Royal Financial, Inc. Releases FY11 Annual Report

Aug 22, 2011, 15:00 ET from Royal Financial, Inc.

CHICAGO, Aug. 22, 2011 /PRNewswire/ -- Royal Financial, Inc. (OTC Bulletin Board: RYFL.OB) (the “Company”) and Royal Savings Bank (the “Bank”), a wholly owned subsidiary of the Company, today announced the release of the Royal Financial, Inc. Annual Report for its fiscal year end June 30, 2011.

Note:

This report complements our audited consolidated financial statements for the years ended June 30, 2011, and June 30, 2010, which are available at www.royal-bank.us. This report provides management's financial commentary for the fiscal year ended June 30, 2011.  This report has not been prepared in accordance with Securities and Exchange Commission (the "SEC") rules applicable to SEC registrant companies and is not intended to comply with such rules.



Forward-Looking Information

This report includes forward-looking statements, including statements regarding our strategy, effectiveness of investment programs, evaluations of future interest rate trends and liquidity, expectations as to growth in assets, deposits and results of operations, future operations, market position, financial position, and prospects, plans and objectives of management.  These forward-looking statements, which are based on certain assumptions and describe our future plans, strategies and expectations, can generally be identified by use of the words "believe," "expect," "intend," "anticipate," "estimate," "project," or similar expressions.  Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain and actual results may differ materially from those predicted in such forward-looking statements.  Factors that could have a material adverse effect on the operations and future prospects of the Company and the Bank include, but are not limited to, changes in interest rates; the economic health of the local real estate market; general economic conditions; credit deterioration in our loan portfolio that would cause us to further increase our allowance for loan losses; legislative/regulatory changes; monetary and fiscal policies of the U.S. government, including policies of the U.S. Treasury and the Federal Reserve Board; the quality or composition of the loan and securities portfolios; demand for loan products in our market areas; deposit flows; competition; demand for financial services in the Company's market area; and changes in accounting principles, policies, and guidelines.  These risks and uncertainties should be considered in evaluating forward-looking statements, and undue reliance should not be placed on such statements.

ROYAL FINANCIAL, INC.

Royal Financial, Inc. ("Royal Financial" or the "Company") was incorporated under the laws of the State of Delaware on September 15, 2004, for the purpose of serving as the holding company of Royal Savings Bank (the "Bank") as part of the Bank's conversion from a mutual to stock form of organization, which was completed on January 20, 2005.  The Bank was founded in 1887 as Royal Savings and Loan Association and is a community- and customer-oriented savings bank organized under the laws of the State of Illinois.  The Bank is engaged in the business of retail banking with operations conducted through its main office and one branch office located in Chicago, Illinois.

The Bank's business consists of attracting deposits from the general public and using those funds to originate one- to four-family residential loans, commercial real estate loans, multi-family real estate loans, consumer loans, and, to a lesser extent, commercial loans and leases. The Bank also maintains an investment portfolio for earnings and liquidity purposes.

Overview of Fiscal Year 2011

During Fiscal Year 2011 (FY11), the operating environment for the banking industry was very challenging.  National and local economic conditions have suppressed the demand for credit-worthy loans, depressed the value of collateral, and exacerbated the anxiety of the Bank's loan and deposit customers.  To promote economic growth, the federal government continues to implement extraordinary monetary policies and actions with little apparent positive effect.  The federal and state governments' continuing failure to resolve their unsustainable fiscal structures contributes significantly to a public lack of confidence which retards the recovery from current economic conditions.  Regulatory initiatives by the federal government (and, to a lesser degree, other jurisdictions) have increased the volume and pace of statutory and regulatory change, burden and cost of regulatory compliance, and risk of and penalties for regulatory non-compliance for financial institutions.

During the current business cycle, the Company's business plan to enhance shareholder value is focused on execution of strategies to:  strengthen the balance sheet; improve earnings; maintain capital strength; manage liquidity; and comply with applicable laws and regulations.  The Company made notable progress during FY11.

The Company had a net profit of $206,000 for the year ended June 30, 2011, compared to a net loss of $2.9 million for the year ended June 30, 2010.  The earnings improvement resulted primarily from a decrease in the provision for loan losses of $3.0 million and a decrease in non-interest expense of $296,000, which was partially offset by a decrease in net interest income of $160,000. Return on average assets was 0.23% for the year ended June 30, 2011 as compared to (3.22)% for the year ended June 30, 2010.  Return on average equity was 1.28% and (18.28)% for the years ended June 30, 2011 and 2010, respectively. The ratio of equity to assets at June 30, 2011 and 2010, was 18.07% and 17.75%, respectively.

Management charged off $1.4 million in loans receivable and recognized a credit provision to the allowance for loan and lease losses of $300,000 for the year ended June 30, 2011. At the end of FY11, non-performing assets (impaired loans, accruing and non-accruing, loans past due over 90 days and other real estate owned) totaled $9.5 million, or 10.16% of total assets.

During FY11, the Company's assets increased by $1.1 million with a commensurate increase in liabilities of $600,000 and stockholders equity of $500,000.  The loan portfolio decreased by $12.0 million, of which $4.8 million was transferred to real estate owned, and which was partially offset by an increase of $10.3 million in the investment securities portfolio.  Deposits increased $5.9 million which was partially offset by a decrease in borrowings of $5.4 million.  The increase in deposits resulted from low-cost public fund certificates of deposits of $6.9 million, which have been classified as brokered funds.  The Company continues to manage its interest rate risk in the current economy by allowing higher priced deposits to runoff in an effort to lower the cost of funds.  The net interest margin slightly decreased to 4.49% at fiscal year end 2011 from 4.53% at June 30, 2010.  Conversely, the interest rate spread increased to 4.36% during 2011 from 4.26% in 2010.

Business Strategy

The Company's mission is to operate the Company and the Bank in a safe and sound manner, to maximize stockholder value and comply with applicable laws and regulations.  The Company's business strategy is to operate as a well-capitalized and profitable community savings bank dedicated to providing quality customer service.

During FY11, the Company's continued focus was to enhance stockholder value through conservation of capital, mitigation of credit risk in our loan portfolio, preservation of liquidity and the continued reduction of general and administrative expenses.  The mergers and acquisitions market for financial institutions continues to be dominated by the resolution of troubled banks by the Federal Deposit Insurance Corporation, which has had an adverse impact on the Company's ability to execute its strategic goal to maximize stockholder value via a strategic transaction.  However, the Company remains receptive to and will evaluate credible strategic opportunities to accomplish this goal.

Specific elements of our business strategy include:

  • Mitigate credit risk.  We believe the greatest threat to stockholder value is the credit risk inherent in certain bank assets, primarily our loan portfolio, which is directly influenced by general and local economic conditions.  The Company will continue to monitor external and internal conditions and trends affecting our borrowers, identify credit risks proactively, analyze and estimate such risks in detail, actively manage work outs, and record appropriate allowances (reserves) promptly.
  • Monitor and manage liquidity risk.  Continuing uncertainty in global credit and capital markets has extended the increased liquidity risk for financial institutions.  The Company maintains and implements a liquidity risk management program to monitor conditions, update cash flow projections and contingency scenarios, and adjust (as needed) contingency funding plans.
  • Anticipate, monitor and mitigate interest rate risk.  The federal government (through its Federal Reserve Board) has adopted extraordinary monetary policies throughout the current economic cycle to reduce the cost of funding.  The Open Market Committee of the Federal Reserve Board recently announced its intent to maintain historically low interest rates for the next two years.  These low interest rates combine with decreased demand for credit-worthy loans to affect the yields earned on interest-bearing assets. The Company continuously monitors its interest rate risk in anticipation that these conditions will change.
  • Improve earnings.  The Company continues to focus on improving core earnings by identifying, analyzing and implementing strategic expense reductions, maintaining tight control of operating expenses, retaining and increasing (where possible) loan volume in local markets where the credit risk is acceptable, and leveraging capital consistent with the Company's capital requirements.
  • Monitor changes to and comply with statutory and regulatory requirements.  As expected, the volume and pace of statutory and regulatory change, cost of compliance, and penalties for non-compliance have begun to increase.  The federal government has begun to implement the regulatory changes required by recently enacted legislation that impose additional reporting obligations, operating restrictions and/or performance requirements on financial institutions.  The Company continues to monitor industry developments and trends and changes in laws, regulations and other external requirements proactively to minimize regulatory and reputational risk.

Market Area and Competition

The Bank is a community-oriented savings bank.  The Bank's primary deposit gathering efforts and lending activities are concentrated primarily in the communities surrounding its offices, which is southeastern Cook County, Illinois and bordering Northwest Indiana.

The Bank's market area is an urban area with the manufacturing industry as the major industrial group, followed by the services sector, and then the wholesale/retail sector.  The Bank's offices are located in diverse communities, which have a high percentage of customers of various ethnic backgrounds.  Management of the Bank believes that its urban communities, which consist of residential neighborhoods of predominantly one-to-four-family residences and low- to middle-income families, have been impacted by the recent economic downturn.

The Bank faces significant competition in its market areas, both in attracting deposits and in making loans.  Its most direct competition for deposits has come historically from commercial banks, credit unions and other savings institutions located in its primary market area, including many large financial institutions which have significant financial and marketing resources.  In addition, the Bank faces significant competition for depositors' funds from short-term money market securities, mutual funds and other corporate and government securities.  The Bank does not rely upon any individual group or entity for a material portion of its deposits.  The ability of the Bank to attract and retain deposits depends on its ability to generally provide a rate of return, liquidity and risk comparable to that offered by competing investment opportunities.

Competition for loans comes principally from other financial institutions and mortgage companies in our primary market area.  The Bank competes for loan originations primarily through the interest rates and loan fees it charges and the efficiency and quality of services it provides borrowers.  Factors that affect competition include general and local economic conditions, current interest rate levels and volatility in the mortgage markets.  Competition has increased as a result of the continuing reduction of restrictions on the interstate operations of financial institutions and the decrease in lending activity in the current economy.

Selected Financial Data

The following tables set forth selected historical financial and other data of the Company for the periods and at the dates indicated.



At June 30,

2011

2010

2009


(In thousands, except per share data)

Selected Financial Condition Data:




Total assets                                 

$93,155

$92,079

$94,848

Cash and cash equivalents                     

1,913

3,030

3,172

Securities available for sale                     

26,345

16,084

3,996

Loans receivable, net                          

54,112

66,124

82,222

Deposits                                     

70,108

64,197

70,487

Federal Home Loan Bank advances and other borrowings

5,368

10,400

3,900

Total stockholders' equity                       

16,836

16,341

18,763

Book value per common share(1)                  

$6.47

$6.59

$7.74






Year Ended June 30,

2011

2010

2009


(In thousands, except per share data)

Selected Operating Data:




Total interest income                             

$4,192

$4,611

$5,568

Total interest expense                            

426

684

1,140

Net interest income                               

3,766

3,927

4,428

Provision for loan losses                          

(300)

2,653

10,263

Net interest income after provision for loan losses      

4,066

1,274

(5,835)

Total non-interest income                         

271

271

538

Total non-interest expense                         

4,131

4,428

6,612

Loss before provision for income taxes              

206

(2,883)

(11,909)

Provision (benefit) for income taxes                 

277

Net income/ (loss)                               

206

(2,883)

(12,186)

Basic loss per share                             

0.08

(1.18)

(5.08)






Year Ended June 30,

2011

2010

2009

Key Financial Ratios:




Performance Ratios:




Return on average assets                          

0.23%

(3.22)%

(11.25)%

Return on average equity                           

1.28

(18.28)

(41.70)

Interest rate spread(2)                              

4.36

4.26

4.19

Net interest margin(3)                               

4.49

4.53

4.49

Total non-interest expenses to average total assets     

4.59

4.94

6.11

Efficiency ratio(4)                                 

94.71

105.48

111.56

Asset Quality Ratios:




Non-performing loans to total loans at end of period (5)   

7.28%

13.24%

11.76%

Non-performing assets to total assets at end of period   

10.16

11.38

10.88

Allowance for loan losses to total loans at end of period  

4.25

5.52

5.98

Allowance for loan losses to total nonperforming loans at end of period

58.32

41.73

50.83

Capital Ratios:




Total capital (to risk-weighted assets) (6)               

27.10%

22.22%

21.50%

Tier 1 capital (to risk-weighted assets) (6)               

25.82

20.91

20.18

Tier 1 capital (to average assets) (6)                   

16.91

15.15

15.10

Equity to assets at end of period                     

18.07

17.75

19.78




(1)

Outstanding common shares as of June 30, 2011 and June 30, 2010 were 2,477,966.  As of June 30, 2009 the outstanding common shares were 2,422,556.

(2)

Yield on average interest-earning assets less rate on average interest-bearing liabilities.

(3)

Net interest income divided by average interest-earning assets.

(4)

Non-interest expense, excluding the expenses related to impairment charges, divided by the sum of net interest income, plus non-interest income, excluding net gain on sales of securities.

(5)

Non-performing loans include impaired loans, accruing and non-accruing loans, and loans past due 90 days or more

(6)

Regulatory capital ratios are disclosed at the Bank level.



Average Balances, Net Interest Income and Yields Earned and Rates Paid

The following table presents for the periods indicated the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the total dollar amount of interest expense on average interest-bearing liabilities and the resultant rates, and the net interest margin.  The table reflects an adjustment to interest income for nontaxable securities to be included on a fully tax adjusted basis.  All average balances are based on average monthly balances during the periods.  The Company does not believe that the monthly averages differ significantly from what the daily averages would be.



Year Ended June 30,


2011

2010

2009


Average Balance

Interest

Average Yield/
Rate(1)

Average Balance

Interest

Average Yield/
Rate(1)

Average Balance

Interest

Average Yield/ Rate(1)


(Dollars in thousands)

Interest-earning assets:










Loans receivable, net(2)     

$63,622

$3,551

5.58%

$78,425

$4,370

5.57%

$93,086

$5,383

5.78%

Securities available for sale 

17,938

639

3.56

7,062

239

3.39

4,378

175

4.01

Deposits with financial institutions(3)

1,362

2

0.14

570

1

0.15

130

1

0.41

Federal funds sold         

474

1

0.17

268

1

0.26

648

9

1.41

Federal Home Loan Bank stock(4)

520

  —

  —

384

  —

  —

381

  —

  —

Total interest-earning assets

83,916

4,193

5.00

86,709

4,611

5.32

98,623

5,568

5.65

Non-interest-earning assets:

6,008



2,949



9,676



Total assets         

$89,924



$89,658



$108,299



Interest-bearing liabilities:










Deposits:










Demand             

$7,061

$22

0.31%

$7,241

$47

0.65%

$13,522

$54

0.40%

Savings             

26,013

39

0.15

25,275

59

0.24

25,462

56

0.22

Certificates of Deposit 

26,418

334

1.27

28,573

562

1.97

34,882

993

2.85

Total deposits        

59,492

395

0.66

61,089

668

1.09

73,866

1,103

1.49

Borrowings:










Federal Home Loan Bank advances

6,896

30

0.43

3,213

15

0.47

4,032

36

0.91

Federal funds purchased

209

  1

0.53

97

  1

0.58

75

  1

1.47

Total interest-bearing liabilities

66,597

426

0.64

64,399

684

1.06

77,973

1,140

1.46

Non-interest-bearing liabilities:

7,216



9,490



1,101



Total liabilities        

73,813



73,889



79,074



Total equity capital(5)     

16,111



15,769



29,225



Total liabilities and equity capital

$89,924



$89,658



$108,299



Net average interest-earning assets

$17,320



$22,310



$20,269



Net interest income; interest rate spread(6)


$3,766

4.36%


$3,927

4.26%


$4,428

4.19%

Net interest margin(7)     



4.49%



4.53%



4.49%

Average interest-earning assets to average interest-bearing liabilities


126.01%



134.64%



126.51%





(1)

Yields and rates have been annualized where appropriate.

(2)

Includes non accrual loans.

(3)

Includes interest-bearing demand deposits.

(4)

The FHLB Chicago began paying dividends on its stock in the first quarter of 2011.

(5)

Includes retained earnings (deficit) and accumulated other comprehensive income/(loss).

(6)

Interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average rate on interest-bearing liabilities.

(7)

Net interest margin is net interest income divided by average interest-earning assets.



Liquidity and Capital Resources

Liquidity.  Uncertainty about the economy continues to increase liquidity risk. The Company continues to exercise an enhanced liquidity risk management program to monitor current liquidity, project liquidity needs and identify potential sources of contingency funding.

Management actively manages liquidity risk by measuring and monitoring liquidity on both a short- and long-term basis, assessing and anticipating changes in the balance sheet and funding sources, and developing contingency funding plans.  After assessing actual and projected cash flow needs, management seeks to obtain funding at the most economical cost.  The Company's primary sources of funds are deposits, principal and interest payments on loans, proceeds from maturities, calls and the sale of securities held in the Bank's investment portfolio, Federal Home Loan Bank (FHLB) advances, and funds provided from operations.  While maturities and scheduled amortization of loans and securities are relatively predictable sources of funds, deposit flows and loan repayments are greatly influenced by general interest rates, economic conditions, and competition.  The Company borrows from the FHLB to satisfy temporary short-term liquidity requirements (when needed) and to fund the purchase of securities as a strategy to increase earnings.

As of June 30, 2011, the Bank had $17.3 million in credit available from the FHLB, of which the Bank had drawn $5.0 million.  The Bank can increase the availability by purchasing additional FHLB stock and providing additional collateral.  Recently, the FHLB implemented a risk rating process which could reduce the lines of credit extended to member banks.  Following its most recent risk analysis of the Bank, FHLB imposed no additional restrictions, terms or reporting requirements on the current borrowing capacity.

The Company also maintains a relationship with the Federal Reserve Bank of Chicago to provide a contingent funding source via the Discount Window.  The funding capacity is based on the value of collateral pledged for borrowing.  As of June 30, 2011, the Company pledged $9.7 million of commercial real estate loans as collateral, which provided the Company with a borrowing capacity of approximately $5.9 million.

Capital.  The Bank is required to maintain regulatory capital sufficient to meet Tier 1 leverage, Tier 1 risk-based and total risk-based capital ratios of at least 4.0%, 4.0% and 8.0%, respectively.  At June 30, 2011, the Bank exceeded each of its capital requirements with ratios of 16.91%, 25.82%, and 27.10%, respectively.

Lending Activities

General. At June 30, 2011, our net loan portfolio totaled $54.1 million, representing approximately 58.1% of total assets at that date.  At June 30, 2011, one- to four-family residential loans amounted to $25.1 million, or 44.4% of the total loan portfolio.  At June 30, 2011, commercial real estate loans and multi-family loans amounted to $23.6 million and $2.9 million, or 41.8% and 5.2% of the total loan portfolio, respectively.  At June 30, 2011, commercial and consumer loans amounted to $4.2 million and $723,000 or 7.4% and 1.3%, respectively of the total loan portfolio, before the allowance for loan losses.

The types of loans that the Bank may originate or purchase are subject to federal and state laws and regulations.  Interest rates charged on loans are affected principally by the demand for such loans and the supply of money available for lending purposes and the rates offered by the Bank's competitors.  These factors are, in turn, affected by general and economic conditions, the monetary policy of the federal government, including the Board of Governors of the Federal Reserve System, or the Federal Reserve Board, legislative and tax policies and governmental budgetary matters.  A savings institution generally may not make loans to any one borrower in an amount that exceeds 25% of the savings bank's total capital plus general loan loss reserves.  At June 30, 2011, the Bank's regulatory limit on loans to one borrower is $4.5 million. The five largest loans, or groups of loans to one borrower, which includes related entities, an aggregate of $4.7 million, $3.2 million, $2.5 million, $2.5 million and $2.4 million.  The loan group of $4.7 million was in conformance with regulatory lending limits that were in effect at the time of its origination. Each of the Bank's five largest loans, or groups of loans, was performing in accordance with its terms at June 30, 2011.

Loan Portfolio Composition.  The following table sets forth the composition of the loan portfolio, net of deferred loan fees and costs, by type of loan at the dates indicated.



June 30,


2011

2010

2009


Amount

Percentage

Amount

Percentage

Amount

Percentage


(Dollars in thousands)

Real estate loans:







One- to four-family loans       

$  25,070

44.36%

$  28,908

41.30%

$  31,632

36.17%

Commercial real estate loans    

23,613

41.78

31,903

45.59

41,266

47.19

Multi-family loans             

2,948

5.22

3,922

5.60

4,417

5.05

Total real estate loans       

51,631

91.36

64,733

92.49

77,315

88.41

Commercial loans:







    Business loans               

3,365

5.96

2,945

4.21

6,179

7.07

    Commercial leases           

793

1.40

1,560

2.23

3,337

3.82

Total commercial loans      

4,158

7.36

4,505

6.44

9,516

10.89

Consumer loans:







Home equity loans            

658

1.16

700

1.00

521

0.60

Share loans                 

65

0.12

50

0.07

95

0.10

Total consumer loans       

723

1.28

750

1.07

616

0.70

Total loans                     

$ 56,512

100.00%

$ 69,988

100.00%

$ 87,447

100.00%








Allowance for loan losses     

(2,400)


(3,864)


(5,225)


Loans receivable, net       

$  54,112


$  66,124


$  82,222





Loan Concentrations:  The following table sets forth the concentrations of the loan portfolio by state as of June 30, 2011.  


Illinois

76.36 %


Indiana

19.05


Michigan

1.77


Florida

0.67


Wisconsin

0.53


Other states combined

0.62


   Total

100.00%



Origination of Loans.  The Company's lending activities are subject to the written underwriting standards and loan origination procedures established by the Board of Directors and management.  Loan originations are obtained through a variety of sources, including referrals from real estate brokers, builders, existing customers and loan officers of the Bank.  Written loan applications are taken by loan officers.  The loan officers also supervise the procurement of credit reports, appraisals and other documentation involved with originating a loan.  Property valuations are performed by independent outside appraisers approved by the Board of Directors of the Bank and are ordered independent of the loan officer.

Under the Bank's real estate lending policy, a title opinion or a title insurance policy must be obtained for each real estate loan.  The Bank also requires fire and extended coverage casualty insurance in order to protect the properties securing its real estate loans.  Borrowers must also obtain flood insurance policies when the property is in a flood hazard area as designated by the Department of Housing and Urban Development.  The Bank frequently requires borrowers to advance funds to an escrow account for the payment of real estate taxes or hazard insurance premiums.  The Bank's loan approval process is intended to assess the borrower's ability to repay the loan, the viability of the loan and the adequacy of the value of the property that will secure the loan.  The Bank's loan policy authorizes the Senior Vice President-Loans and President/CEO to approve extensions of credit with individual authority up to $400,000 and aggregate authority up to $800,000. The Loan Committee, consisting of two outside directors, the Senior Vice President-Loans and the President/CEO is authorized as a committee to approve aggregate extensions of credit up to $2.5 million.  Any aggregate extension of credit over $2.5 million requires approval of the entire Board of Directors.

Maturity of Loan Portfolio.  The following table presents certain information at June 30, 2011 regarding the dollar amount of loans maturing in the portfolio based on their contractual terms to maturity or scheduled amortization, but does not include potential prepayments.  Scheduled contractual maturities of loans do not necessarily reflect the actual expected term of the loan portfolio.  The average life of mortgage loans is substantially less than their average contractual terms because of prepayments.  The average life of mortgage loans tends to increase when current mortgage loan rates are higher than rates on existing mortgage loans and, conversely, decrease when rates on current mortgage loans are lower than existing mortgage loan rates (due to prepayments as a result of the refinancing of adjustable-rate and fixed-rate loans at lower rates).  Loan balances do not include undisbursed loan proceeds or the allowance for loan losses.



At June 30, 2011


One- to Four-Family

Commercial Real Estate

Multi-family

Business

Commercial Leases

Home Equity

Share

Total Loans


(In thousands)

Amounts Due In:









One year or less 

$   5,601

$ 6,348

$     1,979

$  3,035

$       90

$        96

$       9

$  17,158

More than one year to five years

5,756

14,773

845

330

703

346

56

22,809

More than five years

13,713

2,492

124

  —

  —

216

  —

16,545

Total amount due 

$ 25,070

$ 23,613

$  2,948

$  3,365

$   793

$   658

$   65

$  56,512




The following table sets forth the dollar amount of all loans, net of deferred loan fees and costs, as of June 30, 2011, by fixed or floating (adjustable) interest rates.



Fixed-Rates

Floating or Adjustable Rates

Total


(In thousands)

Real estate loans:




One- to four-family loans      

$ 23,918

$     1,152

$ 25,070

Commercial real estate loans   

19,149

4,464

23,613

Multi-family loans             

2,948

-

2,948

Commercial loans:




    Business loans             

1,134

2,231

3,365

    Commercial leases           

793

-

793

Consumer loans:




Home equity loans           

564

94

658

Share loans                 

61

  4

65

Total loans               

$48,567

$ 7,945

$56,512




One- to Four-Family Residential Real Estate Loans.  One of the Bank's primary lending activities is the origination of loans secured by one- to four-family residences.  At June 30, 2011, $25.1 million, or 44.4%, of the total loan portfolio, before net items, consisted of one- to four-family residential loans.

The loan-to-value ratio, maturity and other provisions of the loans made by the Bank generally have reflected the policy of making less than the maximum loan permissible under applicable regulations, in accordance with sound lending practices, market conditions and underwriting standards established by the Bank.  The Bank's present lending policies on one- to four-family residential mortgage loans generally limit the maximum loan-to-value ratio to 80% of the lesser of the appraised value or purchase price of the property.  If the Bank originates a residential mortgage loan with a loan-to-value in excess of 80%, the Bank typically requires the borrower to obtain private mortgage insurance.  Residential mortgage loans are amortized on a monthly basis with principal and interest due each month.  The loans generally include "due-on-sale" clauses.

The Bank offers residential mortgage loans with either fixed rates of interest or interest rates which adjust periodically during the term of the loan.  Fixed rate loans generally have maturities ranging from 5 to 30 years and are fully amortizing with monthly loan payments sufficient to repay the total amount of the loan with interest by the end of the loan term.  The Bank's fixed rate loans generally are originated under terms, conditions and documentation that permit them to be sold to U.S. Government-sponsored agencies, such as the Federal Home Loan Mortgage Corporation, and other investors that purchase mortgages in the secondary market.  

Multi-Family Residential Loans.  The Bank also offers multi-family (over four units) residential loans.  The multi-family residential mortgage loans are underwritten on substantially the same basis as its commercial real estate loans, with loan-to-value ratios of up to 80%.  At June 30, 2011, the Bank had $2.9 million in multi-family residential mortgage loans which amounted to 5.2% of the total portfolio.

Commercial Real Estate Loans.  The Bank's commercial real estate loan portfolio primarily consists of loans secured by office buildings, warehouses, production facilities, retail stores and restaurants generally located within the Chicago Metropolitan Statistical Area (MSA) and Northwest Indiana.  In addition, the Bank has purchased participation interests in commercial real estate loans from various financial institutions in the Midwest.  Some of the collateral securing such loans is outside the Chicago MSA, but is generally still in the Midwest.  Commercial real estate loans amounted to $23.6 million or 41.8% of the total loan portfolio at June 30, 2011.  Participation interest in commercial real estate loans purchased amounted to $3.4 million, or 14.6% of the commercial real estate portfolio at June 30, 2011.  Before purchasing such loans, the Bank utilizes the same underwriting standards and criteria as it would if it originated the loans.

Commercial real estate loans typically have a loan-to-value ratio of 80% or less and generally have shorter maturities than one- to four-family residential mortgage loans.  The maximum term of the commercial real estate loans is from 5 to 25 years based on up to a 25-year amortization schedule.  Most have fixed rates, but some have floating rates tied to the Bank's internal prime rate.  

Commercial real estate lending is generally considered to involve a higher degree of risk than one- to four-family residential lending.  Such lending typically involves large loan balances concentrated in a single borrower or groups of related borrowers for rental or business properties.  In addition, the payment experience on loans secured by income-producing properties is typically dependent on the success of the operation of the related project and thus is typically affected by adverse conditions in the real estate market and in the economy.  The Bank generally attempts to mitigate the risks associated with its commercial real estate lending by, among other things, lending using lower loan-to-value ratios in the underwriting process.

Commercial Loans.  At June 30, 2011, commercial loans amounted to $4.2 million, or 7.4% of the loan portfolio.  Commercial loans generally have a term of up to five years and may have either floating rates tied to the Bank's internal prime rate or fixed rates of interest.  Commercial loans are made to small to medium-size businesses within the Bank's market area.  A substantial portion of the Bank's small business loans are secured by real estate, equipment and other corporate assets.  The Bank also normally obtains personal guarantees from the principals of the borrower with respect to all commercial loans.  In addition, the Bank may extend loans for commercial business purposes, which are secured by a mortgage on the proprietor's home or the business property.  Commercial loans generally are deemed to involve a greater degree of risk than one- to four-family residential mortgage loans.

Consumer Loans.  The Bank originates consumer loans in order to provide a full range of financial services to its customers and because such loans generally have shorter terms and higher interest rates than residential mortgage loans.  At June 30, 2011, $723,000, or 1.3% of the total loan portfolio, consisted of consumer loans.  The consumer loans offered include home equity loans and loans secured by deposit accounts in the Bank, which are sometimes referred to as share loans. At June 30, 2011, home equity loans amounted to $658,000, or 1.2% of the total loan portfolio.  These loans are secured by the underlying equity in the borrower's residence.  As a result, the Bank generally requires loan-to-value ratios of 90% or less after taking into consideration the first mortgage loan held by the Bank.  If the Bank does not own or service the first mortgage, it will limit the total loan-to-value ratio to 80%.  These loans typically have 10-year terms and may have either floating rates of interest tied to the Bank's internal prime rate or fixed rates of interest. Loans secured by deposit accounts in the Bank amounted to $65,000, or 0.1%, of the total loan portfolio at June 30, 2011.  Such deposit account loans are originated for up to 90% of the account balance, with a hold placed on the account restricting the withdrawal of the account balance.  The interest rate on the loan is equal to the interest rate paid on the account plus 3%.  These loans mature on or before the maturity date of the underlying savings account and have five year maximum terms.

Loan Origination and Other Fees.  In addition to interest earned on loans, the Bank receives loan origination fees or "points" for originating loans in most cases.  Loan points are a percentage of the principal amount of the mortgage loan and are charged to the borrower in connection with the origination of the loan.

Asset Quality.  The Bank mails delinquency notices to borrowers when a borrower fails to make a required payment within 15 days of the date due.  Additional notices are sent out when a loan becomes 30 days or 60 days past due.  If a loan becomes 90 days past due, the Bank mails a notice indicating that the Bank will refer the collection of the loan to an attorney within 30 days to commence foreclosure.  In most cases, deficiencies are cured promptly.  While the Bank generally prefers to work with borrowers to resolve such problems, the Bank will institute foreclosure or other collection proceedings when necessary to minimize any potential loss .Loans are placed on non-accrual status when management believes the probability of collection of interest is insufficient to warrant further accrual.  When a loan is placed on non-accrual status, generally, interest accrued but unpaid is deducted from interest income.  As a matter of policy, the Bank generally discontinues the accrual of interest income when the loan becomes 90 days past due as to principal or interest. Real estate and other assets acquired by the Company as a result of foreclosure or by deed-in-lieu of foreclosure are classified as real estate owned until sold.  The Company had $5.3 million in real estate owned at June 30, 2011.

Delinquent Loans.  At June 30, 2011, there were four loans, excluding loans placed on non-accrual, totaling $561,000 that were over 30 days past due.

Non-performing Assets.  The following table presents information with respect to the non-performing assets at the dates indicated.



At June 30,


2011

2010

2009


(Dollars in thousands)

Non-accruing Loans:




Real estate loans:




One- to four-family loans             

$  787

$  981

$  1,219

Commercial real estate loans           

1,860

7,216

6,243

Multifamily loans                    

345

402

553

Commercial loans:




Business loans                     

46

57

187

Leases                           

949

Consumer loans:




Home equity loans                   

104

27

Share loans                        

  —

  —

  —

Total non-accruing loans           

$  3,142

$  8,656

$  9,178





Impaired loans, accruing and non-accruing  

$    3,773

$    8,981

$  10,232

Loans past due over 90 days still on accrual 

342

279

48

      Total non-performing loans(1)         

4,115

9,260

10,280





Real estate owned(2)                   

5,347

1,218

44

Total non-performing assets(3)       

$9,462

$10,478

$10,324





Troubled debt restructurings, included in impaired loans above

1,740

325









Total non-performing loans as a percentage of total loans

7.28%

13.24%

11.76%

Total non-performing assets as a percentage of total assets

10.16%

11.38%

10.88%




(1)

Non-performing loans consist of both accruing and non-accruing impaired loans and loans 90 days past due.

(2)

Real estate owned typically includes other repossessed assets and the balances are shown net of related loss allowances.

(3)

Non-performing assets consist of both accruing and non-accruing impaired loans, loans 90 days past due and real estate owned.



Non-accrual loans for the year ended June 30, 2011 were $3.1 million; non-accrual loans for the years ended June 30, 2010 and 2009, were $8.7 million and $9.2 million, respectively.  

The bank had 21 impaired, accruing and non-accruing, credit relationships, totaling $3.8 million as of June 30, 2011, compared to 25 impaired credit relationships, totaling $9.0 million, as of June 30, 2010.

The specific reserve allocation for the impaired loans as of June 30, 2011 and June 30, 2010, was $102 and $0, respectively.  The increase in the specific reserve allocation was related to several one-to-four family loans and one commercial real estate secured loan.

The Bank recorded loan charge-offs totaling $1.4 million for the year ended on June 30, 2011.  

Discussion of Impaired loans:

  • The Bank remains involved with a loan participation for a hotel in the state of Michigan with an approximate balance of $1.0 million which continues to experience weak operating results.  The lead bank continues to explore all viable exit strategies.
  • A single family residential home builder located in the Chicago area with an approximate balance of $1.9 million was transferred into other real estate owned during the year ended June 30, 2011.  The bank also foreclosed on a second credit with the same borrower involving a commercial real estate loan with an approximate balance of $93,000.
  • A commercial multi-family loan secured by a property in Wisconsin continues to be collected under a workout agreement.  The loan balance has been reduced to approximately $300,000 as of June 30, 2011.
  • Two separate commercial real estate secured loans to affiliated borrowers with an approximate aggregate balance of $656,000 involving retail businesses in the Chicago area remain impaired.  The bank is in the foreclosure process on the larger loan, which had an approximate loan balance of $360,000 as of June 30, 2011. The second commercial real estate loan, with an approximate balance of $296,000 is classified as a troubled debt restructured loan. Management believes that both loans continue to maintain a potential viable exit strategy, which is the potential sale of the collateral.
  • A small commercial real estate loan with an approximate balance of $110,000 as of June 30, 2011 continues to make regular payments per an agreed upon workout arrangement. This commercial credit is classified as a troubled debt restructured loan.
  • Nine local residential mortgage loans with an approximate aggregate balance of $891,000, as of June 30, 2011 are on non-accrual status.  Six of the nine loans are classified as troubled debt restructured loans.  Additionally, six local residential mortgage loans with an approximate aggregate balance of $631,000 as of June 30, 2011 remain on accrual status; these six loans are also classified as troubled debt restructured loans.  
  • The Bank impaired a small commercial real estate participation loan, located in Chicago, having an approximate balance of $45,000 as of June 30, 2011.
  • The Bank no has impaired credits in the state of Florida.

Potential Problem Loans:  In determining the adequacy of the allowance for loan losses the Bank regularly evaluates potential problem loans as to the ability of the borrower to comply with the present loan repayment terms. At June 30, 2011, the Bank has a substandard credit with a local small business with an approximate balance of $1.0 million secured by business assets and commercial real estate.  This credit was downgraded due to weak operating results directly related to the economy.  This credit relationship has an affiliated commercial real estate secured loan with an approximate balance of $608,000 as of June 30, 2011.  Both loans remain on an accrual basis as payments continue to be received in accordance with the original repayment terms.

At June 30, 2011, the Bank also had a local commercial real estate loan to a local retail business with an approximate balance of $120,000 that was 60 days delinquent.

Allowance for Loan Losses.  At June 30, 2011, the allowance for loan losses was $2.4 million, or 4.25% of the total loan portfolio.  The loan loss allowance is maintained by management at a level considered adequate to cover probable incurred losses inherent in the existing portfolio based on prior loan loss experience, known and probable risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, general economic conditions, and other factors and estimates that are subject to change over time.

The Bank relies, among other things, on its experienced senior management in determining the appropriate allowance for loan losses on the loan portfolio. In general, management reviews the composition of the loan portfolio, in detail, on a quarterly basis.  This includes reviewing delinquency trends, impaired loans, loan to value ratios and types of collateral.  Management then compares these trends to FDIC peer group data and actual historical loss experience as a means of additional analysis.  Based on these factors, we determined that the allocation of the allowance for loan losses for these types of loans was appropriate at June 30, 2011.

Management determines the allowance based on information available at the time and adjusts the allowance as circumstances change and assumptions are updated.  Future adjustments to the allowance could significantly affect net income. The following table sets forth information concerning the allocation of the allowance for loan losses by loan category at the dates indicated.



At June 30,

2011

2010

2009


Amount

Percent of Loans in Each Category to Total Loans

Amount

Percent of Loans in Each Category to Total Loans

Amount

Percent of Loans in Each Category to Total Loans


(Dollars in thousands)

Real estate loans:







One- to four-family loans 

$  816

44.36%

$  1,188

41.30%

$  1,327

36.17%

Commercial real estate loans

1,267

41.78

2,048

45.59

3,103

47.19

Multifamily loans        

24

5.22

59

5.60

60

5.05

Commercial loans:







Business loans         

159

5.96

245

4.21

714

7.07

Commercial lease       

134

1.40

324

2.23


3.81

Consumer loans:







Home equity loans       

1.16

1.00

21

0.60

Share loans            

  —

0.12

  —

.07

  —

0.11

Total               

$ 2,400

100.00%

$ 3,864

100.00%

$ 5,225

100.00%




The following table sets forth an analysis of the Bank's allowance for loan losses during the periods indicated.



Year Ended June 30,


2011

2010

2009


(Dollars in thousands)

Balance at beginning of period       

$ 3,864

$ 5,225

$ 2,060

Charge-offs, net                  

(1,165)

(4,014)

(7,098)

Provision for loan losses           

(299)

2,653

10,263

Balance at end of period           

$ 2,400

$ 3,864

$ 5,225

Allowance for loan losses as a percent of total loans outstanding

4.25%

5.52%

5.98%

Allowance for loan losses as a percent of total nonperforming loans

58.35%

41.73%

50.83%

Ratio of net charge-offs to average loans outstanding

1.84%

5.12%

7.63%




The following table represents information concerning impaired loans by category and the percentage of impaired loans by category to total impaired loans. Impaired loans include accruing and non-accruing loans.


June 30, 2011

June 30, 2010

June 30, 2009

Loan Category

Impaired Amount

% of Total Impaired

Impaired Amount

% of Total Impaired

Impaired Amount

% of Total Impaired

One-to-four family loans

$  1,387

36.76%

$  1,306

14.54%

$1,219

11.91%

Commercial real estate loans

1,860

49.30

7,216

80.35

7,297

71.32

Multi-family loans 

345

9.14

402

4.48

553

5.40

Business loans  

46

1.22

57

0.63

1,136

11.10

Commercial leases

-

-

-

-

-

-

Home Equity loans

135

3.58

-

-

27

26

Other          

  -

  -

  -

  -

  -

  -

Total         

$ 3,773

100.00%

$ 8,981

100.00%

$ 10,232

100.00%



The allowance for loan losses was $2.4 million, or 4.25% of total loans, at June 30, 2011, as compared to $3.9 million, or 5.52% of total loans, at June 30, 2010.  The Bank believes, as of June 30, 2011, its allowance for loan losses was adequate to cover probable incurred losses.

Investment Securities

The Bank has authority to invest in various types of securities, including mortgage-backed securities, United States Treasury obligations, securities of various federal agencies, government sponsored entities, and of state and municipal governments, certificates of deposit at federally-insured banks and savings institutions, certain bankers' acceptances and federal funds.  Any material deviation from the investment strategy requires approval by the Board of Directors through the Financial Instruments Committee.

The investment portfolio was $26.3 million, or 28.3% of total assets, at June 30, 2011, compared to $16.1 million, or 17.5% of total assets, at June 30, 2009, an increase of $10.3 million. Management strategically increased the investment portfolio in an effort to improve earnings and also to provide the company with quality assets which may be pledged as collateral for liquidity purposes. Public funds of $6.9 million were obtained and low cost funds were borrowed as needed to fund these purchases.

The fair value of securities available for sale and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows at June 30, 2011 and 2010:



Gross

Gross



Amortized

Unrealized

Unrealized

Fair


Cost

Gains

Losses

Value

2011









   Debt securities:









       Federal Home Loan Bank

$

2,999,279

$

10,741

$

-

$

3,010,020

       Federal Home Loan Mortgage









           Corporation


3,999,113


-


57,553


3,941,560

       Federal National Mortgage









       Association


3,000,000


-


-


3,000,000

       Municipal Taxable Bonds


13,876,325


297,922


40,059


14,134,188

       Corporate Bonds


2,239,490


19,461


  -


2,258,951










           Total

$

26,114,207

$

328,124

$

97,612

$

26,344,719










2010









   Debt securities:









       Federal Home Loan Bank

$

4,000,000

$

1,870

$

-

$

4,001,870

       Federal National Mortgage









       Association


11,996,250


85,650


  -


12,081,900










           Total

$

15,996,250

$

87,520

$

  -

$

16,083,770



Sources of Funds

General.  Deposits are the primary source of funding for lending and other investment purposes.  In addition to deposits, principal and interest payments on loans and mortgage-backed securities are a source of funds.  Loan repayments are a relatively stable source of funds, while deposit inflows and outflows are significantly influenced by general interest rates and money market conditions.  Borrowings may also be used on a short-term basis to compensate for reductions in the availability of funds from other sources and on a longer-term basis for general business purposes.

Deposits.  Deposits are attracted by the Bank principally from within its primary market area.  Deposit account terms vary, with the principal differences being the minimum balance required the time periods the funds must remain on deposit and the interest rate.

The Bank obtains deposits primarily from residents of Illinois and northwest Indiana.  The Bank recently acquired large certificates of deposits for public entities located in Illinois. Though the Bank did not pay fees to brokers to solicit the funds for deposit, the public funds have been classified as brokered deposits. The Bank has not solicited deposits from outside Illinois and northwest Indiana.

Interest rates paid, maturity terms, service fees and withdrawal penalties are established on a periodic basis.  Management determines the rates and terms based on rates paid by competitors, the need for funds or liquidity, growth goals and federal and state regulations.  The Bank attempts to control the flow of deposits by pricing its accounts to remain generally competitive with other financial institutions in its market area.

The following table shows the distribution of and certain other information relating to the Bank's deposits by type as of the dates indicated.



At June 30,


2011

2010

2009


Amount

Percent of Deposits

Amount

Percent of Deposits

Amount

Percent of Deposits


(Dollars in thousands)

Transaction accounts:







Demand deposits







Interest bearing         

$ 6,927

9.88%

$ 6,919

10.78%

$ 7,555

10.72%

Non-interest bearing      

4,998

7.13

5,238

8.16

5,761

8.17

Savings deposits           

27,054

38.59

25,375

39.52

25,684

36.44

Total transaction accounts 

38,979

55.60

37,532

58.46

39,000

55.33

Certificate accounts:







0.01% – 0.99%            

24,776

35.34

12,373

19.27

955

1.35

1.00% – 1.99%             

2,585

3.69

7,982

12.44

12,250

17.38

2.00% – 2.99%             

1,068

1.52

2,703

4.21

9,538

13.53

3.00% – 3.99%             

736

1.05

1,055

1.64

5,073

7.20

4.00% – 4.99%             

1,170

1.67

1,790

2.79

2,946

4.18

5.00% – 5.99%             

794

1.13

762

1.19

725

1.03

Total certificate accounts  

31,129

44.40

26,665

41.54

31,487

44.67

Total deposits         

$ 70,108

100.00%

$ 64,197

100.00%

$ 70,487

100.00%











The following table shows the interest rate and maturity information for the Bank's certificates of deposit at June 30, 2011.



Maturity Date

Interest Rate

One Year or Less

1-2 Years

2-3 Years

Over 3 Years

Total


(In thousands)

0.01% - 0.99%   

$ 22,986

$    1,375

$       415

$    —

$24,776

1.00% - 1.99%   

1,387

763

74

361

2,585

2.00% - 2.99%   

735

60

35

238

1,068

3.00% - 3.99%   

594

89

53

736

4.00% - 4.99%   

1,092

78

1,170

5.00% - 5.99%   

461

333



794

Total        

$ 27,255

$ 2,698

$ 577

$ 599

$ 31,129




As of June 30, 2011, the aggregate amount of outstanding time certificates of deposit at the Bank in amounts greater than or equal to $100,000, was approximately $13.8 million.  The following table presents the maturity of these time certificates of deposit at such dates.



June 30, 2011

(In thousands)

3 months or less       

$  1,327

Over 3 months through 6 months

9,677

Over 6 months through 12 months

2,211

Over 12 months       

619


$ 13,834






Borrowings.  The Bank may obtain advances from the Federal Home Loan Bank of Chicago upon the security of the common stock it owns in that bank and certain of its residential mortgage loans and mortgage-backed and other investment securities, provided certain standards related to creditworthiness have been met.  These advances are made under several credit programs, each of which has its own interest rate and range of maturities.  Federal Home Loan Bank advances are generally available to meet seasonal and other withdrawals of deposit accounts and to permit increased lending.

The following table shows certain information regarding the short-term borrowings of the Bank at or for the dates indicated:



At or for the Year Ended
June 30,


2011

2010

2009


(Dollars in thousands)

Federal Home Loan Bank open line of credit:



Average balance outstanding          

$6,896

$3,213

$4,032

Maximum amount outstanding at any month-end during the period

8,200

10,400

9,200

Balance outstanding at end of period    

5,000

10,400

3,900

Average interest rate during the period   

0.42%

0.47%

0.91%

Weighted average interest rate at end of period

0.14%

0.45%

N/A




At June 30, 2011 the Bank had $5.0 million in outstanding advances with the Federal Home Loan Bank.  The Bank had $12.3 million in additional available credit with the FHLB based on parameters set by the FHLB. Additional stock and collateral may be purchased or provided to increase overall potential advance availability.  At June 30, 2010 and 2009, the outstanding advances from the Federal Home Loan Bank were $10.4 million and $3.9, respectively.

Subsidiaries

The Company's only subsidiary is Royal Savings Bank.  The Bank does not currently have any other subsidiaries.

Total Employees

The Bank had 31 full-time equivalent employees at June 30, 2011.  

Regulatory Matters

The Company and the Bank remain compliant with supervisory agreements entered into in the previous fiscal year with the Federal Reserve Bank (the "FRB"), the Federal Deposit Insurance Corporation (the FDIC") and the Illinois Department of Financial and Professional Regulation (the "IDFPR") following the regularly scheduled examinations.

Royal Financial, Inc. is the holding company for Royal Savings Bank which offers a range of checking and savings products, a full line of home loans, and commercial lending solutions. Royal Savings Bank, with two locations, has been operating continuously in the south and southeast communities of Chicago since 1887.

Contact: Mr. Leonard Szwajkowski
President and CEO
Telephone:  (773) 382-2111

SOURCE Royal Financial, Inc.



RELATED LINKS

http://www.royal-bank.us