SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(mark one)
/X/ QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005
or
/_/ TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE
EXCHANGE ACT
For the transition period from _______to_______
Commission File Number 000-51123
ROYAL FINANCIAL, INC.
(Exact name of small business issuer specified in its charter)
DELAWARE 20-1636029
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
9226 S. COMMERCIAL AVENUE
CHICAGO, ILLINOIS 60617
(Address of principal executive offices)
(773) 768-4800
(Issuer's telephone number)
NOT APPLICABLE
(Former name, former address and former fiscal year,
if changes since last report)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 /_/
Indicate by a check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes /_/ No /X/
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date:
===============================================================================
CLASS OUTSTANDING AS OF SEPTEMBER 11, 2005
-------------------------------------------------------------------------------
Common Stock, $0.01 par value 2,645,000
===============================================================================
Transitional Small Business Disclosure Format (check one): Yes /_/
No /X/
ROYAL FINANCIAL, INC. AND SUBSIDIARY
FORM 10-QSB
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005
TABLE OF CONTENTS
PAGE
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Financial Condition as of September 30, 2005 and June 30, 2005........ 1
Consolidated Statements of Income (Loss) and Comprehensive Income (Loss) for the three months
ended September 30, 2005 and 2004.............................................................. 2
Consolidated Statements of Stockholders' Equity for the three months ended September 30, 2005
and 2004....................................................................................... 3
Consolidated Statements of Cash Flows for the three months ended September 30, 2005 and 2004..... 4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...... 7
Item 3. Controls and Procedures.................................................................... 11
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.......................................................................... 12
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds................................ 12
Item 3. Defaults Upon Senior Securities............................................................ 12
Item 4. Submission of Matters to a Vote of Security Holders........................................ 12
Item 5. Other Information.......................................................................... 12
Item 6. Exhibits................................................................................... 12
SIGNATURES............................................................................................. 13
EXHIBIT INDEX
i
PART I. - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
--------------------
ROYAL FINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30, 2005 and June 30, 2005
SEPTEMBER 30, 2005 JUNE 30, 2005
---------------------- -----------------
(Unaudited)
ASSETS
Cash and due from financial institutions................ $ 3,709,193 $ 5,434,381
Federal funds sold...................................... 5,772,796 11,587,315
------------ ------------
Total cash and cash equivalents...................... 9,481,989 17,021,696
Securities available for sale........................... 31,916,476 33,241,548
Loans receivable, net of allowance for loan losses of
$316,020 at September 30, 2005 and $286,020 at
June 30, 2005........................................ 61,270,150 52,325,571
Federal Home Loan Bank stock, at cost................... 374,000 369,500
Cash surrender value of life insurance.................. 5,092,536 5,038,027
Premises and equipment, net............................. 4,570,781 4,616,417
Accrued interest receivable............................. 326,194 306,961
Other assets............................................ 421,626 301,041
------------ ------------
Total assets......................................... $113,453,752 $113,220,761
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposits............................................. $ 77,967,010 $ 78,107,014
Advances from borrowers for taxes and insurance...... 582,337 377,037
Accrued interest payable and other liabilities....... 421,837 197,419
Common stock in ESOP subject to contingent repurchase
obligation........................................... 293,066 272,964
------------ ------------
Total liabilities.................................... 79,264,250 78,954,434
Stockholders' equity
Preferred stock, $.01 par value per share,
authorized 1,000,000 shares; no issues are
outstanding....................................... -- --
Common stock, $.01 par value per share, authorized
5,000,000 shares; 2,645,000 shares issued at
September 30, 2005 and June 30, 2005.............. 26,450 26,450
Additional paid-in capital........................... 24,771,488 24,764,553
Retained earnings.................................... 12,258,532 12,268,336
Accumulated other comprehensive loss, net of tax..... (231,497) (113,322)
Unearned ESOP shares................................. (2,342,405) (2,406,726)
Reclassification of ESOP shares...................... (293,066) (272,964)
------------ ------------
Total stockholders' equity........................ 34,189,502 34,266,327
------------ ------------
Total liabilities and stockholders' equity...... $113,453,752 $113,220,761
============ ============
See accompanying notes to these unaudited consolidated financial statements.
1
ROYAL FINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
AND COMPREHENSIVE INCOME (LOSS)
Three months ended September 30, 2005 and 2004
(Unaudited)
THREE MONTHS ENDED
SEPTEMBER 30,
----------------------------------------
2005 2004
---------- ---------
Interest income
Loans................................................ $ 923,570 $547,338
Securities
Taxable........................................... 291,168 298,221
Tax-exempt........................................ -- 4,393
Federal funds sold and other......................... 103,188 43,638
---------- --------
Total interest income............................. 1,317,926 893,590
Interest expense
Deposits............................................. 305,020 287,705
Advances from Federal Home Loan Bank................. -- 24,431
---------- --------
Total interest expense............................ 305,020 312,136
NET INTEREST INCOME..................................... 1,012,906 581,454
Provision for loan losses............................... 30,000 --
---------- --------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES..... 982,906 581,454
Noninterest income
Service charges on deposit accounts.................. 56,984 41,040
Gain on sales of securities, net..................... 16,945 175,532
Gain on sales of loans............................... -- 3,253
Earnings on bank-owned life insurance................ 54,509 --
Other income......................................... 18,553 15,487
---------- --------
Total noninterest income.......................... 146,991 235,312
Noninterest expense
Salaries and employee benefits....................... 529,637 398,266
Occupancy and equipment.............................. 207,616 163,876
Data processing...................................... 102,457 124,028
Professional services................................ 171,320 35,850
Director fees........................................ 31,800 30,600
Supplies............................................. 19,702 22,401
Advertising.......................................... 12,588 18,035
Insurance premiums................................... 21,640 19,270
Other................................................ 49,541 61,250
---------- --------
Total noninterest expense......................... 1,146,301 873,576
---------- --------
LOSS BEFORE INCOME TAX EXPENSE.......................... (16,404) (56,810)
Income tax benefit...................................... (6,600) (18,000)
---------- --------
Net income (loss)....................................... $ (9,804) $(38,810)
========== ========
Basic and diluted earnings (loss) per share*............ $ 0.00 N/A
Comprehensive income (loss)............................. $ (127,979) $164,041
========== ========
------------------
* N/A - Not Applicable, see Note 2.
See accompanying notes to these unaudited consolidated financial statements.
2
ROYAL FINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Three months ended September 30, 2005 and 2004
(Unaudited)
AMOUNT
COMPRE- ACCUMULATED RECLASSI-
ADDITIONAL HENSIVE OTHER FIED ON
COMMON PAID-IN RETAINED INCOME UNEARNED ESOP
2004 STOCK CAPITAL EARNINGS (LOSS) ESOP SHARES SHARES TOTAL
--------------------------- ------- ------------ ----------- ---------- ----------- --------- ------------
Balance at July 1, 2004.... $ -- $ -- $12,912,324 $(213,511) -- -- $12,698,813
Comprehensive income
Net income (loss)....... -- -- (38,810) -- -- -- (38,810)
Change in fair value of
securities
available-for-sale,
net.................. -- -- -- 202,851 -- -- 202,851
Total comprehensive
income............... 164,041
------- ----------- ----------- --------- ----------- --------- -----------
Balance at September 30,
2004.................... $ -- -- $12,873,514 $ (10,660) -- -- $12,862,854
------- ----------- ----------- --------- ----------- --------- -----------
2005
---------------------------
Balance at July 1, 2005.... $26,450 $24,764,553 $12,268,336 $(113,322) $(2,406,726) $(272,964) $34,266,327
Comprehensive income (loss)
Net income (loss)....... -- -- (9,804) -- -- -- (9,804)
Change in fair value of
securities
available-for-sale,
net.................. -- -- -- (118,175) -- -- (118,175)
Total comprehensive
(loss)............... -- -- -- -- -- -- (127,979)
Reclassification due to
change in fair value of
common stock in ESOP
subject to contingent
repurchase obligation... -- -- -- -- -- (20,102)
ESOP shares earned......... -- 6,935 -- -- 64,321 -- 71,256
------- ----------- ----------- --------- ----------- --------- -----------
Balance at September 30,
2005.................... $26,450 $24,771,488 $12,258,532 $(231,497) $(2,342,405) $(293,066) $34,189,502
------- ----------- ----------- --------- ----------- --------- ----------
See accompanying notes to these unaudited consolidated financial statements.
3
ROYAL FINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three months ended September 30, 2005 and 2004
(Unaudited)
2005 2004
------------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss).................................... $ (9,804) $ (38,810)
Adjustments to reconcile net income (loss) to net
cash from operating activities:
Depreciation...................................... 69,748 66,283
Provision for loan losses......................... 30,000 --
ESOP expense...................................... 71,256 --
Gain on sales of securities, net.................. (16,945) (175,532)
Federal Home Loan Bank stock dividend............. (4,500) (5,100)
Gain on sales of loans held for sale.............. -- (3,253)
Earnings on bank-owned life insurance............. (54,509) --
Change in accrued interest receivable and other
assets.......................................... (139,818) (320,399)
Change in other accrued interest payable and
liabilities..................................... 224,418 65,680
----------- -----------
Net cash from operating activities.............. 169,846 (411,131)
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales, maturities, calls, and paydowns
of securities available for sale.................. 3,223,842 9,718,553
Purchases of securities available for sale........... (2,000,000) (3,000,000)
Change in loans receivable........................... (5,123,579) (591,109)
Purchase of loan participations...................... (3,851,000) (1,088,000)
Purchase of premises and equipment................... (24,112) (357,929)
----------- -----------
Net cash from investing activities................ (7,774,849) 4,681,515
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits.................. (140,004) 9,278,091
Net increase in advances from borrowers for taxes
and insurance..................................... 205,300 166,823
----------- -----------
Net cash from financing activities................ 65,296 9,444,914
Net change in cash and cash equivalents................. (7,539,707) 13,715,298
Cash and cash equivalents
Beginning of the year................................ 17,021,696 7,942,567
----------- -----------
End of period........................................ $ 9,481,989 $21,657,865
=========== ===========
See accompanying notes to these unaudited consolidated financial statements.
4
ROYAL FINANCIAL, INC. AND SUBSIDIARY
NOTES TO UNAUDITED FINANCIAL STATEMENTS
NOTE 1 - NATURE OF BUSINESS
Royal Financial, Inc. was incorporated under the laws 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. As described in Note 2 below, the conversion was
completed on January 20, 2005.
NOTE 2 - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements include
the accounts of Royal Financial, Inc. (the "Company") and its wholly owned
subsidiary, the Bank, as of and for the three-month period ended September 30,
2005 and the accounts of the Bank as of and for the three months ended September
30, 2004. Significant intercompany accounts and transactions have been
eliminated in consolidation.
On August 18, 2004, the Board of Directors of the Bank unanimously
adopted a plan of conversion providing for the conversion of the Bank from an
Illinois-chartered mutual savings bank to an Illinois-chartered stock savings
bank and the purchase of all of the common stock of the Bank by the Company. The
members of the Bank approved the plan at a meeting held on December 21, 2004,
and the conversion was completed on January 20, 2005 when the Company issued
2,595,000 shares of common stock to the public, resulting in $25,950,000 of
gross proceeds. Costs to complete the stock offering were deducted from the
gross proceeds of the offering. The Bank issued all of its outstanding capital
stock to the Company in exchange for one half of the net proceeds of the
offering, which amounted to $12.1 million. The Company contributed 50,000 shares
of common stock to the Royal Charitable Foundation in February, 2005.
The accompanying unaudited interim consolidated financial statements
have been prepared pursuant to the rules and regulations for reporting on Form
10-QSB. Accordingly, certain disclosures required by U.S. generally accepted
accounting principles (GAAP) are not included herein. These interim financial
statements should be read in conjunction with the audited financial statements
and accompanying notes of the Company for the fiscal years ended June 30, 2005
and 2004. The results of the Company's operations for any interim period are not
necessarily indicative of the results of the Company's operations for any other
interim period or for a full fiscal year.
Interim statements are subject to possible adjustment in connection
with the annual audit of the Company's financial statements for the fiscal year
ending June 30, 2006. In the opinion of management of the Company, the
accompanying unaudited interim consolidated financial statements reflect all
adjustments (consisting of normal recurring adjustments) necessary for a fair
presentation of the consolidated financial position and consolidated results of
operations for the periods presented.
NOTE 3 - USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity
with GAAP requires management to make estimates and assumptions that affect
amounts reported in the consolidated financial statements. Changes in these
estimates and assumptions are considered reasonably possible and may have a
material impact on the consolidated financial statements and thus actual results
could differ from the amounts reported and disclosed herein. The Company
considers the allowance for loan losses and income taxes to be critical
accounting estimates.
5
At September 30, 2005, there were no material changes in the Company's
significant accounting policies or critical accounting estimates from those
disclosed in the audited financial statements and accompanying notes of the
Company for the fiscal years ended June 30, 2005 and 2004.
NOTE 4 - EARNINGS PER SHARE
The following table presents a reconciliation of the components used to
compute basic and diluted earnings (loss) per share for the three-month period
ended September 30, 2005. Weighted average common shares outstanding excludes
unallocated ESOP shares.
THREE MONTHS ENDED
SEPTEMBER 30, 2005
------------------
Basic and diluted loss per share
Net loss as reported................................. $ (9,804)
Weighted average common shares outstanding........... 2,457,205
Basic and diluted loss per share.................. $ 0.00
NOTE 5 - EMPLOYEE STOCK OWNERSHIP PLAN
On January 20, 2005, the Company adopted an employee stock ownership
plan ("ESOP") for the benefit of substantially all employees. The ESOP borrowed
$2.7 million from the Company and used those funds to acquire 211,000 shares of
the Company's stock at an average price of $12.62 per share.
Shares purchased by the ESOP are allocated to ESOP participants based
on principal and interest repayments made by the ESOP on the loan from the
Company. The loan is secured by shares purchased with the loan proceeds and will
be repaid by the ESOP with funds from the Company's discretionary contributions
to the ESOP and earnings on ESOP assets.
The $2.7 million loan from the Company to the ESOP requires annual
principal payments of approximately $267,000, plus interest at 7.25%.
As shares are released from collateral, the Company will report
compensation expense equal to the current market price of the shares and the
shares will become outstanding for earnings-per-share ("EPS") computations.
Dividends on allocated ESOP shares reduce retained earnings; dividends on
unearned ESOP shares reduce accrued interest.
Upon termination of their employment, participants in the ESOP who
elect to receive their benefit distributions in the form of Company common stock
may require the Company to purchase the common stock distributed at fair value.
This contingent repurchase obligation is reflected in the Company's financial
statements as "Common stock in ESOP subject to contingent repurchase obligation"
and reduces stockholders' equity by an amount that represents the market value
of all the Company's common stock held by the ESOP and allocated to
participants, without regard to whether it is likely that the shares would be
distributed or that the recipients of the shares would be likely to exercise
their right to require the Company to purchase the shares.
NOTE 6 - STOCK OPTION PLAN AND RECOGNITION AND RETENTION PLAN
On August 2, 2005, subject to stockholder approval, the Company's Board
of Directors approved the grant of stock options and restricted stock awards to
each of the Company's directors and certain of its executive officers under the
Royal Financial, Inc. 2005 Stock Option Plan ("SOP") and the Royal Financial,
Inc. 2005 Management Recognition and Retention Plan ("RRP"). The SOP and RRP
were subsequently approved by the Company's stockholders on October 26, 2005 at
the Company's 2005
6
Annual Meeting, and upon approval, 185,150 stock options and 74,060 stock awards
were granted at fair market value. A total of 264,500 and 105,800 shares of
Company common stock have been reserved for issuance under the SOP and the RRP,
respectively. The plans have a term of ten years. Both the stock options and
restricted stock awards will vest equally (20% per year) over the next five
years. Compensation expense related to vesting of the stock awards will
approximate $206,000 per year. The Company will also be required to record
compensation expense related to the nonvested portion of the stock options
outstanding beginning July 1, 2006, the effective date of the Company's adoption
of Statement on Financial Account Standard No. 123R.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
-----------------------------------------------------------------------
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; legislative/regulatory provisions; 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; deposit flows; competition; demand for
financial services in the Company's market area; and 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.
COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2005 AND JUNE 30,
2005
The Company's total assets increased $233,000, or 0.2%, to $113.5
million at September 30, 2005, from $113.2 million at June 30, 2005.
Cash and cash equivalents decreased $7.5 million to $9.5 million at
September 30, 2005 from $17.0 million at June 30, 2005, the result of an
increase in loans during the period.
Securities available for sale decreased $1.3 million, or 4.0%, to $31.9
million at September 30, 2005 from $33.2 million at June 30, 2005. The decrease
relates to the sale and maturities of $3.2 million of securities, which resulted
in gains of $17,000, partially offset by securities purchases.
Loans increased $8.9 million, or 17.1%, to $61.3 million at September
30, 2005, from $52.3 million at June 30, 2005. The increase in loans was the
result of the continued emphasis by management on increasing the commercial and
commercial real estate loan portfolios.
Total deposits decreased $140,000, or 0.2%, to $78.0 million at
September 30, 2005 from $78.1 million at June 30, 2005.
Total stockholders' equity decreased $77,000, or 0.2%, to $34.2 million
at September 30, 2005, from $34.3 million at June 30, 2005. The decrease was the
result of a net loss of $10,000 and an increase
7
in ESOP shares earned of $71,000, offset by an increase in unrealized losses on
securities available for sale, net of taxes, of $118,000.
COMPARISON OF RESULTS OF OPERATION FOR THE THREE MONTHS ENDED SEPTEMBER
30, 2005 AND 2004
General. Net loss for the three months ended September 30, 2005 was
$10,000, a decrease of $29,000, from the loss recorded for the same period in
2004. The decrease in net loss resulted primarily from an increase in net
interest income after provision for loan losses of $401,000 offset by an
increase in noninterest expense of $273,000, a decrease in noninterest income of
$88,000 and an increase in income tax expense of $19,000.
Interest Income. Total interest income increased $424,000 to $1.3
million for the three months ended September 30, 2005 from $894,000 for the
three months ended September 30, 2004. For the three months ended September 30,
2005, average interest-bearing assets increased to $99.7 million from $86.4
million for the same period in 2004. The increase was the result of loan growth.
The yield on interest-earning assets for the three month period ended September
30, 2005 was 5.29% compared to 4.04% for the comparable period in 2004.
Net Interest Income. Net interest income increased by $431,000 to $1.0
million for the three months ended September 30, 2005, from $581,000 for the
same period in 2004. The net interest rate spread was 3.73% for the three months
ended September 30, 2005, as compared to 2.56% for the same period in 2004. The
net interest margin was 4.06% for the three month period ended September 30,
2005, an increase from 2.61% for the same period in 2004.
Interest Expense. Total interest expense decreased $7,000 to $305,000
for the three months ended September 30, 2005 from $312,000 for the same period
in 2004. The average cost of deposits increased from 1.40% for the three months
ended September 30, 2004 to 1.55% for the same period in 2005. This increase was
offset by the repayment of FHLB advances which resulted in a reduction of
interest expense by $24,000.
Provision for Loan Losses. Provisions for loan losses are charged to
earnings to bring the total allowance for loan losses to a level considered
adequate by management to cover probable incurred credit losses in the loan
portfolio. In evaluating the level of the allowance for loan losses, management
considers historical loss experience, the types of loans and the amount of loans
in the loan portfolio, overall portfolio mix, the level of past due or
classified loans, the status of past due principal and interest payments,
loan-to-value ratios, adverse situations that may affect the borrower's ability
to repay, estimated value of any underlying collateral, and prevailing economic
conditions, and other factors related to the collectibility of the loan
portfolio. Groups of smaller balance homogenous loans, such as residential real
estate, small commercial real estate, and home equity and consumer loans, are
evaluated in the aggregate using historical loss factors and peer group data
adjusted for current economic conditions. Large more complex loans, such as
multi-family or commercial real estate loans, are evaluated individually for
impairment.
This evaluation is inherently subjective, as it requires estimates that
are susceptible to significant revision, as more information becomes available
or as projected events change. The allowance for loan losses as a percentage of
gross loans outstanding decreased to 0.51% at September 30, 2005, from 0.54% at
June 30, 2005. There were no nonperforming loans at September 30, 2005 or June
30, 2005.
Management assesses the allowance for loan losses quarterly. While
management uses available information to recognize losses on loans, future loan
loss provisions may be necessary based on changes in economic conditions. In
addition, regulatory agencies, as an integral part of their examination process,
8
periodically review the allowance for loan losses and may require us to
recognize additional provisions based on their judgment of information available
to them at the time of their examination. A provision of $30,000 was recorded
during the period ended September 30, 2005 to represent management's estimate of
probable incurred losses in the portfolio, which was reflective of the changing
composition of and growth in the loan portfolio as management continues to
emphasize growth in commercial and commercial real estate loans.
Noninterest Income. Noninterest income decreased $88,000 to $147,000
for the three month period ended September 30, 2005, compared to the same period
in 2004. The decrease in the three month period was primarily the result of a
$159,000 decrease in gain on sales of securities offset by a $55,000 increase in
earnings on bank-owned life insurance.
Noninterest Expense. Noninterest expense increased $273,000 to $1.1
million for the three months ended September 30, 2005 from $874,000 for the
three months ended September 30, 2004. The increase was primarily the result of
increases in salaries and employee benefits of $131,000, and professional
services of $135,000. The increase in salaries and employee benefits was
partially the result of $71,000 of compensation expense related to the ESOP as
well as annual salary adjustments. The increase in professional services was
primarily the result of expenses related to the Company's first annual
stockholders meeting, held in October 2005.
Provision for Income Taxes. The income tax benefit decreased $11,000
for the three months ended September 30, 2005 from the comparable period in
2004. The fluctuation between periods was due to the decrease in taxable net
loss of $29,000.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity. Liquidity management is measured and monitored on both a
short- and long-term basis, allowing management to better understand and react
to emerging balance sheet trends. After assessing actual and projected cash flow
needs, management seeks to obtain funding at the most economical cost. Our
primary sources of funds are deposits, principal and interest payments on loans,
proceeds from maturities and calls of securities and 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. We invest excess funds in short-term
interest-earning assets, which enable us to meet lending requirements. We
utilize FHLB advances as needed. At September 30, 2005 there were no FHLB
advances outstanding.
The Company's cash flows are comprised of three primary
classifications: cash flows from operating activities, investing activities, and
financing activities. Net cash from operating activities were $170,000 and
($411,000) for September 30, 2005 and 2004, respectively. Net cash from
investing activities consisted primarily of disbursements for loan originations
and participation interests and the purchase of securities, offset by principal
collections on loans, proceeds from maturing securities and paydowns on
mortgage-backed securities. Net cash from investing activities were ($7.8)
million and $4.7 million for September 30, 2005, and 2004, respectively. Net
cash from financing activities consisted primarily of the activity in deposit
accounts and FHLB borrowings. The net cash from financing activities was $65,296
at September 30, 2005 and $9.4 million at September 30, 2004.
From June 30, 2005 through September 30, 2005, the Company received
proceeds of $3.2 million from sales, maturities, calls and paydowns of available
for sale securities. These proceeds were primarily reinvested in loans.
9
At September 30, 2005, the Company had outstanding commitments to
originate $2.1 million in loans, unfunded lines of credit and participation
loans of $831,000 and $3.0 million, respectively, and letters of credit
outstanding of $142,000. In addition, as of September 30, 2005, the total amount
of certificates of deposit that were scheduled to mature in the next 12 months
equaled $23.4 million. The Company believes that it has adequate resources to
fund all of its commitments and that it can adjust the rates paid on
certificates of deposit to retain deposits in changing interest rate
environments. If the Company requires funds beyond its internal funding
capabilities, advances from the FHLB are available as an additional source of
funds. As of September 30, 2005, the Bank had $14.6 million of available credit
from the FHLB.
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 September 30, 2005, the Bank
exceeded each of its capital requirements with ratios of 19.89%, 32.81% and
33.27%, respectively.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The accounting and reporting policies of the Company are in accordance
with U.S. generally accepted accounting principles and conform to general
practices within the banking industry. Accounting and reporting policies for the
allowance for loan losses and income tax are deemed critical because they
involve the use of estimates and require significant management judgments.
Allowance for Loan Losses. The allowance for loan losses is an amount
that management believes will be adequate to absorb probable incurred losses in
existing loans, taking into consideration such factors as past loss experience,
changes in the nature and volume of the portfolio, overall portfolio quality,
loan concentrations, specific problem loans, and current economic conditions
that affect the borrower's ability to pay. Determination of the allowance is
inherently subjective due to the above mentioned reasons. Loan losses are
charged off against the allowance when management believes that the full
collectability of the loan is unlikely. Recoveries of amounts previously
charged-off are credited to the allowance. Allowances established to provide for
losses under commitments to extend credit, or recourse provisions under loan
sales agreements or servicing agreements are classified with other liabilities.
A loan is considered impaired when it is probable that not all
principal and interest amounts will be collected according to the loan contract.
Residential mortgage, installment and other consumer loans are collectively
evaluated for impairment. Individual commercial loans are evaluated for
impairment. Impaired loans are recorded at the loan's fair value by the
establishment of a specific allowance where necessary. The fair value of
collateral-dependent loans is determined by the fair value of the underlying
collateral. The fair value of noncollateral-dependent loans is determined by
discounting expected future interest and principal payments at the loan's
effective interest rate.
The Company maintains the allowance for loan losses at a level adequate
to absorb management's estimate of probable losses inherent in the loan
portfolio. Management believes that it uses the best information available to
determine the adequacy of the allowance for loan losses. However, future
adjustments to the allowance may be necessary and the results of operations
could be significantly and adversely affected if circumstances differ
substantially from the assumptions used in making the determinations.
Income Taxes. Accounting for income taxes is a critical accounting
policy due to the subjective nature of certain estimates that are involved in
the calculation. The Company uses an asset/liability method of accounting for
income taxes in which deferred tax assets and liabilities are established for
temporary differences between the financial reporting basis and the tax basis of
the Company's assets and
10
liabilities. The Company must assess the realization of the deferred tax asset
quarterly, and to the extent that management believes that recovery is not
likely, a valuation allowance is established. This assessment is impacted by
various factors, including taxable income and the composition of the investment
securities portfolio. Material changes to these items can cause an adjustment to
the valuation allowance. An adjustment to increase or decrease the valuation
allowance is charged or credited, respectively to income tax expense.
NEW ACCOUNTING PRONOUNCEMENTS
Statement of Position 03-3, effective for fiscal years beginning after
December 15, 2004, requires that a valuation allowance for loans acquired in a
purchase or transfer, including a business combination, reflect only losses
incurred after the acquisition and should not be recorded at acquisition. It
applies to any loan acquired in a transfer that showed evidence of credit
quality deterioration since origination. This new guidance did not have a
material effect on the Company's statement of financial condition or statement
of income (loss).
ITEM 3. CONTROLS AND PROCEDURES.
-----------------------
As of the end of the period covered by this report, we carried out an
evaluation, under the supervision, and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures as contemplated by Exchange Act Rule 13a-15. Based upon, and as of
the date of that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that the Company's disclosure controls and procedures are
effective, in all material respects, in timely alerting them to material
information relating to the Company (and its consolidated subsidiary) required
to be included in the periodic reports the Company is required to file and
submit to the SEC under the Exchange Act.
11
PART II. - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
-----------------
The Company is not involved in any pending legal proceedings other than
routine legal proceedings occurring in the ordinary course of business that, in
the aggregate, are believed by management to be immaterial to the Company's
business, financial condition, results of operations and cash flows.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
-----------------------------------------------------------
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
-------------------------------
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
---------------------------------------------------
None
ITEM 5. OTHER INFORMATION.
-----------------
None
ITEM 6. EXHIBITS.
--------
(a) The exhibits filed as part of this Form 10-QSB are listed in
the Exhibit Index, which is incorporated herein by reference.
12
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
Date: November 14, 2005 ROYAL FINANCIAL, INC.
By: /s/ Donald A. Moll
-------------------------------------
Donald A. Moll
President and Chief Executive Officer
Date: November 14, 2005 By: /s/ Neil Brodzinski
-------------------------------------
Neil Brodzinski
Senior Vice President,
Chief Financial Officer and Treasurer
13
EXHIBIT INDEX
-------------
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.