair value of a security is less than its amortized cost.  All investment securities are evaluated for OTTI

25


 

under FASB ASC Topic 320, “Investments-Debt & Equity Securities” (“ASC Topic 320”).  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.

Allowance for Loan and Lease Losses

The allowance for loan and lease losses (the “allowance”) represents management’s estimate of losses inherent in the loan and lease portfolio as of the statement of financial condition date and is recorded as a reduction to loans and leases. The allowance is increased by the provision for loan and lease losses, and decreased by charge-offs, net of recoveries. We consider that the determination of the allowance involves a higher degree of judgment and complexity than our 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. 

The allowance is based on our past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, the composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available. All of these factors may be susceptible to significant change.  While management uses the best information available to make loan loss allowance evaluations, adjustments to the allowance may be necessary based on changes in economic and other conditions or changes in accounting guidance. In addition, the FDIC, as an integral part of its examination processes, periodically reviews our allowance for loan and lease losses. The FDIC may require the recognition of adjustments to the allowance for loan losses based on their judgment of information available to them at the time of their examinations. 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. We also have a reserve for unfunded lending commitments, which represents management’s estimate of losses inherent in those commitments.  The reserve for unfunded loan commitments is adjusted by a provision for credit losses on off-balance sheet credit exposures and is recorded in other liabilities on the consolidated statement of financial condition. See “Note 1 - Summary of Significant Accounting Policies” to the Consolidated Financial Statements included in Item 8 of this report.

Other Real Estate Owned

Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less costs to sell at the date of foreclosure, establishing a new cost basis.  Foreclosed real estate properties acquired through the tax certificate portfolio are transferred at the lower of cost or fair value principally due to uncertainty around the fair value of the foreclosed properties.  Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount recorded at acquisition date or fair value less costs to sell.  Third-party appraisals or agreements of sale are utilized to determine fair value of the loan collateral while BPOs, agreements of sale, or in some cases, third-party appraisals are utilized to value properties from the tax certificate portfolio.  Revenue and expenses from operations and changes in the valuation allowance are included in other expenses.  For fair value measurement, OREO is included in level 3 assets.

Deferred Tax Assets

We recognize deferred tax assets and liabilities for the future tax consequences related to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets are subject to management’s judgment based upon available evidence that future realization is more likely than not.  We are required to establish a valuation allowance for deferred tax assets and record a charge to income or shareholders' equity if management determines, based on all available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. These estimates and judgments are inherently subjective. Management evaluates the DTAs for recoverability using a consistent approach which considers the relative impact of

26


 

negative and positive evidence, including historical profitability and projections of future reversals of temporary differences and future taxable income. In evaluating our ability to recover deferred tax assets, management considers all available positive and negative evidence, including our past operating results and our forecast of future taxable income. In determining future taxable income, assumptions are made for the amount of taxable income, the reversal of temporary differences and potentially the implementation of feasible and prudent tax planning strategies. These assumptions are consistent with the plans and estimates management uses to manage our business.

Based on the analysis of the DTAs at December 31, 2016, management concluded that it is more likely than not that a portion of the net DTA will be realized by the Company in the future.  As a result of this conclusion, we released an additional $1.9 million of our valuation allowance previously recorded on the net DTAs and credited income tax expense, which was partially offset by the current income expense for the year. The ability to recognize the remaining deferred tax assets that continue to be subject to a valuation allowance will be evaluated on a quarterly basis to determine if there are any significant events that would affect the ability to utilize these deferred tax assets.  Based on the analysis of the DTAs at December 31, 2015, we released $5.4 million of our valuation allowance previously recorded on the net DTAs and credited income tax expense. There can be no assurance, however, as to when we could be in a position to recapture the remaining DTA valuation allowance.  At December 31, 2016, the DTA valuation allowance was $26.6 million compared to $30.6 million at December 31, 2015.  For more information refer to “Note 12 - Income Taxes” to the Consolidated Financial Statements in Item 8 of this Report.

Fair Value Measurements

We use fair value measurements to record fair value adjustments to certain assets to determine fair value disclosures. Investment and mortgage-backed securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other assets on a nonrecurring basis, such as impaired loans, real estate owned and certain other assets. These nonrecurring fair value adjustments typically involve application of lower-of-cost-or-market accounting or write-downs of individual assets. FASB ASC Topic 820 “Fair Value Measurements and Disclosures” (“ASC Topic 820”), establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value.  The three levels of the fair value hierarchy under ASC Topic 820 are as follows:

 

 

Level 1:

Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

 

 

Level 2:

Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability. Level 2 includes debt securities with quoted prices that are traded less frequently then exchange-traded instruments. Valuation techniques include matrix pricing which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices.

 

 

Level 3:

Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported with little or no market activity).

Under ASC Topic 820, we base our fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy in FASB ASC Topic 820.  Fair value measurements for assets where there exists limited or no observable market data and, therefore, are based primarily upon our or other third-party’s estimates, are often calculated based on the characteristics of the asset, the economic and competitive environment and other such factors. Management uses its best judgment in estimating the fair value of our financial instruments; however, there are inherent weaknesses in any estimation technique.  Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts we could have realized in a sales transaction on the dates indicated.  The estimated fair value amounts have been measured as of their respective period end and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates.  As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each period-end. Additionally, changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future valuations.

27


 

Benefit Plans

We have a noncontributory nonqualified defined benefit pension plan (“Pension Plan”) covering certain eligible employees.  Our Pension Plan provides retirement benefits under pension trust agreements.  The benefits are based on years of service and the employee’s compensation during the highest three consecutive years during the last 10 years of employment.  We account for our pension plan in accordance with FASB ASC Topic 715 “Compensation-Retirement Benefits” (“ASC Topic 715”).  ASC Topic 715 requires the recognition of a plan’s over-funded or under-funded status as an asset or liability with an offsetting adjustment to AOCI.  ASC Topic 715 requires the determination of the fair values of plans assets at a company’s year-end and recognition of actuarial gains and losses, prior service costs or credits, and transition assets or obligations as a component of AOCI.  These amounts will be subsequently recognized as components of net periodic benefits cost.  Further, actuarial gains and losses that arise in subsequent periods that are not initially recognized as a component of net periodic benefit cost will be recognized as a component of AOCI.  Those amounts will subsequently be recognized as a component of net periodic benefit cost as they are amortized during future periods.  Net pension expense consists of service costs and interest costs.  We accrue pension costs as incurred. Benefit payments are expected to be substantially made from insurance policies owned by the Company.

We have a capital accumulation and salary reduction plan under Section 401(k) of the Internal Revenue Code of 1986, as amended.  Under the plan, all employees are eligible to contribute up to the maximum allowed by Internal Revenue Service (“IRS”) regulation, with the Company matching 100% of any contribution between 1% and 5% subject to a $2,500 per employee annual limit.  The 401(k) matching contribution was $135 thousand and $134 thousand for 2016 and 2015, respectively.

Recent Accounting Pronouncements

See “Note 1 - Summary Of Significant Accounting Policies” to the Consolidated Financial Statements included in Item 8 of this Report.

Results of Operations

Financial Highlights and Business Results

Our results of operations depend primarily on net interest income.  Its level is a function of the average balance of interest-earning assets, the average balance of interest-bearing liabilities, and the spread between the yield on assets and liabilities. In turn, these factors are influenced by the pricing and mix of our interest-earning assets and funding sources.  Additionally, net interest income is affected by market and economic conditions, which influence rates on loan and deposit growth. 

Interest-earning assets consist principally of loans and investment securities, while interest-bearing liabilities consist primarily of deposits and borrowings. Refer to the “Net Interest Income and Net Interest Margin” section below for additional information on interest yield and cost.  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.

Consistent quality loan growth and expense discipline were key to the increase in net income before taxes. Loan growth in commercial, consumer, and leasing segments and more economical delivery channels, including our loan production office, are helping drive customer growth.  We continued to modernize the ways customers can access our products and services.  During 2016, we introduced a tablet version of our consumer mobile app as well a mobile app for our corporate customers, which includes our cash management suite of products.  We introduced enhancements to our website which improved navigation and functionality.  We added first position residential mortgages through a new arrangement with a local mortgage company experienced in providing and servicing residential mortgages for community banks. Additionally, we completed extensive renovations of our Narberth retail location.  These results and continued progress come at a time when competition, current interest rates, regulatory requirements and domestic and global markets greatly challenge the banking industry.  Our ability to generate consistent earnings led to the partial reversal of the valuation allowance on the deferred tax assets.  For further discussion on the deferred tax assets see “Accounting for Income Taxes.” 

In 2014, we received approval from the Federal Reserve Bank to bid up to $14.0 million, which was raised in a private placement, to purchase shares of the Series A Preferred Stock in an auction of such shares to be conducted by the United States Department of Treasury (“Treasury”).  We repurchased 11,551 shares of Series A Preferred stock in July 2014 as

28


 

part of Treasury’s auction of its holdings of Series A Preferred Stock.  We repurchased the remaining 18,856 shares of Series A preferred stock from time to time during 2016 as shares became available for purchase and we received the required regulatory approvals to repurchase such shares. 

Consolidated Net Income

Net income attributable to the Company for the year ended December 31, 2016 amounted to $10.4 million, or $0.31 per diluted common share, compared to $11.0 million, or $0.31 per diluted common share, for the year ended December 31, 2015. Net interest income grew $2.6 million, or 11.0%, from 2015 and the provision for unfunded loan commitments declined $758 thousand from 2015.  Additionally, net gains on the sales of investment securities increased $531 thousand and net OREO expenses declined $427 thousand from 2015. 

In 2016 we recorded a $1.9 million reversal of the valuation allowance for the net deferred tax assets, which contributed to the $1.8 million tax benefit compared to a $5.4 million reversal of the valuation allowance for the net deferred tax assets which contributed to the $5.1 million tax benefit in 2015.  The provision for loan and lease losses increased $2.0 million from a credit of $748 thousand in 2015 to an expense of $1.2 million in 2016. Additionally, professional and legal fees, communications and data processing, and OTTI on investment securities increased $246 thousand, $206 thousand, and $176 thousand, respectively.

At December 31, 2016, loans and leases totaled $602.0 million, which represents an increase of $102.9 million, or 20.6%, from 2015. New business relationships continue to stimulate the growth of the loan portfolio, which also improved the composition of interest earning assets.  As part of the continued planned reduction of the tax lien portfolio, tax lien certificates declined $1.1 million, or 22.1%, from 2015.  Investment securities declined $54.2 million, or 24.2%, from the level at December 31, 2015 due to the reinvestment of cash flows from sales, calls, and principal payments into loans.  Cash and cash equivalents decreased $4.2 million to $21.2 million at December 31, 2016.  The decrease in cash was primarily the result of funding new loan originations.

Total deposits grew $51.6 million, or 8.9%, from $577.9 million at December 31, 2015 to $629.5 million at December 31, 2016. The increase in deposits reflects a focused change in the deposit mix with a successful savings promotion.  Savings accounts and non-interest bearing deposits increased $31.3 million and $14.3 million, respectively. During the third quarter of 2016, the $25.0 million brokered checking deposit arrangement with a regional financial institution was terminated. We partially replaced these funds with $21.5 million in brokered certificates of deposit through Promontory Interfinancial Network’s CDARS program.  NOW and money market accounts and non-brokered certificates of deposit increased $5.3 million and $4.2 million, respectively.

Total borrowings increased $13.0 million.  Short-term borrowings increased $10.0 million and was due to the rollover strategy of an FHLB advance tied to an interest rate swap agreement. Long-term borrowings increased $3.0 million.

Interest Income

Total interest income of $33.4 million for 2016 grew $3.4 million, or 11.4%, from $30.0 million for 2015.  The increase was primarily driven by an increase of $4.5 million in the interest income earned on average loan balances and was predominantly due to the growth in such assets.  Partially offsetting the increase in loan interest income was a $1.1 million decline in the interest income earned on average investments which was largely due to a drop in the average balance of such assets.  Average interest-earning assets grew $62.6 million, or 9.0%, from $695.1 million for 2015 to $757.7 million for 2016.  During 2016, average loans and leases grew $101.1 million, or 22.5%, to $551.2 million, while average investment securities declined  $34.7 million, or 15.2%, to $194.1 million.  Average interest-earning deposits decreased $3.8 million year over year.   During the past year, we sold investment securities with lower yields or extension risk in a rising rate environment. We also had $26.1 million in government agency bonds called during 2016, which impacted the year over year comparison. The cash flows from these transactions along with principal and interest payments on the investment portfolio were reinvested in loans and leases,  government sponsored mortgage-backed securities and collateralized mortgage obligations (“CMOs”).  Average loan and investment balances for 2015 were $450.1 million and $228.8 million, respectively.

For 2016, the yield on average interest-earning assets was 4.41% and increased nine basis points from 4.32% for the comparable period of 2015.  While the average loan balances significantly increased, the average yield on loans decreased 18 basis points (5.23% in 2016 versus 5.41% in 2015).  The decline in loan yield reflects the competitive pricing environment

29


 

we are experiencing for originating and retaining high quality loans. The average yield on investments declined 13 basis points (2.33% in 2016 versus 2.46% in 2015).

Interest Expense

For 2016 total interest expense was $7.3 million and increased $831 thousand, or 12.8%, from $6.5 million for 2015. The increase in interest expense was primarily associated with an increase in interest expense on average savings accounts and average borrowings. Average interest-bearing liabilities for 2016 were $630.6 million and increased $55.1 million, or 9.6%, year-over-year. Average interest-bearing deposits of $509.3 million increased $50.3 million, or 11.0%, and included increases of $44.5 million and $11.4 million in savings accounts and NOW and money market accounts, respectively.  Partially offsetting these increases was a $5.5 million decrease in average certificates of deposits. Average borrowings increased $4.8 million, or 4.1%, to $121.3 million.  Interest costs associated with average deposit balances increased $519 thousand from 2015.  Interest expense associated with average savings balances accounted for $409 thousand of the increase.  Average non-interest bearing demand deposits grew $6.2 million, or 8.0%. Average interest-bearing deposits for 2015 were $459.0 million.

The interest paid on average borrowings increased $312 thousand, or 11.7% from 2015.  We have one interest rate swap that was tied to a rollover strategy of an FHLB advance that matured on June 24, 2016. We have and will continue to rollover the FHLB advance every three months through the swap expiration of June 2021. The interest expense associated with the swap was $148 thousand for 2016.  Additionally, in the third quarter of 2016, we chose to benefit from the flattening yield curve and borrowed a $15.0 million FHLB advance for five years.  This advance will allow us to guarantee an interest rate spread on $15.0 million in five year fixed rate loans. Average borrowings were $116.5 million for 2015.

The average interest rate paid on interest-bearing liabilities amounted to 1.16% for 2016 and increased three basis points from 1.13% for 2015. The average interest rate paid on interest-bearing deposits in 2016 amounted to 0.85% and increased two basis points from 0.83% for 2015.  During the third quarter of 2015 and throughout 2016, we ran a successful savings account promotion. As a result, the average rates paid on savings accounts increased 31 basis points (0.71% in 2016 versus 0.40% in 2015). Despite the decline in average balances for CDs year over year, the average rate paid on this deposit classification increased five basis points (1.41% in 2016 versus 1.36% in 2015).  The interest rate paid on average NOW and money market accounts increased two basis points (0.36% in 2016 versus 0.34% in 2015).  The increases in the average rates paid on average interest-bearing deposits reflect the competitive pricing in our market area for all deposit product types and our retail savings promotion. The average rate paid on average borrowings increased 16 basis points (2.46% for 2016 versus 2.30% for 2015). Short-term borrowing rates and the subordinated debt rate were directly impacted by the Federal Reserve Bank’s rate increase in December 2015. Additionally, the average borrowing rate paid was negatively impacted by the interest rate swap and the new $15.0 million advance mentioned previously.

Net Interest Income and Margin 

Net interest income for 2016 increased $2.6 million, or 11.0%, to $26.1 million from $23.5 million for 2015. The growth in 2016 was attributed to an increase in interest income due to the growth and change in the composition of average interest-earning assets. Year-over-year average loans increased $101.1 million with growth recognized in multiple commercial loan classes. Average investments and average interest-earning deposits declined $34.7 million and $3.8 million, primarily to fund the growth in loans. Partially mitigating the improvement in interest income was an $831 thousand increase in interest expense.  The $50.3 million net growth in average interest-bearing deposits led to a $519 thousand increase in interest expense on those deposits.  We experienced increases in interest expense across all interest-bearing deposit types.  The $4.8 million increase in average borrowings resulted in a $312 thousand increase in interest expense year over year.    

For 2016, the net interest margin was 3.44%, a six basis point increase from 3.38% for 2015. The nine basis point increase in the yield on average interest-earning assets (4.41% in 2016 versus 4.32% in 2015) was partially offset by a three basis point increase in funding costs (1.16% in 2016 versus 1.13% in 2015). The 18 basis point decrease in average loan yield (5.23% in 2016 versus 5.41% in 2015) reflects the competitive pricing for new loan originations. Average interest rates paid on average interest-bearing deposits grew two basis points from 0.83% for 2015 to 0.85% for 2016. The increase in average interest rates paid occurred in all interest-bearing segments or products. We have been experiencing competitive pricing pressure in our market area to retain deposits.  Additionally, the average rate paid on average borrowings increased 16 basis points due to an $4.8 million increase in the average balance coupled with higher rates paid. Short-term deposit rates paid and the subordinated debt rate were directly impacted by the flattening of the yield curve throughout most of 2016

30


 

and the Federal Reserve Bank’s rate increase in December 2015.  Additionally, the average borrowing rate paid was negatively impacted by the interest rate swap and the new $15.0 million advance mentioned previously. The average rates paid on average borrowings, other than subordinated debt, were 2.35% in 2016 versus 2.25% in 2015, and the average rates paid on subordinated debt were 2.88% in 2016 versus 2.48% in 2015.

Average Balances

The following table represents the average daily balances of assets, liabilities and shareholders’ equity and the respective interest earned and paid on interest-bearing assets and interest-bearing liabilities, as well as average rates for the periods indicated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the year ended

 

 

For the year ended

 

 

For the year ended

 

 

 

December 31, 2016

 

 

December 31, 2015

 

 

December 31, 2014

 

(In thousands, except percentages)

 

Average Balance

 

Interest

 

Yield

 

 

 

Average Balance

 

 

Interest

 

Yield

 

 

 

Average Balance

 

 

Interest

 

Yield

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-earning deposits

 

$

12,416

 

$

63

 

0.51

%

 

$

16,197

 

$

32

 

0.20

%

 

$

9,897

 

$

22

 

0.22

%

Investment securities available for sale

 

 

194,108

 

 

4,528

 

2.33

%

 

 

228,779

 

 

5,617

 

2.46

%

 

 

292,208

 

 

7,191

 

2.46

%

Loans and leases (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial demand loans

 

 

165,369

 

 

8,413

 

5.09

%

 

 

120,460

 

 

5,882

 

4.88

%

 

 

117,943

 

 

5,825

 

4.94

%

Real estate secured

 

 

318,834

 

 

14,916

 

4.68

%

 

 

268,919

 

 

13,443

 

5.00

%

 

 

217,660

 

 

11,622

 

5.34

%

Other loans and leases

 

 

66,958

 

 

5,496

 

8.21

%

 

 

60,715

 

 

5,019

 

8.27

%

 

 

47,979

 

 

4,124

 

8.60

%

Total loans

 

 

551,161

 

 

28,825

 

5.23

%

 

 

450,094

 

 

24,344

 

5.41

%

 

 

383,582

 

 

21,571

 

5.62

%

Total interest-earning assets

 

 

757,685

 

 

33,416

 

4.41

%

 

 

695,070

 

 

29,993

 

4.32

%

 

 

685,687

 

 

28,784

 

4.20

%

Non-earning assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   

 

 

 

 

 

 

 

 

   

 

 

 

Cash and due from banks

 

 

13,586

 

 

 

 

 

 

 

 

14,059

 

 

 

 

 

 

 

 

10,409

 

 

 

 

 

 

Other assets

 

 

44,313

 

 

 

 

 

 

 

 

41,317

 

 

 

 

 

 

 

 

47,312

 

 

 

 

 

 

Allowance for loan and lease losses

 

 

(10,031)

 

 

 

 

 

 

 

 

(10,525)

 

 

 

 

 

 

 

 

(12,163)

 

 

 

 

 

 

Total non-earning assets

 

 

47,868

 

 

 

 

 

 

 

 

44,851

 

 

 

 

 

 

 

 

45,558

 

 

 

 

 

 

Total average assets

 

$

805,553

 

 

 

 

 

 

 

$

739,921

 

 

 

 

 

 

 

$

731,245

 

 

 

 

 

 

Interest-bearing deposits

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NOW and money markets

 

$

222,626

 

$

811

 

0.36

%

 

$

211,271

 

$

716

 

0.34

%

 

$

208,688

 

$

653

 

0.31

%

Savings

 

 

74,520

 

 

529

 

0.71

%

 

 

30,023

 

 

120

 

0.40

%

 

 

18,765