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EX-21 - EX-21 - ROYAL BANCSHARES OF PENNSYLVANIA INCw77910exv21.htm
EX-23 - EX-23 - ROYAL BANCSHARES OF PENNSYLVANIA INCw77910exv23.htm
EX-99.2 - EX-99.2 - ROYAL BANCSHARES OF PENNSYLVANIA INCw77910exv99w2.htm
EX-99.1 - EX-99.1 - ROYAL BANCSHARES OF PENNSYLVANIA INCw77910exv99w1.htm
EX-31.1 - EX-31.1 - ROYAL BANCSHARES OF PENNSYLVANIA INCw77910exv31w1.htm
EX-31.2 - EX-31.2 - ROYAL BANCSHARES OF PENNSYLVANIA INCw77910exv31w2.htm
EX-32.1 - EX-32.1 - ROYAL BANCSHARES OF PENNSYLVANIA INCw77910exv32w1.htm
EX-32.2 - EX-32.2 - ROYAL BANCSHARES OF PENNSYLVANIA INCw77910exv32w2.htm
Table of Contents

 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
 
FORM 10-K
     
(Mark One)  
     
þ   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2009
or
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number 0-26366
ROYAL BANCSHARES OF PENNSYLVANIA, INC.
(Exact name of registrant as specified in its charter)
     
Pennsylvania   23-2812193
     
(State of other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
     
732 Montgomery Avenue, Narberth, Pennsylvania   19072
     
(Address of principal executive offices)   (Zip Code)
(610) 668-4700
(Issuer’s telephone number, including area code)
 
(Former name, former address and former year, if changed since last report)
     
Securities registered pursuant to Section 12(b) of the Act:
 
   
Name of Each Exchange on Which Registered
  Title of Each Class
The NASDAQ Stock Market, LLC
  Class A Common Stock ($2.00 par value)
 
   
Securities registered pursuant to Section 12(g) of the Act:
 
   
Name of Each Exchange on Which Registered   Title of Each Class
None
  Class B Common Stock ($0.10 par value)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
o Yes       þ No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act.
o Yes     þ No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 of 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ     No o
Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding twelve months (or for such shorter period that the registrant was required to submit and post such files). Yes o     No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or smaller reporting company (as defined in Exchange Act Rule 12b-2).
             
Large accelerated filer o   Accelerated filer o   Non-accelerated filer þ (Do not check if a smaller reporting company)   Small reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act) Yes o     No þ
The aggregate market value of Registrant’s Common Stock held by non-affiliates is $9,325,987 based on the June 30, 2009 closing price of the Registrant’s Common Stock of $1.87 per share.
As of February 28, 2010, the Registrant had 11,355,466 and 2,086,689 shares outstanding of Class A and Class B common stock, respectively.
Documents Incorporated by Reference
Portions of the following documents are incorporated by reference: the definitive Proxy Statement of the Registrant relating to Registrant’s Annual meeting of Shareholders to be held on May 19, 2010—Part III.
 
 

 


TABLE OF CONTENTS

PART I
ITEM 1.BUSINESS
ITEM 1A. RISK FACTORS
ITEM 1B. UNRESOLVED STAFF COMMENTS
ITEM 2. PROPERTIES
ITEM 3. LEGAL PROCEEDINGS
ITEM 4. (REMOVED AND RESERVED)
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, AND RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7. MANAGEMENT’S DISCUSSIONS AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
EX-21
EX-23
EX-31.1
EX-31.2
EX-32.1
EX-32.2
EX-99.1
EX-99.2


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

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PART I
ITEM 1. BUSINESS
Royal Bancshares of Pennsylvania, Inc.
Royal Bancshares of Pennsylvania, Inc. (the “Company”), is a Pennsylvania business corporation and a two bank holding company registered under the Federal Bank Holding Company Act of 1956, as amended (the “Holding Company Act”). The Company is supervised by the Board of Governors of the Federal Reserve System (Federal Reserve Board). Its legal headquarters is located at 732 Montgomery Avenue, Narberth, PA. On June 29, 1995, pursuant to the plan of reorganization approved by the shareholders of Royal Bank America, formerly Royal Bank of Pennsylvania (“Royal Bank”), all of the outstanding shares of common stock of Royal Bank were acquired by the Company and were exchanged on a one-for-one basis for common stock of the Company. On July 17, 2006, Royal Asian Bank (“Royal Asian”) was chartered by the Commonwealth of Pennsylvania Department of Banking and commenced operation as a Pennsylvania state-chartered bank. Prior to obtaining a separate charter, the business of Royal Asian was operated as a division of Royal Bank. The principal activities of the Company are supervising Royal Bank and Royal Asian, collectively known as the Banks, which engage in a general banking business principally in Montgomery, Chester, Bucks, Philadelphia and Berks counties in Pennsylvania and in Northern and Southern New Jersey and Delaware. The Company also has a wholly owned non-bank subsidiary, Royal Investments of Delaware, Inc., which is engaged in investment activities. On November 21, 2007, the Company established Royal Captive Insurance Company, a wholly owned subsidiary. Royal Captive Insurance was formed to insure commercial property and comprehensive umbrella liability for the Company and its affiliates. At December 31, 2009, the Company had consolidated total assets of approximately $1.3 billion, total deposits of approximately $881.8 million and shareholders’ equity of approximately $104.3 million. The Company’s two Delaware trusts, Royal Bancshares Capital Trust I and Royal Bancshares Capital Trust II, are not consolidated per requirements under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 810, “Consolidation” (“ASC Topic 810”).
The Company has three reportable operating segments, Community Banking, Tax Liens, and Equity Investments. The Equity Investments are consolidated under ASC Topic 810 as described in “Note 20 - Segment Information” of the Notes to Consolidated Financial Statements in Item 8 of this report.
Regulatory Actions
On July 15, 2009, Royal Bank agreed to enter into a Stipulation and Consent to the Issuance of an Order to Cease and Desist (the “Orders”) with each of the Federal Deposit Insurance Corporation (“FDIC”) and the Commonwealth of Pennsylvania Department of Banking (“Department”). The material terms of the Orders are identical and require Royal Bank to: (i) have and retain qualified management, and notify the FDIC and the Department of any changes in Royal Bank’s Board of Directors or senior management; (ii) increase participation of Royal Bank’s Board of Directors in Royal Bank’s affairs by having the board assume full responsibility for approving Royal Bank’s policies and objectives and for supervising Royal Bank’s management; (iii) eliminate all assets classified as “Loss” and formulate a written plan to reduce assets classified as “Doubtful” and “Substandard” at its regulatory examination; (iv) develop a written plan to reduce delinquent loans, and restrict additional advances to borrowers with existing credits classified as “Loss,” “Doubtful” or “Substandard”; (v) develop a written plan to reduce Royal Bank’s commercial real estate loan concentration; (vi) maintain, after establishing an adequate allowance for loan and lease losses, a ratio of Tier 1 capital to total assets (“leverage ratio”) equal to or greater than 8% and a ratio of qualifying total capital to risk-weighted assets (total risk-based capital ratio) equal to or greater than 12%; (vii) formulate and implement written profit plans and comprehensive budgets for each year during which the Orders are in effect; (viii) formulate and implement a strategic plan covering at least three years, to be reviewed quarterly and revised annually; (ix) revise the liquidity and funds management policy and update and review the policy annually; (x) refrain from increasing the amount of brokered deposits held by Royal Bank and develop a plan to reduce the reliance on non-core deposits and wholesale funding sources; (xi) refrain from paying cash dividends without prior approval of the FDIC and the Department; (xii) refrain from making payments to or entering contracts with Royal Bank’s Holding Company or other Royal Bank affiliates without prior approval of the FDIC and the Department; (xiii) submit to the FDIC for review and approval an executive compensation plan that incorporates qualitative as well as profitability performance standards for Royal Bank’s executive officers; (xiv) establish a compliance

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committee of the Board of Directors of Royal Bank with the responsibility to ensure Royal Bank’s compliance with the Orders; and (xv) prepare and submit quarterly reports to the FDIC and the Department detailing the actions taken to secure compliance with the Orders. The Orders will remain in effect until modified or terminated by the FDIC and the Department.
The Orders do not restrict Royal Bank from transacting its normal banking business. Royal Bank will continue to serve its customers in all areas including making loans (with the exception of new non-owner occupied commercial real estate and construction loans), establishing lines of credit, accepting deposits and processing banking transactions. Customer deposits remain fully insured to the highest limits set by the FDIC. The FDIC and the Department did not impose or recommend any monetary penalties in connection with the Orders.
Following are the actions Royal Bank has taken to respond to and comply with the Orders as of the date of this report:
  1.   Board Oversight and Senior Management
 
      The Board of Director’s has increased their participation in the affairs of Royal Bank. A new Regulatory Compliance Committee comprised of outside directors and management was created in the third quarter of 2009. The purpose of the Committee is to monitor compliance with the Orders. Royal Bank has recently completed an internal assessment of senior management’s qualifications and has submitted the report to the FDIC and the Department for their review.
 
  2.   Reduction of Classified Assets
 
      Royal Bank has eliminated from its books via charge-off all assets classified as “Loss”. Royal Bank submitted to the FDIC and the Department a “Plan for the Reduction of Classified Assets” (“classified assets plan”) required under the Orders. The FDIC and the Department have approved the classified assets plan. No advances were made on any classified loan unless approved by the Board of Directors and determined to be in Royal Bank’s best interest. Royal Bank was successful in reducing net classified loans (outstanding loan balance less charge-offs and specific reserves) and other real estate owned (“OREO”) from $149.6 million at June 30, 2009 to $106.2 million at December 31, 2009.
 
  3.   Reduction of Delinquencies
 
      Royal Bank submitted to the FDIC and the Department a “Plan for the Reduction of Delinquencies” (“delinquency reduction plan”) required under the Orders. The FDIC and the Department have approved the delinquency reduction plan. No advances were made on any delinquent loan unless approved by the Board of Directors and determined to be in Royal Bank’s best interest. Royal Bank was successful in reducing delinquent loans from $36.3 million at June 30, 2009 to $27.5 million at December 31, 2009.
 
  4.   Reduction of Commercial Real Estate Concentrations
 
      Royal Bank submitted to the FDIC and the Department a “Plan for the Reduction of Commercial Real Estate Concentrations” (“CRE concentration plan”) required under the Orders. The FDIC and the Department have approved the CRE concentration plan. Management has been working diligently to reduce the concentration in commercial real estate loans (“CRE loans”). Royal Bank was successful in reducing the CRE concentration from $289.1 million at June 30, 2009 to $253.7 million at December 31, 2009, which amounted to 227.7% of total capital and 251.7% of Tier 1 capital. At year end 2009, Royal’s total CRE loans were below 300% of capital and were almost $49 million less than what was projected under the CRE concentration Plan.
 
      At December 31, 2009, total construction/land loans (“CL loans”) amounted to $114.9 million, or 102.9% of total capital and 113.7% of Tier 1 capital. CL loans were approximately $39 million less than what was projected under the CRE concentration plan at year end 2009.
 
  5.   Capital Maintenance
 
      Under the Orders, Royal Bank must maintain a minimum total risk-based capital ratio and a minimum Tier 1 leverage ratio of 12% and 8%, respectively. At December 31, 2009, Royal Bank’s total risk-based capital and Tier 1 leverage ratios were 13.37% and 8.09%, respectively.

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  6.   Budget Plan
 
      Royal Bank submitted to the FDIC and the Department a revised 2009 budget and profit plan required under the Orders. The FDIC and the Department have approved the 2009 budget and profit plan. In addition Royal Bank has submitted to the FDIC and the Department a 2010 budget and profit plan.
 
  7.   Strategic Plan
 
      Royal Bank submitted to the FDIC and the Department a three-year strategic plan required under the Orders. The FDIC and the Department have approved the three-year strategic plan. The Board of Directors and senior management are executing the strategic plan and will incorporate any modifications as deemed necessary by our regulators.
 
  8.   Liquidity and Funds Management
 
      Royal Bank submitted to the FDIC and the Department a liquidity and funds management plan (“liquidity plan”) required under the Orders. The FDIC and the Department have approved the liquidity plan. At December 31, 2009, Royal Bank had $56.7 million in cash on hand and $143.5 million in unpledged agency securities. At December 31, 2009, the liquidity to deposits ratio was 33.1% compared to Royal Bank’s 12% target and the liquidity to total liabilities was 24.0% compared to Royal Bank’s 10% target.
 
  9.   Brokered Deposits and Borrowings
 
      Royal Bank submitted to the FDIC and the Department a plan for reduction of reliance on non-core deposits and wholesale funding sources plan (“brokered deposit plan”) required under the Orders. The FDIC and the Department have approved the brokered deposit plan. Since entering the Orders Royal Bank has not renewed, accepted, or rolled over any maturing brokered certificates of deposit (“CDs”); nor has Royal Bank issued new brokered CDs. Brokered CDs declined $20 million from $226.9 million at June 30, 2009 to $206.9 million at December 31, 2009. Royal Bank has redeemed an additional $23.8 million in brokered CDs through February 2010. Borrowings declined $26.1 million from $283.9 million at June 30, 2009 to $257.8 million at December 31, 2009. The borrowing amounts do not include the $3.8 million in obligations owned via equity investment which are not guaranteed by Royal Bank or any of its subsidiaries.
 
  10.   Cash Dividends and other Payments to the Company
 
      Royal Bank will seek approval from the FDIC and the Department prior to declaring a cash dividend to the Company and prior to making payments or entering into new contracts with our affiliates.
 
  11.   Executive Compensation
 
      Royal Bank submitted to the FDIC an executive compensation plan (“compensation plan”) required under the Orders. The FDIC has approved the compensation plan. Royal Bank was not required to submit the compensation plan to the Department.
Royal Bank has submitted all required quarterly reports to the FDIC and the Department detailing the actions taken to secure compliance with the Orders as of the date of this report.
On March 17, 2010, the Company agreed to enter into a Written Agreement (the “Federal Reserve Agreement”) with the Federal Reserve Bank of Philadelphia (the “Reserve Bank”).
The material terms of the Federal Reserve Agreement provide that:
    the Company’s Board of Directors will take appropriate steps to fully utilize the Company’s financial and managerial resources to serve as a source of strength to its subsidiary banks, including taking steps to ensure that Royal Bank complies with the Orders previously entered into with the FDIC and the Department on July 15, 2009;
 
    the Company’s Board of Directors will, within 60 days of the Federal Reserve Agreement, submit to the Reserve Bank a written plan to strengthen board oversight of the management and operations of the consolidated operation;

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    the Company will not declare or pay any dividends without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System;
 
    the Company and its non-bank subsidiaries will not make any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without the prior approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System;
 
    the Company and its nonbank subsidiaries will not, directly or indirectly, incur, increase, or guarantee any debt without the prior written approval of the Reserve Bank;
 
    the Company will not, directly or indirectly, purchase or redeem any shares of its stock without the prior written approval of the Reserve Bank;
 
    the Company will, within 60 days of the Federal Reserve Agreement, submit to the Reserve Bank an acceptable written capital plan to maintain sufficient capital at the Company on a consolidated basis, which plan will at a minimum address: regulatory requirements for the Company and the Banks, the adequacy of the Banks’ capital taking into account the volume of classified credits, the allowance for loan and lease losses, current and projected asset growth, and projected retained earnings; the source and timing of additional funds necessary to fulfill the consolidated organization’s and the Banks’ future capital requirements; supervisory requests for additional capital at the Banks or the requirements of any supervisory action imposed on the Banks by federal or state regulators; and applicable legal requirements that the Company serve as a source of strength to the Banks;
 
    the Company will, within 60 days of the Federal Reserve Agreement, submit to the Reserve Bank cash flow projections for 2010 showing planned sources and uses of cash for debt service, operating expenses, and other purposes, and will submit similar cash flow projections for each subsequent calendar year at least one month prior to the beginning of such year;
 
    the Company will comply with applicable legal notice provisions in advance of appointing any new director or senior executive officer or changing the responsibilities of any senior executive officer such that the officer would assume a different senior executive officer position, and comply with restrictions on indemnification and severance payments imposed by the Federal Deposit Insurance Act; and
 
    the Company’s Board of Directors will, within 30 days after the end of each quarter, submit progress reports to the Reserve Bank detailing the form and manner of all actions taken to secure compliance with the Agreement and the results thereof, together with a parent company-level balance sheet, income statement, and, as applicable, report of changes in shareholders’ equity.
The Federal Reserve Agreement will remain in effect and enforceable until stayed, modified, terminated or suspended by the Reserve Bank.
Royal Bank America
Royal Bank was incorporated in the Commonwealth of Pennsylvania on July 30, 1963, was chartered by the Commonwealth of Pennsylvania Department of Banking and commenced operation as a Pennsylvania state-chartered bank on October 22, 1963. Royal Bank is the successor of the Bank of King of Prussia, the principal ownership of which was acquired by The Tabas Family in 1980. The deposits of Royal Bank are insured by the FDIC.
During the third quarter of 2006, Royal Bank formed a subsidiary, RBA ABL Group, LP, to originate asset based loans. The Bank owned 60% of the subsidiary. Royal Bank discontinued operating ABL in January 2008, with no material impact on operating results. The one outstanding loan relationship at ABL was transferred to Royal Bank and sold during the second quarter of 2008 for an amount equal to all sums due under the loan.

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During the fourth quarter of 2006, Royal Bank formed a subsidiary, Royal Tax Lien Services, LLC, to purchase and service delinquent tax liens. The Bank owns 60% of the subsidiary.
During the fourth quarter of 2006, Royal Bank formed a subsidiary, RBA Capital, LP, to originate structured debt. The Bank owns 60% of the subsidiary. During the fourth quarter of 2008, management decided to wind down the operation of RBA Capital. During 2009, the operations of the subsidiary were folded into Royal Bank.
On October 17, 2008, Royal Bank established RBA Property LLC, a wholly owned subsidiary. RBA Property was formed to hold other real estate owned acquired through foreclosure of collateral associated with non-performing loans.
On December 1, 2008, Royal Bank established Narberth Property Acquisition LLC, a wholly owned subsidiary. Narberth Property Acquisition was formed to hold other real estate owned acquired through foreclosure of collateral associated with non-performing loans.
On November 4, 2009, Royal Bank established Rio Marina LLC, a wholly owned subsidiary. Rio Marina LLC was formed to hold other real estate owned acquired through foreclosure of collateral associated with non-performing loans.
Royal Bank derives its income principally from interest charged on loans, interest earned on investment securities, and fees received in connection with the origination of loans and other services. Royal Bank’s principal expenses are interest expense on deposits and operating expenses. Operating revenues, deposit growth, investment maturities, loan sales and the repayment of outstanding loans provide the majority of funds for activities.
Royal Bank conducts business operations as a commercial bank offering checking accounts, savings and time deposits, and loans, including residential mortgages, home equity and SBA loans. Royal Bank also offers safe deposit boxes, collections, internet banking and bill payment along with other customary bank services (excluding trust) to its customers. Drive-up, ATM, and night depository facilities are available. Services may be added or deleted from time to time. The services offered and the business of Royal Bank is not subject to significant seasonal fluctuations. Royal Bank is a member of the Federal Reserve FedLine Wire Transfer System.
Service Area: Royal Bank’s primary service area includes Pennsylvania, primarily Montgomery, Chester, Bucks, Delaware, Berks and Philadelphia counties, and New Jersey. This area includes residential areas and industrial and commercial businesses of the type usually found within a major metropolitan area. Royal Bank serves this area from fifteen branches located throughout Montgomery, Philadelphia and Berks counties and New Jersey. Royal Bank also considers New York, Maryland, and Delaware as a part of its service area for certain products and services. In the past, Royal Bank had frequently conducted business with clients located outside of its service area. Royal Bank has loans in twenty-six states via loan originations and/or participations with other lenders who have broad experience in those respective markets. Royal Bank’s headquarters are located at 732 Montgomery Avenue, Narberth, PA.
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, which give a broader range of products with which Royal Bank must compete. Although the long-range effects of this development cannot be predicted, it will likely further narrow the differences and intensify competition among commercial banks, investment banks, insurance firms and other financial services companies. The Company has not elected financial holding company status.

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Employees: Royal Bank employed approximately 166 persons on a full-time equivalent basis as of December 31, 2009.
Deposits: At December 31, 2009, total deposits of Royal Bank were distributed among demand deposits (7%), money market deposit, savings and Super Now accounts (29%) and time deposits (64%). At year-end 2009, deposits increased $138.9 million to $822.4 million, from year-end 2008, or 20%. NOW and money market accounts increased $40.4 million while time deposits increased $94.9 million. Included in Royal Bank’s deposits are approximately $29.9 million of intercompany deposits that are eliminated through consolidation.
Current market and regulatory trends in banking are changing the basic nature of the banking industry. Royal Bank intends to keep pace with the banking industry by being competitive with respect to interest rates and new types or classes of deposits insofar as it is practical to do so consistent with Royal Bank’s size, objective of profit maintenance and stable capital structure.
Lending: At December 31, 2009, Royal Bank had a total net loan portfolio of $594.1 million, representing 49% of total assets. The loan portfolio is categorized into commercial demand, commercial mortgages, residential mortgages (including home equity lines of credit), construction, real estate tax liens, asset based loans, small business leases and installment loans. At year-end 2009, loans decreased $25.2 million from year end 2008.
Royal Asian Bank
Royal Asian was incorporated in the Commonwealth of Pennsylvania on October 4, 2005, and was chartered by the Commonwealth of Pennsylvania Department of Banking and commenced operation as a Pennsylvania state-chartered bank on July 17, 2006. Royal Asian is an insured bank by the FDIC.
Royal Asian derives its income principally from interest charged on loans and fees received in connection with other services. Royal Asian’s principal expenses are interest expense on deposits and operating expenses. Operating revenues, deposit growth, and the repayment of outstanding loans provide the majority of funds for activities.
On September 25, 2009, the Company announced that it had entered into a stock purchase agreement (the “Agreement”), dated as of September 24, 2009, with a newly formed corporation organized by the President of Royal Asian to purchase all of the outstanding common stock of Royal Asian owned by the Company. On December 21, 2009, the Company announced it was terminating the Agreement because the investor group pursuing the buyout was unable to raise sufficient capital to meet the terms of the agreement and ensure all regulatory approvals necessary to complete the transaction would be obtained. As a result of the Company’s termination of the Agreement, the $251,000 escrow amount previously deposited by Buyer, which was to be credited toward payment of the purchase price, was retained by the Company as liquidated damages and recorded in other income.
Service Area: Royal Asian’s primary service area includes Philadelphia County in Pennsylvania, northern New Jersey, and New York City. The service area includes residential areas and industrial and commercial businesses of the type usually found within a major metropolitan area. Royal Asian serves this area from five branches located throughout Philadelphia, northern New Jersey, and New York City. Royal Asian also considers Maryland and Delaware as a part of its service area for certain products and services. Occasionally, Royal Asian has conducted business with clients located outside of its service area.
Royal Asian conducts business operations as a commercial bank offering checking accounts, savings and time deposits, and loans, including residential mortgages, home equity and SBA loans. Royal Asian also offers collections, internet banking, safe deposit boxes and bill payment along with other customary bank services (excluding trust) to its customers. Drive-up, ATM, and night depository facilities are available. Certain international services are offered via a SWIFT machine which provides international access to transfer information through a secured web based system. This system is for informational purposes only and no funds are transferred through SWIFT. Services may be added or deleted from time to time. The services offered and the business of Royal Asian is not subject to significant seasonal fluctuations. Royal Asian through its affiliation with Royal Bank is a member of the Federal Reserve FedLine Wire Transfer System.

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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, mortgage companies, leasing companies, finance companies and other financial services companies offer products and services similar to those offered by Royal Asian, on competitive terms.
Employees: Royal Asian employed approximately 24 persons on a full-time equivalent basis as of December 31, 2009.
Deposits: At December 31, 2009, total deposits of Royal Asian were distributed among demand deposits (10%), money market deposit, savings and Super Now accounts (16%) and time deposits (74%). At year-end 2009 total deposits were $89.3 million.
Lending: At December 31, 2009, Royal Asian had a total net loan portfolio of $64.7 million, representing 63% of total assets. The loan portfolio is categorized into commercial demand, commercial mortgages, construction, and installment loans.
Current market and regulatory trends in banking are changing the basic nature of the banking industry. Royal Asian intends to keep pace with the banking industry by being competitive with respect to interest rates and new types or classes of deposits insofar as it is practical to do so consistent with Royal Asian’s size, objective of profit maintenance and stable capital structure.
Non-Bank Subsidiaries
On June 30, 1995, the Company established a special purpose Delaware investment company, Royal Investment of Delaware (“RID”), as a wholly owned subsidiary. Its legal headquarters is 1105 N. Market Street, Suite 1300, Wilmington, DE 19899. RID buys, holds and sells investment securities. At December 31, 2009, total assets of RID were $30.1 million, of which $2.0 million was held in cash and cash equivalents and $6.9 million was held in investment securities. RID had net interest income of $1.2 million and $1.4 million for 2009 and 2008, respectively. Non-interest income for 2009 was a loss of $5.8 million compared to a loss of $4.6 million for 2008. During 2009, RID recorded $5.5 million in impairment charges on investment securities of which $3.8 million was related to a managed common stock portfolio, and recorded investment losses of $353,000. During the third quarter of 2009, the Company sold the managed common stock portfolio and minimized additional losses to $130,000, or 1% of their aggregate cost. Royal Bank has extended loans to RID, secured by securities and as per the provisions of Regulation W. During the third quarter of 2009, RID paid off the $9.4 million loan from Royal Bank. In addition RID paid a $10.0 million dividend to Royal Bancshares during the third quarter of 2009.
During 2008, RID took a $3.8 million impairment charge on two bank preferred stocks and recorded investment losses of $828,000. RID’s net loss for 2009 was $5.1 million compared to a net loss of $2.3 million in 2008. The amounts above include the activity related to RID’s wholly owned subsidiary Royal Preferred LLC.
The Company, through its wholly owned subsidiary Royal Bank, holds a 60% ownership interest in Crusader Servicing Corporation (“CSC”). Its legal headquarters is located at 732 Montgomery Avenue, Narberth, PA. CSC acquires, through auction, delinquent property tax liens in various jurisdictions, assuming a lien position that is generally superior to any mortgage liens on the property, and obtaining certain foreclosure rights as defined by local statute. On February 2, 2007, due to a change in CSC management, Royal Bank and other shareholders, constituting a majority of CSC shareholders, voted to liquidate CSC under an orderly, long term plan adopted by CSC management. Royal Bank continues acquiring tax liens through its subsidiary, Royal Tax Lien Services, LLC (“RTL”) which was formed in November 2006. At December 31, 2009, total assets of CSC were $16.2 million. Included in total assets is $2.5 million for the Strategic Municipal Investments (“SMI”) portfolio, which is comprised of residential, commercial, and land tax liens, primarily in Alabama. In 2005, the Company entered into a partnership with SMI, ultimately acquiring a 50% ownership interest in SMI. In connection with acquiring this ownership interest, CSC extended an $18 million line of credit to SMI, which was used by SMI to purchase tax lien portfolios at a discount. As a result of the recent deterioration in residential, commercial and land values principally

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in Alabama, management concluded based on an analysis of the portfolio in the fourth quarter of 2008 that the loan was impaired by approximately $2.5 million as evidenced in the provision for loan and lease losses. During 2009, the loan was impaired by an additional $500,000. CSC charged-off $3.0 million related to this loan in 2009. The outstanding SMI loan balance was $2.5 million at December 31, 2009. In 2009, CSC had net interest income of $468,000 compared to $849,000 for 2008. The 2009 provision for loan and lease losses was $624,000 compared to $2.6 million for 2008. The provision is mainly related to the SMI impairments mentioned above. For 2009 and 2008 other income was $179,000 and $555,000, respectively. Other income is mostly comprised of gain on sale of Real Estate Owned (“REO”) properties. Other expense was $693,000 and $576,000 for 2009 and 2008, respectively. CSC recorded a net loss of $402,000 in 2009 compared to a net loss of $1.0 million in 2008. The 2009 and 2008 losses were impacted by the increase in the provision for loan and lease losses.
On June 23, 2003, the Company, through its wholly owned subsidiary Royal Bank, established Royal Investments America, LLC (“RIA”) as a wholly owned subsidiary. Its legal headquarters is located at 732 Montgomery Avenue, Narberth, Pennsylvania. RIA was formed to invest in equity real estate ventures subject to limitations imposed by regulation. At December 31, 2009, total assets of RIA prior to consolidation under ASC Topic 810 were $8.6 million. During 2009, RIA had net income of $709,000 compared to net income of $852,000 for 2008.
On October 27, 2004, the Company formed two Delaware trust affiliates, Royal Bancshares Capital Trust I and Royal Bancshares Capital Trust II, in connection with the sale of an aggregate of $25.0 million of a private placement of trust preferred securities.
On July 25, 2005, the Company, through its wholly owned subsidiary Royal Bank, formed Royal Bank America Leasing, LP (“Royal Leasing”). Royal Bank holds a 60% ownership interest in Royal Leasing. Its legal headquarters is located at 550 Township Line Road, Blue Bell, Pennsylvania. Royal Leasing was formed to originate small business leases. Royal Leasing originates small ticket leases through its internal sales staff and through independent brokers located throughout its business area. In general, Royal Leasing will portfolio individual small ticket leases in amounts of up to $250,000. Leases originated in amounts in excess of that are sold for a profit to other leasing companies. On occasion, Royal Bank will purchase municipal leases originated by Royal Leasing for its own portfolio. These purchases are at market based pricing and terms that Royal Leasing would expect to receive from unrelated third-parties. From time to time Royal Leasing will sell small lease portfolios to third-parties and will, on occasion, purchase lease portfolios from other originators. During 2009 and 2008, neither sales nor purchases of lease portfolios were material. At December 31, 2009, total assets of Royal Leasing were $37.8 million. For 2009, Royal Leasing had net interest income of $1.8 million, a 39% increase from $1.3 million for 2008. For 2009 provision for lease losses was $1.3 million compared to $1.1 million for 2008. The increase in the provision was primarily related to the 48% growth in the lease portfolio. Other income decreased $13,000 from $403,000 for 2008 to $390,000 for 2009. Other expense was $335,000 and $661,000 for 2009 and 2008, respectively. Royal Leasing recorded net income of $382,000 for the year ended December 31, 2009 compared to a net loss of $26,000 for the year ended December 31, 2008.
On September 1, 2006, the Company, through its wholly owned subsidiary Royal Bank, formed RBA ABL Group, LP (“ABL”). Royal Bank held a 60% ownership interest in ABL. Its legal headquarters was located at 732 Montgomery Avenue, Narberth, Pennsylvania 19072. ABL was formed to originate asset based loans. Royal Bank discontinued operating ABL in January 2008, with no material impact on operating results.
On October 1, 2006, the Company, through its wholly owned subsidiary Royal Bank, formed RBA Capital, LP (“RBA Capital”). Royal Bank held a 60% ownership interest in RBA Capital and its legal headquarters was located at 150 North Radnor Chester Road, Radnor, Pennsylvania 19087. RBA Capital was formed to lend to lenders on a re-discounted basis, which indicates the main business line of RBA Capital is the extension of loans to other lenders. These other lenders are not typically financial institutions, but rather individuals, smaller corporations, or partnerships that make small loans including, but not limited to, loans to contractors, home buyers or the purchasers of smaller, owner occupied, commercial real estate buildings. RBA Capital on occasion referred loans to Royal Bank, or for certain larger loans it originates, participated with Royal Bank in the loan. Royal Bank paid RBA Capital a referral fee for loans referred from RBA Capital or for loans participated with RBA Capital. All transactions between Royal Bank and RBA Capital are on commercially reasonable terms at market rates and terms that would be paid, received or granted by unrelated third-parties.

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During the fourth quarter of 2008, management decided to wind down the operation of RBA Capital and during 2009 took 100% ownership of the Company, which is currently managed as a separate division of Royal Bank. At December 31, 2009 RBA Capital had outstanding loans of $30.7 million, which declined by $7.1 million from the level at the end of 2008, consistent with the goal of having all existing loans pay off during the next few years. At December 31, 2008, total assets of RBA Capital were $37.5 million compared to $33.2 million at December 31, 2007. The net loss for 2008 increased $310,000 from $4,000 for 2007 to $314,000 for 2008 due mainly to a higher provision for loan losses of $582,000 year over year.
On November 17, 2006, the Company, through its wholly owned subsidiary Royal Bank, formed Royal Tax Lien Services, LLC (“RTL”). Royal Bank holds a 60% ownership interest in RTL. Its legal headquarters is located at 732 Montgomery Avenue, Narberth, Pennsylvania 19072. RTL was formed to purchase and service delinquent tax certificates. RTL typically acquires delinquent property tax liens through public auctions in various jurisdictions, assuming a lien position that is generally superior to any mortgage liens that are on the property, and obtaining certain foreclosure rights as defined by local statute. At December 31, 2009, total assets of RTL were $88.9 million compared to $64.3 million at December 31, 2008. Tax certificates outstanding grew $16.4 million from $46.7 million at December 31, 2008 to $63.1 million at December 31, 2009. For 2009, RTL had net interest income of $5.5 million compared to $3.3 million for 2008. Provision for loan and lease losses was $0 compared to $56,000 for 2009 and 2008, respectively. Other expense increased $726,000 from $1.5 million for 2008 to $2.2 million for 2009 primarily due to an increase in legal fees as a result of an internal investigation related to the U.S Department of Justice investigation described in “Item 3-Legal Proceedings” of this Report. Net income for 2009 grew $926,000 from $1.2 million for 2008 to $2.1 million for 2009.
On November 21, 2007, the Company established Royal Captive Insurance Company, a wholly owned subsidiary. Royal Captive Insurance was formed to insure commercial property and comprehensive umbrella liability for the Company and its affiliates. At December 31, 2009, total assets of Royal Captive Insurance were $2.7 million compared to $2.6 million at December 31, 2008.
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, 2009, Royal Preferred LLC had total assets of approximately $21 million.
Website Access to Company Reports
We post publicly available reports required to be filed with the SEC on our website, www.royalbankamerica.com, as soon as reasonably practicable after filing such reports with the SEC. The required reports are available free of charge through our website.
Products and Services with Reputation Risk
The Company offers a diverse range of financial and banking products and services. In the event one or more customers and/or governmental agencies become dissatisfied or object to any product or service offered by the Company or any of its subsidiaries, whether legally justified or not, negative publicity with respect to any such product or service could have a negative impact on the Company’s reputation. The discontinuance of any product or service, whether or not any customer or governmental agency has challenged any such product or service, could have a negative impact on the Company’s reputation.
Future Acquisitions
The Company’s acquisition strategy consists of identifying financial institutions, insurance agencies and other financial companies with business philosophies that are similar to our business philosophies, which operate in strong markets that are geographically compatible with our operations, and which can be acquired at an acceptable cost. In evaluating acquisition opportunities, we generally consider potential revenue enhancements and operating efficiencies, asset quality, interest rate risk, and management capabilities. The Company currently has no formal commitments with respect to future acquisitions although discussions with acquisition candidates take place occasionally.

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Concentrations, Seasonality
The Company does not have any portion of its business dependent on a single or limited number of customers, the loss of which would have a material adverse effect on its business. No substantial portion of loans or investments is concentrated within a single industry or group of related industries, except a significant majority of loans are secured by real estate. The Company has seen a deterioration in economic conditions as it pertains to real estate loans. Construction and land, non-residential real estate, and residential loans represent 33%, 27% and 20%, respectively of the $73.7 million in non-accrual loans at December 31, 2009. The business of the Company and its subsidiaries is not seasonal in nature.
Environmental Compliance
The Company and its subsidiaries’ compliance with federal, state and local environment protection laws had no material effect on capital expenditures, earnings or their competitive position in 2009, and are not expected to have a material effect on such expenditures, earnings or competitive position in 2010.
Supervision and Regulation
Bank holding companies and banks operate in a highly regulated environment and are regularly examined by federal and state regulatory authorities.
The following discussion concerns various federal and state laws and regulations and the potential impact of such laws and regulation on the Company and its subsidiaries.
To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory or regulatory provisions themselves. Proposals to change laws and regulations are frequently introduced in Congress, the state legislatures, and before the various bank regulatory agencies. The Company cannot determine the likelihood or timing of any such proposals or legislations or the impact they may have on the Company and its subsidiaries. A change in law, regulations or regulatory policy may have a material effect on the Company’s business.
Holding Company
The Company, as a Pennsylvania business corporation, is subject to the jurisdiction of the Securities and Exchange Commission (the “SEC”) and of state securities commissions for matters relating to the offering and sale of its securities. Accordingly, if the Company wishes to issue additional shares of its Common Stock, in order, for example, to raise capital or to grant stock options, the Company will have to comply with the registration requirements of the Securities Act of 1933 as amended, or find an applicable exemption from registration.
The Company is subject to the provisions of the Holding Company Act, and to supervision, regulation and examination by the Federal Reserve Board. The Holding Company Act requires the Company to secure the prior approval of the Federal Reserve Board before it owns or controls, directly or indirectly, more than 5% of the voting shares of any corporation, including another bank. In addition, the Holding Company Act prohibits the Company from acquiring more than 5% of the voting shares of, or interest in, or all or substantially all of the assets of, any bank located outside Pennsylvania, unless such an acquisition is specifically authorized by laws of the state in which such bank is located.
A bank holding company also is prohibited from engaging in or acquiring direct or indirect control of more than 5% of the voting shares of any such company engaged in non-banking activities unless the Federal Reserve Board, by order or regulation, has found such activities to be closely related to banking or managing or controlling banks as to be a proper incident thereto. In making this determination, the Federal Reserve Board considers whether the performance of these activities by a bank holding company would offer benefits to the public that outweigh possible adverse effects.
As a bank holding company, the Company is required to file an annual report with the Federal Reserve Board and any additional information that the Federal Reserve Board may require pursuant to the Holding Company Act. The Federal Reserve Board may also make examinations of the Holding Company and any or all of its subsidiaries. Further, under the Holding Company Act and the Federal Reserve Board’s regulations, a bank holding company and its subsidiaries are prohibited from engaging in certain tying arrangements in connection with any extension of credit or provision of credit

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of any property or services. The so called “anti-tying” provisions state generally that a bank may not extend credit, lease, sell property or furnish any service to a customer on the condition that the customer obtain additional credit or service from the banks, its bank holding company or any other subsidiary of its bank holding company, or on the condition that the customer not obtain other credit or services from a competitor of the banks, its bank holding company or any subsidiary of its bank holding company.
Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve Act and by state banking laws on any extensions of credit to the bank holding company or any of the holding company’s subsidiaries, on investments in the stock or other securities of the bank holding company and on taking of such stock or securities as collateral for loans to any borrower.
Under the Pennsylvania Banking Code of 1965, as amended, the (“Code”), the Company is permitted to control an unlimited number of banks. However, the Company would be required under the Holding Company Act to obtain the prior approval of the Federal Reserve Board before it could acquire all or substantially all of the assets of any bank, or acquiring ownership or control of any voting shares of any bank other than Royal Bank or Royal Asian, if, after such acquisition, the registrant would own or control more than 5% of the voting shares of such bank. The Holding Company Act has been amended by the Riegle-Neal Interstate Banking and Branching Act of 1994, which authorizes bank holding companies, subject to certain limitations and restrictions, to acquire banks located in any state.
In 1995, the Code was amended to harmonize Pennsylvania law with the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 to enable Pennsylvania institutions to participate fully in interstate banking and to remove obstacles to the choice by banks from other states engaged in interstate banking to select Pennsylvania as a head office location.
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 and Royal Asian
As previously mentioned under “Regulatory Action”, Royal Bank is operating under the Orders with the FDIC and the Department. The deposits of the Banks are insured by the FDIC. The Banks are subject to supervision, regulation and examination by the Department and by the FDIC. In addition, the Banks are subject to a variety of local, state and federal laws that affect its operation.
The Department and the FDIC routinely examine Pennsylvania state-chartered, non-member banks such as the Banks in areas such as reserves, loans, investments, management practices and other aspects of operations. These examinations are designed for the protection of depositors rather than the Company’s shareholders.
Federal and state banking laws and regulations govern, among other things, the scope of a bank’s business, the investments a bank may make, the reserves against deposits a bank must maintain, the types and terms of loans a bank may make and the collateral it may take, the activities of banks with respect to mergers and consolidations, and the establishment of branches. Pennsylvania law permits statewide branching.
Under the Federal Deposit Insurance Act (“FDIC Act”), the FDIC possesses the power to prohibit institutions regulated by it (such as Royal Bank and Royal Asian) 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 the Banks 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

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have participated in such violations or unsound practices; (iii) restricts lending by the Banks 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 the Banks unless the FDIC has been given 60-days prior written notice and within that time has not disapproved the acquisition or extended the period for disapproval.
Under the Community Reinvestment Act (“CRA”), the FDIC uses a five-point rating scale to assign a numerical score for a bank’s performance in each of three areas: lending, service and investment. Under the CRA, the FDIC is required to: (i) assess the records of all financial institutions regulated by it to determine if these institutions are meeting the credit needs of the community (including low-and moderate-income neighborhoods) which they serve, and (ii) take this record into account in its evaluation of any application made by any such institutions for, among other things, approval of a branch or other deposit facility, office relocation, a merger or an acquisition of another bank. The CRA also requires the federal banking agencies to make public disclosures of their evaluation of each bank’s record of meeting the credit needs of its entire community, including low-and moderate-income neighborhoods. This evaluation will include a descriptive rate (“outstanding,” “satisfactory,” “needs to improve” or “substantial noncompliance”) and a statement describing the basis for the rating. After its most recent examination of Royal Bank under CRA, the FDIC gave Royal Bank a CRA rating of satisfactory.
A subsidiary bank of a holding company is subject to certain restrictions imposed by the Federal Reserve Act, as amended, on any extensions of credit to the bank holding company or its subsidiaries, on investments in the stock or other securities of the bank holding company or its subsidiaries, and on taking such stock or securities as collateral for loans. The Federal Reserve Act, as amended and Federal Reserve Board regulations also place certain limitations and reporting requirements on extensions of credit by a bank to principal shareholders of its parent holding company, among others, and to related interests of such principal shareholders. In addition, such legislation and regulations may affect the terms upon which any person who becomes a principal shareholder of a holding company may obtain credit from banks with which the subsidiary bank maintains a correspondent relationship.
From time to time, various types of federal and state legislation have been proposed that could result in additional regulation of, and restrictions on, the business of the Banks. It cannot be predicted whether any such legislation will be adopted or how such legislation would affect the business of either Royal Bank or Royal Asian. As a consequence of the extensive regulation of commercial banking activities in the United States, the Banks’ business is particularly susceptible to being affected by federal legislation and regulations that may increase the costs of doing business.
Under the Bank Secrecy Act (“BSA”), banks and other financial institutions are required to report to the Internal Revenue Service currency transactions of more than $10,000 or multiple transactions in any one day of which the Bank are aware that exceed $10,000 in the aggregate. Civil and criminal penalties are provided under the BSA for failure to file a required report, for failure to supply information required by the BSA or for filing a false or fraudulent report.
Federal Deposit Insurance Corporation Improvement Act of 1991
General: The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDIC Improvement Act”) includes several provisions that have a direct impact on Royal Bank and Royal Asian. The most significant of these provisions are discussed below.
The FDIC is required to conduct periodic full-scope, on-site examinations of Royal Bank and Royal Asian. In order to minimize losses to the deposit insurance funds, the FDIC Improvement Act establishes a format to monitor FDIC-insured institutions and to enable “prompt corrective action” by the appropriate federal supervisory agency if an institution begins to experience any difficulty. The FDIC Improvement Act establishes five “capital” categories. They are: (1) well capitalized, (2) adequately capitalized, (3) undercapitalized, (4) significantly undercapitalized, and (5) critically undercapitalized. The overall goal of these capital measures is to impose scrutiny and operational restrictions on banks as they descend the capital categories from well capitalized to critically undercapitalized.
Under current regulations, a “well-capitalized” institution is one that has at least a 10% total risk-based capital ratio, a 6% Tier 1 risk-based capital ratio, a 5% Tier 1 Leverage Ratio, and is not subject to any written order or final directive by the FDIC to meet and maintain a specific capital level. Under the Orders as described in

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“Regulatory Action” under “Item 1 — Business” of this Report, Royal Bank is required to maintain a minimum Tier 1 leverage ratio of 8% and a Total risk-based capital ratio of 12% during the term of the Orders. Royal Bank and Royal Asian both meet the capital ratio requirements of a “well-capitalized” institution.
An “adequately capitalized” institution is one that meets the required minimum capital levels, but does not meet the definition of a “well-capitalized” institution. The existing capital rules generally require banks to maintain a Tier 1 Leverage Ratio of at least 4% and an 8% total risk-based capital ratio. Since the risk-based capital requirement is measured in the form of Tier 1 capital, this also will mean that a bank would need to maintain at least 4% Tier 1 risk-based capital ratio. An institution must meet each of the required minimum capital levels in order to be deemed “adequately capitalized.”
An “undercapitalized” institution is one that fails to meet one or more of the required minimum capital levels for an “adequately capitalized” institution. Under the FDIC Improvement Act, an “undercapitalized” institution must file a capital restoration plan and is automatically subject to restrictions on dividends, management fees and asset growth. In addition, the institution is prohibited from making acquisitions, opening new branches or engaging in new lines of business without the prior approval of its primary federal regulator. A number of other restrictions may be imposed.
A “critically undercapitalized” institution is one that has a tangible equity (Tier 1 capital) ratio of 2% or less. In addition to the same restrictions and prohibitions that apply to “undercapitalized” and “significantly undercapitalized” institutions, any institution that becomes “critically undercapitalized” is prohibited from taking the following actions without the prior written approval of its primary federal supervisory agency: engaging in any material transactions other than in the usual course of business; extending credit for highly leveraged transactions; amending its charter or bylaws; making any material changes in accounting methods; engaging in certain transactions with affiliates; paying excessive compensation or bonuses; and paying interest on liabilities exceeding the prevailing rates in the institution’s market area. In addition, a “critically undercapitalized” institution is prohibited from paying interest or principal on its subordinated debt and is subject to being placed in conservatorship or receivership if its tangible equity capital level is not increased within certain mandated time frames.
Real Estate Lending Guidelines: Pursuant to the FDIC Improvement Act, the FDIC has issued real estate lending guidelines that establish loan-to-value (“LTV”) ratios for different types of real estate loans. A LTV ratio is generally defined as the total loan amount divided by the appraised value of the property at the time the loan is originated. If a bank does not hold a first lien position, the total loan amount would be combined with the amount of all senior liens when calculating the ratio. In addition to establishing the LTV ratios, the FDIC’s real estate guidelines require all real estate loans to be based upon proper loan documentation and a recent independent appraisal of the property.
The FDIC’s guidelines establish the following limits for LTV ratios:
         
Loan Category   LTV limit  
Raw land
    65 %
Land development
    65 %
Construction:
       
Commercial, multifamily (includes condos and co-ops) and other nonresidential
    80 %
Improved property
    85 %
Owner occupied 1-4 family and home equity (without credit enhancements)
    90 %
The guidelines provide exceptions to the LTV ratios for government-backed loans; loans facilitating the sale of real estate acquired by the lending institution in the normal course of business; loans where the Banks’ 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, each Bank would be allowed to make real estate loans that do not conform to the LTV ratio limits, up to an amount not to exceed 100% of their total capital.

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Truth in Savings Act: The FDIC Improvement Act also contains the Truth in Savings Act. The purpose of this Act is to require the clear and uniform disclosure of the rates of interest that are payable on deposit accounts by the Banks 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 the Banks 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 the Banks violate any provision or regulation under this Act.
Gramm-Leach-Bliley Act of 1999
The Gramm-Leach-Bliley Act of 1999 (“GLBA”), also known as the Financial Services Modernization Act repeals the two anti-affiliation provisions of the Glass-Steagall Act. GLBA establishes a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers. It revises and expands the framework of the Holding Company Act to permit a holding company to engage in a full range of financial activities through a new entity known as a Financial Holding Company. “Financial activities” is broadly defined to include not only banking, insurance and securities activities, but also merchant banking and additional activities that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to such financial activities, or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally.
In addition, GLBA provides a uniform framework for the functional regulation of the activities of banks, savings institutions and their holding companies; broadens the activities that may be conducted by national banks, banking subsidiaries of bank holding companies, and their financial subsidiaries; and adopts a number of provisions related to the capitalization, membership, corporate governance, and other measures designed to modernize the Federal Home Loan Bank system.
Privacy provision: GLBA provides an enhanced framework for protecting the privacy of consumer information. The FDIC and other banking regulatory agencies, as required under GLBA, have adopted rules limiting the ability of banks and other financial institutions to disclose nonpublic information about consumers to nonaffiliated third parties. Among other things, these provisions require banks and other financial institutions to have in place safeguards to ensure the security and confidentiality of customer records and information, to protect against anticipated threats or hazards to the security or integrity of such records, and to protect against unauthorized access to or use of such records that could result in substantial harm or inconvenience to a customer. GLBA also requires financial institutions to provide customers at the outset of the relationship and annually thereafter written disclosures concerning the institution’s privacy policies.
GLBA also expressly preserves the ability of a state bank to retain all existing subsidiaries. Because Pennsylvania permits commercial banks chartered by the state to engage in any activity permissible for national banks, the Banks 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, either bank must be well-capitalized, and either bank 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 the Banks 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 the Banks.
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

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international money laundering and the financing of terrorism. The potential impact of the Patriot Act on financial institutions of all kinds is significant and wide ranging. The Patriot Act requires regulated financial institutions, among other things, to establish an anti-money laundering program that includes training and auditing components, to take additional precautions with non-U.S. owned accounts, and to comply with regulations related to verifying client identification at account opening. The Patriot Act also provides rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering. Failure of a financial institution to comply with the requirements of the Patriot Act could have serious legal and reputational consequences for the institution. The Company has implemented systems and procedures to meet the requirements of the regulation and will continue to revise and update policies, procedures and necessary controls to reflect changes required by the Patriot Act.
Sarbanes-Oxley Act of 2002
The primary aims of the Sarbanes-Oxley Act of 2002 (“SOX”) was to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. SOX addresses, among other matters, requirements for audit committee membership and responsibilities, requirements of management to evaluate the Company’s disclosure controls and procedures and its internal control over financial reporting, including certification of financial statements and the effectiveness of internal controls by the primary executive officer and primary financial officer; established standards for auditors and regulation of audits, including independence provisions that restrict non-audit services that accountants may provide to their audit clients; and expanded the disclosure requirements for our Company insiders; and increased various civil and criminal penalties for fraud and other violations of securities laws.
Emergency Economic Stabilization Act of 2008
The Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted on October 3, 2008. EESA was designed to enable the federal government, under terms and conditions developed by the Secretary of the Treasury, to insure troubled assets, including mortgage-backed securities, and collect premiums from participating financial institutions. EESA includes, among other provisions: (a) the $700 billion Troubled Asset Relief Program (“TARP”), under which the Secretary of the Treasury was authorized to purchase, insure, hold, and sell a wide variety of financial instruments, particularly those that are based on or related to residential or commercial mortgages originated or issued on or before March 14, 2008; and (b) an increase in the amount of deposit insurance provided by the FDIC.
Under the TARP, the United States Department of Treasury (“Treasury”) authorized a voluntary Capital Purchase Program (“CPP”) to purchase up to $250 billion of senior preferred shares of qualifying financial institutions that elected to participate by November 14, 2008. On February 20, 2009, the Company issued to Treasury, 30,407 shares of Series A Preferred Stock and a warrant to purchase 1,104,370 shares of Class A common stock for an aggregate purchase price of $30.4 million under the TARP CPP. (See “Note 14 — Shareholders’ Equity” of the Notes to Consolidated Financial Statements in Item 8 of this Report.) Companies participating in the TARP CPP were required to adopt certain standards relating to executive compensation. The terms of the TARP CPP also limit certain uses of capital by the issuer, including with respect to repurchases of securities and increases in dividends.
American Recovery and Reinvestment Act of 2009
On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (“ARRA”) was enacted. ARRA is intended to provide a stimulus to the U.S. economy in the wake of the economic downturn brought about by the subprime mortgage crisis and the resulting credit crunch. The bill included federal tax cuts, expansion of unemployment benefits and other social welfare provisions, and domestic spending in education, healthcare, and infrastructure, including the energy structure.
Under ARRA, an institution that received funds under TARP, such as the Company, is subject to certain restrictions and standards throughout the period in which any obligation arising under TARP remains outstanding (except for the time during which the federal government holds only warrants to purchase common stock of the issuer). The following summarizes the significant requirements of ARRA and applicable Treasury regulations:

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    Limits on compensation incentives for risks by senior executive officers;
 
    A requirement for recovery of any compensation paid based on inaccurate financial information;
 
    A prohibition on “golden parachute payments” to specified officers or employees, which term is generally defined as any payment for departure from a company for any reason;
 
    A prohibition on compensation plans that would encourage manipulation of reported earnings to enhance the compensation of employees;
 
    A prohibition on bonus, retention award, or incentive compensation to designated employees, except in the form of long-term restricted stock;
 
    A requirement that the board of directors adopt a luxury expenditures policy;
 
    A requirement that shareholders be permitted a separate nonbinding vote on executive compensation;
 
    A requirement that the chief executive officer and the chief financial officer provide a written certification of compliance with the standards, when established, to the SEC.
Under ARRA, subject to consultation with the appropriate federal banking agency, Treasury is required to permit a recipient of TARP funds to repay any amounts previously provided to or invested in the recipient by Treasury without regard to whether the institution has replaced the funds from any other source or to any waiting period.
Regulation W
Transactions between a bank and its “affiliates” are quantitatively and qualitatively restricted under the Sections 23A and 23B of Federal Reserve Act. The FDIC Act applies Sections 23A and 23B to insured nonmember banks in the same manner and to the same extent as if they were members of the Federal Reserve System. The Federal Reserve Board has also recently issued Regulation W, which codifies prior regulations under Sections 23A and 23B of the Federal Reserve Act and interpretative guidance with respect to affiliate transactions. Regulation W incorporates the exemption from the affiliate transaction rules but expands the exemption to cover the purchase of any type of loan or extension of credit from an affiliate. Affiliates of a bank include, among other entities, the bank’s holding company and companies that are under common control with the bank. The Company is considered to be an affiliate of Royal Bank and Royal Asian. In general, subject to certain specified exemptions, a bank or its subsidiaries are limited in their ability to engage in “covered transactions” with affiliates:
    To an amount equal to 10% of either Bank’s capital and surplus, in the case of covered transactions with any one affiliate; and
 
    To an amount equal to 20% of either Bank’s capital and surplus, in the case of covered transactions with all affiliates.
In addition, a bank and its subsidiaries may engage in covered transactions and other specified transactions only on terms and under circumstances that are substantially the same, or at least as favorable to the bank or its subsidiary, as those prevailing at the time for comparable transactions with nonaffiliated companies. A “covered transaction” includes:
    A loan or extension of credit to an affiliate;
 
    A purchase of, or an investment in, securities issued by an affiliate;
 
    A purchase of assets from an affiliate, with some exceptions;
 
    The acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any party; and

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    This issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate.
In addition, under Regulation W:
    A bank and its subsidiaries may not purchase a low-quality asset from an affiliate;
 
    Covered transactions and other specified transactions between a bank or its subsidiaries and an affiliate must be on terms and conditions that are consistent with safe and sound banking practices; and
 
    With some exceptions, each loan or extension of credit by a bank to an affiliate must be secured by collateral with a market value ranging from 100% to 130%, depending on the type of collateral, of the amount of the loan or extension of credit.
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 Banks’ capital and surplus.
FDIC Insurance Assessments
The Federal Deposit Insurance Reform Act of 2005 (the “Reform Act”), which was signed into law in 2006, resulted in a number of changes to how banks are assessed deposit premiums. Under the new risk-related premium schedule established by the Reform Act, the FDIC assigns each depository institution to one of several supervisory groups based on both capital adequacy and the FDIC’s judgment of the institution’s strength in light of supervisory evaluations, including examination reports, statistical analyses and other information relevant to measuring the risk posed by the institution.
The Reform Act merged the former BIF and SAIF into a single Deposit Insurance Fund (“DIF”), increased deposit insurance coverage for IRAs to $250,000, provides for the future increase of deposit insurance on all other accounts (presently limited to $250,000 per account) by indexing the coverage to the rate of inflation, authorizes the FDIC to set the reserve ratio of the combined DIF at a level between 1.15% and 1.50%, and permits the FDIC to establish assessments to be paid by insured banks to maintain the minimum ratios. The required reserve ratio will depend upon the growth of insured deposits at all banks in the U.S., the number and size of any bank failures, and the FDIC’s assessment of the risk in the banking industry at any given time.
On October 14, 2008, the FDIC announced its temporary “Transaction Account Guarantee Program” (“TAGP”) which provides full coverage for non-interest bearing deposit accounts. Royal Bank and Royal Asian are both participating in the program which guarantees all personal and business non-interest bearing checking accounts. This unlimited coverage expires on June 30, 2010. Additionally the FDIC temporarily raised the insurance limit from $100,000 to $250,000 per depositor until December 31, 2013. Participation in the TAGP added an additional eleven basis points to the Company’s total FDIC assessment for 2009 and is expected to add 25 basis points for the first six months of 2010.
On February 27, 2009, the FDIC’s Board of Directors voted to amend the restoration plan for DIF. Failures of FDIC-insured institutions had caused the reserve ratio of DIF to decline from 1.19 percent as of March 30, 2008, to 0.76 percent as of September 30, 2008. Consequently, the 2009 DIF assessment rates reflected an increase of seven to nine basis points and range from $0.07 for those institutions with the least risk, up to $0.775 for every $100 of insured deposits for institutions deemed to have the highest risk. In May 2009, the Board imposed a five basis point emergency special assessment for every $100 of insured deposits on June 30, 2009. The Banks’ emergency special assessment was $601,000 and was collected on September 30, 2009. Additionally, in November 2009, the FDIC adopted a final rule imposing a 13-quarter prepayment of FDIC insurance premiums payable on December 30, 2009. The FDIC exempted Royal Bank from making this prepayment of approximately $11.8 million. Royal Asian’s prepaid assessment amounted to $557,000.

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In addition to deposit insurance, the Banks are 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 2010, the Financing Corporation’s assessment for Royal Bank and Royal Asian, (and all other banks), is an annual rate of $.0106 for each $100 of deposits. The Financing Corporation bonds are expected to be paid off between 2017 and 2019.
Other Legislation
In addition to the Federal Deposit Insurance Reform Act described above, the Financial Services Regulatory Relief Act of 2006 was also enacted. This legislation is a wide ranging law that affects many previously enacted financial regulatory laws. The overall intent of the law is to simplify regulatory procedures and requirements applicable to all banks, and to conform conflicting provisions. The Relief Act conforms a number of separate statutes to provide equal definitions and treatment for national banks, state banks, and for federal savings banks in a number of respects. The law streamlines certain reporting requirements, and provides for bank examinations on an 18 month schedule for smaller banks that qualify. The law also authorizes the Federal Reserve to pay interest to banks for the required deposit reserves maintained by banks at the Federal Reserve, but such interest would not begin to be paid until 2012. While this law has many facets that should benefit the Banks overall, the individual provisions of this law are not considered currently material to the Banks when considered alone.
Congress is currently considering major financial industry legislation, and the federal banking agencies routinely propose new regulations. The Company cannot predict how any new legislation, or new rules adopted by the federal banking agencies, may affect its business or the business of the Banks in the future.
Monetary Policy
The earnings of Royal Bank and Royal Asian 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 either Banks’ operations in the future. The effect of such policies and regulations upon the future business and earnings of either Banks cannot be predicted.
Effects of Inflation
Inflation can impact the country’s overall economy, which in turn can impact the business and revenues of the Company and its subsidiaries. Inflation has some impact on the Company’s operating costs. Unlike many industrial companies, however, substantially all of the Company’s assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on the Company’s performance than the general level of inflation. Over short periods of time, interest rates may not necessarily move in the same direction or in the same magnitude as prices of goods and services.
Available Information
Upon a shareholder’s written request, a copy of the Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, as required to be filed with the SEC pursuant to Exchange Act Rule 13a-1, may be obtained without charge from our Chief Executive Officer, Royal Bancshares of Pennsylvania, Inc. 732 Montgomery Avenue, Narberth, PA 19072 or on our website www.royalbankamerica.com.

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ITEM 1A. RISK FACTORS
An investment in our common stock involves risks. Before making an investment decision, investors should carefully consider the risks described below in conjunction with the other information in this report, including our consolidated financial statements and related notes. If any of the following risks or other risks, which have not been identified or which we may believe are immaterial or unlikely, actually occurs, our business, financial condition and results of operations could be harmed. In such a case, the trading price of our common stock could decline, and investors may lose all or part of their investment.
Risks Related to Our Business
Our business may be impacted by the existence of the Orders for Royal Bank and the Federal Reserve Agreement with the Federal Reserve Bank of Philadelphia.
Our success as a business is dependent upon pursuing various alternatives in not only achieving the growth and expansion of our banking franchise but also in managing our day to day operations. The existence of the Orders and the Federal Reserve Agreement may limit or impact our ability to pursue all previously available alternatives in the management of the Company. Our ability to retain existing retail and commercial customers as well as the ability to attract potentially new customers may be impacted by the existence of the Orders and the Federal Reserve Agreement. The Company has been successful in commercial real estate lending however, our ability to expand into potentially attractive commercial real estate or construction loans at this time would most likely be limited. Our ability to obtain lines of credit, to receive attractive collateral treatment from funding sources, and to pursue all attractive funding alternatives in this current low interest rate environment could be potentially impacted and thereby limit liquidity alternatives. The Bank’s ability to pay dividends to the Company, which provides funding for cash dividends to the Company’s shareholders, will be limited as a result of the Orders. Moreover, the Company is prohibited from paying cash dividends without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System. Our ability to raise capital in the current economic environment could be potentially limited or impacted as a result of the Orders. Attracting new management talent is critical to the success of our business and could be potentially impacted due to the existence of the Orders and the Federal Reserve Agreement.
Our business is subject to the success of the local economies and real estate markets in which we operate.
Our success significantly depends on the growth in population, income levels, loans and deposits and on the continued stability in real estate values in our markets. If the communities in which we operate do not grow or if prevailing economic conditions locally or nationally are unfavorable, our business may be adversely affected. Adverse economic conditions in our specific market areas, specifically decreases in real estate property values due to the nature of our loan portfolio, over 80% of which is secured by real estate, could reduce our growth rate, affect the ability of customers to repay their loans and generally affect our financial condition and results of operations. The Company is less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of more diverse economies.
Our concentration of non-residential real estate and construction loans is subject to unique risks that could adversely affect our earnings.
Our non-residential real estate and construction and land development loan portfolio was $418.3 million at December 31, 2009 comprising 61% of total loans. Non-residential real estate and construction and development loans are often riskier and tend to have significantly larger balances than home equity loans or residential mortgage loans to individuals. While we believe that the commercial real estate concentration risk is mitigated by diversification among the types and characteristics of real estate collateral properties, sound underwriting practices, and ongoing portfolio monitoring and market analysis, the repayments of these loans usually depends on the successful operation of a business or the sale of the underlying property. As a result, these loans are more likely to be unfavorably affected by adverse conditions in the real estate market or the economy in general. The remaining loans in the portfolio are commercial or industrial loans. These loans are collateralized by various business assets the value of which may decline during adverse market and economic conditions. Adverse conditions in the real estate market and the economy may result in increasing levels of loan charge-offs and nonperforming assets and the

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reduction of earnings. When we take collateral in foreclosures and similar proceedings, we are required to mark the related asset to the then fair market value of the collateral, which may ultimately result in a loss.
Further, under guidance adopted by the federal banking regulators, banks which have concentrations in construction, land development or commercial real estate loans (other than loans for majority owner occupied properties) would be expected to maintain higher levels of risk management and, potentially, higher levels of capital. It is possible that the Banks may be required to maintain higher levels of capital than it would be otherwise be expected to maintain as a result of the Banks’ commercial real estate loans, which may require the Company to obtain additional capital sooner than it would otherwise seek it, which may reduce shareholder returns.
Our allowance for loan and lease losses may not be adequate to cover actual losses.
Like all financial institutions, we maintain an allowance for loan and lease losses to provide for loan defaults and non-performance. Our allowance for loan and lease losses is based on our historical loss experience as well as an evaluation of the risks associated with our loan portfolio, including the size and composition of the loan portfolio, current economic conditions and geographic concentrations within the portfolio. Our allowance for loan and lease losses may not be adequate to cover actual loan and lease losses and future provisions for loan and lease losses could materially and adversely affect our financial results.
Our current level of nonperforming loans and future growth may require us to raise additional capital but that capital may not be available.
We are required by regulatory authorities to maintain adequate capital levels to support our operations. We anticipate that our current capital will satisfy our regulatory requirements for the foreseeable future. Under the Orders as described in “Regulatory Action” under “Item 1 — Business” of this Report, Royal Bank is required to maintain a minimum Tier 1 leverage ratio of 8% and a Total risk-based capital ratio of 12% during the term of the Orders. 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. In addition, on February 20, 2009, we issued 30,407 shares of Fixed Rate Cumulative Preferred Stock, Series A, to the United States Department of Treasury under its TARP Capital Purchase Program, The Series A Preferred Stock issued to Treasury has a liquidation preference of $1,000 per share and contains other provisions, including restrictions on the payment of dividends on common stock and on repurchases of any shares of preferred stock ranking equal to or junior to the Series A Preferred Stock or common stock while the Series A Preferred Stock is outstanding, which provisions may make it more difficult to raise additional capital on favorable terms while the Series A Preferred Stock is outstanding. Therefore, we may be unable to raise additional capital, or to raise capital on terms acceptable to us. If we cannot raise additional capital when required, our ability to further expand operations through both internal growth and acquisitions could be materially impaired. In addition, if we decide to raise additional capital, the existing shareholders are subject to dilution.
We may suffer losses in our loan portfolio despite our underwriting practices.
The Company seeks to mitigate the risks inherent in its loan portfolio by adhering to specific underwriting practices. These practices often include: analysis of a borrower’s credit history, financial statements, tax returns and cash flow projections; valuation of collateral based on reports of independent appraisers; and verification of liquid assets. Although we believe that our underwriting criteria are appropriate for the various kinds of loans we make, the Company may incur losses on loans that meet these criteria.
Holders of our Series A Preferred Stock have certain voting rights that may adversely affect our common shareholders, and the holders of the Series A Preferred Stock may have interests different from our common shareholders.
In the event we fail to pay dividends on the Series A Preferred Stock for a total of at least six quarterly dividend periods (whether or not consecutive), the Treasury will have the right to appoint two directors to our Board of Directors until all accrued but unpaid dividends have been paid. Otherwise, except as required by law, holders of the Series A Preferred Stock have limited voting rights.

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For as long as shares of the Series A Preferred Stock are outstanding, in addition to any other vote or consent of the shareholders required by law or our Articles of Incorporation, the vote or consent of holders of at least 66 2/3% of the shares of the Series A Preferred Stock outstanding is required for any authorization or issuance of shares ranking senior to the Series A Preferred Stock; any amendments to the rights of the Series A Preferred Stock so as to adversely affect the rights, privileges, or voting power of the Series A Preferred Stock; or initiation and completion of any merger, share exchange or similar transaction unless the shares of Series A Preferred Stock remain outstanding, or if we are not the surviving entity in such transaction, are converted into or exchanged for preference securities of the surviving entity and the shares of Series A Preferred Stock remaining outstanding or such preference securities have the rights, preferences, privileges and voting power of the Series A Preferred Stock.
The holders of our Series A Preferred Stock, including the Treasury, may have different interests from the holders of our common stock, and could vote to block the forgoing transactions, even when considered desirable by, or in the best interests of the holders of our common stock.
Our ability to pay dividends depends primarily on dividends from our banking subsidiary, which are subject to regulatory limits and we are subject to other dividend limitations.
We are a bank holding company and our operations are conducted by direct and indirect subsidiaries, each of which is a separate and distinct legal entity. Substantially all of our assets are held by our direct and indirect subsidiaries. Our ability to pay dividends depends on our receipt of dividends from our direct and indirect subsidiaries. Our two banking subsidiaries, Royal Bank and Royal Asian, are our primary source of dividends. Dividend payments from our banking subsidiary are subject to legal and regulatory limitations, generally based on net profits and retained earnings, imposed by the various banking regulatory agencies. The ability of Royal Bank and Royal Asian to pay dividends is also subject to its profitability, financial condition, capital expenditures and other cash flow requirements. At December 31, 2009, as a result of significant losses within Royal Bank, the Company had negative retained earnings and therefore would not have been able to declare and pay any cash dividends. There is no assurance that our subsidiaries will be able to pay dividends in the future or that we will generate adequate cash flow to pay dividends in the future. Under the Orders as described in “Regulatory Action” under “Item 1 — Business” of this Report, Royal Bank must receive prior approval from the FDIC and the Department before declaring and paying a dividend to the Company.
As a result of our participation in the Treasury’s TARP CPP on February 20, 2009, we are required to receive Treasury’s approval for any increases in the dividend above the amount of the last regular quarterly common stock dividend paid prior to October 14, 2008 ($0.15 per Class A share and $0.1725 per Class B share) and any repurchases of common stock. These restrictions on the payment of dividends and the repurchases of common stock will remain in effect until the earlier date of the third anniversary of the closing date of the preferred shares and the date of the redemption of the preferred shares. In addition, under the terms of the TARP CPP, we are not permitted to declare or pay cash dividends on, or redeem or otherwise acquire, stock that is junior to or on parity with the Series A Preferred Stock issued to Treasury at any time when we have not declared and paid full dividends on the Series A Preferred Stock. We suspended regular quarterly cash dividends on the Series A Preferred Stock in August 2009 and, accordingly, are not permitted at this time to pay dividends on our Class A or Class B Common Stock.
Under the terms of the Federal Reserve Agreement, we are prohibited from paying any dividends on shares of our stock without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System.
Failure to pay dividends on our stock could have a material adverse effect on the market price of our Class A Common Stock.
Competition from other financial institutions may adversely affect our profitability.
We face substantial competition in originating loans, both commercial and consumer. This competition comes principally from other banks, savings institutions, mortgage banking companies and other lenders. Many of our competitors enjoy advantages, including greater financial resources and higher lending limits, a wider geographic presence, more accessible branch office locations, the ability to offer a wider array of services or more favorable

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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 and Royal Asian face substantial competition from other insured depository institutions such as banks, savings institutions and credit unions, as well as institutions offering uninsured investment alternatives, including money market funds. Many of our competitors enjoy advantages, including greater financial resources, more aggressive marketing campaigns, better brand recognition and more branch locations. These competitors may offer higher interest rates than we do, which could decrease the deposits that we attract or require us to increase our rates to retain existing deposits or attract new deposits. Increased deposit competition could adversely affect our ability to generate the funds necessary for lending operations. As a result, we may need to seek other sources of funds that may be more expensive to obtain and could increase our cost of funds.
The Company’s banking and non-banking subsidiaries also compete with non-bank providers of financial services, such as brokerage firms, consumer finance companies, credit unions, insurance agencies and governmental organizations which may offer more favorable terms. Some of our non-bank competitors are not subject to the same extensive regulations that govern our banking operations. As a result, such non-bank competitors may have advantages over the Company’s banking and non-banking subsidiaries in providing certain products and services. This competition may reduce or limit our margins on banking and non-banking services, reduce our market share, and adversely affect our earnings and financial condition.
The Company has a lower level of “core deposits” and a higher level of wholesale funding relative to our peer institutions.
Over the past several years, the Company has achieved significant growth in our loan portfolio. Because the Company’s deposits have not grown at similar rates, we have had to supplement our funding sources to include the national market (brokered CDs) to attract funds. During an environment when interest rates are rising and the related U.S. Treasury interest rate curve is flattening, the use of this funding source may result in an increase in interest costs disproportionate to loan yields. This could result in reduced net interest income.
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. During the first quarter of 2010, the Federal Home Loan Bank of Pittsburgh, notified Royal Bank that they were being placed on an over collateralized delivery requirement of 105%. The FHLB’s decision was based primarily upon the level of Royal Bank’s non-performing assets and net loss. The available amount for future borrowings will be based on the amount of collateral to be pledged. We have a liquidity contingency plan in the event liquidity falls below an acceptable level, however in today’s economic environment, we are not certain that those sources of liquid funds will be available in the future when required. As a result, loan growth may be curtailed to maintain adequate liquidity, loans may need to be sold in the secondary market, investments may need to be sold or deposits may need to be raised at above market interest rates to maintain liquidity.
Negative publicity could damage our reputation and adversely impact our business and financial results.
Reputation risk, or the risk to the Company’s earnings and capital from negative publicity, is inherent in our business. Negative publicity can result from the Company’s actual or alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions, and actions taken by government regulators and community organizations in response to those activities. Negative publicity can adversely affect our ability to keep and attract customers and can expose the Company to litigation and regulatory action. Although the Company takes steps to minimize reputation risk in dealing with customers and other constituencies, the Company, as a larger diversified financial services company with a high industry profile, is inherently exposed to this risk.

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Risks Related to Our Industry
Recent legislative and regulatory initiatives to address difficult market and economic conditions may not stabilize the U.S. banking system.
On October 3, 2008, the Emergency Economic Stabilization Act of 2008 (the “EESA”) became law. EESA, among other measures, authorizes Treasury to purchase from financial institutions and their holding companies up to $700 billion in mortgage loans, mortgage-related securities and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies, under the Troubled Asset Relief Program, or “TARP.” The purpose of TARP is to restore confidence and stability to the U.S. banking system and to encourage financial institutions to increase their lending to customers and to each other. Under the TARP Capital Purchase Program, Treasury is purchasing equity securities from participating institutions. EESA also increased federal deposit insurance on most deposit accounts from $100,000 to $250,000. This increase is in place until June 30, 2010 and is not covered by deposit insurance premiums paid by the banking industry.
EESA followed, and has been followed by, numerous actions by the Board of Governors of the Federal Reserve System, the U.S. Congress, Treasury, the FDIC, the SEC and others to address the current liquidity and credit crisis that has followed the sub-prime meltdown that commenced in 2007. These measures include homeowner relief that encourage loan restructuring and modification; the establishment of significant liquidity and credit facilities for financial institutions and investment banks; the lowering of the federal funds rate; emergency action against short selling practices; a temporary guarantee program for money market funds; the establishment of a commercial paper funding facility to provide back-stop liquidity to commercial paper issuers; and coordinated international efforts to address illiquidity and other weaknesses in the banking sector. Additional similar actions may be forthcoming.
The purpose of these legislative and regulatory actions is to stabilize the U.S. banking system. EESA and the other regulatory initiatives described above may not have their desired effects. If the volatility in the markets continues and economic conditions fail to improve or worsen, our business, financial condition, results of operations and cash flows could be materially and adversely affected.
Difficult market conditions and economic trends have adversely affected our industry and our business.
We are exposed to downturns in the U. S. housing market. Dramatic declines in the housing market over the past year, with decreasing home prices and increasing delinquencies and foreclosures, may have a negative impact on the credit performance of mortgage, consumer, commercial and construction loan portfolios resulting in significant write-downs of assets by many financial institutions. In addition, the values of real estate collateral supporting many loans have declined and may continue to decline. General downward economic trends, reduced availability of commercial credit and increasing unemployment may negatively impact the credit performance of commercial and consumer credit, resulting in additional write-downs. Concerns over the stability of the financial markets and the economy have resulted in decreased lending by financial institutions to their customers and to each other. This market turmoil and tightening of credit has led to increased commercial and consumer deficiencies, lack of customer confidence, increased market volatility and widespread reduction in general business activity. Competition among depository institutions for deposits has increased significantly. Financial institutions have experienced decreased access to deposits or borrowings. The resulting economic pressure on consumers and businesses and the lack of confidence in the financial markets may adversely affect our business, financial condition, results of operations and stock price. We do not expect that the difficult market conditions will improve in the immediate future. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the industry. In particular, we may face the following risks in connection with these events:
    We expect to face increased regulation of our industry. Compliance with such regulation may increase our costs and limit our ability to pursue business opportunities.
 
    Our ability to assess the creditworthiness of customers and to estimate the losses inherent in our credit exposure is made more complex by these difficult market and economic conditions.
 
    We also may be required to pay even higher Federal Deposit Insurance Corporation premiums than the recently increased level, because financial institution failures resulting from the depressed market

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      conditions have depleted and may continue to deplete the deposit insurance fund and reduce its ratio of reserves to insured deposits.
 
    Our ability to borrow from other financial institutions or the Federal Home Loan Bank on favorable terms or at all could be adversely affected by further disruptions in the capital markets or other events.
 
    We may experience a prolonged decrease in dividend income from our investment in Federal Home Loan Bank stock.
 
    We may experience increases in foreclosures, delinquencies and customer bankruptcies, as well as more restricted access to funds.
 
    The unrealized losses in our investment portfolio may increase or be deemed other than temporary.
Our business is subject to interest rate risk and variations in interest rates may negatively affect our financial performance.
Changes in the interest rate environment may reduce profits. The primary source of our income is the differential or “spread” between the interest earned on loans, securities and other interest-earning assets, and interest paid on deposits, borrowings and other interest-bearing liabilities. As prevailing interest rates change, net interest spreads are affected by the difference between the maturities and re-pricing characteristics of interest-earning assets and interest-bearing liabilities. In addition, loan volume and yields are affected by market interest rates on loans, and rising interest rates generally are associated with a lower volume of loan originations. An increase in the general level of interest rates may also adversely affect the ability of certain borrowers to pay the interest on and principal of their obligations. Accordingly, changes in levels of market interest rates could materially adversely affect our net interest spread, asset quality, loan origination volume and overall profitability.
Future governmental regulation and legislation could limit our future growth.
The Company and our subsidiaries are subject to extensive state and federal regulation, supervision and legislation that govern almost all aspects of the operations of the Company and our subsidiaries. These laws may change from time to time and are primarily intended for the protection of consumers, depositors and the deposit insurance funds. Any changes to these laws may negatively affect our ability to expand our services and to increase the value of our business. While we cannot predict what effect any presently contemplated or future changes in the laws or regulations or their interpretations would have on the Company, these changes could be materially adverse to shareholders.
Changes in consumer use of banks and changes in consumer spending and saving habits could adversely affect the Company’s financial results.
Technology and other changes now allow many consumers to complete financial transactions without using banks. For example, consumers can pay bills and transfer funds directly without going through a bank. This “disintermediation” could result in the loss of fee income, as well as the loss of customer deposits and income generated from those deposits. In addition, changes in consumer spending and saving habits could adversely affect our operations, and may be unable to timely develop competitive new products and services in response to these changes that are accepted by new and existing customers.
Acts or threats of terrorism and political or military actions taken by the United States or other governments could adversely affect general economic or industry conditions.
Geopolitical conditions may also affect our earnings. Acts or threats or terrorism and political or military actions taken by the United States or other governments in response to terrorism, or similar activity, could adversely affect general economic or industry conditions.

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Other Risks
Our directors, executive officers and principal shareholders own a significant portion of our common stock and can influence shareholder decisions.
Our directors, executive officers and principal shareholders, as a group, beneficially owned approximately 57% of Class A common stock and 86% of Class B common stock as of February 28, 2010. 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. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
Royal Bank has fifteen banking offices, which are located in Pennsylvania and New Jersey.
         
15th Street Office
  Bala Plaza Office (3)   Bridgeport Office (1)
30 South Street
  231 St. Asaph’s Road   105 W. 4th Street
Philadelphia, PA 19102
  Bala Cynwyd, PA 19004   Bridgeport, PA 19406
 
       
Castor Office (1)
  Fairmont Office (1)   Grant Avenue Office (1)
6331 Castor Avenue
  401 Fairmont Avenue   1650 Grant Avenue
Philadelphia, PA 19149
  Philadelphia, PA 19123   Philadelphia, PA 19115
 
       
Henderson Road Office
  Jenkintown Office (1)   King of Prussia Office (1)
Biedler and Henderson Roads
  600 Old York Road   655 West DeKalb Pike
King of Prussia, PA 19406
  Jenkintown, PA 19046   King of Prussia, PA 19406
 
       
Narberth Office (1)
  Narberth Training Center (1)(2)   Phoenixville Office (1)
732 Montgomery Avenue
  814 Montgomery Avenue   808 Valley Forge Road
Narberth, PA 19072
  Narberth, PA 19072   Phoenixville, PA 19460
 
       
Shillington Office
  Trooper Office (1)   Turnersville Office
516 East Lancaster Avenue
  Trooper and Egypt Roads   3501 Black Horse Pike
Shillington, PA 19607
  Trooper, PA 19401   Turnersville, NJ 08012
 
       
Villanova Office
  Walnut Street Office   Storage Facility (1)
801 East Lancaster Avenue
  1230 Walnut Street   3836 Spring Garden Street
Villanova, PA 19085
  Philadelphia, PA 19107   Philadelphia, PA 19104
 
       
Royal Asian Bank has five offices located in Pennsylvania, New Jersey, and New York.
 
       
Cheltenham Office
  Flushing   Fort Lee Office
418 Oak Lane
  136-52 37th Avenue   1550 Lemoine Avenue
Philadelphia, PA 19126
  Flushing, NY 11354   Fort Lee, NJ 07024
 
       
Palisades Park
  Upper Darby Office    
232 Broad Street
  7001 West Chester Pike    
Palisades Park, NJ 07650
  Upper Darby, PA 19082    
 
(1)   Owned
 
(2)   Used for employee training

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(3)   Loan production office
Royal Bank owns eleven of the above properties. The remaining seven properties are leased with expiration dates between 2010 and 2014. During 2009, Royal Bank made aggregate lease payments of approximately $779,000. Royal Asian’s five properties are leased with expiration dates between 2010 and 2017. During 2009, Royal Asian made aggregate lease payments of approximately $441,000. The Company believes that all of its properties are attractive, adequately insured, and well maintained and are adequate for the Banks’ purposes. During the second quarter of 2008, the Company sold the property located at 144 Narberth Avenue, Narberth, PA, for a $2.0 million gain.
ITEM 3. LEGAL PROCEEDINGS
Management is not aware of any litigation that would have a material adverse effect on the consolidated financial position or results of operations of the Company. There are no proceedings pending other than routine litigation incident to the business of the Company.
As described under “Item 1 — Business” of this Report, Royal Bank holds a 60% equity interest in each of Crusader Servicing Corporation (“CSC”) and Royal Tax Lien Services, LLC (“RTL”). CSC and RTL acquire, through public auction, delinquent tax liens in various jurisdictions thereby assuming a superior lien position to most other lien holders, including mortgage lien holders. On March 4, 2009, each of CSC and RTL received a grand jury subpoena issued by the U.S. District Court for New Jersey upon application of the Antitrust Division of the U.S. Department of Justice (“DOJ”). The subpoena seeks certain documents and information relating to an ongoing investigation being conducted by the DOJ. Royal Bank has been advised that neither CSC nor RTL are targets of the DOJ investigation, but they are subjects of the investigation. Royal Bank, CSC and RTL are cooperating in the investigation.
ITEM 4. (REMOVED AND RESERVED)

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PART II
ITEM 5.   MARKET FOR REGISTRANT’S COMMON EQUITY, AND RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company’s Class A Common Stock commenced trading on the NASDAQ Global Market under the symbol RBPAA. There is no market for the Company’s Class B Common Stock. The Class B shares may not be transferred in any manner except to the holder’s immediate family. Class B shares may be converted to Class A shares at the rate of 1.15 to 1.
The following table shows the range of high and low closing prices for the Company’s stock as reported by NASDAQ.
                 
Closing Prices
2009   High   Low
First Quarter
  $ 4.25     $ 2.05  
Second Quarter
    2.65       1.71  
Third Quarter
    2.10       1.40  
Fourth Quarter
    1.80       1.05  
                 
2008   High   Low
First Quarter
  $ 15.88     $ 9.14  
Second Quarter
    15.34       8.87  
Third Quarter
    9.44       4.81  
Fourth Quarter
    6.41       3.33  
The approximate number of recorded holders of the Company’s Class A and Class B Common Stock, as of March 3, 2010, is shown below:
         
Title of Class   Number of record holders  
Class A Common stock
    293  
Class B Common stock
    142  
Dividends
Subject to certain limitations imposed by law or the Company’s articles of incorporation, the Board of Directors of the Company may declare a dividend on shares of Class A or Class B Common Stock.
Stock dividends: On December 18, 2005, the Board of Directors of the Company declared a 2% stock dividend on both its Class A Common Stock and Class B Common Stock shares payable on January 17, 2006, to shareholders of record on January 4, 2006. The stock dividend resulted in the issuance of 205,120 additional shares of Class A common stock and 19,426 additional shares of Class B common stock. There were 20,117 Class B shares deferred (agreed to by the Tabas Family Trust) until the 2006 Annual Shareholders Meeting where Management requested the Company’s shareholders to approve amending the Company’s Articles of Incorporation to increase the number of Class B shares authorized. The 20,117 deferred share of Class B common stock were issued on June 27, 2006.
On December 20, 2006, the Board of Directors of the Company declared a 5% stock dividend on both its Class A Common Stock and Class B Common Stock shares payable on January 17, 2007, to shareholders of record on January 3, 2007. The stock dividend resulted in the issuance of 526,825 additional shares of Class A common stock and 100,345

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additional shares of Class B common stock. Future stock dividends, if any, will be at the discretion of the Board of Directors and will be dependent on the level of earnings and compliance with regulatory requirements. There were no stock dividends declared in 2009, 2008, and 2007.
Cash Dividends: The Company paid cash dividends in the first two quarters of 2008 for holders of Class A Common Stock and for holders of Class B Common Stock. This resulted in a charge to retained earnings of approximately $4.0 million. The Company did not pay cash dividends on its common stock in 2009. In July of 2008, the Company suspended cash dividends on its common stock to preserve capital and maintain liquidity in response to current financial and economic trends. At December 31, 2008, as a result of significant losses within Royal Bank, the Company had negative retained earnings and therefore would not have been able to declare and pay any cash dividends. The following table sets forth on a quarterly basis dividends paid to holders of each Class A and Class B Common Stock for 2008.
                 
    Cash Dividends Per Share  
2008   Class A     Class B  
First Quarter
  $ 0.15000     $ 0.172500  
Second Quarter
  $ 0.15000     $ 0.172500  
Third Quarter
  $     $  
Fourth Quarter
  $     $  
Future dividends depend upon net income, capital requirements, and appropriate legal restrictions and other factors relevant at the time the Board of Directors of the Company considers dividend policy. Cash necessary to fund dividends available for dividend distributions to the shareholders of the Company must initially come primarily from dividends paid by its direct and indirect subsidiaries, including Royal Bank to the Company. As a result of the Orders as described under “Regulatory Action” in “Item 1 — Business” of this Report, Royal Bank must obtain approval from the FDIC and the Department prior to declaring a cash dividend to the Company. Therefore, the restrictions on Royal Bank’s dividend payments are directly applicable to the Company. Under the Pennsylvania Banking Code of 1965, as amended, Royal Bank places a restriction on the availability of capital surplus for payment of dividends.
Under the Pennsylvania Business Corporation Law of 1988, as amended, the Company may pay dividends only if after payment the Company would be able to pay its debts as they become due in the usual course of business and the total assets are greater than the sum of its total liabilities plus the amount that would be needed if the Company were to be dissolved at the time of the dividend to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the dividend. See “Note 13 — Shareholder’s Equity” of the Notes to Consolidated Financial Statements in Item 8 of this Report.
As a result of the investment by Treasury under the TARP CPP on February 20, 2009, the Company is required to receive Treasury’s approval for any increases in the dividend above the amount of the last regular quarterly common stock dividend paid prior to October 14, 2008 ($0.15 per Class A share and $0.1725 per Class B share) and any repurchases of common stock. These restrictions on the payment of dividends and the repurchases of common stock by the Company become effective immediately and remain in effect until the earlier date of the third anniversary of the closing date of the preferred shares and the date of the redemption of the preferred shares.
On August 13, 2009, the Company’s board of directors determined to suspend regular quarterly cash dividends on the $30.4 million in Series A Preferred Stock. The Company’s board of directors took this action in consultation with the Federal Reserve Bank of Philadelphia as required by recent regulatory policy guidance. The Company currently has sufficient capital and liquidity to pay the scheduled dividends on the preferred stock; however, the Company believes this decision will better support the capital position of Royal Bank, a wholly owned subsidiary of the Company. As of December 31, 2009, the Series A Preferred stock dividend in arrears is $774,000 which is comprised of $760,000 in dividends and $14,000 in interest, which have not been recognized in the consolidated financial statements.

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COMMON STOCK PERFORMANCE GRAPH
The performance graph shows cumulative investment returns to shareholders based on the assumption that an investment of $100 was made on December 31, 2004, (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 2009 Peer Group consists of nineteen banks headquartered in the Mid-Atlantic region, trade on the major exchange and have total assets between $750 million and $1.5 billion.
 
    SNL Bank and Thrift Index
(PERFORMANCE GRAPH)
                                                 
    Period Ending  
Index   12/31/04     12/31/05     12/31/06     12/31/07     12/31/08     12/31/09  
Royal Bancshares of Pennsylvania, Inc.
    100.00       91.22       113.52       50.19       15.60       6.09  
NASDAQ Composite
    100.00       101.37       111.03       121.92       72.49       104.31  
SNL Bank and Thrift
    100.00       101.57       118.68       90.50       52.05       51.35  
Royal Bancshares Peer Group*
    100.00       94.01       104.26       82.19       66.74       59.18  

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ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial and operating information for the Company should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and accompanying notes in Item 8 of this Report:
                                         
Statement of Operations Data   For the years ended December 31,  
(In thousands, except share data)   2009     2008     2007     2006     2005  
Interest income
  $ 66,043     $ 72,764     $ 86,736     $ 93,006     $ 76,460  
Interest expense
    37,439       38,109       48,873       46,372       31,796  
 
                             
Net interest income
    28,604       34,655       37,863       46,634       44,664  
Provision for loan and lease losses
    20,605       21,841       13,026       1,803       1  
 
                             
Net interest income after loan and lease losses
    7,999       12,814       24,837       44,831       44,663  
 
                             
Gain on sale of premises & equipment
          1,991                    
Gain on sale of premises & equipment related to real estate owned via equity investments
    1,817       1,679       1,860       3,036       16,779  
Income from bank owned life insurance
    1,099       1,233       875       847       845  
Service charges and fees
    1,419       1,186       1,348       1,404       1,293  
Gains on sales related to real estate joint ventures
          1,092       350              
Income related to real estate owned via equity investments
    1,302       965       1,384       3,591       747  
Gains on sale of real estate
    294       429       1,111       2,129       2,494  
Gains on sale of loans
    914       190       404       379       508  
(Losses) gains on investment securities
    1,892       (1,313 )     5,358       383       227  
Gain from refinance of assets related to real estate owned via equity investments
                            1,892  
Other income
    578       148       198       202       41  
 
                             
Other income,excluding other-than-temporary impairment losses
    9,315       7,600       12,888       11,971       24,826  
 
                             
Total other than-temporary-impairment losses on investment securities
    (13,431 )     (23,388 )                  
Portion of loss recognized in other comprehensive loss
    2,390                          
 
                             
Net impairment losses recognized in earnings
    (11,041 )     (23,388 )                  
 
                             
Total other (loss) income
    (1,726 )     (15,788 )     12,888       11,971       24,826  
 
                             
(Loss) income before other expenses & income taxes
    6,273       (2,974 )     37,725       56,802       69,489  
Non-interest expense
                                       
Salaries and benefits
    12,235       15,044       12,215       13,451       13,488  
Impairment related to real estate owned via equity investments
          1,500       8,500              
Expenses related to real estate owned via equity investments
    907       966       1,590       1,606       262  
Impairment related to real estate joint venture
                5,927              
Other
    24,514       15,023       11,800       9,595       10,981  
 
                             
Total other expense
    37,656       32,533       40,032       24,652       24,731  
 
                             
(Loss) income before tax expense (benefit)
    (31,383 )     (35,507 )     (2,307 )     32,150       44,758  
Income tax expense (benefit)
    474       2,643       (1,568 )     10,015       12,637  
 
                             
Net (loss) income
  $ (31,857 )   $ (38,150 )   $ (739 )   $ 22,135     $ 32,121  
 
                             
Less net income (loss) attributable to noncontrolling interest
    1,402       (68 )     (1,303 )     567       68  
Net (loss) income attributable to Royal Bancshares
    (33,259 )     (38,082 )     564       21,568       32,053  
Less Series A Preferred stock accumulated dividend and accretion
    (1,672 )                        
Net (loss) income available to common shareholders
    (34,931 )     (38,082 )     564       21,568       32,053  
 
                                       
Basic (loss) earnings per common share (1)
  $ (2.64 )   $ (2.86 )   $ 0.04     $ 1.60     $ 2.39  
 
                             
Diluted (loss) earnings per common share (1)
  $ (2.64 )   $ (2.86 )   $ 0.04     $ 1.59     $ 2.37  
 
                             
 
(1)   Earnings per share has the weighted average number of shares used in the calculation adjusted to reflect a 5% stock dividend in December 2006 and a 2% stock dividend in December 2005.

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Balance Sheet Data   For the years ended December 31,
(In thousands)   2009   2008   2007   2006   2005
Total Assets
    1,292,726       1,175,586       1,278,475       1,356,311       1,301,019  
Total average assets (2)
    1,295,126       1,189,518       1,314,361       1,317,688       1,258,137  
Loans, net
    656,533       671,814       625,193       580,759       539,360  
Total deposits
    881,755       760,068       770,152       859,457       697,409  
Total average deposits
    857,742       724,384       869,884       761,267       699,540  
Total borrowings (1)
    283,601       313,805       339,251       301,203       427,130  
Total average borrowings (1)
    307,225       307,597       254,757       377,139       350,662  
Total shareholders’ equity (3)
    101,156       79,687       146,367       163,254       155,508  
Total average shareholders’ equity
    107,511       131,155       158,695       158,372       145,601  
Return on average assets
    (2.57 %)     (3.20 %)     0.04 %     1.64 %     2.55 %
Return on average equity
    (30.94 %)     (29.04 %)     0.36 %     13.62 %     22.01 %
Average equity to average assets
    8.30 %     11.03 %     12.07 %     12.10 %     11.57 %
Dividend payout ratio
    0.00 %     (10.52 %)     2743.40 %     66.10 %     40.10 %
 
(1)   Includes obligations through VIE equity investments and subordinated debt.
 
(2)   Includes premises and equipment of VIE.
 
(3)   Excludes noncontrolling interest.
ITEM 7. MANAGEMENT’S DISCUSSIONS AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements of the Company and the related Notes in Item 8 of this Report.
Results of Operations
General: The Company’s results of operations depend primarily on net interest income, which is the difference between interest income on interest earning assets and interest expense on interest bearing liabilities. Interest earning assets consist principally of loans and investment securities, while interest bearing liabilities consist primarily of deposits and borrowings. Net income is also affected by the provision for loan and lease losses and the level of non-interest income as well as by non-interest expenses, including salary and employee benefits, occupancy expenses and other operating expenses.
Net Loss/Income: The Company recorded a net loss of $33.3 million in 2009, which amounted to an improvement of $4.8 million from the net loss of $38.1 million recorded in 2008. The reduced net loss was attributed to a modest decrease in the provision for loan and lease losses, a smaller loss in other income and a reduction in income taxes due to the valuation allowance in 2008 which resulted in a non-cash charge of $15.5 million. The lower loss in other income was primarily the result of a reduction in the impairment losses on investment securities year over year. Partially offsetting these positive changes was a decline in net interest income associated with a higher level of non-performing loans throughout 2009 and the lagged re-pricing of the deposits and borrowings that fund earning assets coupled with an increase in other expense. The increase in other expense was comprised mainly of Other Real Estate Owned (“OREO”) impairment charges and expenses, such as taxes and insurance, to maintain the OREO properties and increased FDIC insurance.
Significant matters that impacted earnings in 2009 are as follows:
         
Impairment losses on investment securities
  $11.0 million
Provision for loan and lease losses
  $20.6 million
OREO and related expenses
  $7.8 million
FDIC assessments
  $3.8 million

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Other (loss) income recorded a loss of $1.7 million in 2009 which was an improvement of $14.1 million from 2008 due primarily to a reduction of impairment on investment securities. Impairment losses on investment securities of $11.0 million, which declined $12.3 million from the previous year, were related to five trust preferred securities, three corporate bonds, various common stocks, a preferred stock and two private label collateralized mortgage obligations. Impairment losses in 2008 were attributed to the bankruptcy filing of Lehman Brothers Holdings, Inc. (“Lehman”), the FDIC seizure of Washington Mutual, impairments related to two bank preferred stocks and two collateralized mortgage obligations. Net interest income of $28.6 million declined $6.1 million, or 17.5%, due to the lagged re-pricing of the deposits and borrowings during 2009 associated with longer maturities of these liabilities relative to assets and the higher level of nonperforming loans throughout 2009. The provision for loan and lease losses of $20.6 million in 2009 represented a decrease of $1.2 million from the prior year’s results. Income taxes of $474,000 in 2009 was primarily due to the sale of the BOLI and declined $2.2 million from the prior year resulting from the establishment of the valuation allowance for the deferred tax assets in 2008.
Other expense of $37.7 million in 2009 increased $5.1 million, or 15.7%, due to OREO impairment charges of $4.5 million associated with foreclosed properties, OREO expenses increasing by $3.0 million and increased FDIC and state assessments of $3.1 million due to increased rates for insured deposits. The significant increase in OREO expenses reflected the increased foreclosed properties within OREO that require periodic payments for taxes, insurance, maintenance and other expenses. Partially offsetting these expense increases were reductions in salary primarily due to a one-time contractual payment of $2.1 million in 2008 to the former President and a $1.5 million reduction in impairment losses for real estate owned via equity investment.
Non-performing loans at December 31, 2009 amounted to $73.7 million which amounted to a decline of $12.1 million from year end 2008 while OREO at December 31, 2009 amounted to $30.3 million versus $10.3 million at year end 2008. Basic and diluted losses per common share were both $2.64 for 2009 compared to basic and diluted losses per common share of $2.86 in 2008.
The Company recorded a net loss of $38.1 million in 2008, which amounted to a decrease of $38.6 million from the net income of $564,000 recorded in 2007. The decline year over year was attributed to an increase in the provision for loan and lease losses related to an increase in non-performing loans of $8.8 million, impairment losses on investment securities of $23.4 million, a non-cash charge of $15.5 million related to the establishment of a valuation allowance for the deferred tax asset for the portion of the future tax benefit that more likely than not will not be utilized in the future, and a decline in net interest income of $3.2 million associated with increased non-performing loans and the negative impact of declining rates on the variable rate segment of the loan portfolio. Partially offsetting these unfavorable charges was a decrease of $8.8 million in other expense, which was attributed to non-recurring real estate joint ventures and real estate owned via equity investment impairment losses recorded in 2007. The $15.5 million deferred tax asset valuation allowance could be reversed going forward and result in the recognition of an income tax benefit to the extent the Company generates adequate income.
For 2007, included in the operating results is a $1.0 million reduction to net income related to the following accounting errors: a $667,000 reduction in net income resulting from an accounting error related to investments in real estate joint ventures, a $417,000 reduction in net income associated with an accounting error related to the consolidation of an investment in real estate owned via an equity investment and an increase in net income of $60,000 related to an error in the accounting for deferred loan costs per ASC Subtopic 20 under ASC Topic 310.
Net Interest Income and Margin: Net interest income is the Company’s primary source of income. Its level is a function of the average balance of interest-earning assets, the average balance of interest-bearing liabilities, and the spread between the yield on assets and liabilities. In turn, these factors are influenced by the pricing and mix of the Company’s interest-earning assets and funding sources. Additionally, net interest income is affected by market and economic conditions, which influence rates on loan and deposit growth.
The Company utilizes the effective yield interest method for recognizing interest income as required by ASC Subtopic 20, “Nonrefundable Fees and Other Costs” (“ASC Subtopic 20”) under FASB ASC Topic 310, “Receivables” (“ASC Topic 310”). ASC Subtopic 20 also guides our accounting for nonrefundable fees and costs associated with lending activities such as discounts, premiums, and loan origination fees. In the case of loan restructurings, if the terms of the new loan resulting from a loan refinancing or restructuring other than a troubled debt restructuring are at least as favorable to the Company as the terms for comparable loans to other customers with similar collection risks who are not

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refinancing or restructuring a loan with the Company, the refinanced loan is accounted for as a new loan. This condition is met if the new loan’s effective yield is at least equal to the effective yield for such loans. Any unamortized net fees or costs and any prepayment penalties from the original loan shall be recognized in interest income when the new loan is granted.
Net interest income was $28.6 million in 2009 as compared to $34.7 million in 2008. The decrease in net interest income in 2009 of $6.1 million, or 17.5%, was primarily due to the increased level of non-performing loans, lower yields on performing loans and investments, and an increased level of interest bearing deposits related to increased liquidity, which were partially offset by lower rates paid on brokered and retail certificates of deposit. (See the “Average Balance” table included in this discussion.) Net interest income was $34.7 million in 2008 as compared to $37.9 million in 2007.
For the full year December 31, 2009, total interest income amounted to $66.0 million versus $72.8 million for full year 2008 resulting in a decline of $6.7 million, or 9.2%. The decrease was attributable to a lower yield on average interest earning assets year over year, which was partially offset by a higher level of interest earning assets. Average interest earning assets for 2009 of $1.2 billion increased $94.0 million, or 8.5%, above the level of 2008. Average cash and cash equivalents increased $27.0 million, or doubled, average investment securities increased $28.2 million, or 7.1%, and average total loans increased $38.8 million, or 5.7%. The increased levels of interest bearing deposits and investment securities, which were entirely comprised of government agencies, were mainly due to increased retail deposits and the desire to maintain higher liquidity levels during this weak housing market and economy. The growth in average total loans during 2009 resulted from new business relationships, new advances under existing lines of credit and a lower level of loan payoffs resulting from the weak economy.
The decline in the yield on average interest earning assets also contributed to the decline in interest income year over year (5.53% in 2009 versus 6.61% in 2008). This 108 basis point decline was comprised of a decline of 176 basis points on interest bearing deposits, a decline of 90 basis points on investment securities and a 98 basis point decline in total loans. The decline in the yield on interest bearing deposits year over year was attributed to a continued decline in short term market interest rates throughout most of 2008 that significantly impacted the average yield in 2009. The decline of the yield on investment securities was mainly related to the growth of investment securities and the replacement of sold and called investment securities with lower yielding and lower risk-weighted, government agency securities that resulted in reduced credit risk within the investment portfolio but higher interest rate risk when interest rates rise. The interest income associated with investment securities declined $2.3 million, or 10.1%, as a result of the significantly increased concentration of lower yielding, government agency securities despite the $28.2 million, or 7.1%, increase in average balances. The yield reduction on average total loans resulted from lower market interest rates, which mainly impacted new loans and the continued increase in non-performing loans. Interest income on loans declined by $4.1 million, or 8.2%, which was attributed to lost interest on the increased level of average non-accrual loans, and the impact of lower yielding new loans. At year end 2009, the variable rate portfolio represented approximately 56% of total loans; however the Company was able to mitigate a portion of this negative impact through the utilization of rate floors in many of the commercial loan agreements that exceeded the current prime rate.
At December 31, 2009, non-performing loans to total loans amounted to 10.7% of total loans, whereas the same ratio at December 31, 2008, amounted 12.2%. The total interest income lost as a result of non-performing loans during 2009 amounted to $6.2 million, which amounted to an increase of $1.1 million, or 20.3%, from 2008.
Interest income for 2008 amounted to $72.8 million, which resulted in a decline of $14.0 million, or 16.1%, from the level of $86.7 million in 2007. The change year over year was attributed to an increase in the level of non-performing loans during 2008 and the negative impact on interest income of the decline of interest rates through the fourth quarter of 2007 and throughout 2008, which contributed to a decrease in loan yields of 151 basis points. This decline was partially offset by an increase in the yield on investment securities year over year of 43 basis points due to the reduction in government agency securities during the first half of 2008, which generally have a lower yield relative to the remainder of the investment portfolio.
Interest expense of $37.4 million for the full year 2009 decreased $670,000, or 1.8%, from the level of $38.1 million in 2008. This change resulted from an increase in average interest-bearing liabilities, which was more than offset by a reduction in the interest rates paid on those liabilities. Average interest-bearing liabilities in 2009 amounted to $1.1 billion, which represented an increase of $127.7 million, or 13.1%, from the prior year’s average of $974.8 million.

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The majority of the change was attributed to an increase in average interest-bearing deposits of $128.0 million, or 19.2%. This increase was primarily related to new retail certificates of deposit coupled with a very high retention rate of maturing retail certificates of deposit. The new retail certificates of deposit were attributable to a very successful campaign to attract deposits in advance of the disclosure of the Orders to maintain and assure adequate liquidity and to provide the Company with the ability to reduce its concentration of brokered deposits as required under the Orders.
Rates paid on all major liability categories declined year over year with the exception of savings accounts due to the general decline in market rates during 2008, which were attributed to the Federal Reserve’s lowering of the prime rate by 400 basis points. The most significant declines were as follows: certificates of deposits declined by 71 basis points, money market accounts declined by 110 basis points, now accounts declined by 81 basis points, and subordinated debt declined by 116 basis points.
Interest expense of $38.1 million for the year ended December 31, 2008 decreased $10.8 million, or 22%, from the level of 2007 due to an decrease in the average interest-bearing liabilities as well as a decrease in the average rates paid on interest bearing liabilities relative to the previous year. Average interest-bearing liabilities in 2008 declined $81.3 million, or 8%, from the prior year’s average, which was primarily associated with a decline in average interest-bearing deposits which were partially offset by an increase in average borrowings. The net reduction in interest-bearing liabilities reflected a decline in funding needs elated to a corresponding reduction in investment securities.
The net interest margin amounted to 2.39% during the full year 2009 which amounted to a reduction of 76 basis points from the prior year’s level. The decline of 108 basis points in interest-earning assets was primarily due to lower yields on all major interest-earning asset categories due to lower market rates in 2008 and 2009 coupled with a higher level of average non-performing loans in 2009. This was partially offset by average lower rates paid on interest-bearing liabilities of 51 basis points. The reduction of rates paid on interest-bearing liabilities have lagged the decline in interest-earning assets due to the immediate interest rate reduction on prime based loans in 2008 and the shift to lower yielding, cash-flowing government agency investment securities within interest-earning assets while without a corresponding re-pricing of a significant portion of interest bearing liabilities. Many of the higher rate retail certificates of deposit did not mature until the second half of 2009, a significant portion of higher rate brokered deposits and FHLB advances do not mature until 2010. In addition, the Company added slightly higher cost certificates of deposits through a successful retail campaign, mostly within the second quarter of 2009, to maintain liquidity in this current economic environment and in light of the requirement of the Orders to reduce reliance on brokered certificates of deposit.
During 2008 the net interest margin of 3.15% amounted to a modest increase of 4 basis points above the level of 3.11% for 2007. The negative impact of falling interest rates on the variable rate segment of the loan portfolio and the added impact of the increased level of non-performing loans added to the already existing net interest margin compression. However management was able to mitigate this negative effect by shifting the mix of earning assets through redeploying part of the matured and called investment securities into higher yielding loans and not replacing the remainder thereby reducing the overall size of the balance sheet. The shifting of liabilities more towards cost-effective FHLB advances and PNC borrowings and away from maturing higher cost certificates of deposit also contributed to the modest increase in net interest margin. In addition, immediate savings were realized for interest bearing deposits other than time deposits as market interest rates declined during 2008.
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:

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    For the years ended December 31,  
    2009     2008     2007  
    Average             Yield /     Average             Yield /     Average             Yield /  
(Dollars in thousands)   Balance     Interest     Rate     Balance     Interest     Rate     Balance     Interest     Rate  
Assets
                                                                       
Interest bearing deposits
  $ 51,578     $ 164       0.32 %   $ 23,788     $ 495       2.08 %   $ 35,158     $ 1,896       5.39 %
Federal funds
    553       1       0.18 %     1,323       24       1.81 %     2,900       147       5.07 %
Investment securities
                                                                       
Held to maturity
                0.00 %     56,658       3,241       5.72 %     205,686       10,032       4.88 %
Available for sale
    426,829       20,121       4.71 %     341,982       19,141       5.60 %     338,620       18,143       5.36 %
 
                                                     
Total investment securities
    426,829       20,121       4.71 %     398,640       22,382       5.61 %     544,306       28,175       5.18 %
Loans & Leases
                                                                       
Commercial demand loans
    384,831       18,439       4.79 %     395,109       25,270       6.40 %     376,002       31,874       8.48 %
Real estate secured
    294,414       24,285       8.25 %     256,124       22,153       8.65 %     238,929       22,187       9.29 %
Other loans and leases
    36,276       3,032       8.36 %     25,528       2,440       9.56 %     21,681       2,457       11.33 %
 
                                                     
Total loans
    715,521       45,756       6.39 %     676,761       49,863       7.37 %     636,612       56,518       8.88 %
 
                                                     
Total interest earnings assets
    1,194,481       66,042       5.53 %     1,100,512       72,764       6.61 %     1,218,976       86,736       7.12 %
 
                                                     
 
                                                                       
Non interest earnings assets
                                                                       
Cash & due from banks
    11,752                       7,552                       12,369                  
Other assets
    115,173                       106,447                       97,649                  
Allowance for loan loss
    (25,061 )                     (23,301 )                     (12,405 )                
Unearned discount
    (1,219 )                     (1,692 )                     (2,228 )                
 
                                                                 
Total non-interest earning assets
    100,645                       89,006                       95,385                  
 
                                                                 
Total assets
  $ 1,295,126                     $ 1,189,518                     $ 1,314,361                  
 
                                                                 
 
                                                                       
Liabilities & Shareholders’ Equity
                                                                       
Deposits
                                                                       
Savings
  $ 14,802     $ 83       0.56 %   $ 15,125     $ 76       0.50 %   $ 16,461     $ 85       0.52 %
Now
    46,046       478       1.04 %     48,414       894       1.85 %     52,975       1,185       2.24 %
Money market
    153,146       2,797       1.83 %     168,972       4,947       2.93 %     199,921       8,486       4.24 %
Time deposits
    581,202       21,984       3.78 %     434,662       19,497       4.49 %     531,965       27,384       5.15 %
 
                                                     
Total interest bearing deposits
    795,196       25,342       3.19 %     667,173       25,414       3.81 %     801,322       37,140       4.63 %
Federal funds
                0.00 %                 0.00 %                 0.00 %
Borrowings
    271,000       10,717       3.95 %     266,284       11,008       4.13 %     205,823       9,374       4.55 %
Obligation through VIE equity investments
    10,451       243       2.33 %     15,539       251       1.62 %     23,160       623       2.69 %
Subordinated debt
    25,774       1,136       4.41 %     25,774       1,436       5.57 %     25,774       1,736       6.74 %
 
                                                     
 
                                                                       
Total interest bearing liabilities
    1,102,421       37,438       3.40 %     974,770       38,109       3.91 %     1,056,079       48,873       4.63 %
 
                                                     
 
                                                                       
Non interest bearing deposits
    62,546                       57,211                       68,562                  
Other liabilities
    22,648                       26,382                       31,025                  
 
                                                                 
Total liabilities
    1,187,615                       1,058,363                       1,155,666                  
Shareholders’ equity
    107,511                       131,155                       158,695                  
 
                                                                 
Total liabilities and shareholders’ equity
  $ 1,295,126                     $ 1,189,518                     $ 1,314,361                  
 
                                                           
Net interest income
          $ 28,604                     $ 34,655                     $ 37,863          
 
                                                                 
Net interest margin
                    2.39 %                     3.15 %                     3.11 %
 
(1)   Non-accrual loans have been included in the appropriate average loan balance category, but interest on these loans has not been included.
 
(2)   Portions of interest related to obligations through VIE are capitalized on the VIE’s books.

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The following table sets forth a rate/volume analysis, which segregates in detail the major factors contributing to the change in net interest income exclusive of interest on obligation through VIE, for the years ended December 31, 2009 and 2008, as compared to respective previous periods, into amounts attributable to both rate and volume variances.
                                                 
    2009 versus 2008     2008 versus 2007  
    Changes due to:     Changes due to:  
(In thousands)   Volume     Rate     Total     Volume     Rate     Total  
Interest income
                                               
Short term earning assets
                                               
Interest bearing deposits in banks
  $ 88     $ (419 )   $ (331 )   $ (237 )   $ (1,164 )   $ (1,401 )
Federal funds sold
    (1 )     (22 )     (23 )     (28 )     (95 )     (123 )
 
                                   
Total short term earning assets
    87       (441 )     (354 )     (265 )     (1,259 )     (1,524 )
 
                                   
 
                                               
Investments securities
                                               
Held to maturity
    (3,241 )           (3,241 )     (8,583 )     1,790       (6,793 )
Available for sale
    4,023       (3,043 )     980       255       745       1,000  
 
                                   
Total Investments securities
    782       (3,043 )     (2,261 )     (8,328 )     2,535       (5,793 )
 
                                   
 
                                               
Loans
                                               
Commercial demand loans
    (551 )     (4,339 )     (4,890 )     1,329       (6,984 )     (5,655 )
Commercial mortgages
    1,250       (1,223 )     27       634       (2,161 )     (1,527 )
Residential and home equity loans
    (77 )     (127 )     (204 )     (267 )     (147 )     (414 )
Lease receivables
    987       (366 )     621       459       (380 )     79  
Real estate tax liens
    2,945       (637 )     2,308       1,900       7       1,907  
Other loans
    (15 )     (14 )     (29 )     (26 )     (70 )     (96 )
Loan fees
    (1,939 )           (1,939 )     (949 )           (949 )
 
                                   
Total loans
    2,600       (6,706 )     (4,106 )     3,080       (9,735 )     (6,655 )
 
                                   
 
                                               
Total increase (decrease) in interest income
  $ 3,469     $ (10,190 )   $ (6,721 )   $ (5,513 )   $ (8,459 )   $ (13,972 )
 
                                   
 
                                               
Interest expense
                                               
Deposits
                                               
NOW and money market
  $ (456 )   $ (2,109 )   $ (2,565 )   $ (1,227 )   $ (2,603 )   $ (3,830 )
Savings
    (2 )     9       7       (7 )     (2 )     (9 )
Time deposits
    5,871       (3,385 )     2,486       (4,633 )     (3,254 )     (7,887 )
 
                                   
Total deposits
    5,413       (5,485 )     (72 )     (5,867 )     (5,859 )     (11,726 )
 
                                   
 
                                               
Borrowings
                                               
Borrowings
    192       (482 )     (290 )     2,558       (928 )     1,630  
Trust preferred
          (300 )     (300 )           (296 )     (296 )
 
                                   
Total Borrowings
    192       (782 )     (590 )     2,558       (1,224 )     1,334  
 
                                   
 
                                               
Total increase (decrease) in interest expense
    5,605       (6,267 )     (662 )     (3,309 )     (7,083 )     (10,392 )
 
                                   
 
                                               
Total increase (decrease) in net interest income
  $ (2,136 )   $ (3,923 )   $ (6,059 )   $ (2,204 )   $ (1,376 )   $ (3,580 )
 
                                   
Provision for Possible Loan and Lease Losses
The provision for loan and lease losses was $20.6 million in 2009 compared to $21.8 million in 2008. The provision was comprised of $11.0 million in specific reserves for individual loans that became impaired during 2009. The Company recorded $19.2 million in net charge-offs. The remaining 2009 provision was based on the formula allowance reflecting historical losses, as adjusted by loan category and additional provision related to new loans as well as other qualitative and quantitative factors.
The Company recorded a $21.8 million provision for loan and lease losses in 2008. The Company recognized $12.2 million in net charge-offs in 2008. The 2008 provision included $12.9 million in specific reserves for impaired loans and was impacted by the growth in non-accrual loans and the historical losses with the remaining provision The remaining provision was based on the formula allowance reflecting historical losses, as adjusted by loan category and additional provision related to new loans.
The Company recorded a $13.0 million provision for loan and lease losses in 2007. The provision included $7.8 million in specific provision based on the Company’s calculation of allowance for individual impaired loans during 2007. The

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remaining 2007 provision of $5.2 million was the formula allowance reflecting historical losses, as adjusted by loan category.
Total Other (Loss) Income
Other (loss) income includes service charges on depositors’ accounts, safe deposit rentals and various services such as cashing checks, issuing money orders and traveler’s checks, and similar activities. In addition, other forms of non-interest income are derived from changes in the cash value of bank owned life insurance (“BOLI”), and income relating to real estate owned via equity investment. Most components of other income are a modest and stable source of income, with exceptions of one-time gains and losses from the sale of investment securities, other real estate owned, and real estate owned via equity investments. From period to period these sources of income may vary considerably. Service charges on depositors’ accounts, safe deposit rentals and other fees are periodically reviewed by management to remain competitive with other local banks.
Total other (loss) income amounted to a loss of $1.7 million in the current year which amounted to an improvement of $14.1 million from the loss of $15.8 million in 2008. The change was mainly associated with higher service charges and fees of $233,000, increased income of $337,000 related to real estate owned via equity investment, increased gains of $724,000 on the sale of loans and leases, net gains of $1.9 million on the sales of investment securities versus a loss of $1.3 million in 2008, increased other income of $430,000 and a reduction in net impairment losses on AFS investment securities amounting to $12.3 million. Offsetting these favorable changes was a reduction of gains on the sale of premises ($2.0 million in 2008 versus none in 2009), a decline of $134,000 in BOLI income and gains on the sales related to real estate joint ventures ($1.1 million in 2008 versus none in 2009). The increase in gains on the sale of loans was mainly attributed to SBA loan sales within Royal Asian during the past year. Net impairment losses on AFS investment securities amounted to $11.0 million in 2009, which included five trust preferred securities totaling $3.0 million, various common stocks amounting to $4.3 million, three corporate bonds amounting to $1.4 million, a preferred stock of $1.1 million, two real estate funds totaling $769,000 and two private label CMOs in the amount of $459,000. Refer to “Note 3 — Investment Securities” to the consolidated financial statements for more information on the impairment charges. The decline in BOLI income was due to the sale of approximately $23 million of BOLI insurance in the second half of 2009 to reduce the level of risk-weighted assets on the balance sheet to enhance the risk-based capital ratio of Royal Bank.
Total other (loss) income decreased $28.7 million from income of $12.9 million in 2007 to a loss of $15.8 million in 2008. This decrease was mainly attributed to impairment losses on AFS securities of $23.4 million during 2008, a decrease in gains from the sale of AFS securities of $6.7 million ($1.3 million loss in 2008 compared to a $5.4 million gain in 2007) and a decrease in gains from the sale of other real estate owned of $682,000. These decreases were partially offset by a $2.0 million increase in gains from the sale of premises and a $742,000 increase from gains on sales related to real estate joint ventures. The impairment losses on AFS investment securities amounted to $18.4 millions and were comprised of corporate bonds of Lehman and Washington Mutual, two collateralized mortgage obligations (“CMO”) and preferred stock investments in two financial institutions that were deemed by management to be “other than temporarily impaired” and were written down to zero value. In addition, the Company recorded a $5 million impairment charge on the entire carrying value of a CMO that was pledged as collateral for a swap with Lehman Brothers Special Financing, Inc. (“LBSF”) due to uncertainty surrounding the recovery of the collateral. As a consequence of the bankruptcy filing of Lehman an affiliate of LBSF, the Company sued LBSF to recover possession of its collateral.
Total Other Expense
Total other expense of $37.7 million increased $5.2 million, or 15.7%, in 2009 above the prior year’s results. While management was able to reduce selected expense categories throughout 2009, expense increases primarily associated with FDIC insurance rate increase, OREO costs related to foreclosed properties and legal expense increases associated with non-performing loans more than offset management’s expense reduction initiatives. Employee salaries and benefits of $12.2 million during 2009 declined $2.8 million from the level of 2008 due to a modest reduction in headcount and the temporary elimination of selected benefits within 2009 and the contractual payout to the former Company president in 2008 of $2.1 million. Professional and legal fees of $4.4 million in the current year increased $584,000, or 15.4%, above the previous year due mainly to increased legal fees associated with non-performing loans and an internal investigation related to the U.S Department of Justice investigation described in “Item 3-Legal

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Proceedings” of this Report which was partially offset by a decline in professional fees related to reduced consulting and recruiting expense. Occupancy and equipment amounted to $3.4 million, which represented an increase of $521,000, or 18.2%, due primarily to increased rental rates for some of the leased facilities and additional space that was leased for the lending and credit departments at the end of 2008. Impairment of real estate owned via equity investment, which was related to a real estate partnership project to convert apartments into condominiums, amounted to $1.5 million in 2008 due to lower projected operating cash flows. This project experienced significant improvement during the second half of the current year due to increased sales and related cash flows and resulted in no further impairment in 2009. FDIC and state assessments expense of $3.8 million in 2009 increased $3.1 million from the prior year almost entirely due to higher FDIC insurance rates during the past year. Both Royal Bank and Royal Asian Bank were charged higher rates in 2009 consistent with other FDIC insured financial institutions to increase insurance funds, based upon the individual risk profile of each Bank, due to recent and expected future failures of financial institutions.
The OREO impairment charges of $4.5 million reflected a reduction in value of five OREO properties based upon updated appraisals during 2009 while there was no corresponding expense in 2008. OREO and loan collection expense of $3.2 million in 2009 amounted to an increase of $3.0 million year over year and was mainly due to tax payments, insurance, maintenance costs, utilities and other related expenses. During 2009 the level of OREO properties increased by $20.0 million to $30.3 million at year end 2009, which resulted in a significant increase in ongoing costs to maintain the OREO properties. Other operating expense of $3.0 million in 2009 declined $1.8 million, or 37.1%, from the previous year. This expense category is comprised of data processing, postage, telephone, travel and entertainment, advertising, printing and supplies, dues and subscriptions and other miscellaneous expense. The reduction was primarily due to gains associated with the real estate partnership investment of $1.2 million associated with the sales of the converted condominium partnership project previously noted above whereas in 2008 a loss of $254,000 was posted due to much slower sales activity. The Company’s portion of the net gains from the partnership investment is recorded as a reduction to expenses while losses are posted as a charge to expense.
Other expense amounted to $32.5 million in 2008, which represented a decrease of $7.5 million, or 19%, from the level of the previous year. Significant decreases in both impairment of real estate owned via equity investment ($1.5 million in 2008 versus $8.5 million in 2007) due to improved, but continued lower projected operating cash flows and impairment of real estate joint ventures (no impairment in 2008 versus $5.9 million in 2007) for a 55 unit condominium building accounted for a majority of the improvement in expenses year over year. These reductions were partially offset by expense increases associated with salaries and employee benefits mainly related to the contract payout of the former Company president and higher medical benefits expense, professional and legal fees related to non-performing loans and recruiting expense, and other operating expense increases.
Accounting for Income Tax Expense (Benefit)
In 2009, the Company recorded tax expense of $474,000 compared to $2.6 million in 2008. Although the Company recorded a $35.4 million net loss for 2008, the tax expense was the result of the Company establishing a $15.5 million valuation allowance for the deferred tax asset. The Company recorded a $1.6 million tax benefit in 2007. The 2007 tax benefit was the result of the Company recording a $1.0 million loss before income taxes during 2007 and the tax benefit associated with the organization of the Royal Captive Insurance Company during 2007.
As of December 31, 2009 and December 31, 2008, management concluded that it was more likely than not that the Company would not generate sufficient future taxable income to realize all of the deferred tax assets. Management’s conclusion was based on consideration of the relative weight of the available evidence and the uncertainty of future market conditions on results of operations. As a result, the Company recorded a non-cash charge of $15.5 million in the consolidated statements of operations in the three month period ended December 31, 2008 related to the establishment of a valuation allowance for the deferred tax asset for the portion of the future tax benefit that more likely than not will not be utilized in the future. During 2009, the Company established an additional valuation allowance of $10.2 million, which was a result of the net operating loss for the year and the portion of the future tax benefit that more likely than not will not be utilized in the future. The additional valuation allowance did not impact the net loss as no tax benefit was recorded during 2009. As of December 31, 2009 the valuation allowance for deferred tax assets totaled $25.7 million, which excludes the $97,000 valuation allowance related to equity

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securities. The deferred tax asset of $414,000 relates to projected reversals of temporary differences in 2010 that are projected to be carried back to a prior year.
Our effective tax rate is the provision (benefit) for federal income taxes, excluding the tax effect of extraordinary items, expressed as a percentage of income or loss before federal income taxes. The effective tax rate for the twelve months ended December 31, 2009 and 2008 was 1.5% and 7.5%, respectively. In general our effective tax rate is different from the federal statutory rate of 35% primarily due to the benefits related to certain insurance that is non-taxable, equity investments that provide tax credits, and the establishment of a valuation allowance which was $25.7 million as of December 31, 2009.
Results of Operations by Business Segments
Under FASB ASC Topic 280, “Segment Reporting” (“ASC Topic 280”), management of the Company has identified three reportable operating segments, “Community Banking”, “Tax Liens” and “Equity Investments”; and two operating segments that do not meet the quantitative thresholds for requiring disclosure, but have different characteristics than the Community Banking, Tax Liens and Equity Investments segments, and from each other, “RBA Leasing” and “RBA Capital” (“Other” in the segment table in “Note 20 – Segment Information” of the Notes to Consolidated Financial Statements in Item 8 of this Report.)
    Community Bank segment: At December 31, 2009, the Community Bank segment had total assets of $1.1 billion, an increase of $100.5 million or 10% from $1.0 billion at December 31, 2008. Total deposits grew $121.7 million or 16% from $760.1 million at December 31, 2008 to $881.8 million at December 31, 2009. Net interest income for 2009 was $19.1 million compared to $27.4 million for 2008 representing an $8.3 million, or 30%, decline. The reduction in net interest income was related to the increased level of non-performing loans, lower yields on performing loans and investments and an increased level of interest bearing deposits related to increased liquidity, which were partially offset by lower rates paid on brokered and retail certificates of deposit. The loan loss provision was $18.7 million for 2009 compared to $17.4 million for 2008. For 2009, total other loss was $4.8 million compared to $19.1 million for 2008. This loss is mostly attributed to $4.8 million in impairment charges recorded on the available-for-sale investment portfolio for 2009 compared to $23.4 million for 2008. In 2009 total other expense was $32.9 million, an increase of $7.5 million, or 30%, from $25.4 million in 2008. The increase is mostly associated with FDIC insurance rate increase, OREO costs related to foreclosed properties and legal expense. The net loss for 2009 was $35.9 million compared to a net loss of $37.6 million for 2008.
 
    Tax Lien segment: At December 31, 2009, the Tax Lien segment had total assets of $105.0 million compared to $85.0 million at December 31, 2008 representing an increase of $20.1 million, or 24%. Net interest income increased $1.2 million, or 24%, from $4.8 million in 2008 to $6.0 million in 2009. The provision for losses declined from $2.6 million in 2008 to $624,000 in 2009. The 2008 provision was related to a specific reserve for a non-accrual loan with a tax lien portfolio located in Alabama. Total other income was $313,000 in 2009 compared to $560,000 in 2008. Total other income is derived mostly from the gains on sale of OREO property. Total other expense increased $214,000, or 8%, from $2.7 million for 2008 to $2.9 million for 2009. The increase in other total expense was related to legal fees. Net income was $1.0 million in 2009 compared to $85,000 for 2008.
 
    Equity Investment segment: At December 31, 2009 the Equity Investment segment had total assets of $8.7 million compared to $17.4 million at December 31, 2008 representing a decline of $8.7 million, or 50%. The decline was primarily related to a significant number of condominium sales in 2009. Net income for 2009 was $179,000 compared to net loss of $351,000 for 2008.

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Accounting for Debt and Equity Securities
The Company accounts for investment securities in accordance with FASB ASC Topic 320, “Investments-Debt & Equity Securities” (“ASC Topic 320”). ASC Topic 320 requires investments in securities to be classified in one of three categories; held to maturity, trading or available for sale. Debt securities that the Company has the intent and ability to hold to maturity are classified as held to maturity and are reported at amortized cost. All of the Company’s debt and equity securities are classified as available for sale. Net unrealized gains and losses for such securities, net of tax effect, are required to be recognized as a separate component of shareholders’ equity and excluded from the determination of net income.
Financial Condition
Total assets increased $117.1 million, or 10.0%, to $1.3 billion at December 31, 2009 from $1.2 billion at year-end 2008.
Cash and Cash Equivalents: Cash and cash equivalents consist of cash on hand, and cash in interest bearing and non-interest bearing accounts in banks, in addition to federal funds sold. Cash and cash equivalents increased $44.0 million from $14.3 million at December 31, 2008 to $58.3 million at December 31, 2009. The average balance of cash and cash equivalents was approximately $63.9 million for 2009 versus $32.7 million for 2008. The increase during 2009 was primarily related to maintaining strong liquidity during this current economic environment, which resulted in excess cash relative to historical operating requirements for the Company. The majority of this average balance was held in interest-bearing accounts with other financial institutions which were paying a higher interest rate than federal funds. The excess cash is invested daily in overnight and federal funds. The average balance of these funds that earn interest was $51.6 million in 2009.
Investment Securities Available for Sale (“AFS”): AFS investment securities represented 36% of average interest earning assets during 2009 and consisted of government secured agency bonds, government secured mortgaged-backed securities, collateralized mortgage obligations (“CMOs”), collateralized debt obligations (“CDOs”), capital trust security issues of regional banks, domestic corporate debt and third party managed equity funds. At December 31, 2009, AFS investment securities were $438.7 million as compared to $350.3 million at December 31, 2008, an increase of $88.4 million. This increase was primarily associated with the increased level of interest bearing deposits during 2009 without a corresponding increase in loans due to the weak economy. As a result, a significant portion of the interest bearing deposits was invested entirely in government agency investment securities. The increase in government agencies was partially offset by a reduction in third party managed equity funds and corporate debt due to sales and impairment associated with these investment securities.
Loans: The Company’s primary earning assets are loans, representing approximately 60% of average earning assets during 2009. The loan portfolio consists primarily of business demand loans and commercial mortgages secured by real estate, real estate tax liens, lease receivables, and to a significantly lesser extent, residential loans comprised of one to four family residential and home equity loans. During 2009, total loans decreased $13.8 million to $686.9 million at December 31, 2009 from $700.7 million at December 31, 2008. The decline was primarily due to transfers to OREO of approximately $29.2 million in non-performing construction and land development, non-residential, and residential real estate loans, loan charge-offs of $19.8 million, which were offset by net loan growth of $35.2 million.
Non-residential real estate, construction loans and land development make up a significant portion of our loan portfolio and represented 61% of total loans at December 31, 2009, which amounted to a decline from 71% of total loans at December 31, 2008. Management believes our current loan loss reserve is adequate to cover losses arising from these loan categories as well as all others within the portfolio. We continue to monitor these loans, with emphasis on construction, land development and non-residential real estate loans, due to the continuing deterioration in market conditions to evaluate the impact these loans will have on our loan loss reserve.
Allowance for loan and lease losses: The Company’s loan and lease portfolio (the “credit portfolio”) is subject to varying degrees of credit risk. The Company maintains an allowance for loan and lease losses (the “allowance”) to absorb possible losses in the loan and lease portfolio. The allowance is based on the review and evaluation of the loan and lease portfolio, along with ongoing, quarterly assessments of the probable losses inherent in that portfolio. The allowance represents an estimation made pursuant to FASB ASC Topic 450, “Contingencies” (“ASC Topic

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450”) or FASB ASC Topic 310, “Receivables” (“ASC Topic 310”). The adequacy of the allowance is determined through evaluation of the credit portfolio, and involves consideration of a number of factors, as outlined below, to establish a prudent level. Determination of the allowance is inherently subjective and requires significant estimates, including estimated losses on pools of homogeneous loans and leases based on historical loss experience and consideration of current economic trends, which may be susceptible to significant change. Loans and leases deemed uncollectible are charged against the allowance, while recoveries are credited to the allowance. Management adjusts the level of the allowance through the provision for loan and lease losses, which is recorded as a current period expense. The Company’s systematic methodology for assessing the appropriateness of the allowance includes: (1) the formula allowance reflecting historical losses, as adjusted, by loan category, and (2) the specific allowance for risk-rated credits on an individual or portfolio basis.
The Company uses three major components in determining the appropriate value of the loan and lease loss allowance: standards required under ASC Topic 310, an historical loss factor, and an environmental factor. Utilizing standards required under ASC Topic 310, loans are evaluated for impairment on an individual basis considering current collateral values (current appraisals or rent rolls for income producing properties), all known relevant factors that may affect loan collectability, and risks inherent in different kinds of lending (such as source of repayment, quality of borrower and concentration of credit quality). Once a loan is determined to be impaired (or is classified) such loans will be deducted from the portfolio and the net remaining balance will be used in the historical and environmental analysis.
The formula allowance, which is based upon historical loss factors, as adjusted, establishes allowances for the major loan and lease categories based upon a five year rolling average of the historical loss experienced. The factors used to adjust the historical loss experience address various risk characteristics of the Company’s loan and lease portfolio including: (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.
Management recognizes the higher credit risk associated with commercial and construction loans. As a result of the higher credit risk related to commercial and construction loans, the Company computes its formula allowance (which is based upon historical loss factors, as adjusted) using higher quantitative risk weighting factors than used for its consumer related loans. As an example, the Company applies an internal quantitative risk-weighting factor for construction loans which is approximately three times higher than the quantitative risk-weighting factor used for multi-family real estate loans. These higher economic risk factors for commercial and construction loans are used to compensate for the higher volatility of commercial and construction loans to changes in the economy and various real estate markets.
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. Analysis resulting in specific allowances, including those on loans identified for evaluation of impairment, includes consideration of the borrower’s overall financial condition, resources and payment record, support available from financial guarantors and the sufficiency of collateral. For such loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan are lower than the carrying value of that loan. These factors are combined to estimate the probability and severity of inherent losses. Then a specific allowance is established based on the Company’s calculation of the potential loss in individual loans. Additional allowances may also be established in special circumstances involving a particular group of credits or portfolio when management becomes aware that losses incurred may exceed those determined by application of the risk factors.

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Analysis of the Allowance for Loan and Lease Losses:
                                         
    For the years ended December 31,  
(In thousands)   2009     2008     2007     2006     2005  
Total Loans
  $ 686,864     $ 700,722     $ 644,475     $ 602,958     $ 549,636  
 
                             
 
                                       
Daily average loan balance
  $ 715,521     $ 676,761     $ 636,612     $ 618,591     $ 510,349  
 
                             
 
                                       
Allowance for loan and lease losses:
                                       
Balance at the beginning of the year
  $ 28,908     $ 19,282     $ 11,455     $ 10,276     $ 12,519  
Charge-offs by loan type:
                                       
Real Estate – residential
    1,361       37       195       631       142  
Real Estate — residential-mezzanine
          2,220                    
Construction and land development
    6,231       3,852       2,408              
Construction and land develop-mezzanine
    2,756       1,540       1,579              
Real Estate – non-residential
    7,404       1,330       294       5       2,162  
Real Estate – non-residential-mezzanine
    1,132       1,675                    
Leases
    676       642       286       11        
Commercial and industrial
    258       1,009       704             28  
Tax certificates
          22             25       1  
Other
                      73       2  
     
Total charge-offs
    19,818       12,327       5,466       745       2,335  
Recoveries by loan type:
                                       
Construction and land development
                34              
Real Estate – residential
    190       6       28       100       68  
Real Estate – non-residential
    431             4       14       7  
Commercial and industrial
    15       106       201       2       12  
Other
                      5       4  
     
Total recoveries
    636       112       267       121       91  
     
Net loan (charge-offs) recoveries
    (19,182 )     (12,215 )     (5,199 )     (624 )     (2,244 )
Provision for loan and lease losses
    20,605       21,841       13,026       1,803       1  
 
                             
 
                                       
Balance at end of year
  $ 30,331     $ 28,908     $ 19,282     $ 11,455     $ 10,276  
 
                             
 
                                       
Net (charge-offs) recoveries to average loans
    (2.68 %)     (1.80 %)     (0.82 %)     (0.10 %)     (0.44 %)
 
                             
 
                                       
Allowance to total loans at year-end
    4.42 %     4.13 %     2.99 %     1.90 %     1.87 %
 
                             

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Analysis of the Allowance for Loan and Lease Losses by Loan Type:
                                                                                 
    As of December 31,
    2009   2008   2007   2006   2005
            Percent of           Percent of           Percent of           Percent of           Percent of
            outstanding           outstanding           outstanding           outstanding           outstanding
            loans in each           loans in each           loans in each           loans in each           loans in each
    Reserve   category to   Reserve   category to   Reserve   category to   Reserve   category to   Reserve   category to
(In thousands, except percentages)   Amount   total loans   Amount   total loans   Amount   total loans   Amount   total loans   Amount   total loans
                     
Commercial and industrial
  $ 6,542       15.1 %   $ 2,403       12.3 %   $ 2,124       12.0 %   $ 559       7.0 %   $ 494       5.0 %
Construction
    4,713       7.6 %     11,548       23.8 %     7,674       14.4 %     4,117       29.0 %     3,230       31.0 %
Land development (1)
    3,182       9.7 %     2,359       10.6 %           12.2 %           0.0 %           0.0 %
Construction and land development - mezzanine
          0.0 %     1,415       0.3 %     2,493       1.0 %     409       1.0 %     167       1.0 %
Real Estate — residential
    2,762       7.1 %     747       3.9 %     1,014       6.5 %     845       7.0 %     925       8.0 %
Real Estate — residential — mezzanine
    1,000       0.4 %           0.0 %           0.0 %           0.0 %           0.0 %
Real Estate — non-residential
    9,824       40.3 %     5,172       33.4 %     4,746       40.5 %     4,941       46.0 %     4,758       41.0 %
Real Estate — non-residential - mezzanine
          0.0 %     1,188       0.6 %     204       1.4 %     224       1.0 %     374       1.0 %
Real Estate — multi-family
    215       3.2 %     133       2.0 %     59       1.1 %     36       1.0 %     145       4.0 %
Real Estate — multi-family — mezzanine
          0.0 %           0.0 %     6       0.5 %     20       1.0 %     132       1.0 %
Tax certificates
    290       10.6 %     2,735       9.1 %     185       7.1 %           5.0 %           6.0 %
Lease financing
    1,757       5.7 %     1,183       3.7 %     763       3.1 %     293       2.0 %     75       1.0 %
Other
    25       0.3 %     15       0.2 %     14       0.2 %     11       0.0 %     41       1.0 %
Unallocated
    21       0.0 %     10       0.0 %           0.0 %           0.0 %     (65 )     0.0 %
                     
Total
  $ 30,331       100.0 %   $ 28,908       100.0 %   $ 19,282       100.0 %   $ 11,455       100.0 %   $ 10,276       100.0 %
                     
 
(1)   Beginning in 2008, the Company began segregating land development loans from the rest of the loan portfolio.
The amount of the allowance is reviewed and approved by the Chief Operating Officer (“COO”), Chief Financial Officer (“CFO”) and the Chief Accounting Officer (“CAO”) on at least a quarterly basis. The provision for loan and lease losses was $20.6 million in 2009 compared to $21.8 million in 2008. The 2009 provision was the result of $11.0 million in required specific reserves based on the Company’s impairment analysis in accordance with ASC Topic 310 and net charge-offs of $19.2 million recorded in 2009. The remaining 2009 provision was based on the formula allowance reflecting historical losses, as adjusted by loan category and additional provision related to new loans. The historical loss calculation of the formula component of the allowance for loan and lease losses has been specifically impacted by the recent charge-off history of the Company. The deteriorating real estate market that continued from 2008 into 2009 has negatively impacted construction and real estate loans throughout the banking industry. This weak sales market has affected land development, construction and mezzanine loans of the Company. The Company has considered these economic conditions in its methodologies used in setting the allowance for loan and lease losses. Construction and land loans, non-residential and residential real estate loans represent 33%, 27% and 20%, respectively of the $73.7 million in non-accrual loans at December 31, 2009. Total charge-offs recorded in 2009 related to construction and land development loans and non-residential real estate loans were $17.5 million, or 88%, of total charge-offs in 2009.
The provision for loan and lease losses was $21.8 million in 2008 compared to $13.0 million in 2007. The increase in the provision was the result of an $8.3 million increase in the specific reserve based on the Company’s impairment analysis. The increase in the provision for loan and lease losses during 2008 is a reflection of the deteriorating real estate market that continued from 2007 into 2008. It has caused housing sales to slow and has negatively impacted construction loans throughout the banking industry. This weak sales market has affected land development, construction and mezzanine loans of the Company. Consequently, non-accrual loans increased $60.4 million from $25.4 million at December 31, 2007 to $85.8 million at December 31, 2008. Construction, commercial and non-residential real estate loans represented 64%, 14% and 11%, of the total December 31, 2008 non-accrual loans, respectively. The downturn in the real estate market is also reflected in the charge-offs of construction and land development loans and construction and land development mezzanine loans. These two loan categories represented $6.5 million, or 53%, of total charge-offs in 2008.
The provision for loan and lease losses was $13.0 million in 2007. During 2007 the Company recorded $7.8 million in specific reserves based on the Company’s calculation of potential losses in individual impaired loans. The remaining 2007 provision of $5.2 million was the formula allowance reflecting historical losses, as adjusted by credit category. The 2007 provision for loan and lease losses reflected the impact of deteriorating economic conditions as it pertained to real estate related loans. Non-accrual loans were $25.4 million at December 31, 2007.

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Construction loans and non-residential real estate loans represented 69% and 25% of the total December 31, 2007 non-accrual loans, respectively. The downturn in the real estate market was also reflected in the charge-offs of construction and land development loans and construction and land development mezzanine loans. These two loan categories represented $4.0 million, or 73%, of total charge-offs in 2007.
Management believes that the allowance for loan and lease loss at December 31, 2009 is adequate. However, its determination requires significant judgment, and estimates of probable losses inherent in the credit portfolio can vary significantly from the amounts actually observed. While management uses available information to recognize probable losses, future changes to the allowance may be necessary based on changes in the credits comprising the portfolio and changes in the financial condition of borrowers, such as may result from changes in economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the credit portfolio and the allowance. Such review may result in additional provisions based on their judgment of information available at the time of each examination. During 2009, there were changes in assumptions that affected the allowance. These changes included increasing the risk factors as a result of deteriorating economic conditions on both a local and national level as it pertains to construction and land development loans, non-residential real estate loans and single family residential loans. The Company also increased the risk factors associated with the rise in the trends in delinquencies of both construction and real estate loans.
Deposits: The Company’s deposits are an important source of funding. Total deposits of $881.8 million at December 31, 2009 increased $121.7 million, or 16.0%, from $760.1 million at December 31, 2008. The increase occurred in time deposit accounts, money market accounts and demand deposits, which were modestly offset by a decline in brokered deposits. Time deposit accounts of $382.2 million at December 31, 2009 increased $100.2 million, or 36%, from $282.0 million at December 31, 2008 to due to a successful marketing campaign in the second quarter to enhance liquidity and provide the future opportunity to pay down maturing brokered deposits and FHLB advances. Money market accounts of $168.9 million increased $23.5 million, or 16%, mainly due to the increased desire of customers to shift money to liquid accounts in the event of rising interest rates in the near future. Demand deposits increased $12.3 million, or 24%, which was primarily due to increased small business lending. Brokered deposits of $206.9 million at December 31, 2009 declined $11.3 million, or 5%, from year end 2008 as the Company paid off all maturing brokered deposits during the second half of 2009 as required under the Orders.
FHLB Borrowings: Borrowings consist of long-term borrowings (advances) and short-term borrowings (overnight borrowings, advances). Total FHLB borrowings, which include $22.0 million in overnight borrowings, declined from $230.6 million at year end 2008 to $209.5 million at December 31, 2009 due to pay downs of maturing advances. Short term borrowings amounted to $114.5 million at December 31, 2009 versus $37.0 million at December 31, 2008 while long term advances for the periods ending December 31, 2009 and 2008 were $95.0 million and $193.6 million, respectively. The shift in the long term advances to short term borrowings mostly reflected the term of the maturities at year end 2009 versus 2008.
Other Borrowings: During 2004, the Company completed a private placement of trust preferred securities in the aggregate amount of $25.0 million for a term of 30 years with a call feature of 5 years. These securities were eligible to be called in October 2009 by the Company. The maturity date of these securities is October 2034. On August 13, 2009, the Company’s Board of Directors determined to suspend interest payments on the trust preferred securities. The Company’s Board of Directors took this action in consultation with the Federal Reserve Bank of Philadelphia as required by recent regulatory policy guidance. The Company currently has sufficient capital and liquidity to pay the scheduled interest payments; however, the Company believes this decision will better support the capital position of Royal Bank, a wholly owned subsidiary of the Company. As of December 31, 2009 the trust preferred interest payment in arrears was $529,000 and has been recorded in interest expense and accrued interest payable.
During 2006, the Company entered into a borrowing relationship with PNC Bank in the amount of $5.6 million, which amounted to $4.7 million at December 31, 2009, due to monthly payments. During 2008, the Company increased the borrowings outstanding with PNC by $40.0 million. These repurchase agreements are callable between 2011 and 2013 and have a final maturity date of January 7, 2018. In addition, the Company consolidated into its statement of condition $3.7 million of debt related to a real estate equity investment of which none is guaranteed by the Company.

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Other Liabilities: At December 31, 2009, other liabilities of $16.9 million increased $2.9 million from December 31, 2008. This was principally due to an increase of $1.3 million related to unfunded pension plan obligations and increased accruals of $1.2 million for unpaid expenses, mainly FDIC insurance.
Shareholders’ Equity: Shareholders’ equity increased $21.5 million, or 27%, in 2009 to $101.2 million primarily due to the Company receiving on February 20, 2009, approximately $30.4 million via the issuance of preferred stock under the Treasury’s TARP CPP program and a reduction in accumulated other comprehensive loss of $24.5 million, which was partially offset by net losses of $33.3 million. The significant reduction in accumulated other comprehensive loss occurred mainly in the second half of 2009 due to improvements in valuations in both the bond and stock markets that positively impacted the investment portfolio.
Asset Liability Management
The primary functions of asset-liability management are to assure adequate liquidity and maintain an appropriate balance between interest earning assets and interest bearing liabilities. This process is overseen by the Asset-Liability Committee (“ALCO”) which monitors and controls, among other variables, the liquidity, balance sheet structure and interest rate risk of the consolidated company within policy parameters established and outlined in the ALCO Policy which are reviewed by the Board of Directors at least annually. Additionally, the ALCO committee meets periodically and reports on liquidity, interest rate sensitivity and projects financial performance in various interest rate scenarios.
Liquidity: Liquidity is the ability of the financial institution to ensure that adequate funds will be available to meet its financial commitments as they become due. In managing its liquidity position, the financial institution evaluates all sources of funds, the largest of which is deposits. Also taken into consideration is the repayment of loans. These sources provide the financial institution with alternatives to meet its short-term liquidity needs. Longer-term liquidity needs may be met by issuing longer-term deposits and by raising additional capital.
The Company generally targets liquidity ratios equal to or greater than 12% and 10% of total deposits and total liabilities, respectively, effective in 2009. The liquidity ratios are specifically defined as the ratio of net cash, available FHLB and other lines of credit, and unpledged marketable securities relative to both total deposits and total liabilities. At December 31, 2009, liquidity as a percent of deposits was 33% and liquidity as a percent of total liabilities was 24%. For the years ended December 31, 2008 and 2007, the liquidity was measured against the combined total of net deposits and short-term liabilities and the liquidity ratio amounted to 27% and 38%, respectively. Management believes that the Company’s liquidity position continues to be adequate and meets or exceeds the liquidity target set forth in the Asset/Liability Management Policy. Management believes that due to its financial position, it will be able to raise deposits as needed to meet liquidity demands. However, any financial institution could have unmet liquidity demands at any time.
Our funding decisions can be influenced by unplanned events, which include, but are not limited to, the inability to fund asset growth, difficulty renewing or replacing funds that mature, the ability to maintain or draw down lines of credit with other financial institutions, significant customer withdrawals of deposits, and market disruptions. In 2010, FHLB notified Royal Bank that they were being placed on overcollateralization status with a 105% pledged collateral requirement. The available amount for future borrowings will be based on the amount of collateral to be pledged. We have a liquidity contingency plan in the event liquidity falls below an acceptable level, however in today’s economic environment, events could arise that may render sources of liquid funds unavailable in the future when required. During the second quarter of 2009, the Company established a liquidity committee that meets monthly to increase the oversight role of liquidity management during this recessionary economy.

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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, 2009.
                                         
    For the year ended December 31, 2009  
            Less than one     One to three     Four to five     More than five  
(In thousands)   Total     year     years     years     years  
FHLB advances
  $ 209,501     $ 114,500     $ 45,001     $ 50,000     $  
Operating leases
    3,315       1,088       1,494       616       117  
PNC Bank
    44,674                         44,674  
Benefit obligations
    8,672       510       1,208       1,324       5,630  
Commitments to extend credit
    1,630       1,630                    
Standby letters of credit
    3,477       3,477                    
Subordinated debt
    25,774                         25,774  
Non-interest bearing deposits
    63,168       63,168                    
Interest bearing deposits
    229,477       94,916       134,561              
Time deposits
    589,110       392,219       181,564       9,879       5,448  
 
                             
 
                                       
Total
  $ 1,178,798     $ 671,508     $ 363,828     $ 61,819     $ 81,643  
 
                             
Interest-Rate Sensitivity: Interest rate sensitivity is a function of the repricing characteristics of the financial institution’s assets and liabilities. These include the volume of assets and liabilities repricing, the timing of repricing, and the relative levels of repricing. Attempting to minimize the interest rate sensitivity gaps is a continual challenge in a changing rate environment. The interest rate sensitivity report examines the positioning of the interest rate risk exposure in a changing interest rate environment. Ideally, the rate sensitive assets and liabilities will be maintained in a matched position to minimize interest rate risk.
The interest rate sensitivity analysis is an important management tool; however, it does have some inherent shortcomings. It is a “static” analysis. Although certain assets and liabilities may have similar maturities or repricing, they may react in different degrees to changes in market interest rates. Additionally, repricing 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, 2009, 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, 2009, the Company is in a slightly asset sensitive position of $2.4 million, which indicates that within one year the repricing of assets is slightly sooner than the repricing of liabilities.
Interest Rate Swaps: For asset/liability management purposes, the Company uses interest rate swaps which are agreements between the Company and another party (known as counterparty) where one stream of future interest payments is exchanged for another based on a specified principal amount (known as notional amount). The Company will use interest rate swaps to hedge various exposures or to modify interest rate characteristics of various balance sheet accounts. Such derivatives are used as part of the asset/liability management process, are linked to specific liabilities, and have a high correlation between the contract and the underlying item being hedged, both at inception and throughout the hedge period.
The Company had utilized interest rate swap agreements to convert a portion of its fixed rate time deposits to a variable rate (fair value hedge) to fund variable rate loans and investments as well as convert a portion of variable rate borrowings (cash flow hedge) to fund fixed rate loans. Interest rate swap contracts represent a series of interest flows exchanged over a prescribed period. Each quarter the Company used the Volatility Reduction Measure (“VRM”) to determine the effectiveness of their fair value hedges.

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As a consequence of the 2008 third quarter Lehman bankruptcy filing, the swap agreements and cash flow hedge that existed at the end of the 2008 second quarter were terminated. The Company had an agency mortgage-backed security (approximately $5.0 million) that was pledged as collateral at Lehman for our swap agreements. In October 2008, the Company sued Lehman Brothers Special Financing, Inc. (“LBSF”) to recover possession of its collateral. The Company intends to continue to vigorously pursue return of the collateral pledged in connection with the interest rate swap. Because of the uncertainty surrounding the litigation and the bankruptcy of Lehman, the Company classified the collateral as other-than-temporarily impaired as of December 31, 2008.
Interest Rate Sensitivity
(In millions)
                                                 
    For the year ended December 31, 2009
            91 – 365   One to five   Over five   Non-rate    
(In millions)   0 – 90 days   days   years   years   sensitive   Total
     
Assets (1)
                                               
Interest-bearing deposits in banks
  $ 33.0     $     $     $     $ 25.3     $ 58.3  
Federal funds sold
                                   
Investment securities
    70.4       65.8       197.2       105.5       (0.2 )     438.7  
Loans: (2)
                                               
Fixed rate
    23.2       64.4       173.0       29.2             289.8  
Variable rate
    299.3       65.4       34.6             (30.3 )     369.0  
     
Total loans
    322.5       129.8       207.6       29.2       (30.3 )     658.8  
Other assets (3)
          19.3                   117.6       136.9  
     
Total Assets
  $ 425.9     $ 214.9     $ 404.8     $ 134.7     $ 112.4     $ 1,292.7  
     
 
                                               
Liabilities & Capital
                                               
Deposits:
                                               
Non interest bearing deposits
  $     $     $     $     $ 63.2     $ 63.2  
Interest bearing deposits
    19.7       75.2       134.6                   229.5  
Certificate of deposits
    89.8       302.4       191.4       5.5             589.1  
     
Total deposits
    109.5       377.6       326.0       5.5       63.2       881.8  
Borrowings (1)
    54.0       97.3       128.7             3.7       283.7  
Other liabilities
                            22.9       22.9  
Capital
                            104.3       104.3  
     
Total liabilities & capital
  $ 163.5     $ 474.9     $ 454.7     $ 5.5     $ 194.1     $ 1,292.7  
     
 
                                               
Net interest rate GAP
  $ 262.4     $ (260.0 )   $ (49.9 )   $ 129.2     $ (81.7 )        
             
 
                                               
Cumulative interest rate GAP
  $ 262.4     $ 2.4     $ (47.5 )   $ 81.7                  
                     
 
                                               
GAP to total assets
    20 %     (20 %)                                
                                     
GAP to total equity
    252 %     (249 %)                                
                                     
Cumulative GAP to total assets
    20 %     0 %                                
                                     
Cumulative GAP to total equity
    252 %     2 %                                
                                     
 
(1)   Interest earning assets are included in the period in which the balances are expected to be repaid and/or repriced as a result of anticipated prepayments, scheduled rate adjustments, and contractual maturities.
 
(2)   Reflects principal maturing within the specified periods for fixed and repricing 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 reprice or mature in the same time periods.

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The interest rates on certain assets and liabilities may change at different times than changes in market interest rates, with some changes in advance of changes in market rates and some lagging behind changes in market rates. Also, certain assets have provisions, which limit changes in interest rates each time the interest rate changes and for the entire term of the loan. Additionally, prepayments and withdrawals experienced in the event of a change in interest rates may deviate significantly from those assumed in the interest rate sensitivity table. Additionally, the ability of some borrowers to service their debt may decrease in the event of an interest rate increase.
Capital Adequacy
The table below sets forth the Company’s and the Banks’ capital ratios and the Company’s performance ratios:
                         
    For the years ended December 31,
    2009   2008   2007
Company
                       
Leverage ratio
    9.8 %     10.3 %     13.6 %
Risk based capital ratio:
                       
Tier 1
    14.2 %     11.8 %     17.0 %
Total
    15.5 %     13.0 %     18.3 %
 
                       
Royal Bank
                       
Leverage ratio
    8.1 %     7.8 %     10.2 %
Risk based capital ratio:
                       
Tier 1
    12.1 %     9.0 %     13.2 %
Total
    13.4 %     10.3 %     14.5 %
 
                       
Royal Asian
                       
Leverage ratio
    12.5 %     14.0 %     15.7 %
Risk based capital ratio:
                       
Tier 1
    15.7 %     17.4 %     20.2 %
Total
    17.0 %     18.7 %     21.5 %
 
                       
Capital performance
                       
Return on average assets
    (2.57 %)     (3.20 %)     0.04 %
Return on average equity
    (30.94 %)     (29.04 %)     0.36 %
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, 2009, the Company was required to have minimum Tier 1 and total capital ratios of 4.0% and 8.0%, respectively, and a minimum Tier 1 leverage ratio of 4.0%. At December 31, 2009, 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. At December 31, 2009, both Royal Bank and Royal Asian 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%. Under the Orders as described in “Regulatory Action” under “Item 1 – Business” in this Report, Royal Bank is required to maintain a minimum Tier 1 leverage ratio of 8% and a Total risk-based capital ratio of 12% during the term of the Orders. Royal Bank met those requirements at December 31, 2009. See “Note 14 – Regulatory Capital Requirements” of the Notes to Consolidated Financial Statements in Item 8 of this Report.
On February 20, 2009, as part of the Capital Purchase Program (“CPP”) established by the United States Department of Treasury (“Treasury”), the Company issued to Treasury 30,407 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, without par value per share (the “Series A Preferred Stock”), and a liquidation preference of $1,000 per share. In conjunction with the purchase of the Series A Preferred Stock, Treasury received a warrant to purchase 1,104,370 shares of the Company’s Class A common stock. The aggregate purchase price for the Series A Preferred Stock and Warrant was $30.4 million in cash. The Series A Preferred Stock qualifies as Tier

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1 capital and pays cumulative dividends at a rate of 5% per annum for the first five years, and 9% per annum thereafter. The Series A Preferred Stock may generally be redeemed by the Company at any time following consultation with its primary banking regulators. The warrant issued to Treasury has a 10-year term and is immediately exercisable upon its issuance, with an exercise price, subject to anti-dilution adjustments, equal to $4.13 per share of the common stock.
Management Options to Purchase Securities
The 2007 Long-Term Incentive Plan was approved by Shareholders at the May 16, 2007 Annual Meeting. All employees and non-employee directors of the Company and its designated subsidiaries are eligible participants. The plan includes 1,000,000 shares of Class A common stock (of which 250,000 shares may be issued as restricted stock), subject to customary anti-dilution adjustments, or approximately 9.0% of total outstanding shares of the Class A common stock. As of December 31, 2009, 191,072 shares from this plan have been granted. The option price is equal to the fair market value at the date of the grant. The options are exercisable at 20% per year beginning one year after the date of grant and must be exercised within ten years of the grant. The restricted stock is granted with an estimated fair value equal to the market value of the Company closing stock price on the date of the grant. Restricted stock will vest three years from the grant date, if the Company achieves specific goals set by the Compensation Committee and approved by the Board of Directors. These goals include a three year average return on assets compared to peers, a three year average return on equity compared to peers and a minimum return on both assets and equity over the three year period.
In May 2001, the directors of the Company approved the amended Royal Bancshares of Pennsylvania Non-qualified Stock Option and Appreciation Right Plan (the “Plan”). The shareholders in connection with the formation of the Holding Company re-approved the Plan. The Plan is an incentive program under which Bank officers and other key employees may be awarded additional compensation in the form of options to purchase up to 1,800,000 shares of the Company’s Class A common stock (but not in excess of 19% of outstanding shares). In May 2006, the shareholders approved an increase of the number of shares of Class A Common Stock available for issuance under the Plan by 150,000 to 1,800,000 and extended the plan for an additional year At the time a stock option is granted, a stock appreciation right for an identical number of shares may also be granted. The option price is equal to the fair market value at the date of the grant. At December 31, 2009, 401,626 of the options that have been granted are outstanding, which are exercisable at 20% per year. At December 31, 2009, options covering 357,737 shares were exercisable. The ability to grant new options under this plan has expired.
In May 2001, the directors of the Company approved an amended non-qualified Outside Directors’ Stock Option Plan. The shareholders in connection with the formation of the Holding Company re-approved this Plan. Under the terms of the plan, 250,000 shares of Class A stock are authorized for grants. Each director is entitled to a grant of an option to purchase 1,500 shares of stock annually, which is exercisable one year from the grant date. The options are granted at the fair market value at the date of the grant. At December 31, 2009, 90,197 of the options that have been granted are outstanding, and all are exercisable. The ability to grant new options under this plan has expired.
Loans
The following table reflects the composition of the loan portfolio and the percent of gross loans outstanding represented by each category at the dates indicated.

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    As of December 31,  
(Dollars in thousands)   2009     2008     2007     2006     2005  
Commercial and industrial
  $ 104,063       15.1 %   $ 86,278       12.3 %   $ 77,856       12.1 %   $ 43,019       7.2 %   $ 30,075       5.5 %
Construction
    52,196       7.6 %     167,204       23.8 %     92,779       14.4 %     172,745       29.1 %     173,757       31.5 %
Construction and land development - mezzanine
          0.0 %     2,421       0.3 %     6,443       1.0 %     5,177       0.9 %     3,345       0.6 %
Land development (1)
    66,878       9.7 %     74,168       10.6 %     78,874       12.2 %           0.0 %           0.0 %
Real Estate — residential
    48,498       7.1 %     27,480       3.9 %     42,286       6.5 %     43,338       7.3 %     41,900       7.6 %
Real Estate — non-residential
    277,234       40.3 %     234,573       33.4 %     261,350       40.5 %     268,162       45.2 %     228,222       41.4 %
Real Estate — non-residential - mezzanine
          0.0 %     4,111       0.6 %     8,749       1.4 %     8,283       1.4 %     7,477       1.4 %
Real Estate — multi-family
    22,017       3.2 %     14,059       2.0 %     6,887       1.1 %     3,953       0.7 %     22,158       4.0 %
Real Estate — residential — mezzanine
    2,480       0.4 %     335       0.0 %     3,504       0.5 %     2,129       0.4 %     2,646       0.5 %
Tax certificates
    73,106       10.6 %     64,168       9.1 %     46,090       7.1 %     32,235       5.4 %     35,548       6.4 %
Lease financing
    39,097       5.7 %     26,123       3.7 %     19,778       3.1 %     13,404       2.3 %     2,623       0.5 %
Other
    2,173       0.3 %     1,243       0.2 %     1,424       0.2 %     1,333       0.2 %     3,868       0.7 %
                     
Total gross loans
  $ 687,742       100 %   $ 702,163       100 %   $ 646,020       100 %   $ 593,778       100 %   $ 551,619       100 %
Unearned income
    (878 )             (1,441 )             (1,545 )             (1,564 )             (1,983 )        
 
                                                                     
 
  $ 686,864             $ 700,722             $ 644,475             $ 592,214             $ 549,636          
Allowance for loan loss
    (30,331 )             (28,908 )             (19,282 )             (11,455 )             (10,276 )        
 
                                                                     
Total net loans
  $ 656,533             $ 671,814             $ 625,193             $ 580,759             $ 539,360          
 
                                                                     
 
(1)   Land development balances were segregated only from construction and land development for 2009, 2008, and 2007.
Credit Quality
The following table presents the principal amounts of non-accrual loans and other real estate:
                                         
    For the years ended December 31,  
(Dollars in thousands)   2009     2008     2007     2006     2005  
Non-accrual loans (1)
  $ 73,679     $ 85,830     $ 25,401     $ 6,748     $ 4,371  
Other real estate owned
    30,317       10,346       1,048       924       3,834  
 
                             
Total non-performing assets
  $ 103,996     $ 96,176     $ 26,449     $ 7,672     $ 8,205  
 
                             
 
                                       
Non-performing assets to total assets
    8.04 %     8.18 %     2.07 %     0.57 %     0.63 %
 
                             
 
                                       
Non-performing loans to total loans
    10.73 %     12.25 %     3.94 %     1.14 %     0.79 %
 
                             
 
                                       
Allowance for loan loss to non-accrual loans
    41.17 %     33.68 %     75.91 %     169.75 %     235.09 %
 
                             
 
                                       
Total Loans
    686,864       700,722       644,475                  
Total Assets
    1,292,726       1,175,586       1,278,475                  
Allowance for loan and lease losses
    30,331       28,908       19,282                  
 
                                       
ALL / Loans & Leases (MD & A)
    4.42 %     4.13 %     2.99 %                
 
(1)   Generally, a loan is placed in non-accrual status when it has been delinquent for a period of 90 days or more, unless the loan is both well secured and in the process of collection.

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Non-accrual loan activity for each of the four quarters in 2009 is set forth below:
                                                 
            1st Quarter Actvity        
                    Payments and                      
    Balance at             other             Transfer to     Balance at  
(In thousands)   December 31, 2008     Additions     decreases     Charge-offs     OREO     March 31, 2009  
Construction
  $ 41,485     $ 4,966     $ (14,120 )   $     $     $ 32,331  
Land development
    11,044       4,442       (807 )     (913 )     (7,301 )     6,465  
Construction & land development - mezzanine
    2,421                               2,421  
Real Estate-Non-Residential
    6,324       2,244             (1,035 )     (1,930 )     5,603  
Real Estate-Non-Residential - mezzanine
    3,612                   (1,132 )           2,480  
Commercial & Industrial
    12,145       1,530       (412 )     (15 )           13,248  
Residential real estate
    1,472       210       (7 )                 1,675  
Leasing
    711             (33 )     (153 )           525  
Tax certificates
    6,616             (95 )     (1,221 )           5,300  
 
                                   
Total
  $ 85,830     $ 13,392     $ (15,474 )   $ (4,469 )   $ (9,231 )   $ 70,048  
 
                                   
                                                 
            2nd Quarter Actvity        
                    Payments and                      
    Balance at             other             Transfer to     Balance at  
(In thousands)   March 31, 2009     Additions     decreases     Charge-offs     OREO     June 30, 2009  
Construction
  $ 32,331     $ 179     $ (1,509 )   $ (4,357 )   $ (7,551 )   $ 19,093  
Land development
    6,465       9,882       (1,471 )     (426 )     (402 )     14,048  
Construction & land development - mezzanine
    2,421       335             (298 )           2,458  
Real Estate-Non-Residential
    5,603       12,986       (2,355 )     (228 )           16,006  
Real Estate-Non-Residential - mezzanine
    2,480       498                         2,978  
Commercial & Industrial
    13,248       9,706       (273 )     (239 )           22,442  
Residential real estate
    1,675       1,244       (143 )     (153 )           2,623  
Residential real estate — mezzanine
                                   
Leasing
    525       381             (157 )           749  
Tax certificates
    5,300       11       (94 )     (11 )           5,206  
 
                                   
Total
  $ 70,048     $ 35,222     $ (5,845 )   $ (5,869 )   $ (7,953 )   $ 85,603  
 
                                   
                                                         
            3rd Quarter Actvity        
                    Payments and                              
    Balance at             other                     Transfer to     Balance at  
(In thousands)   June 30, 2009     Additions     decreases     Reclassed     Charge-offs     OREO     September 30, 2009  
Construction
  $ 19,093     $ 11,496     $ (2,480 )   $ (5,955 )   $ (1,444 )   $ (76 )   $ 20,634  
Land development
    14,048             (1,483 )           (380 )           12,185  
Construction & land development - mezzanine
    2,458                   2,480       (2,123 )           2,815  
Real Estate-Non-Residential
    16,006       1,990       (2,509 )           (727 )     (644 )     14,116  
Real Estate-Non-Residential - mezzanine
    2,978                   (2,480 )     (498 )            
Commercial & Industrial
    22,442       76       (487 )                       22,031  
Residential real estate
    2,623       15       (231 )     5,955                   8,362  
Leasing
    749       336                   (157 )           928  
Tax certificates
    5,206             (454 )           (1,827 )           2,925  
 
                                         
Total
  $ 85,603     $ 13,913     $ (7,644 )   $     $ (7,156 )   $ (720 )   $ 83,996  
 
                                         

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            4th Quarter Actvity        
                    Payments and                              
    Balance at             other                     Transfer to     Balance at  
(In thousands)   September 30, 2009     Additions     decreases     Reclassed     Charge-offs     OREO     December 31, 2009  
Construction
  $ 20,634     $ 3,570     $ (575 )   $ (4,901 )   $ (50 )   $ (362 )   $ 18,316  
Land development
    12,185             (792 )                 (5,485 )     5,908  
Construction & land development — mezzanine
    2,815                   (2,480 )     (335 )            
Real Estate-Non-Residential
    14,116       2,508       (395 )     3,871       (516 )           19,584  
Real Estate-Non-Residential — mezzanine
                                         
Commercial & Industrial
    22,031       55       (10,578 )     276       (5 )           11,779  
Residential real estate
    8,362       9,763       (1,122 )     754       (1,208 )     (4,104 )     12,445  
Residential real estate — mezzanine
                      2,480                   2,480  
Leasing
    928             (77 )           (224 )           627  
Consumer
                                         
Tax certificates
    2,925             (385 )                       2,540  
 
                                         
Total
  $ 83,996     $ 15,896     $ (13,924 )   $     $ (2,338 )   $ (9,951 )   $ 73,679  
 
                                         
At December 31, 2009 non-accrual and impaired loans was $73.7 million compared to $85.8 million at December 31, 2008. The $12.1 million decline in non-accrual loans was the result of a $42.9 million reduction in existing non-accrual loan balances through payments or loans becoming current and placed back on accrual, $27.8 million transferred to other real estate owned, and $19.8 million in charge-offs which collectively were offset by $78.4 million in additions. The largest increases in non-accrual loans (after reclassifications) occurred in non-residential and residential real estate, which amounted to $8.3 million and 4.3 million, respectively. The largest declines in non-accrual loans (after reclassifications) occurred in construction and land development loans and tax certificates, which amounted to $19.9 million and $4.1 million, respectively.
The following is a detail listing of the significant additions to non-accrual loans during 2009:
First Quarter 2009 new non-accrual loans:
  A $2.5 million loan, in which the bank is a participant, became non-accrual during the first quarter of 2009. The loan is collateralized by a first lien Deed of Trust on two parcels comprising 141.59 acres in Highland, Howard County, Maryland. The land was purchased in August, 2005. The original plan was to build 37 single family lots averaging over 3 acres each under contract with a national builder to take down these lots over a minimum of two years. The contract with the builder has been amended five times. To date, there have been only five lots taken down. The loan has been declared in default and judgment confessed. A foreclosure action was commenced. During the first quarter of 2009, an impairment analysis was performed in accordance with ASC Topic 310 and the loan was deemed impaired. As a result, a charge-off was recorded in the amount of $913,000. During the second quarter of 2009, the lead bank negotiated the sale of the loan which was scheduled to close in the third quarter. Accordingly the loan has been transferred to loans and leases held for sale. An additional charge-off of $416,000 was recorded in the second quarter of 2009 which was based on the expected proceeds from the sale of the loan. The sale of the loan was delayed due to the Office of Thrift Supervision and the FDIC closing the lead bank in late August. The sale of the loan was finally completed in the first quarter of 2010.
 
  Two loans in the aggregate amount of $4.8 million for a construction project in Minneapolis, Minnesota, to renovate a historic building into a luxury hotel and to construct 86 residential condominiums connected to the hotel became non-accrual during the first quarter of 2009. The two loans are under a forbearance agreement. These loans are loan participations in larger loans in the aggregate of $60.3 million. The hotel is fully operational and the construction of the condominiums is complete. As of the date of this filing, approximately 22% percent of the condominiums have been sold. An impairment analysis performed in accordance with ASC Topic 310 indicated impairment. Consequently, the Company established a specific reserve of $221,000 for these loans.
 
  A $1.9 million loan for a fully leased 100,000 square foot industrial building and 1.5 acre parcel of land located in New Morgan, Pennsylvania became non-accrual in the first quarter of 2009. The loan was paid in full during the second quarter of 2009.

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  One loan of RBA Capital in the amount of $1.5 million was related to one borrower extending loans to third-party buyers of single family residences in need of rehab work. During the first quarter of 2009, the borrower failed to meet certain loan covenants and terms and the loan was classified as impaired. RBA Capital has taken over management of this portfolio and is in the process of working out the underlying assets in the portfolio. The independent valuations showed a portfolio value of over $2.0 million and the expectation is that all of the principal and expenses will be recovered.
Second Quarter 2009 new non-accrual loans:
  A $9.2 million commercial participation loan became non-accrual during the second quarter of 2009. The borrower is located in Fort Lauderdale, Florida and the loan is secured by aircraft. Current appraisals of the aircraft indicated additional impairment in accordance with ASC Topic 310. As a result in the fourth quarter of 2009, the Company increased the valuation allowance $2.9 million to $4.0 million for this loan. The outstanding loan balance at December 31, 2009 was $9.0 million.
 
  A $1.1 million loan on 5 condominium units located in Philadelphia, Pennsylvania became non-accrual in the second quarter of 2009. The loan was declared in default and judgment confessed. During the fourth quarter of 2009, the Company foreclosed on the collateral for this loan. It was transferred to OREO at cost or $1.0 million.
 
  A $5.3 million loan on a commercial building located in Conshohocken, Pennsylvania became non-accrual in the second quarter of 2009. The loan is secured by a first mortgage on the property with assignment of rents and leases and a $1.0 million life insurance policy on the guarantor. The building is currently 100% leased. The Company is currently working with the borrower to bring the loan current. A current appraisal indicated impairment in accordance with ASC Topic 310. Consequently, the Company established a specific reserve of $1.2 million for this loan. As of December 31, 2009, the outstanding loan balance was $5.1 million.
 
  A $1.9 million loan for a commercial building became non-accrual in the second quarter of 2009. The loan is secured by a second mortgage with assignment of rents on a property located in Wayne, New Jersey. The current appraisal and occupancy rate indicated impairment in accordance with ASC Topic 310. As a result, the Company established a valuation allowance of $544,000 for this loan. The loan has been declared in default and has been referred for foreclosure.
 
  A $5.8 million land development loan comprised of a $5.5 million loan and a $335,000 mezzanine loan became non-accrual in the second quarter of 2009. The loan is secured by a first mortgage on vacant land in Brigantine, New Jersey. The site is approved for nine single family lots. The borrower is awaiting final approval to change the use to a 42-unit hotel condominium development. The Company declared the loan in default and confessed judgment. In the fourth quarter of 2009, the Company foreclosed on the collateral for the loan. The Company charged-off the $335,000 mezzanine loan and transferred $5.5 million to OREO.
 
  A $1.2 million loan for a hotel became non-accrual in the second quarter of 2009. The loan is secured by first mortgages on a 12-unit hotel and a commercial building in Philadelphia, Pennsylvania. In July, the borrower brought the loan current and agreed to list the property for sale.
 
  A $3.5 million loan for a commercial building became non-accrual in the second quarter of 2009. The loan is secured by a first mortgage on a commercial building located in Jamaica, New York and a $500,000 life insurance policy on the guarantor. The loan has been declared in default and foreclosure commenced. As of December 31, 2009, the outstanding loan balance was $3.3 million.
 
  A $4.6 million land development participation loan, comprised of a $4.1 million loan and a $498,000 mezzanine loan, became non-accrual in the second quarter of 2009. The project is a 114-unit townhouse development located in Millville, Delaware. Current appraisals did not indicate impairment in accordance with ASC Topic 310. In the third quarter, the Company charged-off the mezzanine loan. At December 31, 2009 the balance of the loan was $3.2 million.

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Third Quarter 2009 new non-accrual loans:
  A $3.5 million construction project in Malvern, Pennsylvania, in which the Company is a participant, became non-accrual during the third quarter of 2009. The aggregate loan balance at December 31, 2009 was approximately $69.4 million. The loan provides financing of a 1.9MM sq. ft mixed use development project. There is substantial pre-leasing of the project. However, plans for vertical take-out construction financing have not materialized, the loan has matured and a satisfactory extension has not been agreed upon. The loan has been declared in default and the lead bank is working with the borrower on a forbearance agreement. A third quarter appraisal did not indicate impairment in accordance with ASC Topic 310.
 
  An acquisition and development loan to develop a 133 unit age-restricted community in Richland Township, Pennsylvania became non-accrual during the third quarter of 2009. The borrower had contracted with a national home builder to purchase the lots upon completion of improvements under a take down agreement. As the housing market began to deteriorate, the national home builder pulled the agreement and walked away from the project. As a result, the Company approved a $2.0 million construction loan to the borrower for the purpose of constructing Townhomes and Quads on the lots designated for the national home builder. The current outstanding balance of the residential construction loans is $7.8 million. The project to date is in the process of going into a Forbearance Agreement. A fourth quarter appraisal indicated impairment in accordance with ASC Topic 310. Consequently, the Company established a specific reserve of $1.8 million for this loan.
Fourth Quarter 2009 new non-accrual loans:
  An acquisition and construction loan to build a ten-story condominium building which will contain two ground floor commercial spaces and eleven residential condominium units became non-accrual during the fourth quarter of 2009. The projected is located in New York, New York. The building will be a total of 17,713 square feet, with 14,672 of sellable space. The project is currently approximately 76% complete. The current principal balance is $3.4 million. A current appraisal indicated impairment in accordance with ASC Topic 310. Consequently, the Company established a specific reserve of $663,000 for this loan.
 
  A construction loan to develop a 36-unit condominium project located in Kill Devil Hills, North Carolina became non-accrual during the fourth quarter of 2009. The Borrower has sold 1 unit to date with numerous presale agreements falling through primarily due to end-buyers inability to secure mortgages. A default occurred in November 2009. The Company initiated legal proceedings against the Borrower and Guarantors in February 2010. Attempts to negotiate an acceptable modification or forbearance agreement have not yet been successful although discussions are continuing simultaneously to the Company pursuing its legal remedies. The current outstanding principal balance is $16.3 million of which 50% has been sold to 3rd party banks. Royal Bank is the lead bank. A current appraisal indicated impairment in accordance with ASC Topic 310. Consequently, the Company established a specific reserve of $1.2 million for this loan.
The Company identifies a loan as impaired when it is probable that interest and principal will not be collected according to the contractual term of the loan agreement. The Company recognizes income under the accrual basis when the principal payments on the loans become current and the collateral on the loan is sufficient to cover the outstanding obligation to the Company. If these factors do not exist, the Company does not recognize income.
The following is a summary of information pertaining to impaired loans and leases:
                 
    As of December 31,  
(In thousands)   2009     2008  
Impaired loans and leases with a valuation allowance
  $ 46,670     $ 69,350  
Impaired loans and leases without a valuation allowance
    27,009       16,480  
 
           
Total impaired loans and leases
  $ 73,679     $ 85,830  
 
           
Valuation allowance related to impaired loans and leases
  $ 10,958     $ 12,882  

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    For the years ended December 31,
(In thousands)   2009   2008   2007
Average investment in impaired loans and leases
  $ 79,754     $ 55,134     $ 24,741  
Interest income recognized on impaired loans and leases
  $ 242     $ 302     $ 763  
Interest income recognized on a cash basis on impaired loans and leases
  $ 242     $ 302     $ 763  
Total cash collected on impaired loans and leases during 2009, 2008, and 2007 was $21.6 million, $7.6 million, and $16.6 million, respectively, of which $21.3 million, $7.3 million, and $15.8 million was credited to the principal balance outstanding on such loans, respectively.
Potential problem loans are loans not currently classified as non-accrual loans that management has doubt as to the borrower’s ability to comply with present repayment terms. Potential problems loans were $21.4 million at December 31, 2009. Most of these loans were past due 30 days but less than 90 days.
The Company granted loans to the officers and directors of the Company and to their associates. In accordance with Regulation O related party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than normal risk of collectability. The aggregate dollar amount of these loans was $4.8 million and $4.3 million at December 31, 2009 and 2008. During 2009 there were two new loans approved totaling $650,000. Total payments received on related party loans in 2009 were $160,000.
The Company classifies its leases as capital leases, in accordance to FASB ASC Topic 840, “Leases”. The difference between the Company’s gross investment in the lease and the cost or carrying amount of the leased property, if different, is recorded as unearned income, which is amortized to income over the lease term by the interest method.
The Company’s policy for income recognition on restructured loans is to recognize income on currently performing restructured loans under the accrual method. As of December 31, 2009, the Company did not have any restructured loans.
The Company grants commercial and real estate loans, including construction and land development primarily in the greater Philadelphia metropolitan area as well as selected locations throughout the mid-Atlantic region. The Company also has participated with other financial institutions in selected construction and land development loans outside these geographic areas. The Company has a concentration of credit risk in commercial real estate, construction and land development loans at December 31, 2009. A substantial portion of its debtors’ ability to honor these contracts is dependent upon the housing sector specifically and the economy in general.
Other Real Estate Owned (“OREO”): OREO increased $20.0 million from $10.3 million at December 31, 2008 to $30.3 million at December 31, 2009. Set forth below is a table which details the changes in OREO from December 31, 2008 to December 31, 2009.
                                 
            2009        
(In thousands)   First Quarter     Second Quarter     Third Quarter     Fourth Quarter  
Beginning balance
  $ 10,346     $ 20,244     $ 29,310     $ 25,611  
Capital improvements
    711       1,626       94        
Sales
                (2,958 )     (3,625 )
Assets acquired on non-accrual loans
    9,231       7,953       720       11,252  
Other
    (44 )     37       (324 )     (165 )
Impairment charge
          (550 )     (1,231 )     (2,756 )
 
                       
Ending balance
  $ 20,244     $ 29,310     $ 25,611     $ 30,317  
 
                       

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During the first quarter of 2009, the Company acquired the collateral for three loans through, or in lieu of, foreclosure. At the time of the transfer to OREO, the Company recorded a charge-off of $867,000 through the allowance for loan and lease losses on one of the properties due to the loan balance exceeding the fair market value of the collateral. On another property during the fourth quarter of 2008, the Company recorded a charge-off of $2.3 million through the allowance for loan and lease losses and transferred the remaining balance to OREO in the first quarter of 2009. Additionally, in the second quarter of 2009, the Company established a $550,000 valuation allowance against the carrying value of an asset transferred to OREO during the first quarter of 2009. The Company had negotiated the sale of that asset and used the offered purchase price in valuing the asset. The remaining asset acquired was recorded to OREO at the carrying value of the loan, which approximated fair value.
During the second quarter of 2009, the Company acquired the collateral for four loans through, or in lieu of, foreclosure. At the time of the transfer to OREO, the Company recorded $3.8 million in charge-offs on two of the loans, for which $2.9 million had previously been reserved in the allowance for loan and lease losses in accordance with ASC Topic 310. A third loan had a $954,000 charge-off recorded against the allowance for loan and lease losses in 2008 and was transferred to OREO at the carrying value, which approximated fair value. The last loan was transferred at the carrying value, which approximated fair value.
During the third quarter of 2009, the Company acquired the collateral for one loan relationship through foreclosure. At the time of the transfer to OREO, the Company recorded a $400,000 charge-off on the loan, for which $367,000 million had previously been reserved in the allowance for loan and lease losses in accordance with ASC Topic 310. Also during the third quarter, the Company sold the collateral for a loan that was transferred to OREO in the first quarter of 2009 and recorded a $279,000 gain. In addition, the Company established valuation allowances of $869,000 and $362,000 against the carrying value of assets transferred to OREO during the second quarter of 2009 and the fourth quarter of 2008, respectively.
During the fourth quarter of 2009, the Company acquired the collateral for five loans through, or in lieu of, foreclosure. At the time of the transfer to OREO, the Company recorded $1.8 million in charge-offs on three of the loans, for which $1.2 million had previously been reserved in the allowance for loan and lease losses in accordance with ASC Topic 310. The Company charged-off the $335,000 mezzanine loan related to the fourth loan and the fifth loan was transferred at cost.
In the fourth quarter of 2009, the Company sold the collateral related to three loans which were foreclosed on prior to 2009. The first sale is related to a five building condominium project in Raleigh, North Carolina that the Company foreclosed on during the fourth quarter of 2008. In 2009, the Company completed the construction of two of the buildings. In the fourth quarter of 2009, the Company held an auction of the 51 completed condominiums. As of December 31, 2009, the Company closed on 24 of the condominiums for net proceeds of $3.1 million. As of February 25, 2010, another 16 condominiums have been sold for net proceeds of $2.0 million. In the fourth quarter of 2009, the Company recorded approximately a $2.4 million valuation allowance based on a current appraisal of the three remaining pad sites. The Company is actively marketing those three sites. The second sale in the fourth quarter of 2009 was a home located in King George, Virginia. The Company recorded net proceeds of $453,000 and recorded a $47,000 loss. The third sale was a small home in Columbus, Ohio. The Company received $7,000 in net proceeds and recorded a loss of $16,000.
Additionally, in the fourth quarter of 2009 the Company recorded valuation allowances of $157,000 and $170,000 on loans that were transferred to OREO in the first and second quarters of 2009, respectively. The $157,000 valuation allowance is based on a new appraisal of the property. The $170,000 valuation allowance is based on an agreement of sale which was executed in the fourth quarter of 2009.
The Company is working to satisfactorily sell the remaining OREO properties using existing relationships and possible future auctions. However the Company recognizes that due to the continued weak housing and commercial real estate markets the successful disposition of the properties will likely take considerable time.

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Loans and Lease Financing Receivables
The following table summarizes the loan portfolio by loan category and amount that corresponds to the appropriate regulatory definitions.
                         
    As of December 31,  
(In thousands)   2009     2008     2007  
Loans secured by real estate:
                       
Construction and land development
  $ 52,196     $ 167,204     $ 92,779  
Construction and land development — mezzanine
          2,421       6,443  
Land development
    66,878       74,168       78,874  
Secured by 1-4 family residential properties:
                       
Revolving, open-end loans secured by 1-4 family residential properties and extended under lines of credit
    1,272       1,322       2,094  
All other loans secured by 1-4 family residential properties:
                       
Secured by first liens
    44,053       21,607       32,485  
Secured by junior liens
    3,173       4,551       7,707  
Secured by junior liens — mezzaninie
    2,480              
Secured by multi family (5 or more) residential properties
    22,017       14,059       6,887  
Secured by multi family (5 or more) res. Properties — mezzanine
          335       275  
Secured by non-farm nonresidential properties
    277,234       234,573       262,550  
Secured by non-farm nonresidential properties — mezzanine
          4,111       10,778  
Tax certificates
    73,106       64,168       46,090  
Commercial and industrial loans
    104,063       86,278       77,793  
Loans to individuals for household, family, and other personal expenditures
    1,514       1,031       1,157  
Obligations of state and political subdivisions in the U.S.
          47       63  
Lease financing receivables (net of unearned income)
    39,097       26,123       19,778  
All other loans
    659       165       267  
Less: Net deferred loan fees
    (878 )     (1,441 )     (1,545 )
 
                 
Total loans and leases, net of unearned income
  $ 686,864     $ 700,722     $ 644,475  
 
                 
Credit Classification Process
The loan review function is outsourced to a third party vendor which applies the Company’s loan rating system to specific credits. The Company uses a nine point grading risk classification system commonly used in the financial services industry. The riskier classifications include Watch, Special Mention, Substandard, Doubtful and Loss. Upon completion of a loan review, a copy of any review receiving an adverse classification by the reviewer is presented to the Loan Review Committee for discussion. Minutes outlining in detail the Committee’s findings and recommendations are issued after each meeting for follow-up by individual loan officers. The Committee is comprised of the voting members of the Officers’ Loan Committee. The CCO is the primary bank officer dealing with the third party vendor during the reviews.
All loans are subject to initial loan review. Additional review is undertaken with respect to loans providing potentially greater exposure. This is accomplished by:
a.     Reviewing all loans of $1 million or more annually;
b.     Reviewing 25% of all loans from $500,000 up to $1 million annually;
c.     Reviewing 2% of all loans below $500,000 annually; and
d.     Reviewing any loan requested specifically by the Company’s management
Loans on the Company’s Special Assets Committee list are also subject to loan review even though they are receiving the daily attention of the assigned officer and monthly attention of the Special Assets Committee.

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A watch list is maintained and reviewed at each meeting of the Loan Review Committee. Loans are added to the watch list, even though current or less than 30 days delinquent if they exhibit elements of substandard creditworthiness. The watch list contains a statement for each loan as to why it merits special attention, and this list is distributed to the Board of Directors on a monthly basis. Loans may be removed from the watch list if the Loan Review Committee determines that exception items have been resolved or creditworthiness has improved. Additionally, if loans become serious collection matters and are listed on the Company’s monthly delinquent loan or Special Assets Committee lists, they may be removed from the watch list. During the third quarter of 2009, as a result of the level of classified assets within the loan portfolio, the Company established the CCIC Committee (Classified, Charge-off and Impairment Committee) to formalize the process and documentation required to classify, remove from classification, impair or charge off a loan within the Banks. The Committee, which is comprised of the President, Vice Chairman, Chief Credit Officer, Chief Lending Officer and Chief Risk Officer, meets as required and provides regular updated reports to the Board of Directors.
All loans, at the time of presentation to the appropriate loan committee, are given an initial loan “risk” rating by the CCO. From time to time, and at the general direction of any of the various loan committees, the ratings may be changed based on the findings of that committee. Items considered in assigning ratings include the financial strength of the borrower and/or guarantors, the type of collateral, the collateral lien position, the type of loan and loan structure, any potential risk inherent in the specific loan type, higher than normal monitoring of the loan or any other factor deemed appropriate by any of the various committees for changing the rating of the loan. Any such change in rating is reflected in the minutes of that committee.
Investment Securities
The following tables present the consolidated book values and approximate fair value at December 31, 2009, 2008 and 2007, respectively, for each major category of the Company’s investment securities portfolio for HTM and AFS securities.
                                         
            Included in Accumulated Other        
            Comprehensive Loss (AOCI)        
                    Gross unrealized losses        
                            Non-credit        
            Gross             related        
  Amortized     unrealized     Non-OTTI     OTTI in        
As of December 31, 2009   cost     gains     in OCI     OCI     Fair value  
(In thousands)                    
Investment securities available-for-sale
                                       
Mortgage-backed securities-residential
  $ 21,393     $ 234     $ (26 )   $     $ 21,601  
U.S. government agencies
    1,150       3       (2 )           1,151  
Preferred stocks
    2,500             (270 )           2,230  
Common stocks
    381       71       (8 )           444  
Collateralized mortgage obligations:
                                       
Issued or guaranteed by U.S. government agencies
    316,911       2,871       (1,281 )           318,501  
Non-agency
    23,010       145       (875 )     (1,082 )     21,198  
Collateralized debt obligations
    24,825                         24,825  
Corporate bonds
    7,911       9       (423 )     (630 )     6,867  
Trust preferred securities
    32,926       2,064       (177 )     (678 )     34,135  
Other securities
    7,892       8       (133 )           7,767  
 
                             
Total available for sale
  $ 438,899     $ 5,405     $ (3,195 )   $ (2,390 )   $ 438,719  
 
                             

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            Included in Accumulated Other        
            Comprehensive Loss (AOCI)        
                    Gross Unrealized Losses        
            Gross             Non-credit        
  Amortized     unrealized     Non-OTTI in     related OTTI        
As of December 31, 2008   cost     gains     AOCI     in AOCI     Fair value  
(In thousands)                    
Investment securities available-for-sale
                                       
Mortgage-backed securities-residential
  $ 53,871     $ 1,190     $     $     $ 55,061  
U.S. government agencies
    48,109       82                   48,191  
Preferred stocks
    4,000             (1,703 )           2,297  
Common stocks
    19,907       8       (7,208 )           12,707  
Collateralized mortgage obligations:
                                       
Issued or guaranteed by U.S. government agencies
    77,848       1,649       (72 )           79,425  
Non-agency
    43,711             (6,221 )           37,490  
Collateralized debt obligations
    35,000             (8,840 )           26,160  
Corporate bonds
    57,445       641       (6,748 )           51,338  
Trust preferred securities
    36,316       606       (6,778 )           30,144  
Other securities
    7,631       54       (196 )           7,489  
 
                             
Total available for sale
  $ 383,838     $ 4,230     $ (37,766 )   $     $ 350,302  
 
                             
                                                 
            Included in Accumulated Other                
            Comprehensive Loss (AOCI)                
                    Gross Unrealized Losses                
            Gross             Non-credit                
          unrealized     Non-OTTI     related OTTI             Carrying  
As of December 31, 2007   Amortized cost     gains     in AOCI     in AOCI     Fair value     value  
(In thousands)                        
Investment securities held-to-maturity
                                               
Mortgage-backed securities-residential
  $ 105     $     $     $     $ 105     $ 105  
U.S. government agencies
    80,000       13       (234 )           79,779       80,000  
Collateralized debt obligations
    60,000       1,200       (740 )           60,460       60,000  
Corporate bonds
    2,800       312                   3,112       2,800  
 
                                     
Total held-to-maturity investment securities
  $ 142,905     $ 1,525     $ (974 )   $     $ 143,456     $ 142,905  
 
                                   
 
                                               
Investment securities available-for-sale
                                               
Mortgage-backed securities-residential
  $ 33,090     $ 383     $ (187 )   $     $ 33,286          
U.S. government agencies
    104,982       51       (153 )           104,880          
Common stocks
    20,696       17       (821 )           19,892          
Collateralized mortgage obligations:
                                               
Issued or guaranteed by U.S. government agencies
    40,688       700                   41,388          
Non-agency
    41,629       265       (156 )           41,738          
Collateralized debt obligations
                                     
Corporate bonds
    86,136       523       (1,239 )           85,420          
Trust preferred securities
    44,117       2,151       (2,169 )           44,099          
Other securities
    4,625                         4,625          
 
                                   
Total available-for-sale investment securities
  $ 375,963     $ 4,090     $ (4,725 )   $     $ 375,328          
 
                                   
The contractual maturity distribution and weighted average rate of the Company’s AFS debt securities at December 31, 2009 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.

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    As of December 31, 2009  
                    After one year, but     After five years, but              
    Within one year     within five years     within ten years     After ten years     Total  
(In thousands, except percentages)   Amount     Rate     Amount     Rate     Amount     Rate     Amount     Rate     Amount     Rate  
Mortgage-backed securities-residential
  $           $ 21,601       5.31 %   $           $           $ 21,601       5.31 %
U.S. government agencies
                1,151       1.68 %                             1,151       1.68 %
Collateralized mortgage obligations:
                                                                               
Issued or guaranteed by U.S. government agencies
    22,115       5.57 %     271,233       4.65 %     25,153       4.39 %                 318,501       4.69 %
Non-agency
                19,540       5.39 %     1,658       0.65 %                 21,198       5.01 %
Collateralized debt obligations
    24,825       3.15 %                                         24,825       3.15 %
Corporate bonds
    732       0.77 %     6,135       5.58 %                             6,867       5.14 %
Trust preferred securities
                                        34,135       9.53 %     34,135       9.53 %
 
                                                           
 
Total AFS debt securities
  $ 47,672       4.24 %   $ 319,660       4.78 %   $ 26,811       4.13 %   $ 34,135       9.53 %   $ 428,278       5.02 %
 
                                                           
The Company assesses whether OTTI is present when the fair value of a security is less than its amortized cost. All investment securities are evaluated for OTTI under FASB ASC Topic 320, “Investments-Debt & Equity Securities” (“ASC Topic 320”). The non-agency collateralized mortgage obligations that are rated below AA are evaluated under FASB ASC Topic 320 Subtopic 40, “Beneficial Interests in Securitized Financial Assets” under FASB ASC Topic 325, “Investments-Other”. In determining whether OTTI exists, management considers numerous factors, including but not limited to: (1) the length of time and the extent to which the fair value is less than the amortized cost, (2) the Company’s intent to hold or sell the security, (3) the financial condition and results of the issuer including changes in capital, (4) the credit rating of the issuer, (5) analysts earnings estimate, (6) industry trends specific to the security, and (7) timing of debt maturity and status of debt payments.
At December 31, 2009 investment securities were $438.7 million with a net unrealized loss of $180,000 compared to $350.3 million with a net unrealized loss of $33.4 million at December 31, 2008. The improvement in gross unrealized losses is related to $11.0 million in impairment charges recorded in earnings in 2009 and to the overall improvement in the fair values of the securities in the Company’s investment portfolio. The gross unrealized losses have improved significantly in the last two quarters as the financial markets have begun to recover. Refer to “Note 3- Investment Securities” to the Consolidated Financial Statements in Item 8 for more information.
Deposits
The average balance of the Company’s deposits by major classifications for each of the last three years is presented in the following table.
                                                 
    As of December 31,  
    2009     2008     2007  
    Average             Average             Average        
(In thousands, except percentages)   Balance     Rate     Balance     Rate     Balance     Rate  
Demand deposits
                                               
Non interest bearing
  $ 62,546           $ 57,211           $ 68,562        
Interest bearing (NOW)
    46,046       1.04 %     48,414       1.85 %     52,975       2.24 %
Money market deposits
    153,146       1.83 %     168,972       2.93 %     199,921       4.24 %
Savings deposits
    14,802       0.56 %     15,125       0.50 %     16,461       0.52 %
Certificate of deposit
    581,202       3.78 %     434,662       4.49 %     531,965       5.15 %
 
                                         
Total deposits
  $ 857,742             $ 724,384             $ 869,884          
 
                                         

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The remaining maturity of Certificates of Deposit of $100,000 or greater:
                 
    As of December 31,  
    2009     2008  
Three months or less
  $ 19,960     $ 12,575  
Over three months through twelve months
    78,985       68,825  
Over twelve months through five years
    40,790       24,623  
Over five years
    1,917       1,760  
 
           
Total
  $ 141,652     $ 107,783  
 
           
Short and Long Term Borrowings
                                         
    For the years ended December 31,  
(In thousands)   2009     2008     2007     2006     2005  
Short term borrowings
  $ 114,500     $ 37,000     $ 102,000     $ 53,000     $ 104,500  
Long term borrowings
                                       
Other borrowings
    44,674       45,112       5,411       5,587        
Obligations through RE owned via equity invest(1)
    3,652       12,350       18,566       29,342       47,356  
Subordinated debt
    25,774       25,774       25,774       25,774       25,774  
FHLB advances
    95,001       193,569       187,500       187,500       249,500  
 
                             
Total borrowings
  $ 283,601     $ 313,805     $ 339,251     $ 301,203     $ 427,130  
 
                             
 
(1)   This obligation is consolidated from requirements under ASC Topic 810 of which $0 is guaranteed by the Company.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
A simulation model is used to estimate the impact of various changes, both upward and downward, in market interest rates and volumes of assets and liabilities on the net income. This model produces an interest rate exposure report that forecast changes in the market value of portfolio equity under alternative interest rate environment. The market value of portfolio is defined as the present value of existing assets and liabilities. The calculated estimates of changes in the market value of portfolio value are as follows:
                 
    As of December 31, 2009
(In thousands, except percentages)   Market Value of   Percent of
Changes in Rates   Portfolio Equity   Change
+ 200 basis points
  $ 79,554       (21.56 %)
+ 100 basis points
    92,611       (8.69 %)
Flat rate
    101,423       0.00 %
- 100 basis points
    103,343       1.89 %
- 200 basis points
    103,555       2.10 %
The assumptions used in evaluating the vulnerability of earnings and capital to changes in interest rates are based on management’s considerations of past experience, current position and anticipated future economic conditions. The interest rate sensitivity of assets and liabilities as well as the estimated effect of changes in interest rates on the market value of portfolio equity could vary substantially if different assumptions are used or actual experience differs from what the calculations may be based.

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Critical Accounting Policies, Judgments and Estimates
The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and general practices within the financial services industry. Critical accounting policies, judgments and estimates relate to investment securities, loans, allowance for loan and lease losses and deferred tax assets. The policies which significantly affect the determination of the Company’s financial position, results of operations and cash flows are summarized in “Note 1 — Summary of Significant Accounting Polices” to the Consolidated Financial Statements and are discussed in the section captioned “Recent Accounting Pronouncements” of Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in Items 7 and 8 of this Report, each of which is incorporated herein by reference.
Investment Securities
Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each balance sheet date.
Investments in debt securities that the Company has the positive intent and ability to hold to maturity are classified as held to maturity securities and reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized holding gains and losses included in earnings. Debt and equity securities not classified as trading securities, nor as held to maturity securities are classified as available for sale securities and reported at fair value, with unrealized holding gains or losses, net of deferred income taxes, reported in the accumulated other comprehensive income component of shareholders’ equity. The Company held no trading securities at December 31, 2009 and 2008. 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.
FASB recently issued accounting guidance related to the recognition and presentation of other-than-temporary impairment, which the Company adopted effective June 30, 2009 (“Pending Content” of FASB ASC 320-1). This recent accounting guidance amends the recognition guidance for other-than-temporary impairments of debt securities and expands the financial statement disclosures for other-than-temporary impairment losses on debt and equity securities. The recent guidance replaced the “intent and ability” indication in current guidance by specifying that (a) if a company does not have the intent to sell a debt security prior to recovery and, (b) it is more likely than not that it will not have to sell the debt security prior to recovery, the security would not be considered other-than-temporarily impaired unless there is a credit loss.
When an entity does not intend to sell the security, and it is more likely than not, the entity will not have to sell the security before recovery of its cost basis, it will recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. For held-to-maturity debt securities, the amount of an other-than-temporary impairment recorded in other comprehensive income for the noncredit portion of a previous other-than-temporary impairment should be amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security.
Prior to the adoption of the recent accounting guidance on June 30, 2009, management considered, in determining whether other-than-temporary impairment exists (1) the length of time and the extent to which the fair value has been less than amortized cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain the investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
For more information on the fair value of the Company’s investment securities and other financial instruments refer to “Note 3 — Investment Securities” and “Note 19 - Fair Values of Financial Instruments” to the Consolidated Financial Statements included in Item 8 of this Report.
Allowance for Loan and Lease Losses
The Company considers that the determination of the allowance for loan and lease losses involves a higher degree of judgment and complexity than its other significant accounting policies. The allowance for loan and lease losses is

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calculated with the objective of maintaining a reserve level believed by management to be sufficient to absorb estimated credit losses. Management’s determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective as it requires material estimates, including, among others, expected default probabilities, loss given default, expected commitment usage, the amounts of timing of expected future cash flows on impaired loans, mortgages, and general amounts for historical loss experience. The process also considers economic conditions, uncertainties in estimating losses and inherent risks in the loan portfolio. All of these factors may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provisions for loan and lease losses may be required that would adversely impact earnings in future periods. See “Note 1 — Summary of Significant Accounting Policies” to the Consolidated Financial Statements included in Item 8 of this report.
Deferred Tax Assets
The Company recognizes deferred tax assets and liabilities for the future tax effects of temporary differences, net operating loss carry forwards and tax credits. Deferred tax assets are subject to management’s judgment based upon available evidence that future realization is more likely than not. If management determines that the Company may be unable to realize all or part of net deferred tax assets in the future, a direct charge to income tax expense may be required to reduce the recorded value of the net deferred tax asset to the expected realizable amount.
RECENT ACCOUNTING PRONOUNCEMENTS
See “Note 1 — Summary Of Significant Accounting Policies” to the Consolidated Financial Statements included in Item 8 of this Report.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FINANCIAL STATEMENTS AND REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
December 31, 2009 and 2008

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Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders
Royal Bancshares of Pennsylvania, Inc.
     We have audited the accompanying consolidated balance sheets of Royal Bancshares of Pennsylvania, Inc. and subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of operations, changes in shareholders’ equity and comprehensive loss, and cash flows for each of the years in the three-year period ended December 31, 2009. Royal Bancshares of Pennsylvania, Inc.’s management is responsible for these financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
     We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. 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 as of December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America.
/s/ ParenteBeard LLC
ParenteBeard LLC
Malvern, Pennsylvania
March 29, 2010

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ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
                 
    December 31,  
ASSETS   2009     2008  
    (In thousands, except share data)  
Cash and due from banks
  $ 25,289     $ 5,910  
Interest bearing deposits
    33,009       7,349  
Federal funds sold
          1,000  
 
           
Total cash and cash equivalents
    58,298       14,259  
 
Investment securities available-for-sale (“AFS”) at fair value
    438,719       350,302  
Federal Home Loan Bank (“FHLB”) stock, at cost
    10,952       10,952  
 
           
Total investment securities and FHLB stock
    449,671       361,254  
 
               
Loans and leases held for sale
    2,254       267  
 
Loans and leases
    686,864       700,722  
Less allowance for loan and lease losses
    30,331       28,908  
 
           
Net loans and leases
    656,533       671,814  
 
Bank owned life insurance
    8,263       30,016  
Real estate owned via equity investment
    12,492       18,927  
Accrued interest receivable
    14,942       13,580  
Other real estate owned (“OREO”), net
    30,317       10,346  
Premises and equipment, net
    6,306       6,926  
Investment in real estate joint ventures
    2,520       2,520  
Other assets
    51,130       45,677  
 
           
Total assets
  $ 1,292,726     $ 1,175,586  
 
           
 
               
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
Liabilities
               
Deposits
               
Non-interest bearing
  $ 63,168     $ 50,886  
Interest bearing
    818,587       709,182  
 
           
Total deposits
    881,755       760,068  
 
               
Accrued interest payable
    6,150       6,102  
Short-term borrowings
    114,500       22,000  
Long-term borrowings
    139,675       253,681  
Obligations related to real estate owned via equity investment
    3,652       12,350  
Subordinated debentures
    25,774       25,774  
Other liabilities
    16,906       14,026  
 
           
Total liabilities
    1,188,412       1,094,001  
 
Shareholders’ equity
               
Royal Bancshares of Pennsylvania, Inc. equity:
               
Preferred stock, Series A perpetual, $1,000 liquidation value, 500,000 shares authorized, 30,407 shares issued and outstanding at December 31, 2009 and 0 shares at December 31, 2008
    27,945        
Common stock
               
Class A, par value $2.00 per share, authorized 18,000,000 shares; issued, 11,352,482 and 11,345,127 at December 31, 2009 and 2008, respectively
    22,705       22,690  
Class B, par value $0.10 per share, authorized 3,000,0000 shares; issued, 2,089,284 and 2,095,681 at December 31, 2009 and 2008, respectively
    209       210  
Additional paid in capital
    126,117       123,425  
Accumulated deficit
    (67,197 )     (33,561 )
Accumulated other comprehensive loss
    (1,652 )     (26,106 )
Treasury stock — at cost, shares of Class A, 498,488 at December 31, 2009 and 2008, respectively
    (6,971 )     (6,971 )
 
           
 
Total Royal Bancshares of Pennsylvania, Inc. shareholders’ equity
    101,156       79,687  
Noncontrolling interest
    3,158       1,898  
Total shareholders’ equity
    104,314       81,585  
 
           
Total liabilities and shareholders’ equity
  $ 1,292,726     $ 1,175,586  
 
           
The accompanying notes are an integral part of these consolidated financial statements.

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Consolidated Statements of Operations
                         
    Year ended December 31,  
    2009     2008     2007  
    (In thousands, except per share data)  
Interest income
                       
Loans and leases, including fees
  $ 45,757     $ 49,863     $ 56,518  
Investment securities held to maturity, taxable
          3,241       10,032  
Investment securities available for sale:
                       
Taxable interest
    20,102       19,066       18,068  
Tax exempt interest
    19       75       75  
Deposits in banks
    164       495       1,896  
Federal funds sold
    1       24       147  
 
                 
Total Interest Income
    66,043       72,764       86,736  
 
                 
 
Interest expense
                       
Deposits
    25,342       25,414       37,140  
Short-term borrowings
    169       674       530  
Long-term borrowings
    11,685       11,770       10,580  
Obligations related to real estate owned via equity investments
    243       251       623  
 
                 
Total Interest Expense
    37,439       38,109       48,873  
 
                 
 
Net Interest Income
    28,604       34,655       37,863  
Provision for loan and lease losses
    20,605       21,841       13,026  
 
                 
 
Net Interest Income after Provision for Loan and Lease Losses
    7,999       12,814       24,837  
 
                 
 
Other (loss) income
                       
Gains on sales of premises and equipment
          1,991        
Gains on sale of premises and equipment related to real estate owned via equity investments
    1,817       1,679       1,860  
Income from bank owned life insurance
    1,099       1,233       875  
Service charges and fees
    1,419       1,186       1,348  
Gains on sales related to real estate joint ventures
          1,092       350  
Income related to real estate owned via equity investments
    1,302       965       1,384  
Gains on sales of other real estate owned
    294       429       1,111  
Gains on sales of loans and leases
    914       190       404  
Net gains (losses) on investment securities available for sale
    1,892       (1,313 )     5,358  
Other income
    578       148       198  
 
                 
Other income,excluding other than temporary impairment losses
    9,315       7,600       12,888  
 
                 
Total other than temporary impairment losses on investment securities
    (13,431 )     (23,388 )      
Portion of loss recognized in other comprehensive loss
    2,390              
 
                 
Net impairment losses recognized in earnings
    (11,041 )     (23,388 )      
 
                 
Total Other (Loss) Income
    (1,726 )     (15,788 )     12,888  
 
                 
Other expenses
                       
Employee salaries and benefits
    12,235       15,044       12,215  
Professional and legal fees
    4,367       3,783       1,997  
Occupancy and equipment
    3,381       2,860       2,506  
Impairment of real estate owned via equity investments
          1,500       8,500  
Pennsylvania shares tax
    1,299       1,369       1,158  
Expenses related to real estate owned via equity investments
    907       966       1,590  
Stock option expense
    226       703       657  
Directors fees
    676       675       643  
Impairment of real estate joint venture
                5,927  
FDIC and state assessments
    3,801       658       235  
OREO impairment charge
    4,537              
OREO and loan collection expenses
    3,218       188        
Other operating expenses
    3,009       4,787       5,907  
 
                 
Total Other Expenses
    37,656       32,533       41,335  
 
                 
 
Loss Before Income Tax
    (31,383 )     (35,507 )     (2,307 )
 
Income tax expense (benefit)
    474       2,643       (1,568 )
 
                 
 
Net Loss
  $ (31,857 )   $ (38,150 )   $ (739 )
 
                 
 
Less net income (loss) attributable to noncontrolling interest
    1,402       (68 )     (1,303 )
 
                 
 
Net (loss) income attributable to Royal Bancshares of Pennsylvania, Inc.
  $ (33,259 )   $ (38,082 )   $ 564  
 
Less Preferred stock Series A accumulated dividend and accretion
  $ 1,672     $     $  
 
Net (loss) income available to common shareholders
  $ (34,931 )   $ (38,082 )   $ 564  
 
Per common share data
                       
Net (loss) income — basic
  $ (2.64 )   $ (2.86 )   $ 0.04  
 
                 
Net (loss) income — diluted
  $ (2.64 )   $ (2.86 )   $ 0.04  
 
                 
Cash dividends- Class A shares
  $     $ 0.30     $ 1.15  
 
                 
Cash dividends- Class B shares
  $     $ 0.35     $ 1.32  
 
                 
The accompanying notes are an integral part of these consolidated financial statements.

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

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

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Consolidated Statement of Changes in Shareholders’ Equity and Comprehensive Loss
For the year ended December 31, 2007
                                                                                         
                                                            Accumulated                        
                                            Additional             other                     Total  
    Preferred stock     Class A common stock     Class B common stock     paid in     Retained     comprehensive     Treasury     Noncontrolling     Shareholders’  
(In thousands, except dividend per share data)   Series A     Shares     Amount     Shares     Amount     capital     earnings     loss     stock     Interest     Equity  
     
Balance, January 1, 2007
  $       11,287     $ 22,575       2,108     $ 211     $ 121,542     $ 23,464     $ (2,273 )   $ (2,265 )   $ 3,170     $ 166,424  
Comprehensive loss
                                                                                       
Net income (loss)
                                                    564                       (1,303 )     (739 )
Adjustment related to adoption of FASB No. 158, net of taxes
                                                            1,006                       1,006  
Other comprehensive loss, net of reclassifications and taxes
                                                            (315 )                     (315 )
 
                                                                                     
Total comprehensive loss
                                                                                  $ (48 )
 
                                                                                     
Common stock conversion from Class B to Class A
            14       28       (12 )     (1 )             (27 )                              
Cash in lieu of fractional shares
                                                    (14 )                             (14 )
Stock dividend adjustment
                            1               (13 )     13                                
Stock options exercised
            28       56                       278                                       334  
Stock option expense
                                            657                                       657  
Tax benefit stock options
                                            114                                       114  
Purchase of treasury stock (183 shares)
                                                                    (3,760 )             (3,760 )
Cash dividends on common stock
                                                                                     
(Class A $1.15, Class B $1.3225)
                                                    (15,473 )                             (15,473 )
     
Balance, December 31, 2007
  $       11,329     $ 22,659       2,097     $ 210     $ 122,578     $ 8,527     $ (1,582 )   $ (6,025 )   $ 1,867     $ 148,234  
     
The accompanying notes are an integral part of these consolidated financial statements.

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Consolidated Statements of Cash Flows
                         
    Year ended December 31,  
(In thousands)   2009     2008     2007  
Cash flows from operating activities
                       
Net loss
  $ (31,857 )   $ (38,150 )   $ (739 )
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
                       
Depreciation and amortization
    907       1,059       1,306  
Net (income) loss attributable to noncontrolling interest
    (1,402 )     68       1,303  
Stock compensation expense
    226       703       657  
Impairment charge for other real estate owned
    4,537              
Provision for loan and lease losses
    20,605       21,841       13,026  
Net amortization (accretion) of discounts and premiums on loans, mortgage-backed securities and investments
    518       (2,242 )     (2,793 )
(Benefit) provision for deferred income taxes
    (174 )     10,462       (4,118 )
Gains on sales of other real estate owned
    (294 )     (429 )     (1,111 )
Gain on sales of real estate joint ventures
          (1,092 )     (350 )
Proceeds from sales of loans and leases
    10,844       2,613        
Gains on sales of premises and equipment
          (1,991 )      
Gains on sales of loans and leases
    (914 )     (190 )     (404 )
Net (gains) losses on sales of investment securities
    (1,892 )     1,313       (5,358 )
Distributions from investments in real estate
    (200 )     (241 )     (167 )
Gain from sale of premises of real estate owned via equity investment
    (1,817 )     (1,679 )     (1,860 )
Impairment of real estate owned via equity investments
          1,500       8,500  
Impairment of available-for-sale investment securities
    11,041       23,388        
Income from bank owned life insurance
    (1,099 )     (1,233 )     (875 )
Impairment of real estate joint venture
                5,927  
Changes in assets and liabilities:
                       
(Increase) decrease in accrued interest receivable
    (1,362 )     1,676       1,238  
Increase in other assets
    (5,225 )     (10,766 )     (2,766 )
Increase (decrease) in accrued interest payable
    48       (2,498 )     (2,054 )
Increase (decrease) in other liabilities
    5,292       3,364       (5,518 )
 
                 
Net cash provided by operating activities
    7,782       7,476       3,844  
 
                 
 
Cash flows from investing activities
                       
Proceeds from calls/maturities of held-to-maturity investment securities
          105,265       115,024  
Proceeds from calls/maturities of investment securities available for sale
    148,268       169,901       105,041  
Purchases of investment securities held to maturity
                (2,500 )
Proceeds from sales of investment securities available for sale
    184,226       15,775       20,773  
Purchase of investment securities available for sale
    (398,312 )     (179,257 )     (194,839 )
Redemption (purchase) Federal Home Loan Bank stock
          2,510       (2,186 )
Net increase in loans
    (49,260 )     (81,207 )     (57,524 )
Capital improvements to foreclosed assets
    (2,431 )            
Proceeds from sale of foreclosed assets
    7,877       1,186       2,174  
Proceeds from sale of premises and equipment
          2,065        
Purchase of premises and equipment
    (287 )     (692 )     (728 )
Purchase of life insurance
          (5,000 )      
Proceeds from surrender of life insurance
    22,628              
Net proceeds from sale of premises of real estate owned via equity investments
    11,354       9,064       19,368  
Distributions from real estate owned via equity investments
    200       241       167  
Net decrease (increase) in real estate joint ventures
          5,219       (2,572 )
Net decrease in real estate owned via equity investments
    (9,537 )     (8,885 )     (7,451 )
 
                 
Net cash (used in) provided by investing activities
    (85,274 )     36,185       (5,253 )
 
                 

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ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Continued)
                         
    Year ended December 31,  
    2009     2008     2007  
Cash flows from financing activities:
                       
Increase (decrease) in non-interest bearing and interest bearing demand deposits and savings accounts
    32,719       (65,443 )     (29,009 )
Increase (decrease) in certificates of deposit
    88,968       55,359       (60,296 )
Principal payments on mortgage
                (67 )
Net (decrease) increase in short-term borrowings
          (80,000 )     49,000  
Proceeds from long-term borrowings
          65,000        
Repayments of long-term borrowings
    (21,506 )     (4,230 )     (175 )
Repayment of mortgage debt of real estate owned via equity investments
    (8,698 )     (6,216 )     (10,776 )
Income tax benefit on stock options
                114  
Proceeds from the issuance of preferred stock
    30,407              
Cash dividends paid
    (359 )     (4,005 )     (15,473 )
Cash in lieu of fractional shares
                (14 )
Purchase of treasury stock
          (946 )     (3,760 )
Issuance of common stock under stock option plans
          174       334  
 
                 
Net cash (used in) provided by financing activities
    121,531       (40,307 )     (70,122 )
 
                       
Net increase (decrease) in cash and cash equivalents
    44,039       3,354       (71,531 )
 
                       
Cash and cash equivalents at beginning of period
    14,259       10,905       82,436  
 
                 
 
Cash and cash equivalents at end of period
  $ 58,298     $ 14,259     $ 10,905  
 
                 
 
                       
Supplemental Disclosure Interest
  $ 37,391     $ 40,607     $ 50,927  
 
                 
 
                       
Income taxes
  $     $     $ 6,814  
 
                 
 
                       
Transfers to other real estate owned
  $ 29,660     $ 10,055     $ 1,188  
 
                 
The accompanying notes are an integral part of these consolidated financial statements.

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ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
1. Basis of Financial Statement Presentation
Nature of Operations
Royal Bancshares of Pennsylvania, Inc. (the “Company”), through its wholly owned subsidiaries Royal Bank America (“Royal Bank”) and Royal Asian Bank (“Royal Asian”), (collectively referred to as the “Banks”), offers a full range of banking services to individual and corporate customers primarily located in the Mid-Atlantic states. The Banks compete 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 both Banks with respect to one or more of the services it renders.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Royal Investments of Delaware, Inc., Royal Captive Insurance Company, Royal Preferred, LLC, Royal Asian (effective July 17, 2006) and Royal Bank, including Royal Bank’s subsidiaries, Royal Real Estate of Pennsylvania, Inc., Royal Investment America, LLC, RBA Property LLC, Narberth Property Acquisition LLC, Rio Marina LLC, and the following which are owned 60% by Royal Bank: Royal Bank America Leasing, LP, RBA Capital, LP, Crusader Servicing Corporation and Royal Tax Lien Services, LLC. Royal Bank owned 60% of RBA ABL Group, LP which ceased operations in 2008. Both of the Company’s Trusts are not consolidated as further discussed below in “Variable Interest Entities”. All significant intercompany transactions and balances have been eliminated.
Use of Estimates
In preparing the consolidated financial statements in accordance with GAAP, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenditures for the period. Therefore, actual results could differ significantly from those estimates.
The principal estimates that are particularly susceptible to significant change in the near term relate to the allowance for loan and lease losses, the valuation of deferred tax assets, real estate owned via equity investments, investment in real estate joint ventures, and other than temporary impairment losses on investment securities. In connection with the allowance for loan and lease losses estimate, when circumstances warrant, management obtains independent appraisals for significant properties. However, future changes in real estate market conditions and the economy could affect the Company’s allowance for loan and lease losses. In addition, regulatory agencies, as an integral part of their examination process, periodically review the credit portfolio and the allowance. Such review may result in additional provisions based on their judgment of information available at the time of each examination.
Significant Concentration of Credit Risk
Most of the Company’s activities are with customers located within the Mid-Atlantic region of the country. “Note 3 — Investment Securities” to the Consolidated Financial Statements discusses the types of securities in which the Company invests. “Note 4 — Loans and Leases” to the Consolidated Financial Statements discusses the types of lending in which the Company engages. The Company does not have any portion of its business dependent on a single or limited number of customers, the loss of which would have a material adverse effect on its business. The Company has 78% of its investment portfolio in securities issued by government sponsored entities.

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ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES — Continued
No substantial portion of loans is concentrated within a single industry or group of related industries, except a significant majority of loans are secured by real estate. There are numerous risks associated with commercial and consumer lending that could impact the borrower’s ability to repay on a timely basis. They include, but are not limited to: the owner’s business expertise, changes in local, national, and in some cases international economies, competition, governmental regulation, and the general financial stability of the borrowing entity. The Company has seen a deterioration in economic conditions as it pertains to real estate loans. Construction and land loans, non-residential and residential real estate loans represent 33%, 27% and 20%, respectively of the $73.7 million in non-accrual loans at December 31, 2009.
The Company attempts to mitigate these risks by making an analysis of the borrower’s business and industry history, its financial position, as well as that of the business owner. The Company will also require the borrower to provide financial information on the operation of the business periodically over the life of the loan. In addition, most commercial loans are secured by assets of the business or those of the business owner, which can be liquidated if the borrower defaults, along with the personal surety of the business owner.
Variable Interest Entities (“VIE”)
Real estate owned via equity investments: The Company, together with third party real estate development companies, forms variable interest entities (“VIEs”) to construct various real estate development projects. These VIEs account for acquisition, development and construction costs of the real estate development projects in accordance with FASB ASC Topic 970, “Real Estate-General”, and account for capitalized interest on those projects in accordance with FASB ASC Topic 835, “Interest”. Due to the present economic conditions, management has made a decision to curtail new equity investments.
In accordance with ASC Topic 976, the full accrual method is used to recognize profit on real estate sales. Profits on the sales of this real estate are recorded when cash in excess of the amount of the original investment is received, and calculation of same is made in accordance with the terms of the partnership agreement, the Company is no longer obligated to perform significant activities after the sale to earn profits, there is no continuing involvement with the property and; finally, the usual risks and rewards of ownership in the transaction had passed to the acquirer.
At December 31, 2009, the Company had one VIE which is consolidated into the Company’s financial statements. This VIE met the requirements for consolidation under FASB ASC Topic 810, “Consolidation” (“ASC Topic 810”) based on Royal Investments America being the primary financial beneficiary. This was determined based on the amount invested by Royal Investments America compared to the Company’s partners. In September 2005, the Company, together with a real estate development company, formed a limited partnership. Royal Investments America is a limited partner in the partnership (the “Partnership”). The Partnership was formed to convert an apartment complex into condominiums. The development company is the general partner of the Partnership. The Company invested 66% of the initial capital contribution, or $2.5 million, with the development company investing the remaining equity of $1.3 million. The Company is entitled to earn a preferred return on the $2.5 million capital contribution. In addition, the Company made two mezzanine loans totaling $9.2 million at market terms and interest rates. Royal Bank loaned $814,000 to the Partnership during the fourth quarter of 2009 and is obligated to fund up to $2.7 million if required for the remaining costs associated with capital improvements, operating and marketing expenses. As of December 31, 2009, the Partnership also had $3.7 million outstanding of senior debt with another bank. Upon the repayment of the mezzanine loan interest and principal and the initial capital contributions and preferred return, the Company and the development company will both receive 50% of the remaining distribution, if any.
In accordance with ASC Topic 360, the Partnership assesses the recoverability of fixed assets based on estimated future operating cash flows. The Company had recognized $10 million in impairment charges related to this asset through December 31, 2008. No further impairment of this asset occurred in 2009. The measurement and recognition of the impairment was based on estimated future discounted operating cash flows.

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ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES — Continued
At December 31, 2009, the Partnership had total assets of $14.9 million of which $12.5 million is real estate as reflected on the consolidated balance sheet and total borrowings of $13.7 million, of which $10.0 million relates to the Company’s loans discussed above. None of the third party borrowings are guaranteed by the Company. The Company has made an investment of $12.5 million in this Partnership ($2.5 million capital contribution and $10.0 million of loans). The impairments mentioned above have contributed to an overall reduction in the Company’s investment. At December 31, 2009, the remaining amount of the investment in and receivables due from the Partnership totaled $9.2 million.
On August 13, 2009, the Company received a Senior Loan Default Notice from the Senior Lender as a result of the Partnership not making the required repayment by July 9, 2009. The Company signed a forbearance agreement and an intercreditor agreement between the Company and the Senior Lender on October 23, 2009 which extended the loan until December 9, 2010. As part of the agreement to extend the loan for 14 months, the senior debt lender required the Partnership to provide additional funds to cover current and potential future cash requirements for capital improvements, operating expenses and marketing costs. Royal Bank loaned $814,000 to the Partnership during the fourth quarter of 2009 and is obligated to fund up to $2.7 million if required for the remaining costs associated with capital improvements, operating and marketing expenses. The initial loan amount and any additional funds loaned to the Partnership will be repaid from the cash flow after the senior debt is paid in full, but prior to any other payments to partners. On October 25, 2009 the senior debt lender filed for bankruptcy protection, which has not impacted the relationship between the Partnership and the senior debt lender.
Trust Preferred Securities: Royal Bancshares Capital Trust I/II (“Trusts”) issued mandatory redeemable preferred stock to investors and loaned the proceeds to the Company. The Trusts hold, as their sole asset, subordinated debentures issued by the Company in 2004. The Company does not consolidate the Trusts as ASC Topic 810 precludes consideration of the call option embedded in the preferred stock when determining if the Company has the right to a majority of the Trusts expected returns. The non-consolidation results in the investment in common stock of the Trusts to be included in other assets with a corresponding increase in outstanding debt of $774,000. In addition, the income received on the Company’s common stock investments is included in other income. The Federal Reserve Bank has issued final guidance on the regulatory treatment for the trust-preferred securities issued by the Trusts as a result of the adoption of ASC Topic 810. The final rule would retain the current maximum percentage of total capital permitted for trust preferred securities at 25%, but would enact other changes to the rules governing trust preferred securities that affect their use as a part of the collection of entities known as “restricted core capital elements.” The final adoption of the rule has delayed the effective date until March 31, 2011. Management is evaluating the effects of the final rule and does not anticipate a material impact on its capital ratios. Refer to “Note 9 — Borrowings and Subordinated Debentures” to the Consolidated Financial Statements for more information.
Reclassifications
The Company reviewed the financial reporting of its real estate acquisition, development and construction (“ADC”) loans during 2007. As a result of this review, the Company determined that three ADC loans totaling $13.2 million should have been accounted for as investments in real estate joint ventures in accordance with ASC Topic 310 and ASC Topic 976. An investment in a real estate joint venture of this nature is distinguished from an equity investment in real estate by the fact that the Company is not a party to an operating agreement and has no legal ownership of the entity that owns the real estate. One investment in the amount of $4.7 million was to fund the purchase of property for construction of an office and residential building. This investment paid off during the second quarter of 2008 and resulted in a gain on sales related to real estate joint ventures of $1.1 million. A second investment for $6.0 million was to fund the construction of a 55 unit condominium building. This investment was impaired for its full amount during the third quarter of 2007 and was charged to operating expenses. The third investment in the amount of $2.5 million was to fund the acquisition of a marina project which amounts to the total investments in real estate joint ventures as of December 31, 2009 and 2008.
In addition, certain other reclassifications have been made in the Consolidated Financial Statements for 2008 and 2007 to conform to the classifications in 2009. These reclassifications had no effect on net income (loss).

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ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES — Continued
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 the Company has the positive intent and ability to hold to maturity are classified as held to maturity securities and reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized holding gains and losses included in earnings. Debt and equity securities not classified as trading securities, nor as held to maturity securities are classified as available for sale securities and reported at fair value, with unrealized holding gains or losses, net of deferred income taxes (when applicable), reported in the accumulated other comprehensive income component of shareholders’ equity. The Company held no trading securities at December 31, 2009 and 2008. 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.
FASB recently issued accounting guidance related to the recognition and presentation of other-than-temporary impairment, which the Company adopted effective June 30, 2009 (“Pending Content” of FASB ASC 320-1). This recent accounting guidance amends the recognition guidance for other-than-temporary impairments of debt securities and expands the financial statement disclosures for other-than-temporary impairment losses on debt and equity securities. The recent guidance replaced the “intent and ability” indication in current guidance by specifying that (a) if a company does not have the intent to sell a debt security prior to recovery and, (b) it is more likely than not that it will not have to sell the debt security prior to recovery, the security would not be considered other-than-temporarily impaired unless there is a credit loss.
When an entity does not intend to sell the security, and it is more likely than not, the entity will not have to sell the security before recovery of its cost basis, it will recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. For held-to-maturity debt securities, the amount of an other-than-temporary impairment recorded in other comprehensive income for the noncredit portion of a previous other-than-temporary impairment should be amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security.
Prior to the adoption of the recent accounting guidance on June 30, 2009, management considered, in determining whether other-than-temporary impairment exists (1) the length of time and the extent to which the fair value has been less than amortized cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain the investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
On September 26, 2008 the Company reclassified the remainder of its HTM investment securities to AFS. The transferred investment securities had a total book value of $37.6 million and a fair value of $34.7 million. The unrealized loss of $2.9 million on these securities was recorded, net of tax, as other comprehensive loss, an adjustment to shareholders’ equity. As a result per ASC Topic 320, the Company will not classify any future purchases of investment securities as HTM for at least one more year.

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ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES — Continued
Federal Home Loan Bank Stock
As a member of the Federal Home Loan Bank of Pittsburgh (“FHLB”), the Company is 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, 2009 and 2008, FHLB stock totaled $11.0 million.
In December 2008, the FHLB voluntarily suspended dividend payments on its stock, as well as the repurchase of excess stock from members. The FHLB cited a significant reduction in the level of core earnings resulting from lower short-term interest rates, the increased cost of liquidity, and constrained access to the debt markets at attractive rates and maturities as the main reasons for the decision to suspend dividends and the repurchase of excess capital stock. The FHLB last paid a dividend in the third quarter of 2008.
FHLB stock is held as a long-term investment and its value is determined based on the ultimate recoverability of the par value. The Company evaluates 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. On February 22, 2010, the FHLB filed an 8-K to report their results for the year ended December 31, 2009. For the year ended December 31, 2009, the FHLB had a net loss of $37.4 million compared to net income of $19.4 million for the year ended December 31, 2008 primarily related to credit-related losses on their mortgage-backed securities portfolio. At December 31, 2009, GAAP capital was $3.7 billion as compared to a $4.1 billion at December 31, 2008. The FHLB was in compliance with its risk-based, total and leverage capital requirements at December 31, 2009. The FHLB previously announced that it is updating its capital restoration plan. The FHLB has the capacity to issue additional debt if necessary to raise cash. If needed, the FHLB also has the ability to secure funding available to GSEs through the U.S. Treasury. 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 recovered. Accordingly, there is no other-than-temporary impairment related to the carrying amount of the Company’s FHLB stock as of December 31, 2009. Further deterioration of the FHLB’s capital levels may require the Company to deem its restricted investment in FHLB stock to be other-than-temporarily impaired.
Loans and Leases and Allowance for Loan and Lease Losses
The Company’s loan and lease portfolio (the “credit portfolio”) is subject to varying degrees of credit risk. The Company maintains an allowance for loan and lease losses (the “allowance”) to absorb possible losses in the loan and lease portfo