Internet Address
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 
Washington, D.C. 20549
 
FORM 10-K
 
ANNUAL REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (THE "EXCHANGE ACT")
 
For the fiscal year ended December 31, 2006
 
Commission file number: 000-17007
 
REPUBLIC FIRST BANCORP, INC.
(Exact name of registrant as specified in charter)
 
Pennsylvania
 
 
23-2486815
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification No.)
     
1608 Walnut Street, Suite 1000, Philadelphia, PA
 
19103
(Address of Principal Executive offices)
 
(Zip Code)
 
Issuer’s telephone number, including area code: (215) 735-4422
 
Securities registered pursuant to Section 12(b) of the Act: None.
 
Securities registered pursuant to Section 12(g) of the Act:
 
Common Stock, $0.01 par value
(Title of class)
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
YES   ____ NO __X_    
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15 (d) of the Act.
YES   _ NO __X__ 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES   X  NO ____
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K, or any amendment to this Form 10-K [ X ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ___   Accelerated filer __X__    Non-accelerated filer ____
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES   _ NO __X__ 
 
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of June 30, 2006. The aggregate market value of $105,227,440 was based on the average of the bid and asked prices on the National Association of Securities Dealers Automated Quotation System on June 30, 2006.
 
APPLICABLE ONLY TO CORPORATE REGISTRANTS
 
Indicate the number of shares outstanding of each of the Registrant’s classes of common stock, as of the latest practicable date.
 
Common Stock $0.01 Par Value
 
 
9,747,312
Title of Class
 
Number of Shares Outstanding as of March 2, 2007
 
Documents incorporated by reference 
Part III incorporates certain information by reference from the registrant’s Proxy Statement for the 2007 Annual Meeting of Shareholders to be held on April 24, 2007.

 

 
REPUBLIC FIRST BANCORP, INC.
 
Form 10-K
_____________________

INDEX

 
PART I     Page 
     
     
PART II
   
     
PART III
   
     
PART IV
   
 

 

 




PART I
 
Item 1: Description of Business
 
The Company’s website address is rfbkonline.com. The Company’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and other documents filed by the Company with the Securities and Exchange Commission (“SEC”) are available free of charge on the Company’s website under the Investor Relations menu. Such documents are available on the Company’s website as soon as reasonably practicable after they have been filed electronically with the SEC.
 
Forward Looking Statements
 
This document contains forward-looking statements, which can be identified by reference to a future period or periods or by the use of words such as “would be,” “could be,” “may,” “will,” “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect” and similar expressions or the negative thereof. These forward-looking statements include:
 
·  
statements of goals, intentions and expectations;
·  
statements regarding prospects and business strategy;
·  
statements regarding asset quality and market risk; and
·  
estimates of future costs, benefits and results.
 
These forward-looking statements are subject to significant risks, assumptions and uncertainties, including, among other things, the following: (1) general economic conditions, (2) competitive pressure among financial services companies, (3) changes in interest rates, (4) deposit flows, (5) loan demand, (6) changes in legislation or regulation, (7) changes in accounting principles, policies and guidelines, (8) litigation liabilities, including costs, expenses, settlements and judgments and (9) other economic, competitive, governmental, regulatory and technological factors affecting the Company’s operations, pricing, products and services.
 
Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. We have no obligation to update or revise any forward-looking statements to reflect any changed assumptions, any unanticipated events or any changes in the future. Factors which could have a material adverse effect on the operations and future prospects of the Company are detailed in the “Risk Factors” section included under Item 1A of Part I of this form 10-K.
 
Republic First Bancorp, Inc.
 
Republic First Bancorp, Inc. (the “Company”), was established in 1987. At December 31, 2004, the Company was a two-bank holding company organized and incorporated under the laws of the Commonwealth of Pennsylvania. Its wholly-owned subsidiaries, Republic First Bank (“Republic”) and First Bank of Delaware (“FBD”), offered a variety of credit and depository banking services. Such services were offered to individuals and businesses primarily in the Greater Philadelphia and Delaware area through their ten offices and branches in Philadelphia and Montgomery Counties in Pennsylvania and New Castle County, Delaware, but also through the national consumer loan products offered by the First Bank of Delaware.
 
The First Bank of Delaware was spun off by the Company, on January 31, 2005. All assets, liabilities and equity of FBD were spun off as an independent company, trading on the OTC market under FBOD. Shareholders received one share of stock in FBD, for every share owned of the Company. After that date, the Company became a one bank holding company.
 
As of December 31, 2006, the Company had total assets of approximately $1.0 billion, total shareholder’s equity of approximately $74.7 million, total deposits of approximately $754.8 million and net loans receivable outstanding of approximately $784.0 million. The majority of such loans were made for commercial purposes.
 
The Company provides banking services through Republic and does not presently engage in any activities other than banking activities. The principal executive office of the Company is located at 1608 Walnut Street, Suite 1000, Philadelphia, PA 19103, telephone number (215) 735-4422.
 
At December 31, 2006 the Company and Republic had a total of 147 full-time equivalent employees.
 
 
 
1

 
Republic First Bank
 
Republic First Bank is a commercial bank chartered pursuant to the laws of the Commonwealth of Pennsylvania, and is subject to examination and comprehensive regulation by the Federal Deposit Insurance Corporation (“FDIC”) and the Pennsylvania Department of Banking. The deposits held by Republic are insured up to applicable limits by the Bank Insurance Fund of the FDIC. Republic presently conducts its principal banking activities through its six Philadelphia offices and five suburban offices in Ardmore, East Norriton and Abington, located in Montgomery County, Media, located in Delaware County, and Voorhees, located in southern New Jersey.
 
As of December 31, 2006, Republic had total assets of approximately $1.0 billion, total shareholder’s equity of approximately $80.5 million, total deposits of approximately $754.9 million and net loans receivable of approximately $784.0 million. The majority of such loans were made for commercial purposes.
 
Services Offered
 
Republic offers many commercial and consumer banking services with an emphasis on serving the needs of individuals, small and medium-sized businesses, executives, professionals and professional organizations in their service area.
 
Republic attempts to offer a high level of personalized service to both their small and medium-sized businesses and consumer customers. Republic offers both commercial and consumer deposit accounts, including checking accounts, interest-bearing demand accounts, money market accounts, certificates of deposit, savings accounts, sweep accounts, lockbox services and individual retirement accounts (and other traditional banking services). Republic actively solicits both non-interest and interest-bearing deposits from its borrowers.
 
Republic offers a broad range of loan and credit facilities to the businesses and residents of its service area, including secured and unsecured commercial loans, commercial real estate and construction loans, residential mortgages, automobile loans, home improvement loans, home equity and overdraft lines of credit, and other products.
 
Republic manages credit risk through loan application evaluation and monitoring for adherence with credit policies. Since its inception, Republic has had a senior officer monitor compliance with Republic’s lending policies and procedures by Republic’s loan officers.
 
Republic also maintains an investment securities portfolio. Investment securities are purchased by Republic in compliance with Republic’s Investment Policies, which are approved annually by Republic’s Board of Directors. The Investment Policies address such issues as permissible investment categories, credit quality, maturities and concentrations. At December 31, 2006 and 2005, approximately 71% and 62%, respectively, of the aggregate dollar amount of the investment securities consisted of either U.S. Government debt securities or U.S. Government agency issued mortgage backed securities. Credit risk associated with these U.S. Government debt securities and the U.S. Government Agency securities is minimal, with risk-based capital weighting factors of 0% and 20%, respectively. The remainder of the securities portfolio consists of municipal securities, trust preferred securities, corporate bonds, and Federal Home Loan Bank (FHLB) securities.
 
Service Area/Market Overview
 
Republic’s primary business banking service area consists of the Greater Philadelphia region, including Center City Philadelphia and the northern and western suburban communities located principally in Montgomery and Delaware Counties in Pennsylvania and northern Delaware. Republic also serves the surrounding counties of Bucks and Chester in Pennsylvania, southern New Jersey and southern Delaware.
 
Competition
 
There is substantial competition among financial institutions in Republic’s business banking service area. Competitors include but are not restricted to the following banks: Wachovia, Citizens, PNC, Sovereign, Commerce, Royal Bank of Pennsylvania, and the Bancorp Bank. Republic competes with new and established local commercial banks, as well as numerous regionally based and super-regional commercial banks. In addition to competing with new and established commercial banking institutions for both deposits and loan customers, Republic competes directly with savings banks, savings and loan associations, finance companies, credit unions, factors, mortgage brokers, insurance companies, securities brokerage firms, mutual funds, money market funds, private lenders and other institutions for deposits, commercial loans, mortgages and consumer loans, as well as other services. Competition among financial institutions is based upon a number of factors,
 
 
2

 
including, but not limited to, the quality of services rendered, interest rates offered on deposit accounts, interest rates charged on loans and other credit services, service charges, the convenience of banking facilities, locations and hours of operation and, in the case of loans to larger commercial borrowers, relative lending limits. It is the view of Management that a combination of many factors, including, but not limited to, the level of market interest rates, has increased competition for loans and deposits.
 
Many of the banks with which Republic competes have greater financial resources than Republic and offer a wider range of deposit and lending instruments with higher legal lending limits. Republic’s legal lending limit was approximately $13.3 million at December 31, 2006. Loans above these amounts may be made if the excess over the lending limit is participated to other institutions. After the spin off, Republic and FBD have continued to sell each other such participations. Republic is subject to potential intensified competition from new branches of established banks in the area as well as new banks that could open in its market area. Several new banks with business strategies similar to those of Republic have opened since Republic’s inception. There are banks and other financial institutions which serve surrounding areas, and additional out-of-state financial institutions, which currently, or in the future, may compete in Republic’s market. Republic competes to attract deposits and loan applications both from customers of existing institutions and from customers new to the greater Philadelphia area. Republic anticipates a continued increase in competition in their market area.
 
  Operating Strategy for Business Banking
 
Following the spin off of FBD, the Company’s business banking objective has been for Republic to become the primary alternative to the large banks that dominate the Greater Philadelphia market. The Company’s management team has developed a business strategy consisting of the following key elements to achieve this objective:
 
Providing Attentive and Personalized Service
 
The Company believes that a very attractive niche exists serving small to medium-sized business customers not adequately served by Republic’s larger competitors. The Company believes this segment of the market responds very positively to the attentive and highly personalized service provided by Republic. Republic offers individuals and small to medium-sized businesses a wide array of banking products, informed and professional service, extended operating hours, consistently applied credit policies, and local, timely decision making. The banking industry is experiencing a period of rapid consolidation, and many local branches have been acquired by large out-of-market institutions. The Company is positioned to respond to these dynamics by offering a community banking alternative and tailoring its product offering to fill voids created as larger competitors increase the price of products and services or de-emphasize such products and services.
 
Attracting and Retaining Highly Experienced Personnel 
 
Republic’s officers and other personnel have substantial experience acquired at larger banks in the region. Additionally, Republic extensively screens and trains its staff to instill a sales and service oriented culture and maximize cross-selling opportunities and business relationships. Republic offers meaningful sales-based incentives to certain customer contact employees.
 
Capitalizing on Market Dynamics 
 
In recent years, banks controlling large amounts of the deposits in Republic’s primary market areas have been acquired by large and super-regional bank holding companies. The ensuing cultural changes in these banking institutions have resulted in changes in their product offerings and in the degree of personal attention they provide. The Company has sought to capitalize on these changes by offering a community banking alternative. As a result of continuing consolidations and its marketing efforts, the Company believes it has a continuing opportunity to increase its market share.
 
Products and Services
 
Republic offers a range of competitively priced commercial and other banking services, including secured and unsecured commercial loans, real estate loans, construction and land development loans, automobile loans, home improvement loans, mortgages, home equity and overdraft lines of credit, and other products. Republic offers both commercial and consumer deposit accounts, including checking accounts, interest-bearing demand accounts, money market accounts, certificates of deposit, savings accounts, sweep accounts, lockbox services and individual retirement accounts (and other traditional banking services). Republic’s commercial loans typically range between $250,000 and $5.0 million but customers may borrow significantly larger amounts up to Republic’s legal lending limit of approximately $13.3 million. Individual customers may have several loans, often secured by different collateral, which are in total subject to that lending limit. Relationships in excess
 
 
3

 
of $8.8 million at December 31, 2006, amounted to $291.9 million. The $8.8 million threshold approximates 10% of total capital and reserves and reflects an additional internal monitoring guideline.
 
Republic attempts to offer a high level of personalized service to both their commercial and consumer customers. Republic is a member of the STAR™ and PLUS™ automated teller (“ATM”) networks in order to provide customers with access to ATMs worldwide. Republic currently has eleven proprietary ATMs at branch locations and two additional ATMs at a location in Southern New Jersey.
 
Republic’s lending activities generally are focused on small and medium sized businesses within the professional community. Commercial and construction loans are the most significant category of Republic’s outstanding loans, representing approximately 96% of total loans outstanding at December 31, 2006. Repayment of these loans is, in part, dependent on general economic conditions affecting the community and the various businesses within the community. Although management continues to follow established underwriting policies, and monitors loans through Republic’s loan review officer, credit risk is still inherent in the portfolio. Although the majority of Republic’s loan portfolio is collateralized with real estate or other collateral, a portion of the commercial portfolio is unsecured, representing loans made to borrowers considered to be of sufficient strength to merit unsecured financing. Republic makes both fixed and variable rate loans with terms ranging from one to five years. Variable rate loans are generally tied to the national prime rate of interest.
 
Branch Expansion Plans and Growth Strategy
 
A branch was opened by Republic in Northeast Philadelphia in second quarter 2006. A second branch was opened in Voorhees, New Jersey in third quarter 2006. Two additional branches are planned for 2007 at locations to be determined. A branch is planned for 2007 in Bala Cynwyd, Pennsylvania to replace the 4190 City Line Avenue, Philadelphia location in second quarter 2007. Additional locations may also be pursued.
 
Supervision and Regulation
 
Various requirements and restrictions under the laws of the United States and the Commonwealth of Pennsylvania affect the Company and Republic.
 
General
 
Republic, a Pennsylvania chartered bank, is subject to supervision and regulation by the FDIC and the Pennsylvania Department of Banking. The Company is a bank holding company subject to supervision and regulation by the Federal Reserve Bank of Philadelphia (“FRB”) under the federal Bank Holding Company Act of 1956, as amended (the “BHC Act”). As a bank holding company, the Company’s activities and those of Republic are limited to the business of banking and activities closely related or incidental to banking, and the Company may not directly or indirectly acquire the ownership or control of more than 5% of any class of voting shares or substantially all of the assets of any company, including a bank, without the prior approval of the FRB.
 
Republic is also subject to requirements and restrictions under federal and state law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be granted and the interest that may be charged thereon, and limitations on the types of investments that may be made and the types of services that may be offered. Various consumer laws and regulations also affect the operations of Republic. In addition to the impact of regulation, commercial banks are affected significantly by the actions of the FRB in attempting to control the money supply and credit availability in order to influence market interest rates and the national economy.
 
Holding Company Structure
 
Republic is subject to restrictions under federal law which limits its ability to transfer funds to the Company, whether in the form of loans, other extensions of credit, investments or asset purchases. Such transfers by Republic to the Company are generally limited in amount to 10% of Republic’s capital and surplus. Furthermore, such loans and extensions of credit are required to be secured in specific amounts, and all transactions are required to be on an arm’s length basis. Republic has never made any loans or extensions of credit to the Company or purchased any assets from the Company.
 
Under regulatory policy, the Company is expected to serve as a source of financial strength to Republic and to commit resources to support Republic. This support may be required at times when, absent such policy, the Company might not otherwise provide such support. Any capital loans by the Company to Republic are subordinate in right of payment to deposits
 
 
4

 
and to certain other indebtedness of Republic. In the event of the Company’s bankruptcy, any commitment by the Company to a federal bank regulatory agency to maintain the capital of Republic will be assumed by the bankruptcy trustee and entitled to a priority of payment.
 
Gramm-Leach-Bliley Act
 
On November 12, 1999, the federal Gramm-Leach-Bliley Act (the “GLB Act”) was enacted. The GLB Act did three fundamental things:
 
(a)  
repealed the key provisions of the Glass Steagall Act so as to permit commercial banks to affiliate with investment banks (securities firms);
(b)  
amended the BHC Act to permit qualifying bank holding companies to engage in any type of financial activities that were not permitted for banks themselves; and
(c)  
permitted subsidiaries of banks to engage in a broad range of financial activities that were not permitted for banks themselves.
 
The result was that banking companies would generally be able to offer a wider range of financial products and services and would be more readily able to combine with other types of financial companies, such as securities and insurance companies.
 
The GLB Act created a new kind of bank holding company called a “financial holding company” (an “FHC”). An FHC is authorized to engage in any activity that is “financial in nature or incidental to financial activities” and any activity that the Federal Reserve determines is “complementary to financial activities” and does not pose undue risks to the financial system. Among other things, “financial in nature” activities include securities underwriting and dealing, insurance underwriting and sales, and certain merchant banking activities. A bank holding company qualifies to become an FHC if each of its depository institution subsidiaries is “well capitalized,” “well managed,” and CRA-rated “satisfactory” or better. A qualifying bank holding company becomes an FHC by filing with the Board of Governors of the Federal Reserve System (the “Federal Reserve”) an election to become an FHC. If an FHC at any time fails to remain “well capitalized” or “well managed,” the consequences can be severe. Such an FHC must enter into a written agreement with the Federal Reserve to restore compliance. If compliance is not restored within 180 days, the Federal Reserve can require the FHC to cease all its newly authorized activities or even to divest itself of its depository institutions. On the other hand, a failure to maintain a CR rating of “satisfactory” will not jeopardize any then existing newly authorized activities; rather, the FHC cannot engage in any additional newly authorized activities until a “satisfactory” CRA rating is restored.
 
In addition to activities currently permitted by law and regulation for bank holding companies, an FHC may engage in virtually any other kind of financial activity. Under limited circumstances, an FHC may even be authorized to engage in certain non-financial activities. The most important of these authorized activities are as follows:
 
(a)  Securities underwriting and dealing;
(b)  Insurance underwriting and sales;
(c)  Merchant banking activities;
(d)  Activities determined by the Federal Reserve to be “financial in nature” and incidental activities; and
(e)  Activities determined by the Federal Reserve to be “complementary” to financial activities.
 
Bank holding companies that do not qualify or elect to become FHCs will be limited in their activities to those previously permitted by law and regulation. The Company has not elected to become a FHC but has not precluded the possibility of doing so in the future.
 
The GLB Act also authorized national banks to create “financial subsidiaries.” This is in addition to the present authority of national banks to create “operating subsidiaries”. A “financial subsidiary” is a direct subsidiary of a national bank that satisfies the same conditions as an FHC, plus certain other conditions, and is approved in advance by the Office of the Comptroller of the Currency (the “OCC”). A national bank’s “financial subsidiary” can engage in most, but not all, of the newly authorized activities.
 
In addition, the GLB Act provided significant new protections for the privacy of customer information. These provisions apply to any company the business of which is engaging in activities permitted for an FHC, even if it is not itself an FHC. The GLB Act subjected a financial institution to four new requirements regarding non-public information about a customer. The financial institution must (1) adopt and disclose a privacy policy; (2) give customers the right to “opt out” of disclosures to non-
 
 
5

 
affiliated parties; (3) not disclose any information to third party marketers; and (4) follow regulatory standards (to be adopted in the future) to protect the security and confidentiality of customer information.
 
Although the long-range effects of the GLB Act cannot be predicted with certainty, it will probably further narrow the differences and intensify competition between and among commercial banks, investment banks, insurance firms and other financial service companies.
 
Sarbanes-Oxley Act of 2002
 
The following is a brief summary of some of the provisions of the Sarbanes-Oxley Act of 2002 (“SOX”) that affect the Company. It is not intended as an exhaustive description of SOX or its impact on the Company.
 
SOX instituted or increased various requirements for corporate governance, board of director and audit committee composition and membership, board duties, auditing standards, external audit firm standards, additional disclosure requirements, including CEO and CFO certification of financial statements and related controls, and other new requirements.
 
Boards of directors are now required to have a majority of independent directors, and the audit committees are required to be wholly independent, with greater financial expertise. Such independent directors are not allowed to receive compensation from the company on whose board they serve except for directors’ fees. Additionally, requirements for auditing standards and independence of external auditors were increased and included independent audit partner review, audit partner rotation, and limitations over non-audit services. Penalties for non-compliance with existing and new requirements were established or increased.
 
In addition, Section 404 of SOX required that by each year end, our management perform a detailed assessment of internal controls and report thereon as follows:
 
1.  
We must state that we accept the responsibility for maintaining an adequate internal control structure and procedures for financial reporting;
 
2.  
We must present an assessment, at each year end, of the effectiveness of the internal control structure and procedure for our financial reporting; and
 
3.  
We must have our auditors attest to, and report on, the assessment made by management. The attestation must be made in accordance with standards for attestation engagements issued or adopted by the Public Company Accounting Oversight Board.
 
We had taken necessary steps with respect to achieving compliance and have updated our assessment and reporting on internal controls through the end of 2006.
 
Regulatory Restrictions on Dividends
 
Dividend payments by Republic to the Company are subject to the Pennsylvania Banking Code of 1965 (the “Banking Code”) and the Federal Deposit Insurance Act (the “FDIA”). Under the Banking Code, no dividends may be paid except from “accumulated net earnings” (generally, undivided profits). Under the FDIA, an insured bank may pay no dividends if the bank is in arrears in the payment of any insurance assessment due to the FDIC. Under current banking laws, Republic would be limited to $51.2 million of dividends payable plus an additional amount equal to its net profit for 2007, up to the date of any such dividend declaration. However, dividends would be further limited in order to maintain capital ratios as discussed in “Regulatory Capital Requirements”. The Company may consider dividend payments in 2007.
 
State and federal regulatory authorities have adopted standards for the maintenance of adequate levels of capital by banks, which may vary. Adherence to such standards further limits the ability of Republic to pay dividends to the Company.
 
 
 
6

 
Dividend Policy
 
The Company has not paid any cash dividends on its Common Stock. The Company may consider dividend payments in 2007.
 
FDIC Insurance Assessments
 
The FDIC has implemented a risk-related premium schedule for all insured depository institutions that results in the assessment of premiums based on capital and supervisory measures.
 
Under the risk-related premium schedule, the FDIC, on a semiannual basis, assigns each institution to one of three capital groups (well capitalized, adequately capitalized or under capitalized) and further assigns such institution to one of three subgroups within a capital group corresponding to the FDIC’s judgment of the institution’s strength based on supervisory evaluations, including examination reports, statistical analysis and other information relevant to gauging the risk posed by the institution. Only institutions with a total capital to risk-adjusted assets ratio of 10.00% or greater, a Tier 1 capital to risk-adjusted assets ratio of 6.00% or greater and a Tier 1 leverage ratio of 5.00% or greater, are assigned to the well capitalized group.
 
Capital Adequacy
 
The FRB has adopted risk-based capital guidelines for bank holding companies, such as the Company. The required minimum ratio of total capital to risk-weighted assets (including off-balance sheet activities, such as standby letters of credit) is 8.0%. At least half of the total capital is required to be Tier 1 capital, consisting principally of common shareholders’ equity, non-cumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, less goodwill. The remainder, Tier 2 capital, may consist of a limited amount of subordinated debt and intermediate-term preferred stock, certain hybrid capital instruments and other debt securities, perpetual preferred stock, and a limited amount of the general loan loss allowance.
 
In addition to the risk-based capital guidelines, the FRB has established minimum leverage ratio (Tier 1 capital to average total assets) guidelines for bank holding companies. These guidelines provide for a minimum leverage ratio of 3% for those bank holding companies that have the highest regulatory examination ratings and are not contemplating or experiencing significant growth or expansion. All other bank holding companies are required to maintain a leverage ratio of at least 1% to 2% above the 3% stated minimum. The Company is in compliance with these guidelines. The FDIC subjects Republic to similar capital requirements.
 
The risk-based capital standards are required to take adequate account of interest rate risk, concentration of credit risk and the risks of non-traditional activities.
 
Interstate Banking
 
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1995 (the “Interstate Banking Law”) amended various federal banking laws to provide for nationwide interstate banking, interstate bank mergers and interstate branching. The interstate banking provisions allow for the acquisition by a bank holding company of a bank located in another state.
 
Interstate bank mergers and branch purchase and assumption transactions were allowed effective September 1, 1998; however, states may “opt-out” of the merger and purchase and assumption provisions by enacting a law that specifically prohibits such interstate transactions. States could, in the alternative, enact legislation to allow interstate merger and purchase and assumption transactions prior to September 1, 1999. States could also enact legislation to allow for de novo interstate branching by out of state banks. In July 1997, Pennsylvania adopted “opt-in” legislation that allows interstate merger and purchase and assumption transactions.
 
Profitability, Monetary Policy and Economic Conditions
 
In addition to being affected by general economic conditions, the earnings and growth of Republic will be affected by the policies of regulatory authorities, including the Pennsylvania Department of Banking, the FRB and the FDIC. An important function of the FRB is to regulate the supply of money and other credit conditions in order to manage interest rates. The monetary policies and regulations of the FRB have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. The effects of such policies upon the future business, earnings and
 
 
7

 
growth of the Bank cannot be determined. See “Management’s Discussion and Analysis of Financial Condition - Results of Operations”.
 
Republic is not considered to be a “well known seasoned issuer.”

8


Item 1A: Risk Factors
 
In addition to factors discussed elsewhere in this report and in “Management’s Discussion and Analysis of Results of Operations and Financial Condition,” the following are some of the important factors that could materially and adversely affect our business, financial condition and results of operations.
 
Our earnings are sensitive to fluctuations in interest rates.
 
The earnings of the Company depend on the earnings of Republic. Republic is dependent primarily upon the level of net interest income, which is the difference between interest earned on its interest-earning assets, such as loans and investments, and the interest paid on its interest-bearing liabilities, such as deposits and borrowings. Accordingly, the operations of Republic are subject to risks and uncertainties surrounding their exposure to change in the interest rate environment.
 
Our earnings may be negatively impacted by a general economic downturn or changes in the credit risk of our borrowers.
 
Republic’s results of operations are affected by the ability of its borrowers to repay their loans. Lending money is an essential part of the banking business. However, borrowers do not always repay their loans. The risk of non-payment is affected by credit risks of a particular borrower, changes in economic conditions, the duration of the loan and in the case of a collateralized loan, uncertainties as to the future value of the collateral.
 
Our allowance for loan losses may not be sufficient to absorb actual loan losses.
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America require management to make significant estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
 
Significant estimates are made by management in determining the allowance for loan losses, carrying values of other real estate owned, and income taxes. Consideration is given to a variety of factors in establishing these estimates. There is no precise method of predicting loan losses. Republic can give no assurance that its allowance for loan losses is or will be sufficient to absorb actual loan losses. Loan losses could have a material adverse effect on Republic’s financial condition and results of operations. Republic attempts to maintain an appropriate allowance for loan losses to provide for estimated losses in its loan portfolio. In estimating the allowance for loan losses, management considers current economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, borrowers’ perceived financial and managerial strengths, the adequacy of underlying collateral, if collateral dependent, or present value of future cash flows and other relevant factors. Since the allowance for loan losses and carrying value of real estate owned are dependent, to a great extent, on the general economy and other conditions that may be beyond Republic’s control, it is at least reasonably possible that the estimates of the allowance for loan losses and the carrying values of the real estate owned could differ materially in the near term.
 
We face increasing competition in our market from other banks and financial institutions.
 
Republic may not be able to compete effectively in its markets, which could adversely affect its results of operations. The banking and financial services industry in Republic’s market area is highly competitive. The increasingly competitive environment is a result of changes in regulation, changes in technology and product delivery systems, and the accelerated pace of consolidation among financial service providers. Such larger institutions have greater access to capital markets, with higher lending limits and a broader array of services. Competition may require increases in deposit rates and decreases in loan rates.
 
Our governing documents contain provisions which may reduce the likelihood of a change in control transaction.
 
The Company’s Articles of Incorporation and Bylaws contain certain anti-takeover provisions that may make it more difficult or expensive or may discourage a tender offer, change in control or takeover attempt that is opposed by its Board of Directors. In particular, the Articles of Incorporation and Bylaws: classify the Board of Directors into three groups, so that shareholders elect only one-third of the Board each year; permit shareholders to remove directors only for cause and only upon the vote of the holders of at least 75% of the voting shares; require shareholders to give the Company advance notice to nominate candidates for election to the Board of Directors or to make shareholder proposals at a shareholders’ meeting; and require the vote of the holders of at least 60% of the Company’s voting shares for stockholder amendments to the Company’s
 
 
9

 
Bylaws. These provisions of the Company’s Articles of Incorporation and Bylaws could discourage potential acquisition proposals and could delay or prevent a change in control, even though a majority of the Company’s shareholders may consider such proposals desirable. Such provisions could also make it more difficult for third parties to remove and replace the members of the Company’s Board of Directors. Moreover, these provisions could diminish the opportunities for shareholders to participate in certain tender offers, including tender offers at prices above the then-current market value of the Company’s common stock, and may also inhibit increases in the trading price of the Company’s common stock that could result from takeover attempts or speculation.
 
In addition, in the event of certain hostile fundamental changes, all of our senior officers are entitled to receive payments equal to two times such officers’ base annual salary in the event they determine not to continue their employment.
 
Government regulation restricts the scope of our operations.
 
The Company and Republic operate in a highly regulated environment and are subject to supervision and regulation by several governmental regulatory agencies, including the FDIC and the Pennsylvania Department of Banking. The Company and Republic are subject to federal and state regulations governing virtually all aspects of their activities, including but not limited to, lines of business, liquidity, investments, the payment of dividends, and others. Regulations that apply to the Company and Republic are generally intended to provide protection for depositors and customers rather than for investors. The Company and Republic will remain subject to these regulations, and to the possibility of changes in federal and state laws, regulations, governmental policies, income tax laws and accounting principles. Changes in the regulatory environment in which the Company and Republic operate could adversely affect the banking industry as a whole and the Company and Republic’s operations in particular. For example, regulatory changes could limit our growth and our return to investors by restricting such activities as the payment of dividends, mergers with or acquisitions by other institutions, investments, loans and interest rates, and providing securities, insurance or trust services. Such regulations and the cost of adherence to such regulations can have a significant impact on earnings and financial condition.
 
Also, legislation may change present capital requirements, which could restrict the Company and Republic’s activities and require the Company and Republic to maintain additional capital. The Company and Republic cannot predict what changes, if any, legislators and federal and state agencies will make to existing federal and state legislation and regulations or the effect that such changes may have on the Company and Republic’s business.
 
Our business is concentrated in and dependent upon the continued growth and welfare of our primary market area.
 
We operate primarily in the Philadelphia geographic market. Our success depends upon the business activity, population, income levels, deposits and real estate activity in this market. Although our customers’ business and financial interests may extend well beyond this market area, adverse economic conditions that affect our home market could reduce our growth rate, affect the ability of our customers to repay their loans to us and generally affect our financial condition and results of operations. Because of our geographic concentration, we are less able than other regional or national financial institutions to diversify our credit risks across multiple markets.
 
We may experience difficulties in managing our growth and our growth strategy involves risks that may negatively impact our net income.
 
 As part of our general growth strategy, we may expand into additional communities or attempt to strengthen our position in our current markets by opening new branches and acquiring existing branches of other financial institutions. To the extent that we undertake additional branch openings and acquisitions, we are likely to continue to experience the effects of higher operating expenses relative to operating income from the new operations, which may have an adverse effect on our levels of reported net income, return on average equity and return on average assets. Other effects of engaging in such growth strategies may include potential diversion of our management’s time and attention and general disruption to our business.
 
Although we do not have any current plans to do so, we may also acquire banks and related businesses that we believe provide a strategic fit with our business we may also engage in de novo bank formations. To the extent that we grow through acquisitions and de novo bank formations, we cannot assure you that we will be able to adequately and profitably manage this growth. Acquiring other banks and businesses will involve similar risks to those commonly associated with branching, but may also involve additional risks, including: 
 
 
potential exposure to unknown or contingent liabilities of banks and businesses we acquire;

 
exposure to potential asset quality issues of the acquired bank or related business;
 
 
 
10


 
 
difficulty and expense of integrating the operations and personnel of banks and businesses we acquire; and

 
the possible loss of key employees and customers of the banks and businesses we acquire.
 
Our growth may require us to raise additional capital in the future, but that capital may not be available when it is needed.
 
We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. We anticipate that our existing capital resources will satisfy our capital requirements for the foreseeable future. However, we may at some point need to raise additional capital to support our continued growth. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we cannot assure you of our ability to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth, branching, de novo bank formations and/or acquisitions could be materially impaired.
 
Our community banking strategy relies heavily on our management team, and the unexpected loss of key managers may adversely affect our operations.
 
Much of our success to date has been influenced strongly by our ability to attract and to retain senior management experienced in banking and financial services and familiar with the communities in our market. Our ability to retain executive officers, the current management teams, branch managers and loan officers of our bank subsidiary will continue to be important to the successful implementation of our strategy. It is also critical, as we grow, to be able to attract and retain qualified additional management and loan officers with the appropriate level of experience and knowledge about our market areas to implement our community-based operating strategy. The unexpected loss of services of any key management personnel, or the inability to recruit and retain qualified personnel in the future, could have an adverse effect on our business, financial condition and results of operations.
 
We have a continuing need for technological change and we may not have the resources to effectively implement new technology.
 
The financial services industry is constantly undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend in part upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in our operations as we continue to grow and expand in our market. Many of our larger competitors have substantially greater resources to invest in technological improvements. As a result, they may be able to offer additional or superior products to those that we will be able to offer, which would put us at a competitive disadvantage. Accordingly, we cannot provide you with assurance that we will be able to effectively implement new technology-driven products and services or be successful in marketing such products and services to our customers.
 
There is a limited trading market for our common shares, and you may not be able to resell your shares at or above the price shareholders paid for them.
 
Although our common shares are listed for trading on the NASDAQ Stock Market, the trading in our common shares has less liquidity than many other companies quoted on the NASDAQ. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the market of willing buyers and sellers of our common shares at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. We cannot assure you that volume of trading in our common shares will increase in the future.
 
System failure or breaches of our network security could subject us to increased operating costs as well as litigation and other liabilities.  
 
The computer systems and network infrastructure we use could be vulnerable to unforeseen problems. Our operations are dependent upon our ability to protect our computer equipment against damage from physical theft, fire, power loss, telecommunications failure or a similar catastrophic event, as well as from security breaches, denial of service attacks, viruses, worms and other disruptive problems caused by hackers. Any damage or failure that causes an interruption in our operations could have a material adverse effect on our financial condition and results of operations. Computer break-ins, phishing and other disruptions could also jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability to us and may cause existing and potential customers to refrain
 
 
11

 
 
from doing business with us. Although we, with the help of third-party service providers, intend to continue to implement security technology and establish operational procedures to prevent such damage, there can be no assurance that these security measures will be successful. In addition, advances in computer capabilities, new discoveries in the field of cryptography or other developments could result in a compromise or breach of the algorithms we and our third-party service providers use to encrypt and protect customer transaction data. A failure of such security measures could have a material adverse effect on our financial condition and results of operations.
 
We are subject to certain operational risks, including, but not limited to, customer or employee fraud and data processing system failures and errors. 
 
Employee errors and misconduct could subject us to financial losses or regulatory sanctions and seriously harm our reputation. Misconduct by our employees could include hiding unauthorized activities from us, improper or unauthorized activities on behalf of our customers or improper use of confidential information. It is not always possible to prevent employee errors and misconduct, and the precautions we take to prevent and detect this activity may not be effective in all cases. Employee errors could also subject us to financial claims for negligence.
 
We maintain a system of internal controls and insurance coverage to mitigate operational risks, including data processing system failures and errors and customer or employee fraud. Should our internal controls fail to prevent or detect an occurrence, or if any resulting loss is not insured or exceeds applicable insurance limits, it could have a material adverse effect on our business, financial condition and results of operations.
 
Item 1BUnresolved Staff Comments
 
None
 
Item 2:  Description of Properties
 
Republic leases approximately 34,686 square feet on the second, fourth, tenth and eleventh floors of 1608 Walnut Street, Philadelphia, Pennsylvania, as its headquarter facilities. The space is occupied by the Company and the executive offices of Republic. Back office operations of Republic and commercial bank lending of Republic are located therein. Future staffing needs have required Republic to secure additional space as described below. The current term of the lease on its headquarter facilities expires on July 31, 2007 with rent expense for the seven month period of $271,129, payable in monthly installments. In addition to the base rent and building operation expenses, the Company is required to pay its proportional share of all real estate taxes, assessments, and sewer costs, water charges, excess levies, and license and permit fees under its lease and to maintain insurance on the premises.
 
Republic has entered into a lease agreement, commencing June 1, 2007, for approximately 53,275 square feet on two floors of Two Liberty Place, 1601 Chestnut St., Philadelphia, Pennsylvania, as its new headquarter facilities. The space will be occupied by the Company, the executive offices of Republic and FBD which will assume its proportionate share of related costs. Back office operations of Republic and commercial bank lending of Republic will also be located therein. The initial thirteen year, seven month lease term contains two five year renewal options and the initial lease term will expire on December 31, 2020. Annual rent expense commences at $755,972 less the following abatement periods: (1) the first twenty-eight months for 5,815 square feet of space and (2) the following periods for the remaining rentable area: (a) the first six months of the first lease year, (b) the first four months of the second lease year, and (c) the first four months of the third lease year.
 
Republic leases approximately 1,829 square feet on the ground floor at 1601 Market Street in Center City, Philadelphia. This space contains a banking area and vault and represents Republic’s main office. The initial ten year term of the lease expired March 2003 and contains five-year and ten-year renewal options that have been exercised and also contains an additional five-year option. The annual rent for such location is $98,767 payable in monthly installments.
 
Republic leases approximately 1,743 square feet of space on the ground floor at 1601 Walnut Street, Center City Philadelphia, PA. This space contains a banking area and vault. The initial ten-year term of the lease expired August 2006. The lease has been extended to August 2014 and contains an additional five-year renewal option. The annual rent for such location is $126,399, payable in monthly installments.
 
Republic leases approximately 785 square feet in the lower level of Pepper Pavilion at Graduate Hospital, 19th and Lombard Streets, Philadelphia, Pennsylvania. The space contains a banking area, lobby, office, and vault. The current lease
 
 
12

 
 
has an initial five year term and a one year renewal option which expires June 2007 as well as an additional one-year option. The annual rental at such location is $25,905 payable in monthly installments.
 
Republic leases approximately 798 square feet of space on the ground floor and 903 square feet on the 2nd floor at 233 East Lancaster Avenue, Ardmore, PA. The space contains a banking area and business development office. The initial ten-year term of the lease expired in August 2005, and contains a five year renewal option that has been exercised and also contains an additional five-year option. The annual rental at such location is $57,225, payable in monthly installments.
 
Republic leases approximately 2,466 square foot of space at 4190 City Line Avenue, Philadelphia, Pennsylvania. The space contains a retail banking facility. The initial ten-year term of the lease expires June 2007. The rent for the six month period for such location is $30,825, payable in monthly installments.
 
Republic has entered into a lease agreement, commencing May 1, 2007, for approximately 1,574 square feet for its Bala Cynwyd office at Two Bala Plaza, Bala Cynwyd, Pennsylvania. The space contains a banking area. The initial six-year, four month lease term contains two five-year renewal options and the initial lease term will expire on August 31, 2013. Annual rent commences at $40,662 less two months rent in the first year.
 
Republic leases approximately 4,200 square foot building at 75 East Germantown Avenue, East Norriton, Pennsylvania. The space contains a banking area and business development office. The initial ten-year term contains two five- year renewal options and the initial lease term expires in May 2007. The annual rent for such location is $66,000, payable in monthly installments.
 
Republic owns an approximately 2,800 square foot facility for its Abington, Montgomery County office at 1480 York Road, Abington, Pennsylvania. This space contains a banking area and a business development office.
 
Republic leases approximately 1,822 square feet on the ground floor at 1818 Market St. Philadelphia, Pennsylvania. The space contains a banking area and a vault. The initial ten-year term of the lease expires in August 2008 and contains two five-year renewal options. The annual rent for such location is $71,058, payable in monthly installments.
 
Republic leases approximately 4,700 square feet of space on the first, second, and third floor, at 436 East Baltimore Avenue, Media, Pennsylvania. The space contains a banking area and business development office. The initial five-year term of the lease expires October 2009 with four five-year renewal options. The annual rent is $71,529 payable in monthly installments.
 
Republic leases office space at the Atrium Executive Suites in Mt. Laurel, New Jersey. The space contains a business development office. The one-year term of the lease expires December 2007. The annual rent is $35,280 payable in monthly installments.
 
Republic leases an approximately 6,000 square feet facility for its Northeast Philadelphia office at Mayfair and Cottman Avenues, Philadelphia, Pennsylvania. The space contains a banking area and a business development office. The initial fifteen-year term of the lease expires June 2021 with two five-year renewal options. The annual rent is $96,000 payable in monthly installments.
 
Republic leases an approximately 1,850 square feet facility for its Voorhees office at 342 Burnt Mill Road, Voorhees, New Jersey. The space contains a banking area. The initial fifteen-year term of the lease expires May 2021 with two five-year renewal options. The annual rent is $42,600 payable in monthly installments.
 
Item 3: Legal Proceedings
 
The Company and Republic are from time to time parties (plaintiff or defendant) to lawsuits in the normal course of business. While any litigation involves an element of uncertainty, management, after reviewing pending actions with its legal counsel, is of the opinion that the liability of the Company and Republic, if any, resulting from such actions will not have a material effect on the financial condition or results of operations of the Company and Republic.
 
Item 4: Submission of Matters to a Vote of Security Holders
 
Not applicable.
 
 
13

 
PART II
 
Item 5: Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
Market Information
 
Shares of the Common Stock are quoted on Nasdaq under the symbol “FRBK.” The table below presents the range of high and low trade prices reported for the Common Stock on Nasdaq for the periods indicated. Market quotations reflect inter-dealer prices, without retail mark-up, markdown, or commission, and may not necessarily reflect actual transactions. As of December 31, 2006, there were approximately 2,247 holders of record of the Common Stock. On March 2, 2007, the closing price of a share of Common Stock on Nasdaq was $12.30. 2005 information has been restated for a 10% stock dividend declared during 2006.
 
Year
 Quarter
 High
 Low
2006
4th
$13.61
$12.50
 
3rd
13.78
12.50
 
2nd
14.24
13.09
 
1st
13.52
11.60
 
 
 
 
2005
4th
$12.01
$10.09
 
 3rd
12.50
11.09
 
2nd
12.73
10.75
 
1st
13.48
10.75
 
Common Stock Performance
 
The following line graph compares the yearly percentage change in the cumulative stockholder return on the Company’s common stock to the NASDAQ Market Index and the SNL Bank Index over the five-year period beginning December 31, 2001, and ending December 31, 2006. Cumulative stockholder return has been measured on a weighted-average basis based on market capitalizations of the component companies comprising the peer group index at the close of trading on the last trading day preceding the beginning of each year assuming an initial investment of $100 and reinvestment of dividends.
 

 
     Period Ending      
Index
 
12/31/01
 
12/31/02
 
12/31/03
 
12/31/04
 
12/31/05
 
12/31/06
 
Republic First Bancorp, Inc.
   
100.00
   
131.60
   
246.76
   
340.69
   
424.41
   
459.73
 
NASDAQ Composite
   
100.00
   
68.76
   
103.67
   
113.16
   
115.57
   
127.58
 
SNL Bank Index
   
100.00
   
91.69
   
123.69
   
138.61
   
140.50
   
164.35
 
                                       
                                       
 
14

 
Issuer Purchases of Equity Securities
 
The Company did not purchase any of its equity securities during the quarter ended December 31, 2006.
 
Dividend Policy
 
The Company has not paid any cash dividends on its Common Stock. The Company may consider dividend payments in 2007. The payment of dividends in the future, if any, will depend upon earnings, capital levels, cash requirements, the financial condition of the Company and Republic, applicable government regulations and policies and other factors deemed relevant by the Company’s Board of Directors, including the amount of cash dividends payable to the Company by Republic. The principal source of income and cash flow for the Company, including cash flow to pay cash dividends on the Common Stock, is dividends from Republic. Various federal and state laws, regulations and policies limit the ability of Republic to pay cash dividends to the Company. For certain limitations on Republic’s ability to pay cash dividends to the Company, see “Description of Business - Supervision and Regulation”.
 

15


Item 6: Selected Financial Data
 
   
As of or for the Years Ended December 31,
 
(Dollars in thousands, except per share data)
 
2006
 
2005
 
2004
 
2003
 
2002
 
                       
INCOME STATEMENT DATA (1):
                     
Total interest income
 
$
62,745
 
$
45,381
 
$
33,599
 
$
37,742
 
$
39,782
 
Total interest expense
   
28,679
   
16,223
   
14,748
   
16,196
   
19,367
 
Net interest income
   
34,066
   
29,158
   
18,851
   
21,546
   
20,415
 
Provision for loan losses
   
1,364
   
1,186
   
(314
)
 
5,827
   
5,043
 
Non-interest income
   
3,640
   
3,614
   
4,466
   
2,853
   
2,496
 
Non-interest expenses
   
21,017
   
18,207
   
15,346
   
14,614
   
15,776
 
Income from continuing operations before income taxes
   
15,325
   
13,379
   
8,285
   
3,958
   
2,092
 
Provision for income taxes
   
5,207
   
4,486
   
2,694
   
1,267
   
691
 
Income from continuing operations
   
10,118
   
8,893
   
5,591
   
2,691
   
1,401
 
Income from discontinued operations
   
-
   
-
   
5,060
   
3,440
   
1,262
 
Income tax on discontinued operations
   
-
   
-
   
1,711
   
1,217
   
463
 
Net income
 
$
10,118
 
$
8,893
 
$
8,940
 
$
4,914
 
$
2,200
 
                                 
                                 
PER SHARE DATA (1) (2)
                               
Basic earnings per share
                               
Income from continuing operations
 
$
1.07
 
$
0.97
 
$
0.63
 
$
0.31
 
$
0.16
 
Income from discontinued operations
   
-
   
-
   
0.38
   
0.25
   
0.10
 
Net income
 
$
1.07
 
$
0.97
 
$
1.01
 
$
0.56
 
$
0.26
 
                                 
Diluted earnings per share
                               
Income from continuing operations
 
$
1.04
 
$
0.93
 
$
0.60
 
$
0.29
 
$
0.16
 
Income from discontinued operations
   
-
   
-
   
0.36
   
0.25
   
0.09
 
Net income
 
$
1.04
 
$
0.93
 
$
0.96
 
$
0.54
 
$
0.25
 
                                 
                                 
Book value per share
 
$
7.87
 
$
6.79
 
$
6.04
 
$
5.47
 
$
5.38
 
                                 
BALANCE SHEET DATA (1)
                               
Total assets (3)
 
$
1,008,824
 
$
850,855
 
$
720,412
 
$
654,792
 
$
647,692
 
Total loans, net (4)
   
784,002
   
670,469
   
543,005
   
452,491
   
428,417
 
Total investment securities (5)
   
109,176
   
44,161
   
49,160
   
68,094
   
93,842
 
Total deposits
   
754,773
   
647,843
   
510,684
   
425,497
   
423,727
 
FHLB & overnight advances
   
159,723
   
123,867
   
86,090
   
132,742
   
125,000
 
Subordinated debt
   
6,186
   
6,186
   
6,186
   
6,000
   
6,000
 
Total shareholders’ equity (3)
   
74,734
   
63,677
   
65,224
   
56,376
   
51,276
 
                                 
PERFORMANCE RATIOS (1)
                               
Return on average assets on continuing operations
   
1.19
%
 
1.22
%
 
0.87
%
 
0.45
%
 
0.23
%
Return on average shareholders’ equity on continuing operations
   
14.59
%
 
15.22
%
 
10.93
%
 
5.77
%
 
3.21
%
Net interest margin
   
4.20
%
 
4.23
%
 
3.15
%
 
3.78
%
 
3.47
%
Total non-interest expenses as a percentage of average assets (6)
   
2.48
%
 
2.49
%
 
2.39
%
 
2.42
%
 
2.57
%
                                 
ASSET QUALITY RATIOS (1)
                               
Allowance for loan losses as a percentage of loans (4)
   
1.02
%
 
1.12
%
 
1.22
%
 
1.59
%
 
1.40
%
Allowance for loan losses as a percentage of non-performing loans
   
116.51
%
 
222.52
%
 
137.70
%
 
90.91
%
 
88.65
%
Non-performing loans as a percentage of total loans (4)
   
0.87
%
 
0.50
%
 
0.88
%
 
1.75
%
 
1.58
%
Non-performing assets as a percentage of total assets
   
0.74
%
 
0.42
%
 
0.75
%
 
1.33
%
 
1.30
%
Net charge-offs as a percentage of average loans, net (4)
   
0.13
%
 
0.04
%
 
0.07
%
 
1.04
%
 
0.91
%
                                 
LIQUIDITY AND CAPITAL RATIOS (1)
                               
Average equity to average assets
   
8.17
%
 
7.99
%
 
7.98
%
 
7.73
%
 
7.09
%
Leverage ratio
   
8.75
%
 
8.89
%
 
9.53
%
 
9.07
%
 
8.19
%
Tier 1 capital to risk-weighted assets
   
10.53
%
 
10.65
%
 
11.20
%
 
11.70
%
 
12.68
%
Total capital to risk-weighted assets
   
11.59
%
 
11.81
%
 
12.45
%
 
12.96
%
 
13.93
%

(1)
Reflects the spin off of First Bank of Delaware, presented as discontinued operations for years prior to 2005.
(2)  Restated for 10% stock dividend declared in May 2006 
(3)
Years prior to 2005 include First Bank of Delaware
(4)
Includes loans held for sale
(5)
Includes restricted stock
(6)
Excluding other real estate owned expenses of $1.5 million in 2002.
 
16


 
Item 7: Management’s Discussion and Analysis of Results of Operations and Financial Condition
 
The following is management’s discussion and analysis of the significant changes in the Company’s results of operations, financial condition and capital resources presented in the accompanying consolidated financial statements of Republic First Bancorp, Inc. This discussion should be read in conjunction with the accompanying notes to the consolidated financial statements.
 
Certain statements in this document may be considered to be “forward-looking statements” as that term is defined in the U.S. Private Securities Litigation Reform Act of 1995, such as statements that include the words “may”, “believes”, “expect”, “estimate”, “project”, “anticipate”, “should”, “would”, “intend”, “probability”, “risk”, “target”, “objective” and similar expressions or variations on such expressions. The forward-looking statements contained herein are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. For example, risks and uncertainties can arise with changes in: general economic conditions, including their impact on capital expenditures; business conditions in the financial services industry; the regulatory environment, including evolving banking industry standards; rapidly changing technology and competition with community, regional and national financial institutions; new service and product offerings by competitors, price pressures; and similar items. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date hereof. The Company undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date hereof. Readers should carefully review the risk factors described in other documents the Company files from time to time with the Securities and Exchange Commission, including the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, Quarterly Reports on Form 10-Q filed by the Company in 2006 and any Current Reports on Form 8-K filed by the Company, as well as similar filings in 2006.
 
Critical Accounting Policies, Judgments and Estimates
 
Discontinued Operations - In accordance with SFAS No. 144, the Company has presented the operations of First Bank of Delaware as discontinued operations starting with the first quarter 2005. On January 31, 2005 the First Bank of Delaware was spun off, effective January 1, 2005. All assets, liabilities and equity of First Bank of Delaware were spun off as an independent company, trading on the OTC market under the stock symbol “FBOD”. Shareholders received one share of stock in First Bank of Delaware, for every share owned of the Company. The short-term loan and tax refund lines of business were accordingly transferred after that date. Republic continued to purchase tax refund anticipation loans from the First Bank of Delaware through 2006. However, First Bank of Delaware has decided not to continue with this program.
 
In reviewing and understanding financial information for the Company you are encouraged to read and understand the significant accounting policies used in preparing our consolidated financial statements. These policies are described in Note 2 of the notes to our unaudited consolidated financial statements. The accounting and financial reporting policies of the Company conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. The preparation of the Company’s consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Management evaluates these estimates and assumptions on an ongoing basis including those related to the allowance for loan losses and deferred income taxes. Management bases its estimates on historical experience and various other factors and assumptions that are believed to be reasonable under the circumstances. These form the bases for making judgments on the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
 
Allowance for Loan Losses—The allowance for loan losses is increased by charges to income through the provision for loan losses and decreased by charge-offs (net of recoveries). The allowance is maintained at a level that management considers adequate to provide for losses based upon evaluation of the known and inherent risks in the loan portfolio. Management’s periodic evaluation of the adequacy of the allowance is based on the Company’s past loan loss experience, the volume and composition of lending conducted by the Company, adverse situations that may affect a borrower’s ability to repay, the estimated value of any underlying collateral, current economic conditions and other factors affecting the known and inherent risk in the portfolio. This evaluation is inherently subjective as it requires material estimates including, among others, the amount and timing of expected future cash flows on impacted loans, exposure at default, value of collateral, and estimated losses on our commercial and residential loan portfolios. All of these estimates may be susceptible to significant change.
 
 
 
17

 
The allowance consists of specific allowances for both impaired loans and all classified loans which are not impaired and a general allowance on the remainder of the portfolio. Although we determine the amount of each element of the allowance separately, the entire allowance for loan losses is available for the entire portfolio.
 
We establish an allowance on certain impaired loans for the amount by which the discounted cash flows, observable market price or fair value of collateral if the loan is collateral dependent is lower than the carrying value of the loan. A loan is considered to be impaired when, based upon current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan. An insignificant delay or insignificant shortfall in amount of payments does not necessarily result in the loan being identified as impaired.
 
We also establish a specific valuation allowance on classified loans which are not impaired. We segregate these loans by category and assign allowances to each loan based on inherent losses associated with each type of lending and consideration that these loans, in the aggregate, represent an above-average credit risk and that more of these loans will prove to be uncollectible compared to loans in the general portfolio. The categories used by the Company include “Doubtful,” “Substandard” and “Special Mention.” Classification of a loan within such categories is based on identified weaknesses that increase the credit risk of the loan.
 
We establish a general allowance on non-classified loans to recognize the inherent losses associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem loans. This general valuation allowance is determined by segregating the loans by loan category and assigning allowance percentages based on our historical loss experience, delinquency trends, and management’s evaluation of the collectibility of the loan portfolio.
 
The allowance is adjusted for significant factors that, in management’s judgment, affect the collectibility of the portfolio as of the evaluation date. These significant factors may include changes in lending policies and procedures, changes in existing general economic and business conditions affecting our primary lending areas, credit quality trends, collateral value, loan volumes and concentrations, seasoning of the loan portfolio, loss experience in particular segments of the portfolio, duration of the current business cycle, and bank regulatory examination results. The applied loss factors are reevaluated each reporting period to ensure their relevance in the current economic environment.
 
While management uses the best information available to make loan loss allowance valuations, adjustments to the allowance may be necessary based on changes in economic and other conditions, changes in the composition of the loan portfolio or changes in accounting guidance. In times of economic slowdown, either regional or national, the risk inherent in the loan portfolio could increase resulting in the need for additional provisions to the allowance for loan losses in future periods. An increase could also be necessitated by an increase in the size of the loan portfolio or in any of its components even though the credit quality of the overall portfolio may be improving. Historically, our estimates of the allowance for loan loss have approximated actual losses incurred. In addition, the Pennsylvania Department of Banking and the FDIC, as an integral part of their examination processes, periodically review our allowance for loan losses. The Pennsylvania Department of Banking or the FDIC may require the recognition of adjustment to the allowance for loan losses based on their judgment of information available to them at the time of their examinations. To the extent that actual outcomes differ from management’s estimates, additional provisions to the allowance for loan losses may be required that would adversely impact earnings in future periods.
 
Other-Than-Temporary Impairment of Securities—Securities are evaluated on at least a quarterly basis, and more frequently when market conditions warrant such an evaluation, to determine whether a decline in their value is other-than-temporary. To determine whether a loss in value is other-than-temporary, management utilizes criteria such as the reasons underlying the decline, the magnitude and duration of the decline and the intent and ability of the Company to retain its investment in the security for a period of time sufficient to allow for an anticipated recovery in the fair value. The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value is determined to be other-than-temporary, the value of the security is reduced and a corresponding charge to earnings is recognized.
 
Income Taxes—Management makes estimates and judgments to calculate some of our tax liabilities and determine the recoverability of some of our deferred tax assets, which arise from temporary differences between the tax and financial statement recognition of revenues and expenses. Management also estimates a reserve for deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. These estimates and judgments are inherently subjective. Historically, our estimates and judgments to calculate our deferred tax accounts have not required significant revision from management’s initial estimates.
 
 
18

 
In evaluating our ability to recover deferred tax assets, management considers all available positive and negative evidence, including our past operating results and our forecast of future taxable income. In determining future taxable income, management makes assumptions for the amount of taxable income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require us to make judgments about our future taxable income and are consistent with the plans and estimates we use to manage our business. Any reduction in estimated future taxable income may require us to record a valuation allowance against our deferred tax assets. An increase in the valuation allowance would result in additional income tax expense in the period and could have a significant impact on our future earnings.
 
Recent Accounting Pronouncements—In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments. This statement amends FASB Statements No. 133, Accounting for Derivative Instruments and Hedging Activities, and No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This statement resolves issues addressed in Statement 133 Implementation Issue No. D1, Application of Statement 133 to Beneficial Interest in Securitized Financial Assets. This Statement is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company adopted this guidance on January 1, 2007. The adoption did not have any effect on the Company’s financial position or results of operations.
 
In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Asset- An Amendment of FASB Statement No. 140. This statement amends SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities. This statement requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. It also permits, but does not require, the subsequent measurement of servicing assets and servicing liabilities at fair value. The Company adopted this statement effective January 1, 2007. The adoption did not have a material effect on the Company’s financial position or results of operations.
 
In July 2006, the FASB issued FASB Interpretation (“FIN”) No. 48, Accounting for Uncertainty in Income Taxes. This Interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This Interpretation is effective for fiscal years beginning after December 15, 2006. The Company is continuing to evaluate the impact of this interpretation, but does not expect that the guidance will have a material effect on the Company’s financial position or results of operations.
 
In September 2006, the FASB ratified the consensus reached by the Emerging Issues Task Force (“EITF”) in Issue 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. EITF 06-4 applies to life insurance arrangements that provide an employee with a specified benefit that is not limited to the employee’s active service period, including certain bank-owned life insurance (“BOLI”) policies. EITF 06-4 requires an employer to recognize a liability and related compensation costs for future benefits that extend to postretirement periods. EITF 06-4 is effective for fiscal years beginning after December 15, 2007, with earlier application permitted. The Company is continuing to evaluate the impact of this consensus, which may require the Company to recognize an additional liability and compensation expense related to its BOLI policies.
 
In September 2006, the FASB ratified the consensus reached by the EITF in Issue 06-5, Accounting for Purchases of Life Insurance - Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance. Technical Bulletin No. 85-4 states that an entity should report as an asset in the statement of financial position the amount that could be realized under the insurance contract. EITF 06-5 clarifies certain factors that should be considered in the determination of the amount that could be realized. EITF 06-5 is effective for fiscal years beginning after December 15, 2006, with earlier application permitted under certain circumstances. The Company is continuing to evaluate the impact of this consensus, but does not expect that the guidance will have a material effect on the Company’s consolidated financial position or results of operations.
 
In September 2006, the FASB issued FASB Statement No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurements. FASB Statement No. 157 applies to other accounting pronouncements that require or permit fair value measurements. The new guidance is effective for financial statements issued for fiscal years beginning after November 15, 2007, and for interim periods within those fiscal years. We are currently evaluating the potential impact, if any, of the adoption of FASB Statement No. 157 on our consolidated financial position or results of operations.
 
 
 
19

 
In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R). This statement which amends SFAS No. 87 and SFAS No. 106 to require recognition of the overfunded or underfunded status of pension and other postretirement benefit plans on the balance sheet. Under SFAS No. 158, gains and losses, prior service costs and credits, and any remaining transition amounts under SFAS No. 87 and SFAS No. 106 that have not yet been recognized through net periodic benefit cost will be recognized in accumulated other comprehensive income, net of tax effects, until they are amortized as a component of net periodic cost. The measurement date — the date at which the benefit obligation and plan assets are measured — is required to be the company’s fiscal year end. SFAS No. 158 is effective for publicly-held companies for fiscal years ending after December 15, 2006, except for the measurement date provisions, which are effective for fiscal years ending after December 15, 2008. The Company adopted SFAS No. 158 as of December 31, 2006. The adoption of this FSB Statement did not impact the Company’s financial position or results of operations.
 
In September 2006, the SEC issued SAB No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements. SAB No. 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a potential current year misstatement. Prior to SAB No. 108, companies might evaluate the materiality of financial-statement misstatements using either the income statement or balance sheet approach, with the income statement approach  focusing on new misstatements added in the current year, and the balance sheet approach focusing on the cumulative amount of misstatement present in a company’s balance sheet. Misstatements that would be material under one approach could be viewed as immaterial under another approach, and not be corrected. SAB No. 108 now requires that companies view financial statement misstatements as material if they are material according to either the income statement or balance sheet approach. The Company has analyzed SAB No. 108 and determined that upon adoption it will have no impact on the reported financial position or results of operations.
 
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. This statement permits entities to choose to measure many financial instruments and certain other items at fair value. An entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. This statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provisions of SFAS No.157. We are currently evaluating the potential impact, if any, of the adoption of FASB Statement No. 159 on our consolidated financial position or results of operations.
 
Results of Operations for the years ended December 31, 2006 and 2005
 
Overview
 
The Company's net income increased $1.2 million, or 13.8%, to $10.1 million or $1.04 per diluted share for the year ended December 31, 2006, compared to $8.9 million, or $0.93 per diluted share for the prior year. The improvement reflected a $17.4 million, or 38.3%, increase in total interest income, due primarily to a 21.0% increase in average loans outstanding and secondarily to higher rates. Interest expense increased $12.5 million, also reflecting higher rates, a 15.5% increase in average deposits outstanding and a 16.8% in average borrowings outstanding. Accordingly, net interest income increased $4.9 million. Partially offsetting the increase in net interest income were the provision for loan losses (up approximately $200 thousand), non-interest income (level with 2005 at $3.6 million), and non-interest expenses (up $2.8 million). The decrease in return on average assets and average equity from 1.19% and 14.59% respectively in 2006 compared to 1.22% and 15.22% respectively in 2005, resulted primarily from increased funding costs.
 

20


Analysis of Net Interest Income
 
Historically, the Company’s earnings have depended primarily upon Republic’s net interest income, which is the difference between interest earned on interest-earning assets and interest paid on interest-bearing liabilities. Net interest income is affected by changes in the mix of the volume and rates of interest-earning assets and interest-bearing liabilities. The following table provides an analysis of net interest income on an annualized basis, setting forth for the periods (i) average assets, liabilities, and shareholders’ equity, (ii) interest income earned on interest-earning assets and interest expense on interest-bearing liabilities, (iii) average yields earned on interest-earning assets and average rates on interest-bearing liabilities, and (iv) Republic’s net interest margin (net interest income as a percentage of average total interest-earning assets). Averages are computed based on daily balances. Non-accrual loans are included in average loans receivable. Yields are adjusted for tax equivalency in 2006, as Republic had tax-exempt income. Republic had no tax exempt income on securities in 2005 and 2004.
 
   
Average
Balance
 
Interest
Income/
Expense
 
Yield/
Rate (1)
 
Average
Balance
 
Interest
Income/
Expense
 
Yield/
Rate (1)
 
Average
Balance
 
Interest
Income/
Expense
 
Yield/
Rate (1)
 
(Dollars in thousands)
 
For the Year
Ended
December 31, 2006
 
For the Year
Ended
December 31, 2005
 
For the Year
Ended
December 31, 2004 (3)
 
Interest-earning assets:
                                     
Federal funds sold and other
                                     
interest-earning assets
 
$
25,884
 
$
1,291
   
4.99
%  
$
36,587
 
$
1,078
   
2.95
%  
$
45,430
 
$
563
   
1.24
%
Investment securities and restricted
stock
   
57,163
   
3,282
   
5.74
%
 
51,285
   
1,972
   
3.85
%
 
59,764
   
2,030
   
3.40
%
Loans receivable  
   
728,754
   
58,254
   
7.99
%
 
602,031
   
42,331
   
7.03
%
 
493,635
   
31,006
   
6.28
%
Total interest-earning assets 
   
811,801
   
62,827
   
7.74
%
 
689,903
   
45,381
   
6.58
%
 
598,829
   
33,599
   
5.61
%
Other assets 
   
36,985
               
41,239
               
42,433
             
Total assets 
 
$
848,786
             
$
731,142
             
$
641,262
             
                                                         
Interest-bearing liabilities:
                                                       
Demand - non-interest bearing 
 
$
82,233
 
$
-
   
N/A
 
$
88,702
 
$
-
   
N/A
 
$
85,158
 
$
-
   
N/A
 
Demand - interest-bearing 
   
53,073
   
565
   
1.06
%
 
49,118
   
332
   
0.68
%
 
56,692
   
350
   
0.62
%
Money market & savings 
   
240,189
   
9,109
   
3.79
%
 
238,786
   
6,026
   
2.52
%
 
135,674
   
2,135
   
1.57
%
Time deposits 
   
304,375
   
14,109
   
4.64
%
 
211,972
   
6,789
   
3.20
%
 
178,384
   
5,002
   
2.80
%
Total deposits  
   
679,870
   
23,783
   
3.50
%
 
588,578
   
13,147
   
2.23
%
 
455,908
   
7,487
   
1.64
%
Total interest-
                                                       
bearing deposits 
   
597,637
   
23,783
   
3.98
%
 
499,876
   
13,147
   
2.63
%
 
370,750
   
7,487
   
2.02
%
Other borrowings 
   
88,609
   
4,896
   
5.53
%
 
75,875
   
3,076
   
4.05
%
 
124,303
   
7,261
   
5.84
%
Total interest-bearing
                                                       
liabilities  
   
686,246
   
28,679
   
4.18
%
 
575,751
   
16,223
   
2.82
%
 
495,053
   
14,748
   
2.98
%
Total deposits and
                                                       
other borrowings 
   
768,479
   
28,679
   
3.73
%
 
664,453
   
16,223
   
2.44
%
 
580,211
   
14,748
   
2.54
%
Non-interest-bearing
                                                       
Other liabilities 
   
10,981
               
8,242
               
9,875
             
Shareholders’ equity 
   
69,326
               
58,447
               
51,176
             
Total liabilities and
                                                       
Shareholders’ equity 
 
$
848,786
             
$
731,142
             
$
641,262
             
                                                         
Net interest income (2) 
       
$
34,148
             
$
29,158
             
$
18,851
       
                                                         
Net interest spread 
               
3.56
%
             
3.76
%
             
2.63
%
                                                         
Net interest margin (2) 
               
4.20
%
             
4.23
%
             
3.15
%
                                                         
__________
(1) Yields on investments are calculated based on amortized cost.
(2) The net interest margin is calculated by dividing net interest income by average total interest earning assets. Both net interest income and net interest margin were increased in 2006 over the financial statement amount, to adjust for tax equivalency.
(3) Does not include discontinued operations
 
 
 
21


Rate/Volume Analysis of Changes in Net Interest Income
 
Net interest income may also be analyzed by segregating the volume and rate components of interest income and interest expense. The following table sets forth an analysis of volume and rate changes in net interest income for the periods indicated. For purposes of this table, changes in interest income and expense are allocated to volume and rate categories based upon the respective changes in average balances and average rates.
 
   
Year ended December 31,
2006 vs. 2005 
 
 Year ended December 31,
2005 vs. 2004 
 
 
 
 Change due to
   Change due to  
(Dollars in thousands)
 
Average
Volume
 
Average
Rate
 
Total
 
Average
Volume
 
Average
 Rate
 
Total
 
Interest earned on:
                         
Federal funds sold and other
                         
interest-earning assets 
 
$
(534
)
$
747
 
$
213
 
$
(261
)
$
776
 
$
515
 
Securities 
   
337
   
973
   
1,310
   
(326
)
 
268
   
(58
)
Loans 
   
10,130
   
5,793
   
15,923
   
7,622
   
3,703
   
11,325
 
Total interest earning assets 
 
$
9,933
 
$
7,513
 
$
17,446
 
$
7,035
 
$
4,747
 
$
11,782
 
Interest expense of
                                     
Deposits
                                     
Interest-bearing demand deposits
 
$
(42
)
$
(191
)
$
(233
)
$
51
 
$
(33
)
$
18
 
Money market and savings
   
(53
)
 
(3,030
)
 
(3,083
)
 
(2,602
)
 
(1,289
)
 
(3,891
)
Time deposits
   
(4,283
)
 
(3,037
)
 
(7,320
)
 
(1,075
)
 
(712
)
 
(1,787
)
Total deposit interest expense 
   
(4,378
)
 
(6,258
)
 
(10,636
)
 
(3,626
)
 
(2,034
)
 
(5,660
)
Other borrowings 
   
(704
)
 
(1,116
)
 
(1,820
)
 
1,962
   
2,223
   
4,185
 
Total interest expense 
   
(5,082
)
 
(7,374
)
 
(12,456
)
 
(1,664
)
 
189
   
(1,475
)
Net interest income 
 
$
4,851
 
$
139
 
$
4,990
 
$
5,371
 
$
4,936
 
$
10,307
 
                                       

Net Interest Income
 
The Company’s tax equivalent net interest margin decreased 3 basis points to 4.20% for 2006 compared to 4.23% for 2005. While yields on interest-earning assets increased 116 basis points to 7.74% in 2006 from 6.58% in 2005, the yield on total deposits and other borrowings increased 129 basis points to 3.73% from 2.44% between 2006 and 2005. The increases in yields on assets and cost of funds resulted primarily from the 300 basis points of increases in short-term interest rates between the two periods. The resulting decrease in margin reflected an increase in interest bearing assets of $121.9 million, while interest bearing liabilities increased $110.5 million.
 
The Company's tax equivalent net interest income increased $5.0 million, or 17.1%, to $34.1 million for 2006 from $29.2 million for 2005. As shown in the Rate Volume table above, the increase in net interest income was due primarily to the increased volume of loans. Higher rates on loans resulted primarily from variable rate loans which immediately adjust to increases in the prime rate. Interest expense increased primarily as a result of higher rates, resulting from the higher short-term interest rate environment, and also reflected the impact of the increase in higher cost time deposit balances.
 
The Company's total tax equivalent interest income increased $17.4 million, or 38.4%, to $62.8 million for 2006, from $45.4 million for 2005. Interest and fees on loans increased $15.9 million to $58.3 million for 2006, from $42.3 million for 2005. The majority of the increase resulted from a 21.0% increase in average loan balances. For 2006, average loan balances amounted to $728.8 million, compared to $602.0 million in 2005. The balance of the increase in interest on loans resulted primarily from the repricing of the variable rate loan portfolio to higher short term market interest rates. Tax equivalent interest and dividends on investment securities increased $1.2 million to $3.3 million for 2006, from $2.0 million for 2005. This increase reflected rate increases on variable rate securities as well as an increase in average securities outstanding to $57.2 million for 2006 from $51.3 million for 2005. Interest on federal funds sold and other interest-earning assets increased $213,000, or 19.8%, to $1.3 million for 2006 from $1.1 million for 2005 as increases in short term market interest rates more than offset the $10.7 million decrease in average balances to $25.9 million for 2006 from $36.6 million for 2005.
 
The Company's total interest expense increased $12.5 million, or 76.8%, to $28.7 million for 2006, from $16.2 million for 2005. Interest-bearing liabilities averaged $686.2 million for 2006, from $575.8 million for 2005, an increase of $110.5 million. The increase reflected additional funding utilized for loan growth. Average time deposit (certificates of deposit)
 
 
22

 
balances increased $92.4 million, or 43.6%, to $304.4 million for 2006 from $212.0 million in 2005 while lower cost average transaction account balances declined $1.1 million, or 0.3%, to $375.5 million for 2006 from $376.6 million for 2005. The average rate paid on interest-bearing liabilities increased 136 basis points to 4.18% for 2006. Money market and savings expense increased $3.1 million to $9.1 million for 2006 from $6.0 million for 2005, due almost entirely to increases in short-term rates as average balances increased $1.4 million, or 0.6%. Interest expense on time deposits increased $7.3 million, or 107.8%, to $14.1 million for 2006 from $6.8 million for 2005, primarily as a result of the increased average balances as well as rates. As time deposits mature, they frequently reprice at market rates which are currently 5% or more. Interest expense on other borrowings increased $1.8 million to $4.9 million for 2006 from $3.1 million for 2005, primarily as a result of higher short term rates. Average other borrowings, primarily overnight FHLB borrowings, increased $12.7 million, or 16.8%, to $88.6 million for 2006 from $75.9 million for 2005. Rates on overnight borrowings reflected the higher short-term interest rate environment as the rate on other borrowings increased to 5.53% for 2006 from 4.05% for 2005. Interest expense on other borrowings also includes the interest expense on $6.2 million of trust preferred securities which was approximately $525,000 and $444,000 in 2006 and 2005, respectively.
 
Provision for Loan Losses
 
The provision for loan losses is charged to operations in an amount necessary to bring the total allowance for loan losses to a level that reflects the known and estimated inherent losses in the portfolio. The provision for loan losses amounted to $1.4 million in 2006. The provision reflected $359,000 for net losses on tax refund loans, which were more than offset by $1.6 million in related revenues, and amounts required to increase the allowance for loan growth in accordance with the Company’s methodology. The prior year provision of $1.2 million reflected $496,000 for net losses on tax refund loans, which more than offset by $1.2 million in related revenues. In addition, the 2005 provision was reduced as a result of a $250,000 recovery on a commercial loan which had been charged off in the prior year. That recovery resulted in an allowance balance which exceeded the level deemed necessary by the Company’s methodology and the provision was reduced accordingly.
 
Non-Interest Income
 
Total non-interest income increased $26,000 to $3.6 million for 2006. A $661,000 increase in loan advisory and servicing fees and a $130,000 gain on the sale of other real estate owned were offset by a decrease of $521,000 in service fees on deposit accounts, a one time $251,000 award in a lawsuit recorded in 2005, and a $97,000 gain on call of security also recorded in 2005. The $521,000 decrease in service fees on deposit accounts reflected the termination of services to several large customers.
 
Non-Interest Expenses
 
Total non-interest expenses increased $2.8 million or 15.4% to $21.0 million for 2006, from $18.2 million for 2005. Salaries and employee benefits increased $2.1 million or 21.5%, to $11.6 million for 2006, from $9.6 million for 2005. That increase reflected additional salary expense related to commercial loan and deposit production, including related support staff, and staff for two new branches. It also reflected annual merit increases which are targeted at approximately 3.5%.
 
Occupancy expense increased $321,000, or 20.5%, to $1.9 million for 2006, versus $1.6 million for 2005. The increase reflected two additional branch locations which opened in 2006.
 
Depreciation expense increased $17,000 or 1.7% to $1.0 million for 2006. 2006 expense reflected the impact of the two additional branch locations, which was partially offset by the 2005 write-off assets determined to have shorter lives than originally expected.
 
Legal fees decreased $19,000, or 2.8%, to $654,000 in 2006, compared to $673,000 in 2005, resulting from reduced fees on a number of different matters.
 
Other real estate expense decreased $34,000, or 77.3%, to $10,000 in 2006, compared to $44,000 in 2005. The decrease resulted from the timing of property tax payments.
 
Advertising expense increased $302,000, or 157.3%, to $494,000 in 2006, compared to $192,000 in 2005. The increase was primarily due to higher levels of TV, radio, print, and direct mail advertising including advertising two new branches and deposit promotions.
 
Data processing expense decreased $8,000, or 1.6%, to $496,000 in 2006, compared to $504,000 in 2005.
 
 
 
23

 
Insurance expense increased $57,000 or 19.3% to $353,000 in 2006, compared to $296,000 in 2005. The increase was primarily due the overall growth of the Company.
 
Professional fees decreased $207,000 or 26.9% to $562,000 in 2006, compared to $769,000 in 2005. The decrease reflected lower expenses connected with Sarbanes-Oxley compliance.
 
Taxes, other than income increased $53,000 or 7.7% to $741,000 for 2006 versus $688,000 for 2005. The increase reflected an increase in Pennsylvania shares tax resulting from increases in the Company’s capital. The tax is assessed at an annual rate of 1.25% on a 6 year moving average of regulatory capital.
 
Other expenses increased $268,000, or 9.2% to $3.2 million for 2006, from $2.9 million for 2005, which reflected increases of $114,000 in training and development expenses, $94,000 in expenses for the two additional branch locations and $56,000 in loan production expense.
 
Provision for Income Taxes
 
The provision for income taxes for continuing operations increased $721,000, to $5.2 million for 2006, from $4.5 million for 2005. That increase was primarily the result of the increase in pre-tax income. The effective tax rates in those periods were comparable at 34.0% and 33.5% respectively.
 
Results of Operations for the years ended December 31, 2005 and 2004
 
Overview
 
The Company's income from continuing operations increased $3.3 million, or 59.1%, to $8.9 million or $0.93 per diluted share for the year ended December 31, 2005, compared to $5.6 million, or $0.60 per diluted share for the prior year. The improvement reflected an $11.8 million, or 35.1%, increase in total interest income, reflecting higher rates and a 22.0% increase in average loans outstanding. Interest expense increased only $1.5 million as the Company moved away from relatively high cost Federal Home Loan Bank (“FHLB”) advances, replacing them with overnight FHLB borrowings and deposits. Accordingly, net interest income increased $10.3 million. Partially offsetting the increase in net interest income were the provision for loan losses (up $1.5 million), non-interest income (down approximately $900,000), and non-interest expenses (up $2.9 million). The increased net income resulted in a return on average assets and average equity from continuing operations of 1.22% and 15.22% respectively in 2005 compared to 0.87% and 10.93% respectively in 2004.
 
Net Interest Income
 
The Company’s net interest margin increased 108 basis points to 4.23% for 2005 compared to 3.15% for 2004. While yields on interest-earning assets increased 97 basis points to 6.58% in 2005 from 5.61% in 2004, the yield on total deposits and other borrowings fell 10 basis points to 2.44% from 2.54% between 2005 and 2004. Those 97 and 10 basis point improvements comprise the majority of the improvement in the margin. The increase in yields on assets resulted primarily from the 325 basis points of increases in short-term interest rates between the two periods. The decrease in the cost of funds reflected the impact of the maturity of relatively high cost FHLB advances. A total of $125.0 million of FHLB advances which carried an average interest rate of 6.20% matured beginning the third quarter of 2004 through the first quarter of 2005.
 
The Company's net interest income increased $10.3 million, or 54.7%, to $29.2 million for 2005 from $18.9 million for 2004. As shown in the Rate Volume table above, the increase in net interest income was due primarily to the increased volume of loans. Higher rates on loans resulted primarily from variable rate loans which immediately adjust to increases in the prime rate. Other borrowings expense decreased as a result of the maturity of the $125.0 million of FHLB advances, which were only partially replaced by lower cost overnight FHLB borrowings. Average interest-earning assets amounted to $689.9 million for 2005 and $598.8 million for 2004. Substantially all of the $91.1 million increase resulted from loan growth.
 
The Company's total interest income increased $11.8 million, or 35.1%, to $45.4 million for 2005, from $33.6 million 2004. Interest and fees on loans increased $11.3 million to $42.3 million for 2005, from $31.0 million for 2004. The majority of the increase resulted from a 22.0% increase in average loan balances. For 2005, average loan balances amounted to $602.0 million, compared to $493.6 million in 2004. The balance of the increase in interest on loans resulted primarily from the repricing of the variable rate loan portfolio to higher short term market interest rates. Interest and dividends on investment securities decreased $58,000 to $2.0 million for 2005. This decline reflected the $8.5 million, or 14.2%, decrease in average
 
 
24

 
investment securities outstanding to $51.3 million for 2005 from $59.8 million for 2004. Interest on federal funds sold and other interest-earning assets increased $515,000, or 91.5%, due to increases in short-term market interest rates.
 
The Company's total interest expense increased $1.5 million, or 10.0%, to $16.2 million for 2005, from $14.7 million for 2004. The increase in interest expense primarily reflected higher deposit balances, which more than offset the impact of the maturity of $125.0 million of FHLB advances, with an average rate of 6.20%. Those advances were replaced by overnight FHLB borrowings and deposits which generally bore interest at 4.25% or less. Interest-bearing liabilities averaged $575.8 million for 2005, versus $495.1 million for 2004, or an increase of $80.7 million. The increase reflected additional funding utilized for loan growth. Average transaction account balances increased $99.1 million which facilitated a $48.4 million decrease in other borrowings. A portion of the increase in average transaction accounts is likely short-term. The average rate paid on interest-bearing liabilities decreased 16 basis points to 2.82% for 2005. That decrease resulted notwithstanding the increase in market interest rates due primarily to the maturity of the 6.20% average rate FHLB advances. All such advances had matured by February 2005. Money market and savings interest expense increased $3.9 million to $6.0 million in 2005 from 2004. Related average balances increased $103.1 million, or 76.0%, in those respective periods, and accounted for the majority of the increase. The balance of the increase reflected the higher short-term interest rate environment, which while increased, lagged the general increase in short-term market interest rates. Accordingly, rates on total interest-bearing deposits increased 61 basis points in 2005 compared to 2004, while short term rates increased approximately 325 basis points between those periods.
 
Interest expense on time deposits (certificates of deposit) increased $1.8 million, or 35.7% to $6.8 million for 2005 from $5.0 million for 2004, as a result of increased average balances and rates. Average time deposits increased $33.6 million, or 18.8%, between those periods. Average rates increased only 40 basis points between those periods, as increases lagged the increases in short-term market interest rates.
 
Interest expense on other borrowings decreased $4.2 million to $3.1 million for 2005, as a result of decreased average balances and rates. Average other borrowings, substantially all FHLB advances and overnight borrowings, decreased $48.4 million, or 39.0%, between 2005 and 2004. These reductions in balances reflected the increases in transaction accounts, which were utilized as a less costly funding source for loan growth. As the $125.0 million of 6.20% average rate FHLB advances matured, these were replaced with less costly transaction accounts, or overnight FHLB borrowings. Overnight borrowings were available at a significant lower rate than the maturing FHLB advances and lowered the rates on other borrowings to 4.05% in 2005 compared to 5.84% in 2004.
 
Provision for Loan Losses
 
The provision for loan losses is charged to operations in an amount necessary to bring the total allowance for loan losses to a level that reflects the known and estimated inherent losses in the portfolio. The provision for loan losses amounted to $1.2 million in 2005. The provision reflected $1.1 million for losses on tax refund loans, and amounts required to increase the allowance for loan growth. It also reflected the impact of the approximately $617,000 of tax refund loan recoveries on loans previously charged off and a $250,000 commercial loan recovery. The prior year net credit of $314,000 for the provision resulted from a large recovery credited to the allowance for loan losses, representing the previously charged-off balance of the related loan. The recovery resulted in an allowance balance which exceeded the level deemed necessary by the Company’s methodology. The required adjustment to the allowance resulted in the net credit to the provision.
 
Non-Interest Income
 
Total non-interest income decreased $852,000 to $3.6 million for 2005, versus $4.5 million for 2004. The decrease reflected a non-recurring $1.3 million legal settlement recorded in 2004. The resulting 2005 reduction was partially offset by an increase of $338,000 in service fees on deposit accounts, a one time $251,000 award in a lawsuit, a $97,000 gain on call of security, and an increase of $82,000 in loan advisory and servicing fees, all in 2005.
 
Non-Interest Expenses
 
Total non-interest expenses increased $2.9 million or 18.6% to $18.2 million for 2005, from $15.3 million for 2004. Salaries and employee benefits increased $1.9 million or 25.1%, to $9.6 million for 2005, from $7.6 million for 2004. That increase reflected additional salary expense related to commercial loan and deposit production, including related support staff, and staff for the new branch location. It also reflected annual merit increases which are targeted at approximately 3%.
 
Occupancy expense increased $166,000, or 11.9%, to $1.6 million for 2005, versus $1.4 million for 2004. The increase reflected an additional branch location which was opened in the first quarter 2005.
 
 
25

 
Depreciation expense increased $44,000 or 4.6% to $1.0 million for 2005, versus $947,000 for 2004. The majority of the increase resulted from the write-off of assets determined to have shorter lives than originally expected. It also reflected the additional branch location, and purchase of commercial loan and other software.
 
Legal fees decreased $139,000, or 17.1%, to $673,000 in 2005, compared to $812,000 in 2004, resulting from reduced fees on a number of different matters.
 
Other real estate expense decreased $37,000, or 45.7%, to $44,000 in 2005, compared to $81,000 in 2004. The decrease resulted from an asset write-down recorded in 2004.
 
Advertising expense increased $53,000, or 38.1%, to $192,000 in 2005, compared to $139,000 in 2004. The increase reflected an increase in the number of advertisements.
 
Data processing expense increased $416,000, or 472.7%, to $504,000 in 2005, compared to $88,000 in 2004. The increase reflected the outsourcing of check processing. In previous periods, Republic employees had performed these functions, and related expense was included in salaries and benefits.
 
Insurance expense decreased $11,000 or 3.6% to $296,000 in 2005, compared to $307,000 in 2004.
 
Professional fees increased $197,000 or 34.4% to $769,000 in 2005, compared to $572,000 in 2004. The increase reflected higher expenses connected with Sarbanes-Oxley compliance.
 
Taxes, other increased $121,000 or 21.3% to $688,000 for 2005 versus $567,000 for 2004. The increase reflected an increase in Pennsylvania shares tax, which is assessed at an annual rate of 1.25% on a 6 year moving average of regulatory capital.
 
Other expenses increased $129,000, or 4.6% to $2.9 million for 2005, from $2.8 million for 2004. The increase reflected $103,000 of additional printing and supplies expense.
 
Provision for Income Taxes
 
The provision for income taxes for continuing operations increased $1.8 million, to $4.5 million for 2005, from $2.7 million for 2004. That increase was primarily the result of the increase in pre-tax income. The effective tax rates in those periods were 33.5% and 32.5% respectively. The effective rate was slightly lower in the 2004 period due to the impact of a relatively fixed amount of tax exempt income on lower income.
 
Financial Condition
 
December 31, 2006 Compared to December 31, 2005
 
Total assets increased $158.0 million to $1.0 billion at December 31, 2006, compared to $850.9 million at December 31, 2005. This net increase reflected higher balances in loans and investment securities.
 
Loans:
 
The loan portfolio, which represents the Company’s largest asset, is its most significant source of interest income. The Company’s lending strategy is to focus on small and medium sized businesses and professionals that seek highly personalized banking services. Total loans increased $114.0 million, or 16.8%, to $792.1 million at December 31, 2006, versus $678.1 million at December 31, 2005. The increase reflected $116.2 million, or 17.9%, of growth in commercial and construction loans. The loan portfolio consists of secured and unsecured commercial loans including commercial real estate, construction loans, residential mortgages, automobile loans, home improvement loans, home equity loans and lines of credit, overdraft lines of credit and others. Republic’s commercial loans typically range between $250,000 and $5,000,000 but customers may borrow significantly larger amounts up to Republic’s legal lending limit of approximately $13.3 million at December 31, 2006. Individual customers may have several loans that are secured by different collateral which are in total subject to that lending limit. The aggregate amount of those relationships that exceeded $8.8 million at December 31, 2006, was $291.9 million. The $8.8 million threshold approximates 10% of total capital and reflects an additional internal monitoring guideline.
 
 
 
26

 
Investment Securities:
 
Investment securities available-for-sale are investments which may be sold in response to changing market and interest rate conditions and for liquidity and other purposes. The Company’s investment securities available-for-sale consist primarily of U.S Government debt securities, U.S. Government agency issued mortgage backed securities, municipal securities and debt securities, which include corporate bonds and trust preferred securities. Available-for-sale securities totaled $102.0 million at December 31, 2006, an increase of $64.8 million, or 173.7%, from year-end 2005. This increase reflected $67.1 million in purchases of primarily mortgage backed and municipal securities. The purchases were made to decrease exposure to lower interest rate environments, and enhance net interest income. At December 31, 2006 and December 31, 2005, the portfolio had net unrealized gains of $427,000 and $123,000, respectively.
 
Investment securities held-to-maturity are investments for which there is the intent and ability to hold the investment to maturity. These investments are carried at amortized cost. The held-to-maturity portfolio consists primarily of debt securities and stocks. At December 31, 2006, securities held to maturity totaled $333,000, a decrease of $83,000 or 20.0%, from $416,000 at year-end 2005. The decline reflected a reduction in the amount of debt securities. At both dates, respective carrying values approximated market values.
 
Restricted Stock:
 
Republic is required to maintain FHLB stock in proportion to its outstanding debt to FHLB. When the debt is repaid, the purchase price of the stock is refunded. At December 31, 2006, FHLB stock totaled $6.7 million, an increase of $342,000, or 5.4%, from $6.3 million at December 31, 2005.
 
Republic is also required to maintain ACBB stock as a condition of a rarely used contingency line of credit. At December 31, 20006 and 2005, ACBB stock totaled $143,000.
 
Cash and Cash Equivalents:
 
Cash and due from banks, interest bearing deposits and federal funds sold comprise this category which consists of the Company’s most liquid assets. The aggregate amount in these three categories decreased by $23.8 million, to $83.1 million at December 31, 2006, from $107.0 million at December 31, 2005. Federal funds sold decreased by $23.0 million to $63.2 million from $86.2 million, respectively, but total liquidity increased due to increases in securities balances.
 
Fixed Assets:
 
Bank premises and equipment, net of accumulated depreciation totaled $5.6 million at December 31, 2006 an increase of $2.1 million, or 57.0% from $3.6 million at December 31, 2005. The increase was due primarily to the addition of two branch locations in 2006.
 
Other Real Estate Owned:
 
The OREO property represents parcels of land. The balance increased $435,000, to $572,000 at December 31, 2006 compared to $137,000 at December 31, 2005, as a result of the addition of one of those properties.
 
Bank Owned Life Insurance:
 
At December 31, 2006, the value of the insurance was $11.3 million, an increase of $368,000, or 3.4%, from $10.9 million at December 31, 2005. The increase reflected income earned on the insurance policies.
 
Other Assets:
 
Other assets decreased by $1.2 million to $9.6 million at December 31, 2006, from $10.8 million at December 31, 2005, principally resulting from the collection of receivables in the first and second quarters of 2006.
 
Deposits:
 
 
27

 
Deposits, which include non-interest and interest-bearing demand deposits, money market, savings and time deposits including some brokered deposits, are Republic’s major source of funding. Deposits are generally solicited from the Company’s market area through the offering of a variety of products to attract and retain customers, with a primary focus on multi-product relationships.
 
Total deposits increased by $106.9 million to $754.8 million at December 31, 2006, from $647.8 million at December 31, 2005. Average transaction accounts decreased 0.3% or $1.1 million from the prior year end to $375.5 million in 2006. Time deposits increased $102.3 million, or 38.7%, to $368.8 million at December 31, 2005, versus $265.9 million at the prior year-end.
 
FHLB Borrowings and Overnight Advances:
 
FHLB borrowings and overnight advances are used to supplement deposit generation. Republic had no term borrowings at December 31, 2006 and December 31, 2005, respectively. Republic had short-term borrowings (overnight) of $159.7 million at December 31, 2006 versus $123.9 million at the prior year-end.  
 
Shareholders’ Equity:
 
Total shareholders’ equity increased $11.1 million to $74.7 million at December 31, 2006, versus $63.7 million at December 31, 2005. This increase was primarily the result of 2006 net income of $10.1 million.
 
Commitments, Contingencies and Concentrations
 
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the financial statements.
 
Credit risk is defined as the possibility of sustaining a loss due to the failure of the other parties to a financial instrument to perform in accordance with the terms of the contract. The maximum exposure to credit loss under commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. The Company uses the same underwriting standards and policies in making credit commitments as it does for on-balance-sheet instruments.
 
Financial instruments whose contract amounts represent potential credit risk are commitments to extend credit of approximately $222.2 million and $203.0 million and standby letters of credit of approximately $7.3 million and $5.8 million at December 31, 2006 and 2005, respectively. The increase in commitments reflects an increase in commercial lending. However, commitments often expire without being drawn upon. The $222.2 million of commitments to extend credit at December 31, 2006, were substantially all variable rate commitments.
 
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and many require the payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained upon extension of credit is based on management’s credit evaluation of the customer. Collateral held varies but may include real estate, marketable securities, pledged deposits, equipment and accounts receivable.
 
Standby letters of credit are conditional commitments issued that guarantee the performance of a customer to a third party. The credit risk and collateral policy involved in issuing letters of credit is essentially the same as that involved in extending loan commitments. The amount of collateral obtained is based on management’s credit evaluation of the customer. Collateral held varies but may include real estate, marketable securities, pledged deposits, equipment and accounts receivable.
 

28


Contractual obligations and other commitments
 
The following table sets forth contractual obligations and other commitments representing required and potential cash outflows as of December 31, 2006:
(Dollars in thousands)
 
Total
 
 
Less than
One Year
 
One to
Three
Years
 
Three to
Five
Years
 
 
After
Five
Years
 
 
Minimum annual rentals or noncancellable
        operating leases
 
$
40,440
 
$
1,035
 
$
2,234
 
$
3,013
 
$
34,158
 
 
Remaining contractual maturities of time
       deposits
   
368,823
   
347,067
   
20,383
   
1,373
   
-
 
 
Subordinated debt
   
6,186
   
-
   
-
   
-
   
6,186
 
 
Employment agreements
   
2,002
   
605
   
1,397
   
-
   
-
 
 
Former CEO SERP
   
239
   
96
   
143
   
-
   
-
 
 
Director and Officer retirement plan
  obligations
   
1,563
   
204
   
127
   
227
   
1,005
 
 
Loan commitments
   
222,243
   
174,062
   
41,858
   
491
   
5,832
 
 
Standby letters of credit
   
7,312
   
7,208
   
104
   
-
   
-
 
 
Total
 
$
648,808
 
$
530,277
 
$
66,246
 
$
5,104
 
$
47,181
 

 
As of December 31, 2006, the Company had entered into non-cancelable lease agreements for its current main office and operations center, its new headquarter facilities, eleven current Republic retail branch facilities, and a new branch facility, expiring through June 30, 2031, including renewal options. The leases are accounted for as operating leases. The minimum annual rental payments required under these leases are $40.4 million through the year 2031. The Company has entered into employment agreements with the CEO of the Company and the President of Republic. The aggregate commitment for future salaries and benefits under these employment agreements at December 31, 2006 is approximately $2.0 million. The Company has retirement plan agreements with certain Directors and Officers. The accrual benefits under the plan at December 31, 2006 is approximately $1.6 million, with a minimum age of 65 established to qualify for the payments.
 
The Company and Republic are from time to time a party (plaintiff or defendant) to lawsuits that are in the normal course of business. While any litigation involves an element of uncertainty, management, after reviewing pending actions with its legal counsel, is of the opinion that the liability of the Company and Republic, if any, resulting from such actions will not have a material effect on the financial condition or results of operations of the Company and Republic.
 
At December 31, 2006, the Company had no foreign loans and no loan concentrations exceeding 10% of total loans except for credits extended to real estate operators and lessors in the aggregate amount of $212.7 million, which represented 26.8% of gross loans receivable at December 31, 2006. Various types of real estate are included in this category, including industrial, retail shopping centers, office space, residential multi-family and others. In addition, credits extended for single family construction amounted to $90.4 million, which represented 11.4% of gross loans receivable at December 31, 2006. Loan concentrations are considered to exist when there is amounts loaned to a multiple number of borrowers engaged in similar activities that management believes would cause them to be similarly impacted by economic or other conditions.
 
Interest Rate Risk Management
 
Interest rate risk management involves managing the extent to which interest-sensitive assets and interest-sensitive liabilities are matched. The Company attempts to optimize net interest income while managing period-to-period fluctuations therein. The Company typically defines interest-sensitive assets and interest-sensitive liabilities as those that reprice within one year or less.
 
The difference between interest-sensitive assets and interest-sensitive liabilities is known as the “interest-sensitivity gap” (“GAP”). A positive GAP occurs when interest-sensitive assets exceed interest-sensitive liabilities repricing in the same time periods, and a negative GAP occurs when interest-sensitive liabilities exceed interest-sensitive assets repricing in the same time
 
 
29

 
periods. A negative GAP ratio suggests that a financial institution may be better positioned to take advantage of declining interest rates rather than increasing interest rates, and a positive GAP ratio suggests the converse. Static GAP analysis describes interest rate sensitivity at a point in time. However, it alone does not accurately measure the magnitude of changes in net interest income since changes in interest rates do not impact all categories of assets and liabilities equally or simultaneously. Interest rate sensitivity analysis also requires assumptions about repricing certain categories of assets and liabilities. For purposes of interest rate sensitivity analysis, assets and liabilities are stated at either their contractual maturity, estimated likely call date, or earliest repricing opportunity. Mortgage backed securities and amortizing loans are scheduled based on their anticipated cash flow, including prepayments based on historical data and current market trends. Savings, money market and interest-bearing demand accounts do not have a stated maturity or repricing term and can be withdrawn or repriced at any time. Management estimates the repricing characteristics of these accounts based on historical performance and other deposit behavior assumptions. These deposits are not considered to reprice simultaneously and, accordingly, a portion of the deposits are moved into time brackets exceeding one year. However, management may choose not to reprice liabilities proportionally to changes in market interest rates, for competitive or other reasons.
 
Shortcomings, inherent in a simplified and static GAP analysis, may result in an institution with a negative GAP having interest rate behavior associated with an asset-sensitive balance sheet. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Furthermore, repricing characteristics of certain assets and liabilities may vary substantially within a given time period. In the event of a change in interest rates, prepayments and other cash flows could also deviate significantly from those assumed in calculating GAP in the manner presented in the table below.
 
The Company attempts to manage its assets and liabilities in a manner that optimizes net interest income in a range of interest rate environments. Management uses GAP analysis and simulation models to monitor behavior of its interest sensitive assets and liabilities. Adjustments to the mix of assets and liabilities are made periodically in an effort to provide steady growth in net interest income.
 
Management presently believes that the effect on Republic of any future fall in interest rates, reflected in lower yielding assets, would be detrimental since Republic does not have the immediate ability to commensurately decrease rates on its interest bearing liabilities, primarily time deposits, other borrowings and certain transaction accounts. An increase in interest rates could have a positive effect on Republic, due to repricing of certain assets, primarily adjustable rate loans and federal funds sold, and a possible lag in the repricing of core deposits not assumed in the model.
 
The following tables present a summary of the Company’s interest rate sensitivity GAP at December 31, 2006. For purposes of these tables, the Company has used assumptions based on industry data and historical experience to calculate the expected maturity of loans because, statistically, certain categories of loans are prepaid before their maturity date, even without regard to interest rate fluctuations. Additionally, certain prepayment assumptions were made with regard to investment securities based upon the expected prepayment of the underlying collateral of the mortgage-backed securities. The interest rate on the trust preferred securities is variable and adjusts semi-annually.
 

30


Interest Sensitivity Gap
At December 31, 2006
(Dollars in thousands)

   
 
0-90
Days
 
 
91-180
Days
 
 
181-365
Days
 
 
1-2
Years
 
 
2-3
Years
 
 
3-4
Years
 
 
4-5
Years
 
More
than 5
Years
 
Financial
Statement
Total
 
 
Fair
Value
 
                                           
Interest Sensitive Assets:
                                         
Investment securities and
other interest-bearing
                                         
balances 
 
$
64,883
     
$
39,962
     
$
12,088
     
$
11,465
     
$
9,029
     
$
6,981
      
$
5,411
     
$
23,030
     
$
172,849
     
$
172,854
 
Average interest rate 
   
5.26
%
 
4.60
%
 
5.97
%
 
5.98
%
 
5.99
%
 
6.00
%
 
6.00
%
 
6.07
%
           
Loans receivable 
   
429,743
   
24,190
   
55,868
   
96,148
   
63,517
   
62,813
   
34,811
   
24,970
   
792,060
   
785,561
 
Average interest rate 
   
8.57
%
 
6.68
%
 
6.67
%
 
6.52
%
 
6.52
%
 
6.62
%
 
6.73
%
 
6.67
%
           
Total 
   
494,626
   
64,152
   
67,956
   
107,613
   
72,546
   
69,794
   
40,222
   
48,000
   
964,909
   
958,415
 
                                                               
Cumulative Totals 
 
$
494,626
 
$
558,778
 
$
626,734
 
$
734,347
 
$
806,893
 
$
876,687
 
$
916,909
 
$
964,909
             
                                                               
                                                               
Interest Sensitive Liabilities:
                                                             
Demand Interest Bearing(1) 
 
$
23,787
 
$
-
 
$
-
 
$
23,786
 
$
-
 
$
-
 
$
-
 
$
-
 
$
47,573
 
$
47,573
 
Average interest rate 
   
1.00
%
 
-
   
-
   
1.00
%
 
-
   
-
   
-
   
-
             
Savings Accounts (1) 
   
18,593
   
-
   
-
   
18,593
   
-
   
-
   
-
   
-
   
37,186
   
37,186
 
Average interest rate 
   
5.00
%
 
-
   
-
   
5.00
%
 
-
   
-
   
-
   
-
             
Money Market Accounts(1) 
   
111,530
   
-
   
-
   
111,530
   
-
   
-
   
-
   
-
   
223,060
   
223,060
 
Average interest rate 
   
4.15
%
 
-
   
-
   
4.15
%
 
-
   
-
   
-
   
-
             
Time Deposits 
   
166,943
   
13,938
   
166,186
   
15,418
   
4,965
   
1,113
   
260
   
-
   
368,823
   
367,200
 
Average interest rate 
   
4.87
%
 
4.14
%
 
5.36
%
 
4.14
%
 
4.25
%
 
3.82
%
 
4.02
%
 
-
             
FHLB and Short Term
                                                             
Advances  
   
159,723
   
-
   
-
   
-
   
-
   
-
   
-
   
-
   
159,723
   
159,723
 
Average interest rate 
   
5.45
%
 
-
   
-
   
-
   
-
   
-
   
-
   
-
             
Subordinated Debt 
   
6,186
   
-
   
-
   
-
   
-
   
-
   
-
   
-
   
6,186
   
6,186
 
Average interest rate 
   
7.08
%
 
-
   
-
   
-
   
-
   
-
   
-
   
-
             
Total 
   
486,762
   
13,938
   
166,186
   
169,327
   
4,965
   
1,113
   
260