UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)


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

for the quarterly period ended: March 31, 2017


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

For the transition period from: to

Commission file number: 0-26366

ROYAL BANCSHARES OF PENNSYLVANIA, INC.

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


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

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

(Address of principal Executive Offices)

(610) 668-4700

(Registrant’s telephone number, including area code)

N/A

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

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

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

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


Large accelerated filer ☐	Accelerated filer ☐	Non-accelerated filer ☐ (do not check if a smaller reporting company)
Smaller reporting company ☒		Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

Applicable only to corporate issuers:

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


Class A Common Stock		Outstanding at April 30, 2017
$2.00 par value		27,913,024


Class B Common Stock		Outstanding at April 30, 2017
$0.10 par value		1,924,629

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TABLE OF CONTENTS

		PAGE
PART I	FINANCIAL STATEMENTS
Item 1	Financial Statements
	Consolidated Balance Sheets-unaudited	2
	Consolidated Statements of Income-unaudited	3
	Statements of Consolidated Comprehensive Income-unaudited	4
	Consolidated Statements of Changes in Shareholders’ Equity-unaudited	5
	Consolidated Statements of Cash Flows-unaudited	7
	Notes to Consolidated Financial Statements (unaudited)	9
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	44
Item 3	Quantitative and Qualitative Disclosures about Market Risk	69
Item 4	Controls and Procedures	69
PART II	OTHER INFORMATION	69
Item 1	Legal Proceedings	69
Item 1A	Risk Factors	70
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	70
Item 3	Defaults Upon Senior Securities	70
Item 4	Mine Safety Disclosures	70
Item 5	Other Information	70
Item 6	Exhibits	70
	SIGNATURES	71

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PART I — FINANCIAL STATEMENTS

Item 1.Financial Statements

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

Consolidated Balance Sheets-unaudited


	March 31,		December 31,
	2017		2016
ASSETS	(Dollars in thousands, except share data)
Cash and due from banks	$	10,187	$	13,146
Interest-earning deposits		5,087		8,084
Total cash and cash equivalents		15,274		21,230
Investment securities available for sale (“AFS”), at fair value		163,737		169,854
Other investment, at cost		2,250		2,250
Federal Home Loan Bank (“FHLB”) stock		3,145		3,216
Loans and leases held for sale (“LHFS”), at lower of cost or fair value		205		—
Loans and leases (“LHFI”)		618,784		602,009
Less allowance for loan and lease losses		10,558		10,420
Net loans and leases		608,226		591,589
Company owned life insurance		21,069		20,781
Accrued interest receivable		3,810		3,968
Other real estate owned (“OREO”), net		2,131		3,536
Premises and equipment, net		5,026		5,398
Other assets		11,829		10,663
Total assets	$	836,702	$	832,485

LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits
Non-interest bearing	$	98,391	$	97,859
Interest-bearing		546,034		531,687
Total deposits		644,425		629,546
Short-term borrowings		21,000		19,000
Long-term borrowings		70,000		85,000
Subordinated debentures		25,774		25,774
Accrued interest payable		1,273		711
Other liabilities		19,403		20,181
Total liabilities		781,875		780,212
Shareholders’ equity
Royal Bancshares of Pennsylvania, Inc. equity:
Class A common stock, par value $2 per share, authorized 40,000,000 shares; issued 28,244,055 and 28,242,055 at March 31, 2017 and December 31, 2016, respectively,and outstanding 27,913,024 and 27,887,024 at March 31, 2017 and December 31, 2016, respectively		56,488		56,484
Class B common stock, par value $ 0.10 per share, authorized 3,000,000 shares; issued and outstanding, 1,924,629 at March 31, 2017 and December 31, 2016, respectively		193		193
Additional paid in capital		99,444		99,667
Accumulated deficit		(92,700)		(94,512)
Accumulated other comprehensive loss		(4,529)		(5,219)
Treasury stock - at cost, shares of Class A, 331,031 and 355,031 at March 31, 2017 and December 31, 2016, respectively		(4,629)		(4,965)
Total Royal Bancshares of Pennsylvania, Inc. shareholders’ equity		54,267		51,648
Noncontrolling interest		560		625
Total equity		54,827		52,273
Total liabilities and shareholders’ equity	$	836,702	$	832,485

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

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ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

Consolidated Statements of Income-unaudited


	For the three months ended
	March 31,
(In thousands, except per share data)	2017		2016
Interest Income
Loans and leases, including fees	$	7,916	$	6,864
Investment securities		1,026		1,334
Deposits in banks		16		16
Total Interest Income		8,958		8,214
Interest Expense
Deposits		1,117		1,040
Short-term borrowings		66		12
Long-term borrowings		758		671
Total Interest Expense		1,941		1,723
Net Interest Income		7,017		6,491
Provision for loan and lease losses		297		212
Net Interest Income after Provision for Loan and Lease Losses		6,720		6,279
Non-interest Income
Service charges and fees		363		316
Net losses on sales of loans and leases		(50)		—
Income from company owned life insurance		112		467
Gains on sales of premises and equipment		73		—
Net gains on the sale of AFS investment securities		—		367
Other income		13		57
Total Non-interest Income		511		1,207
Non-interest Expense
Employee salaries and benefits		2,780		2,718
Occupancy and equipment		767		724
Professional and legal fees		385		392
Net OREO (income) expenses		(189)		219
Pennsylvania shares tax expense		169		113
FDIC and state assessments		222		173
Communications and data processing		247		247
Provision (credit) for credit losses on off-balance sheet credit exposures		8		(150)
Directors’ fees		216		141
Insurance		100		90
Merger expenses		243		—
Other operating expenses		428		554
Total Non-interest Expense		5,376		5,221
Income Before Tax Expense		1,855		2,265
Income Tax Expense		—		—
Net Income	$	1,855	$	2,265
Less Net Income Attributable to Noncontrolling Interest	$	43	$	76
Net Income Attributable to Royal Bancshares of Pennsylvania, Inc.	$	1,812	$	2,189
Less Preferred Stock Series A Accumulated Dividend and Accretion	$	—	$	334
Net Income Available to Common Shareholders	$	1,812	$	1,855
Per Common Share Data:
Net Income — Basic and Diluted	$	0.06	$	0.06

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

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ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

Statements of Consolidated Comprehensive Income-unaudited


	For the three months ended
	March 31,
(In thousands)	2017		2016
Net income	$	1,855	$	2,265
Other comprehensive income, net of tax
Unrealized gains on investment securities:
Unrealized holding gains arising during period, net of tax (1)		632		2,333
Less reclassification adjustment for gains realized in net income, net of tax (2)		—		242
Unrealized gains on investment securities		632		2,091
Unrecognized benefit obligation:
Reclassification adjustment for amortization (3)		13		(103)
Unrecognized benefit obligation		13		(103)
Unrealized gain (loss) on derivative instrument, net of tax (4)		45		(322)
Other comprehensive income		690		1,666
Comprehensive income		2,545		3,931
Less net income attributable to noncontrolling interest		43		76
Comprehensive income attributable to Royal Bancshares of Pennsylvania, Inc.	$	2,502	$	3,855

(1)

Net of $326 thousand and $1.2 million in tax expense for the three months ended March 31, 2017 and 2016, respectively.

(2)

Gross amounts are included in net gains on the sale of AFS investment securities on the Consolidated Statements of Income in total non-interest income; amounts in the above table are net of $125 thousand in income taxes for the three months ended March 31, 2016. See Note 14. Comprehensive Income.

(3)

Gross amounts are included in salaries and benefits on the Consolidated Statements of Income in non-interest expense.

(4)

Net of $23 thousand in tax expense and $166 thousand tax benefit for the three months ended March 31, 2017 and 2016, respectively.

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

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ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders’ Equity

Three months ended March 31, 2017-unaudited


											Accumulated
							Additional				other						Total
	Class A common stock			Class B common stock			paid in		Accumulated		comprehensive		Treasury		Noncontrolling		Shareholders’
(In thousands, except share data)	Shares	Amount		Shares	Amount		capital		deficit		loss		stock		Interest		Equity
Balance January 1, 2017	28,242	$	56,484	1,925	$	193	$	99,667	$	(94,512)	$	(5,219)	$	(4,965)	$	625	$	52,273
Net income										1,812						43		1,855
Other comprehensive income, net of reclassifications and taxes												690						690
Distributions to noncontrolling interests																(108)		(108)
Treasury shares issued for compensation (24,000 shares)								(239)						336				97
Stock options exercised (2,000 shares)	2		4					(1)										3
Stock option expense								17										17
Balance March 31, 2017	28,244	$	56,488	1,925	$	193	$	99,444	$	(92,700)	$	(4,529)	$	(4,629)	$	560	$	54,827

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

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ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders’ Equity

Three months ended March 31, 2016-unaudited


													Accumulated
	Preferred								Additional				other						Total
	stock		Class A common stock			Class B common stock			paid in		Accumulated		comprehensive		Treasury		Noncontrolling		Shareholders’
(In thousands, except share data)	Series A		Shares	Amount		Shares	Amount		capital		deficit		loss		stock		Interest		Equity
Balance January 1, 2016	$	18,856	28,204	$	56,408	1,928	$	193	$	110,494	$	(104,879)	$	(3,919)	$	(5,249)	$	394	$	72,298
Net income												2,189						76		2,265
Other comprehensive income, net of reclassifications and taxes														1,666						1,666
Distributions to noncontrolling interests																		(45)		(45)
Repurchase of 4,000 shares of preferred stock		(4,000)								(1,800)										(5,800)
Treasury shares issued for compensation (15,836 shares)										(189)						222				33
Stock options exercised (20,000 shares)			20		40					(11)										29
Stock option expense										21										21
Balance March 31, 2016	$	14,856	28,224	$	56,448	1,928	$	193	$	108,515	$	(102,690)	$	(2,253)	$	(5,027)	$	425	$	70,467

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

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ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows-unaudited

Three months ended March 31,


(In thousands)	2017		2016
Cash flows from operating activities:
Net income	$	1,855	$	2,265
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		152		132
Stock compensation expense		17		21
Provision for loan and lease losses		297		212
Provision (credit) for credit losses on off-balance sheet credit exposures		8		(150)
Impairment charge for OREO		106		58
Net amortization of premiums on AFS investment securities		357		348
Net accretion of net deferred fees on loans		(161)		(144)
Net gains on sales of premises and equipment		(73)		—
Losses on sales of loans and leases		50		—
Net (gains) losses on sales of OREO		(387)		18
Net gains on sales of investment securities		—		(367)
Income from company owned life insurance		(112)		(467)
Changes in assets and liabilities:
Decrease (increase) in accrued interest receivable		158		(71)
Increase in other assets		(1,434)		(297)
Increase in accrued interest payable		562		529
(Decrease) increase in other liabilities		(786)		391
Net cash provided by operating activities		609		2,478
Cash flows from investing activities:
Proceeds from maturities, calls and paydowns of AFS investment securities		7,883		17,308
Proceeds from sales of AFS investment securities		—		10,022
Purchase of AFS investment securities		(1,165)		(1,277)
Redemption of Federal Home Loan Bank stock		71		—
Proceeds from sales of loans and leases		387		—
Net increase in loans		(17,459)		(31,967)
Additions to OREO		(33)		(91)
Proceeds from the sales of premises and equipment		297		—
Purchase of premises and equipment		(4)		(155)
Proceeds from sales of OREO		1,763		461
Payments for life insurance policies		(176)		(180)
Net cash used in investing activities		(8,436)		(5,879)

Statement is continued on the next page.

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ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows-unaudited (continued)

Three months ended March 31,


	2017		2016
Cash flows from financing activities:
Net (decrease) increase in demand and NOW accounts	$	(1,476)	$	8,684
Net increase in money market and savings accounts		3,785		2,873
Net increase (decrease) in certificates of deposit		12,570		(118)
Net increase in short-term borrowings		2,000		—
Repayments of long-term borrowings		(15,000)		(113)
Distributions to noncontrolling interest		(108)		(45)
Issuance of treasury stock		97		33
Repurchase of preferred stock		—		(5,800)
Proceeds from stock options exercised		3		29
Net cash provided by financing activities		1,871		5,543
Net (decrease) increase in cash and cash equivalents		(5,956)		2,142
Cash and cash equivalents at the beginning of the period		21,230		25,420
Cash and cash equivalents at the end of the period	$	15,274	$	27,562
Supplemental Disclosure:
Interest paid	$	1,379	$	1,194
Transfers from loans to OREO	$	44	$	107
Transfers to LHFS	$	205	$	—

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

(UNAUDITED)

Note 1.Summary of Significant Accounting Policies

Nature of Operations

Royal Bancshares of Pennsylvania, Inc. (“Royal Bancshares”, the “Company”, “We” or “Our”), through its wholly-owned subsidiary Royal Bank America (“Royal Bank”) offers a full range of banking services to individual and corporate customers primarily located in the Mid-Atlantic states. Royal Bank competes with other banking and financial institutions in certain markets, including financial institutions with resources substantially greater than its own. Commercial banks, savings banks, savings and loan associations, credit unions, and brokerage firms actively compete for savings and time deposits and for various types of loans. Such institutions, as well as consumer finance and insurance companies, may be considered competitors of Royal Bank with respect to one or more of the services it renders.

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

Basis of Financial Presentation

The accompanying unaudited consolidated financial statements include the accounts of Royal Bancshares of Pennsylvania, Inc. and its wholly-owned subsidiaries, Royal Investments of Delaware, Inc., including Royal Investments of Delaware, Inc.’s wholly owned subsidiary, Royal Preferred, LLC, and Royal Bank, including Royal Bank’s subsidiaries, Royal Real Estate of Pennsylvania, Inc., Royal Investments America, LLC, RBA Property LLC, Narberth Property Acquisition LLC, Rio Marina LLC, and Royal Tax Lien Services, LLC (“RTL”). Royal Bank also has an 80% and 60% ownership interest in Crusader Servicing Corporation (“CSC”) and Royal Bank America Leasing, LP, respectively. The two Delaware trusts, Royal Bancshares Capital Trust I and Royal Bancshares Capital Trust II are not consolidated per requirements under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 810, “Consolidation” (“ASC Topic 810”). These consolidated financial statements reflect the historical information of the Company. All significant intercompany transactions and balances have been eliminated in consolidation.

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information. Applications of the principles in our preparation of the consolidated financial statements in conformity with U.S. GAAP require management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and the accompanying notes. These estimates and assumptions are based on information available as of the date of the consolidated financial statements; therefore, actual results could differ from those estimates. The interim financial information included herein is unaudited; however, such information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, necessary to present a fair statement of the results for the interim periods. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2016. The results of operations for the three month period ended March 31, 2017 are not necessarily indicative of the results to be expected for the full year.

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Reclassifications

Certain items in the 2016 consolidated financial statements and accompanying notes have been reclassified to conform to the current year’s presentation format. There was no effect on net income for the periods presented herein as a result of the reclassification.

Accounting Policies Recently Adopted and Pending Accounting Pronouncements

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which establishes a comprehensive revenue recognition standard for virtually all industries under U.S. GAAP, including those that previously followed industry-specific guidance such as the real estate, construction and software industries. The revenue standard’s core principle is built on the contract between a vendor and a customer for the provision of goods and services. It attempts to depict the exchange of rights and obligations between the parties in the pattern of revenue recognition based on the consideration to which the vendor is entitled. To accomplish this objective, the standard requires five basic steps: i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) the entity satisfies a performance obligation. The ASU is effective for public entities for annual periods beginning after December 15, 2016, including interim periods therein. Three basic transition methods are available – full retrospective, retrospective with certain practical expedients, and a cumulative effect approach. Under the third alternative, an entity would apply the new revenue standard only to contracts that are incomplete under legacy U.S. GAAP at the date of initial application (e.g. January 1, 2017) and recognize the cumulative effect of the new standard as an adjustment to the opening balance of retained earnings. That is, prior years would not be restated and additional disclosures would be required to enable users of the financial statements to understand the impact of adopting the new standard in the current year compared to prior years that are presented under legacy U.S. GAAP. Early adoption is prohibited under U.S. GAAP. In August 2015, the FASB Issued ASU 2015-14 which deferred the effective date to December 15, 2017 and the initial application date (e.g. January 1, 2018.) The majority of our revenue is comprised of net interest income on financial assets and liabilities, which is explicitly excluded from the scope of ASU 2014-09. We continue to analyze this update and do not believe that ASU 2014-09 will have a material effect on our financial statements.

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments – Overall (Topic 825-10): “Recognition and Measurement of Financial Assets and Financial Liabilities.” ASU 2016-01 amends the guidance on the classification and measurement of financial instruments. Some of the amendments in ASU 2016-01 include the following: 1) requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; 2) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; 3) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; and 4) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value; among others. ASU 2016-01 also clarifies that an entity should assess the need for a valuation allowance on a deferred tax asset related to unrealized losses of investments in debt instruments recognized in other comprehensive income in combination with the entity’s other deferred tax assets. Prior to this guidance, the alternative approach used in practice evaluated the need for a valuation allowance for a deferred tax asset related to unrealized losses on debt instruments recognized in other comprehensive income separately from other deferred tax assets. This alternative approach will no longer be acceptable. For public business entities, the amendments of ASU 2016-01 are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. As of December 31, 2016 we do not hold a material amount of equity investments for which fair value is accounted through other comprehensive income. Consequently, we continue to analyze ASU 2016-01 and do not believe that it will have a material effect on our financial statements.

In February 2016, the FASB issued Accounting Standards Update No. 2016-02, “Leases” (“ASU 2016-02”). From the lessee's perspective, the new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement for a lessees. From the lessor's perspective, the new standard requires a lessor to classify leases as either sales-type, finance or operating.

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A lease will be treated as a sale if it transfers all of the risks and rewards, as well as control of the underlying asset, to the lessee. If risks and rewards are conveyed without the transfer of control, the lease is treated as a financing lease. If the lessor doesn’t convey risks and rewards or control, an operating lease results. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. A modified retrospective transition approach is required for lessors for sales-type, direct financing, and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. Our leases are operating leases and ASU 2016-02 will require us to add them to our balance sheet. Our operating leases are predominantly related to real estate. We are currently evaluating other impacts of the pending adoption of the new standard on our consolidated financial statements.

In March 2016, FASB issued Accounting Standards Update No. 2016-09, “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”). FASB issued ASU 2016-09 as part of its initiative to reduce complexity in accounting standards. The areas for simplification in this ASU 2016-09 involve several aspects of the accounting for employee share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Some of the areas for simplification apply only to nonpublic entities. For public business entities, the amendments in ASU 2016-09 were effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. We adopted ASU 2016-09 in the first quarter of 2017. ASU 2016-09 did not have a material effect on our financial statements.

In June 2016, FASB issued Accounting Standards Update No. 2016-13, “Financial Instruments-Credit Losses (Topic 326) Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13”). The main objective of ASU 2016-13 is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in ASU 2016-13 replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The amendments affect entities holding financial assets and net investment in leases that are not accounted for at fair value through net income. The amendments affect loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash.

The amendments in ASU 2016-13 affect an entity to varying degrees depending on the credit quality of the assets held by the entity, their duration, and how the entity applies current GAAP. There is diversity in practice in applying the incurred loss methodology, which means that before transition some entities may be more aligned, under current GAAP, than others to the new measure of expected credit losses.

The amendments in ASU 2016-13 require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. The income statement reflects the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectibility of the reported amount. An entity must use judgment in determining the relevant information and estimation methods that are appropriate in its circumstances. The allowance for credit losses for purchased financial assets with a more-than insignificant amount of credit deterioration since origination (PCD assets) that are measured at amortized cost basis is determined in a similar manner to other financial assets measured at amortized cost basis; however, the initial allowance for credit losses is added to the purchase price rather than being reported as a credit loss expense. Only subsequent changes in the allowance for credit losses are recorded as a credit loss expense for these assets. Interest income for PCD assets should be recognized based on the effective interest rate, excluding the discount embedded in the purchase price that is attributable to the acquirer’s assessment of credit losses at acquisition.

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Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses. Available-for-sale accounting recognizes that value may be realized either through collection of contractual cash flows or through sale of the security. Therefore, the amendments limit the amount of the allowance for credit losses to the amount by which fair value is below amortized cost because the classification as available for sale is premised on an investment strategy that recognizes that the investment could be sold at fair value, if cash collection would result in the realization of an amount less than fair value. The amendments in ASU 2016-13 require that credit losses be presented as an allowance rather than as a writedown. This approach is an improvement to current GAAP because an entity will be able to record reversals of credit losses (in situations in which the estimate of credit losses declines) in current period net income, which in turn should align the income statement recognition of credit losses with the reporting period in which changes occur. Current GAAP prohibits reflecting those improvements in current period earnings.

For public business entities that are SEC filers, the amendments in ASU 2016-13 are effective for financial statements issued for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. All entities may adopt the amendments in ASU 2016-13 earlier as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. An entity will apply the amendments in ASU 2016-13 through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (that is, modified-retrospective approach). A prospective transition approach is required for debt securities for which an other-than-temporary impairment had been recognized before the effective date. The effect of a prospective transition approach is to maintain the same amortized cost basis before and after the effective date of ASU 2016-13. Amounts previously recognized in accumulated other comprehensive income as of the date of adoption that relate to improvements in cash flows expected to be collected should continue to be accreted into income over the remaining life of the asset. Recoveries of amounts previously written off relating to improvements in cash flows after the date of adoption should be recorded in earnings when received. We are currently evaluating the impact of the amendments in ASU 2016-13 on our consolidated financial statements.

In August 2016, FASB issued Accounting Standards Update No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments” (“ASU 2016-15”). Stakeholders indicated that there is diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows under Topic 230, Statement of Cash Flows, and other Topics. The following eight specific cash flow issues are addressed in ASU 2016-15: Debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (“COLI”s) (including bank-owned life insurance policies (“BOLI”s)); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. For public business entities, the amendments in this ASU 2016-15 are effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The amendments in ASU 2016-15 should be applied using a retrospective transition method to each period presented. If it is impracticable to apply the amendments retrospectively for some of the issues, the amendments for those issues would be applied prospectively as of the earliest date practicable. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity that elects early adoption must adopt all of the amendments in the same period. We intend to adopt ASU 2016-15 during the first quarter of 2018 and it will have no effect on our results of operations because it only impacts the presentation of certain information on the statement of cash flows.

In December 2016, FASB issued Accounting Standards Update No. 2016-19, “Technical Corrections and Improvements” (“ASU 2016-19”). The amendments in ASU 2016-19 cover a wide range of Topics in the Accounting Standards Codification. The amendments generally fall into one of four categories: (1) amendments related to differences between original guidance and the codification, (2) guidance clarification and reference corrections, (3) simplification, and (4) minor improvements. Most of the amendments in ASU 2016-19 do not require transition guidance and were effective upon issuance. The amendments that require transition guidance are not applicable to the Company. The amendments that require transition guidance are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. FASB does not expect the changes to affect current accounting practice or result in any significant

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costs. The adoption of ASU 2016-19 effective January 1, 2017, did not have a material impact on our consolidated financial statements.

In February 2017, FASB issued Accounting Standards Update No. 2017-07, “Compensation—Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost” (“ASU 2017-07”). To improve the consistency, transparency, and usefulness of financial information for users, the amendments in ASU 2017-07 require that an employer disaggregate the service cost component from the other components of net benefit cost and report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. It also requires the other components of net periodic pension cost and net periodic postretirement benefit cost to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if one is presented. The amendments in ASU 2017-07 are effective for public business entities for annual periods beginning after December 15, 2017, including interim periods within those annual periods. Early adoption is permitted as of the beginning of an annual period for which financial statements (interim or annual) have not been issued or made available for issuance. The amendments in ASU 2017-07 should be applied retrospectively for the presentation of the service cost component and the other components of net periodic pension cost and net periodic postretirement benefit cost in the income statement and prospectively, on and after the effective date, for the capitalization of the service cost component of net periodic pension cost and net periodic postretirement benefit in assets. We intend to adopt ASU 2017-07 during the first quarter of 2018 and it will have no effect on our results of operations because it only impacts the presentation of certain information on the statements of income.

In March 2017, FASB issued Accounting Standards Update No. 2017-08, “Receivables —Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities” (“ASU 2017-08”). ASU 2017-08 amends guidance on the amortization period of premiums on certain purchased callable debt securities. Specifically, the amendments shorten the amortization period of premiums on certain purchased callable debt securities to the earliest call date. The amendments affect all entities that hold investments in callable debt securities that have an amortized cost basis in excess of the amount that is repayable by the issuer at the earliest call date. For public business entities, the amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity should apply the amendments in this Update on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. Additionally, in the period of adoption, an entity should provide disclosures about a change in accounting principle. The effect of ASU 2017-08 would be lower interest income and a corresponding lower yield as the amortization period would be shortened. As of March 31, 2017 we do not hold any callable debt securities that were purchased at a premium. We intend to adopt ASU 2017-08 during the first quarter of 2019.

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Note 2.Investment Securities

The carrying value and fair value of investment securities available-for-sale (“AFS”) at March 31, 2017 and December 31, 2016 are as follows:


As of March 31, 2017
			Gross		Gross
	Amortized		unrealized		unrealized
(In thousands)	cost		gains		losses		Fair value
U.S. government agencies	$	2,126	$	—	$	(26)	$	2,100
Mortgage-backed securities-residential		6,527		135		—		6,662
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		139,296		1,036		(1,352)		138,980
Non-agency		3,752		—		(71)		3,681
Corporate bonds		1,700		25		—		1,725
Municipal bonds		8,676		130		(64)		8,742
Other securities		1,821		—		—		1,821
Common stocks		26		—		—		26
Total available for sale	$	163,924	$	1,326	$	(1,513)	$	163,737


As of December 31, 2016
			Gross		Gross
	Amortized		unrealized		unrealized
(In thousands)	cost		gains		losses		Fair value
U.S. government agencies	$	988	$	—	$	(22)	$	966
Mortgage-backed securities-residential		6,985		70		(17)		7,038
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		146,666		1,022		(2,129)		145,559
Non-agency		4,121		—		(86)		4,035
Corporate bonds		1,700		1		—		1,701
Municipal bonds		8,691		92		(75)		8,708
Other securities		1,821		—		—		1,821
Common stocks		26		—		—		26
Total available for sale	$	170,998	$	1,185	$	(2,329)	$	169,854

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The amortized cost and fair value of investment securities at March 31, 2017, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.


	As of March 31, 2017
	Amortized
(In thousands)	cost		Fair value
Within 1 year	$	1,638	$	1,625
After 1 but within 5 years		6,852		6,904
After 5 but within 10 years		3,012		3,013
After 10 years		1,000		1,025
Mortgage-backed securities-residential		6,527		6,662
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		139,296		138,980
Non-agency		3,752		3,681
Total available for sale debt securities		162,077		161,890
No contractual maturity		1,847		1,847
Total available for sale securities	$	163,924	$	163,737

Proceeds from the sales of AFS investments during the three months ended March 31, 2017 and 2016 were $0 and $10.0 million, respectively. The following table summarizes gross realized gains and losses on the sale of securities recognized in earnings in the periods indicated:


	For the three months ended
	March 31,
(In thousands)	2017		2016
Gross realized gains	$	—	$	367
Gross realized losses		—		—
Net realized gains	$	—	$	367

The tables below indicate the length of time individual AFS securities have been in a continuous unrealized loss position at March 31, 2017 and December 31, 2016:


March 31, 2017	Less than 12 months					12 months or longer					Total
			Gross		Number			Gross		Number			Gross		Number
			unrealized		of			unrealized		of			unrealized		of
(In thousands)	Fair value		losses		positions	Fair value		losses		positions	Fair value		losses		positions
U.S. government agencies	$	2,100	$	(26)	2	$	—	$	—	—	$	2,100	$	(26)	2
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		74,956		(896)	31		11,654		(456)	4		86,610		(1,352)	35
Non-agency		3,681		(71)	3		—		—	—		3,681		(71)	3
Municipal bonds		665		(2)	2		3,330		(62)	4		3,995		(64)	6
Total available for sale	$	81,402	$	(995)	38	$	14,984	$	(518)	8	$	96,386	$	(1,513)	46

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December 31, 2016	Less than 12 months					12 months or longer					Total
			Gross		Number			Gross		Number			Gross		Number
			unrealized		of			unrealized		of			unrealized		of
(In thousands)	Fair value		losses		positions	Fair value		losses		positions	Fair value		losses		positions
U.S. government agencies	$	966	$	(22)	1	$	—	$	—	—	$	966	$	(22)	1
Mortgage-backed securities-residential		4,237		(17)	2		—		—	—		4,237		(17)	2
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		73,864		(1,630)	31		12,045		(499)	4		85,909		(2,129)	35
Non-agency		4,035		(86)	3		—		—	—		4,035		(86)	3
Municipal bonds		1,678		(45)	3		2,314		(30)	3		3,992		(75)	6
Total available for sale	$	84,780	$	(1,800)	40	$	14,359	$	(529)	7	$	99,139	$	(2,329)	47

We evaluate declines in the fair value of securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis. We assess whether OTTI is present when the fair value of a security is less than its amortized cost. Under ASC Topic 320, OTTI is considered to have occurred with respect to debt securities (1) if an entity intends to sell the security; (2) if it is more likely than not an entity will be required to sell the security before recovery of its amortized cost basis; or (3) the present value of the expected cash flows is not sufficient to recover the entire amortized cost basis. There were no credit-related impairment losses on debt securities held at March 31, 2017 and March 31, 2016 for which a portion of OTTI was recognized in other comprehensive income.

For all debt security types discussed below the fair value is based on prices provided by brokers and safekeeping custodians.

U.S. government-sponsored agencies (“U.S. Agency”): As of March 31, 2017, we had two U.S. Agency securities with a fair value of $2.1 million and a gross unrealized loss of $26 thousand. The bonds have been in an unrealized loss position for less than twelve months at March 31, 2017. Management believes that the unrealized loss on these debt securities are a function of changes in investment spreads. Management expects to recover the entire amortized cost basis of these securities. We do not intend to sell these securities before recovery of their cost basis and have not determined that it is not more likely than not that it will be required to sell these securities before recovery of their cost basis. Therefore, management has determined that these securities are not other-than-temporarily impaired at March 31, 2017.

U.S. government issued or sponsored collateralized mortgage obligations (“Agency CMOs”): As of March 31, 2017, we had 35 Agency CMOs with a fair value of $86.6 million and gross unrealized losses of $1.4 million. Four of the Agency CMOs have been in an unrealized loss position for twelve months or longer and the remaining 31 Agency CMOs have been in an unrealized loss position for less than twelve months. The unrealized loss is attributable to a combination of factors, including relative changes in interest rates since the time of purchase. The contractual cash flows for these securities are guaranteed by U.S. government agencies and U.S. government-sponsored enterprises. Based on its assessment of these factors, management believes that the unrealized losses on these debt securities are a function of changes in investment spreads and interest rate movements and not as a result of changes in credit quality. Management expects to recover the entire amortized cost basis of these securities. We do not intend to sell these securities before recovery of their cost basis and have not determined that it is not more likely than not that we will be required to sell these securities before recovery of their cost basis. Therefore, management has determined that these securities are not other-than-temporarily impaired at March 31, 2017.

Non-agency collateralized mortgage obligations (“Non-agency CMOs”): As of March 31, 2017, we had three non-agency CMOs with a fair value of $3.7 million and gross unrealized losses of $71 thousand. The bonds have been in an unrealized loss position for less than twelve months. We do not intend to sell these securities before recovery of their cost basis, and it is not more likely than not we will be required to sell this security before recovery of its cost basis. Therefore, management has determined that this security is not other-than-temporarily impaired at March 31, 2017.

Municipal bonds: As of March 31, 2017 we had six municipal bonds with a fair value $4.0 million and gross unrealized losses of $64 thousand. Two of the municipal bonds have been in an unrealized loss position for less than twelve months

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and four bonds have been in an unrealized loss position for twelve months or longer at March 31, 2017. Because we do not intend to sell the bonds and it is not more likely than not that we will be required to sell the bonds before recovery of their amortized cost basis, which may be maturity, we do not consider the bonds to be other-than-temporarily impaired at March 31, 2017.

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

Note 3.Loans and Leases

At March 31, 2017 and December 31, 2016, the Company’s LHFS were $205 thousand and $0, respectively. During the first quarter of 2017, we transferred one non-accrual loan to loans held for sale. As a result of this transfer we recorded a charge-off to the allowance of $20 thousand.

Major classifications of LHFI are as follows:


	March 31,		December 31,
(In thousands)	2017		2016
Commercial real estate	$	266,421	$	261,561
Construction and land development		88,561		83,369
Commercial and industrial		115,131		108,146
Multi-family		27,069		23,389
Residential real estate		56,790		56,899
Leases		58,733		61,838
Tax certificates		3,114		3,705
Consumer		2,965		3,102
Total loans, net of unearned income	$	618,784	$	602,009

We use a nine point grading risk classification system commonly used in the financial services industry as the credit quality indicator. The first four classifications are rated Pass. The riskier classifications include Pass-Watch, Special Mention, Substandard, Doubtful and Loss. The risk rating is related to the underlying credit quality and probability of default. These risk ratings are used in the calculation of the allowance for loan and lease losses.

Pass: includes credits that demonstrate a low probability of default;

Pass-watch: a classification which includes currently performing credits that are beginning to demonstrate above average risk through declining earnings, strained cash flows, increased leverage and/or weakening market fundamentals. This class may also include new loan originations which warrant approval but may contain certain risks that require closer than usual monitoring and supervision, such as construction loans;

Special mention: includes credits that have potential weaknesses that if left uncorrected could weaken the credit or result in inadequate protection of our position at some future date. While potentially weak, credits in this classification are marginally acceptable and loss of principal or interest is not anticipated;

Substandard accrual: includes credits that exhibit a well-defined weakness which currently jeopardizes the repayment of debt and liquidation of collateral even though they are currently performing. These credits are characterized by the distinct possibility that we may incur a loss in the future if these weaknesses are not corrected;

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Non-accrual (substandard non-accrual, doubtful, loss): includes credits that demonstrate serious problems to the point that it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement.

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

The following tables present risk ratings for each LHFI portfolio classification at March 31, 2017 and December 31, 2016.


As of March 31, 2017
(In thousands)	Pass		Pass-Watch		Special Mention		Substandard		Non-accrual		Total
Commercial real estate	$	226,674	$	38,390	$	—	$	—	$	1,357	$	266,421
Construction and land development		9,687		78,746		—		—		128		88,561
Commercial and industrial		94,268		18,340		14		1,693		816		115,131
Multi-family		18,620		8,449		—		—		—		27,069
Residential real estate		56,133		103		—		—		554		56,790
Leases		56,419		154		259		—		1,901		58,733
Tax certificates		1,380		—		—		—		1,734		3,114
Consumer		2,853		112		—		—		—		2,965
Total loans, net of unearned income	$	466,034	$	144,294	$	273

ROYAL BANCSHARES OF PENNSYLVANIA INC 10-Q