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, 2015, we had consolidated total assets of approximately $788.3 million, total deposits of approximately $577.9 million and shareholders’ equity of approximately $71.9 million. The Company’s two Delaware trusts, Royal Bancshares Capital Trust I and Royal Bancshares Capital Trust II, are not consolidated per requirements under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 810, “Consolidation” (“ASC Topic 810”). We have two reportable operating segments, “Community Banking” and “Tax Liens”.
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, an MOU, with the Federal Reserve Bank. Included in the MOU are certain continued reporting requirements and a requirement that the Company receive the prior approval of the Federal Reserve Bank prior to declaring or paying any dividends on our common stock, making interest payments related to our
outstanding trust preferred securities or subordinate securities, incurring or guaranteeing certain debt with an original maturity date greater than one year, and purchasing or redeeming any shares of stock. The MOU will remain in effect until stayed, modified, terminated or suspended in writing by the Federal Reserve Bank.
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. Royal Bank also leases a loan production office in Princeton, New Jersey. Royal Bank also considers New York, Maryland, and Delaware as a part of its service area for certain products and services. In the past, Royal Bank had frequently conducted business with clients located outside of its service area. Royal Bank has loans in 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, 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 119 persons on a full-time equivalent basis as of December 31, 2015.
Deposits: At December 31, 2015, total deposits of Royal Bank were distributed among demand deposits (16%), money market deposit, savings and NOW accounts (49%) and time deposits (35%). At year-end 2015, deposits increased $50.7 million to $588.9 million, from year-end 2014, or 9.4%, and reflected a change in the composition. Savings accounts grew $35.1 million, or 188% from December 31, 2014. Additionally, NOW and money market accounts and demand deposits increased $20.1 million and $13.1 million, respectively. In the third quarter of 2015, we entered into a $25.0 million brokered checking deposit arrangement with a regional financial institution. Time deposits decreased $17.6 million primarily due to the
intentional run-off of maturing CDs. Included in Royal Bank’s deposits are approximately $11.0 million of intercompany deposits that are eliminated through consolidation.
Lending: At December 31, 2015, Royal Bank had a total net loan portfolio of $489.4 million, representing 62.4% 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 2015, net loans grew $86.0 million from year end 2014.
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, 2015, total assets of RID were $26.2 million, of which $3.7 million was held in cash and cash equivalents and $1.8 million was held in investment securities. RID had net interest income of $666 thousand and $664 thousand for 2015 and 2014, respectively. Non-interest income for 2015 and 2014 was $316 thousand and $296 thousand, respectively, and was comprised of net gains on sale of investment securities. RID recorded net income of $781 thousand for 2015 compared to $901 thousand for 2014. Royal Bank has previously extended loans to RID, secured by securities, as per the provisions of Regulation W. At December 31, 2015, 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, 2015 and 2014, total assets of CSC were $4.7 million and $4.9 million, respectively. Included in total assets was OREO of $3.2 million and $4.3 million at December 31, 2015 and 2014, respectively. For 2015, CSC recorded net interest expense of $297 thousand compared to $293 thousand for 2014 due to the continued liquidation of CSC’s tax lien certificate portfolio. The 2015 credit for lien losses was $2 thousand compared to a provision for lien losses of $87 thousand for 2014. For 2015 and 2014, non-interest income was $163 thousand and $88 thousand, respectively. Non-interest income is mostly comprised of gains on sales of OREO and rental income. Non-interest expense was $226 thousand and $539 thousand for 2015 and 2014, respectively. CSC recorded a net loss of $357 thousand in 2015 compared to $831 thousand in 2014.
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, 2015 and 2014, total assets of RIA were $6.1 million and $5.9 million, which included $5.8 million and $5.6 million in cash, respectively. For 2015, RIA recorded net income of $170 thousand compared to a net loss of $45 thousand for 2014. The 2015 net income was directly impacted by $182 thousand in gains on the sale of investment securities.
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, 2015 and 2014, total assets of Royal Leasing were $65.1 million and $51.8 million, respectively. For 2015 and 2014, Royal Leasing had net interest income of $3.2 million and $2.7 million, respectively. For 2015, the provision for lease losses was $906 thousand compared to $956 thousand for 2014. Total net leases were $65.0 million at December 31, 2015 compared to $51.7 million at December 31, 2014. Non-interest income for 2015 was $473 thousand compared to $454 thousand for 2014. Non-interest expense was $1.2 million and $803 thousand for 2015 and 2014, respectively. The increase in non-interest expense was due to an increase in management distributions. Royal Leasing recorded net income, prior to management distribution fees, of $2.6 million for the year ended December 31, 2015 compared to a $2.0 million for the year ended December 31, 2014.
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, 2015, total assets of RTL, of which the majority was held in tax certificates and OREO, were $9.4 million compared to $15.2 million at December 31, 2014. Tax certificates declined $3.3 million from $6.6 million at December 31, 2014 to $3.3 million at December 31, 2015. OREO was $4.0 million at December 31, 2015 compared to $5.2 million at December 31, 2014. For 2015, RTL had net interest income of $116 thousand compared to $510 thousand for 2014 due to the reduction in average tax certificates outstanding over the past year. Provision for lien losses was $100 thousand compared to $374 thousand for 2015 and 2014, respectively. Non-interest income, which was mostly comprised of net gains on the sale of OREO, was $967 thousand for 2015 compared to $807 thousand for 2014. Non-interest expense was $1.9 million and $1.5 million for 2015 and 2014, respectively. The $500 thousand increase in non-interest expense was mostly related to OREO related expenses. RTL recorded a net loss of $885 thousand for 2015 compared to $596 thousand for 2014.
On June 16, 2006, the Company, through its wholly-owned subsidiary RID, established Royal Preferred LLC as a wholly-owned subsidiary. Royal Preferred LLC was formed to purchase a subordinated debenture from Royal Bank. At December 31, 2015 and 2014, Royal Preferred LLC had total assets of approximately $21.2 million and $24.7 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.
Future Acquisitions
Our acquisition strategy consists of identifying financial institutions and other financial companies with business philosophies that are similar to our business philosophies, which operate in strong markets that are geographically compatible with our operations, and which can be acquired at an acceptable cost. In evaluating acquisition opportunities, we generally consider potential revenue enhancements and operating efficiencies, asset quality, interest rate risk, and management capabilities. We currently have no formal commitments with respect to future acquisitions.
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.
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 2015, and is not expected to have a material effect on such expenditures, earnings or competitive position in 2016.
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 acquiring ownership or control of any voting shares of any bank other than Royal Bank, if, after such acquisition, the registrant would own or control more than 5% of the voting shares of such bank. A bank holding company located in Pennsylvania, another state, the District of Columbia or a territory or possession of the United States may control one or more banks, bank and trust companies, national banks, interstate banks and, with the prior written approval of the Department, may acquire control of a bank and trust company or a national bank located in Pennsylvania. A Pennsylvania-chartered institution may maintain a bank, branches in any other state, the District of Columbia, or a territory or possession of the United States upon the written approval of the Department.
Federal law also prohibits the acquisition of control of a bank holding company without prior notice to certain federal bank regulators. Control is defined for this purpose as the power, directly or indirectly, to direct the management or policies of a bank or bank holding company or to vote 25% or more of any class of voting securities of a bank or bank holding company.
Royal Bank
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.
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. The Basel III final rules (discussed below) revised certain of the capital thresholds for the different prompt corrective action categories, effective January 1, 2015. As revised, the five categories are as follow:
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Well capitalized-equals or exceeds a 10% total risk-based capital ratio, 8% tier 1 risk-based capital ratio, 5% leverage ratio, and 6.5% common equity tier 1 capital, and is not subject to any written agreement, order or directive requiring it to maintain a specific level for any capital measure;
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Adequately capitalized-equals or exceeds an 8 % total risk-based capital ratio, 6% tier 1 risk-based capital ratio, 4% leverage ratio, and 4.5% common equity tier 1 capital;
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Undercapitalized-total risk-based capital ratio of less than 8%, tier 1 risk-based ratio of less than 6%, a leverage ratio of less than 4%, or common equity tier 1 capital of less than 4.5%;
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Significantly undercapitalized-total risk-based capital ratio of less than 6%, a tier 1 risk-based capital ratio of less than 4%, a leverage ratio of less than 3%, or common equity tier 1 capital of less than 3%; and
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Critically undercapitalized-a ratio of tangible equity to total assets equal to or less than 2%.
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.
The following table shows the required capital ratios with the conservation buffer over the phase-in period.
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010: On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) was enacted into law. The Dodd-Frank Act significantly changes the regulation of financial institutions and the financial services industry and includes provisions that, among other things:
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create the Financial Services Oversight Council to identify emerging systemic risks and improve interagency cooperation;
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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;
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permanently raise the current standard maximum deposit insurance amount to $250 thousand;
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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);
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amend the Truth in Lending Act with respect to mortgage originations and establishing new minimum mortgage underwriting standards;
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strengthen the SEC’s powers to regulate securities markets;
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grant the Federal Reserve Board the power to regulate debit card interchange fees;
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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;
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allow financial institutions to pay interest on business checking accounts; and
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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. While the Federal Reserve Board issued the final rule on December 10, 2013, community banks had until July 21, 2015 to conform their activities and policies to the final rule. If a community bank were to retain an ownership interest in a covered fund that it organized and offered, the final rule places a number of limitations on those ownership interests. 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, 2015, the Company had $2.0 million invested in private equity funds, of which $240 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 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 first quarter of 2016, the Financing Corporation’s assessment for Royal Bank (and all other banks), is an annual rate of $.0058 for each $100 of deposits. The Financing Corporation bonds are expected to be paid off between 2017 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.
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:
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To an amount equal to 10% of Royal Bank’s capital and surplus, in the case of covered transactions with any one affiliate; and
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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:
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A loan or extension of credit to an affiliate;
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A purchase of, or an investment in, securities issued by an affiliate;
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A purchase of assets from an affiliate, with some exceptions;
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The acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any party; and
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This issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate.
In addition, under Regulation W:
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A bank and its subsidiaries may not purchase a low-quality asset from an affiliate;
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Covered transactions and other specified transactions between a bank or its subsidiaries and an affiliate must be on terms and conditions that are consistent with safe and sound banking practices; and
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With some exceptions, each loan or extension of credit by a bank to an affiliate must be secured by collateral with a market value ranging from 100% to 130%, depending on the type of collateral, of the amount of the loan or extension of credit.
Regulation W generally excludes all non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve Board decides to treat these subsidiaries as affiliates.
Concurrently with the adoption of Regulation W, the Federal Reserve Board has proposed a regulation which would further limit the amount of loans that could be purchased by a bank from an affiliate to not more than 100% of Royal Bank’s capital and surplus.
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:
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 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.
ITEM 1A. RISK FACTORS
An investment in our common stock involves risks. Before making an investment decision, investors should carefully consider the risks described below in conjunction with the other information in this Report, including our consolidated financial statements and related notes. If any of the following risks or other risks, which have not been identified or which we may believe are immaterial or unlikely, actually occurs, our business, financial condition and results of operations could be harmed. In such a case, the trading price of our common stock could decline, and investors may lose all or part of their investment.
Risks Related to Our Business
Our business may be impacted by the existence of the informal agreement with the Federal Reserve Bank of Philadelphia.
Our success as a business is dependent upon pursuing various alternatives in achieving the growth and expansion of our banking franchise. We are prohibited from paying cash dividends without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System. Our ability to raise capital could be potentially limited or impacted as a result of the informal agreement. Attracting new management talent is critical to the success of our business and could be potentially impacted due to the existence of the informal agreement.
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 and construction and land development loan portfolio held for investment was $273.7 million at December 31, 2015 comprising 55% 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 17% 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.
Our allowance for loan and lease losses may not be adequate to cover actual losses.
Like all financial institutions, we maintain an allowance for loan and lease losses to provide for loan and lease defaults and non-performance. Our allowance for loan and lease losses is based on our historical loss experience as well as an evaluation of the risks associated with our loan portfolio, including the size and composition of the loan portfolio, current economic conditions and geographic concentrations within the portfolio. Our allowance for loan and lease losses may not be adequate to cover actual loan and lease losses. 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.
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. Additionally, the Series A Preferred Stock outstanding has a preferred cumulative dividend rate of 9% per annum and contains provisions which include restrictions on the payment of dividends on common stock and on repurchases of any shares of preferred stock ranking equal to or junior to the Series A Preferred Stock or common stock while the Series A Preferred Stock is outstanding. These provisions may make it more difficult to raise additional capital on favorable terms while the Series A Preferred Stock is outstanding. As of December 31, 2015, the outstanding shares of Series A Preferred stock were 18,856 and the dividend in arrears including interest was $8.9 million, which has not been recognized in the consolidated financial statements. Therefore, we may be unable to raise additional capital, or to raise capital on terms acceptable to us. 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.
Holders of our Series A Preferred Stock have certain voting rights that may adversely affect our common shareholders, and the holders of the Series A Preferred Stock may have interests different from our common shareholders.
For as long as shares of the Series A Preferred Stock are outstanding, in addition to any other vote or consent of the shareholders required by law or our Articles of Incorporation, the vote or consent of holders of at least 66 2/3% of the shares of the Series A Preferred Stock outstanding is required for any authorization or issuance of shares ranking senior to the Series A Preferred Stock; any amendments to the rights of the Series A Preferred Stock so as to adversely affect the rights, privileges, or voting power of the Series A Preferred Stock; or initiation and completion of any merger, share exchange or similar transaction unless the shares of Series A Preferred Stock remain outstanding, or if we are not the surviving entity in such transaction, are converted into or exchanged for preference securities of the surviving entity and the shares of Series A Preferred Stock remaining outstanding or such preference securities have the rights, preferences, privileges and voting power of the Series A Preferred Stock.
The holders of our Series A Preferred Stock may have different interests from the holders of our common stock, and could vote to block the forgoing transactions, even when considered desirable by, or in the best interests of the holders of our common stock.
Our ability to pay dividends depends primarily on dividends from our banking subsidiary, which are subject to regulatory limits. Additionally, we are subject to other dividend limitations.
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, 2015, 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.
We suspended regular quarterly cash dividends on the Series A Preferred Stock in August 2009 and, accordingly, are not permitted at this time to pay dividends on our Class A or Class B Common Stock. Additionally, under the terms of the informal agreement with the Federal Reserve Bank, we are prohibited from redeeming the Series A Preferred Stock or paying any dividends on shares of our stock without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System. Failure to pay dividends on our stock could have a material adverse effect on the market price of our Class A Common Stock.
Our ability to use net operating loss carryforwards to reduce future tax payments may be limited.
As of December 31, 2015, the Company had a federal net operating loss (“NOL”) carryforwards of approximately $63.2 million and state NOL carryforwards of $147.5 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.
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 2014. 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.
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 DTAs 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 DTAs 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 DTAs at December 31, 2015, 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 $5.4 million of our valuation allowance previously recorded on the net DTAs and credited income tax expense. 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/(liabilities), net of valuation allowances, totaled $5.7 million and $(308) thousand at December 31, 2015 and 2014, respectively. The deferred tax asset valuation allowance was $30.6 million and $39.1 million at December 31, 2015 and 2014, 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.
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, 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 led 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:
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We could face increased regulation of our industry. Compliance with such regulation may increase our costs and limit our ability to pursue business opportunities.
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Our ability to assess the creditworthiness of customers and to accurately estimate the losses inherent in our credit portfolio could be more complex.
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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.
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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.
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We may experience increases in foreclosures, delinquencies and customer bankruptcies.
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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.
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 33% of our Class A common stock and 87% of our Class B common stock outstanding as of February 29, 2016. 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.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
At December 31, 2015, Royal Bank was headquartered and had a retail office at 732 Montgomery Avenue, Narberth, Pennsylvania. Royal Bank has twelve additional retail banking locations and administrative offices situated in Pennsylvania and New Jersey. Additionally, Royal Bank’s Customer Center, which includes a loan production office, is located in Bala Cynwyd, Pennsylvania. In 2014, all non-branch personnel were co-located at the Bala Cynwyd location. This move enhanced operating efficiency.
Royal Bank currently owns six of the branch properties. We have continued with the execution of our real estate rationalization plan and sold a Company owned building and recorded gains of $324 thousand in 2015 and sold one branch property for a gain of $107,000 in 2014. In 2015, the branch located in the sold building was relocated to a leased facility within the same market area of that location. In 2014, we opened a limited service office in Princeton, New Jersey due to our expanding commercial loan growth in the central New Jersey market area. The Company’s leased properties have lease expiration dates between 2016 and 2024. During 2015 and 2014, Royal Bank made aggregate lease payments of approximately $1.3 million and $890 thousand, respectively. The planned increase in rent for 2015 was directly related to the co-location of all non-retail employees and the branch relocations. We believe that all of our properties are sufficiently insured, maintained and are adequate for Royal Bank’s purposes.
ITEM 3.
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 is subject to Court approval after notice and a hearing. Members of the proposed settlement class will have an opportunity to object to the proposed settlement or opt-out.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
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 2015 and 2014.
The approximate number of record holders of our Class A and Class B Common Stock, as of February 29, 2016, is shown below:
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 2015 and 2014. 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.
On August 13, 2009, our board of directors suspended the regular quarterly cash dividends on the Series A Preferred Stock. Our board of directors took this action in consultation with the Federal Reserve Bank of Philadelphia as required by regulatory policy guidance. As of December 31, 2015, the Series A Preferred stock dividend in arrears including interest was $8.9 million and has not been recognized in the consolidated financial statements. In the event we declared the preferred dividend our capital ratios would be negatively affected; however, they would remain above the required minimum ratios. In February 2014, the preferred cumulative dividend rate prospectively increased from 5% to 9% per annum.
Under the Federal Reserve Bank MOU as described under “Regulatory Actions” in “Item 1 - Business” of this Report, the Company may not declare or pay any dividends without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System.
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, 2010, (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 2015 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.
Royal Bancshares of Pennsylvania, Inc.
ITEM 6.
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:
(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 2011 and 2012.
ITEM 7.
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
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
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, 2015, 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 $5.4 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. 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, 2015, the DTA valuation allowance was $30.6 million compared to $39.1 million at December 31, 2014. 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.
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 $134 thousand and $148 thousand for 2015 and 2014, 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.
The financial results for 2015 illustrate further progress on our goal of consistent profitability and serving our four key constituents: customers, shareholders, co-workers, and community. Our financial performance continues to allow us to expand the Royal Bank brand through our relationship based customer model. Loan growth in commercial, consumer, and leasing segments and more economical delivery channels, including a loan production office, are helping drive customer growth. We continue our focus on modernizing the ways customers can access our products and services. In 2015, we introduced a new custom branded “smart phone” application, which provides a simpler online banking experience and online loan applications are increasing. These results and continued progress come at a time when competition, low 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 late June 2014, the United States Department of Treasury auctioned all 30,407 shares of the Fixed Rate Cumulative Perpetual Preferred Stock, Series A, issued by the Company to Treasury in 2009 under the Troubled Asset Relief Program. The Company’s successful bid resulted in the repurchase of 11,551 shares of Series A Preferred Stock by the Company on July 2, 2014 at the clearing price of $1,207.11 per share. The purchase of the Series A Preferred Stock was funded
through the Company’s sale of 11,666,667 shares of its Class A common stock in a private placement transaction, resulting in proceeds of approximately $14.0 million. The remaining 18,856 shares of the Series A Preferred Stock were purchased in the auction by investors unaffiliated with the Company in transactions directly with Treasury and carry an annual dividend rate of 9%.
A shareholder rights offering conducted by the Company for shares of its Class A common stock concluded on August 8, 2014. Royal issued approximately 5,000,000 shares of its Class A common stock in connection with the offering and received gross proceeds of approximately $6.0 million.
Consolidated Net Income
Net income attributable to the Company for the year ended December 31, 2015 amounted to $11.0 million, or $0.31 per diluted common share, compared to $5.1 million, or $0.14 per diluted common share, for the year ended December 31, 2014. The $5.9 million improvement in net income was mainly related to the following items:
·
A $5.4 million reversal of the valuation allowance for the net deferred tax assets, which contributed to the $5.1 million tax benefit
·
Net interest income grew $1.2 million, or 5%.
·
Net gains on the sale of investment securities increased $523 thousand.
·
Professional and legal fees decreased $467 thousand, or 21%.
Partially offsetting these positive items were increases of $464 thousand, $419 thousand, $299 thousand, and $277 thousand in OREO expenses and impairment, provision for unfunded loan commitments, occupancy and equipment expenses, and employee salaries and benefits, respectively. Our leasing subsidiary continued to positively contribute to the annual financial results.
Loans and leases held for investment at December 31, 2015 totaled $499.1 million, which represents an increase of $84.0 million, or 20.2%, from 2014. New business relationships continue to stimulate the growth and further diversification 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 $2.4 million, or 33.9%, from 2014. Investment securities declined $26.3 million, or 10.5%, from the level at December 31, 2014 due to the reinvestment of cash flows from sales, calls, and principal payments into loans. Cash and cash equivalents decreased $5.4 million to $25.4 million at December 31, 2015. The decrease in cash was primarily the result of funding new loan originations.
Total deposits grew $47.5 million, or 8.9%, from $530.4 million at December 31, 2014 to $577.9 million at December 31, 2015. 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 $35.1 million and $9.9 million, respectively, Additionally, in the third quarter of 2015, we entered into a $25.0 million brokered checking deposit arrangement with a regional financial institution. Partially offsetting these product increase were a $17.6 million decline in higher cost certificates of deposit and a $4.9 million decrease in NOW and money market accounts.
Total borrowings decreased $1.5 million. Long-term borrowings declined $10.5 million while short-term borrowings increased $9.0 million.
Interest Income
Total interest income of $30.0 million for 2015 grew $1.2 million, or 4.2%, from $28.8 million for 2014. The increase was primarily driven by an increase of $2.8 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 $1.6 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 $9.4 million, or 1.4%, from $685.7 million for 2014 to $695.1 million for 2015. During 2015, average loans and leases grew $66.5 million, or 17.3%, to $450.1 million, while average investment securities declined $63.4 million, or 21.7%, to $228.8 million. Average interest-earning deposits increased $6.3 million year over year. During the past year, we sold investment securities with lower yields, shorter maturities, or extension risk in a rising rate environment. Additionally, we sold the majority of the corporate bonds to minimize the credit risk within our portfolio. 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”). For 2015, interest income on loans included $232 thousand that was received upon the payoff of two non-accrual loans. Average loan and investment balances for 2014 were $383.6 million and $292.2 million, respectively.
For 2015, the yield on average interest-earning assets was 4.32% and increased 12 basis points from 4.20% for the comparable period of 2014. Despite the $63.4 million decline in average investments, the average yield on such investments was 2.46% for 2015 and 2014. During 2015, the FHLB of Pittsburgh declared and paid a special dividend based on the 2014 average stock outstanding for each shareholder. We received approximately $94 thousand as a result of this special dividend, which had a positive impact on the average investment yield for 2015. While the average loan balances increased, the average yield on loans decreased 21 basis points (5.41% in 2015 versus 5.62% in 2014). The decline in loan yield reflects the competitive pricing environment we are experiencing for originating and retaining high quality loans.
Interest Expense
For 2015 and 2014 total interest expense was $6.5 million. Interest costs associated with average deposit balances increased $202 thousand and was offset by an equal decline in interest expense on our average borrowings. Average interest-bearing liabilities for 2015 were $575.5 million and declined $9.3 million, or 1.6%, year-over-year. Average interest-bearing deposits of $459.0 million increased $2.8 million, or 0.6%, and included increases of $11.3 million and $2.6 million in savings accounts and NOW and money market accounts, respectively. Partially offsetting these increases was an $11.1 million decrease in average time deposits from the intentional runoff of the higher priced maturing CDs. Average borrowings declined $12.1 million, or 9.4%, to $116.5 million and was accompanied by a $202 thousand decrease in interest expense. Average non-interest bearing demand deposits grew $10.8 million, or 16.4%. Average interest-bearing deposits and borrowings for 2014 were $456.2 million and $128.6 million, respectively.
The average interest rate paid on interest-bearing liabilities amounted to 1.13% for 2015 and increased 2 basis points from 1.11% for 2014. The average interest rate paid on interest-bearing deposits in 2015 amounted to 0.83% and increased 4 basis points from 0.79% for 2014. Despite the decline in average balances for CDs year over year, the average rate paid on this deposit classification increased eight basis points (1.36% in 2015 versus 1.28% in 2014). The average rates paid on savings accounts increased 23 basis points (0.40% in 2015 versus 0.17% in 2014) and NOW and money market accounts increased three basis points (0.34% in 2015 versus 0.31% in 2014). 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. Additionally, we have been running a successful savings account promotion. The average rate paid on average borrowings increased six basis points (2.30% for 2015 versus 2.24% for 2014).
Net Interest Income and Margin
Net interest income for 2015 increased $1.2 million, or 5.4%, to $23.5 million from $22.3 million for 2014. The growth in 2015 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 $66.5 million while average investments declined $63.4 million, primarily to fund the growth in loans. Average cash increased $6.3 million in 2015. Interest expense remained the same at $6.5 million for 2015 and 2014. The $2.8 million net growth in average interest-bearing deposits led to a $202 thousand increase in interest expense on those deposits. We experienced increases in interest expense across all interest-bearing deposit types. The $12.1 million decline in average borrowings resulted in a $202 thousand reduction in interest expense year over year.
For 2015, the net interest margin was 3.38%, a 13 basis point increase from 3.25% for 2014. The 12 basis point increase in average interest-earning assets (4.32% in 2015 versus 4.20% in 2014) was accompanied by a two basis point increase in funding costs (1.13% in 2015 versus 1.11% in 2014). Both the FHLB special dividend of approximately $94 thousand and the collection of approximately $232 thousand in interest income upon the payoff of two non-accrual loans contributed to the improvement in the average yield on interest-earning assets. The average yield on investment securities remained 2.46% despite the $63.4 million decline in the average balance. The 21 basis point decrease in average loan yield (5.41% in 2015 versus 5.62% in 2014) reflects the competitive pricing for new loan originations. Average interest rates paid on average interest-bearing deposits grew four basis points from 0.79% for 2014 to 0.83% for 2015. 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 rates paid on average borrowings (2.25% in 2015 versus 2.19% in 2014) and subordinated debt (2.48% in 2015 versus 2.42% in 2014) increased six basis points.
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:
(1)
Non-accrual loans have been included in the appropriate average loan balance category, but interest on these loans has not been included.
The following table sets forth a rate/volume analysis, which segregates in detail the major factors contributing to the change in net interest income for the years ended December 31, 2015 and 2014, as compared to respective previous periods, into amounts attributable to both rate and volume variances.
Credit for Loan and Lease Losses
Due to the continual improvement in credit quality of the loan portfolio and the decline in historical loss rates, we recorded a credit to the allowance for loan and lease losses of $748 thousand in 2015. The credit to the allowance for loan and lease losses was $867 thousand in 2014. The decline in the credit to the provision is related to the overall growth in the loan portfolio and a $175 thousand increase in net charge-offs year over year. We recorded $1.3 million in net charge-offs in 2015 compared to $1.1 million in 2014. The net charge-offs in both periods were primarily related to specific reserves. Growth in the loan portfolio may require provisions to the allowance for loan and lease losses in future periods.
Non-interest Income
Non-interest income includes service charges on depositors’ accounts and fees for various services such as wire transfers, cash management and debit card processing. In addition, other forms of non-interest income are derived from changes in the cash value of bank owned life insurance (“BOLI”). Most components of non-interest income are a modest and stable source of income, with exceptions of one-time gains and losses from the sale of investment securities, OREO, loans, and premises and equipment. From period to period these sources of income may vary considerably. Service charges on depositors’ accounts and other fees are periodically reviewed by management to remain competitive with other local banks.
For 2015, total non-interest income was $4.0 million and increased $497 thousand, or 14.1%, from $3.5 million for 2014. Net gains on the sale of investment securities increased $523 thousand from $377 thousand in 2014 to $900 thousand for 2015. Because the 10-year US Treasury rate had retreated during the year, we were able to sell certain investment securities which had extension risk in a rising interest rate environment for a net gain, reinvest the proceeds into loans and pay off a $10.0 million FHLB borrowing. Additionally in 2015, we sold the majority of the corporate bonds to minimize the credit
risk within our investment portfolio. Net gains on the sale of OREO increased $176 thousand as we continue to liquidate the tax lien portfolio ($919 thousand in 2015 versus $743 thousand in 2014). Gains on the sale of Company owned real estate increased $217 thousand. In 2015, we sold a Company owned building adjacent to our Narberth location and recorded gains of $324 thousand in 2015. During 2014 we sold one branch property for a gain of $107,000. Partially offsetting these improvements was a $232 thousand decline in gains on the sale of loans and leases ($0 in 2015 versus $232 thousand in 2014). The Company recorded an OTTI charge of $14 thousand related to a private equity investment in 2015 compared to $41 thousand in 2014.
Non-interest Expense
Non-interest expense was relatively flat at $21.9 million for 2015 and 2014. Professional and legal fees declined $467 thousand ($1.7 million in 2015 versus $2.2 million in 2014), which was largely due to the resolution of problem assets. We realized a reduction of $329 thousand in our FDIC and state assessments due to the termination of an informal agreement with the FDIC and the Department in the first quarter of 2015 ($688 thousand in 2015 versus $1.0 million in 2014). Additionally in 2014, we pre-paid $5.0 million in borrowings, with a maturity date in January 2018, and incurred a prepayment penalty of $402 thousand, which is included in other operating expenses on the Consolidated Statements of Income. We did not pre-pay any borrowings in 2015 and therefore did not incur any penalties associated with a prepayment. Offsetting these improvements were increases of $464 thousand in OREO expenses and impairment, $419 thousand in provision for credit losses on off-balance sheet credit exposure, $299 thousand in occupancy and equipment costs and $277 thousand in salaries and benefits. OREO expenses and impairment were $1.4 million in 2015 versus $959 thousand in 2014 and were directly related to the tax lien portfolio. The provision for credit losses on off-balance sheet credit exposure was $425 thousand in 2015 versus $6 thousand in 2014 and was directly impacted by the growth of $26.5 million in the unfunded loan commitments from $55.7 million at December 31, 2014 to $82.0 million at December 31, 2015. Occupancy and equipment costs were $3.0 million in 2015 compared to $2.7 million in 2014. The increase in occupancy and equipment costs was the result of a $399 thousand increase in rent expense due to the branch relocations in 2014 and 2015 and the consolidation of non-retail personnel in the Bala Cynwyd Customer Center, each designed for improved marketability and future efficiency. Salaries and benefits were $10.4 million for 2015 compared to $10.2 million for 2014. To attract and retain employees we redesigned our incentive and benefits programs. Both the increase in occupancy and equipment expenses and salaries and benefits were was fully integrated into our budget.
Accounting for Income Tax Expense
In 2015, we recorded a tax benefit of $5.1 million compared to $654 thousand for 2014. 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. We are required to establish a valuation allowance for DTAs 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. Prior to 2015, a full valuation allowance was recorded against the DTA based on the available evidence at that time. Management performs this analysis on an annual basis or sooner if significant events occur which would affect the ability to utilize these DTAs in the future. Based on the analysis of the DTAs at December 31, 2015, 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 $5.4 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 positive evidence that outweighed the negative evidence in management’s assessment included, but was not limited to, the following:
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Positive cumulative pre-tax earnings over the prior three year period ended December 31, 2015.
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Improvement in asset quality and net interest income.
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Management’s consistent ability to exceed annual forecasted financial results.
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Significant reductions in historical credit-related losses and investment impairment.
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Net operating loss carryforwards do not begin to expire until 2028.
As of December 31, 2015 and December 31, 2014 the valuation allowance for deferred tax assets totaled $30.6 million and $39.1 million, respectively. The ability to recognize the remaining DTAs 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. There can be no assurance, however, as to when we could be in a position to reverse the remaining DTA valuation allowance. The deferred tax assets/ (liabilities), net of valuation allowances, totaled $5.7
million and $(308) thousand at December 31, 2015 and 2014, respectively. In 2014, we received a federal tax refund of $654 thousand due to an amended tax return.
The Company’s effective tax rate is the provision for federal income taxes expressed as a percentage of income or loss before federal income taxes. The effective tax rate for the twelve months ended December 31, 2015 and 2014 was 0%. In general our effective tax rate is different from the federal statutory rate primarily due to the valuation allowance which was $30.6 million as of December 31, 2015. For more information refer to “Note 12 - Income Taxes” to the Consolidated Financial Statements in Item 8 of this Report.
Results of Operations by Business Segments
Under FASB ASC Topic 280, “Segment Reporting” (“ASC Topic 280”), management of the Company has identified two reportable operating segments, “Community Banking” and “Tax Liens”. Operating segments are components of an enterprise, which are evaluated regularly by the chief operating decision makers in deciding how to allocate and assess resources and performance. Our chief operating decision makers are the Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”).
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Community Bank segment: At December 31, 2015, the Community Bank segment had total assets of $774.3 million, an increase of $61.8 million, or 8.7%, from $712.5 million at December 31, 2014. Total deposits increased $47.5 million, or 8.9%, from $530.4 million at December 31, 2014 to $577.9 million at December 31, 2015. Net interest income for 2015 was $23.7 million compared to $22.1 million for 2014 representing an increase of $1.6 million, or 7.3%. The improvement in net interest income was primarily attributed to an increase in interest income due to the growth and change in the composition of average interest-earning assets. The credit to the allowance for loan and lease losses was $846 thousand in 2015 compared to $1.3 million for 2014 as a result of growth in the loan portfolio and a $293 thousand increase in loan and lease charge-offs. For 2015, total non-interest income was $2.9 million compared to $2.6 million for 2014. The increase was mostly attributed to a $523 thousand increase in the net gains on the sale of investment securities mitigated by a $232 thousand reduction in the net gains on the sale of loans and leases. For 2015 and 2014, total non-interest expense was $19.8 million. Occupancy and equipment costs and salaries and benefits were up $299 thousand and $277 thousand, respectively, in 2015. FDIC and state assessments and professional and legal fees declined $329 thousand and $252 thousand, respectively in 2015. In 2015, we released $5.4 million of our valuation allowance previously recorded on the net DTAs. As a result of this transaction, the net tax benefit recorded for 2015 was $5.1 million compared to $654 thousand for 2014. Net income for 2015 was $12.2 million compared to $6.4 million for 2014.
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Tax Liens segment: At December 31, 2015, the Tax Liens segment had total assets of $14.0 million compared to $20.0 million at December 31, 2014 representing a decrease of $6.0 million, or 30.0%. The Tax Liens segment had net interest income of $217 thousand in 2014 compared to net interest expense of $181 thousand for 2015. The provision for lien losses decreased $363 thousand from $461 thousand in 2014 to $98 thousand in 2015. The improvement in the 2015 provision was mostly related to the declining portfolio balance. Total non-interest income was $1.1 million in 2015 compared to $896 thousand in 2014. Non-interest income is derived mostly from the gains on sale of OREO property. Total non-interest expense was $2.1 million for 2015 and 2014. OREO expenses and impairment increased $426 thousand while professional and legal fees declined $215 thousand in 2015. Net loss attributed to the tax liens segment was $1.2 million in 2015 compared to $1.3 million for 2014.
Financial Condition
Total assets grew $55.7 million to $788.3 million at December 31, 2015 from $732.6 million at year-end 2014.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash on hand and cash in interest bearing and non-interest bearing accounts in banks. Cash and cash equivalents declined $5.4 million from $30.8 million at December 31, 2014 to $25.4 million at December 31, 2015. The average balance of cash and cash equivalents was approximately $30.3 million for 2015 versus $20.3 million for 2014. The majority of this average balance was held in interest-bearing accounts with other financial institutions which were paying a higher interest rate than federal funds. The excess cash is invested daily in money market funds. The increase in cash and cash equivalents was mainly associated with the sale of investment securities and an increase in demand deposits.
Investment Securities Available for Sale (“AFS”)
AFS investment securities represented 32.9% of average interest earning assets during 2015 and consisted of government secured agency bonds, government secured mortgage-backed securities, collateralized mortgage obligations (“CMOs”), municipal bonds, domestic corporate debt, and third party managed equity funds. At December 31, 2015, AFS investment securities were $224.1 million with a net unrealized loss of $41 thousand compared to $250.4 million with a net unrealized gain of $2.3 million at December 31, 2014. The $26.3 million reduction in investment securities was partially due to the reinvestment of cash flows from sales, principal payments, and calls into loans. The swing to a net unrealized loss was predominantly impacted by a $1.3 million decline in the unrealized gain on agency CMOs. Additionally, the net unrealized gain on other securities decreased $906 thousand as some of the funds were sold and gains realized as a result of these sales. These securities carry lower coupons and their market value was negatively impacted by a increase in the 10-year Treasury yield from 2.17% at December 31, 2014 to 2.27% at December 31, 2015. Refer to “Note 3- Investment Securities” to the Consolidated Financial Statements in Item 8 for more information.
The following tables present the consolidated amortized cost and approximate fair value at December 31, 2015 and 2014, respectively, for each major category of the Company’s AFS investment securities portfolio.
The contractual maturity distribution and weighted average rate of our AFS debt securities at December 31, 2015 are presented in the following table. Mortgage-backed securities and collateralized mortgage obligations are presented within the category that represents the total weighted average expected maturity.
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 under FASB ASC Topic 320, “Investments-Debt & Equity Securities” (“ASC Topic 320”). Non-agency collateralized mortgage obligations may be evaluated under FASB ASC Topic 320 Subtopic 40, “Beneficial Interests in Securitized Financial Assets” under FASB ASC Topic 325, “Investments-Other”. In determining whether OTTI exists, management considers numerous factors, including but not limited to: (1) the length of time and the extent to which the fair value is less than the amortized cost, (2) our intent to hold or sell the security, (3) the financial condition and results of the issuer including changes in capital, (4) the credit rating of the issuer, (5) analysts’ earnings estimate, (6) industry trends specific to the security, and (7) timing of debt maturity and status of debt payments. If we intend to sell a security or will be required to sell a security, the OTTI is recognized in earnings equal to the entire difference between the fair value and the amortized cost basis at the balance sheet date. If we do not intend to sell a security and it is not more likely than not that we will be required to sell a security before the recovery of its amortized cost basis, the OTTI is separated into two amounts, the credit related loss and the loss related to other factors. The credit related loss is based on the present value of the expected cash flows and is recognized in earnings. The noncredit-related loss is based on other factors such as illiquidity and is recognized in other comprehensive income. We recorded an OTTI charge of $14 thousand related to a private equity investment in 2015 compared to $41 thousand in 2014.
Loans and Lease Financing Receivables
Our primary earning assets are loans, representing approximately 64.8% of average interest-earning assets during 2015. We originate loans primarily in the greater Philadelphia metropolitan area as well as selected locations throughout the Mid-Atlantic region. We also have participated with other financial institutions in selected construction and land development loans outside these geographic areas. The loan portfolio consists primarily of commercial demand loans and commercial mortgages secured by real estate, leases, and to a significantly lesser extent, tax liens and residential loans comprised of one to four family residential and home equity loans. We have a concentration of credit risk in commercial real estate and construction and land development loans, which represented 54.8% of total loans at December 31, 2015 compared to 53.2% of total loans at December 31, 2014.
During 2015, total loans grew $84.0 million from $415.1 million at December 31, 2014 to $499.1 million at December 31, 2015. The growth was attributed to new loan originations partially offset by balances being paid down, payoffs, charge-offs, and transfers to OREO.
The loans receivable portfolio is segmented into commercial loans, construction and development loans, residential loans, leases, tax certificates, and consumer loans. The commercial loan segment consists of the following classes: commercial real estate loans, multi-family real estate loans, and other commercial loans, which are also generally known as commercial and industrial loans or commercial business loans. The construction and development loan segment consists of the following classes: residential construction and commercial construction loans. Residential construction loans are made for the acquisition of and/or construction on a lot or lots on which a residential dwelling is to be built. Commercial construction loans are made for the purpose of acquiring, developing and/or constructing a commercial structure. The residential loan segment consists of the following classes: one- to four-family first lien residential mortgage loans, home equity lines of credit, and home equity loans. We classify our leases as finance leases, in accordance with FASB ASC Topic 840, “Leases”. The difference between our gross investment in the lease and the cost or carrying amount of the leased property, if different, is recorded as unearned income, which is amortized to income over the lease term by the interest method. The tax certificate segment includes delinquent property tax certificates that have been acquired through public auctions in various jurisdictions. The tax certificates assume a lien position that is generally superior to any mortgage liens that are on the property and have certain foreclosure rights as defined by state law. The tax certificates are predominantly in New Jersey. We ceased acquiring new tax certificates in 2010. Consumer loans includes cash secured and unsecured loans and lines of credit.
Commercial Loans: The commercial real estate loan portfolio consists primarily of loans secured by office buildings, retail and industrial use buildings, strip shopping centers, mixed-use and other properties used for commercial purposes primarily located in our market area. Although terms for commercial real estate and multi-family loans vary, the underwriting standards generally allow for terms up to 10 years with the interest rate being reset in the sixth year and with monthly amortization not greater than 25 years and loan-to-value ratios of not more than 80%. Interest rates are either fixed or adjustable and are predominantly based upon the prime rate or a borrowing rate from the Federal Home Loan Bank of Pittsburgh plus a margin. Prepayment fees are charged on most loans in the event of early repayment. Generally, the personal guarantees of the principals are obtained as additional collateral for commercial real estate and multi-family real estate loans.
Commercial and multi-family real estate loans generally present a higher level of risk than loans secured by one- to four-family residences. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effect of general economic conditions on income producing properties and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by commercial and multi-family real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed, a bankruptcy court modifies a lease term, or a major tenant is unable to fulfill its lease obligations), the borrower’s ability to repay the loan may be impaired.
Our commercial business loans generally have been made to small to mid-sized businesses predominantly located in our market area. The commercial business loans are either a revolving line of credit or for a fixed term of generally 10 years or less. Interest rates are adjustable, indexed to a published prime rate of interest, or fixed. Generally, equipment, machinery, real property or other corporate assets secure such loans. Personal guarantees from the business principals are generally obtained as additional collateral. Generally, commercial business loans are characterized as having higher risks associated with them than single-family residential loans.
Our underwriting procedures include evaluations of the stability of the property’s cash flow history, future operating projections, current and projected occupancy levels, location and physical condition. Generally, we require a debt service ratio (the ratio of net cash flows from operations before the payment of debt service to debt service) of not less than 120%. We also evaluate the credit and financial condition of the borrower, and if applicable, the guarantor. Appraisal reports prepared by independent appraisers are obtained on each loan to substantiate the property’s market value, and are reviewed prior to the closing of the loan.
Construction and Development Loans: We originate construction loans to builders and developers predominantly in our market area. Construction and development loans are riskier than other loan types because they are more speculative in nature. Deteriorating economic or environmental conditions can negatively affect a project. Construction loans are also more difficult to evaluate and monitor. In order to mitigate some of the risks inherent in construction lending, limits are placed on the number of units that can be built on a speculative basis based upon the reputation and financial position of the builder, his/her present obligations, the location of the property and prior sales in the development and the surrounding area. Additionally, the construction budget is reviewed prior to loan origination and the properties under construction are inspected. During the construction phase of a real estate project, the loan requires interest payments only. Construction loans generally are for 12 to 18 months with loan-to-value ratios of not more than 75%. Most construction loans are assigned an initial risk rating of pass-watch due to the riskier nature of the loan.
Residential Loans: Our residential mortgages were acquired in recent years in pool purchases and are secured primarily by properties located in our primary market and surrounding areas. We originate home equity loans and home equity lines of credit in our market area with a general maximum amount of $250 thousand. The collateral must be the borrower’s primary residence and the loan-to-value does not exceed 80%. Home equity lines of credit are variable rate and are indexed to the prime rate. Our home equity loans are either first or second liens and have a fixed rate.
Consumer Loans: We originate cash-secured and unsecured loans and lines of credit to individuals. Unsecured loans and lines of credit have a maximum amount of $15 thousand. Unsecured consumer loans generally have a higher interest rate than residential loans because they have additional credit risk associated with them.
In the past we have made loans to the officers and directors of the Company and to their associates. In accordance with Regulation O related party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than normal risk of collectability. There were no related party loans outstanding at December 31, 2015 and 2014. Total payments received on related party loans in 2014 were $100 thousand.
The following table reflects the composition of the loan portfolio and the percent of gross loans outstanding represented by each category at the dates indicated.
*For the 2013 through 2015 periods, unearned income was allocated among the various loan types.
Credit Classification Process and Credit Risk Management
We use a nine point grading risk classification system commonly used in the financial services industry. The first four classifications are rated Pass. The riskier classifications include Pass-Watch, Special Mention, Substandard, Doubtful and Loss. During the underwriting process, the Chief Credit Officer (“CCO”) assigns each loan with an initial risk rating, which is approved by the appropriate loan committee. From time to time, and at the general direction of any of the various loan committees, the ratings may be changed based on the findings of that committee. Items considered in assigning ratings include the financial strength of the borrower and/or guarantors, the type of collateral, the collateral lien position, the type of loan and loan structure, any potential risk inherent in the specific loan type, higher than normal monitoring of the loan or any other factor deemed appropriate by any of the various committees for changing the rating of the loan. Any such change in rating is reflected in the minutes of that committee.
The loan review function is outsourced to a third party vendor which examines credit quality and portfolio management. The loan review vendor applies our loan rating system to specific credits and reviews approximately 50% of the total commercial loan portfolio. Emphasis is on the larger new and seasoned loan relationships and includes criticized and classified loans. Additionally, the loan review vendor ensures that all critical industry segments are adequately represented in their review. The loan review vendor will also review loans specifically requested by management. Upon completion of a loan review, a copy of any review receiving an adverse classification by the reviewer is presented to the Classified, Charge-off and Impairment Committee (“CCIC”) for discussion. The CCO is the primary bank officer dealing with the third party vendor during the reviews.
Loans on our Special Assets Committee list are also subject to loan review even though they are receiving the daily attention of an assigned individual and the attention of the Special Assets Committee. A watch list is maintained and reviewed at each meeting of CCIC. CCIC was formed to formalize the process and documentation required to classify, remove from classification, impair or charge-off a loan. The CCIC, which is comprised of the CEO, CFO, CCO, Chief Lending Officer
(“CLO”), and Chief Accounting Officer (“CAO”) meet as required and provide regular updated reports to the Board of Directors. Loans are added to the watch list, even though the loans may be current or less than 30 days delinquent if they exhibit elements of substandard creditworthiness. The watch list contains a statement for each loan as to why it merits special attention, and this list is distributed to the Board of Directors on a quarterly basis. Loans may be removed from the watch list if the CCIC determines that exception items have been resolved or creditworthiness has improved. Additionally, if loans become serious collection matters and are listed on our monthly delinquent loan or Special Assets Committee lists, they may be removed from the watch list. Minutes outlining the CCIC’s findings and recommendations are issued after each meeting for follow-up by individual loan officers.
Non-performing assets
The following table presents the principal amounts of non-accrual loans held for investment and other real estate owned:
(1)
Generally, a loan is placed in non-accrual status when it has been delinquent for a period of 90 days or more, unless the loan is both well secured and in the process of collection.
Non-accrual loan activity for 2015 is set forth below:
Total non-accrual loans at December 31, 2015 were $5.5 million compared to $9.8 million at December 31, 2014. The $4.3 million decline in non-accrual loans was the result of a $4.1 million reduction in existing non-accrual loan balances through payments or payoffs, $2.5 million in charge-offs related to impairment, and transfers to OREO of $4.3 million, which collectively were offset by $6.6 million in additions. The majority of the new non-accrual activity and transfers to OREO originated from the tax certificate portfolio. Commercial real estate, tax certificates, and leases represented 27.2%, 20.5%, and 19.8%, respectively, of the total $5.5 million in non-accrual loans at December 31, 2015.
Impaired Loans
We identify a loan as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. For all classes of loans receivable, with the exception of tax certificates, the accrual of interest is discontinued on a loan when management believes that the borrower’s financial condition is such that collection of principal and interest is doubtful or when a loan becomes 90 days past due. Impaired loans include TDRs. Excess proceeds received over the principal amounts due on impaired non-accrual loans are recognized as income on a cash basis. We
recognize income under the accrual basis when the principal payments on the loans become current and the collateral on the loan is sufficient to cover the outstanding obligation to the Company. If these factors do not exist, we do not recognize interest income. If interest had accrued on these loans, such income would have been approximately $703 thousand and $1.0 million for the years ended December 31, 2015 and 2014, respectively. At December 31, 2015, the Company had no loans past due 90 days or more on which interest continues to accrue. Total cash collected on impaired loans during the year ended December 31, 2015 and 2014 was $9.6 million and $7.0 million respectively, of which $8.4 million and $6.4 million was credited to the principal balance outstanding on such loans, respectively.
The following is a summary of information pertaining to impaired loans and leases:
*Includes loans held for sale during 2014.
Troubled Debt Restructurings
A loan modification is deemed a TDR when two conditions are met: 1) the borrower is experiencing financial difficulty and 2) concessions are made by the Company that would not otherwise be considered for a borrower or collateral with similar credit risk characteristics. All loans classified as TDRs are considered to be impaired. TDRs are returned to an accrual status when the loan is brought current, has performed in accordance with the contractual restructured terms for a reasonable period of time (generally six months) and the ultimate collectibility of the total contractual restructured principal and interest is no longer in doubt. At December 31, 2015, the Company had six TDRs, with a total carrying value of $2.6 million. At the time of the modifications, three of the loans were already classified as impaired non-accrual loans. At December 31, 2014, the Company had 12 TDRs with a total carrying value of $8.8 million. The $6.2 million decline in TDRs was mainly due to principal payments and payoffs. One construction and land development TDR was transferred to OREO in 2015. Our policy for TDRs is to recognize income on currently performing restructured loans under the accrual method.
The following table details the Company’s TDRs that are on an accrual status and a non-accrual status at December 31, 2015.
As of December 31, 2015, the one construction and land development TDR, cited in the above table, was not in compliance with its restructured terms due to payment defaults. There were no TDRs not in compliance with their restructured terms in 2014. We did not have any newly restructured loans that fit the criteria for a TDR during the year ended December 31, 2015.
We may obtain physical possession of real estate collateralizing residential mortgage loans or home equity loans through or in lieu of, foreclosure. As of December 31, 2015, we did not have any foreclosed residential real estate property as a result of physical possession. However, as of December 31, 2015, we had residential mortgage loans with a carrying value of $399 thousand collateralized by residential real estate property for which formal foreclosure proceedings were in process.
Potential Problem Loans
Potential problem loans are loans not currently classified as non-performing loans, but for which management has doubts as to the borrowers’ ability to comply with present repayment terms. The loans are usually delinquent more than 30 days but less than 90 days. Potential problem loans amounted to approximately $3.3 million and $3.4 million at December 31, 2015 and December 31, 2014, respectively.
Allowance for loan and lease losses (“allowance”)
Our loan and lease portfolio (the “credit portfolio”) is subject to varying degrees of credit risk. We maintain an allowance to absorb losses in the loan and lease portfolio. The allowance is based on the review and evaluation of the loan and lease portfolio, along with ongoing, quarterly assessments of the probable losses inherent in that portfolio. The allowance represents an estimation made pursuant to FASB ASC Topic 450, “Contingencies” (“ASC Topic 450”) or FASB ASC Topic 310, “Receivables” (“ASC Topic 310”). The adequacy of the allowance is determined through evaluation of the credit portfolio, and involves consideration of a number of factors, as outlined below, to establish a prudent level.
Determination of the allowance is inherently subjective and requires significant estimates, including estimated losses on pools of homogeneous loans and leases based on historical loss experience and consideration of current economic trends, which may be susceptible to significant change. Loans and leases deemed uncollectible are charged against the allowance, while recoveries are credited to the allowance. Management adjusts the level of the allowance through the provision for loan and lease losses, which is recorded as a current period expense. Our systematic methodology for assessing the appropriateness of the allowance includes: (1) general reserves reflecting historical loss rates by loan type, (2) specific reserves for risk-rated credits based on probable losses on an individual or portfolio basis and (3) qualitative reserves based upon current economic conditions and other risk factors.
The loan portfolio is stratified into loan classifications that have similar risk characteristics. The general allowance is based upon historical loss rates using a weighted three-year rolling average of the historical loss experienced within each loan classification. The qualitative factors used to adjust the historical loss experience address various risk characteristics of the Company’s loan and lease portfolio include evaluating: (1) trends in delinquencies and other non-performing loans, (2) changes in the risk profile related to large loans in the portfolio, (3) changes in the growth trends of categories of loans comprising the loan and lease portfolio, (4) concentrations of loans and leases to specific industry segments, and (5) changes in economic conditions on both a local and national level, (6) quality of loan review and board oversight, (7) changes in lending policies and procedures, and (8) changes in lending staff. Each factor is assigned a value to reflect improving, stable or declining conditions based on management’s best judgment using relevant information available at the time of the evaluation. Adjustments to the factors are supported through documentation of changes in conditions in a report accompanying the allowance calculation.
The specific reserves are determined utilizing standards required under ASC Topic 310. A loan is considered impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. Non-accrual loans and loans restructured under a TDR are evaluated for impairment on an individual basis considering all known relevant factors that may affect loan collectability such as the borrower’s overall financial condition, resources and payment record, support available from financial guarantors and the sufficiency of current collateral values (current appraisals or rent rolls for income producing properties), and risks inherent in different kinds of lending (such as source of repayment, quality of borrower and concentration of credit quality). Non-accrual loans that experience insignificant payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed.
Impairment is measured on a loan by loan basis for commercial and industrial loans, commercial real estate loans and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent. The estimated fair values of substantially all of the Company’s impaired loans are measured based on the estimated fair value of the loan’s collateral. We obtain third-party appraisals to establish the fair value of real estate collateral. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property. For commercial and industrial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Once a loan is determined to be impaired it will be deducted from the portfolio balance and the net remaining balance will be used in the general and qualitative analysis. A specific reserve is established for an impaired loan for the amount that the carrying value exceeds its estimated fair value.
The amount of the allowance is reviewed and approved by the CLO, CFO, CCO, and the Chief Risk Officer (“CRO”) on at least a quarterly basis. Management believes that the allowance for loan and lease losses at December 31, 2015 is adequate. However, its determination requires significant judgment, and estimates of probable losses inherent in the credit portfolio can vary significantly from the amounts actually observed. While management uses available information to recognize probable losses, future changes to the allowance may be necessary. These changes could be based in the credits comprising the portfolio and changes in the financial condition of borrowers, as the result of changes in economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the credit portfolio and the allowance. Such review may result in additional provisions based on their judgment of information available at the time of each examination.
Analysis of the Allowance for Loan and Lease Losses:
Analysis of the Allowance for Loan and Lease Losses by Loan Type:
Due to the continual improvement in credit quality of the loan portfolio and the decline in historical loss rates, we recorded a credit to the allowance for loan and lease losses of $748 thousand in 2015. The credit to the allowance for loan and lease losses was $867 thousand in 2014. The decline in the credit to the provision is related to the overall growth in the loan portfolio and a $175 thousand increase in net charge-offs year over year. We recorded $1.3 million in net charge-offs in 2015 compared to $1.1 million in 2014. The net charge-offs in both periods were primarily related to specific reserves. Commercial real estate, tax certificates, and leases represented 27.2%, 20.5%, and 19.8%, respectively, of the total $5.5 million in non-accrual loans at December 31, 2015. Commercial real estate, commercial, and construction and land development loans represented 37.5%, 25.7%, and 6.5%, respectively, of the total $9.8 million in non-accrual loans at December 31, 2014. Total charge-offs recorded in 2015 related to construction and land development loans and commercial real estate loans were $886 thousand, or 35.0%, of total charge-offs in 2015. Total charge-offs recorded in 2014 related to construction and land development loans and commercial real estate loans were $526 thousand, or 24.8%, of total charge-offs in 2014.
Other Real Estate Owned (“OREO”)
At December 31, 2015, OREO is comprised of two real estate properties acquired through, or in lieu of foreclosure in settlement of loans and 60 real estate properties acquired through foreclosure related to tax liens. Set forth below is a table which detail the changes in OREO from December 31, 2014 to December 31, 2015
At December 31, 2015, OREO was comprised of $215 thousand in land, $7.2 million in tax liens, and residential real estate, related to a condominium construction project in Minneapolis, Minnesota in which we are a participant with a fair value of $5 thousand. During 2015, we sold two land parcels and 11 residential condominiums which related to three loan
relationships. We received $268 thousand in net proceeds and recorded a net gain of $50 thousand as a result of these sales. During 2015, we recorded impairment charges of $125 thousand on the two land parcels that were sold during the year based on their agreements of sale. In 2015, we foreclosed on one commercial real estate property and one single family home that were sold during the period. We received net proceeds of $1.5 million and recorded a net gain of $10 thousand as a result of these two sales. Additionally, we received a deed in lieu on a land parcel in New Jersey and transferred the carrying value of $215,000 from loans to OREO.
At December 31, 2015, OREO assets acquired through the tax lien portfolio were comprised of 60 properties, were valued at $7.2 million, and were primarily located in New Jersey. In 2015, we transferred $2.7 million to OREO which represented 31 separate properties. During 2015, the Company sold 48 of the tax lien properties, received proceeds of $4.7 million, and recorded net gains of $859 thousand as a result of these sales. Additionally, we recorded impairment charges of $578 thousand in 2015 related to the tax lien properties. During the third quarter of 2015, we reached an agreement with a tax payer, which was settled through a bankruptcy court. Under the agreement the tax payer is required to pay us monthly interest payments and annual principal reduction payments for the next three years. In exchange we transferred title to the property back to the tax payer while maintaining a lien on the property. After receiving a principal reduction payment of $250,000, we transferred the remaining balance of $995,000 to tax liens. No gain or loss was recorded on this transaction. At December 31, 2014, OREO assets acquired through the tax lien portfolio were $9.4 million and were comprised of 79 properties.
The Company is working to satisfactorily sell the remaining OREO properties. However, we recognize that the successful disposition of the properties, specifically the land, will likely take considerable time.
Other Assets
Other Assets were $12.9 million and $7.2 million at December 31, 2015 and December 31, 2014, respectively. The $5.7 million increase in other assets was due to the $5.7 million net deferred tax asset at December 31, 2015. Please see discussion under “Accounting for Income Taxes.”
Deposits
Our customer deposits are an important source of funding. Total deposits of $577.9 million at December 31, 2015 increased $47.5 million, or 8.9%, from $530.4 million at December 31, 2014. Savings accounts grew $35.1 million, or 188%, from $18.7 million at December 31, 2014 to $53.8 million at December 31, 2015. Non-interest checking accounts grew $9.8 million, or 13.4%, to $83.5 million at December 31, 2015 from $73.7 million at December 31, 2014. NOW and money market accounts decreased $4.9 million while time deposit accounts of $225.3 million at December 31, 2014 declined $17.6 million, or 7.8%, to $207.7 million at December 31, 2015, primarily as a result of us electing to partially run off the higher cost deposits. Additionally, in the third quarter of 2015, we entered into a $25.0 million brokered checking deposit arrangement with a regional financial institution.
The average balance of the Company’s deposits by major classifications for each of the last three years is presented in the following table.
The remaining maturity of Certificates of Deposit of $100,000 or greater:
Short and Long Term Borrowings
FHLB Borrowings
Borrowings consist of long-term borrowings (advances) and short-term borrowings (overnight borrowings, advances). Total FHLB borrowings were $54.0 million and $55.0 million at December 31, 2015 and 2014, respectively. The maturity dates of the FHLB borrowings range from 2016 through 2018. The weighted average rate on the outstanding FHLB borrowings at December 31, 2015 was 1.35% compared to 1.36% at December 31, 2014.
Other Borrowings
We have a note payable with PNC Bank (“PNC”) as of December 31, 2015 in the amount of $2.0 million with a maturity date of August 25, 2016. The note payable balance as of December 31, 2014 was $2.4 million. The interest rate is a variable rate using a rate index of one month LIBOR + 15 basis points and adjusts monthly. The interest rate at December 31, 2015 and 2014 was 0.57% and 0.31%, respectively. At December 31, 2015 and 2014, we had other borrowings of $35.0 million from PNC which will mature on January 7, 2018. These borrowings are secured by government agencies and mortgaged-backed securities and have a weighted average interest rate of 3.65%. During the fourth quarter of 2014, the Company pre-paid $5.0 million in principal to reduce future interest expense. Although a prepayment penalty of $402 thousand was incurred, the transaction benefited the Company because the interest rate on the borrowing was 3.60%, significantly higher than current market rates. As of December 31, 2015, investment securities with a market value of $43.8 million were pledged as collateral to secure all $37.0 million in borrowings with PNC.
At December 31, 2015, Royal Bank had $20.0 million in lines of credit, of which $0 was outstanding, with two local financial institutions compared to a $10.0 million line of credit, of which $0 was outstanding at December 31, 2014.
Subordinated Debentures
We have outstanding $25.0 million of trust preferred securities which have a maturity date of October 2034. The interest rate resets quarterly at 3-month LIBOR plus 2.15% and was 2.66% at December 31, 2015. On August 13, 2009, our Board suspended the interest payments on the trust preferred securities. Under the Federal Reserve Agreement as described in “Note 2 - Regulatory Matters and Significant Risks or Uncertainties” to the Consolidated Financial Statements, the Company and its non-bank subsidiaries may not make any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without the prior written approval of the Reserve Bank and the Director of the
Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System. We received approval and paid the required interest payments in 2015 and 2014.
Other Liabilities
At December 31, 2015 and December 31, 2014, other liabilities were $20.6 million. The largest component of other liabilities is the unfunded benefit obligation related to our pension plan. We plan to fund a substantial portion of this obligation through existing Company owned life insurance policies. For more information refer to “Note 17 - Pension Plan” to the Consolidated Financial Statements in Item 8 of this Report.
Shareholders’ Equity
Shareholders’ equity attributable to the Company grew $9.7 million, or 15.6%, from $62.2 million at December 31, 2014 to $71.9 million at December 31, 2015. The increase was related to net income of $11.0 million for 2015 which was partially offset by other comprehensive loss of $1.4 million. The other comprehensive loss was mostly related to a decline in the valuation of the investment portfolio. The distributions to non-controlling interests of $524 thousand and $266 thousand for 2015 and 2014, respectively, were to the 40% owners of RBA Leasing and were for tax distributions.
Asset Liability Management
The primary functions of asset-liability management are to ensure adequate liquidity and maintain an appropriate balance between interest-earning assets and interest-bearing liabilities. This process is overseen by the Asset-Liability Committee (“ALCO”) which monitors and controls, among other variables, the liquidity, balance sheet structure and interest rate risk of the consolidated company within policy parameters established and outlined in the ALCO Policy which are reviewed by the Board of Directors at least annually. Additionally, the ALCO committee meets monthly and reports on liquidity and interest rate sensitivity and projects financial performance in various interest rate scenarios.
Liquidity: Liquidity is the ability to ensure that adequate funds will be available to meet our financial commitments as they become due. In managing its liquidity position, all sources of funds are evaluated, the largest of which is deposits. Also taken into consideration are securities maturing in one year or less, other short-term investments and the repayment of loans. These sources provide alternatives to meet our short-term liquidity needs. Longer liquidity needs may be met by issuing longer-term deposits and by raising additional capital. The liquidity ratios are specifically defined as the ratio of net cash, available FHLB and other lines of credit, and unpledged marketable securities relative to both total deposits and total liabilities.
We generally target liquidity ratios equal to or greater than 12% and 10% of total deposits and total liabilities, respectively. At December 31, 2015, liquidity as a percent of deposits was 67% and liquidity as a percent of total liabilities was 55%. At December 31, 2014, liquidity as a percent of deposits was 67% and liquidity as a percent of total liabilities was 53%. Management believes that our liquidity position continues to be adequate and meets or exceeds the liquidity target set forth in the Asset/Liability Management Policy. Management believes that due to its financial position, it will be able to raise deposits as needed to meet liquidity demands. However, any financial institution could have unmet liquidity demands at any time.
Our funding decisions can be influenced by unplanned events, which include, but are not limited to, the inability to fund asset growth, difficulty renewing or replacing funds that mature, the ability to maintain or draw down lines of credit with other financial institutions, significant customer withdrawals of deposits, and market disruptions. We have a liquidity contingency plan in the event liquidity falls below an acceptable level, however in today’s economic environment, events could arise that may render sources of liquid funds unavailable in the future when required. Our ALCO meets monthly to monitor liquidity management.
Contractual Obligations and Other Commitments: The following table sets forth contractual obligations and other commitments representing required and potential cash outflows as of December 31, 2015.
((1) Includes principal and expected interest payments
Capital Adequacy
In connection with a prior bank regulatory examination, the FDIC concluded, based upon its interpretation of the Consolidated Reports of Condition and Income (the “Call Report”) instructions and under regulatory accounting principles (“RAP”), that income from Royal Bank’s tax lien business should be recognized on a cash basis, not an accrual basis. Royal Bank’s current accrual method is in accordance with U.S. GAAP. Royal Bank disagrees with the FDIC’s conclusion and filed the Call Report for December 31, 2015 and the previous 21 quarters in accordance with U.S. GAAP. The change in the method of revenue recognition for the tax lien business for regulatory accounting purposes affects Royal Bank’s capital ratios as shown below. The resolution of this matter will be decided by additional joint regulatory agency guidance which includes the Federal Reserve Bank, the FDIC, and the Office of the Comptroller of the Currency (“OCC”).
The table below sets forth Royal Bank’s capital ratios under RAP, based on the FDIC’s interpretation of the Call Report instructions:
The tables below reflect the adjustments to the net loss as well as the capital ratios under U.S. GAAP:
The tables below reflect the Company’s capital ratios and the Company’s performance ratios:
We have filed the Consolidated Financial Statements for Bank Holding Companies-FR Y-9C (“FR Y-9C”) as of December 31, 2015 consistent with U.S. GAAP and the FR Y-9C instructions. In the event that a similar adjustment for RAP purposes would be required by the Federal Reserve on the holding company level, the adjusted ratios are shown in the table below.
The capital ratios set forth above compare favorably to the minimum required amounts of Tier 1 and total capital to risk-weighted assets and the minimum Tier 1 leverage ratio, as defined by the banking regulators. At December 31, 2015, the Company met the regulatory minimum capital requirements, and management believes that, under current regulations, the Company will continue to meet its minimum capital requirements in the foreseeable future. Royal Bank met the criteria for a well-capitalized institution which is a leverage ratio of 5%, a Tier 1 ratio of 8%, and a total capital ratio of 10%.
Management Options to Purchase Securities
The 2007 Long-Term Incentive Plan was approved by shareholders at the 2007 Annual Meeting. All employees and non-employee directors of the Company and its designated subsidiaries are eligible participants. The plan includes 1,000,000 shares of Class A common stock (of which 250,000 shares may be issued as restricted stock), subject to customary anti-dilution adjustments, or approximately 4.0% of total outstanding shares of the Class A common stock. As of December 31, 2015, options to purchase 296,869 shares from this plan have been granted. The option price is equal to the fair market value
at the date of the grant. The options are exercisable based on the vesting schedule of the specific grant and begin one year after the date of grant. The options must be exercised within ten years of the grant. At December 31, 2015, 271,869 of the options that have been granted are outstanding. The restricted stock is granted with an estimated fair value equal to the market value of the Company closing stock price on the date of the grant. Restricted stock will vest three years from the grant date, if we achieve specific goals set by the Compensation Committee and approved by the Board of Directors. At December 31, 2015, 25,000 shares of restricted stock were outstanding. We had a non-qualified outside directors’ stock option plan and a non-qualified employee stock option and appreciation rights plan. The ability to grant new options under these two plans expired. At December 31, 2015, 4,725 of the options that have been granted under the outside directors’ stock option plan are outstanding and exercisable and 19,061 of the options that have been granted under the employee stock option plan are outstanding and exercisable.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
An interest rate simulation model is used to estimate the impact of various changes, both upward and downward, in market interest rates and volumes of assets and liabilities on net interest income and net income. This model produces an interest rate exposure report that forecasts changes in the economic value of equity (“EVE”) and net interest income under alternative interest rate environments. This model assumes that the change in interest rates occurs immediately. The EVE is the difference between the present value of the expected future cash flows from Royal Bank’s existing assets and the present value of the expected future cash flows from Royal Bank’s existing liabilities. The assumptions used in evaluating the vulnerability of earnings and capital to changes in interest rates are based on management’s considerations of past experience, current position and anticipated future economic conditions. The interest rate sensitivity of assets and liabilities as well as the estimated effect of changes in interest rates on the EVE and net interest income could vary substantially if different assumptions are used or actual experience differs from what the calculations may be based.
The simulation model indicates that we are outside of our policy limits in the EVE increasing rate scenarios for 200, 300 and 400 basis points but within policy limits for rates up 100 basis points. We are within our policy limits for all changes in net interest income scenarios. The cause of the EVE policy exceptions is primarily related to extension risk within the Company’s investment portfolio; the demand for fixed rate loans in this sustained low rate environment; the composition of deposits, and the lower capital from the prior period losses. In a rising interest rate environment general expectations are for prepayments of principal to slow down which cause the life of the our mortgage-backed and CMO securities to extend. Management continues to work on changing the mix of interest-earning assets to mitigate this risk.
In December 2015, the Federal Reserve Bank raised short-term interest rates 25 basis points. We do not expect this singular event to have a significant impact on net interest income in 2016. Based on the simulation results below we expect to remain within our policy limits. The calculated estimates of changes in the EVE as of December 31, 2015 and net interest income for 2015 for Royal Bank are as follows:
Interest-Rate Sensitivity: Interest rate sensitivity is a function of the re-pricing characteristics of our assets and liabilities. These include the volume of assets and liabilities re-pricing, the timing of re-pricing, and the interest rate sensitivity gaps which are a continual challenge in a changing rate environment. In managing our interest rate sensitivity positions, we seek to develop and implement strategies to control exposure of net interest income to risks associated with interest rate movements. The interest rate sensitivity report examines the positioning of the interest rate risk exposure in a changing interest rate environment. Ideally, the rate sensitive assets and liabilities will be maintained in a matched position to minimize interest rate risk. The interest rate sensitivity analysis is an important management tool; however, it does have some inherent shortcomings. It is a “static” analysis. Although certain assets and liabilities may have similar maturities or re-pricing, they may react in different degrees to changes in market interest rates. Additionally, re-pricing characteristics of certain assets and liabilities may vary substantially within a given period.
The following table summarizes re-pricing intervals for interest earning assets and interest bearing liabilities as of December 31, 2015, and the difference or “GAP” between them on an actual and cumulative basis for the periods indicated. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. During a period of falling interest rates, a positive gap would tend to adversely affect net interest income, while a negative gap would tend to result in an increase in net interest income. During a period of rising interest rates, a positive gap would tend to result in an increase in net interest income while a negative gap would tend to affect net interest income adversely. At December 31, 2015, we were in a liability sensitive position of $2.3 million, which indicates that within one year the re-pricing of liabilities is sooner than the re-pricing of assets.
(1)Interest earning assets are included in the period in which the balances are expected to be repaid and/or re-priced as a result of anticipated prepayments, scheduled rate adjustments, and contractual maturities.
(2)Reflects principal maturing within the specified periods for fixed and re-pricing for variable rate loans; includes non-performing loans.
(3) Includes FHLB stock.
The method of analysis of interest rate sensitivity in the table above has a number of limitations. Certain assets and liabilities may react differently to changes in interest rates even though they re-price or mature in the same time periods. The interest rates on certain assets and liabilities may change at different times than changes in market interest rates, with some changes in advance of changes in market rates and some lagging behind changes in market rates. Also, certain assets have provisions, which limit changes in interest rates each time the interest rate changes and for the entire term of the loan. Prepayments and withdrawals experienced in the event of a change in interest rates may deviate significantly from those assumed in the interest rate sensitivity table. Additionally, the ability of some borrowers to service their debt may decrease in the event of an interest rate increase.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
Royal Bancshares of Pennsylvania, Inc. and Subsidiaries
Bala Cynwyd, Pennsylvania
We have audited the accompanying consolidated balance sheets of Royal Bancshares of Pennsylvania, Inc. and subsidiaries (the “Company”) as of December 31, 2015 and 2014, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Royal Bancshares of Pennsylvania, Inc. and subsidiaries at December 31, 2015 and 2014, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
/s/ BDO USA, LLP
Philadelphia, Pennsylvania
March 17, 2016
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
The accompanying notes are an integral part of these consolidated financial statements.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Consolidated Statements of Income
The accompanying notes are an integral part of these consolidated financial statements.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Statements of Consolidated Comprehensive Income
The accompanying notes are an integral part of these consolidated financial statements.
1.
Amounts are included in total other-than-temporary impairment on AFS investment securities on the Consolidated Statements of Income in total non-interest income, net of a $5 thousand and $14 thousand tax benefit for 2015 and 2014, respectively.
2.
Amounts are included in net gains on the sale of AFS investment securities on the Consolidated Statements of Income in total non-interest income, net of $306 thousand and $128 thousand in taxes for 2015 and 2014, respectively.
3.
Amounts are included in salaries and benefits on the Consolidated Statements of Income in non-interest expense.
			 		
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders’ Equity
Years ended December 31, 2015 and 2014
The accompanying notes are an integral part of these consolidated financial statements.
			 		
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Year ended December 31,
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows- continued
Year ended ended December 31,
The accompanying notes are an integral part of these consolidated financial statements.
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
1. Basis of Financial Statement Presentation
Nature of Operations
Royal Bancshares of Pennsylvania, Inc. (“Royal Bancshares”, the “Company”, “We” or “Our”), through its wholly-owned subsidiary Royal Bank America (“Royal Bank”) offers a full range of banking services to individual and corporate customers primarily located in the Mid-Atlantic states. Royal Bank competes with other banking and financial institutions in certain markets, including financial institutions with resources substantially greater than its own. Commercial banks, savings banks, savings and loan associations, credit unions and brokerage firms actively compete for savings and time deposits and for various types of loans. Such institutions, as well as consumer finance and insurance companies, may be considered competitors of Royal Bank with respect to one or more of the services it renders.
Principles of Consolidation
The accompanying audited consolidated financial statements include the accounts of Royal Bancshares of Pennsylvania, Inc. and its wholly-owned subsidiaries, Royal Investments of Delaware, Inc., including Royal Investments of Delaware, Inc.’s wholly owned subsidiary, Royal Preferred, LLC, and Royal Bank America, including Royal Bank’s subsidiaries, Royal Real Estate of Pennsylvania, Inc., Royal Investments America, LLC, RBA Property LLC, Narberth Property Acquisition LLC, Rio Marina LLC, and 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. The two Delaware trusts, Royal Bancshares Capital Trust I and Royal Bancshares Capital Trust II are not consolidated per requirements under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 810, “Consolidation” (“ASC Topic 810”). These consolidated financial statements reflect the historical information of the Company. All significant intercompany transactions and balances have been eliminated in consolidation.
Use of 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 principal estimates that are particularly susceptible to significant change in the near term relate to the allowance for loan and lease losses, the valuation of other real estate owned, the valuation of deferred tax assets, fair value measurements, other-than-temporary impairment losses on investment securities, net periodic pension costs and the pension benefit obligation. Descriptions of these estimates are in the following paragraphs.
Significant Concentration of Credit Risk
Credit risk is one of our most significant risks. It is critical for consistent profitability that we effectively manage credit risk. Most of the Company’s activities are with customers located within the Mid-Atlantic region of the country. “Note 3 - Investment Securities” to the Consolidated Financial Statements discusses the types of securities in which the Company invests. “Note 4 - Loans and Leases” to the Consolidated Financial Statements discusses the types of lending in which we engage. 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. We have 93% of our investment portfolio in securities issued by government sponsored entities. Our tax certificate and other real estate owned portfolios have a geographic concentration in the State of New Jersey.
No substantial portion of loans is concentrated within a single industry or group of related industries, except a significant majority of loans are secured by real estate. There are numerous risks associated with commercial and consumer lending that could impact the borrower’s ability to repay on a timely basis. They include, but are not limited to: the owner’s business expertise, changes in local, national, and in some cases international economies, competition, government regulation, and the general financial stability of the borrowing entity. Our commercial real estate, commercial and industrial and construction and land development loans comprised 45%, 17% and 10%, respectively, of the loan portfolio.
We attempt to mitigate these risks through conservative underwriting policies and procedures which include an analysis of the borrower’s business and industry history, its financial position, as well as that of the business owner. We will also require the borrower to provide current financial information on the operation of the business periodically over the life of the loan. In addition, most commercial loans are secured by assets of the business or those of the business owner, which can be liquidated if the borrower defaults, along with the personal surety of the business owner.
U.S. GAAP RAP Difference
In connection with a prior bank regulatory examination, the Federal Deposit Insurance Company (“FDIC”) concluded, based upon its interpretation of the Consolidated Reports of Condition and Income (the “Call Report”) instructions and under regulatory accounting principles (“RAP”), that income from Royal Bank’s tax lien business should be recognized on a cash basis, not an accrual basis. Royal Bank’s current accrual method is in accordance with U.S. GAAP. Royal Bank disagrees with the FDIC’s conclusion and filed the Call Report for December 31, 2015 and the previous 21 quarters in accordance with U.S. GAAP. However, the change in the manner of revenue recognition for the tax lien business for regulatory accounting purposes affects Royal Bank’s and potentially our capital ratios as disclosed in “Note 2 - Regulatory Matters and Significant Risks And Uncertainties” and “Note 16 - Regulatory Capital Requirements” to the Consolidated Financial Statements. The resolution of this matter will be decided by additional joint regulatory agency guidance which includes the Federal Reserve Bank, the FDIC, and the Office of the Comptroller of the Currency (“OCC”).
Reclassifications
Certain items in the 2014 consolidated financial statements and accompanying notes have been reclassified to conform to the current year’s presentation format. There was no effect on net income for the periods presented herein as a result of the reclassification.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, interest-bearing deposits and federal funds sold. Generally, federal funds are purchased and sold for one-day periods.
Investment Securities
Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each balance sheet date. Investments in debt securities that we have the positive intent and ability to hold to maturity are classified as held to maturity securities and reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized holding gains and losses included in earnings. Debt and equity securities not classified as trading securities, nor as held to maturity securities, are classified as available for sale securities and reported at fair value, with unrealized holding gains or losses, net of deferred income taxes (when applicable), reported in the accumulated other comprehensive income (loss) (“AOCI”) component of shareholders’ equity. We did not hold trading securities nor had securities classified as held to maturity at December 31, 2015 and 2014. Discounts and premiums are accreted/amortized to income by use of the level-yield method. Gain or loss on sales of securities available for sale is based on the specific identification method.
We evaluate declines in the fair value of securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis. The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. All investment securities are evaluated for OTTI under FASB ASC Topic 320, “Investments-Debt & Equity Securities” (“ASC Topic 320”). In determining whether OTTI exists, management considers numerous factors, including but not limited to: (1) the length of time and the extent to which the fair value is less than the amortized cost, (2) our intent to hold or sell the security, (3) the financial condition and results of the issuer including changes in capital, (4) the credit rating of the issuer, (5) analysts’ earnings estimate, (6) industry trends specific to the security, and (7) timing of debt maturity and status of debt payments.
Under ASC Topic 320, OTTI is considered to have occurred with respect to debt securities (1) if an entity intends to sell the security; (2) if it is more likely than not an entity will be required to sell the security before recovery of its amortized cost basis; or (3) the present value of the expected cash flows is not sufficient to recover the entire amortized cost basis. Once a decline in value for a debt security is determined to be other-than-temporary, the other-than-temporary impairment is separated into (a) the amount of the total OTTI related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total OTTI related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total OTTI related to all other factors is recognized in other comprehensive income. In determining our intent not to sell and whether it is more likely than not that we will be required to sell the investments before recovery of their amortized cost basis, management considers the following factors: current liquidity and availability of other non-pledged assets that permits the investment to be held for an extended period of time but not necessarily until maturity, capital planning, and any specific asset liability committee goals or guidelines related to the disposition of specific investments.
Other Investment
This investment includes the Solomon Hess SBA Loan Fund, which we invested in to partially satisfy our community reinvestment requirement. Shares in this fund are not publicly traded and therefore have no readily determinable fair market value. An investor can have their investment in the Fund redeemed for the balance of their capital account at any quarter end with a 60-day notice to the Fund. The investment in this Fund is recorded at cost.
Federal Home Loan Bank Stock
As a member of the Federal Home Loan Bank of Pittsburgh (“FHLB”), we are required to purchase and hold stock in the FHLB to satisfy membership and borrowing requirements. The stock can only be sold to the FHLB or to another member institution, and all sales of FHLB stock must be at par. As a result of these restrictions, there is no active market for the FHLB stock. As of December 31, 2015 and 2014, FHLB stock totaled $2.5 million and $2.6 million, respectively.
FHLB stock is held as a long-term investment and its value is determined based on the ultimate recoverability of the par value. We evaluate impairment quarterly. The decision of whether impairment exists is a matter of judgment that reflects management’s view of the FHLB’s long-term performance, which includes factors such as the following: (1) its operating
performance, (2) the severity and duration of declines in the fair value of its net assets related to its capital stock amount, (3) its liquidity position, and (4) the impact of legislative and regulatory changes on the FHLB. Based on the capital adequacy and the liquidity position of the FHLB, management believes that the par value of its investment in FHLB stock will be realized. Accordingly, there is no impairment related to the carrying amount of the Company’s FHLB stock as of December 31, 2015.
Loans Held for Sale
At and during the year ended December 31, 2015 and December 31, 2014, we did not have any loans classified as loans held for sale (“LHFS”). Generally, loans are transferred from loans held for investment (“LHFI”) to LHFS at fair market value using expected net sales proceeds or collateral values when there is an intent to sell. Gains or losses on the sale of LHFS are recorded in non-interest income. Generally any subsequent credit losses on LHFS are recorded as a component of non-interest expense. During 2014, we received net proceeds of $3.8 million and recorded net gains of $232 thousand as a result of loan sales.
Loans and Leases
We originate commercial and real estate loans, including construction and land development loans primarily in the greater Philadelphia metropolitan area as well as selected locations throughout the mid-Atlantic region. We also have participated with other financial institutions in selected construction and land development loans outside our geographic area. Loans and leases are classified as LHFI when management has the intent and ability to hold the loan or lease for the foreseeable future or until maturity or payoff. LHFI are stated at their outstanding unpaid principal balances, net of an allowance for loan and leases losses and any deferred fees or costs. We utilize the effective yield interest method for recognizing interest income as required under FASB ASC Topic 310-20, “Receivables” - “Nonrefundable Fees and Other Costs” (“ASC 310-20”). ASC 310-20 also guides our accounting for nonrefundable fees and costs associated with lending activities such as discounts, premiums, and loan origination fees. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the yield (interest income) of the related loans. We are generally amortizing these amounts over the contractual life of the loan. For loan modifications, any unamortized net fees or costs and any prepayment penalties from the original loan shall be recognized in interest income when the new loan is granted.
We have a concentration of credit risk in commercial real estate and construction and land development loans at December 31, 2015. We originate mainly small business, commercial real estate, middle market business and consumer loans. Additionally, after thorough due diligence, we have purchased specific commercial and commercial real estate loans and small residential loan pools. A substantial portion of our borrowers’ ability to honor their contracts is dependent upon the regional economy including unemployment and the regional commercial and residential real estate markets.
The loans receivable portfolio is segmented into commercial loans, construction and development loans, residential loans, leases, tax certificates, and consumer loans. The commercial loan segment consists of the following classes: commercial real estate loans, multi-family real estate loans, and other commercial loans, which are also generally known as commercial and industrial loans or commercial business loans. The construction and development loan segment consists of the following classes: residential construction and commercial construction loans. Residential construction loans are made for the acquisition of and/or construction on a lot or lots on which a residential dwelling is to be built. Commercial construction loans are made for the purpose of acquiring, developing and/or constructing a commercial structure. The residential loan segment consists of the following classes: one- to four-family first lien residential mortgage loans, home equity lines of credit, and home equity loans. We classify our leases as finance leases, in accordance with FASB ASC Topic 840, “Leases”. The difference between our gross investment in the lease and the cost or carrying amount of the leased property, if different, is recorded as unearned income, which is amortized to income over the lease term by the interest method. The tax certificate segment includes delinquent property tax certificates that have been acquired through public auctions in various jurisdictions. The tax certificates assume a lien position that is generally superior to any mortgage liens that are on the property and have certain foreclosure rights as defined by state law. The tax certificates are predominantly in New Jersey. We ceased acquiring new tax certificates in 2010. Consumer loans includes cash secured and unsecured loans and lines of credit.
Commercial Loans: The commercial real estate loan portfolio consists primarily of loans secured by office buildings, retail and industrial use buildings, strip shopping centers, mixed-use and other properties used for commercial purposes primarily located in our market area. Although terms for commercial real estate and multi-family loans vary, the underwriting standards generally allow for terms up to 10 years with the interest rate being reset in the sixth year and with monthly amortization not greater than 25 years and loan-to-value ratios of not more than 80%. Interest rates are either fixed or adjustable and are predominantly based upon the prime rate or a borrowing rate from the Federal Home Loan Bank of Pittsburgh plus a margin. Prepayment fees are charged on most loans in the event of early repayment. Generally, the personal guarantees of the principals are obtained as additional collateral for commercial real estate and multi-family real estate loans.
Commercial and multi-family real estate loans generally present a higher level of risk than loans secured by one- to four-family residences. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effect of general economic conditions on income producing properties and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by commercial and multi-family real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed, a bankruptcy court modifies a lease term, or a major tenant is unable to fulfill its lease obligations), the borrower’s ability to repay the loan may be impaired.
Our commercial business loans generally have been made to small to mid-sized businesses predominantly located in our market area. The commercial business loans are either a revolving line of credit or for a fixed term of generally 10 years or less. Interest rates are adjustable, indexed to a published prime rate of interest, or fixed. Generally, equipment, machinery, real property or other corporate assets secure such loans. Personal guarantees from the business principals are generally obtained as additional collateral. Generally, commercial business loans are characterized as having higher risks associated with them than single-family residential loans.
Our underwriting procedures include evaluations of the stability of the property’s cash flow history, future operating projections, current and projected occupancy levels, location and physical condition. Generally, we require a debt service ratio (the ratio of net cash flows from operations before the payment of debt service to debt service) of not less than 120%. We also evaluate the credit and financial condition of the borrower, and if applicable, the guarantor. Appraisal reports prepared by independent appraisers are obtained on each loan to substantiate the property’s market value, and are reviewed prior to the closing of the loan.
Construction and Development Loans: We originate construction loans to builders and developers predominantly in our market area. Construction and development loans are riskier than other loan types because they are more speculative in nature. Deteriorating economic or environmental conditions can negatively affect a project. Construction loans are also more difficult to evaluate and monitor. In order to mitigate some of the risks inherent in construction lending, limits are placed on the number of units that can be built on a speculative basis based upon the reputation and financial position of the builder, his/her present obligations, the location of the property and prior sales in the development and the surrounding area. Additionally, the construction budget is reviewed prior to loan origination and the properties under construction are inspected. During the construction phase of a real estate project, the loan requires interest payments only. Construction loans generally are for 12 to 18 months with loan-to-value ratios of not more than 75%. Most construction loans are assigned an initial risk rating of pass-watch due to the riskier nature of the loan.
Residential Loans: Our residential mortgages were acquired in recent years in pool purchases and are secured primarily by properties located in our primary market and surrounding areas. We originate home equity loans and home equity lines of credit in our market area with a general maximum amount of $250 thousand. The collateral must be the borrower’s primary residence and the loan-to-value does not exceed 80%. Home equity lines of credit are variable rate and are indexed to the prime rate. Our home equity loans are either first or second liens and have a fixed rate.
Consumer Loans: We originate cash-secured and unsecured loans and lines of credit to individuals. Unsecured loans and lines of credit have a maximum amount of $15 thousand. Unsecured consumer loans generally have a higher interest rate than residential loans because they have additional credit risk associated with them.
For all classes of loans receivable, with the exception of tax certificates, the accrual of interest is discontinued on a loan when management believes that the borrower’s financial condition is such that collection of principal and interest is doubtful or when a loan becomes 90 days past due. When a loan is placed on non-accrual all unpaid interest is reversed from interest income. Interest payments received on impaired nonaccrual loans are normally applied against principal. Excess proceeds received over the principal amounts due on impaired non-accrual loans are recognized as income on a cash basis. We recognize income under the accrual basis when the principal payments on the loans become current and the collateral on the loan is sufficient to cover the outstanding obligation to the Company. If these factors do not exist, we do not recognize income. Generally, loans are restored to accrual status when the loan is brought current, has performed in accordance with the contractual terms for a reasonable period of time (generally six months) and the ultimate collectibility of the total contractual principal and interest is no longer in doubt. The past due status of all classes of loans receivable is determined based on contractual due dates for loan payments. Tax certificates have no contractual maturity. Collection is dependent upon the tax payer’s redemption of the lien, which includes principal interest and fees.
A loan modification is deemed a troubled debt restructuring (“TDR”) when two conditions are met: 1) the borrower is experiencing financial difficulty and 2) a concession is made by us that would not otherwise be considered for a borrower with similar credit risk characteristics. All loans classified as TDRs are considered to be impaired. TDRs are returned to an accrual status when the loan is brought current, has performed in accordance with the contractual restructured terms for a reasonable period of time (generally six months) and the ultimate collectibility of the total contractual restructured principal and interest is no longer in doubt. Our policy for TDRs is to recognize interest income on currently performing restructured loans under the accrual method.
We account for guarantees in accordance with FASB ASC Topic 460 “Guarantees” (“ASC Topic 460”). ASC Topic 460 requires a guarantor entity, at the inception of a guarantee covered by the measurement provisions of the interpretation, to record a liability for the fair value of the obligation undertaken in issuing the guarantee. We issue financial and performance letters of credit. Financial letters of credit require us to make a payment if the customer’s condition deteriorates, as defined in agreements. Performance letters of credits require us to make payments if the customer fails to perform certain non-financial contractual obligations.
Allowance for Loan and Lease Losses
Our loan and lease portfolio (the “credit portfolio”) is subject to varying degrees of credit risk. 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. Loans deemed to be uncollectible are charged against the allowance, and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable are charged off to the allowance as soon as it is determined that the repayment or collateral recovery of all, or part, of the principal balance is highly unlikely. The allowance represents an estimation made pursuant to FASB ASC Topic 450, “Contingencies” (“ASC Topic 450”) or FASB ASC Topic 310, “Receivables” (“ASC Topic 310”). The adequacy of the allowance is determined through evaluation of the credit portfolio, and involves consideration of a number of factors, as outlined below, to establish a prudent level. We consider that the determination of the allowance involves a higher degree of judgment and complexity than our other significant accounting policies. Our systematic methodology for assessing the appropriateness of the allowance includes: (1) general reserves reflecting historical loss rates by loan type, (2) specific reserves for risk-rated credits based on probable losses on an individual or portfolio basis and (3) qualitative reserves based upon current economic conditions and other risk factors. 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.
The loan portfolio is stratified into loan classifications that have similar risk characteristics. The general allowance is based upon historical loss rates using a three-year rolling average of the historical loss experienced within each loan segment. The qualitative factors used to adjust the historical loss experience address various risk characteristics of the our loan and lease portfolio include evaluating: (1) trends in delinquencies and other non-performing loans, (2) changes in the risk profile related to large loans in the portfolio, (3) changes in the growth trends of categories of loans comprising the loan and lease portfolio, (4) concentrations of loans and leases to specific industry segments, (5) changes in economic conditions
on both a local and national level, (6) quality of loan review and board oversight, (7) changes in lending policies and procedures, and (8) changes in lending staff. Each factor is assigned a value to reflect improving, stable or declining conditions based on management’s best judgment using relevant information available at the time of the evaluation. Adjustments to the factors are supported through documentation of changes in conditions in a report accompanying the allowance calculation.
The allowance calculation methodology includes further segregation of loan classes into risk rating categories. The borrower’s overall financial condition, repayment sources, guarantors and value of collateral, if appropriate, are evaluated annually for commercial and construction and development loans or when credit deficiencies arise, such as delinquent loan payments, for all loans. Credit quality risk ratings include regulatory classifications of special mention, substandard, doubtful and loss. Loans classified as special mention have potential weaknesses that deserve management’s close attention. If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects. Loans classified as substandard have a well-defined weakness or weaknesses that jeopardize the repayment of the debt. They include loans that are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as doubtful have all the weaknesses inherent in loans classified substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans classified as a loss are considered uncollectible and are charged to the allowance. Loans not classified as special mention, substandard, doubtful or loss are rated pass.
The specific reserves are determined utilizing standards required under ASC Topic 310. We identify a loan as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. Non-accrual loans and loans restructured under a TDR are evaluated for impairment on an individual basis considering all known relevant factors that may affect loan collectability such as the borrower’s overall financial condition, resources and payment record, support available from financial guarantors and the sufficiency of current collateral values (current appraisals or rent rolls for income producing properties), and risks inherent in different kinds of lending (such as source of repayment, quality of borrower and concentration of credit quality). Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed.
Impairment is measured on a loan by loan basis for commercial and industrial loans, commercial real estate loans and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent. The estimated fair values of substantially all of our impaired loans are measured based on the estimated fair value of the loan’s collateral. We obtain third-party appraisals or real estate brokers’ opinions (“BPOs”) to establish the fair value of real estate collateral. Appraised values or BPOs are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value less estimated costs to sell the property. For commercial and industrial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. A specific reserve is established for an impaired loan for the amount that the carrying value exceeds its estimated fair value. Once a loan is determined to be impaired it will be deducted from the portfolio balance and the net remaining balance of the portfolio will be used in the general and qualitative analysis.
Based on management’s comprehensive analysis of the loan and lease portfolio, management believes the current level of the allowance is adequate at December 31, 2015. However, its determination requires significant judgment, and estimates of probable losses inherent in the credit portfolio can vary significantly from the amounts actually observed. While management uses the best information available to make 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 and lease losses based on their judgment of information available to them at the time of their examinations. To the extent that actual outcomes differ from
management’s estimates, additional provisions to the allowance for loan and lease losses may be required that would adversely impact earnings in future periods.
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 non-interest expenses. For fair value measurement, OREO is included in level 3 assets on a non-recurring basis.
Premises and Equipment
Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation, which is computed primarily using the modified accelerated cost recovery system (“MACRS”) over the estimated useful lives of the assets. Leasehold improvements are depreciated over the shorter of the estimated useful lives of the improvements or the terms of the related leases. Expected term includes lease options periods to the extent that the exercise of such options is reasonably assured.
Bank-Owned Life Insurance
Royal Bank has purchased life insurance policies on certain employees. These policies are reflected on the consolidated balance sheets at their cash surrender value, or the amount that can be realized. Income from these policies and changes in the cash surrender value are recorded in non-interest income.
Advertising Costs
Advertising costs are expensed as incurred. Our advertising costs were $190 thousand and $357 thousand for 2015 and 2014, respectively.
Benefit Plans
We have a noncontributory nonqualified, defined benefit pension plan covering certain eligible employees. The 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. In accordance with ASC Topic 715, ”Compensation - Retirement Benefits” (“ASC Topic 715”), we recognize the 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 value of a plan’s assets at the company’s year-end and the recognition of actuarial gains and losses, prior service costs or credits, transition assets or obligations as a component of AOCI. These amounts were previously netted against the plan’s funded status in our consolidated Balance Sheet. These amounts will be subsequently recognized as components of net periodic benefit costs. Further, actuarial gains and losses that arise in subsequent periods that are not initially recognized as a component of net periodic benefit costs will be recognized as a component of AOCI. Those amounts will subsequently be recorded as component of net periodic benefit costs as they are amortized during future periods. Net pension expense consists of service costs and interest costs and are actually determined. We accrue pension costs as incurred. The Plan does not have assets. We plan to fund a substantial portion of the pension plan obligations through existing Company owned life insurance policies.
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. During 2015 and 2014, we recorded a matching contribution expense of $134 thousand and $148 thousand, respectively.
Stock Compensation
FASB ASC Topic 718, “Compensation-Stock Compensation” (“ASC Topic 718”) requires that the compensation cost relating to share-based payment transactions be recognized in consolidated financial statements. The costs are measured based on the fair value of the equity or liability instruments issued. ASC Topic 718 covers a wide range of share-based compensation arrangements including stock options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. The effect of ASC Topic 718 is to require entities to measure the cost of employee services received in exchange for stock options based on the grant-date fair value of the award, and to recognize the cost over the period the employee is required to provide services for the award. ASC Topic 718 permits entities to use any option-pricing model that meets the fair value objective in the Statement. We recorded compensation expense relating to stock options and restricted stock of $78 thousand and $17 thousand during 2015 and 2014, respectively.
At December 31, 2015, the Company had a director stock-based plan, an employee stock-based plan, and a long-term incentive compensation plan, which are more fully described in “Note 18 - Stock Compensation Plans” to the Consolidated Financial Statements.
Trust Preferred Securities
Royal Bancshares Capital Trust I/II (“Trusts”) issued mandatory redeemable preferred stock to investors and loaned the proceeds to the Company. The Trusts hold, as their sole asset, subordinated debentures issued by the Company in 2004. We do not consolidate the Trusts as ASC Topic 810 precludes consideration of the call option embedded in the preferred stock when determining if the Company has the right to a majority of the Trusts expected returns. The non-consolidation results in the investment in common stock of the Trusts to be included in other assets with a corresponding increase in outstanding debt of $774 thousand. In addition, the income accrued on the Company’s common stock investments is included in other income. Refer to “Note 10 - Borrowings and Subordinated Debentures” to the Consolidated Financial Statements for more information.
Derivatives and Hedging
In support of our asset liability management process, we will implement derivative hedging strategies with the intent of reducing interest rate risk and economic value of equity risk. We account for derivatives in accordance with FASB ASC Topic 815 “Derivatives and Hedging” (“ASC Topic 815”). We formally designate our derivatives as cash flow hedges and document the strategy for entering into the transactions and the method of assessing ongoing effectiveness. Changes in the fair value of the derivative are recognized in other comprehensive income (loss) until the underlying forecasted transaction is recognized in earnings. The ineffective portion of a derivative’s change in fair value is recognized in earnings immediately. To determine fair value, we use third party pricing models that incorporate assumptions about market conditions and risks that are current at the reporting date. We do not use derivative instruments for speculative purposes.
Derivative instruments qualify for hedge accounting treatment only if they are designated as such on the date on which the derivative contracted is entered and are expected to be, and are, effective in substantially reducing interest rate risk arising from the assets and liabilities identified as exposing the Company to risk. Those derivative financial instruments that do not meet the hedging criteria discussed below would be classified as undesignated derivatives and would be recorded at fair value with changes in fair value recorded in income.
Derivative hedge contracts must meet specific effectiveness tests (i.e., over time the change in their fair values due to the designated hedge risk must be within 80 to 125 percent of the opposite change in the fair values of the hedged assets or liabilities). Changes in fair value of the derivative financial instruments must be effective at offsetting changes in the fair value of the hedged items due to the designated hedge risk during the term of the hedge.
We formally assess, both at the hedges’ inception, and on an on-going basis, whether derivatives used in hedging transactions have been highly effective in offsetting changes in cash flows of hedged items and whether those derivatives
are expected to remain highly effective in subsequent periods. We discontinue hedge accounting when (a) it determines that a derivative is no longer effective in offsetting changes in cash flows of a hedged item; (b) the derivative expires or is sold, terminated or exercised; (c) probability exists that the forecasted transaction will no longer occur; or (d) management determines that designating the derivative as a hedging instrument is no longer appropriate. In all cases in which hedge accounting is discontinued and a derivative remains outstanding, we will carry the derivative at fair value in the consolidated financial statements, recognizing changes in fair value in current period income in the consolidated statement of income. Cash flows resulting from the derivative financial instruments that are accounted for as hedges of assets and liabilities are classified in the cash flow statement in the same category as the cash flows of the items being hedged.
Income Taxes
We account for income taxes in accordance with FASB ASC Topic 740-10, “Accounting for Uncertainty in Income Taxes”, (“ASC 740”) which includes guidance related to accounting for uncertainty in income taxes, which sets out a consistent framework to determine the appropriate level of tax reserves to maintain for uncertain tax positions. We had no material unrecognized tax benefits or accrued interest and penalties as of December 31, 2015 and 2014. We classify interest and penalties as an element of tax expense.
The Company and its subsidiaries file a consolidated federal income tax return. Income taxes are allocated to the Company and its subsidiaries based on the contribution of their income or use of their loss in the consolidated return. Separate state income tax returns are filed by the Company and its subsidiaries. As of December 31, 2015, tax years 2012 through 2014 are subject to federal examination by the IRS and years 2011 through 2014 are subject to state examination by various state taxing authorities. Tax regulations are subject to interpretation of the related tax laws and regulations and require significant judgment to apply.
Federal and state income taxes have been provided on the basis of reported income or loss. The amounts reflected on the tax returns differ from these provisions principally due to temporary differences in the reporting of certain items for financial reporting and income tax reporting purposes. The tax effect of these temporary differences is accounted for as deferred taxes applicable to future periods. Deferred income tax expense or benefit is determined by recognizing deferred tax assets (“DTA”) and liabilities (“DTL”) for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred assets and liabilities of a change in tax rates is recognized in earnings in the period that includes the enactment date.
We are required to establish a valuation allowance for DTAs 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 in future periods. In evaluating our ability to recover deferred tax assets, we consider all available positive and negative evidence, including past operating results and projections 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. This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws or variances between projected operating performance, actual results and other factors. While these estimates and judgments are inherently subjective, they are consistent with the plans and estimates management uses to manage our business.
In the fourth quarter of 2015, we released a portion of our valuation allowance previously recorded on the net DTAs. In evaluating the need for a valuation allowance, we estimate future taxable income based on management approved business plans and potential tax planning strategies. At December 31, 2015, the DTA valuation allowance was $30.6 million compared to $39.1 million at December 31, 2014. 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. There can be no assurance, however, as to when we could be in a position to recapture the remaining DTA valuation allowance. Refer to “Note 12 - Income Taxes” to the Consolidated Financial Statements for more information.
We had no material unrecognized tax benefits (“UTB”) or accrued interest and penalties as of December 31, 2015. We do not expect the total amount of UTB to significantly increase in the next twelve months. We monitor changes in tax statutes and regulations to determine if significant changes will occur over the next 12 months. As of December 31, 2015 no significant changes to UTB are projected; however, tax audit examinations are possible.
Treasury Stock
Shares of common stock repurchased are recorded as treasury stock at cost.
Earnings Per Share Information
Basic per share data excludes dilution and is computed by dividing income available to common shareholders by the weighted average common shares outstanding during the period. Diluted per share data takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock, using the treasury stock method.
The Class B shares of the Company may be converted to Class A shares at the rate of 1.15 to 1.
Comprehensive Income (Loss)
We report comprehensive income (loss) in accordance with FASB ASC Topic 220, “Comprehensive Income” (“ASC Topic 220”), which requires the reporting of all changes in equity during the reporting period except investments from and distributions to shareholders. Net income is a component of comprehensive income (loss) with all other components referred to in the aggregate as other comprehensive income (loss). Comprehensive income (loss) consists of net income and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on available for sale investment securities, non-credit related losses on other-than-temporarily impaired investment securities, adjustment to net periodic pension cost, and adjustment to the fair value of swaps.
Fair Value of Financial Instruments
For information on the fair value of our financial instruments refer to “Note 21 - Fair Value of Financial Instruments” to the Consolidated Financial Statements.
Restrictions on Cash and Amounts Due From Banks
Royal Bank is required to maintain average balances on hand with the Federal Reserve Bank. At December 31, 2015 and 2014, these reserve balances amounted to $100 thousand.
2. Recent Accounting Pronouncements
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (“ASU 14-09”), which establishes a comprehensive revenue recognition standard for virtually all industries under U.S. GAAP, including those that previously followed industry-specific guidance such as the real estate, construction and software industries. The revenue standard’s core principle is built on the contract between a vendor and a customer for the provision of goods and services. It attempts to depict the exchange of rights and obligations between the parties in the pattern of revenue recognition based on the consideration to which the vendor is entitled. To accomplish this objective, the standard requires five basic steps: i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) the entity satisfies a performance obligation. The ASU is effective for public entities for annual periods beginning after December 15, 2016, including interim periods therein. Three basic transition methods are available - full retrospective, retrospective with certain practical expedients, and a cumulative effect approach. Under the third alternative, an entity would apply the new revenue standard only to contracts that are incomplete under legacy U.S. GAAP at the date of initial application (e.g. January 1, 2017) and recognize the cumulative effect of the new standard as an adjustment to the opening balance of retained earnings. That is, prior years would not be restated and additional disclosures would be required to
enable users of the financial statements to understand the impact of adopting the new standard in the current year compared to prior years that are presented under legacy U.S. GAAP. Early adoption is prohibited under U.S. GAAP. In August 2015, the FASB Issued ASU 2015-14 which deferred the effective date to December 31, 2017 and the initial application date (e.g. January 1, 2018.) We do not believe ASU 2014-09 will have a material effect on its financial statements.
In June 2015, the FASB issued ASU 2015-10, Technical Corrections and Improvements (“ASU 2015-10”). The amendments in ASU 2015-10 affect a wide variety of Topics in the Codification and will apply to all reporting entities within the scope of the affected accounting guidance. ASU 2015-10 includes amendments to clarify the Codification,
correct unintended application of guidance, or make minor improvements to the Codification that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. Additionally, some of the amendments will make the Codification easier to understand and easier to apply by eliminating inconsistencies, providing needed clarifications, and improving the presentation of guidance in the Codification. The amendments in ASU 2015-10 are effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Earlier adoption is permitted , including adoption in an interim period. All other amendments in ASU 2015-10 are effective upon the issuance of ASU 2015-10. The adoption of ASU 2015-10 is not expected to have a material impact on the Company’s financial condition and results of operations.
In January 2016, the FASB issued ASU 2016-01, “Financial Instruments - Overall (Topic 825-10): “Recognition and Measurement of Financial Assets and Financial Liabilities.” ASU 2016-01 amends the guidance on the classification and measurement of financial instruments. Some of the amendments in ASU 2016-01 include the following: 1) requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; 2) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; 3) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; and 4) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value; among others. ASU 2016-01 also clarifies that an entity should assess the need for a valuation allowance on a deferred tax asset related to unrealized losses of investments in debt instruments recognized in OCI in combination with the entity’s other deferred tax assets. Prior to this guidance, the alternative approach used in practice evaluated the need for a valuation allowance for a deferred tax asset related to unrealized losses on debt instruments recognized in other comprehensive income separately from other deferred tax assets. This alternative approach will no longer be acceptable. For public business entities, the amendments of ASU 2016-01 are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. We do not believe ASU 2016-01 will have a material effect on its financial statements.
In February 2016, the FASB issued Accounting Standards Update No. 2016-02, “Leases” (“ASU 2016-02”). From the lessee's perspective, the new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement for a lessees. From the lessor's perspective, the new standard requires a lessor to classify leases as either sales-type, finance or operating. A lease will be treated as a sale if it transfers all of the risks and rewards, as well as control of the underlying asset, to the lessee. If risks and rewards are conveyed without the transfer of control, the lease is treated as a financing lease. If the lessor doesn’t convey risks and rewards or control, an operating lease results. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. A modified retrospective transition approach is required for lessors for sales-type, direct financing, and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. We are currently evaluating the impact of the pending adoption of the new standard on its consolidated financial statements.
Note 2.Regulatory Matters and Significant Risks or Uncertainties
Federal Reserve Memorandum of Understanding
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”). In July 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, an MOU, with the Federal Reserve Bank, effective July 17, 2013. Included in this MOU are certain continued reporting requirements and a requirement that the Company receive the prior approval of the Federal Reserve Bank and the Director of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System prior to declaring or paying any dividends on our capital stock, making interest payments related to our outstanding trust preferred securities or subordinate securities, incurring or guaranteeing certain debt with an original maturity date greater than one year, and purchasing or redeeming any shares of stock. Please refer to “Dividend and Interest Restrictions” below for a discussion on the partial redemption of the Series A Preferred Stock. The MOU will remain in effect until stayed, modified, terminated or suspended in writing by the Federal Reserve Bank.
Dividend and Interest Restrictions
On August 13, 2009, our Board suspended the regular quarterly cash dividends on the 30,407 shares of Series A Preferred Stock and, accordingly, the Company is not permitted at this time to pay dividends on our Class A or Class B Common Stock. Additionally, under the terms of the Federal Reserve MOU, we are prohibited from redeeming the Series A Preferred Stock, or paying any dividends on shares of our stock without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System.
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”). On June 20, 2014, Treasury announced that it had priced auctions of preferred stock of six institutions, including all of the 30,407 shares of the Series A Preferred Stock, issued by the Company to the Treasury in 2009. The Series A Preferred Stock was priced in the auction at $1,207.11 per share for all 30,407 shares of Series A Preferred Stock outstanding. As previously disclosed, the Company was a bidder in the auction and was allocated 11,551 shares of Series A Preferred Stock for repurchase at the clearing price of $1,207.11. Closing for the sale of the Series A Preferred Stock by Treasury, including the repurchase of 11,551 shares of Series A Preferred Stock by the Company, occurred on July 2, 2014. The dividend in arrears including interest on the remaining 18,856 shares of Series A preferred stock is approximately $8.9 million. In the event the Company declared the preferred dividend in arrears the Company’s equity and capital ratios would be negatively affected; however, they would remain above the required minimum ratios.
Under the Federal Reserve MOU, we may not declare or pay any dividends on our capital stock or make interest payments related to our outstanding trust preferred securities or subordinate securities without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System. During the 2015, we received approval from the Federal Reserve Bank and paid all quarterly interest payments on the trust preferred securities.
Note 3. Investment Securities
The carrying value and fair value of investment securities available for sale (“AFS”) at December 31, 2015 and December 31, 2014 are as follows:
The amortized cost and fair value of investment securities at December 31, 2015, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Proceeds from the sales of AFS investments during the year ended December 31, 2015 and 2014 were $47.0 and $72.3 million, respectively. The following table summarizes gross realized gains and losses on the sale of securities recognized in earnings in the periods indicated:
We recorded $14 thousand and $41 thousand in OTTI charges in 2015 and 2014, respectively, related to one private equity investment. There was no non-credit related impairment losses on debt securities held at December 31, 2015 or December 31, 2014 for which a portion of OTTI was recognized in other comprehensive income. As of December 31, 2015, investment securities with a market value of $92.9 million were pledged as collateral for borrowings.
The tables below indicate the length of time individual AFS securities have been in a continuous unrealized loss position at December 31, 2015 and December 31, 2014:
For all debt security types discussed below the fair value is based on prices provided by brokers and safekeeping custodians.
U.S. government-sponsored agencies (“U.S. Agency”): As of December 31, 2015, we had eight U.S. Agency securities with a fair value of $25.6 million and gross unrealized losses of $564 thousand. Six of the bonds had been in an unrealized loss position for twelve months or longer at December 31, 2015. Management believes that the unrealized losses on these debt securities are a function of changes in investment spreads. Management expects to recover the entire amortized cost basis of these securities. We do not intend to sell these securities before recovery of their cost basis and have not determined that it is not more likely than not that it will be required to sell these securities before recovery of their cost basis. Therefore, management has determined that these securities are not other-than-temporarily impaired at December 31, 2015.
Mortgage-backed securities issued by U.S. government agencies and U.S. government sponsored enterprises: As of December 31, 2015, we had three mortgage-backed securities with a fair value of $7.7 million and gross unrealized losses of $50 thousand. One of the mortgage-backed securities had been in an unrealized loss position for twelve months or longer. The unrealized loss is attributable to a combination of factors, including relative changes in interest rates since the time of purchase. The contractual cash flows for these securities are guaranteed by U.S. government agencies and U.S. government-sponsored enterprises. Based on its assessment of these factors, management believes that the unrealized losses on these debt securities are a function of changes in investment spreads and interest rate movements and not as a result of changes in credit quality. Management expects to recover the entire amortized cost basis of these securities. We do not intend to sell these securities before recovery of their cost basis and have not determined that it is not more likely than not that it will be required to sell these securities before recovery of their cost basis. Therefore, management has determined that these securities are not other-than-temporarily impaired at December 31, 2015.
U.S. government issued or sponsored collateralized mortgage obligations (“Agency CMOs”): As of December 31, 2015, we had 36 Agency CMOs with a fair value of $102.7 million and gross unrealized losses of $1.6 million. Five of the Agency CMOs had been in an unrealized loss position for twelve months or longer and the other 31 Agency CMOs have been in an unrealized loss position for less than twelve months. The unrealized loss is attributable to a combination of factors, including relative changes in interest rates since the time of purchase. The contractual cash flows for these securities are guaranteed by U.S. government agencies and U.S. government-sponsored enterprises. Based on its assessment of these factors, management believes that the unrealized losses on these debt securities are a function of changes in investment spreads and interest rate movements and not as a result of changes in credit quality. Management expects to recover the entire amortized cost basis of these securities. We do not intend to sell these securities before recovery of their cost basis and have not determined that it is not more likely than not that it will be required to sell these securities before recovery of their cost basis. Therefore, management has determined that these securities are not other-than-temporarily impaired at December 31, 2015.
Non-agency collateralized mortgage obligations (“Non-agency CMOs”): As of December 31, 2015, we had one non-agency CMO with a fair value of $1.1 million and a gross unrealized loss of $26 thousand. The bond has been in an unrealized loss position for less than twelve months. We do not intend to sell this security before recovery of its cost basis, and it is not more likely than not we will be required to sell this security before recovery of its cost basis. Therefore, management has determined that this security is not other-than-temporarily impaired at December 31, 2015.
Municipal bonds: As of December 31, 2015, we had seven municipal bonds with a fair value $6.1 million and gross unrealized losses of $52 thousand. All seven of the municipal bonds had been in an unrealized loss position for less than twelve months. Because we do not intend to sell the bonds and it is not more likely than not that the we will be required to sell the bond before recovery of its amortized cost basis, which may be maturity, we do not consider the bonds to be other-than-temporarily impaired at December 31, 2015.
Other securities: As of December 31, 2015, we had six investments in private equity funds which were predominantly invested in real estate. In determining whether or not OTTI exists, we review the funds’ financials, asset values, and near-term projections. During 2015, an OTTI charge of $14 thousand was recorded on one private equity investment. Management concluded that the impairment on this investment was other-than-temporary.
We will continue to monitor these investments to determine if the discounted cash flow analysis, continued negative trends, market valuations or credit defaults result in impairment that is other than temporary.
Note 4.Loans and Leases
Major classifications of loans are as follows:
We use a nine point grading risk classification system commonly used in the financial services industry as the credit quality indicator. The first four classifications are rated Pass. The riskier classifications include Pass-Watch, Special Mention, Substandard, Doubtful and Loss. The risk rating is related to the underlying credit quality and probability of default. These risk ratings are used in the calculation of the allowance for loan and lease losses.
·
Pass: includes credits that demonstrate a low probability of default;
·
Pass-watch: a classification which includes currently performing credits that are beginning to demonstrate above average risk through declining earnings, strained cash flows, increased leverage and/or weakening market fundamentals. This class may also include new loan originations which warrant approval but may contain certain risks that require closer than usual monitoring and supervision, such as construction loans;
·
Special mention: includes credits that have potential weaknesses that if left uncorrected could weaken the credit or result in inadequate protection of our position at some future date. While potentially weak, credits in this classification are marginally acceptable and loss of principal or interest is not anticipated;
·
Substandard accrual: includes credits that exhibit a well-defined weakness which currently jeopardizes the repayment of debt and liquidation of collateral even though they are currently performing. These credits are characterized by the distinct possibility that the Company may incur a loss in the future if these weaknesses are not corrected;
·
Non-accrual (substandard non-accrual, doubtful, loss): includes credits that demonstrate serious problems to the point that it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement.
All loans are assigned an initial loan risk rating by the Chief Credit Officer (“CCO”). The initial loan risk rating is approved by another member of executive management or by the appropriate loan committee approving the loan request. From time to time, and at the general direction of any of the various loan committees, the ratings may be changed based on the findings of that committee. Items considered in assigning ratings include the financial strength of the borrower and/or guarantors, the type of collateral, the collateral lien position, the type of loan and loan structure, any potential risk inherent in the specific loan type, higher than normal monitoring of the loan or any other factor deemed appropriate by any of the various committees for changing the rating of the loan. Any such change in rating is reflected in the minutes of that committee.
The following tables present risk ratings for each loan portfolio classification at December 31, 2015 and December 31, 2014.
The following tables present an aging analysis of past due payments for each loan portfolio classification at December 31, 2015 and December 31, 2014.
Total non-accrual loans at December 31, 2015 were $5.5 million compared to $9.8 million at December 31, 2014. If interest had accrued on these loans, such income would have been approximately $703 thousand and $1.0 million for the years ended December 31, 2015 and 2014, respectively. At December 31, 2015 and 2014, the Company had no loans past due 90 days or more on which interest continues to accrue.
Impaired Loans
Total cash collected on impaired loans during the year ended December 31, 2015 and 2014 was $9.6 million and $7.0 million respectively, of which $8.4 million and $6.4 million was credited to the principal balance outstanding on such loans, respectively. Interest income recognized on a cash basis on impaired loans and leases was $234 thousand and $377 thousand for 2015 and 2014, respectively
Troubled Debt Restructurings
The following table details our TDRs that are on an accrual status and non-accrual status at December 31, 2015 and December 31, 2014.
As of December 31, 2015, the one construction and land development TDR, cited in the above table, was not in compliance with its restructured terms due to payment defaults. There were no TDRs not in compliance with their restructured terms in 2014. We did not have any newly restructured loans that fit the criteria for classification as a TDR during the year ended December 31, 2015.
The following table presents the new TDRs that occurred during the year ended December 31, 2014.
We may obtain physical possession of real estate collateralizing residential mortgage loans or home equity loans through or in lieu of, foreclosure. As of December 31, 2015, we did not have any foreclosed residential real estate property as a result of physical possession. However, as of December 31, 2015, we had residential mortgage loans with a carrying value of $399 thousand collateralized by residential real estate property for which formal foreclosure proceedings were in process.
Note 5.Allowance for Loan and Lease Losses
The following tables present the detail of the allowance and the loan portfolio disaggregated by loan portfolio classification as of December 31, 2015 and December 31, 2014.
Allowance for Loan and Lease Losses and Loans Held for Investment
For the year ended December 31, 2015
Allowance for Loan and Lease Losses and Loans Held for Investment
For the year ended December 31, 2014
The following tables detail the LHFI that were evaluated for impairment by loan classification at December 31, 2015 and December 31, 2014.
Note 6.Other Real Estate Owned
At December 31, 2015, OREO is comprised of two real estate properties acquired through, or in lieu of, foreclosure in settlement of loans and 60 real estate properties, primarily located in New Jersey, acquired through foreclosure related to tax liens. Set forth below are tables which detail the changes in OREO from December 31, 2014 to December 31, 2015 and December 31, 2013 to December 31, 2014.
At December 31, 2015, OREO was comprised of $215 thousand in land, $7.2 million in tax liens, and residential real estate, related to a condominium construction project in Minneapolis, Minnesota in which we are a participant with a fair value of $5 thousand. At December 31, 2014, OREO assets acquired through the tax lien portfolio were comprised of 79 properties and were primarily located in New Jersey.
NOTE 7. PREMISES AND EQUIPMENT
Premises and equipment are summarized as follows (in thousands):
Depreciation and amortization expense related to premises and equipment was approximately $634 thousand and $569 thousand, for the years ended 2015 and 2014, respectively. In 2015, we continued with the execution of our real estate rationalization plan and sold a Company owned building. We received $1.4 million in proceeds and recorded a gain of $324 thousand as a result of this sale. In 2014, we sold one branch property and received $303 thousand in net proceeds which resulted in a gain of $107 thousand.
NOTE 8. LEASE COMMITMENTS
The Company leases various premises under operating lease agreements, which expire through 2024 and require minimum annual rentals. Some of these leases are cancelable. The approximate minimum rental commitments under the leases are as follows for the year ended December 31, 2015:
The leases contain options to extend for periods from one to ten years. The cost of such lease extensions is not included in the above table. Rental expense for all leases was approximately $1.3 million and $890 thousand for the years ended December 31, 2015 and 2014, respectively.
Note 9.Deposits
The Company’s deposit composition as of December 31, 2015 and December 31, 2014 is presented below:
Maturities of time deposits for the next five years and thereafter are as follows:
Note 10.Borrowings and Subordinated Debentures
1.
Advances from the Federal Home Loan Bank
As of December 31, 2015, Royal Bank had $229.9 million of available borrowing capacity at the FHLB, which is based on qualifying collateral. Total advances from the FHLB were $54.0 million and had a weighted average rate of 1.35% at December 31, 2015 compared to $55.0 million and a weighted average rate of 1.36% at December 31, 2014. The average balance of advances with the FHLB was $53.6 million and $59.4 million for 2015 and 2014, respectively. The advances and the line of credit are collateralized by FHLB stock, government agencies and mortgage-backed securities. As of December 31, 2015, investment securities with a fair value of $32.0 million were pledged as collateral to the FHLB.
Presented below are the Company’s FHLB borrowings allocated by the year in which they mature with their corresponding weighted average rates:
2.
Other borrowings
We have a note payable with PNC Bank (“PNC”) as of December 31, 2015 in the amount of $2.0 million compared to $2.4 million as of December 31, 2014. The note’s maturity date is August 25, 2016. The interest rate is a variable rate equal to one month LIBOR + 15 basis points and adjusts monthly. The interest rate at December 31, 2015 was 0.57%.
At December 31, 2015 and 2014, we had additional borrowings of $35.0 million from PNC which will mature on January 7, 2018. These borrowings have a weighted average interest rate of 3.65%. During the fourth quarter of 2014, the Company pre-paid $5.0 million in principal to reduce future interest expense and incurred a prepayment penalty of $402 thousand. The note payable and the borrowings are secured by government agencies and mortgage-backed securities. As of December 31, 2015, investment securities with a market value of $43.8 million were pledged as collateral to secure all $37.0 million in borrowings with PNC.
Royal Bank also has $20.0 million in lines of credit, of which $0 was outstanding, with two local financial institutions at December 31, 2015 compared to a $10.0 million line of credit, of which $0 was outstanding at December 31, 2014.
3.
Subordinated debentures
We have outstanding $25.8 million of Trust Preferred Securities issued through two Delaware trust affiliates, Royal Bancshares Capital Trust I (“Trust I”) and Royal Bancshares Capital Trust II (“Trust II”) (collectively, the “Trusts”). We issued an aggregate principal amount of $12.9 million of floating rate junior subordinated debt securities to Trust I and an aggregate principal amount of $12.9 million of fixed/floating rate junior subordinated debt securities to Trust II. Both debt securities bear an interest rate of 2.66% at December 31, 2015, and reset quarterly at 3-month LIBOR plus 2.15%.
Each of Trust I and Trust II issued an aggregate principal amount of $12.5 million of capital securities initially bearing fixed and/or fixed/floating interest rates corresponding to the debt securities held by each trust to an unaffiliated investment vehicle and an aggregate principal amount of $387 thousand of common securities bearing fixed and/or fixed/floating interest rates corresponding to the debt securities held by each trust to the Company. We have fully and unconditionally
guaranteed all of the obligations of the Trusts, including any distributions and payments on liquidation or redemption of the capital securities.
Under the Federal Reserve Agreement as described in “Note 2 - Regulatory Matters and Significant Risks or Uncertainties” to the Consolidated Financial Statements, the Company and its non-bank subsidiaries may not make any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System. We received approval and paid the required interest payments in 2015 and 2014.
NOTE 11. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITY
In 2014, we entered into a forward-starting interest rate swap agreement to hedge the risk of variability in our cash flows attributable to changes in the 3 month LIBOR rate. This particular hedging objective was to reduce the interest rate risk associated with our forecasted issuances of 3 month fixed rate debt arising from a rollover strategy. This derivative was used as part of the asset/liability management process, is linked to a specific liability, and has a high correlation between the contract and the underlying item being hedged, both at inception and throughout the hedge period. The derivative was designated as cash flow hedge with the change in fair value recorded as an adjustment through other comprehensive income (loss) until the underlying forecasted transactions occur, at which time the deferred gains and losses are recognized in earnings. As of December 31, 2015, an investment security with a fair value of $671 thousand was pledged as collateral to the counterparty of this transaction.
The effects of the derivative instrument on the Consolidated Financial Statements for December 31, 2015 and 2014 were as follows:
NOTE 12. INCOME TAXES
The components of income tax (benefit) expense are stated below:
The income tax benefit for 2015 is largely due to the release of a portion of the valuation allowance against the net deferred tax assets (“DTA”) during the fourth quarter of 2015.
The difference between the income tax (benefit) expense and the amount computed by applying the statutory federal income tax rate of 34% in 2015 and 2014 is as follows:
*KNBT: Knoblauch State Bank
Deferred tax assets and liabilities consist of the following:
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. We are required to establish a valuation allowance for DTAs 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 DTAs 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 estimates and judgments are inherently subjective. Based on the analysis of the DTAs at December 31, 2015, 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 assessment, we released $5.4 million of our valuation allowance previously recorded on the net DTAs and credited income tax expense. In accordance with ASC 740, we considered the following sources of income in reaching our conclusion:
·
Future reversal of temporary differences
·
Future taxable income exclusive of reversing temporary differences and carryforwards
·
Taxable income in prior carryback year(s) if carryback is permitted under the tax law
·
Tax-planning strategies
The positive evidence that outweighed the negative evidence in management’s assessment included, but was not limited to, the following:
·
Positive cumulative pre-tax earnings over the prior three year period ended December 31, 2015.
·
Improvement in asset quality and net interest income.
·
Management’s consistent ability to exceed annual forecasted financial results.
·
Significant reductions in historical credit-related losses and investment impairment.
·
Net operating loss carryforwards do not begin to expire until 2028.
The total change to our valuation allowance on the net DTAs was $7.2 million. The change consisted of a gross change in the valuation allowance of $8.6 million and was offset with the write-off of an expiring net operating loss (“NOL”) DTA of $1.4 million that had a full valuation allowance against it. At December 31, 2014, we had NOLs of approximately $4.0 million available to be utilized related to net operating loss carryovers from the acquisition of Knoblauch State Bank. The utilization of these losses was subject to limitation under Section 382 of the Internal Revenue Code. The ability to utilize these carryovers expired in 2015 and we wrote off a gross DTA of $1.4 million related to these NOLs. Consequently, the total amount of our valuation allowance previously recorded on the net DTAs that we released was $7.2 million, representing current income tax expense for the year of $2.1 million that was not required to be recorded in income tax expense due to a corresponding valuation allowance release of $2.1 million. The balance of the change in our valuation allowance in 2015 was recorded as a net tax benefit in income tax expense for $5.1 million.
The ability to recognize the remaining DTAs 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. There can be no assurance, however, as to when we could be in a position to reverse the remaining DTA valuation allowance. The deferred tax assets/ (liabilities), net of valuation allowances, totaled $5.7 million and $(308) thousand at December 31, 2015 and 2014, respectively.
A significant component of the DTAs at December 31, 2015 is our federal NOL carryforwards of approximately $63.2 million and state NOL carryforwards of $147.5 million which are available to be carried forward to future tax years. The federal loss carryforwards will begin to expire in 2028 and the state NOLs will begin to expire in 2026 if not fully utilized.
As of December 31, 2015, we have capital loss carryforwards of approximately $4.8 million which will begin to expire as of December 31, 2016 if not utilized. We also have charitable contribution carryovers of $69 thousand which will begin to expire as of December 31, 2016 if not utilized but would likely be converted to NOLs. We also have general business tax credit carryovers of $1 thousand that will begin to expire as of December 31, 2030 if not utilized and AMT tax credits of $302 thousand that have an indefinite life.
We had no material unrecognized tax benefits (“UTB”) or accrued interest and penalties as of December 31, 2015. We do not expect the total amount of UTB to significantly increase in the next twelve months. As of December 31, 2015 no significant changes to UTB are projected; however, tax audit examinations are possible. As of December 31, 2015, tax years 2012 through 2014 are subject to federal examination by the IRS and years 2011 through 2014 are subject to state examination by various state taxing authorities.
Note 13.FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF CREDIT RISK
We are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they become payable. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract amounts of those instruments reflect the extent of involvement we have in particular classes of financial instruments.
Our exposure to credit loss in the event of non-performance by the other party to commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. We use the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
The contract amounts are as follows:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, and others are for staged construction, the total commitment amounts do not necessarily represent immediate cash requirements.
We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation. Collateral held varies but may include personal or commercial real estate, accounts receivable, inventory or equipment.
Standby letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. Most guarantees extend for one year and expire in decreasing amounts through October 2016. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. We hold personal or commercial real estate, accounts receivable, inventory or equipment as collateral supporting those commitments for which collateral is deemed necessary. The extent of collateral held for those commitments is approximately 75%.
NOTE 14. LEGAL CONTINGENCIES
Royal Bank had 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 is subject to Court approval after notice and a hearing. Members of the proposed settlement class will have an opportunity to object to the proposed settlement or opt-out.
Note 15. Shareholders’ Equity
1.
Preferred Stock
On February 20, 2009, as part of the Capital Purchase Program (“CPP”) established by the Treasury, we issued to Treasury 30,407 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, without par value per share (the “Series A Preferred Stock”), and a liquidation preference of $1,000 per share. In conjunction with the purchase of the Series A Preferred Stock, Treasury received a warrant to purchase 1,104,370 shares of our Class A common stock. The aggregate purchase price for the Series A Preferred Stock and warrant was $30.4 million in cash. The Series A Preferred Stock qualifies as Tier 1 capital and originally paid cumulative dividends at a rate of 5% per annum. In February 2014, the cumulative dividend rate on the Series A Preferred Stock increased to 9% per annum. The Series A Preferred Stock may generally be redeemed by us at any time following consultation with our primary banking regulators. The warrant issued to Treasury has a 10-year term and is immediately exercisable upon its issuance, with an exercise price, subject to anti-dilution adjustments, equal to $4.13 per share of the common stock. As a result of the shareholders’ right offering described below, the number of warrants to purchase our Class A common stock adjusted to 1,368,040 and the warrant exercise price decreased to $3.33 per share of the common stock.
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 Treasury. The auction closed on June 19, 2014. The Series A Preferred Stock was priced in the auction at $1,207.11 per share for all 30,407 shares of Series A Preferred Stock outstanding. We were allocated 11,551 shares of Series A Preferred Stock for repurchase at the clearing price of $1,207.11. Closing for the sale of the Series A Preferred Stock by the Treasury, including the repurchase of 11,551 shares of Series A Preferred Stock by the Company occurred, on July 2, 2014. As part of this redemption, we eliminated nearly $3.5 million in preferred dividend in arrears.
2.
Common Stock
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. Shareholders are entitled to one vote for each Class A share and ten votes for each Class B share held. Holders of either class of common stock are entitled to conversion equivalent per share dividends when declared.
To fund the purchase of the Series A Preferred Stock, described above, the Company sold 11,666,667 shares of its Class A common stock in a private placement transaction at a price of $1.20 per share. Additionally, during the third quarter of 2014, the Company conducted a shareholder rights offering to existing shareholders to limit their ownership dilution from the sale of Class A common stock to the other investors in the private placement. The Company issued 4,999,896 shares and received gross proceeds of approximately $6.0 million.
3.
Payment of Dividends
Under the Pennsylvania Business Corporation Law, the Company may pay dividends only if it is solvent and would not be rendered insolvent by the dividend payment. There are also restrictions set forth in the Pennsylvania Banking Code of 1965 (the “Code”) and in the Federal Deposit Insurance Act (“FDIA”) affecting the payment of dividends to the Company by Royal Bank. Under the Code, no dividends may be paid by a bank except from “accumulated net earnings” (generally retained earnings). 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.
In 2009, our Board suspended the regular quarterly cash dividends on the Series A Preferred Stock. Our Board took this action in consultation with the Federal Reserve Bank of Philadelphia as required by regulatory policy guidance. In February 2014, the preferred cumulative dividend rate prospectively increased to 9% per annum. As a result of the Company’s repurchase of 11,551 shares of Series A Preferred Stock, approximately $3.5 million of the Series A Preferred stock dividend in arrears was eliminated. As of December 31, 2015, the Series A Preferred stock dividend in arrears including interest was approximately $8.9 million and has not been recognized in the consolidated financial statements.
In the event we declared the preferred dividend in arrears our capital ratios would be negatively affected; however, they would remain above the required minimum ratios. Under the Federal Reserve MOU as described in “Note 2 - Regulatory Matters and Significant Risks or Uncertainties” to the Consolidated Financial Statements, the Company may not declare or pay any dividends without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System.
Note 16.Regulatory Capital Requirements
The Company and Royal Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s and Royal Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. As of December 31, 2015, the Company and Royal Bank met all capital adequacy requirements to which it is subject and Royal Bank met the criteria for a well-capitalized institution.
In July 2013, the federal bank regulatory agencies adopted final rules to revise the agencies’ capital adequacy guidelines and prompt corrective action rules, which were designed to enhance such requirements and implement the revised standards of the Basel Committee on Banking Supervision, commonly referred to as Basel III. The July 2013 final rules generally implement higher minimum capital requirements, add a new common equity tier 1 capital requirement, and establish criteria that instruments must meet to be considered common equity tier 1 capital, additional tier 1 capital or tier 2 capital. The new minimum capital to risk-adjusted assets requirements are a common equity tier 1 capital ratio of 4.5% (6.5% to be considered “well capitalized”) and a tier 1 capital ratio of 6.0%, increased from 4.0% (and increased from 6.0% to 8.0% to be considered “well capitalized”); the total capital ratio remains at 8.0% under the new rules (10.0% to be considered “well capitalized”).
In connection with a prior bank regulatory examination, the FDIC concluded, based upon its interpretation of the Call Report instructions and under RAP, that income from Royal Bank’s tax lien business should be recognized on a cash basis, not an accrual basis. Royal Bank’s current accrual method is in accordance with U.S. GAAP. Royal Bank disagrees with the FDIC’s conclusion and filed the Call Report for December 31, 2015 and the previous 21 quarters in accordance with U.S. GAAP. The change in the method of revenue recognition for the tax lien business for regulatory accounting purposes affects Royal Bank’s and the Company’s capital ratios as shown below. The resolution of this matter will be decided by additional joint regulatory agency guidance which includes the Federal Reserve Bank, the FDIC, and the OCC.
The table below sets forth Royal Bank’s capital ratios under RAP based on the FDIC’s interpretation of the Call Report instructions:
The tables below reflect the adjustments to the net income as well as the capital ratios for Royal Bank under U.S. GAAP:
The tables below reflect the Company’s capital ratios:
The Company has filed the Consolidated Financial Statements for Bank Holding Companies-FR Y-9C (“FR Y-9C”) as of December 31, 2015 consistent with U.S. GAAP and the FR Y-9C instructions. In the event that a similar adjustment for RAP purposes would be required by the Federal Reserve on the holding company level, the adjusted ratios are shown in the table below.
Note 17.Pension Plan
The following table sets forth our pension plan’s funded status and amounts recognized in our consolidated balance sheets within other liabilities:
We plan to fund a substantial portion of the pension plan obligations through existing Company owned life insurance policies. The accumulated benefit obligation at December 31, 2015 and 2014 was $14.9 million and $15.3 million, respectively.
The table below reflects the assumptions used to determine the net periodic pension cost:
Net periodic defined benefit pension expense for the years ended December 31, 2015 and 2014 included the following components:
Benefit payments to be made from the Non-qualified Pension Plan are as follows:
A substantial portion of the benefit payments are expected to be made from insurance policies owned by the Company. The cash surrender value for these policies was approximately $3.8 million and $3.6 million as of December 31, 2015 and 2014, respectively.
Defined Contribution Plan
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 IRS regulation, with the Company matching dollar for dollar of any contribution up to 5%, which is subject to a $2,500 per employee annual limit. The 401(k) matching contribution was $134 thousand and $148 thousand for 2015 and 2014, respectively.
NOTE 18. STOCK COMPENSATION PLANS
We recognized compensation expense for stock options in the amounts of $64 thousand and $17 thousand in 2015 and 2014, respectively. We granted 146,500 and 52,500 options to purchase common stock in 2015 and 2014, respectively.
1.
Outside Directors’ Stock Option Plan
We had a non-qualified outside Directors’ Stock Option Plan (the “Directors’ Plan”) which expired in 2006. At December 31, 2015 all outstanding shares are fully vested (exercisable). The ability to grant new options under this plan has expired.
A summary of the Directors’ Plan activity is presented below:
(1) The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had they exercised their options on December 31, 2015. The intrinsic value varies based on the changes in the market value in the Company’s stock. Because the exercise price exceeded the market value of the options, the aggregate intrinsic value was $0 at December 31, 2015.
Information pertaining to options outstanding at December 31, 2015 is as follows:
2. Employee Stock Option and Appreciation Rights Plan
We had a Stock Option and Appreciation Rights Plan (the “Plan”) which expired in 2006. At December 31, 2015 all outstanding shares are fully vested (exercisable). The ability to grant new options under this plan has expired.
A summary of the Plan activity is presented below:
(1) The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had they exercised their options on December 31, 2015. The intrinsic value varies based on the changes in the market value in the Company’s stock. Because the exercise price exceeded the market value of the options, the aggregate intrinsic value was $0 at December 31, 2015.
Information pertaining to options outstanding at December 31, 2015 is as follows:
3.
Long-Term Incentive Plan
Our current share based payment plan is the 2007 Long-Term Incentive Plan (“LTI Plan”), which consists of stock option grants and restricted stock awards. All employees and non-employee directors of the Company and its designated subsidiaries are eligible participants. The LTI Plan includes one million shares of Class A common stock (of which 250,000 shares may be issued as restricted stock), subject to customary anti-dilution adjustments, or approximately 4.0% of the total outstanding shares of the Class A common stock.
As of December 31, 2015, 703,131 shares in the LTI plan are available for future grants. The option price is equal to the fair market value at the date of the grant. The employee options are exercisable based on the grant’s vesting schedule beginning one year after the date of grant and must be exercised within ten years of the grant date. Directors’ options are exercisable on the one year anniversary of the date of grant and must be exercised within ten years of the grant date. Compensation expense for stock options is recognized over the requisite service period. During 2015 and 2014, we recognized $64 thousand and $17 thousand, respectively, in compensation expense for stock options. At December 31, 2015, approximately $123 thousand remained to be recognized in compensation expense over a weighted-average period of 2.0 years.
The fair value of each stock option award is estimated on the date of the grant using the Black-Scholes option-pricing model. The risk-free interest rate for the expected term of the stock option awared is based on the U.S. Treasury yield curve in effect at the time of the grant. Average volatility is based on the historical volatility of our common stock. The average expected life represents the period of time that stock option grants are expected to be outstanding and are based on historical data. The following assumptions were used to estimate the fair value of the options granted during 2015 and 2014:
A summary of the status of the stock options in the LTI Plan is presented below:
(1)
The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had they exercised their options on December 31, 2015. The intrinsic value varies based on the changes in the market value in the Company’s stock. Because the exercise price exceeded the market value of the options, the aggregate intrinsic value was $0 at December 31, 2015.
Information pertaining to options outstanding at December 31, 2015 is as follows:
The following table provides detail for non-vested stock options under the LTI Plan as of December 31, 2015:
Under the aforementioned LTI Plan, we are authorized to grant share-based incentive compensation awards for corporate performance to employees. These awards may be granted in the form of performace restricted shares of our common stock. The vesting of awards is contingent upon meeting performance goals stated in the specific awards when granted. The awards are not permitted to be transferred during the restricted time period from the date of the award and are subject to forfeiture to the extent that the performance restrictions are not satisfied. Awards are also forfeited if the employee terminates his or her service prior to the end of the restricted time period, unless such termination is in accordance with the Company’s mandatory retirement age. Vested awards are converted to shares of our common stock at the end of the restricted time period. The fair market value of each employee based award is estimated based on the fair market value of our common stock on the date of the grant and probable performance goals to be achieved and estimated forfeitures. If such goals are not met then no compensation cost would be recognized and any recognized compensation cost would be reversed. At December 31, 2015 of the 703,131 shares available for future grants, 225,000 shares are available for future restricted stock grants. During 2015, we recognized $14 thousand in compensation expense for restricted stock grants. At December 31, 2015, approximately $31 thousand remained to be recognized in compensation expense over a weighted-average period of 2.0 years.
The following table details the restricted stock awards as of December 31, 2015:
Note 19. Earnings Per Common Share
We follow the provisions of FASB ASC Topic 260, “Earnings per Share” (“ASC Topic 260”). Basic earnings per share (“EPS”) excludes dilution and is computed by dividing income available to common shareholders by the weighted average common shares outstanding during the period. We have two classes of common stock currently outstanding. The classes are A and B, of which one share of Class B is convertible into 1.15 shares of Class A. Diluted EPS takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock using the treasury stock method. For the years ended December 31, 2015 and 2014, 96,655 and 170,239 options to purchase shares of common stock, respectively, were anti-dilutive in the computation of diluted EPS, as the exercise price exceeded average market price in each of those periods. Additionally warrants to purchase 1,368,040 shares of Class A common stock were also anti-dilutive.
Basic and diluted EPS are calculated as follows:
Note 20. Comprehensive Income (Loss)
FASB ASC Topic 220, “Comprehensive Income” (“ASC Topic 220”), requires the reporting of all changes in equity during the reporting period except investments from and distributions to shareholders. Net income is a component of comprehensive income (loss) with all other components referred to in the aggregate as other comprehensive income. Unrealized gains and losses on AFS securities is an example of another comprehensive income (loss) component.
The other components of accumulated other comprehensive loss included in shareholders’ equity at December 31, 2015 and 2014 are as follows:
Note 21. Fair Value of Financial Instruments
Under FASB ASC Topic 820 “Fair Value Measurements and Disclosures” (“ASC Topic 820”), fair values are based 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. When available, management uses quoted market prices to determine fair value. If quoted prices are not available, fair value is based upon valuation techniques such as matrix pricing or other models that use, where possible, current market-based or independently sourced market parameters, such as interest rates. If observable market-based inputs are not available, we use unobservable inputs to determine appropriate valuation adjustments using discounted cash flow methodologies.
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.
ASC Topic 820 provides guidance for estimating fair value when the volume and level of activity for an asset or liability has significantly declined and for identifying circumstances when a transaction is not orderly. ASC Topic 820 establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). 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).
A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. We did not have transfers of financial instruments within the fair value hierarchy during the years ended December 31, 2015 and 2014.
Items Measured on a Recurring Basis
Our available for sale investment securities are recorded at fair value on a recurring basis.
Fair value for Level 1 securities are determined by obtaining quoted market prices on nationally recognized securities exchanges. Level 1 securities include common stocks.
Level 2 securities include obligations of U.S. government-sponsored agencies and debt securities with quoted prices, which are traded less frequently than exchange-traded instruments, whose value is determined using matrix pricing with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. The prices were obtained from third party vendors. This category generally includes our mortgage-backed securities and CMOs issued by U.S. government and government-sponsored agencies, non-agency CMOs, and corporate and municipal bonds. Additionally, Level 2 includes derivative instruments whose valuations are based on observable market data.
Level 3 securities include investments in seven private equity funds which are predominantly invested in real estate. The value of the private equity funds are derived from the funds’ financials and K-1 filings. We also review the funds’ asset values and its near-term projections.
For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at December 31, 2015 and December 31, 2014 are as follows:
The following tables present additional information about assets measured at fair value on a recurring basis and for which the Company has utilized Level 3 inputs to determine fair value for the year ended December 31, 2015 and 2014:
Items Measured on a Nonrecurring Basis
Non-accrual loans and TDRs are evaluated for impairment on an individual basis under FASB ASC Topic 310 “Receivables”. The impairment analysis includes current collateral values, known relevant factors that may affect loan collectability, and risks inherent in different kinds of lending. When the collateral value or discounted cash flows less costs to sell is less than the carrying value of the loan a specific reserve (valuation allowance) is established. OREO is carried at the lower of cost or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the real estate. Additionally, for collateral acquired from tax liens, fair value may be established using brokers opinions due to their lower carrying value. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.
For financial assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at December 31, 2015 and December 31, 2014 are as follows:
The following tables present additional quantitative information about assets measured at fair value on a nonrecurring basis and for which we have utilized Level 3 inputs to determine fair value at December 31, 2015 and December 31, 2014:
(1)
Appraisals may be adjusted for qualitative factors such as interior condition of the property and liquidation expenses.
The following methods and assumptions were used to estimate the fair values of our financial instruments at December 31, 2015 and December 31, 2014. The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of our assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between our disclosures and those of other companies may not be meaningful. The methodologies for estimating the fair value of financial instruments that are measured on a recurring or nonrecurring basis are discussed above.
Cash and cash equivalents (carried at cost):
The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets’ fair values.
Securities:
Management uses quoted market prices to determine fair value of securities (level 1). If quoted prices are not available, fair value is based upon valuation techniques such as matrix pricing or other models that use, where possible, current market-based or independently sourced market parameters, such as interest rates (level 2). If observable market-based inputs are not available, we use unobservable inputs to determine appropriate valuation adjustments by reviewing the private equities funds’ financials and K-1 filings (level 3).
Other Investment (carried at cost):
This investment includes the Solomon Hess SBA Loan Fund, which we invested in to partially satisfy our community reinvestment requirement. Shares in this fund are not publicly traded and therefore have no readily determinable fair market value. An investor can have their investment in the Fund redeemed for the balance of their capital account at any quarter end with 60 days notice to the Fund. The investment in this Fund is recorded at cost. We do not record this investment at fair value on a recurring basis, as this investment’s carrying amount approximates fair value.
Restricted investment in bank stock (carried at cost):
The carrying amount of restricted investment in bank stock approximates fair value, and considers the limited marketability of such securities.
Loans receivable (carried at cost):
The fair values of loans are estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect the credit and interest rate-risk inherent in the loans. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Generally, for variable rate loans that re-price frequently and with no significant change in credit risk, fair values are based on carrying values.
Impaired loans (generally carried at fair value):
Impaired loans are accounted for under ASC Topic 310. Impaired loans are those in which we have measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based on the expected proceeds. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.
Accrued interest receivable and payable (carried at cost):
The carrying amount of accrued interest receivable and accrued interest payable approximates its fair value.
Deposit liabilities (carried at cost):
The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Short-term borrowings (carried at cost):
The carrying amounts of short-term borrowings approximate their fair values.
Long-term debt (carried at cost):
Fair values of FHLB advances and other long-term borrowings are estimated using discounted cash flow analysis, based on quoted prices for new FHLB advances with similar credit risk characteristics, terms and remaining maturity. These prices obtained from this active market represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party.
Subordinated debt (carried at cost):
Fair values of junior subordinated debt are estimated using discounted cash flow analysis, based on market rates currently offered on such debt with similar credit risk characteristics, terms and remaining maturity.
Derivative instruments:
We have contracted with a third party vendor to provide periodic valuations for our interest rate derivatives to determine the fair value of our interest rate swaps. The vendor utilizes standard valuation methodologies applicable to interest rate derivatives such as discounted cash flow analysis and extensions of the Black-Scholes model. Such valuations are based upon readily observable market data and are therefore considered Level 2 valuations by the Company.
Off-balance sheet financial instruments (disclosed at cost):
Fair values for our off-balance sheet financial instruments (lending commitments and letters of credit) are based on fees currently charged in the market to enter into similar agreements, taking into account, the remaining terms of the agreements and the counterparties’ credit standing. They are not shown in the table because the amounts are immaterial.
The tables below indicate the fair value of our financial instruments at December 31, 2015 and December 31, 2014.
Limitations
The fair value estimates are made at a discrete point in time based on relevant market information and information about the financial instruments. Fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors.
These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Further, the foregoing estimates may not reflect the actual amount that could be realized if all or substantially all of the financial instruments were offered for sale. This is due to the fact that no market exists for a sizable portion of the loan, deposit and off balance sheet instruments.
In addition, the fair value estimates are based on existing on-and-off balance sheet financial instruments without attempting to value anticipated future business and the value of assets and liabilities that are not considered financial instruments. Other significant assets that are not considered financial assets include premises and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.
Finally, reasonable comparability between financial institutions may not be likely due to the wide range of permitted valuation techniques and numerous estimates which must be made given the absence of active secondary markets for many of the financial instruments. This lack of uniform valuation methodologies introduces a greater degree of subjectivity to these estimated fair values.
Note 22. Related party transactions
In the ordinary course of business, Royal Bank has had, and expects to have in the future, banking transactions with officers, directors, and their affiliates, which involve substantially the same terms as those prevailing at the time for comparable transactions with other parties not related to the bank. In the past we have originated loans to related parties. In accordance with Regulation O, related party loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than normal risk of collectability. The aggregate dollar amount of these loans and commitments was $0 at December 31, 2015 and 2014. During 2015, there were no new related party loans.
Related party deposits were $12.6 million and $10.9 million at December 31, 2015 and 2014, respectively.
The Company has had and intends to have business transactions in the ordinary course of business with directors, officers and associates on comparable terms as those prevailing from time to time for other non-affiliated vendors of the Company. For these transactions, the expenses are not significant to the operations of the Company.
Note 23.Segment Information
FASB ASC Topic 280, “Segment Reporting” (“ASC Topic 280”) established standards for public business enterprises to report information about operating segments in their annual financial statements and requires that those enterprises report selected information about operating segments in subsequent interim financial reports issued to shareholders. It also established standards for related disclosure about products and services, geographic areas, and major customers. Operating segments are components of an enterprise, which are evaluated regularly by the chief operating decision makers in deciding how to allocate and assess resources and performance. Our chief operating decision makers are the CEO and the CFO. We have identified our reportable operating segments as “Community Banking” and “Tax Liens”.
Community banking
Our community banking segment consists of commercial and retail banking and equipment leasing. The community banking business segment includes Royal Bank and Royal Bank Leasing and generates revenue from a variety of products
and services provided by those entities. Royal Bank and Royal Bank Leasing have similar economic characterisitcs in that earnings are predominantly derived from net interest income. For example, commercial lending is dependent upon the ability of Royal Bank to fund cash needed to make loans with retail deposits and other borrowings and to manage interest rate and credit risk.
Tax liens
At December 31, 2015, Royal Bank’s tax liens segment includes its 80% and 100% ownership interest in CSC and RTL, respectively. Prior to December 31, 2013, Royal Bank’s ownership interest in CSC and RTL was 60%. The Company’s tax liens segment consisted of purchasing delinquent tax certificates from local municipalities at auction and then processing those liens to either encourage the property holder to pay off the lien, or to foreclose and sell the property. The tax liens segment earns income based on interest rates (determined at auction) and penalties assigned by the municipality along with gains on sale of foreclosed properties. CSC is liquidating its assets under an orderly, long term plan. RTL ceased acquiring tax certificates at public auctions in 2010.
The following table presents selected financial information for reportable business segments for the years ended December 31, 2015 and 2014.
Interest income earned by the community banking segment related to the tax liens segment was approximately $795 thousand and $1.1 million for the year ended December 31, 2015 and 2014, respectively.
NOTE 24. CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY
Condensed financial information for the parent company only follows.
CONDENSED BALANCE SHEETS
CONDENSED STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME
CONDENSED STATEMENTS OF CASH FLOWS
NOTE 25. SUMMARY OF QUARTERLY RESULTS (UNAUDITED)
The following summarizes the consolidated results of operations during 2015 and 2014, on a quarterly basis, for the Company:
The sum of the 2014 quarterly amounts for basic and diluted earnings per share do not equal the total earnings per share for 2014 due to 16.7 million shares of common stock issued in the third quarter of 2014.
ITEM 9.
ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
We maintain a set of disclosure controls and procedures that are designed to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. As of the end of the period covered by this report, we evaluated, under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rule 13a-15(e) of the Exchange Act. Based on that evaluation our CEO and CFO concluded that our disclosure controls and procedures were effective as of December 31, 2015.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting during the fourth quarter of 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Our management, with the participation of our principal executive officer and principal financial officer, has assessed the effectiveness of our internal control over financial reporting based on the 2013 framework in “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).
Based on its assessment under the COSO framework, our management concluded that the Company’s control over financial reporting was effective as of December 31, 2015.
There are inherent limitations to the effectiveness of any controls system. A controls system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that its objectives are met. Further, the design of a control system must reflect the fact that there are limits on resources, and the benefits of controls must be considered relative to their costs and their impact on the business model.
This annual report does not include an attestation report of our registered accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to the Dodd-Frank Act, which permits smaller reporting companies, such as the Company, to provide only management’s report in this annual report.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III.
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
The information required in this Item, relating to directors, executive officers, and control persons is set forth in our Proxy Statement to be used in connection with the 2016 Annual Meeting of Shareholders under the captions “Information About Nominees, Continuing Directors and Executive Officers,” “ Section 16(a) Beneficial Ownership Reporting Compliance,” “Meetings and Committees of the Board of Directors,” and “Interests of Management and Others in Certain Transactions,” which pages are incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item, relating to executive compensation, is set forth in our Proxy Statement to be used in connection with the 2016 Annual Meeting of Shareholders, under the captions “Summary Compensation Table,” “Grants of Plan-Based Awards - 2015,” “Outstanding Equity Awards Table,” “Option Exercises and Stock Vested Table,” “Retirement Plans,” “Non-Qualified Deferred Compensation Plans,” “Other Potential Post-Employment Payments,” “Director Compensation Table,” “Outstanding Options Held by Directors,” “Compensation Committee Interlocks and Insider Participation”, and “Compensation Committee Report,” which pages are incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERS MATTERS
The information required by this Item, relating to beneficial ownership of the Registrant’s Common Stock, is set forth in our Proxy Statement to be used in connection with the 2016 Annual Meeting of Shareholders, under the captions “Principal Shareholders” and “Information About Nominees, Continuing Directors and Executive Officers,” which pages are incorporated herein by reference.
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, 2015:
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item, relating to transactions with management and others, certain business relationships and indebtedness of management, is set forth in our Proxy Statement to be used in connection with the 2016 Annual Meeting of Shareholders, under the caption “Interests of Management and Others in Certain Transactions,” which pages are incorporated herein by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this item appears under the caption “Audit Committee Report” of the Proxy Statement to be used in connection with the 2016 Annual Meeting of Shareholders, which pages are incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
						
						
(a.)
1.
Financial Statements
						
						
						
The following financial statements are included by reference in Part II, Item 8 hereof.
						
Report of Independent Registered Public Accounting Firm
						
Consolidated Balance Sheets.
						
Consolidated Statements of Income.
						
Consolidated Statements of Comprehensive Income (Loss).
						
Consolidated Statements of Changes in Shareholders’ Equity.
						
Consolidated Statement of Cash Flows.
						
Notes to Consolidated Financial Statements.
						
						
2.
Financial Statement Schedules
						
						
						
Financial Statement Schedules are omitted because the required information is either not applicable, not required or is shown in the respective financial statements or in the notes thereto.
10.2
Letter Agreement, including Securities Purchase Agreement - Standard Terms, dated December 19, 2008, between Royal Bancshares of Pennsylvania, Inc. and the United States Department of the Treasury. (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Commission on February 26, 2009.)
						
						
10.3
Side Letter Agreement, dated February 20, 2009, between Royal Bancshares of Pennsylvania, Inc. and the United States Department of the Treasury. (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the Commission on February 26, 2009.)
						
						
10.4
Employment Agreement, dated March 4, 2015, between the Company, Royal Bank America and F. Kevin Tylus. (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on March 11, 2015.)*
						
						
10.5
Change in Control Agreement between the Company, Royal Bank America and Michael S. Thompson dated March 10, 2015 (incorporated by reference to Exhibit 99.2 to the Company’s Current Report on Form 8-K filed on March 11, 2015.)*
						
						
10.6
Change in Control Agreement between the Company, Royal Bank America and Lars Eller dated March 10, 2015 (incorporated by reference to Exhibit 99.2 to the Company’s Current Report on Form 8-K filed on March 11, 2015.)*
						
						
10.7
Change in Control Agreement between the Company, Royal Bank America and Kathryn McDonald dated March 10, 2015 (incorporated by reference to Exhibit 99.2 to the Company’s Current Report on Form 8-K filed on March 11, 2015.)*
						
						
10.8
Change in Control Agreement between the Company, Royal Bank America and Mark Beidermann dated March 10, 2015 (incorporated by reference to Exhibit 99.2 to the Company’s Current Report on Form 8-K filed on March 11, 2015.)*
						
						
10.9
Royal Bank America Supplemental Executive Retirement Plan. (Incorporated by reference to Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q filed on November 13, 2009.)*
						
						
10.10
SERP Participation Agreement, as amended - Robert Tabas. (Incorporated by reference to Exhibit 10.6 to the Company’s Quarterly Report on Form 10-Q filed on November 13, 2009.)*
						
						
10.11
SERP Participation Agreement, as amended - Murray Stempel. (Incorporated by reference to Exhibit 10.8 to the Company’s Quarterly Report on Form 10-Q filed on November 13, 2009.)*
						
						
11.
Statement re: Computation of Earnings Per Share. (Included at Item 8, hereof, Note 19, “Earnings Per Common Share”.)
						
						
21.
Subsidiaries of Registrant.
						
						
23.
Consents of Independent Registered Public Accounting Firm.
						
						
31.1
Rule 13a-14(a)/15-d-14(a) Certification of Principal Executive Officer
						
						
31.2
Rule 13a-14(a)/15-d-14(a) Certification of Principal Financial Officer
						
						
32.1
Section 1350 Certification of Principal Executive Officer.
						
						
32.2
Section 1350 Certification of Principal Financial Officer.
						
						
						
						
						
						
						
						
* Denotes compensation plan or arrangement.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
ROYAL BANCSHARES OF PENNSYLVANIA, INC.
						
By: /s/ F. Kevin Tylus
By: /s/ Michael S. Thompson
F. Kevin Tylus
Michael S. Thompson
President and Chief Executive Officer
Chief Financial Officer
(Principal Executive Officer)
(Principal Financial Officer and Principal Accounting Officer)
March 17, 2016
March 17, 2016
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURES
						
By: /s/ Robert R. Tabas
By: /s/ F. Kevin Tylus
Robert R. Tabas
F. Kevin Tylus
Chairman of the Board
President and Chief Executive Officer/Director
March 17, 2016
March 17, 2016
						
By: /s/ Edward F. Bradley
By: /s/ William Hartman
Edward F. Bradley
William Hartman
Director
Lead Independent Director
March 17, 2016
March 17, 2016
						
By: /s/ Wayne R. Huey, Jr.
By: /s/ Michael Piracci
Wayne R. Huey, Jr
Michael Piracci
Director
Director
March 17, 2016
March 17, 2016
						
By: /s/ Linda Tabas Stempel
By: /s/ Murray Stempel, III
Linda Tabas Stempel
Murray Stempel, III
Director
Director
March 17, 2016
March 17, 2016
						
By: /s/ Gerard M. Thomchick
By: /s/ Howard Wurzak
Gerard M. Thomchick
Howard Wurzak
Director
Director
March 17, 2016
March 17, 2016