UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM10-K/A
Amendment No. 1
(Mark One) 10-K
☒ | ANNUAL REPORT |
For the fiscal year ended December 31, 20162018
OR
☐ | TRANSITION REPORT |
For the transition period fromto
Commission file number000-29599
PATRIOT NATIONAL BANCORP, INC.
(Exact name of registrant as specified in its charter)
Connecticut |
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(203)324-7500 (Registrant’s telephone number, including area code) Securities registered under Section 12(b) of the Exchange Act:
Securities registered
Indicate by check mark if the registrant Indicate by check mark if the registrant is not required to file reports pursuant to Section 13
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 Indicate by check mark whether the registrant has submitted electronically Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of RegulationS-K Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. Indicate by check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act). Yes ☐ No ☒
As of June 30, 2018, the aggregate market value of the Number of
Document Incorporated by Reference
PATRIOT NATIONAL BANCORP, INC. 2018 FORM 10-K ANNUAL REPORT For the
“Safe Harbor” Statement Under Private Securities Litigation Reform Act of 1995
As of the date hereof, the only business of the Company
On March 4, 2015, the Company On September 28, 2015, the Bank changed its name from Patriot National Bank to Patriot Bank, N.A. On January 26, 2017,
On May 10, 2017, Joseph D. Perillo was appointed as Chief Financial Officer of Patriot effective as of May 9, 2017. Mr. The Bedford branch was closed on February 28, 2018 and its business and staff transferred to the Scarsdale branch. On May 10, 2018, the Bank completed its acquisition of Prime Bank, a Connecticut bank headquartered in Orange, CT (“Prime Bank”). The closing of the
Business Operations The Bank offers commercial real estate loans, commercial business loans, and
Consumer and commercial deposit accounts offered include: checking, interest-bearing negotiable order of withdrawal (“NOW”), money market, time certificates of deposit, savings, Certificate of Deposit Account Registry Service (“CDARS”), Individual Retirement Accounts (“IRAs”), and Health Savings Accounts (“HSAs”). Other services offered by the Bank include Automated Clearing House (“ACH”) transfers, lockbox, internet banking, bill paying, remote deposit capture, debit cards, money orders, traveler’s checks, and automatic teller machines (“ATMs”). In addition, the Bank may in the future offer other financial services. The Bank’s branch office locations are summarized as follows:
The Stamford, Connecticut location serves as Patriot’s headquarters. Additionally, the Bank also operates a loan origination office at its Stamford location. The Bank’s employees perform most routine day-to-day banking transactions. The Bank has entered into a number of arrangements with third-party outside service providers, who provide services such as correspondent banking, check clearing, data processing services, credit card processing and armored car carrier transport. In the normal course of business, subject to applicable government regulations, the Bank invests a portion of its assets in investment securities, which may include government securities. The Bank’s investment portfolio strategy is to maintain a balance of high-quality diversified investments that minimizes risk, maintains adequate levels of liquidity, and limits exposure to interest rate and credit risk. Guaranteed U.S. federal government issues currently comprise the majority of the Bank’s investment portfolio. Patriot became an approved SBA lender at the end of 2017 and was designated a “preferred lender” by the SBA earlier in this year, enabling it to approve loans to small businesses and entrepreneurs more quickly and efficiently. In 2018, Patriot hired people to support new SBA business development in Stamford, Connecticut, Jacksonville, Florida, Atlanta, Georgia, and Indianapolis, Indiana. Employees As of December 31, 2018, Patriot had 118 full-time equivalent employees. None of Patriot's employees are covered by a collective bargaining agreement. Competition The Bank competes with a variety of financial institutions for loans and deposits in its market area. These include larger financial institutions with greater financial resources, larger branch systems and higher lending
The Bank’s In recent years, intense market demands, economic pressures, and significant legislative and regulatory actions have eroded banking industry classifications, which were once clearly defined, and have increased competition among banks, as well as other financial services institutions including non-bank competitors. This increase in competition has caused banks and other financial services institutions to diversify their services and become more cost effective. The impact of market dynamics, legislative, and regulatory changes on banks and other financial services institutions has increased customer awareness of product and service differences among competitors and increased merger activity among banks and other financial services institutions. Supervision and Regulation As a Under the BHC, the Company is required to file semi-annual reports of its The Fed has A bank holding company is required to give the Fed prior written notice of any purchase or redemption of its outstanding equity securities, if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of its consolidated retained earnings. The Fed may disapprove of such a purchase or redemption, if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, Fed order, or any condition imposed by, or written agreement with, the Fed. The Company is subject to capital adequacy rules and Federal and state banking regulations govern, among other things, the scope of the business of a bank, a bank holding company, or a financial holding company, the investments a bank may make, deposit reserves a bank must maintain, the establishment of branches, and the activities of a bank with respect to mergers and acquisitions. The Bank is a member of the
The OCC regulates the number and The earnings and growth of Patriot and the banking industry in general are affected by the monetary and fiscal policies of the In addition to other laws and regulations, Patriot is subject to the Community Reinvestment Act (“CRA”), which requires the federal bank regulatory agencies, when considering certain applications involving Patriot, to consider Patriot’s record of helping to meet the credit needs of its entire community, including low- and moderate-income neighborhoods. The CRA was originally enacted because of concern over unfair treatment of prospective borrowers by banks and unwarranted geographic differences in lending patterns. Existing banks have sought to comply with the CRA in various ways; some banks have made use of more flexible lending criteria for certain types of loans and borrowers (consistent with the requirement to conduct safe and sound operations), while other banks have increased their efforts to make loans to help meet identified credit needs within the consumer community, such as those for home mortgages, home improvements, and small business loans. Compliance may also include participation in various government insured lending programs, such as Federal Housing Administration insured or Veterans Administration guaranteed mortgage loans, Small Business Administration loans, and participation in other types of lending programs such as high loan-to-value ratio conventional mortgage loans with private mortgage insurance. To date, the market area from which the Bank draws much of its business is in the towns and cities in which the Bank has branch offices, which are characterized by a very diverse ethnic, economic and racial cross-section of the population. As the Bank expands further, the market areas served by the Bank will continue to evolve. The Company and the
On July 20, 2002, the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) was enacted, the primary purpose of which is to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws, and for other purposes. Section 404 of Sarbanes-Oxley, entitled Management Assessment of Internal Controls, requires that each annual report include an internal control report which states that it is the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting, as well as an assessment by management of the effectiveness of the internal control structure and procedures for financial reporting. This section further requires that the external auditors attest to, and report on, the Company’s Recent Legislative Developments Many of the provisions of The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) are aimed at financial institutions that are significantly larger than Patriot. Notwithstanding this, there are many other provisions that Patriot is subject to and had to comply with since July 21, 2010, including any applicable rules promulgated by the Consumer Financial Protection Bureau (“CFPB”). As rules and regulations are promulgated by the agencies responsible for implementing and enforcing Dodd-Frank, Patriot will have to address them to ensure compliance with such applicable provisions. Management expects the cost of compliance to increase, due to the regulatory burden imposed by Dodd-Frank. Dodd-Frank also broadened the base for FDIC insurance assessments. Under rules issued by the FDIC in February 2011, the base for insurance assessments changed from domestic deposits to consolidated assets less tangible equity. Assessment rates are calculated using formulas that take into account the risks of the institution being assessed. The rule was effective beginning April 1, 2011 and Financial reform legislation and the implementation of In July 2013, the Fed, the FDIC, and the OCC approved final rules establishing a new comprehensive capital framework for U.S. Banking organizations (the “New Capital Rules”). The New Capital Rules generally implement the Basel Committee on Banking Supervision’s (the “Basel Committee”) December 2010 final capital framework (referred to as “Basel III”) for strengthening international capital standards. The New Capital Rules substantially revise the risk-based capital requirements applicable to bank holding companies and their depository institution subsidiaries, including Patriot, as compared to the current U.S. general risk-based capital rules. The New Capital Rules revise the definitions and the components of regulatory capital, as well as address other issues affecting the numerator in banking institutions’ regulatory capital ratios. The New Capital Rules also address asset risk weights and other matters affecting the denominator in banking institutions’ regulatory capital ratios and replace the existing general risk-weighting approach with a more risk-sensitive approach, based, in part, on the “standardized approach” adopted by the Basel Committee in 2004. In addition, the New Capital Rules implement certain provisions of Dodd-Frank. The New Capital Rules became effective for Patriot on January 1, 2015. Patriot has not experienced any difficulties in complying with the New Capital Rules. Recent Developments with Regulators In November 2018 the Bank entered into a formal written agreement (the “Agreement”) with the Office of the OCC. The Agreement states that by December 31, 2018 the Board and the Bank would develop, implement and revise written documents and policies related to executive compensation, conflict of interest, internal audit, liquidity and asset/liability management, commercial loan administration, leveraged lending, practices relating to the Allowance for Loan Losses, and assumptions used in the Bank’s interest rate risk model. Under the Agreement the Bank has also agreed to provide a revised written 3-year strategic and capital plan for the Bank by December 31, 2018. The Bank has provided the documents and policies requested in the Agreement and awaits further assessment by the OCC. On October 29, 2018, the Company withdrew its initial application to the OCC requesting approval of the acquisition of Hana Small Business Lending, Inc. (“Hana SBL”) pursuant to a purchase agreement entered into on February 6, 2018 and amended on August 2, 2018. As of March 30, 2019, the Company has not received regulatory non-objection. On March 30, 2019 the Company and Hana SBL mutually agreed to terminate the purchase agreement between the parties. The termination agreement provides for the release of escrowed funds back to the Company. Available Information The Company’s website address is https://www.bankpatriot.com; however, information found on, or that can be accessed through, the website is not incorporated by reference into this Form 10-K. The Company makes available free of charge on its website (under the links entitled “For Investors”, then “SEC filings”, then “Documents”), its annual report on Form 10-K, its quarterly reports on Form 10-Q, current reports on Form 8-K, information statements on Schedule 14C, and amendments to those reports filed or furnished pursuant to Section 13(a) of ITEM 1A. Risk Factors Patriot’s financial condition and results of operation are subject to The risks involved in the Bank’s commercial real estate loan portfolio are material. The Bank’s commercial real estate loan portfolio constitutes a material portion of its assets and generally has different risks than residential mortgage loans. Commercial real estate loans often involve larger loan balances concentrated with single borrowers or groups of related borrowers as compared to single-family residential loans. Because the repayment of commercial real estate loans depends on the successful management and operation of the borrower’s properties or related businesses, repayments of such loans can be affected by adverse conditions in the real estate market or local economy. A downturn in the real estate market within the Bank’s market area may adversely impact the value of properties securing these loans. These risks are partially offset by shorter terms, reduced loan-to-value ratios, and guarantor support of the borrower. Real estate lending in the Bank’s core market involves risks related to a decline in value of commercial and residential real estate. The market value of real estate can fluctuate significantly in a relatively short period of time, as a result of market conditions in the geographic area in which real estate is located. A significant portion of the Bank’s total loan portfolio is secured by real estate located in Fairfield County, Connecticut and Westchester County, New York, areas historically of high affluence that had been materially impacted by the financial troubles experienced by large financial service companies on Wall Street and other companies during the financial crisis as well as the recent changes in tax laws. Since then, credit markets have become tighter and underwriting standards more stringent and the inability of purchasers of real estate to obtain financing will continue to impact the real estate market. Therefore, these loans may be subject to changes in grade, classification, accrual status, foreclosure, or loss, which could have an effect on the adequacy of the allowance for loan and lease losses. The Bank’s business is subject to various lending and other economic risks that could adversely impact its results of operations and financial condition. Changes in economic conditions, particularly a continued economic slowdown in Fairfield County, Connecticut and the New York metropolitan area could result in the following consequences, any of which may have a material detrimental effect on the Bank’s business:
During the years 2007 through 2009, the general economic conditions and specific business conditions in the United States, including Fairfield County, Connecticut and the New York metropolitan area deteriorated, resulting in increases in loan delinquencies, problem assets and foreclosures, and declines in the value and collateral associated with the Bank’s loans. During 2010 through 2018, however, the economic climate improved, contributing to decreases in the Bank’s problem assets, delinquencies and foreclosures from the levels experienced in the earlier period of economic turbulence. The Company is unable to predict, however, future economic conditions and their impact on the Company’s business. The Bank’s allowance for loan losses may not be adequate to cover actual losses. Like all Federal regulatory agencies, as an integral part of their examination process, review the Bank’s loan portfolio and assess the adequacy of the allowance for loan losses. The regulatory agencies may require the Bank to change classifications or grades on loans, increase the allowance for loan losses by recognizing additional loan loss provisions, or to recognize further loan charge-offs based upon their judgments, which may differ from the Bank’s. Any increase in the allowance for loan losses required by these regulatory agencies could have a negative effect on the Bank’s results of operations and financial condition. While management believes that the allowance for loan losses is currently adequate to cover inherent losses, further loan deterioration could occur, and therefore, management cannot assure shareholders that there will not be a need to increase the allowance for loan losses, or that the regulators will not require management to increase this allowance. Either of these occurrences could materially and adversely affect Patriot’s earnings and profitability. Patriot is subject to certain risks with respect to liquidity. "Liquidity" refers to Patriot’s ability to generate sufficient cash flows to support its operations and fulfill its obligations, including commitments by the Bank to originate loans, to repay its wholesale borrowings and other liabilities, and to satisfy the withdrawal of deposits by its customers. Patriot’s primary sources of liquidity are the deposits the Bank acquires organically through its branch network and through the brokered deposit market, borrowed funds, primarily in the form of collateralized borrowings from the Federal Home Loan Bank, and the cash flows generated through the collection of loan payments and on mortgage-related securities. In addition, depending on current market conditions, Patriot may have the ability to access the capital markets. Deposit flows, calls of investment securities and wholesale borrowings, and prepayments of loans and mortgage-related securities are strongly influenced by such external factors as the direction of interest rates, whether actual or perceived; local and national economic conditions; and competition for deposits and loans in the markets served. Furthermore, changes to the The Bank’s business is subject to interest rate risk and variations in interest rates may negatively affect the Bank’s financial performance. Patriot is unable to predict, with any degree of certainty, fluctuations of market interest rates, which are affected by many factors including inflation, recession, a rise in unemployment, a tightening money supply, domestic and international disorder, and instability in domestic and foreign financial markets. Changes in the interest rate environment may reduce Patriot’s profits. Patriot realizes income from the differential or “spread” between the interest earned on loans, securities, and other interest-earning assets and interest paid on deposits, borrowings, and other interest-bearing liabilities. Net interest spreads are affected by the difference between the maturities and repricing characteristics of interest-earning assets and interest-bearing liabilities. In addition, an increase in the general level of interest rates may adversely affect the ability of some borrowers to pay the interest on and principal of their obligations. Although Patriot has implemented strategies which are designed to reduce the potential effects of changes in interest rates on operations, these strategies may not always be successful. Accordingly, changes in levels of market interest rates could materially and adversely affect Patriot’s net interest spread, asset quality, levels of prepayments, and cash flow, as well as the market value of its securities portfolio and overall profitability. Patriot’s investment portfolio includes securities that are sensitive to interest rates and variations in interest rates may adversely impact Patriot’s profitability. Patriot’s security portfolio is classified as available-for-sale, and is comprised primarily of corporate debt and mortgage-backed securities, which are insured or guaranteed by the U.S. Government. These securities are sensitive to interest rate fluctuations. Unrealized gains or losses in the available-for-sale portfolio of securities are reported as a separate component of shareholders’ equity. As a result, future interest rate fluctuations may impact shareholders’ equity, causing material fluctuations from quarter to quarter. The inability to hold its securities until market conditions are favorable for a sale, or until payments are received on mortgage-backed securities, could adversely affect Patriot’s earnings and profitability. Patriot is dependent on its locally-based management team and the loss of its senior executive officers or other key employees could impair its relationship with its customers and adversely affect its business and financial results. The Bank’s success is dependent upon the continued services and skills of its long-term locally-based management team. The unexpected loss of services of one or more of these key personnel, because of their skills, knowledge of the Bank’s market, years of industry experience, and the difficulty of promptly finding qualified replacement personnel could have an adverse impact on the Bank’s business. Patriot’s success also depends, in part, on its continued ability to attract and retain experienced commercial lenders and retail bankers, as well as other management personnel. The loss of services of several such key personnel could adversely affect Patriot’s growth and prospects, to the extent replacement personnel are not able to be identified and promptly retained. Competition for commercial lenders and retail bankers is strong, and Patriot may not be successful in retaining or attracting such personnel. Patriot is subject to certain general affirmative debt covenants, which if it cannot comply, may result in default and actions taken against it by its debt holders. On June 29, 2018, the Company entered into certain subordinated note purchase agreements with two institutional accredited investors and completed a In December 2016, the Company issued $12 million of senior notes (the “Senior Notes”) that contain certain affirmative covenants, which require the Company to: maintain its and its subsidiaries’ legal entity and tax status, pay its income tax obligations on a timely basis, and comply with SEC and FDIC reporting requirements. The Senior Notes are unsecured, rank equally with all other senior obligations of the Company, are not redeemable nor may they be put to the Company by the holders of the notes, and require no payment of principal until maturity. The affirmative covenants contained in the Senior Note agreements are of a general nature and not uncommon in such debt agreements. Management does not anticipate an inability to maintain its compliance with the affirmative covenants contained in the Senior Notes as such compliance is inherent in the Bank’s continued operation and Patriot’s public company status, as well as management’s overall strategic plan. A breach of information security could negatively affect Patriot’s earnings. Patriot increasingly depends upon data processing, communications, and information exchange on a variety of computing platforms and networks, and the internet to conduct its business. Patriot cannot be certain that all of its systems are entirely free from vulnerability to attack, despite safeguards it has instituted. In addition, Patriot relies on the services of a variety of vendors to meet its data processing and communication needs. If information security is breached, information can be lost or misappropriated and could result in financial loss or costs to Patriot, or damages to others. These financial losses or costs could materially exceed the amount of Patriot’s insurance coverage, if applicable, which would have an adverse effect on its results of operations and financial condition. In addition, the Bank’s reputation could suffer if its database were breached, which could materially affect Patriot’s financial condition and results of operations. The Bank is subject to environmental liability risk associated with its lending activities. A significant portion of the Bank’s loan portfolio is secured by real property. During the ordinary course of business, the Bank may foreclose on, and take title to, properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties, which may make Patriot liable for remediation costs, as well as for personal injury and property damage. In addition, Patriot owns and operates certain properties that may be subject to similar environmental liability risks. Environmental laws may require the Bank to incur substantial expense and may materially reduce the affected property's value, or limit the Bank’s ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase the Bank’s exposure to environmental liability. Although the Bank has policies and procedures requiring the performance of an environmental site assessment before loan approval or initiating any foreclosure action on real property, these assessments may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on Patriot’s financial condition and results of operations. The Company relies on the dividends it receives from its subsidiary. The Company is a separate and distinct legal entity from the Bank. The Company’s primary source of revenue is the dividends it receives from the Bank, which the Company uses to fund its activities, meet its obligations, and remit dividends to its shareholders. Various federal and state laws and regulations limit the amount of dividends that a bank may pay to its parent company. In addition, the Company’s right to participate in a distribution of assets, upon liquidation or reorganization of the Bank or another regulated subsidiary, may be subordinate to claims by the Bank’s or subsidiary's creditors. If the Bank were to be restricted from paying dividends to the Company, the The price of the Company’s common stock may fluctuate. The market price of the Company’s common stock could be subject to significant fluctuations due to changes in sentiment in the market regarding the Company’s operations or business prospects. Among other factors, the Company’s stock price may be affected by:
Difficult market conditions have adversely affected the Company’s industry. The Company is exposed to general downturns in the U.S. economy, and particularly downturns in the local Connecticut and New York markets in which it operates. Two significant impacts resulting from the financial crisis included the housing market suffering falling home prices leading to increased foreclosures and our customer base experiencing rampant unemployment and sustained under-employment. These conditions negatively impacted the credit performance of mortgage and construction loans, and resulted in significant asset-value write-downs by financial institutions, including government-sponsored enterprises, as well as major commercial and investment banks. The loss of mortgage and construction loan asset-value caused many financial institutions to seek additional capital, to merge with larger and financially stronger financial institutions and, in some cases, to fail. Many lenders and institutional investors reduced or ceased providing funding to borrowers, including other financial institutions. This market turmoil, and the tightening of credit by the Fed, led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility, and generally widespread reductions in business activity. The resulting economic pressure on consumers and lack of confidence in the financial markets has adversely affected the Company’s business, financial condition, and results of operations. A worsening of these conditions would likely exacerbate the adverse effects these difficult market conditions have had on the Company and other financial institutions. In particular:
The Bank may be required to pay significantly higher FDIC premiums, special assessments, or taxes that could adversely affect its earnings. Market developments have significantly impacted the insurance fund of the FDIC. As a result, the Bank may be required to pay higher premiums, or special assessments, that could adversely affect earnings. The amount of premiums the FDIC requires for the insurance coverage it provides is outside the Bank’s control. If there are additional banks or financial institution failures, the Bank may be required to pay higher FDIC premiums than are currently assessed. Increases in FDIC insurance premiums, including any future increases or required prepayments, may materially adversely affect the Bank’s results of operations. Patriot is subject to risks associated with taxation. The amount of income taxes Patriot is required to pay on its earnings is based on federal and state legislation and regulations. Patriot provides for current and deferred taxes in its financial statements, based on the results of operations, business activity, legal structure, interpretation of tax statutes, assessment of risk of adjustment upon audit, and application of financial accounting standards. Patriot may take tax return filing positions for which the final determination of tax is uncertain. Patriot’s net income or loss and the related amount per share may be reduced, if a federal, state, or local tax authority assesses additional taxes, penalties, or interest that has not been provided for in the consolidated financial statements. There can be no assurance that Patriot will achieve its anticipated effective tax rate, due to a change in a tax law, or the result of a tax audit that disallows previously recognized tax benefits. Risks associated with changes in technology. Financial products and services have become increasingly technology-driven. The Bank’s ability to compete for new and meet the needs of existing customers, in a cost-efficient manner, is dependent on its ability to keep pace with technological advances and to invest in new technology as it becomes available. Many of the Bank’s competitors have greater resources to invest in technology and may be better equipped to market new technology-driven products and services. Failing to keep pace with technological change could have a material adverse impact on the Bank’s business and therefore on Patriot’s financial condition and results of operations. Strong competition in Patriot’s geographical market could limit growth and profitability. Competition in the banking and financial services industry is intense. Fairfield County, Connecticut and the New York City metropolitan areas have a high concentration of financial institutions including large money center and regional banks, community banks, and credit unions. Some of Patriot’s competitors offer products and services that the Bank currently does not offer, such as private banking and trust services. Many of these competitors have substantially greater resources and lending limits than the Bank, and may offer certain services that Patriot does not or cannot provide. Price competition might result in the Bank earning less on its loans and paying more for deposits, which would reduce net interest income. Patriot expects competition to increase in the future, as a result of legislative, regulatory and technological changes. Patriot’s profitability depends upon its continued ability to successfully compete in its geographical market. Government regulation may have an adverse effect on Patriot’s profitability and growth. Patriot is subject to extensive regulation, supervision, and examination by the OCC as the Bank’s chartering authority, the FDIC as the insurer of its deposits, and the Fed as its primary regulator. Changes in federal and state banking laws and regulations, or in federal monetary policies, could adversely affect the Bank’s profitability and continued growth. In light of recent events, legislative and regulatory changes are expected, but cannot be predicted. For example, new legislation or regulation could limit the manner in which Patriot may conduct its business, including the Bank’s ability to obtain financing, attract deposits, make loans, and achieve satisfactory interest spreads. The laws, regulations, interpretations, and enforcement policies that apply to Patriot have been subject to significant, and sometimes retroactively applied, changes in recent years, and are likely to change significantly in the future. Legislation enacted by the U.S. Congress, proposing significant structural reforms to the financial services industry, has, among other things, created the CFPB, which is given broad authority to regulate financial service providers and financial products. In addition, the Fed has passed guidance on incentive compensation at financial institutions it regulates and the United States Department of the Treasury and federal banking regulators have issued statements calling for higher capital and liquidity requirements. Complying with any new legislative or regulatory requirements and any programs established thereunder by federal and state governments, could have an adverse impact on Patriot’s operations and the results thereof. Changing regulation of corporate governance and public disclosure. Patriot is subject to laws, regulations, and standards relating to corporate governance and public disclosure, SEC rules and regulations, and NASDAQ rules. These laws, regulations, and standards are subject to varying interpretations, and as a result, their practical application may evolve over time as new guidance is provided by regulatory and governing bodies. Due to the evolving legal and regulatory environment, compliance may become more difficult and result in higher costs. Patriot is committed to maintaining high standards of corporate governance and public disclosure. As a result, Patriot’s efforts to comply with evolving laws, regulations and standards have resulted in, and are likely to continue to result in, increased general and administrative expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities. Patriot’s reputation may be harmed, if it does not continue to comply with these laws, regulations and standards. The earnings of financial institutions are significantly affected by general business and economic conditions. As a financial institution, Patriot’s operations and profitability are impacted by general business and economic conditions in the United States and abroad. These conditions include short- and long-term interest rates, inflation, money supply, political issues, legislative and regulatory changes, and the overall strength of the U.S. economy and the local economies in which it operates, all of which conditions are beyond Patriot’s control. In recent years, the financial services industry has experienced unprecedented upheaval, including the failure of some of the World’s leading financial institutions. Further deterioration in economic conditions could result in an increase in loan delinquencies and non-performing assets, decreases in loan collateral values, and a decrease in demand for the Bank’s products and services, among other things, any of which could have a material adverse impact on Patriot’s results of operations and financial condition. Patriot cannot currently predict or implement plans to mitigate the effects of unknown future industry developments. The Company is a “Controlled Company” within the meaning of the NASDAQ U.S. Market Rules and Regulations and, as a result, the Company qualifies for, and relies on, exemptions from certain corporate governance requirements. Holdings controls a majority of the Company’s voting common stock. As a result, the Company is a “Controlled Company” within the meaning of Nasdaq corporate governance standards. Under the Nasdaq Rules and Regulations, a company of which more than 50% of the voting power is held by an individual, group or another company is considered a “Controlled Company”, which may utilize exemptions relating to certain Nasdaq corporate governance requirements, including:
As a result of these exemptions, the Company’s Nominating and Governance Committee and Compensation Committee do not consist entirely of independent directors and the Company is not required to have an annual performance evaluation of the Nominating and Governance and Compensation Committees. Accordingly, a holder of its common stock will not have the same protections afforded to stockholders of companies that are subject to all of the NASDAQ corporate governance requirements. ITEM 1B. Unresolved Staff Comments None. ITEM 2. Properties The following table summarizes Patriot’s owned and leased properties, as of December 31, 2018:
At December 31, 2018, five branch buildings were owned and four branch facilities were leased. Additionally, the Bank maintains certain operating and administrative service facilities and additional parking at its main branch banking office, which is subject to three distinct lease agreements. Patriot’s lease agreements have terms ranging from one year to fifteen years with thirteen years and six months remaining on the longest lease term. Generally, Patriot’s lease agreements contain rent escalation clauses, and renewals for one or more periods at the Bank’s option. On May 10, 2018 the Bank completed its acquisition of Prime Bank. The closing of the transaction added a new Patriot branch located in the Town of Orange, New Haven County, Connecticut. On February 28, 2018, the Bedford branch was closed and its business and staff transferred to the Scarsdale branch. On May 1, 2017, Patriot completed renovation on 999 Bedford Street, Stamford and moved certain corporate staff and its main branch banking office to this location, which was purchased in November 2014. In 2014, the Bank purchased two new buildings, which now house the Milford branch and Darien branch. In 2013, Patriot purchased 900 Bedford Street, Stamford, Connecticut. In 2015, Patriot moved its corporate headquarters and main branch banking office to this location, leaving some operational departments at the old leased location. In 2013, the Bank purchased its Greenwich branch building. At three of its branch buildings, the Bank has excess space that it leases to seven unrelated parties. For additional information, see the Commitment and Contingencies footnote disclosure in the Consolidated Financial Statements included herein. ITEM 3. Legal Proceedings Other than ordinary routine litigation incidental to its business, neither the Company nor the Bank has any pending legal proceedings to which the Company or the Bank is a party or any of its property is subject. ITEM 4. Mine Safety Disclosures Not applicable. PART II ITEM 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities Market Information The Company’s Common Stock is traded on the Nasdaq Global Market under the Symbol “PNBK.” Holders There were approximately 313 shareholders of record of the Company’s Common Stock as of December 31, 2018. This number does not reflect the number of persons or entities holding stock in nominee name through banks, brokerage firms or other nominees. Dividends The Company’s ability to pay dividends is dependent on the Bank’s ability to pay dividends to the Company. The Bank can pay dividends to the Company pursuant to a dividend policy requiring compliance with the Bank's OCC-approved capital program, in compliance with applicable law, and with the prior written determination of no supervisory objection by the Assistant Deputy Comptroller. In addition to the capital program, certain other restrictions exist regarding the ability of the Bank to transfer funds to the Company in the form of cash dividends, loans or advances. The approval of the OCC is required to pay dividends in excess of the Bank’s earnings retained in the current year plus retained net earnings for the preceding two years. The Company is also prohibited from paying dividends that would reduce its capital ratios below minimum regulatory requirements. OCC regulations impose limitations upon all capital distributions by commercial institutions, like the Bank, such as dividends and payments to repurchase or otherwise acquire shares. The Company may not declare or pay cash dividends on or repurchase any of its shares of common stock, if the effect thereof would cause stockholders’ equity to be reduced below applicable regulatory capital maintenance requirements, or if such declaration and payments would otherwise violate regulatory requirements. On July 17, 2017, the Company announced its intention to make quarterly cash dividend payments. For the year ended December 31, 2018 and 2017, the Company paid cash dividends of $154,000 and $77,000, respectively. Recent Sales of Unregistered Securities On June 29, 2018, the Company entered into certain subordinated note purchase agreements with two institutional accredited investors and completed a private placement of $10 million of fixed-to-floating rate subordinated notes with the maturity date of September 30, 2028 (the “Subordinated Notes”) pursuant to Section 4(a)(2) of the Securities Act of 1933, as amended, and Rule 506(b) of Regulation D promulgated thereunder. The Subordinated Notes will initially bear interest at 6.25% per annum, from and including June 29, 2018, to but excluding, June 30, 2023, payable semi-annually in arrears. From and including June 30, 2023, until but excluding June 30, 2028 or an early redemption date, the interest rate shall reset quarterly to an interest rate per annum equal to the then current three-month LIBOR (but not less than zero) plus 332.5 basis points, payable quarterly in arrears. The Company may, at its option, beginning on June 30, 2023 and on any scheduled interest payment date thereafter, redeem the Subordinated Notes. Interest on the Subordinated Notes is payable beginning on December 30, 2018. Purchases of Equity Securities by the Issuer and Affiliated Purchasers None. Performance Graph The performance graph compares the Company’s cumulative total shareholder return on its common stock over the last five fiscal years to the NASDAQ Community Bank Total Return Index and the S&P 500 Total Return Index. Total shareholder return is measured by dividing the sum of the cumulative amount of dividends for the measurement period (assuming dividend reinvestment) and the Company’s share price at the end of the measurement period, by the share price at the beginning of the measurement period.
ITEM 6. Selected Financial Data
(1) All common stock and per share data have been restated to give effect to a reverse stock split of 1-for-10 effective March 4, 2015. ITEM 7. Management’s Discussion and Analysis - Financial Condition & Results of Operations Critical Accounting Policies The accounting and reporting policies of Patriot conform to accounting principles generally accepted in the United States of America (“U.S. GAAP”) and to general practices within the financial services industry. A summary of Patriot’s significant accounting policies is included in the Notes to Consolidated Financial Statements that are referenced in Item 8. Financial Statements and Supplementary Data. Although all of Patriot’s policies are integral to understanding its Consolidated Financial Statements, certain accounting policies involve management to exercise judgment, develop assumptions, and make estimates that may have a material impact on the financial information presented in the Consolidated Financial Statements or Notes thereto. The assumptions and estimates are based on historical experience and other factors representing the best available information to management as of the date of the Consolidated Financial Statements, up to and including the date of issuance or availability for issuance. As the basis for the assumptions and estimates incorporated in the Consolidated Financial Statements may change, as new information comes to light, the Consolidated Financial Statements could reflect different assumptions and estimates. Due to the judgments, assumptions, and estimates inherent in the following policies, management considers such accounting policies critical to an understanding of the Consolidated Financial Statements and Management's Discussion and Analysis of Financial Condition and Results of Operations. Allowance for Loan and Lease Losses (ALLL) The Company maintains an ALLL at a level management believes is sufficient to absorb estimated credit losses incurred as of the report date. Management’s determination of the adequacy of the ALLL is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective as it requires significant estimates by management. As applicable, consideration is given to a variety of factors in establishing these estimates including historical losses, peer and industry data, current economic conditions, the size and composition of the loan portfolio, delinquency statistics, criticized and classified assets and impaired loans, results of internal loan reviews, borrowers’ perceived financial and management strengths, the adequacy of underlying collateral, the dependence on collateral, and the strength of the present value of future cash flows and other relevant factors. These factors may be susceptible to significant change. To the extent actual outcomes differ from management’s estimates, additional provisions for loan losses may be required, which may adversely affect the Company’s results of operations in the future. Subsequent to acquisition of purchased-credit-impaired loans, estimates of cash flows expected to be collected are updated each reporting period based on updated assumptions regarding default rates, loss severities, and other factors that are reflective of current market conditions. Subsequent decreases in expected cash flows will generally result in a provision for loan losses; subsequent increases in expected cash flows may result in a reversal of the provision for loan losses to the extent of prior charges. Unrealized Gains and Losses on Securities Available-for-sale The Company receives estimated fair values of debt securities from independent valuation services and brokers. In developing these fair values, the valuation services and brokers use estimates of cash flows based on historical performance of similar instruments in similar rate environments. Available-for-sale debt securities consist primarily of mortgage-backed securities that are guaranteed by the U.S. government. The Company uses various indicators in determining whether a security is other-than-temporarily impaired including, for debt securities, when it is probable that the contractual interest and principal will not be collected, or for equity securities, whether the market value is below its cost for an extended period of time with low expectation of recovery. The debt securities are monitored for changes in credit ratings because adverse changes in credit ratings could indicate a change in the estimated cash flows of the underlying collateral or issuer. For marketable equity securities, the Company considers the issuer’s financial condition, capital strength, and near term prospects to determine whether impairment is temporary or other-than-temporary. The Company also considers the volatility of a security’s price in comparison to the market as a whole and any recoveries or declines in fair value subsequent to the balance sheet date. If management determines that the impairment is other-than-temporary, the entire amount of the impairment, as of the balance sheet date, is recognized in earnings, even if the decision to sell the security has not been made. The fair value of the security becomes the new amortized cost basis of the investment and is not adjusted for subsequent recoveries in fair value. Available-for-sale debt securities were not considered to be other-than-temporarily impaired as of December 31, 2018, 2017, or 2016 because the unrealized losses were related to changes in interest rates and did not affect the expected cash flows to be received, or indicate a loss of value on the underlying collateral, or a loss of financial stability on the part of the issuer. Management concluded that the declines in fair value of the investment portfolio as of the reporting dates is temporary and that values would recover by way of increases in market price or positive changes in market interest rates. Deferred Income Taxes The Company provides for deferred income taxes on the asset and liability approach, whereby a deferred tax liability or asset is recognized for the estimated future tax effect attributable to temporary differences or carryforwards. Temporary differences are the differences between the reported amounts of assets and liabilities in the financial statements and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. Business Combinations FINANCIAL CONDITION Assets The Company’s total assets increased $99.6 million, or 11.7%, from $852.1 million at December 31, 2017 to $951.7 million at December 31, 2018. The growth in assets is primarily attributable to management’s efforts to increase the amount and quality of its loan portfolio through its loan origination activities and by investing in quality loan pools, primarily funded through a growth in deposits. Following is a detailed discussion and analysis of events and transactions during the years ended December 31, 2018 and 2017 and the impacts that have been realized with respect to Patriot’s financial position. Cash and cash equivalents Cash and cash equivalents have increased $17.7 million or 36.3%, from $48.7 million at December 31, 2017 to $66.4 million as of December 31, 2018. The net cash provided primarily due to a $59.7 million increase in deposits, and $37.0 million of proceeds from maturity or sales on available-for-sale securities, and $5.6 million in net cash provided by operations during the period. The cash inflows were partially offset by funding of $47.1 million in purchases of loans and $18.6 million in purchases of available-for-sale securities, and $29.8 million in repayments of FHLB and correspondent bank borrowing. Investment securities Patriot’s investment security portfolio has increased $13.9 million or 45.6% from $30.5 million at December 31, 2017 to $44.4 million at December 31, 2018. The total investment among the existing investment security classes, consisting of U.S. Treasury notes, U.S. Government agency mortgage-backed securities, corporate bonds, subordinated notes, and other investments. This increase was primarily attributable to purchases of $15.6 million of U.S. Government agency mortgage-backed securities and $3.0 million U.S. Treasury notes, which was offset by $2.3 million principal repayments on Government agency mortgage-backed securities, $1.5 million proceeds from maturity of U.S. Treasury notes, and $860,000 change in unrealized losses on the available-for-sale securities. In 2018, the Company sold $35.5 million securities acquired in the Prime Bank transaction, which were sold at the fair value at the acquisition date with no recorded gain or loss. Loans receivable, net The following table provides the composition of the Company’s loan portfolio as of December 31, for each of the years shown:
The total loans receivable increased $60.8 million or 8.4%, from $719.6 million at December 31, 2017 to $780.4 million at December 31, 2018. The increase in loans receivable included purchases of $21.4 million education loans and $25.6 million of residential real estate loans. In addition, loans totaling $21.6 million were acquired from Prime Bank. Excluding the loan purchases and acquisitions, net loans receivable decreased $5.3 million. The Company continued to demonstrate impressive trajectory in its core competency of loan originations, with approximately $230 million in new loans funded and committed in 2018. As of December 31, 2018, the loan pipeline was strong, and management expects continued growth. The Company will continue to add to the product lines and enhance service offerings to the customers. Maturities and Sensitivities of Loans to Changes in Interest Rates The following table presents loans receivable, gross by portfolio segment, by contractual maturity as of December 31, 2018:
Approximately 37.5% of the loan portfolio is variable rate and reprices with changes in interest rates within three months of the rate change. The balance of the loan portfolio is either fixed rate or variable over a longer period of rate change (for example, adjustable rate mortgage loans are generally fixed for 3-5 years and then reprice annually after the fixed period). All variable rate loans account for 71.1% of the total loan portfolio, which is attractive to the Bank in a period of increasing interest rates. As a community bank, the Bank is invested in a thriving, robust local economy, which may be subject to the vagaries of general economic conditions. The existing conditions have led an investment in the loan portfolio weighted to Commercial Real Estate and Commercial and Industrial, which accounts for 59.8% of total loans receivable. These loans generally are collateralized by the underlying real estate and supported by personal guarantees of the borrowers. Allowance for Loan and Lease Losses The allowance for loan and lease losses increased $1.3 million from $6.3 million at December 31, 2017 to $7.6 million at December 31, 2018. The increase was primarily attributable to $1.0 million provision booked in December 2018, that was associated with one loan stemming from operating cash flow weakness and a collateral shortfall. Based upon the overall assessment and evaluation of the loan portfolio at December 31, 2018, management believes the allowance for loan and lease losses of $7.6 million, which represents 0.98% of gross loans outstanding, was adequate under prevailing economic conditions to absorb existing losses in the loan portfolio. The following table provides detail of activity in the allowance for loan and lease losses:
The following table provides an allocation of allowance for loan and lease losses by portfolio segment and the percentage of the loans to total loans:
Nonperforming Assets The following table presents non-accrual and accruing loans which were past due by over 90 days for the dates indicated:
Non-accrual loans increased $15.4 million, from $3.8 million at December 31, 2017 to $19.2 million at December 31, 2018. The $19.2 million of non-accrual loans at December 31, 2018 is comprised of 23 relationships, for which a specific reserve of $1.5 million has been established. The $3.8 million of non-accrual loans at December 31, 2017 is comprised of eight relationships, for which a specific reserve of $253,000 has been established. The Company has obtained appraisal reports from independent licensed appraisal firms and discounted those values for estimated selling costs to estimate potential loan impairment. Premises and equipment Management continuously reviews its branch locations and corporate offices to improve penetration in targeted markets and increase operating efficiencies. During the year ended December 31, 2018, construction-in-process decreased approximately $2.1 million or 94.9%. Reduction of the construction-in-process was primarily impacted by the completion of the renovation and build-out of a new branch location in Westport, CT located at 50 Charles Street. Other Real Estate Owned (“OREO”) As of December 31, 2018 and 2017, Patriot recorded OREO of $2.9 million and $0 on the Consolidated Balance Sheet, respectively. The 2018 OREO balance consists of two properties, $1.0 million was acquired from the acquisition of Prime Bank in May 2018, and the additional $1.9 million represents the value of one loan receivable due from the mortgagor of a foreclosed residential property that is currently being marketed for sale. No OREO property was sold in 2018. In 2017, Patriot sold the OREO recorded in 2016 and recognized a loss of $9,000. Deferred Taxes As of December 31, 2018, Patriot has available approximately $19.6 million of Federal net operating loss carryforwards (“NOL”) that is offset by $15.5 million in §382 limitations imposed by the Internal Revenue Code.The $4.1 million of Federal NOLs are available to offset Patriot’s taxable income for periods up to and through 2032, as these NOLs expire on various dates beginning in 2029. In 2018, the Bank recorded an uncertain tax position (“UTP”) of $1.1 million related to the utilization of certain federal net operating losses. At December 31, 2017, there were no uncertain tax positions recognized in the Consolidated Financial Statements. Additionally, Patriot has approximately $51.6 million of NOLs available for Connecticut tax purposes, which may be used to offset up to 50% of taxable income in any year. The NOLs have an approximate fourteen year life. As of December 31, 2018, Patriot had a $10.9 million deferred tax asset, comprised of multiple temporary differences, in addition to the previously aforementioned NOLs, which management believes will be fully realized in the future. The assessment of the potential realizability of the deferred tax assets is based on observation of the condition and future of the Bank, including:
There is no guarantee that Patriot will realize the benefits of the NOLs in the future. As such, management continues to evaluate its ability to realize the benefits of the net deferred tax assets and will act accordingly if conditions change. Deposits Total deposits increased by $105.8 million or 16.6%, from $637.4 million at December 31, 2017 to $743.3 million at December 31, 2018. The increase included a $45.5 million increase in brokered deposits and a $41.9 million increase in listed time deposits as the Bank utilizes these wholesale funding sources to support growth in its loan portfolio. In addition, $46.2 million of the increase came from the purchase of Prime Bank, which partially offsets a $54.1 million decrease in savings accounts. Changes in all the deposit accounts may be summarized as:
Borrowings Total borrowings declined by $10.4 million or 7.4%, from $141.4 million at December 31, 2017 to $131.0 million at December 31, 2018. Borrowings consist of Federal Home Loan Bank (“FHLB”) advances, senior notes, junior subordinated debentures, and a note payable to the seller from whom the Fairfield branch building was purchased in 2015. FHLB advances decreased by $20.0 million or 16.7% at December 31, 2018 compared to 2017, which decrease is primarily attributable to the decision to fund balance sheet growth at slightly lower rates in the brokered deposit market. The Bank maintains strong standing with the FHLB and its “Well Capitalized” designation with the FDIC, as provided below. On June 29, 2018, the Company entered into certain subordinated note purchase agreements with two institutional accredited investors and completed a private placement of $10 million of fixed-to-floating rate subordinated notes with the maturity date of September 30, 2028 pursuant to Section 4(a)(2) of the Securities Act of 1933, as amended, and Rule 506(b) of Regulation D promulgated thereunder. Proceeds of $7.8 million was directly contributed to the Bank. The subordinated debt qualifies for Tier 2 Capital of the Company and the funds contributed to the Bank qualify as Tier 1 capital at the Bank. Shareholders’ Equity Equity increased $2.6 million from $66.7 million at December 31, 2017 to $69.3 million at December 31, 2018, primarily due to $3.2 million of year-to-date net income, $220,000 of equity compensation, which were offset by $671,000 of investment portfolio unrealized loss and $154,000 common stock dividend payments. Derivatives In 2018, Patriot entered into two interest rate swaps (“swaps”), one with a loan customer to provide a facility to mitigate the fluctuations in the variable rate on the respective loan. The customer swap is matched in offsetting terms to another swap that Patriot entered with an outside third party. These two swaps are reported at fair value in other assets or other liabilities. Patriot’s swaps qualify as derivatives, but are not designated as hedging instruments, thus any net gain or loss resulting from changes in the fair value is recognized in other noninterest income. A net gain of $98,000 was recognized on the swaps for the year ended December 31, 2018, resulting from one nonperiodic payment to Patriot from the outside third party. Further discussion of the final derivatives is set forth in Note 19 to the Consolidated Financial Statements. Average Balances The following table presents daily average balance sheets, interest income, interest expense and the corresponding yields earned and rates paid for each of the years in the three-year period ended December 31, 2018.
The following table presents the change in interest-earning assets and interest-bearing liabilities by major category and the related change in the interest income earned and interest expense incurred thereon attributable to the change in transactional volume in the financial instruments and the rates of interest applicable thereto, comparing the years ended December 31, 2018 to 2017 and December 31, 2017 to 2016.
RESULTS OF OPERATIONS Comparison of Results of Operations for the years 2018 and 2017 For the year ended December 31, 2018, the Company recorded net income of $3.2 million ($0.82 per share) compared to a net income of $4.1 million ($1.06 per share) for the year ended December 31, 2017. Income before tax expense was $4.1 million compared to 2017’s income before income tax expense of $7.0 million. Highlights include:
The 2018 net income is not comparable to the same period in the prior year due to a $2.8 million credit recovery that was recognized in the first quarter of 2017 and $2.1 million of non-recurring acquisition-related expenses recognized in 2018. Net interest income Net interest income is the difference between interest income on interest earning assets and interest expense on interest-bearing liabilities. Net interest income depends on the relative amounts of interest earning assets and interest bearing liabilities and the interest rates earned or paid on them, respectively. Net interest income for the years ended December 31, 2018 and 2017 was $28.0 million and $25.9 million, respectively. The increase of $2.1 million in 2018 over the previous year was the result of focused growth and diversification in the loan portfolio which yielded an increase in interest income. Average loan balances increased $86.0 million in 2018 as compared to 2017. Average yields on loans increased slightly from 4.72% in 2017 to 5.02% in 2018. As loans continued to grow in 2018, so did the need to increase the Bank’s deposit base and liquidity sources. Since the second half of 2016, the Bank has adopted a certificate of deposits (CD) program to attract term deposits at competitive rates. For the year ended December 31, 2018, total interest expense increased $5.4 million compared to the year ended December 31, 2017, primarily driven by $4.1 million increase in interest on deposits as the result of an increase in higher cost brokered and listing service deposits which carry higher rates than retail banking deposits. In addition, interest expense increased $407,000 primarily associated with the subordinated debt issued on June 29, 2018. Net interest margin for the year ended December 31, 2018 was 3.29% as compared to 3.58% for 2017. The decline in net interest margin reflects the impact of the subordinated debt added on June 29, 2018 and increasing deposit costs associated with higher rates paid on retail deposits and an increased reliance on more expansive wholesale funding sources. Provision (credit) for loan losses For the year ended December 31, 2018, provision (credit) for loan losses increased to $1.3 million, as compared to a net credit for loan losses of $857,000 in 2017. The increase of provision (credit) for loan losses in 2018 was the growth in the loan portfolio and an incremental provision recognized in December 2018 associated with a single credit experiencing cash flow difficulty. The credit for loan losses in 2017 represents an insurance recovery for a loan that had been fully reserved in a previous year. Non-interest income Non-interest income increased $183,000 from $1.4 million for 2017 to $1.6 million for 2018. The increase was primarily attributable to realized gains on the sale of SBA loans. Non-interest expense Non-interest expense increased $3.0 million from $21.2 million for 2017 to $24.2 million for 2018. The increase in non-interest expense was primarily impacted by an increase of $826,000 in salaries and benefits associated with increased staffing, and $1.5 million increase in nonrecurring project costs for merger and tax initiative projects. Excluding project costs, full year 2018 operating expense increased 8% reflecting investments in the organic SBA business and deposit gathering initiatives. Business Combination On August 1, 2017, a definitive merger agreement was entered into by and among the Company, Patriot Bank, Prime Bank, a Connecticut bank headquartered in Orange, CT (“Prime Bank”) (PMHV:US) and a stockholder representative of Prime Bank. On May 10, 2018, the Company completed its acquisition of Prime Bank. The closing of the transaction added a new Patriot branch located in the Town of Orange, New Haven County, Connecticut. On the acquisition date, Prime Bank had assets with a carrying value of approximately $65 million, including investment securities with a carrying value of $36 million, loans outstanding with a carrying value of approximately $23 million, as well as deposits with a carrying value of approximately $46 million. The results of Prime Bank’s operations are included in the Company’s Consolidated Statement of Income from the date of acquisition. The acquisition enabled Patriot to expand its consumer and small business relationships, lending operations, and community presence, all of which are expected to improve key operating metrics. Pending Acquisition and Subsequent Termination On February 06, 2018, the Company and Hana SBL, a wholly-owned subsidiary of Hana Financial, Inc. (“Hana Financial”) announced the signing of a definitive purchase agreement pursuant to which Patriot would acquire Hana SBL’s SBA Lending business. On August 2, 2018, the Company, Hana SBL and three wholly-owned subsidiaries of Hana SBL, entered into an amendment to the purchase agreement, pursuant to which the closing date of the above referenced transaction had been extended from August 2, 2018 to August 1, 2019. On October 29, 2018, the Company withdrew its initial application to the OCC requesting approval of the acquisition of Hana SBL. As of March 30, 2019, the Company has not received regulatory non-objection. On March 30, 2019 the Company and Hana SBL mutually agreed to terminate the purchase agreement between the parties. The termination agreement provides for the release of escrowed funds back to the Company. Comparison of Results of Operations for the years 2017 and 2016 For the year ended December 31, 2017, the Company recorded net income of $4.1 million ($1.06 per share) compared to a net income of $1.9 million ($0.49 per share) for the year ended December 31, 2016. The 2017 full year results represented the strongest earnings year in the Company’s history. Income before tax expense was $7.0 million in 2017 compared to 2016’s income before income tax expense of $3.1 million. Highlights include:
The positive results for 2017 demonstrate the continued growth and success of the Company, primarily due to loan and deposit growth as well as balance sheet and operational efficiencies implemented during the past two years. These initiatives included:
Net interest Income Net interest income is the difference between interest income on interest earning assets and interest expense on interest-bearing liabilities. Net interest income depends on the relative amounts of interest earning assets and interest bearing liabilities and the interest rates earned or paid on them, respectively. Net interest income for the years ended December 31, 2017 and 2016 was $25.9 million and $22.4 million, respectively. The increase of $3.5 million in 2017 over the previous year as focused growth and diversification in the loan portfolio yielded an increase in interest income. Average loan balances increased $140.3 million in 2017 as compared to the year ended December 31, 2016. Average yields on loans increased slightly to 4.72% in 2017 from 4.67% in 2016. Average yields on investment securities improved in 2017 to 3.54% from 2.39% in 2016 resulting in higher interest income of $468,000. This increase was primarily due to average higher yield of the subordinated bonds from two creditworthy financial institutions, which were purchased during 2016, each yielding 5% or greater. As loans continued to grow in 2017, so did the need to increase the Bank’s deposit base and liquidity sources. Since the second half of 2016, the Bank has adopted a certificate of deposits (CD) program to attract term deposits at competitive rates. For the year ended December 31, 2017, total interest expense increased $3.9 million as compared to the year ended December 31, 2016, primarily driven by $2.7 million increase in interest on deposits as the result of an increase in deposit volumes and rates. In addition, interest expense increased $890,000 associated with the issuance of senior debt in December 2016. In December 2016, the Company completed an issuance, through a private placement, of $12 million aggregate principal amount of 7.0% fixed senior unsecured notes due December 22, 2021 (the “Notes”). The Notes were issued pursuant to a Purchase Agreement, dated as of December 22, 2016, between the Company and accredited institutional investors. The Notes bear a fixed interest rate of 7.00% per annum from December 22, 2016 up to but excluding December 22, 2021. The Notes are payable semi-annually in arrears on June 22 and December 22 of each year, beginning June 22, 2017. The Notes are not subject to redemption at the option of the Company. Principal and interest on the Notes are subject to acceleration only in limited circumstances. Net interest margin for the year ended December 31, 2017 was 3.58% as compared to 3.78% for the year-ago period. The margin decline primarily reflected the cost of the Senior Notes and the higher cost associated with raising funds in the brokered deposit market. Management regularly reviews loan and deposit rates and strives to price the Bank’s products competitively. The Bank tracks its mix of asset and liability maturities and manages its balance sheet in an effort to maintain a reasonable maturity match, between the two. Provision for loan losses For the year ended December 31, 2017, provision (credit) for loan losses of $(857,000) decreased $3.3 million from $2.5 million provision in 2016. This is primarily attributable to a single recovery in its Commercial and Industrial portfolio segment. Potential loss on the loan was fully reserved during 2016 and the loan was charged off during the fourth quarter of 2016. In March 2017, the Bank received a $2.8 million insurance recovery, which was recorded as a credit to the allowance for loan and lease losses. Non-interest income Non-interest income decreased $112,000 from $1.6 million for 2016 to $1.4 million for 2017. The decrease was primarily attributable to a decrease of $107,000 in loan application and processing fees, a $10,000 decrease in deposit fees and service charges, and a $15,000 decrease in rental income. Non-interest expense Non-interest expense increased $2.8 million from $18.4 million for 2016 to $21.2 million for 2017. As the Bank grew in 2017, additional client facing and support team members were necessary. As such, salary and related benefit costs increased by $1.4 million and professional and other outside services increased $303,000. In addition, the expenses were impacted by non-recurring project costs of $640,000 associated with the pending merger and acquisition and an income tax related consulting project in 2017. LIQUIDITY The Company’s balance sheet liquidity to total assets ratio was 10.7% at December 31, 2018 compared to 8.2% at December 31, 2017. Liquidity including readily available off-balance sheet funding sources was 19.4% at December 31, 2018 compared to 15.6% at December 31, 2017. The Company’s available total liquidity (readily available plus brokered deposit availability) to total assets ratio was 23.7% at December 31, 2018 compared to 18.3% at December 31, 2017. The following categories of assets are considered balance sheet liquidity: cash and due from banks, federal funds sold (if any), short-term investments (if any) and unpledged available-for-sale securities. In addition, off balance sheet funding sources include collateral based borrowing available from the FHLB, correspondent bank borrowing lines, and brokered deposits subject to internal limitations. Liquidity is a measure of the Company’s ability to generate adequate cash to meet its financial obligations. The principal cash requirements of a financial institution are to cover downward fluctuations in deposit accounts. Management believes the Company’s liquid assets provide sufficient coverage to satisfy loan demand, cover potential fluctuations in deposit accounts, and to meet other anticipated operational cash requirements. At December 31, 2018, cash and cash equivalents and unpledged available-for-sale securities amounted to $66.4 million and $32.5 million, respectively. At December 31, 2018, the Bank had additional borrowing capacity of $49.9 million available from FHLB Boston, which is comprised of $47.9 million of advances and a $2.0 million overnight line of credit. These amounts are in addition to the FHLB advances of $100 million that are outstanding at December 31, 2018. Additionally, the Bank has the ability to borrow from the FRB. As of December 31, 2018, the maturities of Patriot’s contractual obligations are as follows:
OFF-BALANCE SHEET ARRANGEMENTS The Bank’s off-balance sheet commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee by the borrower. Since these commitments could expire without being drawn upon or are contingent upon the customer adhering to the terms of the agreements, the total commitment amounts do not necessarily represent future cash requirements. As of December 31, 2018, the Bank’s off-balance sheet commitments are as follows:
REGULATORY CAPITAL REQUIREMENTS The following tables illustrate the Company’s and the Bank’s regulatory capital ratios at December 31, 2018 and 2017:
Capital adequacy is one of the most important factors used to determine the safety and soundness of individual banks and the banking system. Under the regulatory framework for prompt correction action, to be considered “well capitalized,” an institution must generally have a leverage capital ratio of at least 5.0%, Common Equity Tier 1 capital ratio at least 6.5%, a Tier 1 risk-based capital ratio of at least 8.0% and a total risk-based capital ratio of at least 10%. However, the OCC has the discretion to require increased capital ratios. Under the final capital rules that became effective on January 1, 2015, there is a requirement for a CET1 Capital conservation buffer of 2.5% of risk-weighted assets, which is in addition to the other minimum risk-based capital standards in the rule. Institutions that do not maintain this required capital buffer become subject to progressively more stringent limitations on the percentage of earnings that may be distributed to shareholders or used for stock repurchases and on the payment of discretionary bonuses to senior executive management. The capital buffer requirement is being phased in over three years beginning in 2016. The 0.625% capital conservation buffer for 2016 has been included in the minimum capital adequacy ratios in 2016 column in the table above. The capital conversation buffer increased to 1.25% for 2017, which has been included in the minimum capital adequacy ratios in the 2017 column above. The capital conversation buffer increased to 1.875% for 2018, which has been included in the minimum capital adequacy ratios in the 2018 column above. The capital buffer requirement effectively raises the minimum required Total Capital ratio to 10.5%, the Tier 1 Capital ratio to 8.5%, and the CET1 Capital ratio to 7.0% on a fully phased-in basis, which will be effective beginning on January 1, 2019. As of December 31, 2018, Patriot satisfies all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis, as if all such requirements were currently in effect. Management continuously assesses the adequacy of the Bank’s capital with the goal to maintain a “well capitalized” classification. ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk Market risk is defined as the sensitivity of income to fluctuations in interest rates, foreign exchange rates, equity prices, commodity prices and other market-driven rates or prices. The Bank’s market risk is primarily limited to interest rate risk. The Bank’s goal is to maximize long term profitability while minimizing its exposure to interest rate fluctuations. The first priority is to structure and price the Bank’s assets and liabilities to maintain an acceptable interest rate spread while reducing the net effect of changes in interest rates. In order to accomplish this, the focus is on maintaining a proper balance between the timing and volume of assets and liabilities re-pricing within the balance sheet. One method of achieving this balance is to originate variable rate loans for the portfolio and purchase short-term investments to offset the increasing short term re-pricing of the liability side of the balance sheet. In fact, a number of the interest-bearing deposit products have no contractual maturity. Therefore, deposit balances may run off unexpectedly due to changing market conditions. Additionally, loans and investments with longer term rate adjustment frequencies can be matched against longer term deposits and borrowings to lock in a desirable spread. The exposure to interest rate risk is monitored by the Management Asset and Liability Committee consisting of senior management personnel. The Committee reviews the interrelationships within the balance sheet to maximize net interest income within acceptable levels of risk. This Committee reports to the Board of
Management analyzes the Bank’s interest rate sensitivity position to manage the risk associated with interest rate movements through the use of interest income simulation and GAP analysis. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest sensitive.” An asset or liability is said to be interest sensitive within a specific time period if it will mature or reprice within that time period. Management’s goal is to manage asset and liability positions to moderate the effects of interest rate fluctuations on net interest income. Interest income simulations are completed quarterly and presented to ALCO. The simulations provide an estimate of the Simulation analysis is only an estimate of the Company’s interest rate risk exposure at a particular point in time. Management regularly reviews the potential effect changes in interest rates could have on the repayment of rate sensitive assets and funding requirements of rate sensitive liabilities. The tables below set forth examples of changes in estimated net interest income and the estimated net portfolio value based on projected scenarios of interest rate increases and decreases. The analyses indicate the rate risk embedded in the Company’s portfolio at the dates indicated should all interest rates instantaneously rise or fall. The results of these changes are added to or subtracted from the base case; however, there are certain limitations to these types of analyses. Rate changes are rarely instantaneous and these analyses may therefore overstate the impact of short-term repricings. As a result of the historically low interest rate environment, the calculated effects of the 100 and 200 basis point downward shocks cannot absolutely reflect the risk to earnings and equity, since the interest rates on certain balance sheet items have approached their minimums. Therefore, it is not possible for
Impact of Inflation and Changing Prices Patriot’s financial statements have been prepared in terms of historical dollars, without considering changes in relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on the Bank’s performance than the effect of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as ITEM 8. Financial Statements and Supplementary Data The Financial Statements required by - Report of Independent Registered Public Accounting Firm - As of and - Report of Independent Registered Public Accounting Firm - For the year ended December 31, 2016 - Consolidated Balance Sheets as of December 31, 2018 and 2017 - Consolidated Statements of Income for each of the years in the three-year period ended December 31, 2018 - Consolidated Statements of Comprehensive Income for each of the years in the three-year period ended December 31, 2018 - Consolidated Statements of Shareholders’ Equity for each of the years in the three-year period ended December 31, 2018 - Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 2018 - Consolidated Supplemental Statements of Non-Cash Activity for each of the years in the three-year period ended December 31, 2018 - Notes to Consolidated Financial Statements The supplementary data required by this item (selected quarterly financial data) is provided below. The following tables present the summarized quarterly results of operations (unaudited) to the
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. ITEM 9A. Controls and Procedures Disclosure Controls and Procedures Patriot
As used herein, “disclosure controls and procedures” means controls and other procedures of
A Management’s Annual Report on Internal Control Over Financial Reporting Patriot’s management is responsible for establishing and maintaining adequate internal controls over financial reporting, as defined in rules 13a-15(f) and 15d-15f under the Exchange Act. Patriot’s internal control over financial reporting is a process designed under the supervision of its Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP. Patriot’s internal control over financial reporting includes those policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and deployment of its assets; provide reasonable assurance that transactions are recorded in a timely manner to enable the preparation of financial statements in accordance with U.S. GAAP; receipts and disbursements are made only in compliance with the authorizations established by management and policies instituted by its Board of Directors; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of assets that could have a material effect on the financial statements. Due to its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. In addition, projections of any evaluations of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and/or procedures may deteriorate. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company’s financial statements will not be prevented or detected on a timely basis. Management assessed the effectiveness of internal controls over financial reporting as of December 31, 2018, based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control — Integrated Framework (2013). Based on this assessment, management concluded that internal control over financial reporting was not effective as of December 31, 2018 as a result of an identified material weakness resulting from the aggregation of control deficiencies in management’s review of the calculation of the allowance for loan losses, which includes the review of the completeness and accuracy of inputs and other information used in the allowance for loan losses calculation, as well as the precision of management’s review over the allowance for loan losses calculation. Management has reviewed and confirmed that the calculation of the allowance for loan losses included in the December 31, 2018 financial statements did not result in a material misstatement of the consolidated financial statements for any period presented. Management is currently reviewing the control processes around the precision of the preparation and review of the calculation of the allowance for loan losses for completeness and accuracy in light of the material weakness identified and will incorporate any necessary changes to its processes, including expanding the resources dedicated to the preparation and review of the calculations and strengthening the documentation of the support for the underlying assumptions included in the allowance for loan losses calculation. In accordance with the rules and regulations of the SEC, management’s report on the design and effectiveness of Patriot’s system of internal controls over financial reporting is not subject to attestation by Patriot’s independent registered public accounting firm. The SEC rules and regulations applicable to Patriot only require a report by management. Accordingly, this annual report filed on Form 10-K for the year ended December 31, 2018 does not include an opinion by Patriot’s independent registered public accounting firm regarding management’s system of internal controls over financial reporting. Changes in Internal Control Over Financial Reporting There were no changes in the Company’s internal controls over financial reporting during the fourth fiscal quarter of 2018 that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting. ITEM 9B. Other Information Agreement with the OCC On November 7, 2018, the Bank entered into an agreement (the “Agreement”) with the OCC, pursuant to which the Bank agreed to take certain actions, including the following:
As a result of the Agreement, the Bank is designated by the OCC to be in “troubled condition” as set forth in 12 C.F.R. §5.51(c)(7)(ii) and not an “eligible bank” for purposes of 12 C.F.R. §5.3(g) and 12 C.F.R. §24.2(e). Patriot has provided the documents requested in each of the items in the Agreement and awaits further assessment by the OCC. Patriot will continue to respond and address enhancements requested by the OCC, if any. The foregoing description of the terms of the Agreement does not purport to be complete and is qualified in its entirety by reference to the full text of the form of the Agreement filed as Exhibit 99(1) to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2018 filed on November 14, 2018, which is incorporated herein by reference. Termination of Purchase Agreement with Hana SBL On March 30, 2019, the Company, Hana SBL and three wholly-owned subsidiaries of Hana SBL agreed to terminate a purchase agreement to acquire Hana SBL’s SBA Lending business by the Company, which was entered into by and among the parties on February 06, 2018 and amended on August 2, 2018. The termination agreement provides for the release of escrowed funds back to the Company. PART III ITEM 10. Directors, Executive Officers and Corporate Governance The information required by Items 401, 405, 406 and 407 (c)(3); (d)(4) and (d)(5) of Regulation S-K is incorporated into this Form 10-K by reference to the Company’s definitive proxy statement or information statement for its 2018 Annual Meeting of Shareholders to be filed within 120 days following December 31, 2018. The Company has previously adopted a Code of
ITEM 11. Executive Compensation The ITEM 12. Security Ownership of The information required by Item 201(d) and Item 403 of Regulation S-K is incorporated into this Form 10-K by reference to the Definitive Proxy Statement or
The table below
ITEM 13. Certain Relationships and Related Transactions, and Director Independence The information required by Items 404 and 407(a) of Regulation S-K is incorporated into this Form 10-K by reference to the Definitive Proxy Statement or Information Statement to be filed within 120 days following December 31, 2018. ITEM 14. Principal Accountant Fees and Services The information required by Item 9(e) of Schedule 14A of Regulation S-K is incorporated into this Form 10-K by reference to the Definitive Proxy Statement or Information Statement to be filed within 120 days following December 31, 2018. Part IV ITEM 15. Exhibits and Financial Statement Schedules
To the Shareholders and the Board of Directors of Patriot National Bancorp, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Patriot National Bancorp, Inc. and its subsidiary (the Company) as of December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income, shareholders’ equity and cash flows for each of the Basis for Opinion These financial statements are the responsibility of the Company’s management. Our responsibility is to We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or
/s/ RSM US LLP We have served as the Company's auditor since 2017. New Haven, Connecticut April 1, 2019 Report of PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
See Accompanying Notes to Consolidated Financial Statements. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME
See Accompanying Notes to Consolidated Financial Statements. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
See Accompanying Notes to Consolidated Financial Statements. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
See Accompanying Notes to Consolidated Financial Statements. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS
See Accompanying Notes to Consolidated Financial Statements.
See Accompanying Notes to Consolidated Financial Statements. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements
Patriot National Bancorp, Inc.
On March 11, 2003, the Company formed Patriot National Statutory Trust I (the “Trust”) for the purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures issued by the Company, and on March 26, 2003, the first series of trust preferred securities were issued. In accordance with accounting principles generally accepted in the United States of America (“US GAAP”), the Trust is not included in the Company’s Consolidated Financial Statements. On May 10, 2018 the Bank completed its acquisition of Prime Bank, a Connecticut bank headquartered in Orange, CT (“Prime Bank”). The closing of the transaction added a new Patriot branch located in the Town of Orange, New Haven County, Connecticut. The results of Prime Bank’s operations are included in the Company’s Consolidated Financial Statements from the date of acquisition. The preparation of consolidated financial statements in accordance with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and to disclose contingent assets and liabilities. Actual results could differ from those estimates. Management has identified accounting for the allowance for loan losses, the analysis and valuation of its investment securities, the valuation of deferred tax assets, and accounting for the business combination as certain of Patriot’s more significant accounting policies and estimates, in that they are critical to the presentation of Patriot’s financial condition and results of operations. As they concern matters that are inherently uncertain, these estimates require management to make subjective and complex judgments in the preparation of Patriot’s Consolidated Financial Statements. These and other of Patriot’s significant accounting policies are summarized below. Certain prior period amounts have been reclassified to conform to current year presentation. Summary of Significant Accounting Policies Principles of consolidation and basis of financial statement presentation The Consolidated Financial Statements include the accounts of Patriot, and the Bank's wholly owned subsidiaries, PinPat Acquisition Corporation and ABC HOLD Co, LLC, (inactive) and have been prepared in conformity with US GAAP. All significant intercompany balances and transactions have been eliminated. Cash and cash equivalents Patriot considers all short-term, highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Cash and due from banks, federal funds sold, and short-term investments are recognized as cash equivalents in the Consolidated Balance Sheets. Patriot maintains amounts due from banks which, at times, may exceed federally insured limits. Patriot has not experienced any losses from such concentrations. Federal Reserve Bank and Federal Home Loan Bank stock The Bank is required to maintain an investment in capital stock of the Federal Home Loan Bank of Boston (“FHLB”), as collateral, in an amount equal to a percentage of its outstanding mortgage loans and loans secured by residential properties, including mortgage-backed securities. Additionally, the Bank is required to maintain an investment in the capital stock of the Federal Reserve Bank (“FRB”), as collateral, in an amount equal to one percent of six percent of the Bank’s total equity capital as per its latest Report of Condition (“Call Report”) filed with the Federal Deposit Insurance Corporation. The FRB requires that one-half of the investment in its stock be funded currently, with the remaining amount subject to call when deemed necessary by the FRB Board of Governors. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements Shares in the FHLB and FRB are purchased and redeemed based upon their $100 par value. The stocks are non-marketable equity securities, and as such, are considered restricted securities that are carried at cost, and evaluated for impairment in accordance with relevant accounting guidance. In accordance with this guidance, the stocks’ values are determined by the ultimate recoverability of the par value rather than by recognizing temporary declines. The determination of whether the par value will ultimately be recovered is influenced by criteria such as: (a) the significance of any decline in net assets of the FHLB or FRB, as applicable, compared to its capital stock amount, and the length of time this situation has persisted; (b) commitments by either the FHLB or FRB to make payments required by law or regulation and the level of such payments in relation to their operating performance; (c) the potential impact of any legislative or regulatory changes; and (d) the regulatory capital ratios and liquidity position of the FHLB or FRB, as applicable. Included in the Bank’s investment portfolio are shares in the FHLB and FRB of $7.8 million and $8.4 million as of December 31, 2018 and 2017, respectively. Management has evaluated its investment in the capital stock of the FHLB and FRB for impairment, based on the aforementioned criteria, and has determined that as of December 31, 2018 and 2017 there is no impairment of its investment in either the FHLB or FRB. Investment Securities Management determines the appropriate classification of securities at the date individual investment securities are acquired, and the appropriateness of such classification is reassessed at each balance sheet date. Debt securities, if any, that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and are recorded at amortized cost. “Trading” securities, if any, are carried at fair value with unrealized gains and losses recognized in earnings. Securities classified as “available-for-sale” are recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income (loss), net of taxes. Purchase premiums and discounts are recognized in interest income using the interest method of accounting, in order to achieve a constant effective yield over the contractual term of the securities. Patriot conducts a quarterly review and evaluation of the securities portfolio to determine if a decline in the fair value of any security below its cost basis is an other-than-temporary impairment (“OTTI”). Our evaluation of OTTI considers the duration and severity of the impairment, our intent to hold the securities, whether or not we will be required to sell the securities, and our assessments of the reason for the decline in value and the likelihood of a near-term recovery. If such decline is deemed to be an OTTI, the security is written down to its fair value, which becomes its new cost basis, and the resulting loss is charged to earnings as a component of non-interest income. Other than the credit loss portion, OTTI on a debt security that we have the intent and ability to hold until recovery of its amortized cost is recognized in other comprehensive income/loss, net of applicable taxes. The credit loss portion of OTTI (i.e., any losses resulting from an inability to collect on the instrument) is charged against earnings. Security transactions are recorded on the trade date. Realized gains and losses on the sale of securities are determined using the specific identification method, recorded on the trade date, and reported in non-interest income for the period. At December 31, 2018 and 2017, the Bank’s investment portfolio includes a $4.5 million investment in the Solomon Hess SBA Loan Fund (“SBA Fund”). The Bank uses this investment to satisfy its Community Reinvestment Act lending requirements. At December 31, 2018 and 2017, the investment in the SBA Fund is reported in the Consolidated Balance Sheets at cost, which management believes approximates fair value. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements Loans receivable Loans that Patriot has the intent and ability to hold until maturity or for the foreseeable future generally are reported at their outstanding unpaid principal balances adjusted for unearned income, an allowance for loan losses, if any, and any unamortized discount, premium and deferred fees. Interest income is accrued based on unpaid principal balances. Loan application fees are reported as non-interest income, while other certain direct origination costs, or for purchased loans, any discounts or premiums are deferred and amortized to interest income as a level yield adjustment over the respective term of the loan. Loans are placed on non-accrual status or charged off when collection of principal or interest is considered doubtful. The accrual of interest on loans is discontinued no later than when the loan is 90 days past due for payment, unless the loan is well secured and in process of collection. Consumer installment loans are typically charged off no later than when they become 180 days past due. Past due status is based on the contractual terms of the loan. Accrued uncollected interest income on loans that are placed on non-accrual status or have been charged off is reversed against interest income. Interest income on such non-performing loans is accounted for on the cash-basis of accounting until qualifying for return to accrual status. Any cash received on non-accrual or charged off loans is first applied against unpaid and past-due principal and then to interest, unless the loan is in a cure period. If in a cure period, and management believes there will be a loss, cash receipts are applied to principal until the balance at risk and collateral value, if any, is equal to the amount management believes will ultimately be collected. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured. The interest on these loans is accounted for on the cash-basis method until qualifying for return to accrual status. Patriot’s real estate loans are collateralized by real estate located principally in Fairfield and New Haven Counties in Connecticut and Westchester County, New York. Accordingly, the ultimate collectability of a substantial portion of Patriot’s loan portfolio is susceptible to regional real estate market conditions. A loan is considered impaired when, based on current information and events, it is probable that Patriot will be unable to collect the scheduled payments of principal or interest when due, according to the loan’s contractual terms. Factors considered by management in determining impairment include payment status and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and shortfalls generally are not classified as impaired. Management determines the significance of payment delays and shortfalls on a case-by-case basis, taking into consideration the circumstances contributing to the borrower’s loan performance issues, including the length of the delay, the reasons for the delay, the borrower’s prior payment history, and the amount of the shortfall in relation to the principal and interest owed. For commercial and real estate loans, impairment is measured for each individual loan based on the present value of the expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or, for collateral dependent loans, the fair value of the collateral. Impaired loans also include loans modified in troubled debt restructurings (“TDR”), where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. TDRs are generally placed on non-accrual status until the loan qualifies for return to accrual status. Loans qualify for return to accrual status once they have demonstrated compliance with the restructured terms of the loan agreement and have performed for a minimum of six months. Lower balance lending arrangements, such as consumer installment loans, are evaluated for impairment by pooling the loans into homogenous groupings. Accordingly, Patriot does not separately identify individual consumer installment loans for impairment, unless such loans are individually evaluated for impairment due to financial difficulties of the borrower. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements Acquired Loans Acquired loans are initially recorded at their acquisition date fair values. The carryover of allowance for loan losses is prohibited as any credit losses in the acquired loans are included in the determination of the fair value of the loans at the acquisition date. Fair values for acquired loans are based on a discounted cash flow methodology that involves assumptions and judgments as to credit risk, prepayment risk, liquidity risk, default rates, loss severity, payment speeds, collateral values and discount rate. Acquired Impaired Loans- Purchase Credit Impaired “PCI” Loans Acquired loans that exhibit evidence of deterioration in credit quality since origination and for which it is probable, at acquisition, that the Company will be unable to collect all contractually required payments are accounted for as PCI loans under Accounting Standards Codification (“ASC”) 310-30. The excess of undiscounted cash flows expected at acquisition over the estimated fair value is referred to as the accretable discount and is accreted into interest income over the remaining life of the loans using the interest method. The difference between contractually required payments at acquisition and the undiscounted cash flows expected to be collected at acquisition is referred to as the non-accretable discount. The non-accretable discount represents estimated future credit losses and other contractually required payments that the Company does not expect to collect. Subsequent decreases in expected cash flows are recognized as impairments through a charge to the provision for loan losses resulting in an increase in the allowance for loan losses. Subsequent improvements in expected cash flows result in a recovery of previously recorded allowance for loan and lease losses or a reversal of a corresponding amount of the non-accretable discount, which the Company then reclassifies as an accretable discount that is accreted into interest income over the remaining life of the loans using the interest method. PCI loans are initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loan. Accordingly, the associated allowance for credit losses related to these loans is not carried over at the acquisition date. Acquired loans that met the criteria for non-accrual of interest prior to acquisition were not considered performing upon acquisition. When the customers resume payments, to make the nonaccrual loans current, the loans may return to accrual status, including the impact of any accretable discounts, if the Company can reasonably estimate the timing and amount of the expected cash flows on such loans and if the Company expects to fully collect the new carrying value of the loans. Acquired Non-impaired Loans Acquired loans that do not meet the requirements under ASC 310-30 are considered acquired non-impaired loans. The difference between the acquisition date fair value and the outstanding balance represents the fair value adjustment for a loan and includes both credit and interest rate considerations. Fair value adjustments may be discounts (or premiums) to a loan’s cost basis and are accreted (or amortized) to net interest income (or expense) over the loan’s remaining life in accordance with ASC 310-20. Fair value adjustments for revolving loans are accreted (or amortized) using a straight-line method. Term loans are accreted (or amortized) using the constant effective yield method. Subsequent to the purchase date, the methods used to estimate the allowance for loan losses for the acquired non-impaired loans are consistent with the policy for allowance for loan losses described below. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements Allowance for loan and lease losses The allowance for loan and lease losses (“ALLL”) is regularly evaluated by management, based upon the nature and volume of the loan portfolio, periodic review of loan collectability using historical experience rates, adverse situations potentially affecting individual borrowers’ ability to repay, the estimated value of any underlying collateral, and prevailing economic conditions on overall segments of the loan portfolio. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The non-specific ALLL by loan segment is calculated using a systematic methodology, consisting of a quantitative and qualitative analytical component, applied on a quarterly basis to homogeneous loans. The model is comprised of six distinct loan portfolio segments: Commercial Real Estate, Residential Real Estate, Commercial and Industrial, Consumer and Other, Construction, and Construction to Permanent – Commercial Real Estate (“Construction to permanent – CRE”). Management monitors a distinct set of risk characteristics for each loan segment. Additionally, management assesses and monitors risk and performance on a disaggregated basis, including an internal risk rating system for loans included in the Commercial loan segment and analyzing the type of collateral, lien position, and loan-to-value (i.e., LTV) ratio for loans included in the Consumer loan segment. Management’s ALLL process first applies historical loss rates to pools of loans with homogeneous risk characteristics. Loss rates are calculated by historical charge-off rates that have occurred within each pool of homogenous loans over its loss emergence period (“LEP”). The LEP is an estimate of the average amount of time from the point at which a loan loss is incurred to the point in time at which the loan loss is confirmed. In general, the LEP will be shorter in an economic slowdown or recession and longer during times of economic stability or growth, when adverse conditions are not generally applicable across a class of borrowers and individual customers are better able to manage deteriorating conditions. Another key assumption is the look-back period (“LBP”), which represents the historical data period utilized to calculate loss rates. A three-year LBP is used for each loan segment, in order to capture relevant historical data believed to reflect losses inherent in the loan segment portfolios. After considering the historic loss calculations, management applies additional qualitative adjustments to the ALLL to reflect the inherent risk of loss that exists in the loan portfolio at the balance sheet date. Qualitative adjustments are made based upon changes in economic conditions, loan portfolio and asset quality data, and credit process changes, such as credit policies or underwriting standards. Evaluation of the ALLL requires considerable judgment, in order to adequately estimate and provide for the risk of loss inherent in the loan portfolio segments. Qualitative adjustments are aggregated into the nine categories described in the Interagency Policy Statement (“Interagency Statement”) issued by the bank regulators. Within the statement, the following qualitative factors are considered:
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements Patriot provides for loan losses by consistently applying the documented ALLL methodology. Loan losses are charged to the allowance as incurred and recoveries are credited to the ALLL. Additions to the ALLL are charged against income, based on various factors which, in management’s judgment, deserve current recognition in estimating probable losses. Loan losses are charged-off in the period the loans, or portions thereof, are deemed uncollectible. Generally, Patriot will record a loan charge-off (including a partial charge-off) to reduce a loan to the estimated fair value of the underlying collateral, less costs to sell, for collateral dependent loans. Subsequent recoveries, if any, are credited to the ALLL. Patriot regularly reviews the loan portfolio and makes adjustments for loan losses, in order to maintain the allowance for loan losses in accordance with US GAAP. The allowance for loan losses consists primarily of the following three components:
In addition, a risk rating system is utilized to evaluate the general component of the ALLL. Under this system, management assigns risk ratings between one and eleven. Risk ratings are assigned based upon the recommendation of the credit analyst and the originating loan officer. The risk ratings are reviewed and confirmed by the management loan committee of the Board of Directors (the “Loan Committee”). Risk ratings are established at the initiation of transactions and are reviewed and changed, when necessary, during the life of the loan. Loans assigned a risk rating of six or above are monitored more closely by the credit administration officers and the Loan Committee.
In underwriting a loan secured by real property, a property appraisal is required to be performed by an independent licensed appraiser that has been approved by Patriot’s Board of Directors. Appraisals are subject to review by independent third parties hired by Patriot. All appraisals are reviewed by qualified independent parties to the firm preparing the appraisals. Generally, management obtains updated appraisals when a loan is deemed impaired. These appraisals may be more limited than those prepared for the underwriting of a new loan. Additionally, Management reviews and inspects properties before disbursing funds, during the term of a construction loan. In the third quarter of 2018, the Company changed its methodology to estimate its allowance for loan losses. The Bank further segmented its loan pools by Pass, Special Mention, and Substandard risk ratings and assigned additional risk premiums to each group. The qualitative and economic factors for all of the pools and subsegments were also evaluated, with Pass loans receiving adjustments to reflect their credit profile relative to the non-impaired criticized assets. These adjustments generally flow through the qualitative factors addressing severity of past due loans and other similar conditions and the nature and volume of the portfolio and terms of the loans. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements The Bank’s leveraged lending portfolio was evaluated relative to the rest of the Commercial & Industrial (“C&I”) pool and an additional risk premium was assigned to those loans in aggregate, and is reflected in the “commercial and industrial” category in the ALLL calculation. These loans were isolated due their risk parameters and profile, including higher leverage than the rest of the Bank’s C&I portfolio. The change in methodology resulted in better alignment of the credit characteristics of the various risk grades and loan types with the calculated allowance. The provision of $1.3 million in 2018 incorporated these changes. Acquired loans are marked to fair value on the date of acquisition and are evaluated on a quarterly basis to ensure the necessary purchase accounting updates are made in parallel with the allowance for loan loss calculation. Acquired loans that have been renewed since acquisition are included in the allowance for loan loss calculation since these loans have been underwritten to the Bank’s guidelines. Acquired loans that have not been renewed since acquisition, or that have a PCI mark, are excluded from the allowance for loan loss calculation. While Patriot uses the best information available to evaluate the ALLL, future adjustments to the ALLL may be necessary if conditions differ or substantially change from the information used in making the evaluation. In addition, as an integral part of its regulatory examination process, the Office of the Comptroller of the Currency (the "OCC") will periodically review the ALLL. The OCC may require Patriot to adjust the ALLL based on its analysis of information available at the time of its examination. Transfers of financial assets Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from Patriot -- put presumptively beyond the reach of Patriot and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and no condition both constrains the transferee from taking advantage of that right and provides more than a trivial benefit for Patriot, and (3) Patriot does not maintain effective control over the transferred assets through either (a) an agreement that both entitles and obligates it to repurchase or redeem the assets before maturity or (b) the ability to unilaterally cause the holder to return specific assets, other than through a cleanup call. Other real estate owned Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis. In addition, when Patriot acquires other real estate owned (“OREO”), it obtains a current appraisal to substantiate the net carrying value of the asset. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in the results of operations. Costs relating to the development and improvement of the property are capitalized, subject to the limit of fair value of the collateral. Gains or losses are included in non-interest expenses upon disposal. Write-downs of foreclosed properties that are required upon transfer to OREO are charged to the ALLL. Thereafter, an allowance for OREO losses is established for any further declines in the property’s value. These losses are included in non-interest expenses in the Consolidated Statements of Income. Premises and equipment Premises and equipment are stated at cost, net of accumulated depreciation and amortization. Leasehold improvements are capitalized and amortized over the shorter of the terms of the related leases or the estimated economic lives of the improvements. Depreciation is charged to operations for buildings, furniture, equipment and software using the straight-line method over the estimated useful lives of the related assets which range from three to forty years. Gains and losses on dispositions are recognized upon realization. Maintenance and repairs are expensed as incurred and improvements are capitalized. Impairment of assets Long-lived assets, which are held and used, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If impairment is indicated by that review, the asset is written down to its estimated fair value through a charge to non-interest expense. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements Intangible Assets Intangible assets include core deposit intangibles and goodwill arising from acquisitions. The initial and ongoing carrying value of intangible assets is based upon modeling techniques that require management to make estimates regarding the amount and timing of expected future cash flows. It also requires use of a discount rate that reflects the current return requirements of the market in relation to present risk-free interest rates, required equity market premiums, peer volatility indicators, and company-specific risk indicators. Core deposit intangibles are amortized on straight-line basis over a 10-year period because that is managements’ conservative estimate of the period Patriot will benefit from Prime Bank’s stable deposit base comprised of funds associated with long-term customer relationships. The Company evaluates goodwill for impairment on an annual basis, or more often if events or the circumstances indicate there may be impairment. The annual impairment test is conducted as of November annually. The implied fair value of goodwill is compared to its carrying amount and the impairment loss is measured by the excess of the carrying value over fair value. The fair value of each reporting unit is compared to the carrying amount of such reporting unit in order to determine if impairment is indicated. There was no goodwill impairment at December 31, 2018. Contingent Consideration Contingent consideration represents an estimate of the additional amount of purchase price consideration and is measured based on the probability that certain loans are restructured in accordance with the related acquisition agreement. Resolution of the contingent consideration will result in a cash payment and will be reflected in the financial statements as a measurement period adjustment as they are finalized. Changes will be recognized as an increase or decrease to goodwill, the valuation of the related loans and the contingent consideration/purchase price. The Company estimates the fair value of the contingent consideration liability by using a discounted cash flow model of future contingent payments based on interest income related to the acquired PCI loans. Income taxes Patriot recognizes income taxes under the asset and liability method. Under this method, deferred taxes are recognized for the estimated tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and loss carry forwards. Deferred tax assets (“DTA”s) and liabilities (“DTL”s) are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on DTAs and DTLs of a change in tax rates is recognized in income in the period that includes the enactment date. On December 22, 2017, the Tax Cuts and Jobs Act was signed into law. The Tax Cuts and Jobs Act reduces the corporate tax rate to 21% from 35%, and companies are required to recognize the effect of the tax law changes in the period of enactment in accordance with GAAP. As a result of the change in tax rates the Company revalued its deferred tax assets to reflect realization at the lower rate in December 2017, the date the law was enacted. The impact of this adjustment was a provisional increase to income tax expense of $2.8 million and reduction in the Bank's DTA for the year ended December 31, 2017. In addition, for the year ended December 31, 2017, the income tax provision was reduced by $2.8 million, as a result of the recognition of deferred tax benefits due to a change in the classification of certain net operating loss carryforwards that were previously deemed to have been subject to Internal Revenue Code (“IRC”) Section 382 limitations. In certain circumstances DTAs are subject to reduction by a valuation allowance. A valuation allowance is subject to ongoing adjustment based on changes in circumstances that affect management’s judgment about the realizability of the deferred tax asset. Adjustments to increase or decrease the valuation allowance are charged or credited to the deferred tax component of the income tax provision or benefit. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements Patriot evaluates its ability to realize its net deferred tax assets on a quarterly basis. In doing so, management considers all available evidence, both positive and negative, to determine whether it is more likely than not that the deferred tax assets will be realized. When comparing 2018 and 2017 to prior periods, management noted improvements in the results of operations, forecasted future period taxable income, the overall quality of the loan portfolio, continued efforts to reduce and control operating expenses, and net operating loss carry-forwards that do not begin to expire until the year 2030. Based upon this evidence, management concluded there was no need for a valuation allowance as of December 31, 2018 and 2017. Management will continue to evaluate its ability to realize the net deferred tax asset. Future evidence may indicate that it is more likely than not that a portion of the net deferred tax asset will not be realized at which point the valuation allowance may need to be increased. Patriot had a net deferred tax asset of $10.9 million at December 31, 2018 as compared to a net deferred tax asset of $10.4 million at December 31, 2017. Unrecognized tax benefits Patriot recognizes a benefit from its tax positions only if it is more likely than not that the tax position will be sustained on examination by taxing authorities, based on the technical merits of the position. The tax benefits recognized in the Consolidated Financial Statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. Patriot’s returns for tax years 2015 through 2017 are subject to examination by the Internal Revenue Service (“IRS”) for U.S. Federal tax purposes and, for State tax purposes, by the Department of Revenue Services for the State of Connecticut and the State of New York Department of Taxation and Finance. In 2018, the Bank recorded an uncertain tax position (“UTP”) of $1.1 million related to the utilization of certain federal net operating losses. At December 31, 2017, there were no uncertain tax positions recognized in the Consolidated Financial Statements. Additionally, Patriot has no pending or on-going audits in any tax jurisdiction. The Company’s policy is to recognize interest and penalties related to income tax matters in income tax expense. Earnings per Share Basic earnings per share represents earnings accruing to common shareholders and are computed by dividing net income by the weighted average number of common shares outstanding. Diluted earnings per share reflects additional common shares that would have been outstanding if potentially dilutive securities had been converted to common stock, as well as any adjustments to earnings resulting from the assumed conversion, unless such effect is anti-dilutive. Potential common shares that may be issued by Patriot include any unvested restricted stock awards, stock options, and stock warrants and are determined using the treasury stock method. Common stock shares held in treasury are not included in shares outstanding for purposes of computing basic or diluted earnings per share. Share-based compensation plan Incentive and compensatory share-based compensation granted to employees is accounted for at the grant date fair value of the award and recognized in the results of operations as compensation expense with an off-setting entry to equity on a straight-line basis over the requisite service period, which is the vesting period. Non-employee members of the Board of Directors are treated as employees for any share-based compensation granted in exchange for their service on the Board of Directors. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements Patriot does not currently have, nor has it had in the past, any grants of share-based compensation to non-employees. However, should such awards exist in the future, the value of the goods or services received shall be measured at the grant date fair value of the award or the goods or services to be received, if determined to be a more reliable measurement of fair value. A liability will be recognized for the award, which will periodically be adjusted to reflect the then current fair value, and compensation expense will be recognized over the requisite period during which the goods or services are received, so that the fair value at the date of settlement is the compensation expense recognized. The Compensation Committee of the
Treasury Stock Common stock purchased and held in treasury is recorded at cost. Comprehensive income Accounting principles generally require that recognized revenues, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of shareholders' equity in the Consolidated Balance Sheets, such items, along with net income, are components of comprehensive income. Segment reporting Patriot’s only business segment is Community Banking. During the years ended December 31, 2018, 2017 and 2016, this segment represented all the revenues and income of Patriot. Fair value Patriot uses fair value measurements to record adjustments to the carrying amounts of certain assets and liabilities. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in certain instances, there are no quoted market prices for certain assets or liabilities. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate sale or settlement of the asset or liability, respectively. Provided in these notes to the Consolidated Financial Statements is a detailed summary of Patriot’s application of fair value measurements and the effect on the assets and liabilities presented in the Consolidated Financial Statements. Derivatives In 2018, Patriot entered into two interest rate swaps (“swaps”), one with a loan customer to provide a facility to mitigate the fluctuations in the variable rate on the respective loan. The customer swap is matched in offsetting terms to another swap that Patriot entered into with an outside third party. These two swaps are reported at fair value in other assets or other liabilities. Patriot’s swaps qualify as derivatives, but are not designated as hedging instruments, thus any net gain or loss resulting from changes in the fair value is recognized in other noninterest income. The credit risk associated with derivatives executed with customers is similar as that involved in extending loans and is subject to normal credit policies. Collateral is obtained based on management’s assessment of the customer. The positions of customer derivatives are recorded at fair value and changes in value are included in noninterest income on the consolidated statement of income. Neither of the two swaps entered into in 2018 are designated as cash flow hedges. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements Advertising Costs Patriot's policy is to expense advertising costs in the period in which they are incurred. Revenue Recognition ASC 606, Revenue from Contracts with Customers ("ASC 606"), establishes principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from the entity's contracts to provide goods or services to customers. The core principle requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to receive in exchange for those goods or services recognized as performance obligations are satisfied. The majority of our revenue-generating transactions are not subject to ASC 606, including revenue generated from financial instruments, such as our loans, letters of credit, derivatives and investment securities, as well as revenue related to our mortgage servicing activities, as these activities are subject to other GAAP discussed elsewhere within our disclosures. Descriptions of our revenue-generating activities that are within the scope of ASC 606, which are presented in our income statements as components of non-interest income are as follows:
Recently Adopted and Issued Accounting Standards Accounting Standards Adopted During 2018 Effective January 1, 2018, the following new Accounting Standards Updates (ASUs) were adopted by the Company: ASU 2014-09 ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) including subsequent ASUs issued to clarify this Topic. The ASU, and subsequent related updates, establish a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most previous revenue recognition guidance, including industry-specific guidance. The ASUs are intended to increase comparability across industries. The core principle of the revenue model is that a company will recognize revenue when it transfers control of goods or services to customers, at an amount that reflects the consideration to which it expects to be entitled in exchange for those goods or services. The Company adopted the ASU on January 1, 2018 on a modified retrospective transition approach. The adoption of this guidance did not have a material impact on the Company’s PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements ASU 2016-01 and ASU 2018-03 ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities, and ASU No. 2018-03, Technical Corrections and Improvements to Financial Instruments - Overall (Subtopic 825-10). The ASUs included targeted amendments in connection with the recognition, measurement, presentation, and disclosure of financial instruments. The main provisions require investments in equity securities to be measured at fair value through net income, unless they qualify for a practical expedient, and require fair value changes arising from changes in instrument-specific credit risk for financial liabilities that are measured under the fair value option to be recognized in other comprehensive income. The provisions also emphasized the existing requirement to use exit prices to measure fair value for disclosure purposes. The Company adopted the ASUs on January 1, 2018 on a modified retrospective basis. In connection with the adoption of ASU 2016-01 on January 1, 2018, we refined our methodology to estimate the fair value of our loan portfolio using an exit price notion resulting in prior-periods no longer being comparable. ASU 2016-15 In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 addresses the classification of certain specific transactions presented on the Statement of Cash Flows, in order to improve consistency across entities. Debt prepayment or extinguishment, debt-instrument settlement, contingent consideration payments post-business combination, and beneficial interests in securitization transactions are specific items addressed by this ASU that may affect the Bank. Additionally, the ASU codifies the predominance principle for classifying separately identifiable cash flows. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, with early adoption permitted. As of December 31, 2018, Patriot did not have any debt prepayment or extinguishment, debt-instrument settlement, or beneficial interests in securitization transactions. Contingent consideration payments post-business combination were classified as a specific item under cash flows from financing activities. ASU 2016-18 In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows:Restricted Cash.The purpose of the standard is to improve consistency and comparability among companies with respect to the reporting of changes in restricted cash and cash equivalents on the Statement of Cash Flows. The ASU requires the Statement of Cash Flows to include all changes in total cash and cash equivalents, including restricted amounts, and to the extent restricted cash and cash equivalents are presented in separate line items on the Balance Sheet, disclosure reconciling the change in total cash and cash equivalents to the amounts shown on the Balance Sheet are required. ASU 2016-18 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, with early adoption permitted. As of December 31, 2018 and December 31, 2017, Patriot did not have restricted cash and cash equivalents separately disclosed on its Balance Sheet. In the future, if Patriot’s activities warrant presenting separate line items on its Balance Sheet for restricted cash and cash equivalents, management does not envision any difficulties implementing the requirements of ASU 2016-18, as applicable. ASU 2017-09 In May 2017, the FASB issued ASU 2017-09, Scope of Modification Accounting, which provide guidance on determining which changes to the terms and conditions of share-based payment awards require an entity to apply modification accounting under Topic 718 Stock compensation. The ASU is effective to all entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim period. This ASU did not have a material impact on its Consolidated Financial Statements. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements ASU 2018-02 In February 2018, the FASB issued ASU 2018-02, Income Statement-Reporting Comprehensive Income: This update requires a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the newly enacted federal corporate tax rate. The amount of the reclassification would be the difference between the historical 35% corporate income tax rate and the newly enacted 21% corporate tax rate. The amendments would be effective for all entities for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years. Early adoption of the amendments would be permitted including adoption in any interim period, for public business entities for reporting periods for which financial statements have not yet been issued and all other entities for reporting periods for which financial statements have not yet been made available for issuance. An entity would apply the amendments in the update retrospectively to each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act of 2017 is recognized. The Company elected to adopt this update as of December 31, 2018. This ASU did not have a material impact on the Company’s Consolidated Financial Statements. ASU 2018-04 ASU 2018-04 - Investments - Debt Securities (Topic 320) and Regulated Operations (Topic 980): The amendment in this ASU adds, amends and supersedes various paragraphs that contain SEC guidance in ASC 320, Investments-Debt Securities and ASC 980, Regulated Operations. The amendments in this ASU are effective when a registrant adopts ASU 2016-01, which for Patriot, was January 1, 2018. This amendment did not have an impact on the Company’s Consolidated Financial Statements. ASU 2018-05 Accounting Standards Issued But Not Yet Adopted ASU 2016-02 ASU 2016-13 In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses: Measurement of Credit Losses on Financial Instruments. The ASU changes the methodology for measuring credit losses on financial instruments measured at amortized cost to a current expected loss (“CECL”) model. Under the CECL model, entities will estimate credit losses over the entire contractual term of a financial instrument from the date of initial recognition of the instrument. The ASU also changes the existing impairment model for available-for-sale debt securities. In cases where there is neither the intent nor a more-likely-than-not requirement to sell the debt security, an entity will record credit losses as an allowance rather than a direct write-down of the amortized cost basis. Additionally, ASU 2016-13 notes that credit losses related to available-for-sale debt securities and purchased credit impaired loans should be recorded through an allowance for credit losses. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, with early adoption permitted for fiscal years beginning after December 15, 2018. Management is currently evaluating the impact that the standard will have on its Consolidated Financial Statements. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements ASU 2017-04 In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment: The objective of this guidance is to simplify an entity’s required test for impairment of goodwill by eliminating Step 2 from the goodwill impairment test. In Step 2 an entity measured a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. In computing the implied fair value of goodwill, an entity had to determine the fair value at the impairment date of its ASU 2017-08 In March 2017, the FASB issued ASU 2017-08, Premium Amortization on Purchased Callable Debt Securities, which amends the amortization period for certain purchased callable debt securities held at a premium, shortening such period to the earliest call date. The ASU is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. For all other entities, the ASU is effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Earlier application is permitted for all entities, including adoption in an interim period. If an entity early adopts the ASU in an interim period, any adjustments must be reflected as of the beginning of the fiscal year that includes that interim period. Management is currently evaluating the impact the adoption of ASU 2017-08 will have on its Consolidated Financial Statements. ASU 2018-13 In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820) - Changes to the Disclosure Requirements for Fair Value Measurement, to modify the disclosure requirements on fair value measurements. This ASU removes requirements to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, the policy for timing of transfers between levels and the valuation processes for Level 3 fair value measurements. ASU 2018-13 clarifies that disclosure regarding measurement uncertainty is intended to communicate information about the uncertainty in measurement as of the reporting date. ASU 2018-13 adds certain disclosure requirements, including disclosure of changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The amendments in this update are PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements ASU 2017-12 "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities." ASU 2017-12 was issued to ease the burden associated with assessing hedge effectiveness and to promote better financial statement alignment of the recognition and presentation of the effects of the hedging instrument and the hedged item. This guidance requires entities to present the earnings effect of the hedging instrument in the same income statement line item with the earnings effect on the hedged item. In October 2018, FASB issued ASU 2018-16, "Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financial Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes." ASU 2018-16 was issued to expand the list of benchmark interest rates for hedge accounting. The effective date for the amendment is the same as the effective date for ASU 2017-12. For public business entities, ASU 2017-12 is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. ASU 2017-12 and ASU 2018-16 are not expected to have any impact on the Consolidated Financial Statements. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements
The Company’s acquisitions are accounted for under the Acquisition of Prime Bank On May 10, 2018 the Company completed its acquisition of Prime Bank, a Connecticut bank headquartered in Orange, CT. The The acquisition will enable Patriot to The assets acquired and liabilities assumed from Prime Bank were recorded at their fair value as of the closing date of the acquisition. Goodwill of $2.1 million was recorded at the time of the acquisition, and was adjusted to $1.7 million as of December 31, 2018, primarily due to updating of fair value of the core deposit intangibles and adjustment of cash and contingent considerations. The goodwill is all deductible for income taxes over 15 years. Patriot engaged independent consultants recognized as experts in the field of valuations and fair value measurements for acquisition and merger transactions. Fair value is defined as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” Loans were evaluated on an individual basis, considering the loan’s underlying characteristics, types, remaining terms, annual interest rates, current market rates, loan to value ratios (LTV), loss exposure and remaining balances. The independent consultants utilized a discounted cash flow model to estimate the fair value of the loans using assumptions for probability of defaults, loss given defaults / recovery rates and foreclosure / recovery lags. ASC 310-30 Purchase Credit Impaired Loans were separately addressed with specific discount rates adjusted for an illiquidity premium. To estimate the core deposit customer relationships intangible the consultants first identified the core deposits and utilized assumptions regarding the account retention rate, growth rate and float and reserve percentages. Retention rates were based on historical attrition rates based on previous transactions, the growth rate assumed no new accounts, and 3% increase in existing account balances, while the floats and reserve percentage assumed the market participant would most likely be subject to a reserve requirement given the current level of core deposits. The fair value of time deposits included segmenting into certificate of deposits (“CDs”) and IRA CDs and CDs less than $100,000 and those $100,000 and above. The methodology entailed discounting the contractual cash flows of the instruments over their remaining contractual lives at prevailing market rates. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements The following table summarizes the consideration paid by the Company in the merger with Prime Bank and the estimated fair values of the assets acquired and liabilities assumed recognized at the acquisition date and subsequent measurement period adjustments:
All securities acquired in the transaction with Prime Bank were sold at the fair value at acquisition date with no recorded gain or loss. Fair value adjustments to assets acquired and liabilities assumed will be amortized on a straight-line basis over periods consistent with the average useful life or contractual term of related assets and liabilities. The core deposit intangible will be amortized over a 10-year period using the straight-line method. Under the terms of the agreement, the transaction is accounted for as an asset sale. As a result, tax basis to Prime Bank is not carried over to Patriot and deferred tax assets on Prime Bank’s books have been written off as part of the purchase accounting adjustments. The cash consideration is based on the initial calculation of Prime Bank tangible book value in accordance with the agreement. The initial cash payment made totaled $5.89 million and $1.0 million of this amount remains with the escrow agent pending resolution of the final closing tangible book value calculation. Pursuant to a letter agreement, Patriot will make payments for up to one year after the acquisition date. These additional payments (contingent consideration) are to be determined based on the curing of certain loan deficiencies. On August 29, 2018 Patriot paid $1.28 million to the shareholders of Prime Bank pursuant to the agreement. The maximum remaining amount payable under the letter agreement is $1.57 million and the liability under the agreement is currently estimated to be $707,000. This estimate has been measured based on Patriots assessment of the probability that certain loans are cured in accordance with the agreement. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements The accounting for the business combination includes certain provisional amounts associated with the resolution of the purchase price consideration noted above. In addition, certain other provisional amounts have been included in the determination of the fair value of the acquired assets and liabilities and changes to those underlying estimates will be reflected as measurement period adjustments within the one-year measurement period. Those provisional amounts relate to the valuation of loans, other real estate owned, deposits, tax and other accrued liabilities of the acquired company. The nature of the measurement period adjustments noted in the table above were a result of a series of payments in August 2018 and pursuant to ongoing negotiations between the parties, and information obtained subsequent to our initial reporting of provisional fair values but prior to finalizing our fair values as of December 31, 2018. Such information was determined to be a condition in existence as of acquisition date. There were no income effects resulting from the recorded measurement period adjustments for the year ended December 31, 2018. Information on goodwill for the year ended December 31, 2018 is as follows:
The Company tests for goodwill impairment annually as of November 30th. No impairment was required to be recorded on goodwill for 2018. The table below provides information regarding the carrying amounts and accumulated amortization of amortized intangible assets as of the dates set forth below. The remaining net intangible asset as of December 31, 2018 will be amortized over a period of approximately 10 years.
Pending Acquisition and Subsequent Termination On February 6, 2018, the Company, Hana Small Business Lending, Inc. (“Hana SBL”), a wholly-owned subsidiary of Hana Financial, Inc. (“Hana Financial”), and three wholly-owned subsidiaries of Hana SBL entered into a definitive purchase agreement pursuant to which Patriot would acquire Hana SBL’s small business administration (“SBA”) lending business. On August 2, 2018, the Company, Hana SBL and three wholly-owned subsidiaries of Hana SBL, entered into an amendment to the purchase agreement, pursuant to which, the closing date of the above referenced transaction had been extended from August 2, 2018 to August 1, 2019. On October 29, 2018 the Company withdrew its initial application to the OCC requesting approval of the acquisition of Hana SBL. As of March 30, 2019, the Company has not received regulatory non-objection. On March 30, 2019 the Company and Hana SBL mutually agreed to terminate the purchase agreement as amended between the parties. The termination agreement provides for the release of escrowed funds back to the Company. To date the Company incurred $1.15 million of merger and acquisition expenses related to the Hana SBL acquisition for the year ended December 31, 2018. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements
Federal Reserve System regulations require depository institutions to maintain cash reserves against their transaction accounts, primarily interest-bearing and regular checking accounts. The required cash reserves can be in the form of vault cash and, if vault cash does not fully satisfy the required cash reserves, in the form of a balance maintained with Federal Reserve Banks. The Board of Governors of the Federal Reserve System generally makes annual adjustments to the tiered cash reserve requirements. Based on Patriot’s deposits in transaction accounts, which were less than the exemption amount of $16 million, the Bank was not subject to a reserve requirement as of December 31, 2018 and 2017.
At December 31, 2018 and 2017, the amortized cost, gross unrealized gains, gross unrealized losses and approximate fair value of available-for-sale securities was as follows:
The following table presents available-for-sale securities’ gross unrealized losses and fair value, aggregated by the length of time the individual securities have been in a continuous loss position as of December 31, 2018 and 2017:
At December 31, 2018 and 2017, ten out of sixteen and nine out of eleven available-for-sale securities had unrealized losses with an aggregate depreciation of 4.4% and 1.4% from amortized cost, respectively. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements Management believes that none of the losses on available-for-sale securities noted above constitute an OTTI. The noted losses are considered temporary due to market fluctuations in available interest rates on U.S. Government agency debt, mortgage-backed securities issued by U.S. Government agencies, and corporate debt. Management considers the issuers of the securities to be financially sound, the corporate bonds are investment grade, and the collectability of all contractual principal and interest payments is reasonably expected. Since it is not more-likely-than-not that Patriot would be required to sell the investments before recovery of the amortized cost basis and does not intend to sell the securities at a loss, none of the available-for-sale securities noted are considered to be OTTI as of December 31, 2018. At December 31, 2018 and 2017, available-for-sale securities of $7.0 million and $6.7 million were pledged primarily to secure municipal deposits, respectively. In 2018, available-for-sale securities of $5.5 million were pledged to the FRB of New York, and $1.5 million were pledged to St. Louis Fed. In 2017, $6.7 million available-for sale securities were pledged to the FRB of New York. The following summarizes, by class and contractual maturity, the amortized cost and estimated fair value of available-for-sale debt securities held at December 31, 2018. The mortgages underlying the mortgage-backed securities are not due at a single maturity date. Additionally, these mortgages often are and generally may be pre-paid without penalty, creating a degree of uncertainty that such investments can be held until maturity. For convenience, mortgage-backed securities have been included in the summary as a separate line item.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements
As of December 31, 2018 and 2017, loans receivable, net, consists of the following:
Patriot's lending activities are conducted principally in Fairfield and New Haven Counties in Connecticut and Westchester County in New York, and the five Boroughs of New York City. Patriot originates commercial real estate loans, commercial business loans, a variety of consumer loans, and construction loans, and has recently purchased residential loans since 2016. All commercial and residential real estate loans are collateralized primarily by first or second mortgages on real estate. The ability and willingness of borrowers to satisfy their loan obligations is dependent to some degree on the status of the regional economy as well as upon Patriot has established credit policies applicable to each type of lending activity in which it engages and evaluates the creditworthiness of each borrower. Unless extenuating circumstances exist, Patriot limits the extension of credit on commercial real estate loans to 75% of the market value of the underlying collateral. Patriot’s loan origination policy for multi–family residential real estate is limited to 80% of the market value of the underlying collateral. In the case of construction loans, the maximum loan-to-value is 75% of the “as completed” appraised value of the real estate project. Management monitors the appraised value of collateral on an on-going basis and additional collateral is requested when warranted. Real estate is the primary form of collateral, although other forms of collateral do exist and may include such assets as accounts receivable, inventory, marketable securities, time deposits, and other business assets. In connection with the Prime Bank merger in May 2018 loans were acquired, a subset of these loans was determined to have evidence of credit deterioration at the acquisition date, which was accounted for in accordance with ASC 310-30. The purchased credit impaired (“PCI”) loans presently maintain a carrying value of $615,000 as of December 31, 2018. The loans were evaluated for impairment through the periodic reforecasting of expected cash flows. Income is recognized on PCI loans pursuant to ASC Topic 310-30. A portion of the fair value discount has been ascribed as an accretable yield that is accreted into interest income over the estimated remaining life of the loans. The remaining non-accretable difference represents cash flows not expected to be collected. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements The table below summarizes the total contractually required principal and interest cash payments, management’s estimate of expected total cash payments and fair value of the loans at acquisition date. Contractually required principal and interest payments have been adjusted for estimated prepayments.
A summary of changes in the accretable discount for PCI loans for the year ended December 31, 2018 follows:
The accretion of the accretable discount for PCI loans for the year end December 31, 2018 was $92,000. The table above includes $887,000 additional expected cash flows at acquisition, and $887,000 additional accretable discount, both resulting from a revised acquisition date estimate of PCI loans performance. Risk characteristics of the Company’s portfolio classes include the following: Commercial Real Estate Loans In underwriting commercial real estate loans, Patriot evaluates both the prospective borrower’s ability to make timely payments on the loan and the value of the property securing the loans. Repayment of such loans may be negatively impacted should the borrower default, the value of the property collateralizing the loan substantially decline, or Residential Real Estate Loans In 2013, Patriot discontinued offering primary mortgages on personal residences. Repayment of residential real estate loans may be negatively impacted should the borrower have financial difficulties, should there be a significant decline in the value of the In 2018 and 2017, Patriot purchased $25.6 million and $73.0 million of PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements Commercial and Industrial Loans Patriot’s commercial and industrial loan portfolio consists primarily of commercial business loans and lines of credit to businesses and professionals. These loans are generally for the Consumer and Other Loans Patriot offers individual consumers various forms of credit including installment loans, credit cards, overdraft protection, auto loans, and reserve lines of credit. Repayments of such loans are generally dependent on the personal income of the borrower, which may be negatively impacted by adverse changes in economic conditions. The Company does not place a high emphasis on originating these types of loans. The Company does not have any lending programs commonly referred to as subprime lending. Subprime lending generally targets borrowers with weakened credit histories that are typically characterized by payment delinquencies, previous charge-offs, judgments against the During 2018, $21.4 million education loans were purchased. No education loans were purchased in 2017. Construction Loans Construction loans are of a short-term nature, generally of eighteen-months or less, that are secured by land intended for commercial, residential, or mixed-use development. Loan proceeds may be used for the acquisition of or improvements to the land under development and funds are generally disbursed as phases of construction are completed. Included in this category are loans to construct single family homes where no contract of sale exists, based upon the experience and financial strength of Construction to Permanent – Commercial Real Estate (“CRE”) These loans allow a single closing for a construction facility leading to conversion to an amortizing mortgage loan. Construction to permanent loans combine a short-term period similar to a construction loan, generally with a variable rate, and a longer term CRE loan typically 20-25 years, resetting every five years to the FHLB rate. Fulfillment of the construction facility typically occurs when events dictate, such as receipt of a certificate of occupancy and property stabilization, which is defined as cash flow sufficient to support a pre-defined minimum debt coverage ratio and other conditions and covenants particular to the loan. Construction facilities are typically variable rate instruments that, upon conversion to an amortizing mortgage loan, reset to a fixed rate instrument that is the greater of the in-force variable rate plus a predetermined spread over a reference rate (e.g., prime) or a minimum interest rate. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements SBA Loans: Patriot originates SBA 7(a) loans, on which the SBA has historically provided guarantees of up to 75 percent of the principal balance. The guaranteed portion of the Company’s
Name Edward N. Constantino Raymond Smyth Emile Van den Bol Michael J. Weinbaum
Michael A. Carrazza Richard A. Muskus Joseph D. Perillo Frederick K. Staudmyer Samuel S. Davis Judith P. Corprew Edward N. Constantino Raymond Smyth Emile Van den Bol Michael J. Weinbaum All Directors and Executive Officers
Allowance for Loan and Lease Losses
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements The following tables summarize, by loan portfolio segment, the amount of loans
Patriot monitors the Patriot employs a risk rating system as part of PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements Additionally, Patriot retains an objective and independent third-party loan review expert to perform a quarterly analysis of the results of its risk rating process. The quarterly review is based on a randomly selected sample of loans within established parameters (e.g., value, concentration), in order to assess and validate the risk ratings assigned to individual loans. Any changes to the assigned risk ratings, based on the quarterly review, are required to be approved by the Loan Committee. When assigning a risk rating to a loan, management utilizes the Bank’s internal eleven-point risk rating system. An asset is considered “special mention” when it has a potential weakness based on objective evidence, but does not currently expose the Company to sufficient risk to warrant classification in one of the following categories:
Charge-offs, to reduce the loan to its recoverable value, generally commence after the loan is classified as “doubtful”. In accordance with Federal Financial Institutions Examination Council published policies establishing uniform criteria for the classification of retail credit based on delinquency status, “Open-end” and “Closed-end” credits are charged-off when 180 days and 120 days delinquent, respectively. If an account is classified as “Loss”, the full balance of the loan receivable is charged off, regardless of the potential recovery from a sale of the underlying collateral. Any amount that may be recovered on the sale of collateral underlying a loan is recognized as a “recovery” in the period in which the collateral is sold. In March 2017, the Bank PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements Loan Portfolio Aging Analysis The
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements The following tables summarize performing and non-performing (i.e., non-accruing) loans receivable by portfolio segment, by aging category, by delinquency status as of December 31, 2017.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements The following tables summarize non-performing (i.e., non-accruing) loans by aging category and status, within the
If non-accruing loans
Additionally, certain loans for which the borrower cannot demonstrate sufficient cash flow to continue loan payments in the future and certain troubled debt restructurings (“TDRs”) are placed on non-accrual status. During the years ended December 31, 2018, 2017, and 2016, no interest income was collected and recognized on non-accruing loans. The accrual of interest on loans is discontinued at the time the loan is 90 days past due for payment unless the loan is well-secured and in process of collection. Consumer installment loans are typically charged off no later than 180 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on non-accrual status or charged-off, at an earlier date, if collection of principal or interest is considered doubtful. All interest accrued, but not collected for loans that are placed on non-accrual status or charged off, is reversed against interest income. The interest on these loans is accounted for on the cash-basis method until qualifying for return to accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current, future payments are reasonably assured, and there is six months of performance. Management considers all non-accrual loans and troubled debt restructurings to be impaired. In most cases, loan payments that are past due less than 90 days, based on contractual terms, are considered collection delays and not an indication of loan impairment. The Bank considers consumer installment loans to be pools of smaller homogeneous loan balances, which are collectively evaluated for impairment. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements Troubled Debt Restructurings (“TDR”) On a case-by-case basis, Patriot may agree to modify the contractual terms of a borrower’s loan to assist customers who may be experiencing financial difficulty. If the borrower is experiencing financial difficulties and a concession has been made, the loan is classified as a TDR. Substantially all TDR loan modifications involve lowering the monthly payments on such loans through either a reduction in interest rate below market rate, an extension of the term of the loan, or a combination of adjusting these two contractual attributes. TDR loan modifications may result in the forgiveness of principal or accrued interest. In addition, when modifying commercial loans, Patriot frequently obtains additional collateral or guarantor support. If the borrower has performed under the existing contractual terms of the loan and Patriot’s underwriters determine that the borrower has the capacity to continue to perform under the terms of the TDR, the loan continues accruing interest. Non-accruing TDRs may be returned to accrual status when there has been a sustained period of performance (generally six consecutive months of payments) and both principal and interest are reasonably assured of collection. The recorded investment in TDRs as of December 31, 2018 and 2017 were $2.1 million and $3.0 million, respectively. All TDRs at December 31, 2018 and 2017 were performing in accordance with their modified terms and therefore, were on accrual status.
There were no loans modified as TDRs during the years ended December 31, 2018, 2017 or 2016 and
Impaired Loans Impaired loans may consist of non-accrual loans and/or performing and non-performing TDRs. As of December 31, 2018 and 2017, based on the on-going monitoring and analysis of the loan portfolio, impaired loans of $21.2 million and $6.8 million were identified, for which $1.5 million and $253,000 specific reserves were established, respectively. Loans not requiring specific reserves had sufficient collateral values, less costs to sell, supporting the carrying amount of the loans. In some cases, there may be no specific reserves due to the carrying amount of the loan having been charged off. Once a borrower is in default, Patriot is under no obligation to advance additional funds on unused commitments. At December 31, 2018 and 2017, exposure to the impaired loans was related to 25 and 12 borrowers, respectively. In all cases, appraisal reports of the underlying collateral, if any, have been obtained from independent licensed appraisal firms. For non-performing loans, the independently determined appraised values were reduced by an estimate of the costs to sell the assets, in order to estimate the potential loss, if any, that may eventually be realized. Performing loans are monitored to determine when, if at all, additional loan loss reserves may be required for a loss of underlying collateral value. In addition, the remaining $615,000 PCI loans acquired from Prime Bank acquisition; all remaining PCI loans were commercial and industrial loans. The PCI loans were originally recorded at fair value by the Bank on the date of acquisition. At December 31, 2018, those loans were considered individually evaluated for impairment, with no allowance recorded. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements The following table reflects information about the impaired loans, excluding PCI loans, by class as of December 31, 2018 and 2017:
For each year in the three-year period ended December 31, 2018, the average recorded investment in and interest income recognized on impaired loans without and with a related allowance, by loan portfolio segment, was as follows:
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements
At December 31, 2018 and 2017, premises and equipment consisted of the following:
For the years ended December 31, 2018, 2017 and 2016, depreciation and amortization expense related to premises and equipment totaled $1.5 million, $1.2 million, and $1.2 million respectively. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements
As of December 31, 2018 and 2017, Patriot recorded OREO of $2.9 million and $0 on the Consolidated Balance Sheet, respectively. The 2018 OREO balance consists of two properties. One OREO of $1.0 million was acquired from the acquisition of Prime Bank in May 2018, and the additional $1.9 million represents the value of one loan receivable due from the mortgagor of a foreclosed residential property that is currently being market for sale. In 2017, Patriot sold the OREO recorded in 2016 and recognized a loss of $9,000. No OREO property was sold in 2018.
The following table presents the balance of deposits held, by category, and the related weighted average stated interest rate as of December 31, 2018 and 2017.
The following table presents interest expense, by deposit category, and the related weighted average effective interest rate for each of the years in the three-year period ended December 31, 2018.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements As of December 31, 2018, contractual maturities of brokered deposits, and the related weighted average stated interest rate by maturity is summarized as follows:
Total borrowings were $131.0 million and $141.4 million as of December 31, 2018 and 2017, respectively. Borrowings consist primarily of FHLB advances, senior notes, subordinated notes, junior subordinated debentures and a note payable. Federal Home Loan Bank borrowings The Company is a member of the Federal Home Loan Bank of Boston ("FHLB-B"). Borrowings from the FHLB-B are limited to a percentage of the value of qualified collateral, as defined on the FHLB-B Statement of Products Policy. Qualified collateral, as defined, primarily consists of mortgage-backed securities and loans receivable that are required to be free and clear of liens and encumbrances, and may not be pledged for any other purposes. As of December 31, 2018, the Bank had $47.9 million of available borrowing capacity from the FHLB-B. FHLB-B advances are structured to facilitate the Bank’s management of its balance sheet and liquidity requirements. At December 31, 2018 and 2017, outstanding advances from the FHLB-B aggregated $100.0 million and $120.0 million, respectively. $40.0 million advances outstanding at December 31, 2018 bore fixed rates of interest ranging from 2.68% to 3.2% with maturities ranging from 7 days to 2.8 years. $60.0 million advances from the FHLB-B with a weighted average interest rate of 1.0% are callable in the second half of 2019 and up to October 2020. After 90 days, each of these advances converts to a floating rate from 100 basis points to 200 basis points below LIBOR. After one year, the rates reset to fixed rates between 3.47% and 4.23%, per annum, and the borrowing can be called by the FHLB-B on a quarterly basis. At December 31, 2018, collateral for FHLB-B borrowings consisted of a mixture of real estate loans and securities with book value of $258.6 million. In addition, Patriot has a $2.0 million revolving line of credit with the FHLB-B. At December 31, 2018 and 2017, no funds had been borrowed under the line of credit. Interest expenses incurred for the year ended December 31, 2018 and 2017 were $1.6 million and $702,000, respectively. Correspondent Bank - Lines of Credit Patriot has entered into unsecured federal funds sweep and federal funds line of credit facility agreements with certain correspondent Banks. Borrowings available under the agreements totaled $26 million at December 31, 2018 and $16 million at December 31, 2017. The purpose of the agreement is to provide a credit facility intended to satisfy overnight federal account balance requirements and to provide for daily settlement of FRB, ACH, and other clearinghouse transactions. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements There was no outstanding balance under the agreements at December 31, 2018 and 2017. Interest expenses incurred for the year ended December 31, 2018 and 2017 were $13,000 and $2,000, respectively. Senior notes On December 22, 2016, the Company issued $12 million of senior notes bearing interest at 7% per annum and maturing on December 22, 2021 (the “Senior Notes”). Interest on the Senior Notes is payable semi-annually on June 22 and December 22 of each year beginning on June 22, 2017. In connection with the issuance of the Senior Notes, the Company incurred $374,000 of costs, which are being amortized over the term of the Senior Notes to recognize a constant rate of interest expense. At December 31, 2018 and 2017, $222,000 and $297,000 of unamortized debt issuance costs have been deducted from the face amount of the Senior Notes included in the Consolidated Balance Sheet. The Senior Notes contain affirmative covenants that require the Company to: maintain its and its subsidiaries’ legal entity and tax status, pay its income tax obligations on a timely basis, and comply with SEC and FDIC reporting requirements. The Senior Notes are unsecured, rank equally with all other senior obligations of the Company, are not redeemable nor may they be put to the Company by the holders of the notes, and require no payment of principal until maturity. For the year ended December 31, 2018 and 2017, the Company recognized interest expense of $915,000 and $915,000, respectively, at an effective rate of 7.62%, which amount is greater than the stated interest rate on the Senior Notes due to debt issuance cost amortization expense of $75,000 and $75,000, respectively. As of December 31, 2018 and 2017, $23,000 and $23,000 of interest has been included in the Consolidated Balance Sheet in Accrued expenses and other liabilities, respectively. Subordinated notes On June 29, 2018, the Company entered into certain subordinated note purchase agreements with two institutional accredited investors and completed a private placement of $10 million of fixed-to-floating rate subordinated notes with the maturity date of September 30, 2028 (the “Subordinated Notes”) pursuant to Section 4(a)(2) of the Securities Act of 1933, as amended, and Rule 506(b) of Regulation D promulgated thereunder. The Subordinated Notes initially bear interest at 6.25% per annum, from and including June 29, 2018, to but excluding, June 30, 2023, payable semi-annually in arrears. From and including June 30, 2023, until but excluding June 30, 2028 or an early redemption date, the interest rate shall reset quarterly to an interest rate per annum equal to the then current three-month LIBOR (but not less than zero) plus 332.5 basis points, payable quarterly in arrears. The Company may, at its option, beginning on June 30, 2023 and on any scheduled interest payment date thereafter, redeem the Subordinated Notes. Interest on the Subordinated Notes is payable beginning on December 30, 2018. In connection with the issuance of the Subordinated Notes, the Company incurred $291,000 of debt issuance costs, which are being amortized over the term of the Subordinated Notes to recognize a constant rate of interest expense. At December 31, 2018, $277,000 of unamortized debt issuance costs have been deducted from the face amount of the Subordinated Notes included in the Consolidated Balance Sheet. For the year ended December 31, 2018, the Company recognized interest expense of $327,000. Junior subordinated debt owed to unconsolidated trust In 2003, the Patriot National Statutory Trust I (“the Trust”), which has no independent assets and is wholly-owned by the Company, issued $8.0 million of trust preferred securities. The proceeds, net of a $240,000 placement fee, were invested in junior subordinated debentures issued by the Company, which invested the proceeds in the Bank. The Bank used the proceeds to fund its operations. Trust preferred securities currently qualify for up to 25% of the Company’s Tier I Capital, with the excess qualifying as Tier 2 Capital. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements The junior subordinated debentures are unsecured obligations of the Company. The debentures are subordinate and junior in right of payment to all present and future senior indebtedness of the Company. In addition to its obligations under the junior subordinated debentures and in conjunction with the Trust, the Company issued an unconditional guarantee of the trust preferred securities. The junior subordinated debentures bear interest at three-month LIBOR plus 3.15% (5.97% at December 31, 2018) and mature on March 26, 2033, at which time the principal amount borrowed will be due. Beginning in the second quarter of 2009, the Company opted to defer payment of quarterly interest on the junior subordinated debentures for 20 consecutive quarters. In June of 2014, the Company brought the debt current by paying approximately $1.7 million of interest in arrears to the holders of the junior subordinated debentures. On bringing the debt current and, as permitted under the terms of the junior subordinated debentures, the Company again opted to defer payment of quarterly interest through September 2016, when a $0.7 million payment was made to bring the debt current. The placement fee of $240,000 is amortized and included as a component of the periodic interest expense on the junior subordinated debentures, in order to produce a constant rate of interest expense. For the years ended December 31, 2018 and 2017, $7,000 of debt placement fee amortization has been included in interest expense recognized of $440,000 and $360,000, respectively. As of December 31, 2018 and 2017, the unamortized placement fee deducted from the face amount of the junior subordinated debt owed to the unconsolidated trust amounted to $154,000 and $162,000, respectively, and accrued interest on the junior subordinated debentures was $8,000 and $6,000, respectively. At its option, exercisable on a quarterly basis, the Company may redeem the junior subordinated debentures from the Trust, which would then redeem the trust preferred securities. Note Payable In September 2015, the Bank purchased the property in which its Fairfield, Connecticut branch is located for approximately $2.0 million, a property it had been leasing until that date. The purchase price was primarily satisfied by issuing the seller a $2.0 million, nine-year, promissory note bearing interest at a fixed rate of 1.75% per annum. As of December 31, 2018 and 2017, the note had a balance outstanding of $1.4 million and $1.6 million, respectively. The note matures in August 2024 and requires a balloon payment of approximately $234,000. The note is secured by a first Mortgage Deed and Security Agreement on the purchased property. Interest expenses incurred for the year ended December 31, 2018 and 2017 were $26,000 and $29,000, respectively. Maturity of borrowings At December 31, 2018, the contractual maturities of the Company’s borrowings in future periods were as follows:
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements
Operating leases Patriot has seven non-cancelable operating leases, including four Bank branch locations and two for administrative and operational space, and one equipment lease. The leases expire on various dates through 2032. Most of the leases contain rent escalation provisions, as well as renewal options for one or more periods. The last potential year the leases can be extended through is 2032. Certain leases require Patriot to reimburse the lessors for a proportion of property operating costs such as insurance and property taxes. Future minimum rental commitments under the terms of these leases by year and in the aggregate, are as follows:
*Minimum payments have not been reduced by minimum sublease rentals of $2.4 million due in the future under non-cancelable subleases. Rent expense for operating leases is recognized in earnings on a straight-line basis over the base term of the respective lease and is included in the Statement of Income as a component of Occupancy and Equipment expense. For the years ended December 31, 2018, 2017 and 2016, total rent expense for cancellable and non-cancellable operating leases was $593,000, $953,000, and $1.1 million, respectively. For the years ended December 31, 2018, 2017 and 2016, Patriot recognized gross rental income of $413,000, $399,000, and $414,000 offset by rental costs of $5,000, $5,000, and $5,000, respectively. Employment Agreements The Company has a severance agreement for each of the Executive Vice Presidents that provides for severance equal to 12 months of current salary, if the EVP is terminated within 12 months of a change of control of Patriot. Legal Matters Patriot does not have any pending legal proceedings, other than ordinary routine litigation, incidental to its business, to which Patriot is a party or any of its property is subject. Management and Patriot’s legal counsel are of the opinion that the ultimate disposition of these routine legal matters will not have a material adverse effect on the consolidated financial condition, results of operations, or liquidity of Patriot. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements
Following is a summary of the components of the federal and state income tax expense (benefit) for each of the years in the three-year period ended December 31, 2018.
For each of the years in the three-year period ended December 31, 2018, the difference between the federal statutory income tax rate and Patriot’s effective income tax rate reconciles as follows:
The effective tax rate for the years ended December 31, 2018, 2017 and 2016 was 21.8%, 41.1%, and 38.5%, respectively. The effective tax rate for 2018 was impacted by the reduction in the statutory Federal corporate tax rate to 21% from 34% that was effective January 1, 2018. The effective tax rate for the year ended December 31, 2017 was impacted by two significant and mostly offsetting items:
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PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements Deferred Tax Assets and Liabilities The significant components of Patriot’s net deferred tax assets at December 31, 2018 and 2017 are presented below.
At December 31, 2018, the Bank had $19.6 million of Federal net operating loss carryforwards (“NOLs”) and $51.6 million of State NOLs to offset future taxable income. The NOLs expire over various periods beginning with tax year 2029 through tax year 2033. Valuation Allowance against net Deferred Tax Assets At December 31, 2018 and 2017, there was no need for a valuation allowance. Patriot management believes no valuation allowance is needed based on consideration of various factors including improvements in and historical and prospective results of operations, improvements in quality of the loan portfolio, general financial, economic and market data, and the period over which the NOLs are available to offset taxable income. Management continues to monitor circumstances to determine if it is more likely than not to realize the NOL benefits or if the valuation allowance may be required to be increased. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements Unrecognized tax benefits Patriot recognizes a benefit from its tax positions only if it is more likely than not that the tax position will be sustained on examination by taxing authorities, based on the technical merits of the position. The tax benefits recognized in the Consolidated Financial Statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. Patriot’s returns for tax years 2015 through 2017 are subject to examination by the Internal Revenue Service (“IRS”) for U.S. Federal tax purposes and, for State tax purposes, by the Department of Revenue Services for the State of Connecticut and the State of New York Department of Taxation and Finance. In 2018, the Bank recorded an uncertain tax position of $1.1 million related to the utilization of certain federal net operating losses. At December 31, 2017, there were no uncertain tax positions recognized in the Consolidated Financial Statements. Additionally, Patriot has no pending or on-going audits in any tax jurisdiction. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
The Company’s policy is to recognize interest and penalties related to income tax matters in income tax expense. At December 31, 2018, the Company has not accrued any interest and penalties related to income tax matters into income tax expense. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements
The Company maintains the Patriot National Bancorp, Inc. 2012 Stock Plan (the “Plan”) to provide an incentive to directors and employees of the Company by the grant of restricted stock awards (“RSA”), options, or phantom stock units. Since 2013, the Company’s practice is to grant RSAs; as of December 31, 2018, there are no options or phantom stock units outstanding or that have been exercised. The Plan provides for the issuance of up to 3,000,000 shares of the Company’s common stock subject to certain Plan limitations. As of December 31, 2018, 2,870,113 shares of stock remain available for issuance under the Plan. In accordance with the terms of the Plan, the vesting of RSAs and options may be accelerated at the discretion of the Compensation Committee of the Board of Directors. The Compensation Committee sets the terms and conditions applicable to the vesting of RSAs and stock option grants. RSAs granted to directors and employees generally vest in quarterly or annual installments over a three, four or five year period from the date of grant. The following is a summary of the status of the Company’s restricted share awards as of and for each of the years in the three-year period ended December 31, 2018.
The Company recognizes compensation expense for all director and employee share-based compensation awards on a straight-line basis over the requisite service period, which is equal to the vesting schedule of each award, for each vesting portion of an award equal to its grant date fair value. For the years ended December 31, 2018, 2017 and 2016, the Company recognized share-based compensation expense of $220,000, $146,000, and $161,000, respectively. For the years ended December 31, 2018, 2017 and 2016, share-based compensation attributable to employees of Patriot amounted to $135,000, $68,000, and $100,000, respectively. Included in share-based compensation expense for the years ended December 31, 2018, 2017, and 2016 was $85,000, $78,000, and $61,000, respectively, attributable to Patriot’s external Directors, who received total compensation of $370,000, $318,000, and $302,000 for each of those years, respectively, which amounts are included in Other Operating Expenses in the Consolidated Statements of Income. Unrecognized compensation expense attributable to the unvested restricted shares outstanding as of December 31, 2018 amounted to $370,000, which amount is expected to be recognized over the weighted average remaining life of the awards of 2.48 years. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements RSA Grant - Non-executive Employees On January 4, 2016, the Company granted 100 restricted shares to eighty-seven full- and part-time non-executive employees as of December 31, 2015. The total number of shares granted was 8,700 at a grant date fair value of $15.50 per share. As of December 31, 2018, 2,700 granted shares granted have been forfeited. The remaining 6,000 shares were vested through the January 2019 vesting date.
Common Stock On December 16, 2009, the Company entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) with PNBK Holdings, LLC, a limited liability company controlled by Michael Carrazza (“Holdings”). Pursuant to the Securities Purchase Agreement, on October 15, 2010, the Company issued 3.36 million shares of common stock to Holdings at $15.00 per share, for an aggregate issuance value of $50.4 million. The shares issued to Holdings represented 87.6% of the Company’s then issued and outstanding common stock. In connection with the equity interest obtained by Holdings, Michael Carrazza became Patriot’s Chairman of the Board and nominees of Holdings replaced certain directors and officers who resigned. Additionally, the Company reduced the par value of its common stock from $2 to $0.01 per share, increased the number of its authorized common shares to 100 million, and entered into a Registration Rights Agreement with Holdings. The Registration Rights Agreement provides Holdings with customary demand, shelf, and piggyback registration rights. Stock Repurchase Program On July 26, 2016, the Company authorized a stock repurchase program whereby management may repurchase up to 500,000 shares of common stock. The authorization expired on July 31, 2017, unless extended, suspended, or otherwise modified. The program authorizes the Company’s chairman to direct management to repurchase shares on the open-market or in private transactions, in accordance with applicable security laws and regulations. Share repurchases, if any, are anticipated to be funded from available cash-on-hand. During the year ended December 31, 2017, 72,471 shares of common stock were repurchased in a combination of open market and private transactions at an average cost of $14.04 per share. In August 2017, after the Program closed, one shareholder elected to sell 100 shares back to the Company at a cost of $17.10 per share. This transaction was accepted and executed on the same terms as those executed during the Program. No treasury stock was purchased in 2018. Dividends On July 17, 2017, the Company announced its intention to make quarterly cash dividend payments. For the year ended December 31, 2018 and 2017, the Company paid cash dividends of $154,000 and $77,000, respectively. No dividend was declared and paid for the years ended December 31, 2016. Earnings per Share The Company is required to present basic earnings per share and diluted earnings per share in its Consolidated Statements of Income. Basic earnings per share amounts are computed by dividing net income by the weighted average number of common shares outstanding. Diluted earnings per share reflects additional common shares that would have been outstanding if potentially dilutive common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate to the outstanding unvested RSAs granted to directors and employees. The dilutive effect resulting from these potential shares is determined using the treasury stock method. The Company is also required to provide a reconciliation of the numerator and denominator used in the computation of both basic and diluted earnings per share. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements The following is a summary of the computation of basic and diluted earnings per share for each of the years in the three-year period ended December 31, 2018.
Patriot offers employees participation in the Patriot Bank, N.A. 401(k) Savings Plan (the "401(k) Plan") under Section 401(k) of the Internal Revenue Code, along with the ROTH feature to the Plan. The 401(k) Plan covers substantially all employees who have completed one month of service, are 21 years of age and who elect to participate. Under the terms of the 401(k) Plan, participants can contribute up to the maximum amount allowed, subject to Federal limitations. At its discretion, Patriot may match eligible participating employee contributions at the rate of 50% of the first 6% of the participants’ salary contributed to the 401(k) Plan. Eligibility for matching contributions is dependent on an employee’s completing 6 consecutive month(s) of service or 500 hours of employment. Participants immediately vest in Patriot’s matching contributions, if applicable. During the years ended December 31, 2018, 2017, and 2016, Patriot made matching contributions to the 401(k) Plan of $204,000, $173,000, and $169,000, respectively. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements
In the normal course of business, the Bank is a party to financial instruments with off-balance-sheet risk to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the balance sheet. The contractual amounts of these instruments reflect the extent of involvement Patriot has in particular classes of financial instruments. The contractual amounts of commitments to extend credit and standby letters of credit represent the maximum amount of potential accounting loss should: the contract be fully drawn upon; the customer default; and the value of any existing collateral becomes worthless. Patriot applies its credit policies to entering commitments and conditional obligations and, as with its lending activities, evaluates each customer's creditworthiness on a case-by-case basis. Management believes that it effectively mitigates the credit risk of these financial instruments through its credit approval processes, establishing credit limits, monitoring the on-going creditworthiness of recipients and grantees, and the receipt of collateral as deemed necessary. At December 31, 2018 and 2017, financial instruments with credit risk are as follows:
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 to extend credit generally have fixed expiration dates or other termination clauses and may require payment of a fee by the borrower. Since these commitments could expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if deemed necessary upon extending credit, is based on management's credit evaluation of the customer. Collateral held varies, but may include commercial property, residential property, deposits, and securities. The Bank has established a reserve for credit loss of $8,000 and $5,000 as of December 31, 2018 and 2017, respectively. Standby letters of credit are written commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loan facilities to customers. Guarantees that are not derivative contracts are recorded at fair value and included in the Consolidated Balance Sheet. In November 2018, the Company entered two $5 million notional interest rate swaps maturing in 2029. For further information about the interest rate swaps, refer to Note 19 Derivatives. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements
In November 2018, the Bank entered into a formal written agreement (the “Agreement”) with the Office of the Comptroller of the Currency (the “OCC”). Under the terms of the Agreement, the Bank has appointed a Compliance Committee of three independent outside directors and one member of management responsible for monitoring adherence to the Agreement and has appointed a Lead Independent Director. The Agreement stated that by December 31, 2018 the Board and Bank would develop, implement and revise written documents and policies related to executive compensation, conflict of interest, internal audit, liquidity and asset/liability management, commercial loan administration, leveraged lending, practices relating to the allowance for loan and lease losses, and assumptions used in the Bank’s interest rate risk model. Under the Agreement the Bank also agreed to provide a revised written 3-year strategic and capital plan for the Bank by December 31, 2018. To date, the Bank has addressed each of the items in accordance with the agreement and continues to respond to any further enhancements requested by the OCC. Further details pertaining to the Agreement are provided in Part II Item 9B: Other information. Federal and state regulatory authorities have adopted standards requiring financial institutions to maintain increased levels of capital. Effective January 1, 2015, federal banking agencies imposed four minimum capital requirements on a community bank’s risk-based capital ratios consisting of Total Capital, Tier 1 Capital, Common Equity Tier 1 (“CET1”) Capital, and a Tier 1 Leverage Capital ratio. The risk-based capital ratios measure the adequacy of a bank's capital against the riskiness of its on- and off-balance sheet assets and activities. Failure to maintain adequate capital is a basis for "prompt corrective action" or other regulatory enforcement action. In assessing a bank's capital adequacy, regulators also consider other factors such as interest rate risk exposure, liquidity, funding and market risks, quality and level of earnings, concentrations of credit, quality of loans and investments, nontraditional activity risk, policy effectiveness, and management's overall ability to monitor and control risk. Capital adequacy is one of the most important factors used to determine the safety and soundness of individual banks and the banking system. Under the instituted regulatory framework, to be considered “well capitalized”, a financial institution must generally have a Total Capital ratio of at least 10%, a Tier 1 Capital ratio of at least 8.0%, a CET1 Capital ratio at least 6.5%, and a Tier 1 Leverage Capital ratio of at least 5.0%. However, regardless of a financial institution’s ratios, the OCC may require increased capital ratios or impose dividend restrictions based on the other factors it considers in assessing a bank’s capital adequacy. Management continuously assesses the adequacy of the Bank’s capital in order to maintain its “well capitalized” status. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements The Company’s and the Bank’s regulatory capital amounts and ratios at December 31, 2018 and 2017 are summarized as follows:
Under the final capital rules that became effective on January 1, 2015, there was a requirement for a CET1 capital conservation buffer of 2.5% of risk-weighted assets, which is in addition to the other minimum risk-based capital standards in the rule. Institutions that do not maintain this required capital buffer become subject to progressively more stringent limitations on the percentage of earnings that may be distributed to shareholders or used for stock repurchases and on the payment of discretionary bonuses to senior executive management. The capital buffer requirement is being phased in over three years beginning in 2016. The 1.25% capital conversation buffer for 2017 has been included in the minimum capital adequacy ratios in the 2017 column in the table above. The capital conversation buffer increased to 1.875% for 2018, which has been included in the minimum capital adequacy ratios in the 2018 column above. The capital buffer requirement effectively raises the minimum required Total Capital ratio to 10.5%, the Tier 1 capital ratio to 8.5% and the CET1 capital ratio to 7.0% on a fully phased-in basis, which will be effective beginning on January 1, 2019. Management believes that, as of December 31, 2018, Patriot satisfies all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis, as if all such requirements were currently in effect. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements
In the normal course of business, the Company grants loans to executive officers, directors and members of their immediate families, as defined, and to entities in which these individuals have more than a 10% equity ownership. The transactions are completed under the same terms applied to transaction with unrelated third parties. There was $150,000 and $139,000 of loans to related parties outstanding as of December 31, 2018 and 2017, respectively. As of December 31, 2018 and 2017, deposits by related parties aggregated $1.1 million and $1.3 million, respectively. For the years ended December 31, 2018 and 2017, no referral fees and commissions were paid to affiliates of members of the Board of Directors.
Patriot measures the carrying value of certain financial assets and liabilities at fair value, as required by its policies as a financial institution and by US GAAP. The carrying values of certain assets and liabilities are measured at fair value on a recurring basis, such as available-for-sale securities; while other assets and liabilities are measured at fair value on a non-recurring basis due to external factors requiring management’s judgment to estimate potential losses of value resulting in asset impairments or the establishment of valuation reserves. Measuring assets and liabilities at fair value may result in fluctuations to carrying value that have a significant impact on the results of operations or other comprehensive income for the period and period over period. Following is a detailed summary of the guidance provided by US GAAP regarding the application of fair value measurements and Patriot’s application thereof. Additionally, the following information includes detailed summaries of the effects fair value measurements have on the carrying amounts of asset and liabilities presented in the Consolidated Financial Statements. The objective of fair value measurement is to value an asset that may be sold or a liability that may be transferred at the estimated value which might be obtained in a transaction between unrelated parties under current market conditions. US GAAP establishes a framework for measuring assets and liabilities at fair value, as well as certain financial instruments classified in equity. The framework provides a fair value hierarchy, which prioritizes quoted prices in active markets for identical assets and liabilities and minimizes unobservable inputs, which are inputs for which market data are not available and that are developed by management using the best information available to develop assumptions about the value market participants might place on the asset to be sold or liability to be transferred. The three levels of the fair value hierarchy consist of:
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements A description of the valuation methodologies used for assets and liabilities recorded at fair value, and for estimating fair value for financial and non-financial instruments not recorded at fair value, is set forth below. Cash and due from banks, federal funds sold, short-term investments, and accrued interest receivable and payable The carrying amount is a reasonable estimate of fair value and accordingly these are classified as Level 1. These financial instruments are not recorded at fair value on a recurring basis. Available-for-sale securities The fair value of securities available-for-sale (carried at fair value) are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities, but rather by relying on the securities' relationship to other benchmark quoted prices, or using unobservable inputs employing various techniques and assumptions (Level 3). Other Investments The Bank’s investment portfolio includes the Solomon Hess SBA Loan Fund totaling $4.45 million. This investment is utilized by the Bank to satisfy its Community Reinvestment Act (“CRA”) lending requirements. As this fund operates as a private fund, shares in the fund are not publicly traded but may be redeemed with 60 days’ notice at cost. For that reason, the carrying amount was considered comparable to fair value at both December 31, 2018 and 2017. The remaining balance in other investments is a $513,000 time deposit matures on October 6, 2019, which is carried at cost, which approximates fair value due to its short-term nature. Loans The fair values of loans are estimated by discounting the future cash flows using the rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. In connection with the adoption of ASU 2016-01 on January 1, 2018, we refined our methodology to estimate the fair value of our loan portfolio using an exit price notion resulting in prior periods no longer being comparable. The exit price notion requires determination of the price at which willing market participants would transact at the measurement date under current market conditions depending on facts and circumstances, such as origination rates, credit risk, transaction costs, liquidity, national and regional market trends and other adjustments, utilizing publicly available rates and indices. The application of an exit price notion requires the use of significant judgment. Other Real Estate Owned The fair value of OREO the Bank may obtain is based on current appraised property value less estimated costs to sell. When fair value is based on unadjusted current appraised value, OREO is classified within Level 2 of the fair value hierarchy. Patriot classifies OREO within Level 3 of the fair value hierarchy when unobservable inputs are used to determine adjustments to appraised values. Patriot does not record OREO at fair value on a recurring basis, but rather initially records OREO at fair value on a non recurring basis and then monitors property and market conditions that may indicate a change in value is warranted. Derivative asset (liability)- Interest Rate Swaps The valuation of the Company’s interest rate swaps is obtained from a third-party pricing service and is determined using a discounted cash flow analysis on the expected cash flows of each derivative. The pricing analysis is based on observable inputs for the contractual terms of the derivatives, including the period to maturity and interest rate curves. The Company has determined that the majority of the inputs used to value its interest rate derivatives fall within Level 2 of the fair value hierarchy. Deposits The fair value of demand deposits, regular savings and certain money market deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposit and other time deposits is estimated using a discounted cash flow calculation that applies interest rates currently being offered for deposits of similar remaining maturities, estimated using local market data, to a schedule of aggregated expected maturities on such deposits. The Company does not record deposits at fair value on a recurring basis. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements Senior Notes, Subordinated Notes, and Junior Subordinated Debt Patriot does not record senior notes at fair value on a recurring basis. The fair value of the senior notes was estimated by discounting future cash flows at rates at which similar notes would be made. The carrying value is considered comparable to fair value. Patriot does not record subordinated notes issued in June 2018 at fair value on a recurring basis. The fair value of the subordinated notes was estimated by discounting future cash flows at rates at which similar notes would be made. The carrying value is considered comparable to fair value. Patriot does not record junior subordinated debt at fair value on a recurring basis. Junior subordinated debt reprices quarterly, as a result, the carrying amount is considered a reasonable estimate of fair value. Federal Home Loan Bank Borrowings The fair value of FHLB advances is estimated using a discounted cash flow calculation that applies current FHLB interest rates for advances of similar maturity to a schedule of maturities of such advances. Patriot does not record FHLB advances at fair value on a recurring basis. Contingent Consideration Liability The Company estimates the fair value of the contingent consideration liability by using a discounted cash flow model of future contingent payments based on interest income related to the acquired PCI loans. The estimated fair value of the contingent consideration liability is reviewed on a quarterly basis and any valuation adjustments resulting from a change of estimated future contingent payments based on interest income of the acquired PCI loans affecting the contingent consideration liability will be recorded through noninterest expense. Due to the significant unobservable input related to the interest income, the contingent consideration liability is classified within Level 3 of the valuation hierarchy. An increase in the interest income may result in a higher fair value of the contingent consideration liability. Alternatively, a decrease in the interest income may result in a lower estimated fair value of the contingent consideration liability. Off-balance sheet financial instruments Off-balance sheet financial instruments are based on interest rate changes and fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. Patriot off-balance sheet financial instruments (i.e., commitments to extend credit) are insignificant and are not recorded on a recurring basis. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements The following table provides a comparison of the carrying amounts and estimated fair values of Patriot’s financial assets and liabilities as of December 31, 2018 and 2017:
The carrying amount of cash and noninterest bearing balances due from banks, interest-bearing deposits due from banks, and demand deposits approximates fair value, due to the short-term nature and high turnover of these balances. These amounts are included in the table above for informational purposes. In the normal course of its operations, Patriot assumes interest rate risk (i.e., the risk that general interest rate levels will fluctuate). As a result, the fair value of Patriot’s financial assets and liabilities are affected when interest market rates change, which change may be either favorable or unfavorable. Management attempts to mitigate interest rate risk by matching the maturities of its financial assets and liabilities. However, borrowers with fixed rate obligations are less likely to prepay their obligations in a rising interest rate environment and more likely to prepay their obligations in a falling interest rate environment. Conversely, depositors receiving fixed rates are more likely to withdraw funds before maturity in a rising interest rate environment and less likely to do so in a falling interest rate environment. Management monitors market rates of interest and the maturities of its financial assets and financial liabilities, adjusting the terms of new loans and deposits in an attempt to minimize interest rate risk. Additionally, management mitigates its overall interest rate risk through its available funds investment strategy. PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements The following tables detail the financial assets measured at fair value on a recurring basis and the valuation techniques utilized relative to the fair value hierarchy, as of December 31, 2018 and 2017.
During the year ended December 31, 2018, the Company had no transfers into or out of Levels 1, 2 or 3. During the year ended December 31, 2017, Patriot observed market activity in financial instruments similar to an available-for-sale subordinated note investment, and sufficient to justify transfer out of Level 3 into Level 2 of the fair value hierarchy. Management monitors the fair value used to measure financial assets and liabilities and, when changes in circumstances occur, such as volume change in market activity or an absence of identical or similar financial assets or liabilities due to a change in instrument terms or features, transfers of the fair value measurement hierarchy occur. No other significant activity occurred during 2017 related to Level 3 instruments. The fair value of the subordinated note classified as Level 3 during the year ended December 31, 2017 was determined using a present value approach. The discount rate assumed was determined relative to market rates of interest and considering the history and credit worthiness of the note’s issuer. The resulting computations did not result in any change in to the fair value of the subordinated note classified as available-for-sale. Other than the subordinated note, there have been no transfers into or out of Level 3 of the fair value measurement hierarchy in 2017. Patriot measures certain financial assets and financial liabilities at fair value on a non-recurring basis. When circumstances dictate (e.g., impairment of long-lived assets, other than temporary impairment of collateral value), the carrying values of such financial assets and financial liabilities are adjusted to fair value or fair value less costs to sell, as may be appropriate. The following tables detail the financial assets measured at fair value on a non-recurring basis and the valuation techniques utilized relative to the fair value hierarchy, as of December 31, 2018 and 2017:
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements The Company’s acquisitions are accounted for under the acquisition method of accounting in accordance with ASC 805, Business Combinations. Both the purchased assets and liabilities assumed are recorded at their respective acquisition date fair values. The assets and liabilities from the business combination were measured at fair value on a non-recurring basis. For further information, refer to Note 2 Business Combinations. Patriot discloses fair value information about financial instruments, whether or not recognized in the Consolidated Balance Sheet, for which it is practicable to estimate that value. Certain financial instruments are excluded from disclosure requirements and, accordingly, the aggregate fair value amounts presented do not necessarily represent the complete underlying value of financial instruments included in the Consolidated Financial Statements. The estimated fair value amounts have been measured as of December 31, 2018 and December 31, 2017 and have not been reevaluated or updated for purposes of these consolidated financial statements subsequent to those respective dates. As such, the estimated fair values of the financial instruments measured may be different than if they had been subsequently valued. The information presented should not be interpreted as an estimate of the total fair value of Patriot’s assets and liabilities, since only a portion of Patriot’s assets and liabilities are required to be measured at fair value for financial reporting purposes. Due to the wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between Patriot’s fair value disclosures and those of other bank holding companies may not be meaningful.
Patriot is a party to interest rate derivatives that are not designated as hedging instruments. Under a program, Patriot will execute interest rate swaps with commercial lending customers to facilitate their respective risk management strategies. These interest rate swaps with customers are simultaneously offset by interest rate swaps that Patriot executes with a third party, such that Patriot minimizes its net risk exposure resulting from such transactions. Because the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings. The changes in the fair value of the swaps offset each other, except for the credit risk of the counterparties, which is determined by taking into consideration the risk rating, probability of default and loss given default for all counterparties. As of December 31, 2018 and 2017, Patriot had $300,000 and $0, respectively, in cash pledged for collateral on its interest rate swaps. Patriot entered the two initial interest rate swaps under the program in November 2018. There were no interest rate swaps entered into as of December 31, 2017. The following table presents summary information regarding these derivatives for the periods presented (dollars in thousands):
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements
The following represent the condensed stand-alone financial statements of Patriot National Bancorp, Inc., (the “Company”), which is the sole owner and parent company of Patriot Bank, N.A. (the “Bank”), its operating bank subsidiary.
(In thousands)
(In thousands)
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY Notes to consolidated financial statements
On March 30, 2019 the Company and Hana SBL mutually agreed to terminate the Asset Purchase Agreement dated February 6, 2018 and amended on August 2, 2018 between the parties. The termination agreement provides for the release of escrowed funds back to the Company. The Company has evaluated all events or transactions that occurred through the date the Company issued these financial statements. During this period, the Company did not have any other material recognizable or non-recognizable subsequent events. SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act,
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in capacities and on the dates indicated.
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