Quarterly Report (10-q)

Share Name	Share Symbol	Market	Type
Royal Bancshares of Pennsylvania, Inc.	NASDAQ:RBPAA	NASDAQ	Common Stock

	Price Change	% Change	Share Price	Bid Price	Offer Price	High Price	Low Price	Open Price	Shares Traded	Last Trade
	0.00	0.00%	4.52	3.24	4.75				0	01:00:00

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC20549

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: June 30, 2013

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 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.)

732 Montgomery Avenue, Narberth, PA19072

(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 x 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 x No o

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 12-b-2 of the Exchange Act.

	Large accelerated filer o	Accelerated filer o
	Non-accelerated filer o (do not check if a smaller reporting company)	Smaller reporting company x

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

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 July 31, 2013
$2.00 par value	10,957,114

Class B Common Stock Outstanding at July 31, 2013
$0.10 par value	2,074,099

PART I – FINANCIAL STATEMENTS

Item 1.

Financial Statements

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(unaudited)

	June 30,			December 31,
	2013			2012
ASSETS	(In thousands, except share data)
Cash and due from banks	$	9,056		$	10,621
Interest bearing deposits		15,726			18,181
Total cash and cash equivalents		24,782			28,802
Investment securities available-for-sale ("AFS”)		304,117			349,203
Other investment, at cost		2,250			2,250
Federal Home Loan Bank ("FHLB") stock, at cost		4,594			6,011
Loans and leases held for sale ("LHFS")		1,419			1,572
Loans and leases held for investment ("LHFI")		367,867			344,165
Less allowance for loan and lease losses		15,179			17,261
Net loans and leases		352,688			326,904
Bank owned life insurance		14,852			14,585
Accrued interest receivable		8,733			10,256
Other real estate owned ("OREO"), net		13,002			13,435
Premises and equipment, net		4,709			5,232
Other assets		17,455			15,466
Total assets	$	748,601		$	773,716

LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits
Non-interest bearing	$	66,121		$	58,531
Interest bearing		459,549			496,386
Total deposits		525,670			554,917
Short-term borrowings		10,000			-
Long-term borrowings		98,108			108,333
Subordinated debentures		25,774			25,774
Accrued interest payable		4,917			3,760
Other liabilities		30,857			22,517
Total liabilities		695,326			715,301
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 June 30, 2013 and December 31, 2012		29,668			29,396
Class A common stock, par value $2.00 per share, authorized 40,000,000 shares; issued, 11,431,638 at June 30, 2013 and December 31, 2012		22,863			22,863
Class B common stock, par value $0.10 per share; authorized 3,000,000 shares; issued, 2,020,449 at June 30, 2013 and December 31, 2012		202			202
Additional paid in capital		126,092			126,287
Accumulated deficit		(118,037	)		(117,080	)
Accumulated other comprehensive loss		(4,017	)		(142	)
Treasury stock - at cost, shares of Class A, 481,821 and 498,488 at June 30, 2013 and December 31, 2012, respectively		(6,738	)		(6,971	)
Total Royal Bancshares of Pennsylavania, Inc. shareholders’ equity		50,033			54,555
Noncontrolling interest		3,242			3,860
Total equity		53,275			58,415
Total liabilities and shareholders’ equity	$	748,601		$	773,716

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 Operations - (unaudited)

	For the three months ended						For the six months ended
	June 30,						June 30,
(In thousands, except per share data)	2013			2012			2013			2012
Interest income
Loans and leases, including fees	$	5,444		$	6,651		$	10,905		$	13,468
Investment securities available-for-sale		1,291			1,763			2,575			3,743
Deposits in banks		8			9			15			18
Total Interest Income		6,743			8,423			13,495			17,229
Interest expense
Deposits		1,005			1,573			2,078			3,201
Short-term borrowings		11			15			11			308
Long-term borrowings		781			929			1,688			1,821
Total Interest Expense		1,797			2,517			3,777			5,330
Net Interest Income		4,946			5,906			9,718			11,899
(Credit) provision for loan and lease losses		(163	)		1,515			(414	)		1,599
Net Interest Income after (Credit) Provision for Loan and Lease Losses		5,109			4,391			10,132			10,300

Other income
Net gains on sales of other real estate owned		418			255			580			117
Service charges and fees		325			277			638			578
Income from bank owned life insurance		131			137			267			275
Net gains on the sale of AFS investment securities		25			20			70			159
Gain on sale of premises and equipment		2			-			678			-
Income related to real estate owned via equity investments		-			19			-			38
Gains on sales of loans and leases		-			1,964			16			2,005
Other income		60			132			120			293
Total other-than-temporary impairment on investment securities		-			(859	)		-			(859	)
Total Other Income		961			1,945			2,369			2,606
Other expenses
Employee salaries and benefits		2,662			3,167			5,451			6,051
Loss contingency		1,650			-			1,650			-
Professional and legal fees		808			1,306			1,468			2,310
Occupancy and equipment		546			571			1,116			1,120
OREO expenses and impairment		528			996			897			2,274
Pennsylvania shares tax		283			322			557			637
FDIC and state assessments		261			285			528			491
Loan collection expenses		142			670			278			193
Directors' fees		117			107			218			209
Impairment on loans held for sale		53			-			153			-
Restructuring charges		24			-			111			-
Department of Justice fine		-			400			-			2,000
Other operating expenses		493			768			1,280			1,374
Total Other Expenses		7,567			8,592			13,707			16,659
Loss Before Tax Expense (Benefit)		(1,497	)		(2,256	)		(1,206	)		(3,753	)
Income tax expense (benefit)		-			-			-			-
Net Loss	$	(1,497	)	$	(2,256	)	$	(1,206	)	$	(3,753	)
Less net loss attributable to noncontrolling interest	$	(694	)	$	(306	)	$	(521	)	$	(934	)
Net loss attributable to Royal Bancshares of Pennsylvania, Inc.	$	(803	)	$	(1,950	)	$	(685	)	$	(2,819	)
Less Preferred stock Series A accumulated dividend and accretion	$	518		$	508		$	1,033		$	1,014
Net loss to common shareholders	$	(1,321	)	$	(2,458	)	$	(1,718	)	$	(3,833	)
Per common share data
Net loss – basic and diluted	$	(0.10	)	$	(0.19	)	$	(0.13	)	$	(0.29	)

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 Loss - (unaudited)

	For the three months ended						For the six months ended
	June 30,						June 30,
(In thousands)	2013			2012			2013			2012
Net loss	$	(1,497	)	$	(2,256	)	$	(1,206	)	$	(3,753	)
Other comprehensive loss, net of tax (benefit)
Unrealized gains (losses) on investment securities:
Unrealized holding losses arising during period		(4,253	)		(593	)		(4,018	)		(229	)
Less adjustment for impaired investments ¹		-			(558	)		-			(558	)
Less reclassification adjustment for gains realized in net income loss ²		16			13			46			103
Unrealized (losses) gains on investment securities		(4,269	)		(48	)		(4,064	)		226
Unrecognized benefit obligation expense:
Less reclassification adjustment for amortization ³		(95	)		(63	)		(189	)		(114	)
Other comprehensive (loss) income		(4,174	)		15			(3,875	)		340
Comprehensive loss	$	(5,671	)	$	(2,241	)	$	(5,081	)	$	(3,413	)
Less net loss attributable to noncontrolling interest		(694	)		(306	)		(521	)		(934	)
Comprehensive loss attributable to Royal Bancshares of Pennsylvania, Inc.	$	(4,977	)	$	(1,935	)	$	(4,560	)	$	(2,479	)

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

¹ Amounts are included in total other-than-temporary impairment on investment securities on the Consolidated Statements of Operations in total non-interest income.

² Amounts are included in net gains on the sale of available for sale investment securities on the Consolidated Statements of Operations in total non-interest income.

³ Amounts are included in salaries and benefits on the Consolidated Statements of Operations in non-interest expense.

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ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

Consolidated Statement of Changes in Shareholders' Equity

Six months ended June 30, 2013

(unaudited)

(In thousands, except share data)	Preferred stock		Class A common stock				Class B common stock				Additional paid in			Accumulated			Accumulated other comprehensive			Treasury			Non controlling			Total Shareholders'
(In thousands, except share data)	Series A		Shares		Amount		Shares		Amount		capital			deficit			loss			stock			Interest			Equity
Balance January 1, 2013	$	29,396		11,432	$	22,863		2,020	$	202	$	126,287		$	(117,080	)	$	(142	)	$	(6,971	)	$	3,860		$	58,415
Comprehensive loss
Net loss															(685	)								(521	)		(1,206	)
Other comprehensive loss, net of reclassifications and taxes																		(3,875	)								(3,875	)
Distributions to noncontrolling interests																								(97	)		(97	)
Accretion of discount on preferred stock		272													(272	)											-
Treasury shares issued for compensation												(208	)								233						25
Stock option expense												13															13
Balance June 30, 2013	$	29,668		11,432	$	22,863		2,020	$	202	$	126,092		$	(118,037	)	$	(4,017	)	$	(6,738	)	$	3,242		$	53,275

ROYAL BANCSHARES OF PENNSYLVANIA, INC. AND SUBSIDIARIES

Consolidated Statement of Changes in Shareholders' Equity

Six months ended June 30, 2012

(unaudited)

(In thousands, except share data)	Preferred stock		Class A common stock				Class B common stock						Additional paid in		Accumulated			Accumulated other comprehensive		Treasury			Non controlling			Total Shareholders'
(In thousands, except share data)	Series A		Shares		Amount		Shares			Amount			capital		deficit			income		stock			Interest			Equity
Balance January 1, 2012	$	28,878		11,362	$	22,723		2,081		$	208		$	126,245	$	(100,803	)	$	800	$	(6,971	)	$	4,865		$	75,945
Comprehensive loss
Net loss																(2,819	)							(934	)		(3,753	)
Other comprehensive income, net of reclassifications and taxes																			340								340
Common stock conversion from Class B to Class A				8		17		(7	)		(1	)				(16	)										-
Accretion of discount on preferred stock		254														(254	)										-
Stock option expense														28													28
Balance June 30, 2012	$	29,132		11,370	$	22,740		2,074		$	207		$	126,273	$	(103,892	)	$	1,140	$	(6,971	)	$	3,931		$	72,560

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)

Six months ended June 30,

(In thousands)	2013			2012
Cash flows from operating activities:
Net loss	$	(685	)	$	(2,819	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		190			204
Stock compensation expense		13			28
(Credit) provision for loan and lease losses		(414	)		1,599
Impairment charge for other real estate owned		341			1,049
Net amortization of AFS investment securities		2,601			2,910
Net accretion on loans		(151	)		(132	)
Net gains on sales of other real estate		(580	)		(117	)
Proceeds from sales of loans and leases		123			11,000
Net gains on sales of premises and equipment		(678	)		-
Gains on sales of loans and leases		(16	)		(2,005	)
Net gains on sales of AFS investment securities		(70	)		(159	)
Distribution from investments in real estate		-			(38	)
Income from bank owned life insurance		(267	)		(275	)
Impairment of loans held for sale		153			-
Impairment of AFS investment securities		-			859
Changes in assets and liabilities:
Decrease in accrued interest receivable		1,523			3,592
(Increase) decrease in other assets		(1,989	)		331
Increase in accrued interest payable		1,157			1,649
Increase in other liabilities		8,340			1,980
Net cash provided by operating activities		9,591			19,656
Cash flows from investing activities:
Proceeds from maturities, calls and paydowns of AFS investment securities		62,193			69,917
Proceeds from sales of AFS investment securities		20,428			11,902
Purchase of AFS investment securities		(46,386	)		(113,125	)
Redemption of Federal Home Loan Bank stock		1,417			826
Net (increase) decrease in loans		(27,682	)		31,468
Purchase of premises and equipment		(110	)		(157	)
Proceeds from the sales of premises and equipment		1,121			-
Distribution from investments in real estate		-			38
Proceeds from sales of real estate owned		4,880			5,453
Net cash provided by investing activities		15,861			6,322
Cash flows from financing activities:
Increase (decrease) in demand and NOW accounts		5,871			(2,856	)
(Decrease) increase in money market and savings accounts		(14,469	)		10,953
Decrease in certificates of deposit		(20,649	)		(1,721	)
Repayments of short-term borrowings		-			(39,218	)
Repayments of long-term borrowings		(50,225	)		(224	)
Proceeds from short-term borrowings		10,000			-
Proceeds from long-term borrowings		40,000			15,000
Net cash used in financing activities		(29,472	)		(18,066	)
Net (decrease) increase in cash and cash equivalents		(4,020	)		7,912
Cash and cash equivalents at the beginning of the period		28,802			24,506
Cash and cash equivalents at the end of the period	$	24,782		$	32,418
Supplemental Disclosure
Interest paid	$	2,620		$	3,681
Transfers to other real estate owned	$	4,208		$	9,096

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

Basis of Financial Presentation

The accompanying unaudited consolidated financial statements include the accounts of Royal Bancshares of Pennsylvania, Inc. (“Royal Bancshares” or the “Company”) and its wholly-owned subsidiaries, Royal Investments of Delaware, Inc., including Royal Investments of Delaware, Inc.’s wholly-owned subsidiary, Royal Preferred, LLC, and Royal Bank America (“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 its three 60% ownership interests in Crusader Servicing Corporation, Royal Tax Lien Services, LLC, and Royal Bank America Leasing, LP. 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.

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 the Company’s 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, 2012. The results of operations for the three and six month periods ended June 30, 2013 are not necessarily indicative of the results to be expected for the full year.

Reclassifications

Certain items in the 2012 consolidated financial statements and accompanying notes have been reclassified to conform to the current year’s presentation format. There was no effect on net loss for the periods presented herein as a result of reclassification.

Accounting Policies Recently Adopted and Pending Accounting Pronouncements

In December 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities (“ASU 2011-11”). Because of the significant differences in requirements under U.S. GAAP and IFRS, FASB and the International Accounting Standards Board (“IASB”) are issuing joint requirements that will enhance current disclosures. Entities are required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. This scope would include derivatives, sale and repurchase agreements and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. The objective of this disclosure is to facilitate comparison between those entities that prepare their financial statements on the basis of U.S. GAAP and those entities that prepare their financial statements on the basis of IFRS. ASU 2011-11 is effective for annual periods beginning on or after January 1, 2013 and interim periods within those annual periods. An entity should provide the disclosures required by these amendments retrospectively for all comparative periods presented. The adoption of ASU 2011-11 did not have a significant impact on the Company’s consolidated financial statements.

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In February 2013, the FASB issued ASU No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (“ASU 2013-02”) to improve the reporting of reclassifications out of accumulated comprehensive income. ASU 2013-02 does not change the current requirements for reporting net income or other comprehensive income in financial statements. However, ASU 2013-02 requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts. ASU 2013-02 is effective for reporting periods b eginning after December 15, 2012. The adoption of ASU 2013-02 did not have a significant impact on the Company’s consolidated financial statements.

In February 2013, the FASB issued ASU No. 2013-04, Liabilities (Topic 405): Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date (ASU 2013-04).ASU 2013-04 provides guidance for the recognition, measurement and disclosure of obligations resulting from joint and several liability arrangements. ASU 2013-04 requires an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this guidance is fixed at the reporting date, as the sum of the following:

a. The amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors

b. Any additional amount the reporting entity expects to pay on behalf of its co-obligors.

ASU 2013-04 also requires an entity to disclose the nature and amount of the obligation as well as other information about those obligations. For public companies ASU 2013-04 is effective for reporting periods b eginning after December 15, 2013. The adoption of ASU 2013-04 is not expected to have a significant impact on the Company’s consolidated financial statements.

In July 2013, the FASB issued ASU No. 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (“ASU 2013-11”). Currently there is diversity in practice in the presentation of unrecognized tax benefits. The aim of ASU 2013-11 is to provide guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, similar tax loss, or tax credit carryforward exists. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except for circumstances outlined in ASU 2013-11. For public companies ASU 2013-11 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The adoption of ASU 2013-04 is not expected to have a significant impact on the Company’s consolidated financial statements.

Note 2.

Regulatory Matters and Significant Risks or Uncertainties

FDIC and Department of Banking Memorandum of Understanding

On July 15, 2009, Royal Bank agreed to enter into a Stipulation and Consent to the Issuance of an Order to Cease and Desist (the “Orders”) with each of the Federal Deposit Insurance Corporation (“FDIC”) and the Pennsylvania Department of Banking (the “Department”). The material terms of the Orders were identical and required Royal Bank among other items to maintain, after establishing an adequate allowance for loan and lease losses, a ratio of Tier 1 capital to total assets (“leverage ratio”) equal to or greater than 8% and a ratio of qualifying total capital to risk-weighted assets (“total risk-based capital ratio”) equal to or greater than 12%. The FDIC and the Department replaced the Orders in the fourth quarter of 2011 with an informal agreement, known as a memorandum of understanding (“MOU”). Included in the MOU is the continued requirement of maintaining a leverage ratio equal to or greater than 8% and a total risk-based capital ratio equal to or greater than 12%. At June 30, 2013, based on capital levels calculated under regulatory accounting principles (“ RAP”) , Royal Bank’s Tier 1 leverage and total risk-based capital ratios were 9.09% and 15.45%, respectively. Please refer to “Note 11 – Regulatory Capital Requirements” to the consolidated financial statements.

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Following the issuance of the Orders, management implemented plans to address key areas that were noted in the Orders. Management has reduced classified assets, delinquencies, commercial real estate concentrations, reliance on non-core deposits and wholesale funding sources and maintained capital ratios above required minimums which were all factors that contributed to replacing the Orders with the MOU. Management has continued to improve in each of these areas since the Orders were replaced with the MOU.

Federal Reserve Memorandum of Understanding

As previously disclosed, in March 2010, the Company agreed to enter into a written agreement (the “Federal Reserve Agreement”) with the Federal Reserve Bank of Philadelphia (the “Federal Reserve Bank”). In July 2013, the Board of Governors of the Federal Reserve System terminated the enforcement action under Federal Reserve Agreement, and it was replaced with an informal agreement, an MOU, with the Federal Reserve Bank, effective July 17, 2013. Included in the MOU are certain continued reporting requirements and a requirement that the Company receive the prior approval of the Federal Reserve Bank prior to declaring or paying any dividends on the Company’s common stock, making interest payments related to the Company’s outstanding trust preferred securities or subordinate securities, incurring or guaranteeing certain debt with an original maturity date greater than one year, and purchasing or redeeming any shares of stock. The MOU will remain in effect until stayed, modified, terminated or suspended in writing by the Federal Reserve Bank.

Our success as a Company 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 two MOUs 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 MOUs. Additionally, the Company’s ability to raise capital in the current economic environment could be potentially limited or impacted as a result of the MOUs. Attracting new management talent is critical to the success of our business and could be potentially effected due to the existence of the MOUs.

Significant Losses

For the period 2008 through 2012, the Company has recorded significant losses totaling $119.6 million which were primarily related to charge-offs on the loan and lease portfolio, impairment charges on investment securities, impairment charges on other real estate owned (“OREO”), credit related expenses and the establishment of a deferred tax valuation allowance. For the second quarter of 2013, the Company recorded a net loss of $803,000 compared to a net loss of $2.0 million for the comparable period in 2012. The quarter over quarter decline in net loss was mainly related to a $1.7 million decline in provision for loan and lease losses, a $943,000 decrease in credit related expenses and an $859,000 decline in other-than-temporary impairment on investment securities. Partially offsetting these items was a $1.65 million loss contingency accrual for a settlement of the class action lawsuit related to the tax lien subsidiaries. After adjusting for the noncontrolling interest, the Company’s 60% share of the loss contingency amounted to $990,000 on a pre-tax basis. Additionally for the second quarter of 2013 net interest income declined $960,000 from the comparable quarter in 2012. For the six months ended June 30, 2013, the Company recorded a net loss of $685,000 compared to a net loss of $2.8 million for the same period in 2012. The decline in net loss was mainly related to a $2.0 million decline in provision for loan and lease losses and a $1.1 million decrease in credit related expenses and an $842,000 decline in professional and legal fees. Partially offsetting these items was a decrease in net interest income of $2.2 million. In addition to reducing the total shareholders’ equity, the continued losses and negative retained earnings impacts the Company’s ability to pay cash dividends to its shareholders now and in future years. The Company’s deferred tax valuation allowance amounted to $39.6 million at June 30, 2013. The deferred tax valuation allowance is a result of management’s conclusion that it was more likely than not that the Company would not generate sufficient future taxable income to realize all of the deferred tax asset which equaled $41.5 million at June 30, 2013.

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Credit Quality

Adverse economic conditions in our specific market areas and decreases in real estate property values due to the nature of our loan portfolio in particular have affected the ability of customers to repay their loans and generally impact our financial condition and results of operations. The financial services and real estate industries were hit particularly hard during the “Great Recession” and as a result the Company’s loan and investment portfolios were directly affected. The Company’s commercial real estate loans, including construction and land development loans, have seen a decline in the collateral values, and a reduction in the borrowers’ ability to meet the payment terms of their loans due to reduced cash flow. Further declines in collateral values and borrowers’ liquidity with sustained unemployment at current levels may lead to additional increases in foreclosures, delinquencies and customer bankruptcies. 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.

The Company had non-performing loans of $17.8 million and $23.0 million at June 30, 2013 and December 31, 2012, respectively. The Company recorded $311,000 and $2.4 million in charge-offs and write-downs for the three and six months ended June 30, 2013, respectively compared to $628,000 and $781,000 in charge-offs and write-downs for the comparable periods of 2012, respectively. OREO balances were $13.0 million at June 30, 2013 and $13.4 million at December 31, 2012.

Royal Bank was successful in reducing net classified loans, which includes LHFS and OREO from $51.8 million at December 31, 2012 to $45.6 million at June 30, 2013. Royal Bank’s delinquent loans held for investment (30 to 90 days) amounted to $1.3 million at June 30, 2013 versus $4.6 million at December 31, 2012. Material advances on any classified or delinquent loan are to be approved by the Board of Directors and determined to be in Royal Bank’s best interest. The Company has restructured the investment portfolio to reduce credit risk by selling corporate debt securities and equity securities and replacing their maturities with U.S. government issued or sponsored securities. Royal Bank recorded $859,000 in other-than-temporary-impairment (“OTTI”) losses during the six months ended June 30, 2012 compared to $0 for the comparable period in 2013.

Commercial Real Estate Concentrations

As mentioned previously the adverse economic conditions have primarily impacted the real estate secured loan portfolio. Commercial real estate and construction and development loans are often riskier and tend to have significantly larger balances than home equity loans or residential mortgage loans to individuals. While the Company believes 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 profitable 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, which may result in increasing levels of loan charge-offs and non-performing assets and the reduction of earnings. When we take collateral in foreclosures and similar proceedings, we are required to mark the related asset to the then fair market value of the collateral, which may ultimately result in a loss. It is possible that Royal Bank may be required to maintain higher levels of capital than it would be otherwise be expected to maintain as a result of the Bank’s commercial real estate loans, which may require the Company to obtain additional capital.

Commercial real estate, multi-family and construction and land development loans held for investment were $227.0 million at June 30, 2013 comprising 62% of total loans compared to $216.1 million at December 31, 2012 comprising 63% of total loans. Based on capital levels calculated under U.S. GAAP and RAP, Royal Bank does not have a concentration of commercial real estate loans as defined in the joint agency “Guidance on Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices” issued on December 12, 2006. Please see discussion in “Note 11 – Regulatory Capital Requirements” to the consolidated financial statements.

Liquidity and Funds Management

Royal Bank has limited capacity to borrow additional funds in the event it is needed for liquidity purposes. However, Royal Bank has continued to maintain liquidity measures that are well in excess of the target levels. As discussed in “Note 8 – Borrowings and Subordinated Debentures” to the consolidated financial statements, Royal Bank has an over collateralized delivery requirement of 105% with the FHLB as a result of the level of non-performing assets and the losses that have been experienced over the past five years. The ability to borrow additional funds is based on the amount of collateral that is available to be pledged. As of June 30, 2013, Royal Bank had $21.5 million of available borrowing capacity at the FHLB as a result of excess collateral that has been pledged. In addition at June 30, 2013, Royal Bank had $164.6 million in unpledged agency securities that were available to be pledged as collateral if needed and $23.5 million in cash on hand . Royal Bank also has limited availability to borrow from the Federal Reserve Discount Window, which was $7.9 million at June 30, 2013, and was based on collateral pledged.

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At June 30, 2013, the liquidity to deposits ratio was 42.6% compared to Royal Bank’s 12% policy target and the liquidity to total liabilities ratio was 32.8% compared to Royal Bank’s 10% policy target. Borrowings were $108.1 million and $108.3 million at June 30, 2013and December 31, 2012, respectively.

The Company also has unfunded pension plan obligations, which potentially could impact liquidity, of $16.7 million as of June 30, 2013 compared to $16.9 million at December 31, 2012. The Company plans to fund the pension plan obligations through existing Company owned life insurance policies.

Dividend and Interest Restrictions

Due to the MOU, 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 impacted and thereby limit liquidity alternatives. 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 and to suspend interest payments on the $25.8 million in trust preferred securities. As of June 30, 2013, the Series A Preferred stock dividend in arrears was $6.8 million and has not been recognized in the consolidated financial statements. In the event the Company declared the preferred dividend the Company’s capital ratios would be negatively affected; however, they would remain above the required minimum ratios. Please read “Note 11 - Regulatory Capital Requirements” to the consolidated financial statements. As of June 30, 2013 the trust preferred interest payment in arrears was $2.8 million and has been recorded in interest expense and accrued interest payable. The Company believes the decision to suspend the preferred cash dividends and the trust preferred interest payments will better support the liquidity position of Royal Bank. The interest payment deferral period on the trust preferred securities ends after the second quarter of 2014. After the ending of the deferral period if the interest payments are not made then it would constitute an event of default which could impact the Company’s consolidated financial statements and liquidity.

At June 30, 2013, 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. Royal Bank must receive prior approval from the FDIC and the Department before declaring and paying a dividend to the Company. Under the Federal Reserve MOU the Company may not declare or pay any dividends without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System.

Capital Adequacy

In connection with a prior bank regulatory examination, the FDIC concluded, based upon its interpretation of the Consolidated Reports of Condition and Income (the “Call Report”) instructions and under RAP, that income from Royal Bank’s tax lien business should be recognized on a cash basis, not an accrual basis. Royal Bank’s current accrual method is in accordance with U.S. GAAP. Royal Bank disagrees with the FDIC’s conclusion and filed the Call Report for June 30, 2013 and the previous eleven quarters in accordance with U.S. GAAP. However, the change in the manner of revenue recognition for the tax lien business for regulatory accounting purposes affects Royal Bank’s and potentially the Company’s capital ratios as disclosed in “Note 11 - Regulatory Capital Requirements” to the consolidated financial statements. Royal Bank is in discussions with the FDIC to resolve the matter.

Under the FDIC MOU, Royal Bank must maintain a minimum total risk-based capital ratio and a minimum Tier 1 leverage ratio of 12% and 8%, respectively. At June 30, 2013, based on capital levels calculated under RAP, Royal Bank’s Tier 1 leverage and total risk-based capital ratios were 9.09% and 15.45%, respectively.

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Department of Justice Investigation (“DOJ”)

Royal Bank holds a 60% equity interest in each of CSC and RTL. The Company acquired its ownership interest in CSC in 2001. CSC and RTL acquired, through public auction, delinquent tax liens in various jurisdictions thereby assuming a superior lien position to most other lien holders, including mortgage lien holders. On March 4, 2009, each of CSC and RTL received grand jury subpoenas issued by the U.S. District Court for New Jersey (“Court”) upon application of the Antitrust Division of the United States DOJ. The subpoenas sought certain documents and information relating to an ongoing investigation being conducted by the DOJ relating to alleged bid-rigging at tax lien auctions in New Jersey. On February 23, 2012, the former President of CSC and RTL entered a plea of guilty to one count of conspiring to rig bids at certain auctions for tax liens in New Jersey from 1998 until approximately the spring of 2009. The former President’s employment with CSC and RTL was terminated in November 2010. Based on discussions with the DOJ and the plea entered by the former President of CSC and RTL, the Company believed that the outcome of the investigation would result in fines and penalties being assessed against CSC, RTL or both. As a result, the Company accrued $2.0 million during 2012 for a DOJ fine relating to the DOJ investigation. After adjusting for the noncontrolling interest, the Company’s 60% share of the fine amounted to $1.2 million. On September 26, 2012, as a result of the former President’s guilty plea and pursuant to a plea agreement with the DOJ, CSC entered a guilty plea in the United States District Court for the District of New Jersey to one count of conspiracy to commit bid-rigging at certain auctions for tax liens in New Jersey. Under the terms of the plea agreement, which the Court accepted at the September 26, 2012 plea hearing, the DOJ agreed not to bring further criminal charges against CSC and not to bring criminal charges against RTL, or any current or former director, officer, or employee of CSC and/or RTL, for any act or offense committed prior to the date of the plea agreement that was in furtherance of any agreement to rig bids at municipal tax lien sales or auctions in the State of New Jersey. The former President of CSC and RTL and any person who bid at any time at a tax lien auction on behalf of CSC and/or RTL are excluded from this non-prosecution protection. At the sentencing hearing held in December 2012, the sentencing judge agreed with the DOJ’s recommendation and imposed a $2.0 million fine for CSC, which, as stated above, had been previously recognized in the Company’s consolidated financial statements. The Company is evaluating appropriate legal action against the former President of CSC and RTL to attempt to recover legal expenses and any fines or penalties ultimately levied against CSC.

Additionally a number of lawsuits have been filed in the Superior Court of New Jersey against the former President of CSC and RTL, CSC, RTL, Royal Bancshares of Pennsylvania and certain other parties on behalf of a proposed class of taxpayers who became delinquent in paying their municipal tax obligations. These lawsuits allege violations of the New Jersey Antitrust Act and unjust enrichment, and seek treble damages, attorney fees and injunctive relief. CSC, RTL and Royal Bancshares removed these cases to the U.S. District Court for the District of New Jersey. On June 12, 2012, the Court entered an Order consolidating for pretrial purposes the above actions with all subsequently filed or transferred related actions, collectively referred to as In re New Jersey Tax Sale Certificates Antitrust Litigation . On October 22, 2012, the Court appointed two law firms as interim class counsel and another law firm as liaison class counsel and further ordered appointed counsel to file a master complaint for the consolidated action. On December 21, 2012, plaintiffs filed a Consolidated Master Class Action Complaint (the “Complaint”) against numerous defendants, including the former President of CSC and RTL, Royal Bancshares of Pennsylvania, Inc., Royal Bank America, CSC and RTL. The Company filed a motion to dismiss the Complaint on March 8, 2013, which is currently pending before the Court. During the second quarter of 2013, the Company accrued a loss contingency of $1.65 million for a potential settlement with the plaintiffs. After adjusting for the noncontrolling interest, the Company’s 60% share of the loss contingency amounted to $990,000. Subsequently, Royal Bancshares of Pennsylvania, Inc., Royal Bank America, CSC, and RTL reached an agreement in principle with plaintiffs to settle the litigation for $1.65 million and other terms and conditions, including an opportunity for members of the proposed settlement class whose tax liens are currently held by CSC or RTL to redeem those liens for a one-time cash payment equaling 85% of the redemption amount by making such payment within 35 days of the date of written notice. The proposed settlement class does not include, and therefore the offer to redeem does not apply to, tax liens acquired at 0% interest or at a premium. The settlement is contingent upon negotiation of a definitive settlement agreement and is subject to Court approval after notice and a hearing. Members of the proposed settlement class will have an opportunity to object to the proposed settlement or opt-out.

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Company Plans and Strategy

The Company has enhanced the Board through the addition of experienced directors with diverse backgrounds. The newer members are comprised of the following: a former banking regulator with consulting experience, a former Chief Executive Officer (“CEO”) of a much larger financial institution who has bank turnaround experience, a former President of the lead bank within a larger financial institution (Treasury appointee), a former executive within the financial services industry (Treasury appointee) and a former senior partner of a public accounting firm. During the first quarter of 2012, the Board elected a Lead Independent Director to further improve corporate governance by serving as a liaison between the Chairman of the Board, management, and the independent directors. During 2012, Royal Bank hired a new Chief Lending Officer (“CLO”) who has significant experience in commercial and consumer lending with a larger bank within the Philadelphia market. On December 18, 2012 the Company announced F. Kevin Tylus as President and CEO of Royal Bank. On February 20, 2013, the Company announced that Mr. Tylus was appointed President, CEO and a Class III member of the Board of Directors of the Company. Former CEO, Robert Tabas, remains as Chairman of the Board of Directors.

In order to meet the requirements in the previous Orders, the previous Federal Reserve Agreement, and the current MOUs, management adopted a strategy to deleverage the balance sheet in order to maintain capital ratios at required regulatory minimums. The Board and management remain committed to meeting the capital level requirements for Royal Bank as set forth in the FDIC MOU. As a result, the Board and management have developed a contingency plan to maintain capital ratios at required levels which may include selling interest-earning assets. This strategy also assisted in reducing the level of classified assets by giving management the ability to actively pursue exit strategies on loans and OREO which were at historically high levels. The deleveraging was largely accomplished by the continued reduction of brokered deposits from $89.1 million at December 31, 2010 to $0 as of June 30, 2013. In addition, borrowings were reduced by $46.8 million during the same period. The Company’s strategic plan includes improving the overall level of credit quality, maintaining reduced credit risk within the investment portfolio, reducing the overall level of expenses, and returning to profitability.

During the past few years, the Company recorded significant impairment charges and carrying costs on non-accrual loans and OREO which has weighed heavily on earnings and was the largest contributing factor to the Company’s losses. While sustaining capital ratios above the required minimum, the Company has made progress in improving credit quality, reducing the CRE concentration, strengthening the Board and maintaining liquidity. As a result of the decline in level of classified assets, there has been a corresponding reduction in the provision for loan and lease losses and the overall carrying costs associated with classified assets. The deleveraging of the balance sheet has also reduced earning assets which has resulted in a decline in net interest income and has had a significant impact on overall earnings. To improve net interest margin and net interest income, management is diligently working on changing the mix of earnings assets and interest-bearing liabilities. In the event further deleveraging is necessary to maintain the required capital levels, net interest income would be negatively impacted.

The Company is focused on transitioning Royal Bank into a more traditional community bank with the branches becoming selling centers and not just service centers. Traditional consumer products such as home equity loans and a new mobile banking application are part of the expanded product offerings. Recently the Company launched a new website, which takes advantage of the latest technologies and trends in web development, including responsive design which reformats content to fit any screen, improving both aesthetics and user experience. Visitors will also find a renewed emphasis on our most important products and services, including quick links to key revenue driving product lines, our newly launched secure home equity application and our powerful online and mobile banking tools. With the recent retirement of Royal Bank’s Senior Vice President of Branch Administration, the Company has launched an executive search for a retail executive with prior experience in expanding retail sales capabilities, refreshing the branch footprint and achieving further penetration of its recently-expanded retail and web-based products.

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The Company has developed a management Profitability Improvement Plan (the “Plan”) to generate steady revenue growth, expense management and gain operational efficiencies. Specific initiatives of the Plan effectuated in the first two quarters of 2013 focused on adjustments to personnel of the Company and discretionary expenses. These efforts, which included a 9% reduction in workforce and an annualized reduction of approximately 10% of discretionary expenses, were implemented and enhanced day-to-day operations and the ability of the Company to drive new revenue. The Company has reorganized and relocated certain personnel to improve departmental synergies and better align managers and staff so they can work together in cohesive teams to accomplish these objectives. Additionally, the Company is currently developing a facilities rationalization plan as part of the overall strategic goal to return to profitability. During the first quarter of 2013, the Company sold its storage facility site in Philadelphia and a building in Narberth that housed the training center. The Company recorded gains of $676,000 as a result of these sales. In January 2013, Royal Bank consolidated the leased Henderson Road office between the King of Prussia and Bridgeport offices and retained the majority of the deposits. Additionally, in April 2013, to achieve operational efficiencies, the tax lien subsidiaries relocated from their leased office space in Jenkintown, Pennsylvania to the corporate location in Narberth. As a result of the reduction in workforce and the vacating of leased real estate, the Company recorded $111,000 in restructuring charges directly related to one-time employee termination benefits and an effective termination of a lease. During the third quarter of 2013, the Company will consolidate the 15 ^th Street branch office into the Walnut Street branch office, which are both located in Center City Philadelphia. The Company continues to review its retail footprint and will explore additional branch office relocations, consolidations or both. The Company also is implementing a unique opportunity to reduce employee expenses as certain individuals will become employees of a local company who in turn will provide servicing of the remaining tax lien and non-performing assets portfolios. Those portfolios continue to diminish per the Company's strategic plan. This outsourcing arrangement allows the Company to focus on the expansion of its core banking products while de-emphasizing legacy non-core activity such as tax liens. The Company has targeted to have the Plan fully implemented by the end of 2013. Through the reorganizing of the Lending and Credit departments during the last half of 2012, Royal Bank was able to increase LHFI $23.7 million from $344.2 million at December 31, 2012 to $367.9 million at June 30, 2013. All of these plans are focused on repositioning the Company for 2013 and beyond.

Note 3.

Investment Securities

The carrying value and fair value of investment securities AFS at June 30, 2013 are as follows:

			Included in Accumulated Other Comprehensive Loss (AOCL)
					Gross unrealized losses
(In thousands)	Amortized cost		Gross unrealized gains		Non-OTTI in AOCL			Non-credit related OTTI in AOCL		Fair value
U.S. government agencies	$	74,354		18		(3,200	)	$	-	$	71,172
Mortgage-backed securities-residential		33,271		375		(724	)		-		32,922
Collateralized mortgage obligations-residential		178,476		2,958		(925	)		-		180,509
Corporate bonds		9,785		37		(92	)		-		9,730
Municipal bonds		5,519		-		(188	)		-		5,331
Other securities		3,676		880		(149	)		-		4,407
Common stocks		33		13		-			-		46
Total available for sale	$	305,114	$	4,281	$	(5,278	)	$	-	$	304,117

The carrying value and fair value of investment securities AFS at December 31, 2012 are as follows:

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			Included in Accumulated Other Comprehensive Loss (AOCL)
					Gross unrealized losses
(In thousands)	Amortized cost		Gross unrealized gains		Non-OTTI in AOCL			Non-credit related OTTI in AOCL		Fair value
U.S. government agencies	$	66,371	$	151	$	(78	)	$	-	$	66,444
Mortgage-backed securities-residential		30,038		518		(47	)		-		30,509
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		229,556		5,031		(611	)		-		233,976
Non-agency		1,007		4		-			-		1,011
Corporate bonds		7,477		32		(72	)		-		7,437
Municipal bonds		5,645		-		(30	)		-		5,615
Other securities		3,752		520		(108	)		-		4,164
Common stocks		33		14		-			-		47
Total available for sale	$	343,879	$	6,270	$	(946	)	$	-	$	349,203

The amortized cost and fair value of investment securities at June 30, 2013, 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 June 30, 2013
(In thousands)	Amortized cost		Fair value
Within 1 year	$	15,906	$	15,301
After 1 but within 5 years		5,445		5,406
After 5 but within 10 years		35,874		34,413
After 10 years		32,433		31,113
Mortgage-backed securities-residential		33,271		32,922
Collateralized mortgage obligations-residential		178,476		180,509
Total available for sale debt securities		301,405		299,664
No contractual maturity		3,709		4,453
Total available for sale securities	$	305,114	$	304,117

Proceeds from the sales of investments AFS during the three months ended June 30, 2013 and 2012 were $8.3 million and $75,000, respectively. Proceeds from the sales of investments AFS for the six months ended June 30, 2013 and 2012 were $20.4 million and $11.9 million, respectively. The following table summarizes gross realized gains and losses realized on the sale of securities recognized in earnings in the periods indicated:

	For the three months						For the six months
	ended June 30,						ended June 30,
(In thousands)	2013			2012			2013			2012
Gross realized gains	$	43		$	29		$	181		$	340
Gross realized losses		(18	)		(9	)		(111	)		(181	)
Net realized gains	$	25		$	20		$	70		$	159

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The Company evaluates securities for OTTI at least on a quarterly basis. The Company assesses whether OTTI is present when the fair value of a security is less than its amortized cost. All investment securities are evaluated for OTTI under FASB ASC Topic 320, “Investments-Debt & Equity Securities” (“ASC Topic 320”). The non-agency collateralized mortgage obligations that are rated below AA are evaluated under FASB ASC Topic 320 Subtopic 40, “Beneficial Interests in Securitized Financial Assets” under FASB ASC Topic 325, “Investments-Other”. 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.

Under ASC Topic 320, OTTI is considered to have occurred with respect to debt securities (1) if an entity intends to sell the security; (2) if it is more likely than not an entity will be required to sell the security before recovery of its amortized cost basis; or (3) the present value of the expected cash flows is not sufficient to recover the entire amortized cost basis. In addition, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell or will more likely than not be required to sell the security. If an entity intends to sell the security or will be required to sell the security, the OTTI shall be recognized in earnings equal to the entire difference between the fair value and the amortized cost basis at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before the recovery of its amortized cost basis, the OTTI shall be separated into two amounts, the credit-related loss and the noncredit-related loss. The credit-related loss is based on the present value of the expected cash flows and is recognized in earnings. The noncredit-related loss is based on other factors such as illiquidity and is recognized in other comprehensive income.

The following table summarizes OTTI losses on securities recognized in earnings in the periods indicated:

	For the three months				For the six months
	ended June 30,				ended June 30,
(In thousands)	2013		2012		2013		2012
Other securities	$	-	$	859	$	-	$	859
Total OTTI charges	$	-	$	859	$	-	$	859

The following table presents a roll-forward of the balance of credit-related impairment losses on debt securities held at June 30, 2013 and 2012 for which a portion of OTTI was recognized in other comprehensive income:

(In thousands)	2013			2012
Balance at January 1,	$	173		$	173
Reductions for securities sold during the period (realized)		(173	)		-
Balance at June 30,	$	-		$	173

The tables below indicate the length of time individual securities have been in a continuous unrealized loss position at June 30, 2013 and December 31, 2012:

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June 30, 2013	Less than 12 months					12 months or longer					Total
(In thousands)	Fair value		Gross unrealized losses			Fair value		Gross unrealized losses			Fair value		Gross unrealized losses
U.S. government agencies	$	58,159	$	(3,200	)	$	-	$	-		$	58,159	$	(3,200	)
Mortgage-backed securities-residential		19,201		(724	)		-		-			19,201		(724	)
Collateralized mortgage obligations-residential		39,185		(920	)		2,642		(5	)		41,827		(925	)
Corporate bonds		4,035		(50	)		958		(42	)		4,993		(92	)
Municipal bonds		5,331		(188	)		-		-			5,331		(188	)
Other securities		270		(50	)		205		(99	)		475		(149	)
Total available-for-sale	$	126,181	$	(5,132	)	$	3,805	$	(146	)	$	129,986	$	(5,278	)

December 31, 2012	Less than 12 months					12 months or longer					Total
(In thousands)	Fair value		Gross unrealized losses			Fair value		Gross unrealized losses			Fair value		Gross unrealized losses
U.S. government agencies	$	23,818	$	(78	)	$	-	$	-		$	23,818	$	(78	)
Mortgage-backed securities-residential		7,280		(47	)		-		-			7,280		(47	)
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		44,937		(592	)		3,975		(19	)		48,912		(611	)
Corporate bonds		2,165		(13	)		941		(59	)		3,106		(72	)
Municipal bonds		4,597		(21	)		882		(9	)		5,479		(30	)
Other securities		289		(38	)		255		(70	)		544		(108	)
Total available-for-sale	$	83,086	$	(789	)	$	6,053	$	(157	)	$	89,139	$	(946	)

The AFS portfolio had gross unrealized losses of $5.3 million and $946,000 at June 30, 2013 and December 31, 2012, respectively. The considerable increase in the gross unrealized loss was directly impacted by the $3.1 million increase in the gross unrealized loss on government agency debt securities. These securities carry lower coupons and their market value was negatively impacted by a 45% increase in the 10-year Treasury yield from 1.76% at December 31, 2012 to 2.55% at June 30, 2013. The Company did not record OTTI charges in 2013. For the three and six months ended June 30, 2012, the Company recorded $859,000 in OTTI on a private equity real estate fund due to the fund’s financial performance. In determining the Company’s intent not to sell and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, management considers the following factors: current liquidity and availability of other non-pledged assets that permits the investment to be held for an extended period of time but not necessarily until maturity, capital planning, and any specific investment committee goals or guidelines related to the disposition of specific investments.

Common stocks: As of June 30, 2013, the Company had two common stocks of financial institutions with a total fair value of $46,000 and an unrealized gain of $13,000. During the first quarter of 2012 the Company sold one common stock investment and recorded a gain of $112,000.

For all debt security types discussed below the fair value is based on prices provided by brokers and safekeeping custodians with the exception of trust preferred securities which are described below.

U.S. government-sponsored agencies (“U.S. Agencies”): As of June 30, 2013, the Company had 20 callable U.S. Agencies with a fair value of $58.2 million and gross unrealized losses of $3.2 million. All of these U.S. Agencies have been in an unrealized loss position for twelve months or less. Management believes that the unrealized losses on these debt securities are a function of changes in investment spreads and interest rate movements and not changes in credit quality. Management expects to recover the entire amortized cost basis of these securities. The Company does not intend to sell these securities before recovery of their cost basis and will not more likely than not 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 June 30, 2013.

- 17 -

Mortgage-backed securities issued by U.S. government agencies and U.S. government sponsored enterprises: As of June 30, 2013 the Company had seven mortgage-backed securities with a fair value of $19.2 million and gross unrealized losses of $724,000. All of these mortgage-backed securities have been in an unrealized loss position for twelve months or less. 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 changes in credit quality. Management expects to recover the entire amortized cost basis of these securities. The Company does not intend to sell these securities before recovery of their cost basis and will not more likely than not 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 June 30, 2013.

U.S. government issued or sponsored collateralized mortgage obligations (“Agency CMOs”): As of June 30, 2013, the Company had 14 Agency CMOs with a fair value of $41.8 million and gross unrealized losses of $925,000. Twelve of the Agency CMOs have been in an unrealized loss position for twelve months or less. The two Agency CMOs that have been in an unrealized loss position for more than twelve months have a fair market value of $2.6 million and an unrealized loss of $5,000 at June 30, 2013. 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 changes in credit quality. Management expects to recover the entire amortized cost basis of these securities. The Company does not intend to sell these securities before recovery of their cost basis and will not more likely than not 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 June 30, 2013.

Corporate bonds: As of June 30, 2013, the Company had five corporate bonds with a fair value of $5.0 million and gross unrealized losses of $92,000. Four bonds have been in an unrealized loss position for twelve months or less. The one bond that has been in an unrealized loss position for more than twelve months has a fair market value of $958,000 and an unrealized loss of $42,000 at June 30, 2013. All five bonds are above investment grade. The Company’s unrealized losses in investments in corporate bonds represent interest rate risk and not credit risk of the underlying issuers. As previously mentioned management also considered (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. Management utilizes discounted cash flow analysis based upon the credit ratings of the securities, liquidity risk premiums, and the recent corporate spreads for similar securities as required under ASC Topic 320 to determine the credit risk component of the corporate bonds. Based on these analyses, there was no credit-related loss on these bonds. Because the Company does not intend to sell the corporate bonds and it is not more likely than not that the Company will be required to sell the bonds before recovery of their amortized cost basis, which may be maturity, the Company does not consider these bonds to be other-than-temporarily impaired at June 30, 2013.

Municipal bonds: As of June 30, 2013, the Company had seven municipal bonds with a fair value of $5.3 million and gross unrealized losses of $188,000. The municipal bonds have been in an unrealized loss position for twelve months or less and are investment grade. Because the Company does not intend to sell the bonds and it is not more likely than not that the Company will be required to sell the bonds before recovery of its amortized cost basis, which may be maturity, the Company does not consider the bonds to be other-than-temporarily impaired at June 30, 2013.

Other securities: As of June 30, 2013, the Company had seven investments in private equity funds which were predominantly invested in real estate. In determining whether or not OTTI exists, the Company reviews the funds’ financials, asset values, and its near-term projections. At June 30, 2013, two of the private equity funds had a combined fair value of $475,000 and a gross unrealized loss of $149,000. OTTI charges were recorded in a prior period on these two funds. One of the private equity funds has been in an unrealized loss for more than twelve months. The Company receives capital distributions on this fund. Management concluded that there was no additional impairment on these two funds as of June 30, 2013.

- 18 -

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

Note 4.

Loans and Leases

Major classifications of LHFI are as follows:

	June 30,		December 31,
(In thousands)	2013		2012
Commercial real estate	$	180,601	$	167,115
Construction and land development		34,696		37,215
Commercial and industrial		66,985		40,560
Multi-family		11,736		11,756
Residential real estate		15,873		24,981
Leases		38,497		37,347
Tax certificates		18,578		24,569
Consumer		901		1,139
Total gross loans	$	367,867	$	344,682
Deferred fees, net*		-		(517	)
Total loans and leases	$	367,867	$	344,165

* For the 2013 period net deferred fees were allocated among the loan types.

The Company grants commercial and real estate loans, including construction and land development loans primarily in the greater Philadelphia metropolitan area as well as selected locations throughout the mid-Atlantic region. The Company also has participated with other financial institutions in selected construction and land development loans outside our geographic area. The Company has a concentration of credit risk in commercial real estate, construction and land development loans at June 30, 2013. A substantial portion of its debtors’ ability to honor their contracts is dependent upon the housing sector specifically and the economy in general.

Loans and leases are classified as LHFI when management has the intent and ability to hold the loan or lease for the foreseeable future or until maturity or payoff. LHFI are stated at their outstanding unpaid principal balances, net of an allowance for loan and leases losses (“ALLL”) and any deferred fees or costs. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the yield (Interest Income) of the related loans. The Company is generally amortizing these amounts over the contractual life of the loan.

At June 30, 2013 and December 31, 2012, the Company’s LHFS were $1.4 million and $1.6 million, respectively, and were comprised of one non-accrual commercial real estate loan. This loan was transferred from LHFI at the lower of cost or fair market value using expected net sales proceeds. For the three and six months ended June 30, 2013, the Company recorded additional impairment of $53,000 and $153,000, respectively.

The Company classifies its leases as finance leases, in accordance with 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 uses a nine point grading risk classification system commonly used in the financial services industry as the credit quality indicator. The first five classifications are rated Pass. The riskier classifications include 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 to calculate the historical loss component of the allowance.

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

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Pass-Watch: a warning classification which includes credits that are beginning to demonstrate above average risk through declining earnings, strained cash flows, increased leverage and/or weakening market fundamentals;

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

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

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

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

The following tables present risk ratings for each loan portfolio segment at June 30, 2013 and December 31, 2012, excluding LHFS.

June 30, 2013					Special
(In thousands)	Pass		Pass-Watch		Mention		Substandard		Non-accrual		Total
Commercial real estate	$	95,756	$	50,340	$	22,118	$	3,703	$	8,684	$	180,601
Construction and land development		5,235		13,910		12,221		575		2,755		34,696
Commercial and industrial		39,394		12,721		674		10,514		3,682		66,985
Multi-family		9,025		2,130		581		-		-		11,736
Residential real estate		15,382		-		-		-		491		15,873
Leases		38,050		195		12		-		240		38,497
Tax certificates		18,094		-		-		-		484		18,578
Consumer		831		70		-		-		-		901
Total LHFI	$	221,767	$	79,366	$	35,606	$	14,792	$	16,336	$	367,867

December 31, 2012					Special
(In thousands)	Pass		Pass-Watch		Mention		Substandard		Non-accrual		Total
Commercial real estate	$	64,308	$	69,510	$	19,529	$	3,423	$	10,345	$	167,115
Construction and land development		2,139		13,872		16,343		581		4,280		37,215
Commercial and industrial		14,764		10,774		92		9,969		4,961		40,560
Multi-family		9,019		2,034		703		-		-		11,756
Residential real estate		15,125		6,634		602		1,626		994		24,981
Leases		36,755		325		16		-		251		37,347
Tax certificates		23,968		-		-		-		601		24,569
Consumer		926		213		-		-		-		1,139
Subtotal LHFI	$	167,004	$	103,362	$	37,285	$	15,599	$	21,432	$	344,682
Less: Deferred loan fees												(517	)
Total LHFI											$	344,165

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The past due status of all classes of loans and leases receivable is determined based on contractual due dates for loan payments. Generally, a loan is placed on non-accruing status when it has been delinquent for a period of 90 days or more. The following tables present an aging analysis of past due payments for each loan portfolio segment at June 30, 2013 and December 31, 2012, excluding LHFS.

June 30, 2013	30-59 Days		60-89 Days		Accruing		Total
(In thousands)	Past Due		Past Due		90+ Days		Non-accrual		Current		Total
Commercial real estate	$	176	$	-	$	-	$	8,684	$	171,741	$	180,601
Construction and land development		-		-		-		2,755		31,941		34,696
Commercial and industrial		-		-		-		3,682		63,303		66,985
Multi-family		-		-		-		-		11,736		11,736
Residential real estate		595		299		-		491		14,488		15,873
Leases		194		12		-		240		38,051		38,497
Tax certificates		-		-		-		484		18,094		18,578
Consumer		-		-		-		-		901		901
Total LHFI	$	965	$	311	$	-	$	16,336	$	350,255	$	367,867

December 31, 2012	30-59 Days		60-89 Days		Accruing		Total
(In thousands)	Past Due		Past Due		90+ Days		Non-accrual		Current		Total
Commercial real estate	$	1,548	$	1,486	$	-	$	10,345	$	153,736	$	167,115
Construction and land development		-		-		-		4,280		32,935		37,215
Commercial and industrial		200		-		-		4,961		35,399		40,560
Multi-family		-		-		-		-		11,756		11,756
Residential real estate		562		486		-		994		22,939		24,981
Leases		325		16		-		251		36,755		37,347
Tax certificates		-		-		-		601		23,968		24,569
Consumer		-		-		-		-		1,139		1,139
Subtotal LHFI	$	2,635	$	1,988	$	-	$	21,432	$	318,627	$	344,682
Less: Deferred loan fees												(517	)
Total LHFI											$	344,165

The following tables detail the composition of the non-accrual loans at June 30, 2013 and December 31, 2012.

	June 30, 2013				December 31, 2012
(In thousands)	Loan balance		Specific reserves		Loan balance		Specific reserves
Non-accrual loans held for investment
Commercial real estate	$	8,684	$	605	$	10,345	$	835
Construction and land development		2,755		-		4,280		820
Commercial and industrial		3,682		12		4,961		255
Residential real estate		491		15		994		14
Leases		240		67		251		55
Tax certificates		484		101		601		47
Total non-accrual LHFI	$	16,336	$	800	$	21,432	$	2,026
Non-accrual loans held for sale
Commercial real estate	$	1,419	$	-	$	1,572	$	-
Total non-accrual LHFS	$	1,419	$	-	$	1,572	$	-
Total non-accrual loans	$	17,755	$	800	$	23,004	$	2,026

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Total non-accrual loans at June 30, 2013 were $17.8 million and were comprised of $16.4 million in LHFI and $1.4 million in LHFS. Total non-accrual loans at December 31, 2012 were $23.0 million and were comprised of $21.4 million in LHFI and $1.6 million in LHFS. The $5.2 million decrease was the result of a $4.3 million reduction in existing non-accrual loan balances through payments and payoffs, $2.2 million in charge-offs related to specific reserves on LHFI, $153,000 write down on the LHFS and $100,000 in transfers to OREO, which were partially offset by additions of $1.6 million. If interest had been accrued, such income would have been approximately $453,000 and $979,000 for the three and six months ended June 30, 2013, respectively. The Company had no loans past due 90 days or more on which it has continued to accrue interest during the quarter. Typically, loans are restored to accrual status when the loan is brought current, has performed in accordance with the contractual terms for a reasonable period of time (generally six months) and the ultimate collectibility of the total contractual principal and interest is no longer in doubt.

Impaired Loans

The Company identifies a loan as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. Impaired loans include troubled debt restructurings (“TDRs”). The Company does not accrue interest income on impaired non-accrual loans. Excess proceeds received over the principal amounts due on impaired non-accrual loans are recognized as income on a cash basis. 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.

Total cash collected on impaired loans during the six months ended June 30, 2013 and June 30, 2012 was $5.9 million and $17.8 million respectively, of which $5.6 million and $15.6 million was credited to the principal balance outstanding on such loans, respectively.

The following is a summary of information pertaining to impaired loans:

	June 30,		December 31,
(In thousands)	2013		2012
Impaired loans with a valuation allowance	$	8,401	$	9,405
Impaired loans without a valuation allowance		17,885		19,423
Impaired LHFS		1,419		1,572
Total impaired loans	$	27,705	$	30,400

Valuation allowance related to impaired loans	$	800	$	2,026

Troubled Debt Restructurings

A loan modification is deemed a TDR when two conditions are met: 1) the borrower is experiencing financial difficulty and 2) concessions are made by the Company that would not otherwise be considered for a borrower or collateral with similar credit risk characteristics. All loans classified as TDRs are considered to be impaired. TDRs are returned to an accrual status when the loan is brought current, has performed in accordance with the contractual restructured terms for a reasonable period of time (generally six months) and the ultimate collectibility of the total contractual restructured principal and interest is no longer in doubt. At June 30, 2013, the Company had 14 TDRs, of which seven are on non-accrual status, with a total carrying value of $20.4 million. At the time of the modifications, seven of the loans were already classified as impaired loans. At December 31, 2012, the Company had 12 TDRs with a total carrying value of $21.1 million. The Company’s policy for TDRs is to recognize income on currently performing restructured loans under the accrual method. During 2013, the Company received pay downs and payoffs of $3.4 million and recorded specific reserve charge-offs of $1.1 million.

The following table details the Company’s TDRs that are on an accrual status and a non-accrual status at June 30, 2013.

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(In thousands)	Number of loans		Accrual Status		Non-Accrual Status		Total TDRs

Construction and land development		4	$	1,328	$	512	$	1,840
Commercial real estate		5		4,338		7,483		11,821
Commercial and industrial		3		4,536		2,054		6,590
Residential real estate		2		-		134		134
Total		14	$	10,202	$	10,183	$	20,385

At June 30, 2013, all of the TDRs were in compliance with their restructured terms.

The following tables present the newly restructured loans that occurred during the three and six months ended June 30, 2013. There were no newly restructured loans for the comparable periods in 2012.

	Modifications by type for the three months ended June 30, 2013
(Dollars in thousands)	Number of loans		Rate		Term		Payment		Combination of types		Total		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial real estate		2	$	-	$	-	$	-	$	3,741	$	3,741	$	3,761	$	3,761
Total		2	$	-	$	-	$	-	$	3,741	$	3,741	$	3,761	$	3,761

	Modifications by type for the six months ended June 30, 2013
(Dollars in thousands)	Number of loans		Rate		Term		Payment		Combination of types		Total		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial real estate		2	$	-	$	-	$	-	$	3,741	$	3,741	$	3,761	$	3,761
Commercial and industrial		1		-		-		-		83		83		87		87
Total		3	$	-	$	-	$	-	$	3,824	$	3,824	$	3,848	$	3,848

Note 5.

Allowance for Loan and Lease Losses

The following tables present the detail of the ALLL and the loan portfolio disaggregated by loan portfolio segment for the three and six months ended June 30, 2013, the year ended December 31, 2012 and the three and six months ended June 30, 2012.

Allowance for Loan and Leases Losses

For the three months ended June 30, 2013

(In thousands)	Commercial real estate			Construction and land development			Commercial and industrial			Multi-family			Residential real estate		Leases			Tax certificates			Consumer		Unallocated			Total
Beginning balance	$	8,103		$	2,078		$	2,713		$	658		$	168	$	1,061		$	384		$	18	$	206		$	15,389
Charge-offs		-			-			(21	)		-			-		(99	)		(138	)		-		-			(258	)
Recoveries		23			95			6			-			5		10			72			-		-			211
Provision		(174	)		(156	)		(233	)		(70	)		180		27			268			-		(5	)		(163	)
Ending balance	$	7,952		$	2,017		$	2,465		$	588		$	353	$	999		$	586		$	18	$	201		$	15,179
Ending balance: related to loans individually evaluated for impairment	$	605		$	-		$	12		$	-		$	15	$	67		$	101		$	-	$	-		$	800
Ending balance: related to loans collectively evaluated for impairment	$	7,347		$	2,017		$	2,453		$	588		$	338	$	932		$	485		$	18	$	201		$	14,379

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Allowance for Loan and Leases Losses

For the six months ended June 30, 2013

(In thousands)	Commercial real estate			Construction and land development			Commercial and industrial			Multi-family			Residential real estate			Leases			Tax certificates			Consumer			Unallocated			Total
Beginning balance	$	8,750		$	2,987		$	1,924		$	654		$	1,098		$	1,108		$	472		$	29		$	239		$	17,261
Charge-offs		(835	)		(820	)		(195	)		-			-			(108	)		(285	)		-			-			(2,243	)
Recoveries		127			191			9			-			156			20			72			-			-			575
Provision		(90	)		(341	)		727			(66	)		(901	)		(21	)		327			(11	)		(38	)		(414	)
Ending balance	$	7,952		$	2,017		$	2,465		$	588		$	353		$	999		$	586		$	18		$	201		$	15,179
Ending balance: related to loans individually evaluated for impairment	$	605		$	-		$	12		$	-		$	15		$	67		$	101		$	-		$	-		$	800
Ending balance: related to loans collectively evaluated for impairment	$	7,347		$	2,017		$	2,453		$	588		$	338		$	932		$	485		$	18		$	201		$	14,379

Loans Held for Investment and Evaluated for Impairment

For the three and six months ended June 30, 2013

(In thousands)	Commercial real estate		Construction and land development		Commercial and industrial		Multi-family		Residential real estate		Leases		Tax certificates		Consumer		Unallocated		Total
LHFI
Ending balance	$	180,601	$	34,696	$	66,985	$	11,736	$	15,873	$	38,497	$	18,578	$	901	$	-	$	367,867
Ending balance: individually evaluated for impairment	$	13,022	$	4,082	$	8,038	$	-	$	-	$	169	$	484	$	-	$	-	$	25,795
Ending balance: collectively evaluated for impairment	$	167,579	$	30,614	$	58,947	$	11,736	$	15,873	$	38,328	$	18,094	$	901	$	-	$	342,072

Allowance for Loan and Leases Losses and Loans Held for Investment

For the year ended December 31, 2012

(In thousands)	Commercial real estate			Construction and land development			Commercial and industrial			Multi-family			Residential real estate			Leases			Tax certificates			Consumer		Unallocated			Total
Allowance for Loan and Leases Losses
Beginning balance	$	7,744		$	2,523		$	2,331		$	531		$	1,188		$	1,311		$	425		$	20	$	307		$	16,380
Charge-offs		(1,313	)		(2,452	)		(586	)		(542	)		(111	)		(465	)		(802	)		-		-			(6,271	)
Recoveries		3			816			67			-			208			32			29			-		-			1,155
Provision		2,316			2,100			112			665			(187	)		230			820			9		(68	)		5,997
Ending balance	$	8,750		$	2,987		$	1,924		$	654		$	1,098		$	1,108		$	472		$	29	$	239		$	17,261
Ending balance: related to loans individually evaluated for impairment	$	835		$	820		$	255		$	-		$	14		$	55		$	47		$	-	$	-		$	2,026
Ending balance: related to loans collectively evaluated for impairment	$	7,915		$	2,167		$	1,669		$	654		$	1,084		$	1,053		$	425		$	29	$	239		$	15,235
LHFI
Ending balance	$	167,115		$	37,215		$	40,560		$	11,756		$	24,981		$	37,347		$	24,569		$	1,139	$	-		$	344,682
Ending balance: individually evaluated for impairment	$	10,958		$	5,943		$	10,251		$	-		$	994		$	81		$	601		$	-	$	-		$	28,828
Ending balance: collectively evaluated for impairment	$	156,157		$	31,272		$	30,309		$	11,756		$	23,987		$	37,266		$	23,968		$	1,139	$	-		$	315,854

Allowance for Loan and Leases Losses

For the three months ended June 30, 2012

(In thousands)	Commercial real estate			Construction and land development		Commercial and industrial			Multi-family		Residential real estate			Leases			Tax certificates			Consumer		Unallocated		Total
Beginning balance	$	7,896		$	2,449	$	2,354		$	615	$	1,194		$	1,295		$	406		$	20	$	225	$	16,454
Charge-offs		-			-		(208	)		-		-			(162	)		(258	)		-		-		(628	)
Recoveries		-			87		55			-		1			7			4			-		-		154
Provision		(217	)		1,202		5			331		(70	)		72			180			-		12		1,515
Ending balance	$	7,679		$	3,738	$	2,206		$	946	$	1,125		$	1,212		$	332		$	20	$	237	$	17,495
Ending balance: related to loans individually evaluated for impairment	$	-		$	1,243	$	139		$	439	$	22		$	32		$	-		$	-	$	-	$	1,875
Ending balance: related to loans collectively evaluated for impairment	$	7,679		$	2,495	$	2,067		$	507	$	1,103		$	1,180		$	332		$	20	$	237	$	15,620

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Allowance for Loan and Leases Losses

For the six months ended June 30, 2012

(In thousands)	Commercial real estate			Construction and land development		Commercial and industrial			Multi-family		Residential real estate			Leases			Tax certificates			Consumer		Unallocated			Total
Beginning balance	$	7,744		$	2,523	$	2,331		$	531	$	1,188		$	1,311		$	425		$	20	$	307		$	16,380
Charge-offs		-			-		(208	)		-		-			(295	)		(278	)		-		-			(781	)
Recoveries		3			191		57			-		2			15			29			-		-			297
Provision		(68	)		1,024		26			415		(65	)		181			156			-		(70	)		1,599
Ending balance	$	7,679		$	3,738	$	2,206		$	946	$	1,125		$	1,212		$	332		$	20	$	237		$	17,495
Ending balance: related to loans individually evaluated for impairment	$	-		$	1,243	$	139		$	439	$	22		$	32		$	-		$	-	$	-		$	1,875
Ending balance: related to loans collectively evaluated for impairment	$	7,679		$	2,495	$	2,067		$	507	$	1,103		$	1,180		$	332		$	20	$	237		$	15,620

Loans Held for Investment and Evaluated for Impairment

For the three and six months ended June 30, 2012

(In thousands)	Commercial real estate		Construction and land development		Commercial and industrial		Multi-family		Residential real estate		Leases		Tax certificates		Consumer		Unallocated		Total
LHFI
Ending balance	$	166,315	$	46,548	$	47,567	$	13,008	$	26,556	$	37,775	$	34,094	$	973	$	-	$	372,836
Ending balance: individually evaluated for impairment	$	12,674	$	10,712	$	5,643	$	1,673	$	1,325	$	35	$	893	$	-	$	-	$	32,955
Ending balance: collectively evaluated for impairment	$	153,641	$	35,836	$	41,924	$	11,335	$	25,231	$	37,740	$	33,201	$	973	$	-	$	339,881

The following tables detail the loans that were evaluated for impairment by loan segment at June 30, 2013 and December 31, 2012.

	For the six months ended June 30, 2013
(In thousands)	Unpaid principal balance		Carrying value		Related allowance		Average recorded investment		Interest income recognized
With no related allowance recorded:
Construction and land development	$	11,196	$	4,082	$	-	$	3,469	$	27
Commercial real estate		10,090		7,822		-		7,443		70
Commercial and industrial		7,128		5,981		-		6,190		149
Residential real estate		-		-		-		226		27
Leasing		-		-		-		9		-
Tax certificates		-		-		-		73		-
Total:	$	28,414	$	17,885	$	-	$	17,410	$	273
With an allowance recorded:
Construction and land development	$	-	$	-	$	-	$	708	$	-
Commercial real estate		5,424		5,200		605		1,410		-
Commercial and industrial		2,315		2,057		12		2,627		-
Residential real estate		667		491		15		446		-
Leasing		169		169		67		78		-
Tax certificates		4,364		484		101		407		-
Total:	$	12,939	$	8,401	$	800	$	5,676	$	-

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	For the year ended December 31, 2012
(In thousands)	Unpaid principal balance		Carrying value		Related allowance		Average recorded investment		Interest income recognized
With no related allowance recorded:
Commercial real estate	$	10,417	$	8,623	$	-	$	11,163	$	78
Construction and land development		6,250		3,464		-		10,059		187
Commercial and industrial		7,790		6,820		-		5,545		73
Multi-family		-		-		-		780		-
Residential real estate		572		516		-		490		21
Tax certificates		-		-		-		583		-
Total:	$	25,029	$	19,423	$	-	$	28,620	$	359
With an allowance recorded:
Commercial real estate	$	4,136	$	2,335	$	835	$	1,526	$	-
Construction and land development		6,180		2,479		820		923		-
Commercial and industrial		9,585		3,431		255		682		-
Multi-family		-		-		-		383		-
Residential real estate		685		478		14		714		7
Leases		81		81		55		86		-
Tax certificates		4,408		601		47		288		-
Total:	$	25,075	$	9,405	$	2,026	$	4,602	$	7

Note 6.

Other Real Estate Owned

OREO decreased $433,000 from $13.4 million at December 31, 2012 to $13.0 million at June 30, 2013. Set forth below is a table which details the changes in OREO from December 31, 2012 to June 30, 2013.

	2013
(In thousands)	First Quarter			Second Quarter
Beginning balance	$	13,435		$	13,264
Net proceeds from sales		(2,277	)		(2,603	)
Net gain on sales		162			418
Assets acquired on non-accrual loans		1,956			2,252
Impairment charge		(12	)		(329	)
Ending balance	$	13,264		$	13,002

At June 30, 2013, OREO was comprised of $4.6 million in tax liens, $4.5 million in land, $3.6 million in commercial real estate, and residential real estate with a fair value of $283,000. During the second quarter of 2013, the Company sold collateral related to land, received net proceeds of $765,000 and recorded a net gain of $12,000.The Company also sold nine condominiums related to a construction project in Minneapolis, Minnesota in which the Company is a participant. The Company received its pro rata share of net proceeds in the amount of $99,000 and recorded a net gain of $37,000. T he Company also sold collateral related to two residential real estate loans. The Company received net proceeds of $114,000 and recorded a small net gain of $5,000. In addition to these second quarter sales, the Company sold 15 properties acquired through the tax lien portfolio. The Company received proceeds of $1.6 million and recorded net gains of $364,000 as a result of these sales. During the second quarter of 2013, the Company recorded impairment charges of $146,000 related to residential real estate and $183,000 related to properties acquired through the tax lien portfolio. In addition the Company acquired collateral related to the tax lien portfolio and transferred $2.3 million to OREO.

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D uring the first quarter of 2013, the Company sold collateral related to land, received net proceeds of $1.8 million and recorded a loss of $38,000. The Company also sold three condominiums related to a construction project mentioned above. The Company received its pro rata share of net proceeds in the amount of $24,000 and recorded a gain of $17,000. Additionally the Company sold four single family homes related to two loans. The Company received net proceeds of $43,000 and recorded a small net gain of $3,000. In addition to these first quarter sales, the Company sold eleven properties acquired through the tax lien portfolio. The Company received proceeds of $367,000 and recorded a net gain of $180,000 as a result of these sales. During the first quarter of 2013, the Company acquired collateral related to a residential real estate loan and transferred $100,000 to OREO. In addition the Company acquired collateral related to the tax lien portfolio and transferred $1.9 million to OREO. The Company recorded impairment charges of $12,000 related to properties acquired through the tax lien portfolio.

Note 7. Deposits

The Company’s deposit composition as of June 30, 2013 and December 31, 2012 is presented below:

	June 30,		December 31,
(In thousands)	2013		2012
Demand	$	66,121	$	58,531
NOW		42,201		43,920
Money Market		163,944		179,359
Savings		18,418		17,472
Time deposits (over $100)		84,795		91,233
Time deposits (under $100)		150,191		164,402
Total deposits	$	525,670	$	554,917

Note 8.

Borrowings and Subordinated Debentures

1. Advances from the Federal Home Loan Bank

The available borrowing capacity with the FHLB is based on qualified collateral. Royal Bank has a collateralized delivery requirement of 105% with the FHLB due to the level of Royal Bank’s non-performing assets and net losses. The available amount for future borrowings will be based on the amount of collateral to be pledged. Royal Bank has a $150 million line of credit with the FHLB of which $0 was outstanding as of June 30, 2013 and December 31, 2012. Total borrowings from the FHLB were $65.0 million at June 30, 2013 and December 31, 2012. The advances and the line of credit are collateralized by FHLB stock, government agencies and mortgage-backed securities, residential loans, and commercial real estate loans. As of June 30, 2013, investment securities with a market value of $63.1 million and loans with a book value of $39.6 million were pledged as collateral to the FHLB.

Presented below are the Company’s FHLB borrowings allocated by the year in which they mature with their corresponding weighted average rates:

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	As of June 30,					As of December 31,
(Dollars in thousands)	2013					2012
	Amount		Rate			Amount		Rate
Advances maturing in
2013	$	10,000		0.25	%		50,000		2.64	%
2015		10,000		0.71	%		-		-
2016		10,000		1.11	%		-		-
2017		25,000		1.46	%		15,000		1.39	%
2018		10,000		2.01	%		-		-
Total FHLB borrowings	$	65,000				$	65,000

As of June 30, 2013, there were no FHLB advances scheduled to mature in 2014.

2. Other borrowings

The Company has a note payable with PNC Bank (“PNC”) at June 30, 2013 in the amount of $3.1 million compared to $3.3 million at December 31, 2012. The note’s maturity date is August 25, 2016. The interest rate is a variable rate using rate index of one month LIBOR + 15 basis points and adjusts monthly. The interest rate at June 30, 2013 was 0.35%.

At June 30, 2013 and December 31, 2012, the Company had additional borrowings of $40.0 million from PNC which will mature on January 7, 2018. These borrowings have a weighted average interest rate of 3.65%. The note payable and the borrowings are secured by government agencies and mortgage-backed securities.

3. Subordinated debentures

The Company has outstanding $25.0 million of Trust Preferred Securities issued through two Delaware trust affiliates, Royal Bancshares Capital Trust I (“Trust I”) and Royal Bancshares Capital Trust II (“Trust II”) (collectively, the “Trusts”). The Company issued an aggregate principal amount of $12.9 million of floating rate junior subordinated debt securities to Trust I and an aggregate principal amount of $12.9 million of fixed/floating rate junior subordinated deferrable interest to Trust II. Both debt securities bear an interest rate of 2.42% at June 30, 2013, and reset quarterly at 3-month LIBOR plus 2.15%.

Each of Trust I and Trust II issued an aggregate principal amount of $12.5 million of capital securities initially bearing fixed and/or fixed/floating interest rates corresponding to the debt securities held by each trust to an unaffiliated investment vehicle and an aggregate principal amount of $387,000 of common securities bearing fixed and/or fixed/floating interest rates corresponding to the debt securities held by each trust to the Company. The Company has fully and unconditionally guaranteed all of the obligations of the Trusts, including any distributions and payments on liquidation or redemption of the capital securities.

On August 13, 2009, the Company’s Board of Directors determined to suspend interest payments on the trust preferred securities. Under the Federal Reserve MOU as described in “Note 2 – Regulatory Matters and Significant Risks or Uncertainties” to the consolidated financial statements, the Company and its non-bank subsidiaries may not make any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System. As of June 30, 2013 the trust preferred interest payment in arrears was $2.8 million and has been recorded in interest expense and accrued interest payable. The interest payment deferral period on the trust preferred securities ends after the second quarter of 2014. After the ending of the deferral period if the interest payments are not made then it would constitute an event of default which could impact the Company’s consolidated financial statements and liquidity.

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Note 9.

Commitments and Contingencies

The Company’s exposure to credit loss in the event of non-performance by the other party to commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

The contract amounts are as follows:

	June 30,		December 31,
(In thousands)	2013		2012
Financial instruments whose contract amounts represent credit risk:
Open-end lines of credit	$	23,609	$	20,515
Commitments to extend credit		10,748		24,030
Standby letters of credit and financial guarantees written		801		1,199

Litigation

From time to time, the Company is a party to routine legal proceedings within the normal course of business. Such routine legal proceedings in the aggregate are believed by management to be immaterial to the Company's financial condition or results of operations.

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On March 13, 2012, March 30, 2012, April 20, 2012, May 2, 2012, May 11, 2012, May 18, 2012, June 18, 2012 and June 29, 2012, the former President of CSC and RTL, CSC, RTL and the Company were named defendants, among others, in putative class action lawsuits filed in the U.S. District Court for the District of New Jersey (“Court”) on behalf of a proposed class of taxpayers who became delinquent in paying their municipal tax obligations: Boyer v. Robert W. Stein, Crusader Servicing Corp. Royal Tax Lien Services LLC, Royal Bancshares of Pennsylvania, Inc., et al., Superior Court of New Jersey, Chancery Division (“the Boyer Action”), Contarino v Robert W. Stein, Crusader Servicing Corp. Royal Tax Lien Services LLC, Royal Bancshares of Pennsylvania, Inc., et al., U.S. District Court for the District of New Jersey; MSC LLC v Robert W. Stein, Crusader Servicing Corp. Royal Tax Lien Services LLC, Royal Bancshares of Pennsylvania, Inc., et al., U.S. District Court for the District of New Jersey; English v Robert W. Stein, Crusader Servicing Corp. Royal Tax Lien Services LLC, Royal Bancshares of Pennsylvania, Inc., et al., U.S. District Court for the District of New Jersey; Ledford v Robert W. Stein, Crusader Servicing Corp. Royal Tax Lien Services LLC, Royal Bancshares of Pennsylvania, Inc., et al., U.S. District Court for the District of New Jersey; T&B Associates v Robert W. Stein, Crusader Servicing Corp. Royal Tax Lien Services LLC, Royal Bancshares of Pennsylvania, Inc., et al., U.S. District Court for the District of New Jersey; Jacobs et al v Robert W. Stein, Crusader Servicing Corp. Royal Tax Lien Services LLC, Royal Bancshares of Pennsylvania, Inc., et al., U.S. District Court for the District of New Jersey; Senatore Builders, LLC v Robert W. Stein, Crusader Servicing Corp. Royal Tax Lien Services LLC, Royal Bancshares of Pennsylvania, Inc., et al., U.S. District Court for the District of New Jersey, respectively alleging a conspiracy to rig bids in municipal tax lien auctions. On June 12, 2012, the Court entered an Order consolidating for pretrial purposes the above actions with all subsequently filed or transferred related actions, collectively referred to as In re New Jersey Tax Sale Certificates Antitrust Litigation . On October 22, 2012, the Court appointed two law firms as interim class counsel and another law firm as liaison class counsel and further ordered appointed counsel to a master complaint for the consolidated action. On December 21, 2012, plaintiffs filed a Consolidated Master Class Action Complaint (the “Complaint”) against numerous defendants, including the former President of CSC and RTL, Royal Bancshares of Pennsylvania, Inc., Royal Bank America, CSC and RTL. The Company filed a motion to dismiss the Complaint on March 8, 2013, which is currently pending before the Court. During the second quarter of 2013, the Company accrued a loss contingency of $1.65 million for a potential settlement with the plaintiffs. After adjusting for the noncontrolling interest, the Company’s 60% share of the loss contingency amounted to $990,000 on a pre-tax basis. Subsequently, Royal Bancshares of Pennsylvania, Inc., Royal Bank America, CSC, and RTL reached an agreement in principle with plaintiffs to settle the litigation for $1.65 million and other terms and conditions, including an opportunity for members of the proposed settlement class whose tax liens are currently held by CSC or RTL to redeem those liens for a one-time cash payment equaling 85% of the redemption amount by making such payment within 35 days of the date of written notice. The proposed settlement class does not include, and therefore the offer to redeem does not apply to, tax liens acquired at 0% interest or at a premium. The settlement is contingent upon negotiation of a definitive settlement agreement and is subject to Court approval after notice and a hearing. Members of the proposed settlement class will have an opportunity to object to the proposed settlement or opt-out.

On or about March 15, 2012, CSC, RTL and the Company were named defendants, among others, in a complaint filed by Marina Bay Towers Urban Renewal II, LP (“MBT”) in the Superior Court of New Jersey, Law Division, Cape May County. The complaint alleges essentially the same claims as asserted in the Complaint. However MBT does not seek to represent a class and only seeks remedies related to itself. As of the date of this filing, the Company cannot reasonably estimate the possible loss or range of loss that may result from this proceeding.

In 2005, the Company purchased $25.0 million in Class B-1 Notes of a collateralized debt obligation (“CDO”) offered by Lehman Brothers, Inc. Concurrently with the issuance of the notes, the issuer entered into a credit swap with Lehman Brothers Special Financing (“LBSF”). Lehman Brothers Holdings, Inc. (“LBHI”) guaranteed LBSF’s obligations to the issuer under the credit swap. When LBHI filed for bankruptcy in September 2008, an event of default under the indenture occurred, and the trustee declared the notes to be immediately due and payable. The Company was repaid its principal on the notes in September 2008. In September 2010, LBSF filed suit in the United States Bankruptcy court for the Southern District of New York against certain indenture trustees, certain special-purpose entities (issuers) and a class of noteholders and trust certificate holders who received distributions from the trustees, to recover funds that were allegedly improperly paid to the noteholders in forty-seven separate CDO transactions. In July 2012, LBSF added the Company as a defendant in the proceeding. In June 2013, LBSF voluntarily dismissed without prejudice and without costs all claims against the Company related to the CDO transaction.

- 30 -

Note 10.

Shareholders’ Equity

A.	Preferred Stock

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 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. The Company has utilized the extra capital provided by the CPP funds to support its efforts to prudently and transparently provide lending and liquidity while also balancing the goal to remain well-capitalized.

B.	Common Stock

The Company’s Class A common stock trades 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. Each shareholder is entitled to one vote for each Class A share held and ten votes for each Class B share held. Holders of either class of common stock are entitled to conversion equivalent per share dividends when declared.

C. Payment of Dividends

Under the Pennsylvania Business Corporation Law, the Company may pay dividends only if it is solvent and would not be rendered insolvent by the dividend payment. There are also restrictions set forth in the Pennsylvania Banking Code of 1965 (the “Code”) and in the Federal Deposit Insurance Act (“FDIA”) affecting the payment of dividends by the Company. Under the Code, no dividends may be paid by a bank except from “accumulated net earnings” (generally retained earnings). Under the FDIA, no dividend may be paid if a bank is in arrears in the payment of any insurance assessment due to the FDIC. In addition, dividends paid by Royal Bank to the Company would be prohibited if the effect thereof would cause Royal Bank’s capital to be reduced below applicable minimum capital requirements. At June 30, 2013, 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. Royal Bank must receive prior approval from the FDIC and the Department before declaring and paying a dividend to the Company.

On August 13, 2009, the Company’s Board of Directors determined to suspend regular quarterly cash dividends on the $30.4 million in Series A Preferred Stock. The Company’s Board of Directors took this action in consultation with the Federal Reserve Bank of Philadelphia as required by regulatory policy guidance. The Company currently has sufficient liquidity to pay the scheduled dividends on the preferred stock; however, this decision better supports the capital position of Royal Bank, a wholly owned subsidiary of the Company. As of June 30, 2013, the Series A Preferred stock dividend in arrears was $6.8 million and has not been recognized in the consolidated financial statements. In the event the Company declared the preferred dividend the Company’s capital ratios would be negatively affected however they would remain above the required minimum ratios. In February 2014, the preferred cumulative dividend rate will prospectively increase to 9% per annum.

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Note 11.

Regulatory Capital Requirements

The Company and Royal Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s and Royal Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Under the informal agreement referenced in “Note 2 – Regulatory Matters and Significant Risks And Uncertainties” to the consolidated financial statements, Royal Bank is required to maintain a minimum Tier 1 leverage ratio of 8% and a Total risk-based capital ratio of 12%. As of June 30, 2013, the Company and Royal Bank met all capital adequacy requirements to which it is subject and Royal Bank met the criteria for a well capitalized institution.

In connection with a prior bank regulatory examination, the FDIC concluded, based upon its interpretation of the Call Report instructions and under RAP, that income from Royal Bank’s tax lien business should be recognized on a cash basis, not an accrual basis. Royal Bank’s current accrual method is in accordance with U.S. GAAP. Royal Bank disagrees with the FDIC’s conclusion and filed the Call Report for June 30, 2013 and the previous eleven quarters in accordance with U.S. GAAP. The change in the method of revenue recognition for the tax lien business for regulatory accounting purposes affects Royal Bank’s and the Company’s capital ratios as shown below. Royal Bank is in discussions with the FDIC to resolve the matter.

The table below sets forth Royal Bank’s capital ratios under RAP based on the FDIC’s interpretation of the Call Report instructions:

	As of June 30, 2013
											To be well capitalized
						For capital					capitalized under prompt
	Actual					adequacy purposes					corrective action provision
(Dollars in thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total capital (to risk-weighted assets)	$	72,511		15.45	%	$	37,536		8.00	%	$	46,919		10.00	%
Tier I capital (to risk-weighted assets)	$	66,531		14.18	%	$	18,768		4.00	%	$	28,152		6.00	%
Tier I capital (to average assets, leverage)	$	66,531		9.09	%	$	29,267		4.00	%	$	36,584		5.00	%

The tables below reflect the adjustments to the net loss as well as the capital ratios for Royal Bank under U.S. GAAP:

	For the six
	months ended
(In thousands)	June 30, 2013
RAP net loss	$	(4,377	)
Tax lien adjustment, net of noncontrolling interest		3,883
U.S. GAAP net loss	$	(494	)

	At June 30, 2013
	As reported			As adjusted
	under RAP			for U.S. GAAP
Total capital (to risk-weighted assets)		15.45	%		16.62	%
Tier I capital (to risk-weighted assets)		14.18	%		15.35	%
Tier I capital (to average assets, leverage)		9.09	%		9.89	%

The tables below reflect the Company’s capital ratios:

- 32 -

	As of June 30, 2013
											To be well capitalized
						For capital					capitalized under prompt
	Actual					adequacy purposes					corrective action provision
(Dollars in thousands)	Amount		Ratio			Amount		Ratio			Amount			Ratio
Total capital (to risk-weighted assets)	$	87,801		18.29	%	$	38,406		8.00	%		N/	A		N/	A
Tier I capital (to risk-weighted assets)	$	75,777		15.78	%	$	19,203		4.00	%		N/	A		N/	A
Tier I capital (to average assets, leverage)	$	75,777		10.17	%	$	29,801		4.00	%		N/	A		N/	A

The Company has filed the Consolidated Financial Statements for Bank Holding Companies-FR Y-9C (“FR Y-9C”) as of June 30, 2013 consistent with U.S. GAAP and the FR Y-9C instructions. In the event that a similar adjustment for RAP purposes would be required by the Federal Reserve on the holding company level, the adjusted ratios are shown in the table below.

	For the six
	months ended
(In thousands)	June 30, 2013
U.S. GAAP net loss	$	(685	)
Tax lien adjustment, net of noncontrolling interest		(3,883	)
RAP net loss	$	(4,568	)

	At June 30, 2013
	As reported			As adjusted
	under U.S. GAAP			for RAP
Total capital (to risk-weighted assets)		18.29	%		17.16	%
Tier I capital (to risk-weighted assets)		15.78	%		14.18	%
Tier I capital (to average assets, leverage)		10.17	%		9.09	%

Note 12.

Pension Plan

The Company has a noncontributory nonqualified defined benefit pension plan (“Pension Plan”) covering certain eligible employees. The Company’s Pension Plan provides retirement benefits under pension trust agreements. The benefits are based on years of service and the employee’s compensation during the highest three consecutive years during the last 10 years of employment.

Net periodic defined benefit pension expense for the three and six month periods ended June 30, 2013 and 2012 included the following components:

	Three months ended				Six months ended
	June 30,				June 30,
(In thousands)	2013		2012		2013		2012
Service cost	$	19	$	68	$	37	$	136
Interest cost		133		144		266		296
Amortization of prior service cost		22		22		45		44
Amortization of actuarial loss		123		95		245		191
Net periodic benefit cost	$	297	$	329	$	593	$	667

- 33 -

The Company has unfunded pension plan obligations of $16.7 million as of June 30, 2013 compared to $16.9 million at December 31, 2012. The Company plans to fund the pension plan obligations through existing Company owned life insurance policies.

Note 13.

Loss Per Common Share

The Company follows the provisions of FASB ASC Topic 260, “Earnings per Share” (“ASC Topic 260”). Basic earnings per share (“EPS”) excludes dilution and is computed by dividing income available to common shareholders by the weighted average common shares outstanding during the period. The Company has two classes of common stock currently outstanding. The classes are A and B, of which one share of Class B is convertible into 1.15 shares of Class A. Diluted EPS takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock using the treasury stock method. For the three months and six months ended June 30, 2013, 215,317 options to purchase shares of common stock, respectively, were anti-dilutive in the computation of diluted EPS, as exercise price exceeded average market price and as a result of the net loss for the three months and six months ended June 30, 2013. For the three months and six months ended June 30, 2012, 466,876 options to purchase shares of common stock, respectively, were anti-dilutive in the computation of diluted EPS, as exercise price exceeded average market price and as a result of the net loss for the three months and six months ended June 30, 2012. Additionally 30,407 warrants were also anti-dilutive for all periods presented below.

Basic and diluted EPS for the three and six months ended June 30, 2013 and 2012 are calculated as follows:

	Three months ended June 30, 2013
	Loss			Average shares		Per share
(In thousands, except for per share data)	(numerator)			(denominator)		Amount
Basic and Diluted EPS
Loss available to common shareholders	$	(1,321	)		13,257	$	(0.10	)

	Three months ended June 30, 2012
	Loss			Average shares		Per share
(In thousands, except for per share data)	(numerator)			(denominator)		Amount
Basic and Diluted EPS
Loss available to common shareholders	$	(2,458	)		13,257	$	(0.19	)

	Six months ended June 30, 2013
	Loss			Average shares		Per share
(In thousands, except for per share data)	(numerator)			(denominator)		Amount
Basic and Diluted EPS
Loss available to common shareholders	$	(1,718	)		13,257	$	(0.13	)

	Six months ended June 30, 2012
	Loss			Average shares		Per share
(In thousands, except for per share data)	(numerator)			(denominator)		Amount
Basic and Diluted EPS
Loss available to common shareholders	$	(3,833	)		13,257	$	(0.29	)

- 34 -

Note 14.

Comprehensive Income

FASB ASC Topic 220, “Comprehensive Income” (“ASC Topic 220”), requires the reporting of all changes in equity during the reporting period except investments from and distributions to shareholders. Net income (loss) is a component of comprehensive income (loss) with all other components referred to in the aggregate as other comprehensive income (loss). Unrealized gains and losses on AFS securities is an example of an other comprehensive income component.

	Six months ended June 30, 2013
(In thousands)	Before tax amount			Tax expense (benefit)			Net of tax amount
Unrealized losses on investment securities:
Unrealized holding losses arising during period	$	(6,251	)	$	(2,233	)	$	(4,018	)
Less reclassification adjustment for gains realized in net loss		70			24			46
Unrealized losses on investment securities		(6,321	)		(2,257	)		(4,064	)
Unrecognized benefit obligation expense:
Less reclassification adjustment for amortization		(287	)		(98	)		(189	)
Other comprehensive loss, net	$	(6,034	)	$	(2,159	)	$	(3,875	)

	Six months ended June 30, 2012
(In thousands)	Before tax amount			Tax expense (benefit)			Net of tax amount
Unrealized gains on investment securities:
Unrealized holding losses arising during period	$	(310	)	$	(81	)	$	(229	)
Less adjustment for impaired investments		(859	)		(301	)		(558	)
Less reclassification adjustment for gains realized in net loss		159			56			103
Unrealized gains on investment securities		390			164			226
Unrecognized benefit obligation expense:
Less reclassification adjustment for amortization		(176	)		(62	)		(114	)
Other comprehensive income, net	$	566		$	226		$	340

Note 15.

Fair Value of Financial Instruments

Under FASB ASC Topic 820 “Fair Value Measurements” (“ASC Topic 820”), fair values are based on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When available, management uses quoted market prices to determine fair value. If quoted prices are not available, fair value is based upon valuation techniques such as matrix pricing or other models that use, where possible, current market-based or independently sourced market parameters, such as interest rates. If observable market-based inputs are not available, the Company uses unobservable inputs to determine appropriate valuation adjustments using discounted cash flow methodologies.

Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in sales transactions on the dates indicated. The estimated fair value amounts have been measured as of their respective period end and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each period-end.

- 35 -

ASC Topic 820 provides guidance for estimating fair value when the volume and level of activity for an asset or liability has significantly declined and for identifying circumstances when a transaction is not orderly. ASC Topic 820 establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under ASC Topic 820 are as follows:

Level 1 :

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

Level 2:

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

Level 3:

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

A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company did not have transfers of financial instruments within the fair value hierarchy during the three and six months ended June 30, 2013 and 2012.

Items Measured on a Recurring Basis

The Company’s available for sale investment securities are recorded at fair value on a recurring basis.

Fair value for Level 1 securities are determined by obtaining quoted market prices on nationally recognized securities exchanges. Level 1 securities include common stocks.

Level 2 securities include obligations of U.S. government-sponsored agencies, debt securities with quoted prices, which are traded less frequently than exchange-traded instruments, whose value is determined using matrix pricing with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. The prices were obtained from third party vendors. This category generally includes mortgage-backed securities and CMOs issued by U.S. government and government-sponsored agencies, non-agency CMOs, and corporate and municipal bonds.

Level 3 securities include investments in seven private equity funds which are predominantly invested in real estate. The value of the private equity funds are derived from the funds’ financials and K-1 filings. The Company also reviews the funds’ asset values and its near-term projections.

For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at June 30, 2013 and December 31, 2012 are as follows:

- 36 -

	Fair Value Measurements Using:
	Quoted Prices
	in Active		Significant
	Markets for		Other		Significant
	Identical		Observable		Unobservable
Balances as of June 30, 2013	Assets		Inputs		Inputs
(In thousands)	Level 1		Level 2		Level 3		Fair Value
Investment securities available-for-sale
U.S. government agencies	$	-	$	71,172	$	-	$	71,172
Mortgage-backed securities-residential		-		32,921		-		32,921
Collateralized mortgage obligations-residential		-		180,509		-		180,509
Corporate bonds		-		9,730		-		9,730
Municipal bonds		-		5,331		-		5,331
Other securities		-		-		4,407		4,407
Common stocks		46		-		-		46
Total investment securities available-for-sale	$	46	$	299,664	$	4,407	$	304,117

	Fair Value Measurements Using:
	Quoted Prices
	in Active		Significant
	Markets for		Other		Significant
	Identical		Observable		Unobservable
Balances as of December 31, 2012	Assets		Inputs		Inputs
(In thousands)	Level 1		Level 2		Level 3		Fair Value
Investment securities available-for-sale
U.S. government agencies	$	-	$	66,444	$	-	$	66,444
Mortgage-backed securities-residential		-		30,509		-		30,509
Collateralized mortgage obligations:
Issued or guaranteed by U.S. government agencies		-		233,976		-		233,976
Non-agency		-		1,011		-		1,011
Corporate bonds		-		7,437		-		7,437
Municipal bonds		-		5,615		-		5,615
Other securities		-		-		4,164		4,164
Common stocks		47		-		-		47
Total investment securities available-for-sale	$	47	$	344,992	$	4,164	$	349,203

The following table presents additional information about assets measured at fair value on a recurring basis and for which the Company has utilized Level 3 inputs to determine fair value for the six months ended June 30, 2013 and 2012:

- 37 -

(In thousands)
Investment Securities Available for Sale	Other securities
Beginning balance January 1, 2013	$	4,164
Total gains/(losses) - (realized/unrealized):
Included in earnings		5
Included in other comprehensive income		319
Purchases		32
Sales and calls		(113	)
Transfers in and/or out of Level 3		-
Ending balance June 30, 2013	$	4,407

	Investment Securities Available for Sale
	Trust
	preferred			Other
(In thousands)	securities			securities			Total
Beginning balance January 1, 2012	$	12,603		$	6,918		$	19,521
Total gains/(losses) - (realized/unrealized):
Included in earnings		-			(818	)		(818	)
Included in other comprehensive income		(608	)		(151	)		(759	)
Purchases		-			499			499
Sales and calls		-			(530	)		(530	)
Amortization of premium		(13	)		-			(13	)
Transfers in and/or out of Level 3		-			-			-
Ending balance June 30, 2012	$	11,982		$	5,918		$	17,900

Items Measured on a Nonrecurring Basis

Non-accrual loans and TDRs are evaluated for impairment on an individual basis under FASB ASC Topic 310 “Receivables”. The impairment analysis includes current collateral values, known relevant factors that may affect loan collectability, and risks inherent in different kinds of lending. When the collateral value or discounted cash flows less costs to sell is less than the carrying value of the loan a specific reserve (valuation allowance) is established. Loans held for sale are carried at the lower of cost or fair value. OREO is carried at the lower of cost or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.

For financial assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at June 30, 2013 and December 31, 2012 are as follows:

- 38 -

	Fair Value Measurements Using:
	Quoted Prices
	in Active		Significant
	Markets for		Other		Significant
	Identical		Observable		Unobservable
Balances as of June 30, 2013	Assets		Inputs		Inputs
(In thousands)	Level 1		Level 2		Level 3		Fair Value
Assets
Impaired loans and leases	$	-	$	-	$	7,601	$	7,601
Other real estate owned		-		-		4,585		4,585
Loans and leases held for sale		-		-		1,419		1,419

	Fair Value Measurements Using:
	Quoted Prices
	in Active		Significant
	Markets for		Other		Significant
	Identical		Observable		Unobservable
Balances as of December 31, 2012	Assets		Inputs		Inputs
(In thousands)	Level 1		Level 2		Level 3		Fair Value
Assets
Impaired loans and leases	$	-	$	-	$	9,180	$	9,180
Other real estate owned		-		-		7,632		7,632
Loans and leases held for sale		-		-		1,572		1,572

The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis and for which the Company has utilized Level 3 inputs to determine fair value:

	Qualitative Information about Level 3 Fair Value Measurements
Balances as of June 30, 2013			Valuation	Unobservable	Range (Weighted
(In thousands)	Fair Value		Techniques	Input	Average)
Impaired loans and leases	$	7,601	Appraisal of collateral (1)	Appraisal adjustments	0.0% to -15.8% (-11.9%)
				Liquidation expenses	0.0% to -16.4% (-8.1%)

			Salvageable value of			0.0	%
			collateral (2)

Other real estate owned		4,585	Appraisal of collateral (1)	Appraisal adjustments	0.0% to -81.1% (-5.4%)

Loans and leases held for sale		1,419	Sales prices	Liquidation expenses		-14.0	%

(1)

Appraisals may be adjusted for qualitative factors such as interior condition of the property and liquidation expenses. Fair value may also be based on negotiated settlements with the borrower.

(2)

Leases are measured using the salvageable value of the collateral.

The following methods and assumptions were used to estimate the fair values of the Company’s financial instruments at June 30, 2013 and December 31, 2012. The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful. The methodologies for estimating the fair value of financial instruments that are measured on a recurring or nonrecurring basis are discussed above.

- 39 -

Cash and cash equivalents (carried at cost):

The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets’ fair values.

Securities:

Management uses quoted market prices to determine fair value of securities (level 1). If quoted prices are not available, fair value is based upon valuation techniques such as matrix pricing or other models that use, where possible, current market-based or independently sourced market parameters, such as interest rates (level 2). If observable market-based inputs are not available, the Company uses unobservable inputs to determine appropriate valuation adjustments by reviewing the private equities funds’ financials and K-1 filings (level 3).

Other Investment (carried at cost):

This investment includes the Solomon Hess SBA Loan Fund, which the Company invested in to partially satisfy its community reinvestment requirement. Shares in this fund are not publicly traded and therefore have no readily determinable fair market value. An investor can have their investment in the Fund redeemed for the balance of their capital account at any quarter end with 60 days notice to the Fund. The investment in this Fund is recorded at cost. The fair value is computed by applying the Company’s ownership percentage of the fund to the fund’s net asset value at year end.

Restricted investment in bank stock (carried at cost):

The carrying amount of restricted investment in bank stock approximates fair value and considers the limited marketability of such securities.

Loans held for sale (carried at lower of cost or fair value):

The fair values of loans held for sale are based upon appraised values of the collateral less costs to sell, management’s estimation of the value of the collateral or expected net sales proceeds. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Loans receivable (carried at cost):

The fair values of loans are estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect the credit and interest rate-risk inherent in the loans. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Generally, for variable rate loans that re-price frequently and with no significant change in credit risk, fair values are based on carrying values.

Impaired loans (generally carried at fair value):

Impaired loans are accounted for under ASC Topic 310.Impairedloans are those in which the Company has measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based on the expected proceeds. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Accrued interest receivable and payable (carried at cost):

The carrying amount of accrued interest receivable and accrued interest payable approximates its fair value.

- 40 -

Deposit liabilities (carried at cost):

The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Short-term borrowings (carried at cost):

The carrying amounts of short-term borrowings approximate their fair values.

Long-term debt (carried at cost):

Fair values of FHLB advances and other long-term borrowings are estimated using discounted cash flow analysis, based on quoted prices for new FHLB advances with similar credit risk characteristics, terms and remaining maturity. These prices obtained from this active market represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party.

Subordinated debt (carried at cost):

Fair values of junior subordinated debt are estimated using discounted cash flow analysis, based on market rates currently offered on such debt with similar credit risk characteristics, terms and remaining maturity.

Off-balance sheet financial instruments (disclosed at cost):

Fair values for the Company’s off-balance sheet financial instruments (lending commitments and letters of credit) are based on fees currently charged in the market to enter into similar agreements, taking into account, the remaining terms of the agreements and the counterparties’ credit standing. They are not shown in the table because the amounts are immaterial.

The tables below state the fair value of the Company’s financial instruments at June 30, 2013 and December 31, 2012.

- 41 -

					Fair Value Measurements
					At June 30, 2013
					Quoted Prices
					in Active		Significant
					Markets for		Other		Significant
					Identical		Observable		Unobservable
	Carrying		Estimated		Assets		Inputs		Inputs
(In thousands)	amount		fair value		Level 1		Level 2		Level 3
Financial Assets:
Cash and cash equivalents	$	24,782	$	24,782	$	24,782	$	-	$	-
Investment securities available-for-sale		304,117		304,117		46		299,664		4,407
Other investment		2,250		2,250		-		-		2,250
Federal Home Loan Bank stock		4,594		4,594		-		-		4,594
Loans held for sale		1,419		1,419		-		-		1,419
Loans, net		352,688		351,840		-		-		351,840
Accrued interest receivable		8,733		8,733		-		8,733		-
Financial Liabilities:
Demand deposits		66,121		66,121		-		66,121		-
NOW and money markets		206,145		206,145		-		206,145		-
Savings		18,418		18,418		-		18,418		-
Time deposits		234,986		233,071		-		233,071		-
Short-term borrowings		10,000		10,000		10,000		-		-
Long-term borrowings		98,108		95,385		-		95,385		-
Subordinated debt		25,774		23,970		-		23,970		-
Accrued interest payable		4,917		4,917		-		4,917		-

					Fair Value Measurements
					At December 31, 2012
					Quoted Prices
					in Active		Significant
					Markets for		Other		Significant
					Identical		Observable		Unobservable
	Carrying		Estimated		Assets		Inputs		Inputs
(In thousands)	amount		fair value		Level 1		Level 2		Level 3
Financial Assets:
Cash and cash equivalents	$	28,802	$	28,802	$	28,802	$	-	$	-
Investment securities available-for-sale		349,203		349,203		47		344,992		4,164
Other investment		2,250		2,250		-		-		2,250
Federal Home Loan Bank stock		6,011		6,011		-		-		6,011
Loans held for sale		1,572		1,572		-		-		1,572
Loans, net		326,904		330,260		-		-		330,260
Accrued interest receivable		10,256		10,256		-		10,256		-
Financial Liabilities:
Demand deposits		58,531		58,531		-		58,531		-
NOW and money markets		223,279		223,279		-		223,279		-
Savings		17,472		17,472		-		17,472		-
Time deposits		255,635		251,532		-		251,532		-
Long-term borrowings		108,333		102,824		-		102,824		-
Subordinated debt		25,774		23,837		-		23,837		-
Accrued interest payable		3,760		3,760		-		3,760		-

- 42 -

Limitations

The fair value estimates are made at a discrete point in time based on relevant market information and information about the financial instruments. Fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors.

These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Further, the foregoing estimates may not reflect the actual amount that could be realized if all or substantially all of the financial instruments were offered for sale. This is due to the fact that no market exists for a sizable portion of the loan, deposit and off balance sheet instruments.

In addition, the fair value estimates are based on existing on-and-off balance sheet financial instruments without attempting to value anticipated future business and the value of assets and liabilities that are not considered financial instruments. Other significant assets that are not considered financial assets include premises and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.

Finally, reasonable comparability between financial institutions may not be likely due to the wide range of permitted valuation techniques and numerous estimates which must be made given the absence of active secondary markets for many of the financial instruments. This lack of uniform valuation methodologies introduces a greater degree of subjectivity to these estimated fair values.

Note 16.

Segment Information

FASB ASC Topic 280, “Segment Reporting” (“ASC Topic 280”) established standards for public business enterprises to report information about operating segments in their annual financial statements and requires that those enterprises report selected information about operating segments in subsequent interim financial reports issued to shareholders. It also established standards for related disclosure about products and services, geographic areas, and major customers. Operating segments are components of an enterprise, which are evaluated regularly by the chief operating decision makers in deciding how to allocate and assess resources and performance. The Company’s chief operating decision makers are the CEO and the Chief Administrative and Risk Officer (“CARO”).The Company has identified its reportable operating segments as “Community Banking” and “Tax Liens”.

Community banking

The Company’s Community Banking segment which includes Royal Bank consists of commercial and retail banking and leasing. The Community Banking business segment is managed as a single strategic unit which generates revenue from a variety of products and services provided by Royal Bank. For example, commercial lending is dependent upon the ability of Royal Bank to fund cash needed to make loans with retail deposits and other borrowings and to manage interest rate and credit risk.

Tax lien operation

The Company’s Tax Lien Operation consists of purchasing delinquent tax certificates from local municipalities at auction and then processing those liens to either encourage the property holder to pay off the lien, or to foreclose and sell the property. The tax lien operation earns income based on interest rates (determined at auction) and penalties assigned by the municipality along with gains on sale of foreclosed properties.

The following tables present selected financial information for reportable business segments for the three and six month periods ended June 30, 2013 and 2012.

- 43 -

	Three months ended June 30, 2013
	Community			Tax Lien
(In thousands)	Banking			Operation			Consolidated
Total assets	$	717,220		$	31,381		$	748,601
Total deposits	$	525,670		$	-		$	525,670
Interest income	$	6,077		$	666		$	6,743
Interest expense		1,415			382			1,797
Net interest income	$	4,662		$	284		$	4,946
(Credit) provision for loan and lease losses		(431	)		268			(163	)
Total other income		550			411			961
Total other expenses		5,054			2,513			7,567
Income tax expense (benefit)		-			-			-
Net income (loss )	$	589		$	(2,086	)	$	(1,497	)
Noncontrolling interest	$	140		$	(834	)	$	(694	)
Net income (loss) attributable to Royal Bancshares	$	449		$	(1,252	)	$	(803	)

	Three months ended June 30, 2012
	Community			Tax Lien
(In thousands)	Banking			Operation			Consolidated
Total assets	$	779,932		$	50,694		$	830,626
Total deposits	$	582,292		$	-		$	582,292
Interest income	$	7,074		$	1,349		$	8,423
Interest expense		1,811			706			2,517
Net interest income	$	5,263		$	643		$	5,906
Provision for loan and lease losses		1,334			181			1,515
Total other income		1,797			148			1,945
Total other expenses		6,811			1,781			8,592
Income tax expense (benefit)		306			(306	)		-
Net loss	$	(1,391	)	$	(865	)	$	(2,256	)
Noncontrolling interest	$	40		$	(346	)	$	(306	)
Net loss attributable to Royal Bancshares	$	(1,431	)	$	(519	)	$	(1,950	)

- 44 -

	Six months ended June 30, 2013
	Community			Tax Lien
(In thousands)	Banking			Operation			Consolidated
Total assets	$	717,220		$	31,381		$	748,601
Total deposits	$	525,670		$	-		$	525,670
Interest income	$	12,026		$	1,469		$	13,495
Interest expense		2,965			812			3,777
Net interest income	$	9,061		$	657		$	9,718
(Credit) provision for loan and lease losses		(741	)		327			(414	)
Total other income		1,712			657			2,369
Total other expenses		10,665			3,042			13,707
Income tax expense (benefit)		-			-			-
Net income (loss )	$	849		$	(2,055	)	$	(1,206	)
Noncontrolling interest	$	301		$	(822	)	$	(521	)
Net income (loss) attributable to Royal Bancshares	$	548		$	(1,233	)	$	(685	)

	Six months ended June 30, 2012
	Community			Tax Lien
(In thousands)	Banking			Operation			Consolidated
Total assets	$	779,932		$	50,694		$	830,626
Total deposits	$	582,292		$	-		$	582,292
Interest income	$	14,291		$	2,938		$	17,229
Interest expense		3,712			1,618			5,330
Net interest income	$	10,579		$	1,320		$	11,899
Provision for loan and lease losses		1,443			156			1,599
Total other income		2,586			20			2,606
Total other expenses		12,583			4,076			16,659
Income tax expense (benefit)		357			(357	)		-
Net loss	$	(1,218	)	$	(2,535	)	$	(3,753	)
Noncontrolling interest	$	80		$	(1,014	)	$	(934	)
Net loss attributable to Royal Bancshares	$	(1,298	)	$	(1,521	)	$	(2,819	)

Interest income earned by the Community Banking segment related to the Tax Lien Operation was approximately $382,000 and $706,000 for the three month periods ended June 30, 2013 and 2012, respectively and $812,000 and $1.6 million for the six months ended June 30, 2013 and 2012, respectively.

Note 17.

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 June 30, 2013 and December 31, 2012, FHLB stock totaled $4.6 million and $6.0 million, respectively.

FHLB stock is held as a long-term investment and its value is determined based on the ultimate recoverability of the par value. 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. 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 June 30, 2013.

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ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis is intended to assist in understanding and evaluating the changes in the financial condition and earnings performance of the Company and its subsidiaries for the three and six month periods ended June 30, 2013 and 2012. This discussion and analysis should be read in conjunction with the Company’s consolidated financial statements and notes thereto for the year ended December 31, 2012, included in the Company’s Form 10-K for the year ended December 31, 2012.

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.

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

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. Applications of the principles in the Company’s preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires 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.

Note 1 to the Company’s consolidated financial statements (included in Item 8 of the Form 10-K for the year ended December 31, 2012) lists significant accounting policies used in the development and presentation of the Company’s consolidated financial statements. The following discussion and analysis, the significant accounting policies, and other financial statement disclosures identify and address key variables and other quantitative and qualitative factors that are necessary for an understanding and evaluation of the Company and its results of operations. We complete an internal review of this financial information. This review requires substantive judgment and estimation. As disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012, we have identified other-than-temporary impairment on investment securities, accounting for allowance for loan and lease losses, deferred tax assets, loans held for sale, the valuation of other real estate owned, net periodic pension costs and the pension benefit obligation as among the most critical accounting policies and estimates. These critical accounting policies and estimates are important to the presentation of the Company’s financial condition and results of operations, and they require difficult, subjective or complex judgments as a result of the need to make estimates.

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Financial Highlights and Business Results

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 Royal Bancshares and were exchanged on a one-for-one basis for common stock of Royal Bancshares. The principal activities of the Company are supervising Royal Bank, which engages 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.

The chief sources of revenue for the Company are interest income from extending loans and from investing in security instruments, mostly through its subsidiary Royal Bank. Royal Bank principally generates commercial real estate loans primarily secured by first mortgage liens, construction loans for commercial real estate projects and residential home development, land development loans, tax liens and leases. At June 30, 2013, commercial real estate loans, commercial and industrial loans, leases, and construction and land development loans comprised 49%, 18%, 10%, and 9%, respectively, of Royal Bank’s loan portfolio. Construction loans and land development loans can have more risk associated with them, especially when a weakened economy, such as we have experienced the past few years, adversely impacts the commercial rental or home sales market. Net earnings of the Company are largely dependent on taking in deposits at competitive market rates, and then redeploying those deposited funds into loans and investments in securities at rates higher than those paid to the depositors to earn an interest rate spread. Refer to the “Net Interest Income and Net Interest Margin” section in Management’s Discussion and Analysis of Financial Condition and Results of Operation below for additional information on interest yield and cost.

Like many other financial institutions the Company’s financial results were negatively impacted by the recession, but the effects on the Company were more pronounced than the effects on its competitors. The concentration of commercial real estate loans coupled with the introduction of additional lines of business resulted in a much higher level of non-performing loans and losses. The past losses were partially attributed to charge-offs and impairment of commercial, construction and land loans associated with real estate projects, many of which were participation loans outside the Company’s primary market. Some of the participation loans were located in Florida, Nevada, North Carolina and other markets that were overbuilt during the construction boom within the United States from 2000-2007. The Company also launched new business initiatives such as mezzanine lending, real estate joint ventures, hard money lending and equity investments in real estate shortly before the housing bubble burst which contributed to the losses. Additionally, the Company experienced a high level of investment impairment associated with corporate bonds, common stocks, private label mortgage backed securities and real estate investment funds that experienced declines in value during the past few years. Also contributing to the losses were increased costs associated with the high level of non-performing assets, legal expenses related to credit quality issues and the U. S. Department of Justice (“DOJ”) tax lien investigation (for additional information refer to Item 1 “Legal Proceedings” under Part II “Other Information” of this Form 10-Q), and higher Federal Deposit Insurance Corporation (“FDIC”) assessments resulting from the higher rates for deposit insurance due to the Orders to Cease and Desist (the “Orders”) which were issued in 2009 and replaced in 2011 with an informal agreement, known as a memorandum of understanding (“MOU”). Finally, the establishment of a valuation allowance in 2008 and subsequent years that currently amounts to $39.6 million, has prevented the Company from utilizing tax credits on losses during the past five years.

While the Company’s deleveraging strategy improved the risk profile of the Company by shedding higher risk assets and paying off higher cost brokered CDs, it has had a negative impact on income. The deleveraging has resulted in lower average loan balances and a higher proportion of lower yielding investment securities, which have negatively impacted net interest income, a principal source of income. While the Company still expects external headwinds and credit quality costs associated with non-performing assets to negatively affect financial results, over time their impact may decline as the overall level of non-performing assets declines.

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After announcing the retirements of the Company’s Chief Executive Officer (“CEO”) and President during the second quarter of 2012, the Company’s Board conducted an executive search for a candidate for the combined role of President and CEO. On December 18, 2012 the Company announced F. Kevin Tylus as President and CEO of Royal Bank. On February 20, 2013, the Company announced that Mr. Tylus was appointed President, CEO and a Class III member of the Board of Directors of the Company. Former CEO, Robert Tabas, remains as Chairman of the Board of Directors. Recently the Company launched a new website, which takes advantage of the latest technologies and trends in web development, including responsive design which reformats content to fit any screen, improving both aesthetics and user experience. Visitors will also find a renewed emphasis on our most important products and services, including quick links to key revenue driving product lines, our newly launched secure home equity application and our powerful online and mobile banking tools. The Company is also evaluating the addition of fee-based business lines to complement and enhance existing services. With the recent retirement of Royal Bank’s Senior Vice President of Branch Administration, the Company has launched an executive search for a retail executive with prior experience in expanding retail sales capabilities, refreshing the branch footprint and achieving further penetration of its recently-expanded retail and web-based products.

The Company has developed a management Profitability Improvement Plan (the “Plan”) to generate steady revenue growth, expense management and gain operational efficiencies. Specific initiatives of the Plan effectuated in the first two quarters of 2013 focused on adjustments to personnel of the Company and discretionary expenses. These efforts, which included a 9% reduction in workforce during the first quarter of 2013 and an annualized reduction of approximately 10% of discretionary expenses, were implemented and enhanced day-to-day operations and the ability of the Company to drive new revenue. The Company has reorganized and relocated certain personnel to improve departmental synergies and better align managers and staff so they can work together in cohesive teams to accomplish these objectives. Additionally, the Company is currently developing a facilities rationalization plan as part of the overall strategic goal to return to profitability. During the first quarter of 2013, the Company sold its storage facility site in Philadelphia and a building in Narberth that housed the training center. The Company recorded gains of $676,000 as a result of these sales. In January 2013, Royal Bank consolidated the leased Henderson Road office between the King of Prussia and Bridgeport offices and retained over 90% of the deposits. Additionally, in April 2013, to achieve operational efficiencies, the tax lien subsidiaries relocated from their leased office space in Jenkintown, Pennsylvania to the corporate location in Narberth. As a result of the reduction in workforce and the vacating of leased real estate, the Company recorded $111,000 in restructuring charges directly related to one-time employee termination benefits and an effective termination of a lease. During the third quarter of 2013, the Company will consolidate the 15 ^th Street branch office into the Walnut Street branch office, which are both located in Center City Philadelphia. The Company continues to review its retail footprint and will explore additional branch office relocations, consolidations or both. The Company also is implementing a unique opportunity to reduce employee expenses as certain individuals will become employees of a local company who in turn will provide servicing of the remaining tax lien and non-performing assets portfolios. Those portfolios continue to diminish per the Company's strategic plan. This outsourcing arrangement allows the Company to focus on the expansion of its core banking products while de-emphasizing legacy non-core activities such as tax liens. The Company has targeted to have the Plan fully implemented by the end of 2013. Through the reorganizing of the Lending and Credit departments during the last half of 2012, Royal Bank was able to increase loans held for investment (“LHFI”) $23.7 million from $344.2 million at December 31, 2012 to $367.9 million at June 30, 2013. All of these plans are focused on repositioning the Company for 2013 and beyond.

During the second quarter of 2013, the Company was able to resolve the uncertainties around two separate legal matters. In June 2013, Lehman Brothers Special Financing voluntarily dismissed without prejudice and without costs all claims against the Company related to a $25.0 million CDO transaction. Additionally, the Company accrued a loss contingency of $1.65 million as a reasonable estimate for a potential settlement with the plaintiffs of a class action lawsuit regarding the tax lien subsidiaries. (For additional information refer to Item 1 “Legal Proceedings” under Part II “Other Information” of this Form 10-Q). As mentioned previously the legal expenses associated with the DOJ investigation and these two matters have been significant and negatively impacted earnings. As a result of these legal proceedings being finalized or coming to a conclusion soon, the Company anticipates legal expenses to decline.

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Consolidated Net Loss

The Company recorded a net loss of $803,000 for the second quarter of 2013 compared to a net loss of $2.0 million for the comparable quarter of 2012. Contributing to the net loss was a $1.65 million loss contingency accrual for a settlement of the class action lawsuit related to the Company’s tax lien subsidiaries. After adjusting for the noncontrolling interest, the Company’s 60% share of the loss contingency amounts to $990,000. (For additional information on the DOJ matter, see Item 1 “Legal Proceedings” of this Form 10-Q.) Absent the loss contingency accrual the Company would have recorded net income of $187,000 for the quarter ended June 30, 2013. The quarter over quarter improvement was mainly related to a $1.7 million decline in provision for loan and lease losses due to the improving credit quality of the loan portfolio, a $943,000 decrease in credit related expenses and an $859,000 decline in other-than-temporary impairment on investment securities. In addition employee salaries and benefits and professional and legal fees declined $505,000 and $498,000, respectively, quarter over quarter. Partially offsetting these positive items was a $2.0 million reduction in gains on the sales of loans and leases and a $960,000 decline in net interest income quarter over quarter. Although the level of non-performing assets has declined it continues to negatively impact net interest income as well as operating expenses, such as legal, loan collection and OREO costs, and therefore the overall level of profitability. The Company has been able to mitigate part of the impact of the nonperforming assets by reducing funding costs through the re-pricing of retail CDs and the paying down and re-pricing of FHLB advances. Impaired and non-accrual loans are reviewed in the “Credit Risk Management” section of this report. Loss per share for basic and diluted were both $0.10 for the second quarter of 2013, as compared to basic and diluted loss per share of $0.19 for the same quarter of 2012.

For the six months ended June 30, 2013, the net loss amounted to $685,000 compared to a net loss of $2.8 million for the comparable period of 2012. Contributing to the net loss was a $1.65 million loss contingency accrual as mentioned previously. After adjusting for the noncontrolling interest, the Company’s 60% share of the loss contingency amounts to $990,000. Absent the loss contingency accrual the Company would have recorded net income of $305,000 for the six months ended June 30, 2013. The year over year improvement was due to a $2.0 million decrease in provision for loan and lease losses as a result of the improvement in the credit quality of the loan portfolio, a $1.1 million reduction in credit related expenses, an $859,000 decline in other-than-temporary impairment on investment securities and $678,000 in gains primarily on the sales of two premises. In addition gains on the sale of OREO increased $463,000 while professional and legal fees and employee salaries and benefits declined $842,000 and $600,000, respectively. Partially offsetting these improvements were a $2.2 million reduction in net interest income and a $2.0 million decrease in gains on the sales of loans and leases. In 2012, the Company recorded a $2.0 million accrual for a DOJ fine related to the tax lien subsidiaries. After adjusting for the noncontrolling interest, the Company’s 60% share of the DOJ fine amounted to $1.2 million. As previously noted, while the level of non-performing assets has declined it continues to negatively impact net interest income as well as operating expenses, such as legal, loan collection and OREO costs, and therefore the overall level of profitability. Impaired and non-accrual loans are reviewed in the “Credit Risk Management” section of this report. Basic and diluted loss per share were both $0.13 for the first six months of 2013, while basic and diluted loss per share were both $0.29 for the first six months of 2012.

Interest Income

For the second quarter of 2013, total interest income of $6.7 million declined $1.7 million, or 19.9%, from the comparable quarter of 2012. The decrease was driven by a decline in average loan and investment balances quarter over quarter coupled with a decline in the yield on loans and investments. Average interest-earning assets of $685.2 million in the current quarter declined $77.0 million, or 10.1%, from $762.2 million in the comparable quarter of 2012, which was primarily attributed to a decline in loans and investments. Average loan balances of $363.2 million in the second quarter of 2013 decreased $37.4 million, or 9.3%, year over year and negatively impacted interest income by $1.2 million of which $683,000 is directly related to the tax lien portfolio. The decline in loan balances was attributed to loan prepayments, loan pay downs including $16.1 million in higher yielding tax lien certificates and transfers to OREO. Average investment securities of $307.2 million during the second quarter of 2013 decreased $32.3 million, or 9.5%, from the second quarter of 2012 primarily due to incoming cash flows on the Company’s government agency mortgage-backed (“MBS”) and collateralized mortgage obligation (“CMO”) investment securities. Average cash equivalents for the three months ended June 30, 2013 of $14.8 million declined $7.4 million, or 33.3%. The decline resulted from funding new loan originations and improved funding options relative to the comparable period of 2012.

For the second quarter of 2013, the yield on average interest-earning assets of 3.95% decreased 48 basis points from the level recorded during the comparable quarter of 2012. The yield reduction was comprised of a 67 basis point decline for loans (6.01% in 2013 versus 6.68% in 2012) and a 40 basis point reduction for investments (1.69% in 2013 versus 2.09% in 2012) quarter over quarter. The decrease in loan yields reflects the $16.1 million, or 43.0%, decline in higher yielding tax liens quarter versus quarter and lower rates on new loan originations. The decline in the investment yield was due to the replacement of sold and called higher yielding investment securities with lower yielding government agency securities and the accelerated amortization of premiums due to prepayments of MBS and CMO securities due to mortgage re-financings.

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For the six months ended June 30, 2013, total interest income amounted $13.5 million declined $3.7 million, or 21.7% year over year. The decrease was primarily driven by a decline in average loan balances year over year and a decline in the yield on investments. Average interest-earning assets were $695.4 million for the first six months of 2013 compared to $771.3 million for the comparable period of 2012 resulting in a decline of $75.8 million, or 9.8%. Average loan balances of $358.1 million in the first half of 2013 decreased $53.1 million, or 12.9%, year over year and negatively impacted interest income by $2.6 million of which $1.4 million is directly related to the tax lien portfolio. The decline in loan balances for the first half of 2013 was attributed to loan prepayments, loan pay downs including $18.9 million in tax lien certificates, and transfers to OREO through foreclosure proceedings. Average investments of $322.2 million decreased $17.0 million, or 5.0%, from the first six months of 2012 primarily due to incoming cash flows on the Company’s MBS and CMO investment securities.

The yield on average interest-earning assets for the six months ended June 30, 2013 of 3.91% declined by 58 basis points from 4.49% for the comparable period of 2012. The yield reduction was comprised of a year over year decrease of 61 basis points in the investment yield (1.61% in 2013 versus 2.22% in 2012) and a 45 basis point reduction in the yield on the loan portfolio (6.14% in 2013 versus 6.59% in 2012 ). The decrease in investment yield was due to the replacement of sold and called higher yielding investment securities with lower yielding government agency securities. Additionally the investment yield was negatively impacted by the accelerated amortization of premiums due to prepayments of MBS and CMO securities. The decrease in loan yields reflects the $18.9 million, or 45.0%, decline in higher yielding tax liens year over year and lower rates on new loan originations.

Interest Expense

For the second quarter of 2013, total interest expense of $1.8 million declined $720,000, or 28.6%, from the comparable quarter of 2012. The reduction in interest expense was mainly associated with both lower balances of interest-bearing liabilities as well as a decline in the interest rates paid on those liabilities. Average interest-bearing liabilities for the second quarter of 2013 were $598.4 million decreasing $81.9 million, or 12.0%, from the comparable quarter of 2012. The reduction was primarily due to maturing CDs and the payoff of maturing FHLB advances. Average time deposits declined $41.8 million, or 15.1%, from the second quarter of 2012 to $235.5 million for the second quarter of 2013, principally due to the intentional runoff of higher priced retail CDs. Additionally, average NOW and money market deposits decreased $19.2 million, or 8.3%, quarter over quarter. Average borrowings declined $22.0 million, or 14.1%, from $156.0 million to $134.0 million quarter over quarter.

The yield on average interest-bearing liabilities was 1.20% for the second quarter of 2013 down 28 basis points from 1.48% for the comparable quarter of 2012 as all interest-bearing liabilities experienced interest rate declines year over year. The average interest rate paid on average interest-bearing deposits for the second quarter of 2013 was 0.87% resulting in a decline of 34 basis points from the level of 1.21% during the comparable quarter of 2012. The average interest rate paid on CDs during the second quarter of 2013 was 1.43%, which declined 23 basis points, year over year, due to lower interest rates on new accounts and the maturities re-pricing at lower interest rates. The yield on average NOW and money market deposits of 0.29% declined quarter over quarter by 43 basis points due to lower market interest rates. The average interest rate paid on borrowings during the second quarter of 2013 was 2.37% resulting in a decline of 6 basis points year over year due to the re-pricing of FHLB advances. During the second quarter of 2013 a maturing $50.0 million FHLB advance with a rate of 2.64% was replaced with four separate FHLB advances and short-term borrowings which carry an average yield of 1.13%. This re-pricing opportunity will enhance the margin in future quarters.

For the six months ended June 30, 2013, total interest expense of $3.8 million decreased $1.6 million, or 29.1%, from the comparable period in 2012. The decline in interest expense for the first half of 2013 was due to an $80.7 million, or 11.7%, decline in average interest-bearing liabilities relative to the comparable six month period of 2012 and a 31 basis point decline in the interest rates paid on interest-bearing liabilities year over year. For the first half of 2013, average interest-bearing deposits of $474.0 million decreased $50.8 million, or 9.7%, year over year. The reduction was mainly associated with the intentional runoff of higher priced retail CDs. Average time deposits amounted to $240.4 million during the first six months of 2013, which resulted in a decline of $39.4 million, or 14.1%, from the level during the comparable period in 2012. Average borrowings of $134.0 million for the first six months of 2013 declined $30.0 million, or 18.3%, from the first six months of 2012 due to the redemption or re-pricing of higher rate FHLB advances.

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The average interest rate paid on interest-bearing liabilities amounted to 1.25% for the first half of 2013 which represented a decline of 31 basis points year over year. The average interest rate paid on interest-bearing deposits in the first half of 2013 amounted to 0.88%, which resulted in a year over year decline of 35 basis points. Year over year lower average interest rates were paid on NOW and money market accounts (0.29% in 2013 versus 0.74% in 2012) and on CDs (1.46% in 2013 versus 1.67% in 2012). The average rate paid on borrowings amounted to 2.56% for the first half of 2013 as compared to 2.61%, which resulted in a 5 basis point decline for the comparable six month period of 2012. As stated previously, during the second quarter of 2013, a maturing $50.0 million FHLB advance with a rate of 2.64% was replaced with four separate FHLB advances and short-term borrowings which carry an average yield of 1.13%. This re-pricing opportunity will enhance the margin in future quarters.

Net Interest Income and Net Interest Margin

Net interest income for the quarter ended June 30, 2013 was $4.9 million declining $960,000, or 16.3%, from the comparable quarter of 2012. The decrease was primarily attributed to a reduction in interest-earning assets coupled with a decline in the yield on loans and investments quarter versus quarter. The decline in loan balances was attributed to loan prepayments, loan pay downs and transfers to OREO. The decrease in the investment portfolio was primarily due to incoming cash flows on the Company’s MBS and CMO investment securities. The decrease in loan yields reflects a $16.1 million decline in higher yielding tax liens which negatively impacted interest income by $683,000 quarter versus quarter and lower rates on new loan originations. The decline in the investment yield was due to the replacement of sold and called higher yielding investment securities with lower yielding government agency securities and the accelerated amortization of premiums due to prepayments of MBS and CMO securities due to mortgage re-financings. The decline in net interest income was partially offset by a reduction in the average balance of interest-bearing deposits and the average interest rates paid on those deposits which primarily were associated with the redemption of maturing retail CDs and lower rates paid on renewing and new retail CDs and NOW and money market accounts.

For the second quarter of 2013, the net interest margin of 2.90% decreased 22 basis points from the comparable quarter of 2012. The 28 basis point improvement in funding costs was more than offset by the overall decline of 48 basis points in the yield on interest-earning assets. The decline in the yield on interest-earning assets was driven by lower yields on average loan balances (6.01% in 2013 versus 6.68% in 2012) mainly due to the $16.1 million decline of the higher yielding tax liens and investment securities (1.69% in 2013 versus 2.09% in 2012) quarter over quarter. The Company continued to redeem maturing retail CDs and was also able to lower retail deposit costs through the re-pricing of maturing CDs at lower interest rates. However the replacement of sold and called investment securities during the past year with lower yielding government agency securities and the accelerated amortization of premiums on investment securities also accounted for the decline in the yield on interest-earning assets.

Net interest income for the six months ended June 30, 2013 was $9.7 million declining $2.2 million, or 18.3%, from the comparable period in 2012. The decrease was primarily attributed to a reduction in interest-earning assets coupled with a decline in the yield on loans and investments year over year. The decline in loan balances was attributed to loan prepayments, loan pay downs and transfers to OREO. The decrease in the investment portfolio was primarily due to incoming cash flows on the Company’s MBS and CMO investment securities. The decrease in loan yields reflects an $18.9 million decline in higher yielding tax liens which negatively impacted interest income by $1.4 million year over year and lower rates on new loan originations. The decline in the investment yield was due to the replacement of sold and called higher yielding investment securities during the past year with lower yielding government agency securities and the accelerated amortization of premiums due to prepayments of MBS and CMO securities due to mortgage re-financings. The decline in net interest income was partially offset by a reduction in the average balance of interest-bearing liabilities and the average interest rates paid on average interest-bearing deposits which primarily were associated with the redemption of maturing retail CDs and lower rates paid on renewing and new retail CDs and NOW and money market accounts.

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For the six month period ended June 30, 2013, the net interest margin of 2.82% declined 28 basis points from 3.10% in the comparable period of 2012. The 31 basis point improvement in funding costs was more than offset by the overall decline of 58 basis points in the yield on interest-earning assets. The decline in the yield on interest-earning assets was driven by lower yields on average loan balances (6.14% in 2013 versus 6.59% in 2012) mainly due to the $18.9 million decline of the higher yielding tax liens and investment securities (1.61% in 2013 versus 2.22% in 2012) year over year. The replacement of sold and called investment securities during the past year with lower yielding government agency securities and the accelerated amortization of premiums on investment securities also accounted for the decline in the yield on interest-earning assets. The average interest rate paid on total interest-bearing liabilities for the six month period ended June 30, 2013 was 1.25% compared to 1.56% for the same period in 2012. The Company continued to redeem maturing retail CDs and was also able to lower retail deposit costs through the lower re-pricing of maturing CDs.

The following table represents the average daily balances of assets, liabilities and shareholders’ equity and the respective interest bearing assets and interest bearing liabilities, as well as average interest rates for the periods indicated, exclusive of interest on obligations related to real estate owned via equity investment. The loans outstanding include non-accruing loans. The yield on earning assets and the net interest margin are presented on a fully tax-equivalent (FTE) and annualized basis. The FTE basis adjusts for the tax benefit of income on certain tax-exempt investments and loans using the federal statutory tax rate of 35% for each period presented.

	For the three months ended							For the three months ended
	June 30, 2013							June 30, 2012
(In thousands, except percentages)	Average Balance		Interest		Yield			Average Balance		Interest		Yield
Cash equivalents	$	14,774	$	8		0.22	%	$	22,140	$	9		0.16	%
Investment securities		307,216		1,291		1.69	%		339,489		1,763		2.09	%
Loans		363,183		5,444		6.01	%		400,557		6,651		6.68	%
Total interest earning assets		685,173		6,743		3.95	%		762,186		8,423		4.43	%
Non-earning assets		59,864							74,390
Total average assets	$	745,037						$	836,576
Interest-bearing deposits
NOW and money markets	$	210,778	$	153		0.29	%	$	229,958	$	410		0.72	%
Savings		18,189		10		0.22	%		17,132		21		0.49	%
Time deposits		235,508		842		1.43	%		277,294		1,142		1.66	%
Total interest bearing deposits		464,475		1,005		0.87	%		524,384		1,573		1.21	%
Borrowings		133,952		792		2.37	%		155,971		944		2.43	%
Total interest bearing liabilities		598,427		1,797		1.20	%		680,355		2,517		1.48	%
Non-interest bearing deposits		58,865							52,337
Other liabilities		30,310							28,672
Shareholders' equity		57,435							75,212
Total average liabilities and equity	$	745,037						$	836,576
Net interest margin			$	4,946		2.90	%			$	5,906		3.12	%

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	For the six months ended							For the six months ended
	June 30, 2013							June 30, 2012
(In thousands, except percentages)	Average Balance		Interest		Yield			Average Balance		Interest		Yield
Cash equivalents	$	15,139	$	15		0.20	%	$	20,934	$	18		0.17	%
Investments securities		322,229		2,575		1.61	%		339,218		3,743		2.22	%
Loans		358,058		10,905		6.14	%		411,115		13,468		6.59	%
Total interest earning assets		695,426		13,495		3.91	%		771,267		17,229		4.49	%
Non-earning assets		57,975							71,942
Total average assets	$	753,401						$	843,209
Interest-bearing deposits
NOW and money markets	$	215,768	$	315		0.29	%	$	228,074	$	834		0.74	%
Savings		17,887		19		0.21	%		16,916		43		0.51	%
Time deposits		240,361		1,744		1.46	%		279,799		2,324		1.67	%
Total interest bearing deposits		474,016		2,078		0.88	%		524,789		3,201		1.23	%
Borrowings		134,008		1,699		2.56	%		163,971		2,129		2.61	%
Total interest bearing liabilities		608,024		3,777		1.25	%		688,760		5,330		1.56	%
Non-interest bearing deposits		58,620							53,504
Other liabilities		28,704							25,285
Shareholders' equity		58,053							75,660
Total average liabilities and equity	$	753,401						$	843,209
Net interest margin			$	9,718		2.82	%			$	11,899		3.10	%

Rate Volume Analysis

The following tables 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 real estate owned via equity investment, for the three and six month periods ended June 30, 2013, as compared to the respective periods in 2012, into amounts attributable to both rates and volume variances.

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	For the three months ended									For the six months ended
	June 30,									June 30,
	2013 vs. 2012									2013 vs. 2012
	Increase (decrease)									Increase (decrease)
(In thousands)	Volume			Rate			Total			Volume			Rate			Total
Interest income
Interest-bearing deposits	$	(5	)	$	4		$	(1	)	$	(7	)	$	4		$	(3	)
Total short term earning assets		(5	)		4			(1	)		(7	)		4			(3	)
Investments securities		(242	)		(230	)		(472	)		(359	)		(809	)		(1,168	)
Loans
Commercial demand loans		(692	)		(26	)		(718	)		(1,392	)		5			(1,387	)
Commercial mortgages		570			(213	)		357			767			(362	)		405
Residential and home equity		40			3			43			53			38			91
Leases receivables		(28	)		68			40			(37	)		144			107
Tax certificates		(509	)		(140	)		(649	)		(1,203	)		(195	)		(1,398	)
Other loans		(22	)		(7	)		(29	)		(39	)		(12	)		(51	)
Loan fees		(251	)		-			(251	)		(330	)		-			(330	)
Total loans		(892	)		(315	)		(1,207	)		(2,181	)		(382	)		(2,563	)
Total decrease in interest income	$	(1,139	)	$	(541	)	$	(1,680	)	$	(2,547	)	$	(1,187	)	$	(3,734	)
Interest expense
Deposits
NOW and money market	$	(32	)	$	(225	)	$	(257	)	$	(42	)	$	(477	)	$	(519	)
Savings		1			(12	)		(11	)		2			(26	)		(24	)
Time deposits		(160	)		(140	)		(300	)		(304	)		(276	)		(580	)
Total deposits		(191	)		(377	)		(568	)		(344	)		(779	)		(1,123	)
Trust preferred		-			(10	)		(10	)		-			(30	)		(30	)
Borrowings		(129	)		(13	)		(142	)		(376	)		(24	)		(400	)
Total decrease in interest expense	$	(320	)	$	(400	)	$	(720	)	$	(720	)	$	(833	)	$	(1,553	)
Total decrease in net interest income	$	(819	)	$	(141	)	$	(960	)	$	(1,827	)	$	(354	)	$	(2,181	)

Credit Risk Management

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 losses in the loan and lease portfolio. The allowance is based on the review and evaluation of the loan and lease portfolio, along with ongoing, quarterly assessments of the probable losses inherent in that portfolio. The allowance represents an estimation made pursuant to FASB ASC Topic 450, “Contingencies” (“ASC Topic 450”) or FASB ASC Topic 310, “Receivables” (“ASC Topic 310”). The adequacy of the allowance is determined through evaluation of the credit portfolio, and involves consideration of a number of factors, as outlined below, to establish a prudent level. Determination of the allowance is inherently subjective and requires significant estimates, including estimated losses on pools of homogeneous loans and leases based on historical loss experience and consideration of current economic trends, which may be susceptible to significant change. Loans and leases deemed uncollectible are charged against the allowance, while recoveries are credited to the allowance. Management adjusts the level of the allowance through the provision for loan and lease losses, which is recorded as a current period expense. The Company’s systematic methodology for assessing the appropriateness of the allowance includes: (1) general reserves reflecting historical loss rates by loan type, (2) specific reserves for risk-rated credits based on probable losses on an individual or portfolio basis and (3) qualitative reserves based upon current economic conditions and other risk factors.

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The loan portfolio is stratified into loan segments that have similar risk characteristics. The general allowance is based upon historical loss rates using a weighted three-year rolling average of the historical loss experienced within each loan segment. The qualitative factors used to adjust the historical loss experience address various risk characteristics of the Company’s loan and lease portfolio include evaluating: (1) trends in delinquencies and other non-performing loans, (2) changes in the risk profile related to large loans in the portfolio, (3) changes in the growth trends of categories of loans comprising the loan and lease portfolio, (4) concentrations of loans and leases to specific industry segments, and (5) changes in economic conditions on both a local and national level, (6) quality of loan review and board oversight, (7) changes in lending policies and procedures, and (8) changes in lending staff. Each factor is assigned a value to reflect improving, stable or declining conditions based on management’s best judgment using relevant information available at the time of the evaluation. Adjustments to the factors are supported through documentation of changes in conditions in a report accompanying the allowance calculation.

The specific reserves are determined utilizing standards required under ASC Topic 310. A loan is considered impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. Non-accrual loans and loans restructured under a troubled debt restructuring are evaluated for impairment on an individual basis considering all known relevant factors that may affect loan collectability such as the borrower’s overall financial condition, resources and payment record, support available from financial guarantors and the sufficiency of current collateral values (current appraisals or rent rolls for income producing properties), and risks inherent in different kinds of lending (such as source of repayment, quality of borrower and concentration of credit quality). Non-accrual loans that experience insignificant payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed.

Impairment is measured on a loan by loan basis for commercial and industrial loans, commercial real estate loans and commercial construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent. The estimated fair values of substantially all of the Company’s impaired loans are measured based on the estimated fair value of the loan’s collateral. The Company obtains third-party appraisals on the fair value of real estate collateral. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property. For commercial and industrial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Once a loan is determined to be impaired it will be deducted from the portfolio and the net remaining balance will be used in the general and qualitative analysis. A specific reserve is established for an impaired loan if its carrying value exceeds its estimated fair value.

The provision for loan and lease losses was a credit of $163,000 and $414,000 for the three and six months ended June 30, 2013, respectively compared to $1.5 million and $1.6 million for the three and six months ended June 30, 2012, respectively. The 2013 credit was directly related to the improved credit quality of the loan portfolio and recoveries received on previously charged-off loans. The 2012 provision was directly related to specific reserves on impaired loans. The allowance decreased $2.1 million from $17.3 million at December 31, 2012 to $15.2 million at June 30, 2013. The decline in the allowance was directly related to the charge-off of specific reserves and improved credit quality. Impaired loans decreased $2.7 million during the first two quarters of 2013. The allowance was 4.13% of total loans and leases at June 30, 2013 compared to 5.02% at December 31, 2012.

The amount of the allowance is reviewed and approved by the Chief Financial Officer (“CFO”), Chief Administrative and Risk Officer (“CARO”), CLO, and Chief Credit Officer (“CCO”) on at least a quarterly basis. Management believes that the allowance at June 30, 2013 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.

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Changes in the ALLL were as follows:

	For the three months ended						For the six months ended
	June 30,						June 30,
(In thousands)	2013			2012			2013			2012
Balance at period beginning	$	15,389		$	16,454		$	17,261		$	16,380
Charge-offs
Commercial real estate		-			-			(835	)		-
Construction and land development		-			-			(820	)		-
Commercial and industrial		(21	)		(208	)		(195	)		(208	)
Leases		(99	)		(162	)		(108	)		(295	)
Tax certificates		(138	)		(258	)		(285	)		(278	)
Total charge-offs		(258	)		(628	)		(2,243	)		(781	)
Recoveries
Commercial real estate		23			-			127			3
Construction and land development		95			87			191			191
Commercial and industrial		6			55			9			57
Residential real estate		5			1			156			2
Leases		10			7			20			15
Tax certificates		72			4			72			29
Total recoveries		211			154			575			297
Net charge offs		(47	)		(474	)		(1,668	)		(484	)
(Credit) provision for loan and lease losses		(163	)		1,515			(414	)		1,599
Balance at period end	$	15,179		$	17,495		$	15,179		$	17,495

An analysis of ALLL by loan type is set forth below:

	June 30, 2013					December 31, 2012
(In thousands, except percentages)	Allowance amount		Percent of outstanding loans in each category to total loans			Allowance amount		Percent of outstanding loans in each category to total loans
Commercial real estate	$	7,952		49.1	%	$	8,750		48.5	%
Construction and land development		2,017		9.4	%		2,987		10.8	%
Commercial and industrial		2,465		18.2	%		1,924		11.8	%
Multi-family		588		3.2	%		654		3.4	%
Residential real estate		353		4.3	%		1,098		7.3	%
Leases		999		10.5	%		1,108		10.8	%
Tax certificates		586		5.1	%		472		7.1	%
Consumer		18		0.2	%		29		0.3	%
Unallocated		201		-			239		-
Total allowance	$	15,179		100.0	%	$	17,261		100.0	%

The following table presents the principal amounts of non-accrual loans and other real estate owned:

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	June 30,			December 31,
(Amounts in thousands)	2013			2012
Non-accrual LHFI ⁽¹⁾	$	16,336		$	21,432
Non-accrual LHFS		1,419			1,572
Other real estate owned		13,002			13,435
Total nonperforming assets	$	30,757		$	36,439
Nonperforming assets to total assets		4.11	%		4.71	%
Total non-accural loans to Total loans		4.81	%		6.65	%
ALLL to non-accrual LHFI		92.92	%		80.54	%
ALLL to Total LHFI		4.13	%		5.02	%

⁽¹⁾ Generally, a loan is placed on non-accruing status when it has been delinquent for a period of 90 days or more.

The composition of non-accrual loans is as follows:

	June 30, 2013				December 31, 2012
(In thousands)	Loan balance		Specific reserves		Loan balance		Specific reserves
Non-accrual loans held for investment
Commercial real estate	$	8,684	$	605	$	10,345	$	835
Construction and land development		2,755		-		4,280		820
Commercial & industrial		3,682		12		4,961		255
Residential real estate		491		15		994		14
Leases		240		67		251		55
Tax certificates		484		101		601		47
Total non-accrual LHFI	$	16,336	$	800	$	21,432	$	2,026
Non-accrual loans held for sale
Commercial real estate	$	1,419	$	-	$	1,572	$	-
Total non-accrual LHFS	$	1,419	$	-	$	1,572	$	-
Total non-accrual loans	$	17,755	$	800	$	23,004	$	2,026

Non-accrual loan activity for the first and second quarters of 2013 is set forth below:

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			1st Quarter Actvity
(In thousands)	Balance at January 1, 2013		Additions		Payments and other decreases			Charge-offs/ Impairment*			Transfer to OREO			Balance at March 31, 2013
Non-accrual loans held for investment
Construction and land development	$	4,280	$	-	$	(418	)	$	(820	)	$	-		$	3,042
Commercial real estate		10,345		-		(1,631	)		(835	)		-			7,879
Commercial & industrial		4,961		141		(906	)		(173	)		-			4,023
Residential real estate		994		-		(462	)		-			(100	)		432
Leases		251		-		(84	)		(10	)		-			157
Tax certificates		601		100		(3	)		(147	)		-			551
Total non-accrual LHFI	$	21,432	$	241	$	(3,504	)	$	(1,985	)	$	(100	)	$	16,084
Non-accrual loans held for sale
Commercial real estate	$	1,572	$	-	$	-		$	(100	)	$	-		$	1,472
Total non-accrual LHFS	$	1,572	$	-	$	-		$	(100	)	$	-		$	1,472
Total non-accrual loans	$	23,004	$	241	$	(3,504	)	$	(2,085	)	$	(100	)	$	17,556

			2nd Quarter Actvity
(In thousands)	Balance at March 31, 2013		Additions		Payments and other decreases			Charge-offs/ Impairment*			Transfer to OREO		Balance at June 30, 2013
Non-accrual loans held for investment
Construction and land development	$	3,042	$	-	$	(287	)	$	-		$	-	$	2,755
Commercial real estate		7,879		926		(121	)		-			-		8,684
Commercial & industrial		4,023		44		(364	)		(21	)		-		3,682
Residential real estate		432		59		-			-			-		491
Leases		157		197		(15	)		(99	)		-		240
Tax certificates		551		110		(39	)		(138	)		-		484
Total non-accrual LHFI	$	16,084	$	1,336	$	(826	)	$	(258	)	$	-	$	16,336
Non-accrual loans held for sale
Commercial real estate	$	1,472	$	-	$	-		$	(53	)	$	-	$	1,419
Total non-accrual LHFS	$	1,472	$	-	$	-		$	(53	)	$	-	$	1,419
Total non-accrual loans	$	17,556	$	1,336	$	(826	)	$	(311	)	$	-	$	17,755

Impaired Loans

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The following is a summary of information pertaining to impaired loans and leases:

	June 30,		December 31,
(In thousands)	2013		2012
Impaired loans with a valuation allowance	$	8,401	$	9,405
Impaired loans without a valuation allowance		17,885		19,423
Impaired LHFS		1,419		1,572
Total impaired loans	$	27,705	$	30,400

Valuation allowance related to impaired loans	$	800	$	2,026

	For the six months
	ended June 30,
(In thousands)	2013		2012
Average investment in impaired loans	$	24,593	$	47,726
Interest income recognized on impaired loans and leases	$	273	$	228
Interest income recognized on a cash basis on impaired loans and leases	$	273	$	228

Other Real Estate Owned

Other real estate owned (“OREO”) decreased $433,000 from $13.4 million at December 31, 2012 to $13.0 million at June 30, 2013. Set forth below is a table which details the changes in OREO from December 31, 2012 to June 30, 2013.

	2013
(In thousands)	First Quarter			Second Quarter
Beginning balance	$	13,435		$	13,264
Net proceeds from sales		(2,277	)		(2,603	)
Net gain on sales		162			418
Assets acquired on non-accrual loans		1,956			2,252
Impairment charge		(12	)		(329	)
Ending balance	$	13,264		$	13,002

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Credit Classification Process

The Company outsources the loan review function to a third party vendor which examines credit quality and portfolio management. The Company uses a nine point grading risk classification system commonly used in the financial services industry. The first four classifications are rated Pass. The riskier classifications include Pass-Watch, Special Mention, Substandard, Doubtful and Loss. Upon completion of a loan review, a copy of any review receiving an adverse classification by the reviewer is presented to the Classified, Charge-off and Impairment Committee (“CCIC”) for discussion. The CCO is the primary bank officer dealing with the third party vendor during the reviews.

All loans are subject to initial loan review. Additional review is undertaken with respect to loans providing potentially greater exposure. This is accomplished by:

100% of loans with balances of $1.5 million or greater;

80% of loans with balances from $1.0 million up to $1.5 million;

25% of loans with balances from $500,000 up to $1 million;

5% of loans with balances below $500,000; and

Loans 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 an assigned officer and monthly attention of the Special Assets Committee. A watch list is maintained and reviewed at each meeting of CCIC. CCIC was formed to formalize the process and documentation required to classify, remove from classification, impair or charge-off a loan. The CCIC, which is comprised of the CEO, CARO, CFO, CCO, and CLO meet as required and provide regular updated reports to the Board of Directors. Loans are added to the watch list, even though the loans may be current or less than 30 days delinquent if they exhibit elements of substandard creditworthiness. The watch list contains a statement for each loan as to why it merits special attention, and this list is distributed to the Board of Directors on a monthly basis. Loans may be removed from the watch list if the CCIC determines that exception items have been resolved or creditworthiness has improved. Additionally, if loans become serious collection matters and are listed on the Company’s monthly delinquent loan or Special Assets Committee lists, they may be removed from the watch list. Minutes outlining the CCIC’s findings and recommendations are issued after each meeting for follow-up by individual loan officers.

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.

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Potential Problem Loans

Potential problem loans are loans not currently classified as non-accrual, but management has doubts as to the borrowers’ ability to comply with present repayment terms. The loans are usually delinquent more than 30 days but less than 90 days or they have a risk rating of substandard. Potential problem loans amounted to approximately $11.0 million and $13.3 million at June 30, 2013 and December 31, 2012.

Other Income

For the second quarter of 2013 other income was $961,000 compared to $1.9 million for the comparable quarter in 2012. The $984,000 or 50.6%, decrease in other income quarter over quarter was primarily related to the $2.0 million decrease in gains on the sale of loans and leases ($0 in 2013 compared to $2.0 million in 2012). Partially offsetting this transaction was a decline in OTTI charges related to available for sale securities ($0 in 2013 versus $859,000 in 2012). Additionally net gains on the sale of OREO increased $163,000 quarter over quarter ($418,000 in 2013 versus $255,000 in 2012).

For the six months ended June 30, 2013, other income amounted to $2.4 million compared to other income of $2.6 million for comparable period in 2012, a decrease of $237,000, or 9.1%. During the first quarter of 2013, the Company sold its storage facility site in Philadelphia and a building in Narberth that housed the training center. The Company received net proceeds of $1.1 million and recorded gains of $676,000. Additionally net gains on the sale of OREO increased $463,000 year over year ($580,000 in 2013 versus $117,000 in 2012). As previously mentioned OTTI charges related to available for sale securities declined $859,000 ($0 in 2013 versus $859,000 in 2012). Offsetting these positive items was a $2.0 million decrease in gains on the sale of loans and leases ($0 in 2013 compared to $2.0 million in 2012) and an $89,000 decrease in net gains on the sale of available for sale securities ($70,000 in 2013 compared to $159,000 in 2012).

Other Expense

Non-interest expense for the second quarter of 2013 decreased $1.0 million, or 11.9%, to $7.6 million when compared to the same period in 2012. The quarter versus quarter reductions was mainly related to declines in credit related expenses, salaries and benefits, and professional and legal fees of $943,000, $505,000 and $498,000, respectively. Credit related expenses ($723,000 in 2013 versus $1.7 million in 2012) and professional and legal fees ($808,000 in 2013 versus $1.3 million in 2012) declined as a result of a decline in the Company’s non-performing assets and the resolution of the DOJ investigation. Salaries and benefits declined $505,000 ($2.7 million in 2013 versus $3.2 million in 2012) due to the reduction in work force executed in the first quarter of 2013, various salary reductions, and a phasing out of certain nonessential employee benefits. Offsetting these positive items was a $1.65 million loss contingency accrual for a potential settlement of the class action lawsuit related to the Company’s tax lien subsidiaries. After adjusting for the noncontrolling interest, the Company’s 60% share of the loss contingency amounted to $990,000. (For additional information on the DOJ matter, see Item 1 “Legal Proceedings” of this Form 10-Q.)

For the six months ended June 30, 2013 non-interest expense declined $3.0 million, or 17.7% to $13.7 million when compared to the same period in 2012. The decrease year over year was primarily attributable to reductions in credit related expenses, professional and legal fees, and salaries and benefits of $1.1 million, $842,000 and $600,000, respectively. Credit related expenses ($1.3 million in 2013 versus $2.4 million in 2012) and professional and legal fees ($1.5 million in 2013 versus $2.3 million in 2012) declined as a result of a reduction in the Company’s non-performing assets and the resolution of the DOJ investigation. Salaries and benefits declined $600,000 ($5.5 million in 2013 versus $6.1 million in 2012) due to the reduction in work force executed in the first quarter of 2013, various salary reductions, and a phasing out of certain nonessential employee benefits. Additionally in the 2012 period the Company recorded a $2.0 million accrual for a DOJ fine related to the tax lien subsidiaries. After adjusting for the noncontrolling interest, the Company’s 60% share of the DOJ fine amounted to $1.2 million. Offsetting these positive items was a $1.65 million loss contingency accrual for a settlement of the class action lawsuit related to the Company’s tax lien subsidiaries. After adjusting for the noncontrolling interest, the Company’s 60% share of the loss contingency amounted to $990,000. (For additional information on the DOJ matter, see Item 1 “Legal Proceedings” of this Form 10-Q.)

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Income Taxes

Total income tax expense for the second quarter and the first six months of 2013 and the comparable quarter and the first six months of 2012 was $0. The Company did not record a tax benefit despite the net loss since it concluded at that time that it was more likely than not that the Company would not generate sufficient taxable income to realize all of the deferred tax assets.

The Company concluded at June 30, 2013 and December 31, 2012 that it was more likely than not that the Company would not generate sufficient future taxable income to realize all of the deferred tax assets. Management’s conclusion was based on consideration of the relative weight of the available evidence and the uncertainty of future market conditions on results of operations. The Company recorded a non-cash charge of $15.5 million in the consolidated statements of operations in the period ended December 31, 2008 related to the establishment of a valuation allowance for the deferred tax asset for the portion of the future tax benefit that more likely than not will not be utilized in the future. During 2009, 2010, 2011 and 2012 the Company established additional valuation allowances of $10.2 million, $7.7 million, $3.0 million and $3.2 million respectively, which was the result of the net operating losses for each year and the portion of the future tax benefit that more than likely will not be utilized in the future. The valuation allowance for deferred tax assets at June 30, 2013, totaled $39.6 million. The effective tax rate for the second quarters and the first six months of both 2013 and 2012 was 0%.

Results of Operations by Business Segments

Operating segments are components of an enterprise, which are evaluated regularly by the chief operating decision makers in deciding how to allocate and assess resources and performance. The Company’s chief operating decision makers are the CEO and the CARO. The Company has identified two reportable operating segments, “Community Banking” and “Tax Liens”.

	Three months ended June 30, 2013
	Community			Tax Lien
(In thousands)	Banking			Operation			Consolidated
Total assets	$	717,220		$	31,381		$	748,601
Total deposits	$	525,670		$	-		$	525,670
Interest income	$	6,077		$	666		$	6,743
Interest expense		1,415			382			1,797
Net interest income	$	4,662		$	284		$	4,946
(Credit) provision for loan and lease losses		(431	)		268			(163	)
Total other income		550			411			961
Total other expenses		5,054			2,513			7,567
Income tax expense (benefit)		-			-			-
Net income (loss )	$	589		$	(2,086	)	$	(1,497	)
Noncontrolling interest	$	140		$	(834	)	$	(694	)
Net income (loss) attributable to Royal Bancshares	$	449		$	(1,252	)	$	(803	)

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	Three months ended June 30, 2012
	Community			Tax Lien
(In thousands)	Banking			Operation			Consolidated
Total assets	$	779,932		$	50,694		$	830,626
Total deposits	$	582,292		$	-		$	582,292
Interest income	$	7,074		$	1,349		$	8,423
Interest expense		1,811			706			2,517
Net interest income	$	5,263		$	643		$	5,906
Provision for loan and lease losses		1,334			181			1,515
Total other income		1,797			148			1,945
Total other expenses		6,811			1,781			8,592
Income tax expense (benefit)		306			(306	)		-
Net loss	$	(1,391	)	$	(865	)	$	(2,256	)
Noncontrolling interest	$	40		$	(346	)	$	(306	)
Net loss attributable to Royal Bancshares	$	(1,431	)	$	(519	)	$	(1,950	)

	Six months ended June 30, 2013
	Community			Tax Lien
(In thousands)	Banking			Operation			Consolidated
Total assets	$	717,220		$	31,381		$	748,601
Total deposits	$	525,670		$	-		$	525,670
Interest income	$	12,026		$	1,469		$	13,495
Interest expense		2,965			812			3,777
Net interest income	$	9,061		$	657		$	9,718
(Credit) provision for loan and lease losses		(741	)		327			(414	)
Total other income		1,712			657			2,369
Total other expenses		10,665			3,042			13,707
Income tax expense (benefit)		-			-			-
Net income (loss )	$	849		$	(2,055	)	$	(1,206	)
Noncontrolling interest	$	301		$	(822	)	$	(521	)
Net income (loss) attributable to Royal Bancshares	$	548		$	(1,233	)	$	(685	)

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	Six months ended June 30, 2012
	Community			Tax Lien
(In thousands)	Banking			Operation			Consolidated
Total assets	$	779,932		$	50,694		$	830,626
Total deposits	$	582,292		$	-		$	582,292
Interest income	$	14,291		$	2,938		$	17,229
Interest expense		3,712			1,618			5,330
Net interest income	$	10,579		$	1,320		$	11,899
Provision for loan and lease losses		1,443			156			1,599
Total other income		2,586			20			2,606
Total other expenses		12,583			4,076			16,659
Income tax expense (benefit)		357			(357	)		-
Net loss	$	(1,218	)	$	(2,535	)	$	(3,753	)
Noncontrolling interest	$	80		$	(1,014	)	$	(934	)
Net loss attributable to Royal Bancshares	$	(1,298	)	$	(1,521	)	$	(2,819	)

Community Bank Segment

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. In 2006, Royal Bank formed a subsidiary, Royal Tax Lien Services, LLC, to purchase and service delinquent tax liens. Royal Bank owns 60% of the subsidiary. Royal Bank established the wholly owned subsidiaries RBA Property LLC and Narberth Property Acquisition LLC in 2008 and Rio Marina LLC in 2009. These three subsidiaries were 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 borrowings 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. Royal Bank’s business and services are not subject to significant seasonal fluctuations. During the first quarter of 2013, Royal Bank launched its mobile banking application. 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 Camden and Gloucester counties in 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 fourteen branches located throughout Montgomery, Philadelphia, Chester, Delaware and Berks counties and Camden County, New Jersey. Royal Bank also considers New York, Maryland, and Delaware as a part of its service area for certain products and services. In the past, Royal Bank had frequently conducted business with clients located outside of its service area. Royal Bank has loans in nineteen states via loan originations and/or participations with other lenders who have broad experience in those respective markets. Royal Bank’s headquarters are located at 732 Montgomery Avenue, Narberth, Pennsylvania.

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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 Bank, on competitive terms.

Employees: Royal Bank employed approximately 132 people on a full-time equivalent basis as of June 30, 2013.

Deposits: At June 30, 2013, total deposits of Royal Bank were distributed among demand deposits (14%), money market deposit, savings and NOW accounts (42%) and time deposits (44%). At June 30, 2013, deposits of $531.8 million decreased $29.2 million from $561.0 million at year end 2012. Included in Royal Bank’s deposits are approximately $6.0 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 June 30, 2013, Royal Bank, including its subsidiaries, had a total net loan portfolio (excluding loans held for sale) of $352.7 million, representing 48% 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, small business leases and consumer loans. At June 30, 2013, total loans increased a net of $25.8 million from December 31, 2012 due to new loan originations, an $8.3 million purchase of a pool of jumbo residential mortgages on properties located in Washington, D.C., and a decline in allowance and were partially offset by pay downs, payoffs, charge-offs, and transfers to OREO.

Business results : Total assets of Royal Bank were $741.7 million at June 30, 2013 compared to $767.3 million at year end 2012. Royal Bank recorded a net loss of $698,000 for the second quarter of 2013 compared to a net loss of $818,000 for the comparable quarter of 2012. For the first half of 2013, Royal Bank recorded a net loss of $494,000 compared to a net loss of $1.7 million for the first half of 2012. Total interest income of Royal Bank for the quarter and six months ended June 30, 2013 was $6.7 million and $13.5 million, respectively, compared to $8.4 million and $17.2 million for the quarter ended and six months ended June 30, 2012, respectively. The decline in interest income for both the quarter and year to date was attributed to a reduced level of interest-earning assets coupled with lower yields. Interest expense was $1.8 million and $3.8 million for the quarter and six months ended June 30, 2013, respectively, compared to $2.5 million and $5.3 million for the quarter and six months ended June 30, 2012, respectively. The decline in interest expense for both the quarter and year to date was due to the intentional run off of higher cost CDs and FHLB advances and the favorable re-pricing of maturing CDs and FHLB advances. The primary transaction contributing to the net loss for the quarter and six months ended June 30, 2013 was a loss contingency accrual of $1.65 million for a potential settlement with the plaintiffs of a class action lawsuit related to the tax lien subsidiaries. After adjusting for the noncontrolling interest, Royal Bank’s 60% share of the loss contingency amounted to $990,000.The improvement in the net loss year over year was largely due to a $2.0 million reduction in the provision for loan and lease losses, a $1.1 million decrease in credit related expenses, and a $676,000 gain on the sale of two facilities. The above amounts reflect the consolidation totals for Royal Bank and its subsidiaries. The subsidiaries included in these amounts are Royal Investments America, Royal Real Estate, Royal Bank America Leasing, Royal Tax Lien Services, Crusader Servicing Corporation, RBA Property LLC, Narberth Property Acquisitions, and Rio Marina LLC.

Royal Bank America Leasing, LP

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. Legal headquarters are 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. These purchases are at market based on 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 the first six months of 2013 and 2012, neither sales nor purchases of lease portfolios were material.

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Business results : At June 30, 2013, total assets of Royal Leasing were $38.3 million, including $38.1 million in net leases, as compared to $37.1 million in assets at December 31, 2012. During the quarter ended June 30, 2013, Royal Leasing had net interest income of $533,000, a decrease of $2,000 from the comparable period of 2012; provision for lease losses of $26,000 versus $71,000 in the comparable quarter of 2012; non-interest income of $152,000 as compared to $122,000 in the second quarter of 2012; and non-interest expense of $112,000 versus $100,000 for the second quarter of 2012. Royal Leasing recorded net income prior to management distribution fees of $545,000 for the three months ended June 30, 2013 compared to net income of $297,000 for the comparable period in 2012, which represents an increase of $248,000. For the first half of 2013, Royal Leasing recorded net income prior to management distribution fees of $1.2 million compared to net income of $679,000 for the comparable period of 2012.

Royal Bank has extended loans to RBA Leasing at market interest rates, secured by the lease portfolio of RBA Leasing and as per the provisions of Regulation W. At June 30, 2013, the amount due Royal Bank from RBA Leasing was $35.3 million.

Royal Investments America

On June 23, 2003, the Company, through its wholly owned subsidiary Royal Bank, established Royal Investments America, LLC (“RIA”) as a wholly owned subsidiary. Legal headquarters are at 732 Montgomery Avenue, Narberth, Pennsylvania. RIA was formed to invest in equity real estate ventures subject to limitations imposed by the FDIC and Pennsylvania Department of Banking by regulation.

Business results : At June 30, 2013 and December 31, 2012, total assets of RIA were $5.9 million. For the quarter ended June 30, 2013, RIA had net income of $6,000 compared to net income of $28,000 for the comparable period of 2012 while the net loss for the first half of 2013 amounted to $4,000 compared to net income of $41,000 for the comparable six months of 2012.

Royal Bank had previously extended loans to RIA at market interest rates, secured by the loan portfolio of RIA and in accordance with the provisions of Regulation W. At June 30, 2013, there were no outstanding loans from Royal Bank to RIA.

Royal Investments of Delaware

On June 30, 1995, the Company established a special purpose Delaware investment company, Royal Investments of Delaware (“RID”), as a wholly owned subsidiary. Legal headquarters are at 1105 N. Market Street, Suite 1300, Wilmington, Delaware. RID buys, holds and sells investment securities.

Business results : For the quarter ended June 30, 2013, RID reported net income of $147,000, compared to a net loss of $707,000 for the quarter ended June 30, 2012. The 2012 loss was primarily due to $859,000 in investment impairment on a private equity real estate fund. For the first half of 2013, RID reported net income of $317,000 versus a net loss of $400,000 in the comparable period of 2012. At June 30, 2013, total assets of RID were $29.6 million, of which $2.6 million was held in cash and cash equivalents and $3.2 million was held in investment securities. The amounts shown above include the activity related to RID’s wholly owned subsidiary Royal Preferred LLC. Royal Bank previously extended loans to RID, secured by securities and as per the provisions of Regulation W. At June 30, 2013 no loans were outstanding.

Royal Preferred LLC

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 America. At June 30, 2013, Royal Preferred LLC had total assets of approximately $23.8 million.

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Royal Bancshares Capital Trust I and II

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. The interest rates for the debt securities associated with the Trusts at June 30, 2013 amounted to 2.42%.

On August 13, 2009, the Company’s Board determined to suspend interest payments on the trust preferred securities. The Company’s Board took this action in consultation with the Federal Reserve Bank of Philadelphia as required by regulatory policy guidance. The Company currently has sufficient capital and liquidity to pay the scheduled interest payments; however, this decision better supports the capital position of Royal Bank, a wholly owned subsidiary of the Company. As of June 30, 2013 the trust preferred interest payment in arrears was $2.8 million and has been recorded in interest expense and accrued interest payable. The interest payment deferral period on the trust preferred securities ends after the second quarter of 2014. After the ending of the deferral period if the interest payments are not made then it would constitute an event of default which could impact the Company’s consolidated financial statements and liquidity.

Tax Lien Operations

Crusader Servicing Corporation

The Company, through its wholly owned subsidiary Royal Bank, holds a 60% ownership interest in Crusader Servicing Corporation (“CSC”). Legal headquarters are at 732 Montgomery Avenue, Narberth, Pennsylvania. 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. 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.

Business results : CSC had net interest expense of $67,000 for the quarter ended June 30, 2013 compared to net interest income of $51,000 for the comparable quarter in 2012. Net interest income for the first half of 2013 decreased $179,000 from $48,000 for the first half of 2012 to net interest expense of $131,000 due to the liquidation of the portfolio. For the three and six months ended June 30, 2013, CSC recorded net losses of $213,000 and $325,000, respectively, compared to net losses of $542,000 and $1.6 million, respectively, for the comparable periods of 2012. The net loss for the six months ended June 30, 2012 was largely driven by a $1.0 million accrual for a DOJ fine for a settlement with the DOJ related to their investigation. At June 30, 2013, total assets of CSC were $5.5 million, of which $3.8 million was held in tax liens compared to total assets at December 31, 2012 of $6.7 million, of which the majority was held in tax liens. The allowance for lien loss was $240,000 at June 30, 2013.

Royal Bank has extended loans to CSC at market interest rates, secured by the tax lien portfolio of CSC and in accordance with the provisions of Regulation W. At June 30, 2013, the amount due Royal Bank from CSC was $5.6 million.

Royal Tax Lien Services, LLC

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.

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Business results: Net interest income for RTL was $351,000 and $788,000 for the three and six months ended June 30, 2013, respectively, compared to $592,000 and $1.3 million for the comparable periods in 2012, respectively. The decline in net interest income was largely due to a decline in the average tax liens outstanding. RTL recorded a net loss of $1.9 million for the quarter ended June 30, 2013 compared to a net loss of $323,000 for the comparable quarter of 2012 primarily due to a $1.65 million loss contingency accrual for a potential settlement with the plaintiffs in a class action lawsuit related to the tax lien subsidiaries. For the six months ended 2013, RTL recorded a net loss of $1.7 million compared to a net loss of $974,000 for the comparable period in 2012. The $700,000 decline was primarily related to the $1.65 million loss contingency mentioned previously offset by a decline of a $1.0 million accrual for a DOJ fine for a settlement with the DOJ related to their investigation recorded in the first quarter of 2012. At June 30, 2013, total assets of RTL were $25.8 million, of which $24.0 million was held in tax liens compared to total assets at December 31, 2012 of $30.6 million, of which the majority was held in tax liens. The allowance for lien loss was $346,000 at June 30, 2013.

Royal Bank has extended loans to RTL at market interest rates, secured by the tax lien portfolio of RTL and in accordance with the provisions of Regulation W. At June 30, 2013, the amount due Royal Bank from RTL was $15.7 million.

FINANCIAL CONDITION

Consolidated Assets

Total consolidated assets at June 30, 2013 were $748.6 million, a decrease of $25.1million, or 3.2%, from December 31, 2012. This decrease was mainly attributed to a reduction of $45.1 million and $4.0 million in investment securities and cash and cash equivalents, respectively. Cash flows from the investment portfolio including sales, calls and principal payment on mortgage-backed securities and CMOs were redeployed into new loan originations and to fund the reduction in deposits. Net loans and leases grew $25.8 million while deposits declined $29.2 million.

Cash and Cash Equivalents

Total cash and cash equivalents of $24.8 million at June 30, 2013 decreased $4.0 million, or 14.0%, from $28.8 million at December 31, 2012 mainly due to the decline in deposits.

Investment Securities

AFS investment securities of $304.1 million at June 30, 2013, declined $45.1 million, or 12.9%, from the level at December 31, 2012. The decrease was primarily due to changing the mix of interest-earning assets to loans and to fund the intentional run-off of maturing CDs. FHLB stock was $4.6 million at June 30, 2013 and $6.0 million at December 31, 2012.

The AFS portfolio had gross unrealized losses of $5.3 million at June 30, 2013 compared to gross unrealized losses of $946,000 at December 31, 2012. The considerable increase in the gross unrealized loss was directly impacted by the $3.1 million increase in the gross unrealized loss on government agency debt securities. These securities carry lower coupons and their market value was negatively impacted by a 45% increase in the 10-year Treasury yield from 1.76% at December 31, 2012 to 2.55% at June 30, 2013. The Company did not record OTTI charges in 2013. For the three and six months ended June 30, 2012, the Company recorded $859,000 in OTTI on a private equity real estate fund due to the fund’s financial performance. The AFS portfolio had a net unrealized loss of $997,000 at June 30, 2013 compared to net unrealized gains of $5.3 million at December 31, 2012. The decrease in value of the investment portfolio is directly related to the increase in the 10-year Treasury yield at June 30, 2013.

Investment securities within the AFS portfolio are marked to market quarterly and any resulting gains or losses are recorded in other comprehensive income, net of taxes, within the equity section of the balance sheet as shown in “Note 14 - Comprehensive Income (Loss)” to the consolidated financial statements. When a loss is deemed to be other-than-temporary but the Company does not intend to sell the security and it is not more likely than not that the Company will have to sell the security before recovery of its cost basis, the Company will recognize the credit component of an OTTI charge in earnings and the remaining portion in other comprehensive income.

The Company will continue to monitor these investments to determine if the continued negative trends, market valuations or credit defaults result in impairment that is other than temporary.

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Loans and Leases

Total loans and leases of $367.9 million grew $23.7 million, or 6.9%, from the level at December 31, 2012. The increase was attributed to new loan originations partially offset by balances being paid down, payoffs, charge-offs, and transfers to OREO during the first quarter of 2013. The higher yielding tax certificates declined $6.0 million, or 24.4%. The Company has become more selective in approving commercial real estate loans. As a result, the Company has shifted its lending focus to generating small business loans, owner occupied commercial real estate, middle market business lending and more recently home equity loans.

The following table represents loan balances by type:

	June 30,		December 31,
(In thousands)	2013		2012
Commercial real estate	$	180,601	$	167,115
Construction and land development		34,696		37,215
Commercial and industrial		66,985		40,560
Multi-family		11,736		11,756
Residential real estate		15,873		24,981
Leases		38,497		37,347
Tax certificates		18,578		24,569
Consumer		901		1,139
Total gross loans and leases	$	367,867	$	344,682
Deferred fees, net ⁽¹⁾		-		(517	)
Total loans and leases	$	367,867	$	344,165

¹ For the 2013 period net deferred fees were allocated among the loan types.

Deposits

Total deposits, the Company’s primary source of funds, declined $29.2 million, or 5.3%, from $554.9 million at December 31, 2012 to $525.7 million at June 30, 2013. Time deposits and money market accounts decreased $20.6 million and $15.4 million, respectively from year end 2012. Partially offsetting these declines was an increase in demand deposits of $7.6 million from December 31, 2012.

The following table represents ending deposit balances by type:

	June 30,		December 31,
(In thousands)	2013		2012
Demand (non-interest bearing)	$	66,121	$	58,531
NOW		42,201		43,920
Money Markets		163,944		179,359
Savings		18,418		17,472
Time deposits (over $100)		84,795		91,233
Time deposits (under $100)		150,191		164,402
Total deposits	$	525,670	$	554,917

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Borrowings

At June 30, 2013, total borrowings, which include short-term and long-term borrowings and trust preferred securities, amounted to $133.9 million at June 30, 2013 compared to $134.1 million at December 31, 2012. The small reduction is attributable to payments made on an amortizing loan with another financial institution.

Shareholders’ Equity

Consolidated shareholders’ equity of $53.3 million at June 30, 2013 decreased $5.1 million or 8.8%, from $58.4 million at December 31, 2012. The decrease was related to a reduction of $3.9 million in other comprehensive income mostly related to a decline in the valuation of the investment portfolio, a $618,000 decline in non-controlling interest and net loss of $685,000 for the first two quarters of 2013.

CAPITAL ADEQUACY

Quantitative measures established by regulations to ensure capital adequacy require the Company and Royal Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). As of June 30, 2013, the Company and Royal Bank met all capital adequacy requirements to which they are subject.

Under the informal agreement referenced in “Note 2 – Regulatory Matters and Significant Risks And Uncertainties” to the consolidated financial statements, Royal Bank is required to maintain a minimum Tier 1 leverage ratio of 8% and a Total risk-based capital ratio of 12%. As shown in the table below, Royal Bank met these requirements at June 30, 2013 and December 31, 2010 and met the criteria for a well capitalized institution.

In connection with a prior bank regulatory examination, the FDIC concluded, based upon its interpretation of the Consolidated Reports of Condition and Income (the “Call Report”) instructions and under regulatory accounting principles (“RAP”), that income from Royal Bank’s tax lien business should be recognized on a cash basis, not an accrual basis. Royal Bank’s current accrual method is in accordance with U.S. GAAP. Royal Bank disagrees with the FDIC’s conclusion and filed the Call Report for June 30, 2013 and the most recent eleven quarters in accordance with U.S. GAAP. A change in the method of revenue recognition for the tax lien business for regulatory accounting purposes affects Royal Bank’s capital ratios as shown below. Royal Bank is in discussions with the FDIC to resolve the matter.

The table below sets forth Royal Bank’s capital ratios under RAP, based on the FDIC’s interpretation of the Call Report instructions:

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											To be well capitalized
						For capital					capitalized under prompt
	Actual					adequacy purposes					corrective action provision
(Dollars in thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total capital (to risk-weighted assets)
At June 30, 2013	$	72,511		15.45	%	$	37,536		8.00	%	$	46,919		10.00	%
At December 31, 2012	$	71,891		16.10	%	$	35,732		8.00	%	$	45,169		10.00	%
Tier I capital (to risk-weighted assets)
At June 30, 2013	$	66,531		14.18	%	$	18,768		4.00	%	$	28,152		6.00	%
At December 31, 2012	$	66,164		14.81	%	$	17,866		4.00	%	$	27,101		6.00	%
Tier I capital (to average assets, leverage)
At June 30, 2013	$	66,531		9.09	%	$	29,267		4.00	%	$	36,584		5.00	%
At December 31, 2012	$	66,164		8.53	%	$	31,012		4.00	%	$	38,765		5.00	%

The tables below reflect the adjustments to the net loss as well as the capital ratios under U.S. GAAP:

	For the six			For the
	months ended			year ended
(In thousands)	June 30, 2013			December 31, 2012
RAP net loss	$	(4,377	)	$	(17,974	)
Tax lien adjustment, net of noncontrolling interest		3,883			4,731
U.S. GAAP net loss	$	(494	)	$	(13,243	)

	At June 30, 2013						At December 31, 2012
	As reported			As adjusted			As reported			As adjusted
	under RAP			for U.S. GAAP			under RAP			for U.S. GAAP
Total capital (to risk-weighted assets)		15.45	%		16.62	%		16.10	%		17.57	%
Tier I capital (to risk-weighted assets)		14.18	%		15.35	%		14.81	%		16.29	%
Tier I capital (to average assets, leverage)		9.09	%		9.89	%		8.53	%		9.45	%

The tables below reflect the Company’s capital ratios:

											To be well capitalized
						For capital					capitalized under prompt
	Actual					adequacy purposes					corrective action provision
(Dollars in thousands)	Amount		Ratio			Amount		Ratio			Amount			Ratio
Total capital (to risk-weighted assets)
At June 30, 2013	$	87,801		18.29	%	$	38,406		8.00	%		N/	A		N/	A
At December 31, 2012	$	88,838		19.33	%	$	36,774		8.00	%		N/	A		N/	A
Tier I capital (to risk-weighted assets)
At June 30, 2013	$	75,777		15.78	%	$	19,203		4.00	%		N/	A		N/	A
At December 31, 2012	$	77,450		16.85	%	$	18,387		4.00	%		N/	A		N/	A
Tier I capital (to average assets, leverage)
At June 30, 2013	$	75,777		10.17	%	$	29,801		4.00	%		N/	A		N/	A
At December 31, 2012	$	77,450		9.80	%	$	31,614		4.00	%		N/	A		N/	A

As of June 30, 2013, the Company has filed the Consolidated Financial Statements for Bank Holding Companies-FR Y-9C (“FR Y-9C”) consistent with U.S. GAAP and the FR Y-9C instructions. In the event that a similar adjustment for RAP purposes would be required by the Federal Reserve on the holding company level, the adjusted ratios are shown in the table below.

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	For the six			For the
	months ended			year ended
(In thousands)	June 30, 2013			December 31, 2012
U.S. GAAP net loss	$	(685	)	$	(15,625	)
Tax lien adjustment, net of noncontrolling interest		(3,883	)		(4,731	)
RAP net loss	$	(4,568	)	$	(20,356	)

	At June 30, 2013						At December 31, 2012
	As reported			As adjusted			As reported			As adjusted
	under U.S. GAAP			for RAP			under U.S. GAAP			for RAP
Total capital (to risk-weighted assets)		18.29	%		17.16	%		19.33	%		17.90	%
Tier I capital (to risk-weighted assets)		15.78	%		14.18	%		16.85	%		14.82	%
Tier I capital (to average assets, leverage)		10.17	%		9.09	%		9.80	%		8.56	%

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 banking regulation. At June 30, 2013, 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 June 30, 2013, 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.

In June 2012, the federal bank regulatory agencies issued a series of proposed revisions to the agencies’ capital adequacy guidelines and prompt corrective action rules, which were designed to enhance such requirements and implement the revised standards of the Basel Committee on Banking Supervision, commonly referred to as Basel III. In July 2013, the federal bank regulatory agencies adopted final rules, which differ in certain respects from the June 2012 proposals.

The July 2013 final rules generally implement higher minimum capital requirements, add a new common equity tier 1 capital requirement, and establish criteria that instruments must meet to be considered common equity tier 1 capital, additional tier 1 capital or tier 2 capital. The new minimum capital to risk-adjusted assets requirements are a common equity tier 1 capital ratio of 4.5% (6.5% to be considered “well capitalized”) and a tier 1 capital ratio of 6.0%, increased from 4.0% (and increased from 6.0% to 8.0% to be considered “well capitalized”); the total capital ratio remains at 8.0% under the new rules (10.0% to be considered “well capitalized”). Under the new rules, in order to avoid limitations on capital distributions (including dividend payments and certain discretionary bonus payments to executive officers), a banking organization must hold a capital conservation buffer comprised of common equity tier 1 capital above its minimum risk-based capital requirements in an amount greater than 2.5% of total risk-weighted assets. The new minimum capital requirements are effective on January 1, 2015. The capital contribution buffer requirements phase in over a three-year period beginning January 1, 2016.

The July 2013 final rules include three significant changes from the June 2012 proposals: (i) the final rules do not change the current risk weighting for residential mortgage exposures; (ii) the final rules permit institutions, other than certain large institutions, to elect to continue to treat certain components of accumulated other comprehensive income as permitted under the current general risk-based capital rules, and not reflect unrealized gains and losses on available-for-sale securities in common equity tier 1 calculations; and (iii) the final rules permit institutions with less than $15.0 billion in assets to grandfather certain non-qualifying capital instruments (including trust preferred securities) issued prior to May 19, 2009 into tier 1 capital.

The Company and Royal Bank will continue to analyze these new rules and their effects on the business, operations and capital levels of the Company and the Bank.

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LIQUIDITY & INTEREST RATE SENSITIVITY

Liquidity is the ability to ensure that adequate funds will be available to meet the Company’s financial commitments as they become due. In managing its liquidity position, all sources of funds are evaluated, the largest of which is deposits. Also taken into consideration are securities maturing in one year or less, other short-term investments and the repayment of loans. These sources provide alternatives to meet its short-term liquidity needs. Longer liquidity needs may be met by issuing longer-term deposits and by raising additional capital. The liquidity ratio is calculated by adding total cash, availability on lines of credit, and unpledged investment securities and subtracting any reserve requirements, this amount is then divided by total deposits as well as by total liabilities to determine the liquidity ratios. The Company’s policy is to maintain a liquidity ratio as a percentage of total deposits of at least 12% and a liquidity ratio as a percentage of total liabilities of at least 10%. At June 30, 2013, the Company’s liquidity ratios were more than three times the policy minimums.

On August 13, 2009, the Company’s Board of Directors determined to suspend the regular quarterly cash dividends on the $30.4 million in Series A Preferred Stock issued to the United States Department of the Treasury (“Treasury”) as part of the Capital Purchase Program (“CPP”) established by the Treasury. 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 Board of Directors also suspended interest payments on its $25.8 million of outstanding trust preferred securities. The decision to suspend the preferred cash dividend and the trust preferred interest payment better supports the liquidity position of Royal Bank, a wholly owned subsidiary of the Company. As of June 30, 2013 the trust preferred interest payment in arrears was $2.8 million and has been recorded in interest expense and accrued interest payable. The interest payment deferral period on the trust preferred securities ends after the second quarter of 2014. After the ending of the deferral period if the interest payments are not made then it would constitute an event of default which could impact the Company’s consolidated financial statements and liquidity. As of June 30, 2013 the Series A Preferred stock dividend in arrears was $6.8 million and has not been recognized in the consolidated financial statements. In the event the Company declared the preferred dividend the Company’s capital ratios would be negatively affected however they would remain above the required minimum ratios. In February 2014, the preferred cumulative dividend rate will prospectively increase to9% per annum.

In managing its interest rate sensitivity positions, the Company seeks to develop and implement strategies to control exposure of net interest income to risks associated with interest rate movements. Interest rate sensitivity is a function of the re-pricing characteristics of the Company's assets and liabilities. These include the volume of assets and liabilities re-pricing, the timing of the re-pricing, and the interest rate sensitivity gaps which are a continual challenge in a changing rate environment.

The following table shows separately the interest sensitivity of each category of interest earning assets and interest bearing liabilities as of June 30, 2013:

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(In millions)	Days						1 to 5			Over 5		Non-rate
Assets		0 – 90			91 – 365		Years			Years		Sensitive			Total
Interest-bearing deposits in banks	$	15.7		$	-		$	-		$	-	$	9.1		$	24.8
Investment securities AFS		19.0			30.6			139.7			115.8		(1.0	)		304.1
Loans:
Fixed rate		13.3			47.5			123.1			70.0		(15.2	)		238.7
Variable rate		63.0			52.4			-			-		-			115.4
Total loans		76.3			99.9			123.1			70.0		(15.2	)		354.1
Other assets		-			21.8			-			-		43.8			65.6
Total Assets	$	111.0		$	152.3		$	262.8		$	185.8	$	36.7		$	748.6
Liabilities & Capital
Deposits:
Non interest bearing deposits	$	-		$	-		$	-		$	-	$	66.1		$	66.1
Interest bearing deposits		24.5			73.7			126.4			-		-			224.6
Certificate of deposits		39.3			88.2			92.9			14.6		-			235.0
Total deposits		63.8			161.9			219.3			14.6		66.1			525.7
Borrowings		38.9			-			95.0			-		-			133.9
Other liabilities		-			-			-			-		35.8			35.8
Capital		-			-			-			-		53.2			53.2
Total liabilities & capital	$	102.7		$	161.9		$	314.3		$	14.6	$	155.1		$	748.6
Net interest rate GAP	$	8.3		$	(9.6	)	$	(51.5	)	$	171.2	$	(118.4	)
Cumulative interest rate GAP	$	8.3		$	(1.3	)	$	(52.8	)	$	118.4
GAP to total assets		1	%		-1	%
GAP to total equity		16	%		-18	%
Cumulative GAP to total assets		1	%		0	%
Cumulative GAP to total equity		16	%		-2	%

The Company’s exposure to interest rate risk is mitigated somewhat by a portion of the Company’s loan portfolio consisting of floating rate loans, which are tied to the prime lending rate but which have interest rate floors and no interest rate ceilings. Although the Company is originating fixed rate loans, a portion of the loan portfolio continues to be comprised of floating rate loans with interest rate floors. At June 30, 2013, floating rate loans with floors and without floors were $85.8 million and $29.6million, respectively.

REGULATORY ORDERS

FDIC and Department of Banking Memorandum of Understanding

On July 15, 2009, Royal Bank agreed to enter into a Stipulation and Consent to the Issuance of an Order to Cease and Desist (the “Orders”) with each of the Federal Deposit Insurance Corporation (“FDIC”) and the Pennsylvania Department of Banking (the “Department”). The material terms of the Orders were identical and required Royal Bank among other items to maintain, after establishing an adequate allowance for loan and lease losses, a ratio of Tier 1 capital to total assets (“leverage ratio”) equal to or greater than 8% and a ratio of qualifying total capital to risk-weighted assets (“total risk-based capital ratio”) equal to or greater than 12%. The FDIC and the Department replaced the Orders in the fourth quarter of 2011 with an informal agreement, known as a memorandum of understanding (“MOU”). Included in the MOU is the continued requirement of maintaining a leverage ratio equal to or greater than 8% and a total risk-based capital ratio equal to or greater than 12%. At June 30, 2013, based on capital levels calculated under regulatory accounting principles (“ RAP”) , Royal Bank’s Tier 1 leverage and total risk-based capital ratios were 9.09% and 15.45%, respectively. Please refer to “Capital Adequacy” under “Financial Condition”.

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Federal Reserve Memorandum of Understanding

ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information presented in the “Liquidity and Interest Rate Sensitivity” section of the “Management’s Discussion and Analysis of Financial Condition and Results Operations” of this Report is incorporated herein by reference.

ITEM 4 – CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures

The Company maintains a set of disclosure controls and procedures that are designed to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission’s rules and forms. As of the end of the period covered by this report, the Company evaluated, under the supervision and with the participation of our management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rule 13a-15(e) of the Exchange Act. Based on that evaluation our CEO and CFO concluded that the Company’s disclosure controls and procedures were effective at June 30, 2013.

(b) Changes in Internal Control Over Financial Reporting

There have been no changes in the Company’s internal control over financial reporting during the second quarter of 2013 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

There are inherent limitations to the effectiveness of any controls system. A controls system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that its objectives are met. Further, the design of a control system must reflect the fact that there are limits on resources, and the benefits of controls must be considered relative to their costs and their impact on the business model. We intend to continue to improve and refine our internal control over financial reporting.

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PART II - OTHER INFORMATION

Item 1.

Legal Proceedings

On March 13, 2012, March 30, 2012, April 20, 2012, May 2, 2012, May 11, 2012, May 18, 2012, June 18, 2012 and June 29, 2012, the former President of CSC and RTL, CSC, RTL and the Company were named defendants, among others, in putative class action lawsuits filed in the U.S. District Court for the District of New Jersey (“Court”) on behalf of a proposed class of taxpayers who became delinquent in paying their municipal tax obligations: Boyer v. Robert W. Stein, Crusader Servicing Corp. Royal Tax Lien Services LLC, Royal Bancshares of Pennsylvania, Inc., et al., Superior Court of New Jersey, Chancery Division (“the Boyer Action”), Contarino v Robert W. Stein, Crusader Servicing Corp. Royal Tax Lien Services LLC, Royal Bancshares of Pennsylvania, Inc., et al., U.S. District Court for the District of New Jersey; MSC LLC v Robert W. Stein, Crusader Servicing Corp. Royal Tax Lien Services LLC, Royal Bancshares of Pennsylvania, Inc., et al., U.S. District Court for the District of New Jersey; English v Robert W. Stein, Crusader Servicing Corp. Royal Tax Lien Services LLC, Royal Bancshares of Pennsylvania, Inc., et al., U.S. District Court for the District of New Jersey; Ledford v Robert W. Stein, Crusader Servicing Corp. Royal Tax Lien Services LLC, Royal Bancshares of Pennsylvania, Inc., et al., U.S. District Court for the District of New Jersey; T&B Associates v Robert W. Stein, Crusader Servicing Corp. Royal Tax Lien Services LLC, Royal Bancshares of Pennsylvania, Inc., et al., U.S. District Court for the District of New Jersey; Jacobs et al v Robert W. Stein, Crusader Servicing Corp. Royal Tax Lien Services LLC, Royal Bancshares of Pennsylvania, Inc., et al., U.S. District Court for the District of New Jersey; Senatore Builders, LLC v Robert W. Stein, Crusader Servicing Corp. Royal Tax Lien Services LLC, Royal Bancshares of Pennsylvania, Inc., et al. ,U.S. District Court for the District of New Jersey, respectively alleging a conspiracy to rig bids in municipal tax lien auctions. On June 12, 2012, the Court entered an Order consolidating for pretrial purposes the above actions with all subsequently filed or transferred related actions, collectively referred to as In re New Jersey Tax Sale Certificates Antitrust Litigation . On October 22, 2012, the Court appointed two law firms as interim class counsel and another law firm as liaison class counsel and further ordered appointed counsel to a master complaint for the consolidated action. On December 21, 2012, plaintiffs filed a Consolidated Master Class Action Complaint (the “Complaint”) against numerous defendants, including the former President of CSC and RTL, Royal Bancshares of Pennsylvania, Inc., Royal Bank America, CSC and RTL. The Company filed a motion to dismiss the Complaint on March 8, 2013, which is currently pending before the Court. During the second quarter of 2013, the Company accrued a loss contingency of $1.65 million for a potential settlement with the plaintiffs. After adjusting for the noncontrolling interest, the Company’s 60% share of the loss contingency amounted to $990,000. Subsequently, Royal Bancshares of Pennsylvania, Inc., Royal Bank America, CSC, and RTL reached an agreement in principle with plaintiffs to settle the litigation for $1.65 million and other terms and conditions, including an opportunity for members of the proposed settlement class whose tax liens are currently held by CSC or RTL to redeem those liens for a one-time cash payment equaling 85% of the redemption amount by making such payment within 35 days of the date of written notice. The proposed settlement class does not include, and therefore the offer to redeem does not apply to, tax liens acquired at 0% interest or at a premium. The settlement is contingent upon negotiation of a definitive settlement agreement and is subject to Court approval after notice and a hearing. Members of the proposed settlement class will have an opportunity to object to the proposed settlement or opt-out.

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Item 1A.

Risk Factors.

There have been no material changes from risk factors as previously disclosed in our Form 10-K for the year ended December 31, 2012.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds.

None

Item 3.

Default Upon Senior Securities.

None

Item 4.

Mine Safety Disclosures.

None

Item 5.

Other Information.

None

Item 6.

Exhibits.

(a)

	3.1	Articles of Incorporation of the Company.

	3.2	Bylaws of the Company (Incorporated by reference to Exhibit 3(ii) to the Company’s report on Form 10-K filed with the Commission on March 30, 2009.)

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	31.1	Section 302 Certification Pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934 signed by F. Kevin Tylus, Principal Executive Officer of Royal Bancshares of Pennsylvania on August 14, 2013.

	31.2	Section 302 Certification Pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934 signed by Michael S. Thompson, Principal Financial Officer of Royal Bancshares of Pennsylvania on August 14, 2013.

	32.1	Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by F. Kevin Tylus, Principal Executive Officer of Royal Bancshares of Pennsylvania on August 14, 2013.

	32.2	Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by Michael S. Thompson, Principal Financial Officer of Royal Bancshares of Pennsylvania on August 14, 2013.

	101	Interactive Data File

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

ROYAL BANCSHARES OF PENNSYLVANIA, INC.

(Registrant)

Dated: August 14, 2013

/s/ Michael S. Thompson

Michael S. Thompson

Principal Financial and Accounting Officer

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RBPAA Royal Bancshares of Pennsylvania, Inc.