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PNBK Patriot National Bancorp

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2019

 

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number 000-29599

 

PATRIOT NATIONAL BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

Connecticut

 

06-1559137

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

 

 

900 Bedford Street, Stamford, Connecticut

 

06901

(Address of principal executive offices)

 

(Zip Code)

 

(203) 324-7500

(Registrant’s telephone number, including area code)

 

Securities registered under Section 12(b) of the Exchange Act:

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock, par value $0.01 per share

PNBK 

NASDAQ Global Market

 

Securities registered under Section 12(g) of the Exchange Act: None

 

Indicate by check mark if the registrant in a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933.     Yes   ☐    No ☒

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 of 15(d) of the Securities Exchange Act of 1934.     Yes   ☐    No ☒

 

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 past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:     Yes ☒    No   ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).     Yes ☒    No   ☐

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K  ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act

 

Large accelerated filer

 

  

Accelerated filer

 

Non-accelerated filer

 

☐  

  

Smaller reporting company

 

Emerging growth company

 

 

 

 

 

 

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 Rule 12b-2 of the Exchange Act).    Yes   ☐    No ☒

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

As of June 30, 2019, the aggregate market value of the voting stock held by non-affiliates of the registrant based on the last sale price on June 30, 2019 as reported on the NASDAQ Global Market: $20.5 million.

 

Number of shares of the registrant’s Common stock, $0.01 par value per share, 3,935,141 shares outstanding as of April 24, 2020.

 

Document Incorporated by Reference

 

The information required by Part III of this Form 10-K will be incorporated by reference from an amendment (the “Amendment”) to this Form 10-K, which is due on April 29, 2020, 120 days after the close of the fiscal year covered by this Form 10-K. The Company plans to avail itself of a 45-day extension to file the Amendment relying on an order issued by the Securities and Exchange Commission (the “SEC”) on March 25, 2020 pursuant to Section 36 of the Securities Exchange Act of 1934, as amended (Release No. 34-88465, the “SEC Order”) granting exemptions to public companies affected by COVID-19. The Company plans to file the Amendment no later than June 15, 2020.


EXPLANATORY NOTE


Due to the outbreak of coronavirus disease 2019 (COVID-19), starting from early March 2020, the Company’s employees and external auditors have been asked to work remotely. As a result, the Company’s books and records have not been easily accessible and communication among internal financial staff and external auditors has been challenging, resulting in delay in preparation and completion of its consolidated financial statements. Based on the foregoing, on March 30, 2020, the Company filed a Current Report on Form 8-K to avail itself of a 45-day extension to file this Form 10-K relying on the exemptions provided by the SEC Order. This Form 10-K is being filed in reliance on the SEC Order.

 

 

 

 

PATRIOT NATIONAL BANCORP, INC.

2019 FORM 10-K ANNUAL REPORT

For the Year Ended December 31, 2019

 

TABLE OF CONTENTS

 

“Safe Harbor” Statement Under Private Securities Litigation Reform Act of 19951
  

PART I

2

ITEM 1. Business

2

ITEM 1A. Risk Factors

8

ITEM 1B. Unresolved Staff Comments

14

ITEM 2. Properties

15

ITEM 3. Legal Proceedings

15

ITEM 4. Mine Safety Disclosures

15

  

PART II

16

ITEM 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

16

ITEM 6. Selected Financial Data

18

ITEM 7. Management’s Discussion and Analysis - Financial Condition & Results of Operations

19

ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk

35

ITEM 8. Financial Statements and Supplementary Data

37

ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

40

ITEM 9A. Controls and Procedures

40

ITEM 9B. Other Information

41

  

PART III

42

ITEM 10. Directors, Executive Officers and Corporate Governance

42

ITEM 11. Executive Compensation

42

ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters

42

ITEM 13. Certain Relationships and Related Transactions, and Director Independence

43

ITEM 14. Principal Accountant Fees and Services

43

  

Part IV

44

ITEM 15. Exhibits and Financial Statement Schedules

44

  

SIGNATURES

112

 

 

 

 

 

“Safe Harbor” Statement Under Private Securities Litigation Reform Act of 1995


 

Certain statements contained in the Company’s periodic reports, public statements and other filings, including this one, and in particular in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” may be forward-looking and subject to a variety of risks and uncertainties. These factors include, but are not limited to:
(1) changes in prevailing interest rates which would affect the interest earned on the Company’s interest earning assets and the interest paid on its interest bearing liabilities;
(2) the timing of re-pricing of the Company’s interest earning assets and interest bearing liabilities;
(3) the effect of changes in governmental monetary policy;
(4) the effect of changes in regulations applicable to the Company and the Bank and the conduct of its business;
(5) changes in competition among financial service companies, including possible further encroachment of non-banks on services traditionally provided by banks;
(6) the ability of competitors that are larger than the Company to provide products and services which it is impracticable for the Company to provide;
(7) the state of the economy and real estate values in the Company’s market areas, and the consequent effect on the quality of the Company’s loans;
(8) demand for loans and deposits in our market area;
(9) recent governmental initiatives that are expected to have a profound effect on the financial services industry and could dramatically change the competitive environment of the Company;
(10) other legislative or regulatory changes, including those related to residential mortgages, changes in accounting standards, and Federal Deposit Insurance Corporation (“FDIC”) premiums that may adversely affect the Company;
(11) the application of generally accepted accounting principles, consistently applied;
(12) the fact that one period of reported results may not be indicative of future periods;
(13) the state of the economy in the greater New York metropolitan area and its particular effect on the Company's customers, vendors and communities and other such factors, including risk factors, as may be described in the Company’s other filings with the Securities and Exchange Commission (the “SEC”);
(14) political, social, legal and economic instability, civil unrest, war, catastrophic events, acts of terrorism;
(15) widespread outbreaks of infectious diseases, including the ongoing novel coronavirus ( COVID-19) outbreak;
(16) changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of the allowance for loan losses;
(17) our ability to access cost-effective funding;
(18) our ability to implement and change our business strategies;
(19) changes in the quality or composition of our loan or investment portfolios;
(20) technological changes that may be more difficult or expensive than expected;
(21) our ability to manage market risk, credit risk and operational risk in the current economic environment;
(22) our ability to enter new markets successfully and capitalize on growth opportunities;
(23) changes in consumer spending, borrowing and savings habits;
(24) our ability to retain key employees; and
(25) our compensation expense associated with equity allocated or awarded to our employees

 

Although the Company believes that it offers competitive loan and deposit products and has the resources needed for continued success, future revenues and interest spreads and yields as well as loan losses and demand cannot be reliably predicted. These trends may cause the Company to adjust its operations in the future. Because of the foregoing and other factors, recent and historical trends should not be considered reliable indicators of future financial results or stock prices.

 

1

 

PART I

 

ITEM 1. Business

 

General

 

Patriot National Bancorp, Inc. (the “Company”), a Connecticut corporation, is a one-bank holding company for Patriot Bank, N.A, a national banking association headquartered in Stamford, Fairfield County, Connecticut (the “Bank”) (collectively, “Patriot”). The Bank received its charter and commenced operations as a national bank on August 31, 1994. The Bank has a total of nine branch offices comprised of eight branch offices located in Fairfield and New Haven Counties, Connecticut and one branch office located in Westchester County, New York as of December 31, 2019.

 

On March 11, 2003, the Company formed Patriot National Statutory Trust I (the “Trust”) for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures issued by the Company. The Company primarily invested the funds from the issuance of the debt in the Bank. The Bank used the proceeds to fund general operations.

 

On October 15, 2010, pursuant to a Securities Purchase Agreement (the “Securities Purchase Agreement”) entered into on December 16, 2009, the Company issued and sold to PNBK Holdings LLC (“Holdings”), an investment limited liability company controlled by Michael Carrazza, 3.36 million shares of its common stock at a purchase price of $15.00 per share (adjusted for a 1-for-10 reverse stock split discussed below) for an aggregate purchase price of $50.4 million. The shares sold to Holdings represented 87.6% of the Company’s then issued and outstanding common stock. In connection with the reverse stock split, the par value of the common stock was changed to $0.01 per share. Also in connection with the sale of the shares, certain directors and officers of both the Company and the Bank resigned. Such directors and officers were replaced with nominees of Holdings and Michael Carrazza became the Chairman of the Board of Directors (the “Board”) of the Company. In January 2018, Holdings transferred 840,000 shares to its investors.

 

As of the date hereof, the only business of the Company is its ownership of all of the issued and outstanding capital stock of the Bank and the Trust. Except as specifically noted otherwise herein, the balance of the description of the Company’s business is a description of the Bank’s business.

 

On March 4, 2015, the Company effected a 1-for-10 reverse stock split.

 

On September 28, 2015, the Bank changed its name from Patriot National Bank to Patriot Bank, N.A.

 

On January 26, 2017, the Board appointed Richard A. Muskus, Jr. President of Patriot. Mr. Muskus had served as Executive Vice President and Chief Lending Officer of the Bank since February 2014. Mr. Muskus’ appointment replaced Peter D. Cureau who was acting as the Interim President and Chief Operating Officer of Patriot and who continued to work with Mr. Carrazza in the office of the Chairman through the first quarter of 2017. On March 27, 2020, Richard A. Muskus, Jr. resigned as President and Director of the Company and the Bank, effective April 17, 2020. Mr. Muskus' resignation from the aforementioned positions was not a result of any disagreements with the Company and Patriot Bank regarding their operations, policies or practices.

 

On May 10, 2017, Joseph D. Perillo was appointed as Chief Financial Officer of Patriot effective as of May 9, 2017. Mr. Perillo’s appointment was in response to the resignation of Neil M. McDonnell, who was Chief Financial Officer of Patriot from January 5, 2016 through May 9, 2017 and who resigned on that date as an Executive Vice President and Chief Financial Officer.

 

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 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.

 

On April 2, 2020, the Bank eliminated the positions of President (effective as of April 17, 2020) and Chief Lending Officer. As a result, Scott Laughinghouse’s employment as Executive Vice President and Chief Lending Officer of the Bank was terminated. The decisions to eliminate such officer positions, in conjunction with other profit improvement strategies, were being proactively implemented by the Bank to build regulatory capital buffers and to strengthen the Bank’s profitability ahead of uncertain times.

 

2

 

Business Operations

 

The Bank offers commercial real estate loans, commercial business loans, and a variety of consumer loans with an emphasis on serving the needs of individuals, small and medium-sized businesses and professionals. The Bank previously had offered loans on residential real estate, but discontinued doing so during 2013. The Bank’s lending activities are conducted principally in Fairfield and New Haven Counties in Connecticut and Westchester County in New York, although the Bank’s loan business is not necessarily limited to these areas.

 

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:

 

Branch No.

 

City

 

County

 

State

1

 

Darien

 

Fairfield

 

Connecticut

2

 

Fairfield

 

Fairfield

 

Connecticut

3

 

Greenwich

 

Fairfield

 

Connecticut

4

 

Milford

 

New Haven

 

Connecticut

5

 

Norwalk

 

Fairfield

 

Connecticut

6

 

Orange

 

New Haven

 

Connecticut

7

 

Stamford

 

Fairfield

 

Connecticut

8

 

Westport

 

Fairfield

 

Connecticut

9

 

Scarsdale

 

Westchester

 

New York

 

 

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 lender under the Small Business Administration (“SBA”) program at the end of 2017. Since 2018, Patriot has hired people to support new SBA business development in Stamford, Connecticut, Jacksonville, Florida, Atlanta, Georgia, Indianapolis, Indiana, and Warwick, Rhode Island.

 

Employees

 

As of December 31, 2019, Patriot had 131 full-time equivalent employees. None of Patriot’s employees are covered by a collective bargaining agreement.

 

3

 

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 limits, as well as the ability to conduct larger advertising campaigns to attract business. The larger financial institutions may also offer additional services such as trust and international banking, which the Bank is not equipped to offer directly. When the need arises, arrangements are made with correspondent financial institutions to provide such services. To attract business in this competitive environment, the Bank relies on local promotional activities, personal contact by officers and directors, customer referrals, and its ability to distinguish itself by offering personalized and responsive banking service.

 

The customer base of the Bank generally is meant to be diversified, so that there is not a concentration of either loans or deposits within a single industry, a group of industries, or a single person or groups of people. The Bank is not dependent on one or a few major customers for its lending or deposit activities, the loss of any one of which would have a material adverse effect on the business of the Bank.

 

The Bank’s loan customers extend beyond the towns and cities in which the Bank has branch offices, including nearby towns in Fairfield and New Haven Counties in Connecticut, and Westchester County and the five boroughs of New York City in New York, although the Bank’s loan business is not necessarily limited to these areas. While the Bank does not currently hold or intend to attract significant deposit or loan business from major corporations with headquarters in its market area, the Bank believes that small manufacturers, distributors and wholesalers, and service industry professionals and related businesses, which have been attracted to this area, as well as the individuals that reside in the area, represent current and potential customers of the Bank.

 

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 bank holding company, the Company’s operations are subject to regulation, supervision, and examination by the Board of Governors of the Federal Reserve System (the “Fed”). The Fed has established capital adequacy guidelines for bank holding companies that are similar to the Office of the Comptroller of the Currency’s (“OCC”) capital guidelines applicable to the Bank. The Bank Holding Company Act of 1956, as amended (the “BHC”), limits the types of companies that a bank holding company may acquire or organize and the activities in which it or they may engage. In general, bank holding companies and their subsidiaries are only permitted to engage in, or acquire direct control of, any company engaged in banking or in a business so closely related to banking as to be a proper incident thereto. Federal legislation enacted in 1999 authorizes certain entities to register as financial holding companies. Registered financial holding companies are permitted to engage in businesses, including securities and investment banking businesses, which are prohibited to bank holding companies. The creation of financial holding companies has had no significant impact on the Company.

 

Under the BHC, the Company is required to file semi-annual reports of its operations with the Fed for the period ended June 30 and for the year ended December 31. Patriot and any of its subsidiaries are subject to examination by the Fed. In addition, the Company will be required to obtain the prior approval of the Fed to acquire, with certain exceptions, more than 5% of the outstanding voting stock of any bank or bank holding company, to acquire all or substantially all of the assets of a bank, or to merge or consolidate with another bank holding company. Moreover, Patriot and any of its subsidiaries are prohibited from engaging in certain tying arrangements, in connection with any extension of credit or provision of any property or services. The Bank is also subject to certain restrictions imposed by the Federal Reserve Act on issuing any extension of credit to the Company or any of its subsidiaries, or making any investments in the stock or other securities thereof, and on the taking of such stock or securities as collateral for loans to any borrower. If the Company wants to engage in businesses permitted to financial holding companies, but not to bank holding companies, it would need to register with the Fed as a financial holding company.

 

4

 

The Fed has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses its view that a bank holding company should pay cash dividends only to the extent that the bank holding company’s net income for the past year is sufficient to cover both the cash dividend and a rate of earnings retention that is consistent with the bank holding company’s capital needs, asset quality, and overall financial condition. The Fed has also indicated that it would be inappropriate for a bank holding company experiencing serious financial problems to borrow funds to pay dividends. Furthermore, under the prompt corrective action regulations adopted by the Fed, if any of its subsidiaries is classified as “undercapitalized”, the bank holding company may be prohibited from paying dividends.

 

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 guidelines issued by the Fed and the FDIC and the Bank is subject to capital adequacy rules and guidelines issued by the OCC. These substantially identical rules and guidelines require Patriot to maintain certain minimum ratios of capital to adjusted total assets and/or risk-weighted assets. Under the provisions of the FDIC Improvements Act of 1991, the federal regulatory agencies are required to implement and enforce these rules in a stringent manner. The Company is also subject to applicable provisions of Connecticut law, insofar as they do not conflict with, or are not otherwise preempted by, federal banking law. Patriot’s operations are subject to regulation, supervision, and examination by the FDIC and the OCC.

 

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 Fed and, as such, is subject to applicable provisions of the Federal Reserve Act and regulations thereunder. The Bank is subject to the federal regulations promulgated pursuant to the Financial Institutions Supervisory Act that are designed to prevent banks from engaging in unsafe and unsound practices, as well as various other federal, state, and consumer protection laws. The Bank is also subject to the comprehensive provisions of the National Bank Act.

 

The OCC regulates the number and locations of branch offices of a national bank. The OCC may only permit a national bank to maintain branches in locations and under the conditions imposed by state law upon state banks. At this time, applicable Connecticut banking laws do not impose any material restrictions on the establishment of branches by Connecticut banks throughout Connecticut. New York State law is similar; however, the Bank cannot establish a branch in a New York town with a population of less than 50,000 inhabitants, if another bank is headquartered in that town.

 

The earnings and growth of Patriot and the banking industry in general are affected by the monetary and fiscal policies of the United States (“U.S.”) government and its agencies, particularly the Fed. The Open Market Committee of the Fed implements national monetary policy to curb inflation and combat recession. The Fed uses its power to adjust interest rates on U.S. government securities, the discount rate, and deposit reserve retention rates. The actions of the Fed influence the growth of bank loans, investments, and deposits. They also affect interest rates charged on loans and paid on deposits. The nature and impact of any future changes in monetary policies cannot be predicted.

 

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 Bank have not and will not adopt any policies or practices, which discourage credit applications from, or unlawfully discriminate against, individuals or segments of the communities served by the Bank.

 

5

 

On October 26, 2001, the United and Strengthening America by Providing Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “Patriot Act”) was enacted to further strengthen domestic security following the September 11, 2001 attacks. The Patriot Act amended various federal banking laws, particularly the Bank Secrecy Act, with the intent to curtail money laundering and other activities that might be undertaken to finance terrorist actions. The Patriot Act also requires that financial institutions in the U.S. enhance already established anti-money laundering policies, procedures and audit functions, and ensure that controls are reasonably designed to detect instances of money laundering through certain correspondent or private banking accounts. Verification of customer identification, maintenance of said verification records, and cross-checking names of new customers against government lists of known or suspected terrorists is also required. The Patriot Act was reauthorized and modified with the enactment of The USA Patriot Act Improvement and Reauthorization Act of 2005.

 

The Company is subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and, in accordance with the Exchange Act, files periodic reports, proxy statements, and other information with the SEC.

 

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 internal controls over financial reporting; although, Smaller Reporting Companies as defined by the SEC are exempt from this requirement. Sarbanes-Oxley contains provisions for the limitations of services that external auditors may provide, as well as requirements for the credentials of members of the Audit Committee of Patriot’s Board of Directors. In addition, Sarbanes-Oxley requires principal executive and principal financial officers to certify to the adequacy of internal controls over financial reporting and to the accuracy of financial information released to the public on a quarterly and annual basis. Specifically, Sarbanes-Oxley requires Patriot’s Chief Executive and Chief Financial officer to certify that, to their best of their knowledge, the financial information reported accurately presents the financial condition and results of operations of the Company and that it contains no untrue statement or omission of material fact. Patriot’s Chief Executive and Chief Financial officer also are required to certify to their responsibility for establishing and maintaining a system of internal controls, the design and implementation of which insures that all material information is made known to these officers or other responsible individuals; this certification also includes the evaluation of the effectiveness of disclosure controls and procedures, and the impact thereof, on the Company’s financial reporting.

 

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 did not have a material impact on the Company.

 

Financial reform legislation and the implementation of any rules ultimately issued could have adverse implications on the financial industry, the competitive environment, and the Bank’s ability to conduct business.

 

6

 

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 implemented 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 revised the risk-based capital requirements applicable to bank holding companies and their depository institution subsidiaries, including Patriot.

 

In September 2019, the community bank leverage ratio (CBLR) framework was jointly issued by the FDIC, OCC and Federal Reserve Bank (“FRB”). The final rule gives qualifying community banks the option to use a simplified measure of capital adequacy instead of risk based capital, beginning with their March 31, 2020 Call Report. Under the final rule a community bank may qualify for the CBLR framework if it has a Tier 1 leverage ratio of greater than 9%, less than $10 billion in total consolidated assets, and limited amounts of off-balance sheet exposures and trading assets and liabilities.

 

Coronavirus Aid, Relief, and Economic Security Act


In response to the COVID-19 pandemic, President Trump signed into law the Coronavirus Aid, Relief and Economic Security (CARES) Act on March 27, 2020. Among other things, the CARES Act included the following provisions impacting financial institutions:


Legal Lending Limit Waiver. The CARES Act permits the OCC to waive legal lending limits to any particular borrower (i) with respect to loans to non-bank financial companies or (ii) upon a finding by the OCC that such exemption is in the public interest, with respect to any other borrower, in each case until the earlier of the termination date of the national emergency or December 31, 2020.


Community Bank Leverage Ratio. The CARES Act directs federal banking agencies to adopt interim final rules to lower the threshold under the CBLR from 9% to 8% and to provide a reasonable grace period for a community bank that falls below the threshold to regain compliance, in each case until the earlier of the termination date of the national emergency or December 31, 2020. In April 2020, the federal bank regulatory agencies issued two interim final rules implementing this directive. One interim final rule provides that, as of the second quarter 2020, banking organizations with leverage ratios of 8% or greater (and that meet the other existing qualifying criteria) may elect to use the CBLR framework. It also establishes a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall below the 8% CBLR requirement, so long as the banking organization maintains a leverage ratio of 7% or greater. The second interim final rule provides a transition from the temporary 8% CBLR requirement to a 9% CBLR requirement. It establishes a minimum CBLR of 8% for the second through fourth quarters of 2020, 8.5% for 2021, and 9% thereafter, and maintains a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall no more than 100 basis points below the applicable CBLR requirement.


Temporary Troubled Debt Restructurings (“TDRs”) Relief. The CARES Act allows banks to elect to suspend requirements under accounting principles generally accepted in the United States of America (“U.S. GAAP”) for loan modifications related to the COVID-19 pandemic (for loans that were not more than 30 days past due as of December 31, 2019) that would otherwise be categorized as a TDR, including impairment for accounting purposes, until the earlier of 60 days after the termination date of the national emergency or December 31, 2020. Federal banking agencies are required to defer to the determination of the banks making such suspension.


Small Business Administration Paycheck Protection Program. The CARES Act created the SBA’s Paycheck Protection Program. Under the Paycheck Protection Program, $669 billion was authorized for small business loans to pay payroll and group health costs, salaries and commissions, mortgage and rent payments, utilities, and interest on other debt. The loans are provided through participating financial institutions, that process loan applications and service the loans.

 

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 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 and lease losses, and assumptions used in the Bank’s interest rate risk model. Under the Agreement the Bank agreed to provide a revised written 3-year strategic and capital plan for the Bank by December 31, 2018. The Bank provided the documents and policies requested in the Agreement.

 

To date, the Bank has addressed each of the items identified in the Agreement and is currently working collaboratively with the OCC to bring all matters to full resolution.

 

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 the Exchange Act, as soon as practicable after such reports are electronically filed with or furnished to the SEC. Because the Company is an electronic filer, such reports are filed with the SEC and are also available on their website (http://www.sec.gov). The public may also read and copy any materials filed with the SEC at the SEC’s Public Reference Room, 100 F Street, N.E. Room 1580, Washington, DC 20549. Information about the Public Reference Room can be obtained by calling 1-800-551-8090 or SEC Investor Information Service 1-800-SEC-0330.

 

7

 

ITEM 1A. Risk Factors

 

Patriot’s financial condition and results of operation are subject to various risks inherent to its business, including those noted below.

 

The ongoing COVID-19 pandemic and measures intended to prevent its spread could have a material adverse effect on our business, results of operations and financial condition, and such effects will depend on future developments, which are highly uncertain and are difficult to predict.


Global health concerns relating to the COVID-19 outbreak and related government actions taken to reduce the spread of the virus have been weighing on the macroeconomic environment, and the outbreak has significantly increased economic uncertainty and reduced economic activity. The outbreak has resulted in authorities implementing numerous measures to try to contain the virus, such as travel bans and restrictions, quarantines, shelter in place or total lock-down orders and business limitations and shutdowns. Such measures have significantly contributed to rising unemployment and negatively impacted consumer and business spending. The United States government has taken steps to attempt to mitigate some of the more severe anticipated economic effects of the virus, including the passage of the CARES Act, but there can be no assurance that such steps will be effective or achieve their desired results in a timely fashion.


The outbreak has adversely impacted and is likely to further adversely impact our operations and the operations of our borrowers, customers and business partners. In particular, we may experience financial losses due to a number of operational factors impacting us or our borrowers, customers or business partners, including but not limited to:

 

 

credit losses resulting from financial stress being experienced by our borrowers as a result of the outbreak and related governmental actions, particularly in the hospitality, energy, retail and restaurant industries, but across other industries as well;

 

declines in collateral values;

 

third party disruptions, including outages at network providers and other suppliers;

 

increased cyber and payment fraud risk, as cybercriminals attempt to profit from the disruption, given increased online and remote activity; and

 

operational failures due to changes in our normal business practices necessitated by the outbreak and related governmental actions.


These factors may remain prevalent for a significant period of time and may continue to adversely affect our business, results of operations and financial condition even after the COVID-19 outbreak has subsided.


The extent to which the coronavirus outbreak impacts our business, results of operations and financial condition will depend on future developments, which are highly uncertain and are difficult to predict, including, but not limited to, the duration and spread of the outbreak, its severity, the actions to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume.

 

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.

 

8

 

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:

 

 

Increases in:

 

-

Loan delinquencies;

 

-

Problem assets and foreclosures; or

 

Decreases in:

 

-

Demand for the Bank’s products and services;

 

-

Customer borrowing power that is caused by declines in the value of assets and/or collateral supporting the Bank’s loans, especially real estate.

 

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 2019, 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 and lease losses may not be adequate to cover actual losses.

 

Like all financial institutions, the Bank maintains an allowance for loan and lease losses to provide for loan defaults and non-performance. The allowance for loan and lease losses is based on an evaluation of the risks associated with the Bank’s loans receivable, as well as the Bank’s prior loss experience. Deterioration in general economic conditions and unforeseen risks affecting customers could have an adverse effect on borrowers’ capacity to timely repay their obligations before risk grades could reflect those changing conditions. Maintaining the adequacy of the Bank’s allowance for loan and lease losses may require that the Bank make significant and unanticipated increases in the provision for loan losses, which would materially affect the results of operations and capital adequacy. The amount of future losses is susceptible to changes in economic, operating, and other conditions including changes in interest rates that may be beyond the Bank’s control and which losses may exceed current allowance estimates. Although the current economic environment has improved, conditions remain uncertain and may result in additional risk of loan losses.

 

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 and lease losses. The regulatory agencies may require the Bank to change classifications or grades on loans, increase the allowance for loan and lease 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 and lease 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 and lease 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 and lease 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 underwriting guidelines for wholesale borrowings, or lending policies may limit or restrict Patriot’s ability to borrow, and could therefore have a significant adverse impact on its liquidity. A decline in available funding could adversely impact Patriot’s ability to originate loans, invest in securities, and meet its expenses, or to fulfill such obligations as repaying its borrowings or meeting deposit withdrawal demands.

 

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.

 

9

 

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.

 

Natural disasters, acts of war or terrorism, the impact of health epidemics and other adverse external events could detrimentally affect our financial condition and results of operations.

Natural disasters, acts of war or terrorism, and other adverse external events could have a significant negative impact on our ability to conduct business or upon third parties who perform operational services for us or our customers. Such events also could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in lost revenue or cause us to incur additional expenses.

 

The recent outbreak of COVID-19 could negatively impact the ability of our employees and customers to engage in banking and other financial transactions in the geographic areas in which the Company operates. The Company also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to a coronavirus outbreak in our market areas. Although the Company has business continuity plans and other safeguards in place, there is no assurance that such plans and safeguards will be effective. In the event of a natural disaster, the spread of the coronavirus to our market areas or other adverse external events, our business, services, asset quality, financial condition and results of operations could be adversely affected.

 

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 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 were 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.

 

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.

 

10

 

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 Company’s ability to fund its activities, meet its obligations, or pay dividends to its shareholders might be curtailed. The inability to receive dividends from the Bank could therefore have a material adverse effect on the Company.

 

Per agreement with Bank regulators, dividends from the Bank to the Holding Company are subject to prior approval from the OCC, and dividends from the Company to third parties are also subject to prior approval from FRB.

 

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:

 

 

Operating results that vary from the expectations of securities analysts and investors;

 

Developments in its business or in the financial services sector in-general;

 

Regulatory or legislative changes affecting its business or the financial services sector in-general;

 

Operating results or securities price performance of companies that investors consider being comparable to the Company;

 

Changes in estimates or recommendations by securities analysts or rating agencies;

 

Announcements of strategic developments, acquisitions, dispositions, financings, and other material events by the Company or the Company’s competitors; and

 

Changes or volatility in global financial markets and economies, general market conditions, interest or foreign exchange rates, stock, commodity, credit, or asset valuations.

 

11

 

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 in 2008, which might again result from the economic uncertainty caused by the COVID-19 pandemic, 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:

 

Less than optimal economic conditions may continue to affect market confidence levels and may cause adverse changes in payment patterns, thereby causing increased delinquencies, which could affect the Bank’s provision for loan losses and charge-off of loans receivable.

 

The ability to assess the creditworthiness of the Bank’s customers, or to accurately estimate loan collateral value, may be impaired if the models and approaches the Bank uses becomes less predictive of future behaviors, valuations, assumptions, or estimates due to the unpredictable economic climate.

 

Increasing consolidation of financial services companies, as a result of current market conditions, could have unexpected adverse effects on the Bank’s ability to compete effectively.

 

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.

 

12

 

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 years following the financial crisis in 2008, the financial services industry experienced unprecedented upheaval, including the failure of some of the world’s leading financial institutions. Since earlier this year, the COVID-19 pandemic has caused economic repercussions across the world. 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.

 

13

 

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:

 

Requiring the Board of Directors to be comprised of Independent Directors (as defined);

 

The requirement that the Company have a Nominating and Governance Committee that is composed entirely of independent directors;

 

The requirement that the Company have a Compensation Committee that is composed entirely of independent directors; and

 

The requirement for an annual performance evaluation of the Nominating and Governance and Compensation Committees.

 

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. 

 

14

 

ITEM 2. Properties 

 

The following table summarizes Patriot’s owned and leased properties, as of December 31, 2019:

 

 

Street Address

 

City

 

County

 

State

Owned:

      
 

233 Post Road

 

Darien

 

Fairfield

 

Connecticut

 

1755 Black Rock Turnpike

 

Fairfield

 

Fairfield

 

Connecticut

 

100 Mason Street

 

Greenwich

 

Fairfield

 

Connecticut

 

900 Bedford Street

 

Stamford

 

Fairfield

 

Connecticut

 

999 Bedford Street

 

Stamford

 

Fairfield

 

Connecticut

 

771 Boston Post Road

 

Milford

 

New Haven

 

Connecticut

 

50 Charles Street

 

Westport

 

Fairfield

 

Connecticut

 

50 Church Street

 

New Haven

 

New Haven

 

Connecticut

Leased:

      
 

16 River Street

 

Norwalk

 

Fairfield

 

Connecticut

 

415 Post Road East

 

Westport

 

Fairfield

 

Connecticut

 

495 Central Park Avenue

 

Scarsdale

 

Westchester

 

New York

 

7 Old Tavern Road

 

Orange

 

New Haven

 

Connecticut

 

30 Oak Street

 

Stamford

 

Fairfield

 

Connecticut

 

At December 31, 2019, 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 nine non-cancelable operating lease agreements. Patriot’s lease agreements have terms ranging from one year to fifteen years with twelve years and three 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.

 

At three of its branch buildings, the Bank has excess space that it leases to seven unrelated parties.

 

For additional information, see the Leases footnote disclosure in the Consolidated Financial Statements included herein.

 

ITEM 3. Legal Proceedings

 

From time to time we are a party to various litigation matters incidental to the conduct of our business and otherwise. We are not presently party to any legal proceedings the resolution of which we believe would have a material adverse effect on our business, future prospects, financial condition, liquidity, results of operation, cash flows or capital levels.

 

 

ITEM 4. Mine Safety Disclosures

 

Not applicable.

 

15

 

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 289 shareholders of record of the Company’s Common Stock as of December 31, 2019. 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. 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, 2019, 2018 and 2017, the Company paid cash dividends of $.01 per share of common stock, or an aggregate of $155,000, $154,000 and $77,000, respectively.

 

On March 26, 2020, the Company received a notice of rejection from the Federal Reserve Bank of New York regarding the Company’s request to make a quarterly dividend to its shareholders in March 2020. As a result, the Company did not pay the dividend that would normally have been paid during the first quarter of 2020.

 

 

Recent Sales of Unregistered Securities

 

No sales of unregistered securities were entered during 2019.

 

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

 

None.

 

16

 

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.

 

 

  

Period Ending

 
  

2014

  

2015

  

2016

  

2017

  

2018

  

2019

 

Patriot National Bancorp ("PNBK")

  100.00%  88.61%  85.57%  108.71%  86.78%  77.71%
Nasdaq Community Bank Index                        

Total Return Index ("XABQ")

  100.00%  106.63%  143.97%  149.02%  122.35%  148.32%

S&P 500 Total Return Index ("SP500TR")

  100.00%  101.38%  113.51%  138.29%  132.23%  173.86%

 

17

 

ITEM 6. Selected Financial Data 

 

(In thousands, except per share data)

 

As of and for the year ended December 31,

 
  

2019

  

2018

  

2017

  

2016

  

2015

 

Balance Sheet Data:

                    

Cash and due from banks

 $39,404  $66,437  $48,729  $92,289  $85,400 

Investment securities

  52,767   52,253   38,929   36,596   42,472 

Loans, net

  802,049   772,767   713,350   576,982   479,127 

Total assets

  979,836   951,696   852,080   756,654   653,355 

Total deposits

  769,535   743,281   637,439   529,324   444,665 

Total borrowings

  130,900   130,983   141,369   159,476   142,026 

Total shareholders' equity

  66,994   69,340   66,749   62,570   61,464 
                     
                     

Operating Data:

                    

Interest and dividend income

 $43,644  $40,375  $32,849  $25,408  $23,741 

Interest expense

  18,218   12,378   6,956   3,008   2,690 

Net interest income

  25,426   27,997   25,893   22,400   21,051 

Provision (credit) for loan losses

  4,971   1,303   (857)  2,464   250 

Non-interest income

  2,483   1,627   1,444   1,556   1,551 

Non-interest expense

  26,654   24,235   21,172   18,355   18,851 

(Benefit) provision for income taxes

  (899)  890   2,875   1,207   1,358 

Net (loss) income

 $(2,817) $3,196  $4,147  $1,930  $2,143 
                     
                     
                     

Per Share Data:

                    

Basic (loss) income per share

 $(0.72) $0.82  $1.06  $0.49  $0.55 

Diluted (loss) income per share

 $(0.72) $0.82  $1.06  $0.49  $0.55 
                     
                     

Selected Ratios:

                    

Return on average assets

  (0.29)%  0.35%  0.54%  0.30%  0.34%

Return on average equity

  (4.05)%  4.64%  6.32%  3.08%  3.55%

Average equity to average assets

  7.18%  7.63%  8.48%  9.83%  9.65%
                     

 

18

 

ITEM 7. Management’s Discussion and Analysis - Financial Condition & Results of Operations

 

General

 

Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to assist in understanding the consolidated financial condition and results of operations of the Company. The information contained in this section should be read in conjunction with the Consolidated Financial Statements and accompanying notes thereto included in Item 8 of this Annual Report on Form 10-K.

 

Critical Accounting Policies

 

The accounting and reporting policies of Patriot conform to 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.

 

19

 

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. 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, 2019, 2018, or 2017 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.

 

Impairment of Goodwill

 

Goodwill represents the excess of cost over the identifiable net assets of businesses acquired. Goodwill is recognized as an asset and is to be reviewed for impairment annually and between annual tests when events and circumstances indicate that impairment may have occurred. Impairment is a condition that exists when the carrying amount of goodwill exceeds its implied fair value.

 

Servicing Assets

 

A servicing asset related to SBA loans is initially recorded when these loans are sold and the servicing rights are retained. The servicing asset is recorded on the balance sheet and included in other assets. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Impairment is evaluated based on stratifying the underlying financial assets by date of origination and term. Any impairment, if temporary, would be reported as a valuation allowance.

 

Derivatives

 

The Company enters into interest rate swap agreements (“swaps”), to provide a facility to mitigate for the borrower the fluctuations in the variable rate on the respective loan. The customer swaps are simultaneously hedge by offsetting derivatives that Patriot entered into with an outside third party. The 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.

 

20

 

FINANCIAL CONDITION

 

Assets

 

The Company’s total assets increased $28.1 million, or 3.0%, from $951.7 million at December 31, 2018 to $979.8 million at December 31, 2019. The growth in assets is primarily attributable to an increase in the loan portfolio of $29.3 million primarily funded through a growth in deposits.

 

On March 30, 2019 the Company and Hana Small Business Lending Inc. mutually agreed to terminate the purchase agreement between the parties entered into in November 2018. The termination agreement provided for the release of escrowed funds back to the Company. The Company received the escrowed funds of $500,000 on May 9, 2019. Following is a detailed discussion and analysis of events and transactions during the years ended December 31, 2019 and 2018 and the impacts that have been realized with respect to Patriot’s financial position.

 

Cash and cash equivalents

 

Cash and cash equivalents have decreased $27.0 million or 40.7%, from $66.4 million at December 31, 2018 to $39.4 million as of December 31, 2019. The decrease as of December 31, 2019 was primarily attributable to $54.6 million cash used in purchases of loans and $26.9 million used for origination of SBA loans held for sale, and $18.7 million in purchases of available-for-sale securities. The cash outflows were partially offset by a $26.2 million increase in deposits, and $12.6 million of proceeds from sales of SBA loans. Liquid funds in the form of cash and cash equivalents, investment securities and loans held for sale were maintained at a level throughout the year to result in an on-balance sheet liquidity ratio of between 7% and 10%, with the ratio equal to 10.96% of total assets at December 31, 2019.

 

Investment securities

 

The following table is a summary of the Company’s available-for-sale securities portfolio and other investments at the dates shown:

 

(In thousands)

 

December 31,

 
  

2019

  

2018

  

2017

 

U. S. Government agency mortgage-backed securities

 $16,685  $20,473  $7,224 

Corporate bonds

  17,313   12,974   13,804 

Subordinated notes

  9,204   4,564   4,548 

SBA loan pools

  5,115   -   - 

U.S. Treasury notes

  -   1,485   - 

Total Available-for-Sale Securities, at fair value

  48,317   39,496   25,576 
             

Other Investments, at cost

  4,450   4,963   4,962 
             
  $52,767  $44,459  $30,538 

 

Available-for-sale securities increased $8.8 million or 22.3%, from $39.5 million at December 31, 2018 to $48.3 million at December 31, 2019. This increase was primarily attributable to the purchases of $5.5 million in SBA government guaranteed loan pools, $4.6 million in U.S. Government agency mortgage-backed securities, $4.5 million in subordinated notes, and $4.0 million in corporate bonds, which was offset by $3.9 million in repayments of principal on available-for-sale securities and $6.5 million proceeds from maturity on available-for-sale securities. There were no sales of available-for-sales securities during the year ended December 31, 2019.

 

21

 

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:

 

  

December 31,

 

(In thousands)

 

2019

  

2018

  

2017

 
  

Amount

  

%

  

Amount

  

%

  

Amount

  

%

 

Loan portfolio segment:

                        

Commercial Real Estate

 $314,414   38.71% $274,938   35.23% $299,925   41.68%

Residential Real Estate

  175,489   21.61%  157,300   20.16%  146,377   20.34%

Commercial and Industrial

  173,875   21.41%  191,852   24.58%  131,161   18.23%

Consumer and Other

  85,934   10.58%  94,569   12.12%  87,707   12.19%

Construction

  48,388   5.96%  46,040   5.90%  47,619   6.62%

Construction to permanent - CRE

  14,064   1.73%  15,677   2.01%  6,858   0.94%

Loans receivable, gross

  812,164   100.00%  780,376   100.00%  719,647   100.00%

Allowance for loan losses

  (10,115)      (7,609)      (6,297)    

Loans receivable, net

 $802,049      $772,767      $713,350     

 

The total loans receivable increased $31.8 million or 4.1%, from $780.4 million at December 31, 2018 to $812.2 million at December 31, 2019. Additions to the portfolio were made throughout the year with the intention of maintaining the appropriate balance of diversified risk throughout the portfolio, while generating a strong yield on earning assets. The Company will continue to add to the product lines and enhance service offerings to the customers.

 

Patriot originates SBA 7(a) loans, on which the SBA has historically provided guarantees of 75 percent of the principal balance. The guaranteed portion of the Company’s SBA loans is generally sold in the secondary market with the unguaranteed portion held in the portfolio as a loan held for investment.

 

SBA loans held for investment were included in the commercial real estate loans and commercial and industrial loan classifications above. As of December 31, 2019 and 2018, SBA loans included in the commercial real estate loans were $4.0 million and $0, respectively. SBA loans included in the commercial and industrial loan were $5.6 million and $1.5 million as of December 31, 2019 and 2018, respectively. Delays in SBA loan sales have been caused by a requirement from the SBA that requires the Bank to receive SBA approval prior to sale.  The Bank does expect to have these transactions approved and loans sold during the first half of 2020.

 

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, 2019:

 

(In thousands) 

Contractual Maturity of Loan Balance

     

 

 

One year
or less

  

One
through
Five Years

  

After
Five Years

  

Total

 

Loan portfolio segment:

                

Commercial Real Estate

 $55,870  $57,095  $201,449  $314,414 

Residential Real Estate

  2,487   3,756   169,246   175,489 

Commercial and Industrial

  32,323   74,189   67,363   173,875 

Consumer and Other

  1,344   6,267   78,323   85,934 

Construction

  41,923   6,370   95   48,388 

Construction to permanent - CRE

  -   -   14,064   14,064 

Total

 $133,947  $147,677  $530,540  $812,164 
                 
                 

Fixed rate loans

 $14,978  $64,723  $153,082  $232,783 

Variable rate loans

  118,969   82,954   377,458   579,381 

Total

 $133,947  $147,677  $530,540  $812,164 

 

22

 

All variable rate loans account for 71.3% of the total loan portfolio. Approximately 37.1% 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). These repricing characteristics are reflected in the Bank’s aggregate analysis of net interest sensitivity included in Item 7A. of this report.

 

As a community bank, the Bank is invested in a 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 60.1% 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 $2.5 million from $7.6 million at December 31, 2018 to $10.1 million at December 31, 2019. The increase in the allowance for loan and lease losses was due to a provision of $2.9 million (with a corresponding $2.3 million charge-off) booked in the second quarter associated with a single loan stemming from operating cash flow weaknesses and collateral shortfall, and an additional $1.5 million reserve added in connection with accounting for one troubled debt restructuring in the fourth quarter of 2019.

 

Based upon the overall assessment and evaluation of the loan portfolio at December 31, 2019, management believes the allowance for loan and lease losses of $10.1 million, which represents 1.25% 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:

 

  

Year ended December 31,

 

(In thousands)

 

2019

  

2018

  

2017

 
             

Balance at beginning of the period

 $7,609  $6,297  $4,675 

Charge-offs:

            

Residential Real Estate

  (118)  (2)  - 

Commercial and Industrial

  (2,418)  -   (265)

Consumer and Other

  (123)  (33)  (39)

Total charge-offs

  (2,659)  (35)  (304)

Recoveries:

            

Commercial Real Estate

  2   7   10 

Residential Real Estate

  10   2   - 

Commercial and Industrial

  172   34   2,769 

Consumer and Other

  10   1   4 

Total recoveries

  194   44   2,783 
             

Net (charge-offs) recoveries

  (2,465)  9   2,479 

Provision (credit) charged to earnings

  4,971   1,303   (857)

Balance at end of the period

 $10,115  $7,609  $6,297 
             

Ratios:

            

Net (charge-offs) recoveries to average loans

  (0.305)%  0.001%  0.370%

Allowance for loan losses to total loans

  1.25%  0.98%  0.88%

 

23

 

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:

 

  

December 31,

 

(In thousands)

 

2019

  

2018

  

2017

 
  

Allowance for loan losses

  

% of
loans

  

Allowance for loan losses

  

% of
loans

  

Allowance for loan losses

  

% of
loans

 

Commercial Real Estate

 $3,789   38.71% $1,866   35.23% $2,212   41.68%

Residential Real Estate

  1,038   21.61%  1,059   20.16%  959   20.34%

Commercial and Industrial

  4,340   21.41%  3,558   24.58%  2,023   18.23%

Consumer and Other

  341   10.58%  641   12.12%  568   12.19%

Construction

  477   5.96%  350   5.90%  481   6.62%

Construction to permanent - CRE

  130   1.73%  108   2.01%  54   0.94%

Unallocated

  -   N/A   27   N/A   -   N/A 

Total

 $10,115   100.00% $7,609   100.00% $6,297   100.00%

 

Nonperforming Assets

 

The following table presents non-accrual and accruing loans which were past due by over 90 days for the dates indicated:

 

(In thousands)

 

December 31,

 
  

2019

  

2018

  

2017

 

Non-accruing loans:

            

Commercial Real Estate

 $11,961  $3,525  $- 

Residential Real Estate

  3,228   2,006   3,028 

Commercial and Industrial

  2,094   4,681   748 

Consumer and Other

  766   174   2 

Construction

  -   8,800   - 

Total non-accruing loans

  18,049   19,186   3,778 
             

Loans past due over 90 days and still accruing

  19   1,316   1,356 

Other real estate owned

  2,400   2,945   - 

Total nonperforming assets

 $20,468  $23,447  $5,134 
             

Nonperforming assets to total assets

  2.09%  2.46%  0.60%

Nonperforming loans to total loans, net

  2.25%  2.65%  0.72%

 

Non-accrual loans decreased $1.2 million, from $19.2 million at December 31, 2018 to $18.0 million at December 31, 2019. The $18.0 million of non-accrual loans at December 31, 2019 was comprised of 27 borrowers. Two TDR loans of $9.3 million were included in the non-accrual loans. The Company has obtained appraisal reports from independent licensed appraisal firms, applied a 12% discount to reflect the Bank's experience selling OREO properties and applied 8% selling costs to determine estimated impairment. The Bank evaluated the impaired loans individually. A specific reserve of $1.5 million has been established for one of the twenty-seven impaired loans. After evaluation for other twenty-six impaired loans, the Bank determined that there was no resulting specific reserve as of December 31, 2019 due to sufficient cash flow or collateral supporting each loan.

 

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. There were no TDR loans included in the non-accrual loans as of December 31, 2018.

 

24

 

Loans held for sale

 

Loans held for sale are made up of SBA loans which totaled $15.3 million at December 31, 2019, with no balance at December 31, 2018.

 

SBA loans are originated under the U.S. Small Business Administration ("SBA") 7(a) program. Loans made by the Bank under the SBA 7(a) program generally are made to small businesses to provide working capital or to provide funding for the purchase of businesses, real estate, or equipment. SBA loans are made based primarily on the historical and projected cash flow of the business and secondarily on the underlying collateral provided.

 

Under the SBA 7(a) program the loans generally carry a SBA guaranty for 75% of the loan. The Bank can sell the guaranteed portion in the secondary market and retain and hold for investment the related unguaranteed portion of these loans, as well as the servicing on such loans, for which it is paid a fee. SBA loans held for investment are included in the commercial real estate loans and commercial and industrial loan classifications.

 

Patriot sells the guaranteed portion of SBA loans for liquidity purposes and to generate non-interest income. Loans held for sale represent the guaranteed portion of SBA loans and are reflected at the lower of aggregate cost or market value. Loans held for sale at December 31, 2019, consisted of $10.2 million commercial and industrial loans and $5.1 million commercial real estate. The increase in loans held for sale was due to the retention of certain loans that were pending SBA review prior to completion of the sale. These loans are expected to clear SBA review and to be sold in the first half of 2020. The Company sold $12.0 million SBA loans during year ended December 31, 2019, compared to $1.9 million for the year ended December 31, 2018.

 

Premises and equipment

 

As of December 31, 2019 and 2018, Patriot recorded premises and equipment, net of $34.6 million and $35.4 million, respectively. The decrease was primarily due to normal depreciation of the active premises and equipment during the year ended December 31, 2019.

 

Management continuously reviews its branch locations and corporate offices to improve penetration in targeted markets and increase operating efficiencies.

 

Other Real Estate Owned (“OREO”)

 

As of December 31, 2019 and 2018, Patriot recorded OREO of $2.4 million and $2.9 million on the Consolidated Balance Sheet, respectively. The 2019 OREO balance consists of the lower of the carrying value of loans receivable due from the mortgage of two foreclosed residential properties or the estimated net realizable value of the underlying properties acquired through foreclosure which properties are currently being marketed for sale. In 2019, Patriot sold the OREO acquired from Prime Bank merger in May 2018 and recognized a loss of $14,000. No OREO property was sold in 2018.

 

Goodwill 

 

The Company completed its acquisition of Prime Bank in May 2018, and recorded $1.7 million of goodwill at December 31, 2018. The goodwill was adjusted to $1.1 million as a result of reducing by $621,000 the estimated amount to be paid pursuant to certain problem loans pending resolution as of May 10, 2019. No further adjustment was made during the year ended December 31, 2019. The Company performed its annual review of the goodwill as of December 31, 2019 and determined that there was no impairment of goodwill.

 

Core deposit intangible (“CDI”)

Core deposit intangible (“CDI”) was recorded as part of the Prime Bank business combination in May 2018. The CDI is amortized over a 10-year period using the straight-line method. CDI decreased $75,000 from $698,000 at December 31, 2018 to $623,000 at December 31, 2019 solely due the amortization for the year 2019. The Company performed a review of the CDI as of December 31, 2019 and determined that there was no impairment of the CDI.

 

25

 

Deferred Taxes

 

As of December 31, 2019, Patriot had available approximately $22.7 million of Federal net operating loss carryforwards (“NOL”) that are offset by $15.5 million in Internal Revenue Code §382 limitations. Of the NOL of $22.7 million, approximately $20.2 million will expire between 2030 and 2033 and $2.5 million does not expire.

 

For the year ended December 31, 2019 and 2018, the Bank recorded an uncertain tax position (“UTP”) of $1.2 million and $1.1 million related to the utilization of certain federal net operating losses, respectively.

 

Additionally, Patriot has approximately $56.4 million of NOLs available for Connecticut tax purposes at December 31, 2019, which may be used to offset up to 50% of taxable income in any year. The NOLs expire between 2030 and 2039.

 

As of December 31, 2019, Patriot had a $11.1 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:

 

Exclusive of what management believes is an isolated credit loss in 2019, favorable financial performance over the past three years;

 

Forecasted taxable income for 2020 and future periods;

 

The growth in loan originations and the overall quality of the loan portfolio;

 

Improvements in operations and cost management; and

 

Net operating loss carry-forwards that do not begin to expire until 2030.

 

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.

 

Derivatives

 

As of December 31, 2019, Patriot had entered into four interest rate swaps (“swaps”). Two swaps are with a loan customer to provide a facility to mitigate the fluctuations in the variable rate on the respective loan. The other two swaps are with an outside third party. The customer interest rate swaps are matched in offsetting terms to the third party interest rate swaps. The swaps are reported at fair value in other assets or other liabilities on the Consolidated Balance Sheets. Patriot’s swaps are 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 Company recognized $30,000 gain on the swaps for the year ended December 31, 2019. There was no gain on the swaps for the year ended December 31, 2018 as the initial swaps were entered in the fourth quarter of 2018.

 

Further discussion of the final derivatives is set forth in Note 11 to the Consolidated Financial Statements.

 

26

 

Deposits

 

The following table is a summary of the Company’s deposits at the dates shown:

 

(In thousands)

 

December 31,

 
  

2019

  

2018

  

2017

 
             

Non-interest bearing

 $88,135  $84,471  $81,197 

Interest bearing:

            

NOW

  26,864   26,100   25,476 

Savings

  64,020   81,912   135,975 

Money market

  99,115   85,197   16,575 

Certificates of deposit, less than $250,000

  193,942   203,683   173,221 

Certificates of deposit, $250,000 or greater

  67,550   78,318   66,866 

Brokered deposits

  229,909   183,600   138,129 

Total Interest bearing

  681,400   658,810   556,242 
             

Total Deposits

 $769,535  $743,281  $637,439 

 

Total deposits increased by $26.2 million or 3.5%, from $743.3 million at December 31, 2018 to $769.5 million at December 31, 2019, resulting from an increase of $46.3 million in brokered deposits and $13.9 million in money market deposits, which partially offset by a decline of $20.5 million in certificates of deposits (CDs) and $17.9 million in savings deposits. Total core deposits (DDA, NOW, Savings, MMA and CD’s less than $250,000) declined slightly from $481.4 million at the end of 2018 to $472.1 million at the end of 2019, a decline of 1.9%. The decline reflects a very competitive local deposit rate market. Patriot is attempting to expand its core deposit growth with the development of a national on-line money market account which launched in January of 2020.

 

Other deposit initiatives, including establishing a foundation for a prepaid deposit account operation, are in place and are expected to add lower-cost deposit balances by the middle of 2020. This initiative includes the purchase of deposit balances from a third party which is currently moving through an application and review process with the OCC division of licensing.

 

Borrowings

 

As of December 31, 2019 and 2018, total borrowings were $130.9 million and $131.0 million, respectively. 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.

 

Shareholders’ Equity

 

Equity decreased $2.3 million from $69.3 million at December 31, 2018 to $67.0 million at December 31, 2019. The decrease was primarily due to $2.8 million of net loss for the year ended December 31, 2019 and $155,000 common stock dividend payments, which was partially offset by $423,000 of investment portfolio unrealized gain and $214,000 of equity compensation for the year ended December 31, 2019.

 

27

 

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, 2019.

 

(In thousands)

 

Year ended December 31,

 
  

2019

  

2018

  

2017

 
  

Daily
Average
Balance ($)

  

Interest
($)

  

Yield
(%)

  

Daily
Average
Balance ($)

  

Interest
($)

  

Yield
(%)

  

Daily
Average
Balance ($)

  

Interest
($)

  

Yield
(%)

 

ASSETS

                                    

Interest Earning Assets:

                                    

Loans

 $807,162  $40,568   5.03  $748,260  $37,546   5.02  $662,299  $31,270   4.72 

Investments

  56,897   2,120   3.73   45,514   1,796   3.95   38,527   1,365   3.54 

Cash equivalents and other

  45,276   956   2.11   55,858   1,033   1.84   22,970   214   0.93 
                                     

Total interest earning assets

  909,335   43,644   4.80   849,632   40,375   4.75   723,796   32,849   4.54 
                                     

Cash and due from banks

  5,024           5,330           3,966         

Allowance for loan losses

  (8,087)          (6,507)          (5,734)        

OREO

  2,551           748           840         

Other assets

  59,318           54,017           50,434         
                                     

Total Assets

 $968,141          $903,220          $773,302         
                                     

Liabilities

                                    

Interest bearing liabilities:

                                    

Deposits

 $682,826  $13,985   2.05  $616,081  $9,024   1.46  $500,953  $4,948   0.99 

Borrowings

  94,084   2,175   2.31   108,108   1,634   1.51   107,554   702   0.65 

Senior notes

  11,814   915   7.75   11,739   915   7.79   11,664   915   7.84 

Subordinated debt

  17,834   1,118   6.27   13,060   767   5.87   8,204   360   4.39 

Note Payable and other

  1,364   25   1.83   2,037   38   1.87   1,788   31   1.75 
                                     

Total interest bearing liabilities

  807,922   18,218   2.25   751,025   12,378   1.65   630,163   6,956   1.10 
                                     

Demand deposits

  81,754           78,765           75,177         

Other liabilities

  8,965           4,545           2,393         
                                     

Total Liabilities

  898,641           834,335           707,733         
                                     

Shareholders' equity

  69,500           68,885           65,569         
                                     

Total Liabilities and Shareholders' Equity

 $968,141          $903,220          $773,302         
                                     

Net interest income

     $25,426          $27,997          $25,893     
                                     

Interest margin

          2.80           3.29           3.58 

Interest spread

          2.55           3.10           3.44 

 

28

 

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, 2019 to 2018 and December 31, 2018 to 2017.

 

  

Year ended December 31,

 
  

2019 compared to 2018

  

2018 compared to 2017

 

(In thousands)

 

Increase/(Decrease)

  

Increase/(Decrease)

 
  

Daily Average Balance

  

Volume

  

Rate

  

Total

  

Daily Average Balance

  

Volume

  

Rate

  

Total

 

Interest Earning Assets:

                                

Loans

 $58,902  $2,894  $128  $3,022  $85,961  $4,148  $2,128  $6,276 

Investments

  11,383   412   (88)  324   6,987   246   185   431 

Cash equivalents and other

  (10,582)  (199)  122   (77)  33,156   305   514   819 
                                 

Total interest earning assets

  59,703   3,107   162   3,269   126,104   4,699   2,827   7,526 
                                 

Interest bearing liabilities:

                                

Deposit

  66,745   1,609   3,352   4,961   115,128   1,614   2,462   4,076 

Borrowings

  (14,024)  (212)  753   541   554   4   928   932 

Senior notes

  75   -   -   -   75   -   -   - 

Subordinated debt

  4,774   280   71   351   4,856   213   194   407 

Note payable and other

  (673)  (13)  -   (13)  249   3   4   7 
                                 

Total interest bearing liabilities

  56,897   1,664   4,176   5,840   120,862   1,834   3,588   5,422 
                                 

Net interest income

 $2,806  $1,443  $(4,014) $(2,571) $5,242  $2,865  $(761) $2,104 

 

29

 

RESULTS OF OPERATIONS

 

Comparison of Results of Operations for the years 2019 and 2018

 

For the year ended December 31, 2019, the Company recorded a net loss of $2.8 million ($0.72 basic and diluted loss per share) compared to a net income of $3.2 million ($0.82 basic and diluted earnings per share) for the year ended December 31, 2018.

 

Loss before tax benefit was $3.7 million for the year ended December 31, 2019, compared to income before income tax expense of $4.1 million for the year ended December 31, 2018. Highlights include:

Interest and dividend income increased $3.2 million;

Net interest income decreased $2.6 million;

Provision for loan losses increased $3.7 million; and

Non-interest expense increased $2.5 million.

 

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.

 

For the year ended December 31, 2019, interest income increased $3.2 million as compared to the year ended December 31, 2018. Average loan balances increased $58.9 million as compared to the year ended December 31, 2018. Total interest expense increased $5.8 million as compared to the year ended December 31, 2018, primarily due to an increase of $4.9 million in deposit interest expense, an increase of $541,000 in interest on FHLB borrowings, and $351,000 in subordinated debt interest.

 

The increase in deposit interest cost was associated with an increase in higher cost wholesale funding (brokered deposits increased $46 million from the balance of a year ago) along with higher deposit rates associated with a competitive retail deposit market. The increase in interest cost on FHLB borrowings was due to the re-set of FHLB convertible floating to fixed rate advances to longer-term fixed rate borrowings to rates ranging from 3.47% to 3.61%, and the increase in subordinated debt interest reflects the full year cost of subordinated debt issued in June of 2018.

 

Net interest income for the years ended December 31, 2019 and 2018 was $25.4 million and $28.0 million, respectively. Net interest margin for the year ended December 31, 2019 and 2018 were 2.8% and 3.29%, respectively.

 

The decline in net interest income and net interest margin reflects the impact of increasing deposit costs associated with higher rates paid on retail deposits, the impact of non-accrual and reduced rate loans, an increased reliance on more expensive wholesale funding sources, and the impact of the higher FHLB borrowing rates and subordinated debt issued in June 2018. Higher retail deposit rates are primarily the result of increased rate competition in Patriot’s local retail markets. Patriot is exploring alternative lower-cost funding sources which, along with a recent decline in market interest rates, is expected to positively impact the aggregate cost of funding.

 

Provision (credit) for loan losses

 

For the year ended December 31, 2019, provision for loan losses increased to $5.0 million, as compared to $1.3 million in 2018. The increase of provision for loan losses in 2019 was primarily attributable to the growth in the loan portfolio, a $2.3 million commercial loan charge-off and a reserve for loan losses of $1.5 million for one commercial real estate loan in 2019.

 

Non-interest income

 

For the year ended December 31, 2019, non-interest income increased to $2.5 million, as compared to $1.6 million in 2018. The increase was primarily attributable to net realized gains of $891,000 on the sale of SBA loans. SBA loans sold in 2019 totaled $12.0 million and the premium recognized on SBA loans sold was 9.4% of the balance of loans sold.

 

30

 

Non-interest expense

 

For the year ended December 31, 2019, non-interest expense increased to $26.7 million, as compared to $24.2 million for 2018. The increase in non-interest expenses was primarily driven by increases of $1.9 million in salaries and benefits, $833,000 in professional and other outside services, and $431,000 in other operating expenses, due to continued expansion of the Bank’s business activities. The increases were partially offset by reduction of $1.6 million in non-recurring project expenses.

 

The increase in salaries and benefits reflects the build-up of the SBA team, additional costs associated with the Prime acquisition, and increased headcount supporting new deposit initiatives and expansion of credit, finance and compliance support functions.

 

The increase in professional and outside service fees included the impact of costs incurred with SBA origination and sale activities and additional expenses associated with the expansion of deposit raising initiatives and resolution of documentation and policy matters associated with the OCC Formal Agreement.

 

 

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:

 

Interest and dividend income increased $7.5 million;

 

Net interest income increased $2.1 million;

 

Provision for loan losses increased $2.2 million; and

 

Non-interest expense increased $3.0 million.

 

The 2018 net income is not comparable to 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 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.

 

31

 

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.

 

32

 

LIQUIDITY

 

The Company’s balance sheet liquidity to total assets ratio was 10.0% at December 31, 2019 compared to 10.7% at December 31, 2018. Liquidity including readily available off-balance sheet funding sources was 17.3% at December 31, 2019 compared to 19.4% at December 31, 2018. The Company’s available total liquidity (readily available plus brokered deposit availability) to total assets ratio was 18.21% at December 31, 2019 compared to 23.7% at December 31, 2018.

 

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), unpledged available-for-sale securities, and loans held for sale. 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 are included in the Bank’s available total liquidity measure.

 

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.

 

The Company is a member of the Federal Home Loan Bank of Boston ("FHLB-B"). At December 31, 2019, the outstanding advances from the FHLB-B aggregated $100.0 million. The additional borrowing capacity available from FHLB-B is $65.9 million, which is comprised of $63.9 million of advances and a $2.0 million overnight line of credit. Additionally, the Bank has the ability to borrow from the FRB.

 

As of December 31, 2019, the maturities of Patriot’s contractual obligations are as follows:

 

(In thousands)

                    
  

Contractual Obligations Due

 

Contractual Obligation Category

 

Less than
One Year

  

One to
Three Years

  

Three to
Five Years

  

Over
Five Years

  

Total

 

Certificates of deposit

 $242,036  $17,607  $1,849  $-  $261,492 

Brokered deposits

  206,707   22,952   250   -   229,909 

Federal Home Loan Bank borrowings

  10,000   -   90,000   -   100,000 

Senior notes

  -   12,000   -   -   12,000 

Subordinated debt

  -   -   -   10,000   10,000 

Junior subordinated debt

  -   -   -   8,248   8,248 

Note payable

  199   408   586   -   1,193 

Operating lease obligations

  520   1,028   813   1,564   3,925 
                     

Total contractual obligations

 $459,462  $53,995  $93,498  $19,812  $626,767 

 

33

 

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, 2019, the Bank’s off-balance sheet commitments are as follows:

 

(In thousands)

 

December 31, 2019

 

Commitments to extend credit:

    

Unused lines of credit

 $71,101 

Undisbursed construction loans

  25,367 

Home equity lines of credit

  20,032 

Future loan commitments

  27,822 

Financial standby letters of credit

  743 
  $145,065 

 

REGULATORY CAPITAL REQUIREMENTS

 

 

The following tables illustrate the Company’s and the Bank’s regulatory capital ratios at December 31, 2019 and 2018:

 

  

Patriot National Bancorp, Inc.

  

Patriot Bank, N.A.

 

(In thousands)

 

December 31, 2019

  

December 31, 2018

  

December 31, 2019

  

December 31, 2018

 
  

Amount
($)

  

Ratio
(%)

  

Amount
($)

  

Ratio
(%)

  

Amount
($)

  

Ratio
(%)

  

Amount
($)

  

Ratio
(%)

 

Total Capital (to risk weighted assets)

 $90,083   10.510  $90,722   10.452  $100,953   11.826  $99,341   11.500 

Tier 1 Capital (to risk weighted assets)

  69,957   8.161   73,101   8.422   90,827   10.640   91,720   10.618 

Common Equity Tier 1 Capital (to risk weighted assets)

  61,957   7.228   65,101   7.500   90,827   10.640   91,720   10.618 

Tier 1 Leverage Capital (to average assets)

  69,957   7.148   73,101   7.842   90,827   9.279   91,720   9.838 

 

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 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. Patriot satisfies all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis.

 

Management continuously assesses the adequacy of the Bank’s capital with the goal to maintain a “well capitalized” classification.

 

34

 

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 Directors. In addition to the Management Asset and Liability Committee, there is a Board Asset and Liability Committee (“ALCO”), which meets quarterly. ALCO monitors the interest rate risk analyses, reviews investment transactions during the period and determines compliance with the Bank’s Investment, ALCO and Liquidity policies.

 

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 impact of changes in interest rates on net interest income under a range of assumptions. Changes to these assumptions can significantly affect the results of the simulations. The simulation incorporates assumptions regarding the potential timing in the repricing of certain assets and liabilities when market rates change and the changes in spreads between different market rates.

 

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.

 

35

 

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 the analyses to fully measure the true impact of these downward shocks.

 

(In thousands)

                        
  

Net Portfolio Value - Performance Summary

 
  

As of December 31, 2019

  

As of December 31, 2018

 

Projected Interest
Rate Scenario

 

Estimated
Value

  

Change from
Base ($)

  

Change from
Base (%)

  

Estimated
Value

  

Change from
Base ($)

  

Change from
Base (%)

 

+200

 $115,401  $(4,473)  (3.7) $122,002  $(3,027)  (2.4)

+100

  119,249   (625)  (0.5)  125,681   652   0.5 

BASE

  119,874   -   -   125,029   -   - 
-100  119,167   (707)  (0.6)  120,108   (4,921)  (3.9)
-200  117,418   (2,456)  (2.0)  115,924   (9,105)  (7.3)

 

(In thousands)

 

Net Interest Income - Performance Summary

 
  

Year ended December 31, 2019

  

Year ended December 31, 2018

 

Projected Interest
Rate Scenario

 

Estimated
Value

  

Change from
Base ($)

  

Change from
Base (%)

  

Estimated
Value

  

Change from
Base ($)

  

Change from
Base (%)

 

+200

 $30,354  $2,160   7.7  $32,729  $1,712   5.5 

+100

  29,385   1,191   4.2   32,179   1,162   3.7 

BASE

  28,194   -   -   31,017   -   - 
-100  27,173   (1,021)  (3.6)  30,014   (1,003)  (3.2)
-200  26,280   (1,914)  (6.8)  28,615   (2,402)  (7.7)

 

 

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 the prices of goods and services. Notwithstanding this, inflation can directly affect the value of loan collateral, in particular, real estate. Inflation, or disinflation, could significantly affect Patriot’s earnings in future periods.

 

36

 

ITEM 8. Financial Statements and Supplementary Data

 

The Financial Statements required by this item are presented in the order shown below, in ITEM 15:

 

-

Report of Independent Registered Public Accounting Firm - As of and for each of the years ended December 31, 2019, 2018 and 2017

-

Consolidated Balance Sheets as of December 31, 2019 and 2018

-

Consolidated Statements of Operations for each of the years in the three-year period ended December 31, 2019

-

Consolidated Statements of Comprehensive (Loss) Income for each of the years in the three-year period ended December 31, 2019

-

Consolidated Statements of Shareholders’ Equity for each of the years in the three-year period ended December 31, 2019

-

Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 2019

-

Consolidated Supplemental Statements of Non-Cash Activity for each of the years in the three-year period ended December 31, 2019

-

Notes to Consolidated Financial Statements

 

The supplementary data required by this item (selected quarterly financial data) is provided below. 

 

37

 

The following tables present the summarized quarterly results of operations (unaudited) to the Consolidated Financial Statements for each of the calendar years in the two-year period ended December 31, 2019:

 

(In thousands, except per share amounts)

                
  

First
Quarter

  

Second
Quarter

  

Third
Quarter

  

Fourth
Quarter

 

2019:

                

Interest and Dividend Income

 $10,585  $11,094  $11,012  $10,953 

Interest expense

  4,227   4,474   4,769   4,748 

Net Interest Income

  6,358   6,620   6,243   6,205 

Provision for loan losses

  165   2,937   100   1,769 

Non-interest income

  746   758   571   408 

Non-interest expense

  6,448   6,728   6,679   6,799 

Income before income taxes

  491   (2,287)  35   (1,955) (2)

Provision (benefit) for income taxes

  168   (632)  8   (443)

Net income (loss)

 $323  $(1,655) $27  $(1,512) (2)
                 

Earnings per share

                

Basic

 $0.08  $(0.42) $0.01  $(0.39) (2)

Diluted (1)

 $0.08  $(0.42) $0.01  $(0.39) (2)
                 

Weighted average shares outstanding - Basic

  3,917,312   3,921,878   3,922,783   3,925,064 

Weighted average shares outstanding - Diluted

  3,917,312   3,921,878   3,922,783   3,925,064 

 

 

(1)

The weighted average diluted shares outstanding did not include 448, 5,572, 417, and 4,604 anti-dilutive restricted common shares as of March 31, 2019, June 30, 2019, September 30, 2019 and December 31, 2019, respectively.

 

 

(2)

In the fourth quarter of 2019, an addition to the allowance of loan loss reserve of $1.5 million was recorded in connection with accounting for one troubled debt restructuring in the fourth quarter. The increase in loan loss provision had the effect of reducing net income for the fourth quarter of 2019 from a net loss of $422,000 to a net loss of $1.5 million. Basic and diluted loss per share was reduced from $0.11 to a loss per share of $0.39 for the fourth quarter of 2019.

 

38

 

(In thousands, except per share amounts)

 

First
Quarter

   

Second
Quarter

   

Third
Quarter

   

Fourth
Quarter

  

2018:

                    

Interest and Dividend Income

 $9,312   $9,890   $10,244   $10,929  

Interest expense

  2,249    2,849    3,456    3,824  

Net Interest Income

  7,063    7,041    6,788    7,105  

Provision for loan losses

  185    50    50    1,018  

Non-interest income

  322    386    354    565  

Non-interest expense

  5,791    5,961 

 

  6,047 

 

  6,436 

 

Income before income taxes

  1,409    1,416    1,045    216  

Provision (benefit) for income taxes

  344    380    276    (110) 

Net income

 $1,065   $1,036   $769   $326  
                     

Earnings per share

                    

Basic

 $0.27   $0.27   $0.20   $0.08  

Diluted

 $0.27   $0.26   $0.20   $0.08 

(2) 

                     

Weighted average shares outstanding - Basic

  3,900,513    3,903,858    3,904,751    3,907,006  

Weighted average shares outstanding - Diluted

  3,917,114    3,917,461    3,918,818    3,917,096  

 

 

(2)

The sum of Earnings (loss) per share - Diluted of each of the quarters in the year ended December 31, 2018 does not agree to the amount of Diluted earnings per share presented on the Consolidated Statement of Operations for the year ended December 31, 2018, due to the impact of rounding to the nearest cent on the amount of Earnings per share - Diluted for the three months ended December 31, 2018 (i.e., the "Fourth Quarter").

 

39

 

ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

None.

 

ITEM 9A. Controls and Procedures 

 

Disclosure Controls and Procedures

 

Patriot maintains disclosure controls and procedures that are designed to provide reasonable assurance that information that is required to be disclosed is accumulated and communicated to management in a timely fashion. In designing and evaluating such controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Management’s judgment is required in evaluating controls and procedures.

 

As used herein, “disclosure controls and procedures” means controls and other procedures of Patriot that are designed to ensure that information required to be disclosed by Patriot in the reports that it files or submits under the Exchange Act are recorded, processed, summarized and reported, within the time periods specified in the SEC rules and regulations. Patriot’s disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that such information is accumulated and communicated to management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Continual evaluation of the effectiveness of its disclosure controls and procedures is performed by management, with the participation of Patriot’s Chief Executive Officer and Chief Financial Officer. Management has concluded that Patriot’s disclosure controls and procedures were effective as of and for the year ended December 31, 2019.

 

A system of internal controls is designed to provide reasonable assurance that management’s operating objectives, reliance on financial information and reports, and compliance with its mandated and stakeholder obligations are achieved. In implementing internal controls, management must consider constraints on resources and the benefits of controls relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. The design of any system of controls is based, in part, upon certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

 

Management believes all necessary disclosure controls and procedures needed to provide reasonable assurance that information will be communicated in a timely fashion to management are in place.

 

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.

 

40

 

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.

 

A material weakness in the Company’s internal control over financial reporting, disclosed in Item 9A, Controls and Procedures, of the Company’s Annual Report on Form 10-K for the year ended December 31, 2018, resulted 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. This previously identified internal control weakness has now been remediated.

 

In response to the identified material weakness, management implemented changes to its disclosure controls and procedures and its system of internal control over financial reporting in each of the quarters ended March 31, 2019, June 30, 2019 and September 30, 2019, and December 31, 2019 including changes to the process and procedures for establishing allowances for loan loss and enhancements to create a more robust review process. Other implemented enhancements include strengthened controls over the monitoring and valuation of collateral related to loans deemed to be impaired and for which specific reserves have been established. Management has determined that the control processes around the precision of the preparation and review of the calculation of the allowance for loan losses are effective.

 

Management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2019 based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).Based on management's assessment, management concluded that, as of December 31, 2019, the Company's internal control over financial reporting was effective based on criteria established in Internal Control-Integrated Framework (2013) issued by COSO.

 

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 on Form 10-K for the year ended December 31, 2019 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 2019 that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

 

 

ITEM 9B. Other Information

 

 

None

 

41

 

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 Amendment to this Form 10-K, which is due in 120 days following December 31, 2019. The Company plans to avail itself of a 45-day extension to file the Amendment relying on an order issued by the SEC on March 25, 2020 (Release No. 34-88465) granting exemptions to public companies affected by COVID-19. The Company plans to file the Amendment no later than June 15, 2020.

 

The Company has previously adopted a Code of Conduct for its senior financial officers, which was filed as Exhibit 14 to the Company’s Annual Report on Form 10-KSB for the year ended December 31, 2004, filed with the SEC on March 25, 2015. In addition, the Company adopted a Code of Ethics and Conflict of Interest Policy on October 24, 2018, amended as of March 27, 2019, which was filed as Exhibit 14.2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2018, filed with the SEC on April 1, 2019. Copies of these codes will be provided to any person so requesting by writing to Patriot National Bancorp Inc., 900 Bedford Street, Stamford, Connecticut 06901, Attn: Joseph D. Perillo, Chief Financial Officer.

 

ITEM 11. Executive Compensation

 

The information required by Item 402 of Regulation S-K is incorporated into this Form 10-K by reference to the Amendment to this Form 10-K, which the Company plans to file no later than June 15, 2020 relying on the exemptions provided by an order issued by the SEC on March 25, 2020 (Release No. 34-88465).

 

ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters

 

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 Amendment to this Form 10-K, which the Company plans to file no later than June 15, 2020 relying on the exemptions provided by an order issued by the SEC on March 25, 2020 (Release No. 34-88465).

 

The table below provides information as of December 31, 2019, with respect to the compensation plan under which equity securities of the Company are authorized for issuance to directors, officers or employees.

 

Plan Category

 

Number of common shares
to be issued upon vesting of restricted shares

  

Weighted average
grant date fair value

  

Number of common shares
available for issuance
under the Plan
excluding unvested shares

 
             

Equity compensation plans approved by security holders

  21,470  $12.91   2,860,438 
             

Equity compensation plans not approved by security holders

  -   -   - 
             

Total

  21,470  $12.91   2,860,438 

 

42

 

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 Amendment to this Form 10-K, which the Company plans to file no later than June 15, 2020 relying on the exemptions provided by an order issued by the SEC on March 25, 2020 (Release No. 34-88465).

 

ITEM 14. Principal Accountant Fees and Services

 

The information required by Item 9(e) of Schedule 14A is incorporated into this Form 10-K by reference to the Amendment to this Form 10-K, which the Company plans to file no later than June 15, 2020 relying on the exemptions provided by an order issued by the SEC on March 25, 2020 (Release No. 34-88465).

 

43

 

Part IV

 

ITEM 15. Exhibits and Financial Statement Schedules 

 

Exhibits

 

No.

Description

  

3(i)

Certificate of Incorporation of Patriot National Bancorp, Inc. (incorporated by reference to Exhibit 3(i) to the Company’s Current Report on Form 8-K filed on December 1, 1999)

3(i)(A)

Certificate of Amendment of Certificate of Incorporation of Patriot National Bancorp, Inc. dated July 16, 2004 (incorporated by reference to Exhibit 3(i)(A) to the Company’s Annual Report on Form 10-KSB for the year ended December 31, 2004 filed on March 25, 2005)

3(i)(B)

Certificate of Amendment of Certificate of Incorporation of Patriot National Bancorp, Inc. dated June 15, 2006 (incorporated by reference to Exhibit 3(i)(B) to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2006 filed on November 14, 2006)

3(i)(C)

Certificate of Amendment of Certificate of Incorporation of Patriot National Bancorp Inc., dated October 6, 2010 (incorporated by reference to Exhibit 3.l to the Company’s Current Report Form 8-K filed on October 21, 2010)

3(ii)

Amended and Restated By-laws of Patriot National Bancorp Inc. (incorporated by reference to Exhibit 3(ii) to the Company’s Current Report on Form 8-K filed on November 1, 2010)

4

Form of 6.25% Fixed to Floating Rate Subordinated Note (incorporated by reference to Exhibit 4 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2018 filed on August 14, 2018)

10(a)(1)

2012 Stock Plan of Patriot National Bancorp Inc. (incorporated by reference from Annex A to the Proxy Statement on Form 14C filed on November 1, 2011)

10(a)(2)

Amended Financial Services Agreement, by and between Patriot National Bancorp, Inc. and PNBK Sponsor LLC, dated August 7, 2014 (incorporated by reference to Exhibit 10(a) (20) to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2014 (Commission File No. 000-29599) filed on August 8, 2014)

10(a)(3)

Form of Subordinated Note Purchase Agreement (incorporated by reference to Exhibit 10(6) to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2018 filed on August 14, 2018)

10(a)(4)

Form of Agreement with The Comptroller of the Currency, dated as of November 7, 2018 (incorporated by reference to 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)

14.1

Code of Conduct for Senior Financial Officers (incorporated by reference to Exhibit 14 to the Company’s Annual Report on Form 10 -KSB for the year ended December 31, 2004 (Commission File No. 000-29599)

14.2

Code of Ethics and Conflict of Interest Policy, dated March 27, 2019 Form of Agreement with The Comptroller of the Currency, dated as of November 7, 2018 (incorporated by reference to Exhibit 14.2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 filed on April 1, 2019)

21

Subsidiaries of Bancorp (filed herewith)

 

44

 

23.1

Consent of RSM US LLP

31(1)

Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer

31(2)

Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer

32

Section 1350 Certifications

101.INS#

XBRL Instance Document

101.SCH#

XBRL Schema Document

101.CAL#

XBRL Calculation Linkbase Document

101.LAB#

XBRL Labels Linkbase Document

101.PRE#

XBRL Presentation Linkbase Document

101.DEF# XBRL Presentation Linkbase Document

 
 

The exhibits marked with the section symbol (#) are interactive data files.

 

45

 

Report of Independent Registered Public Accounting Firm

 

 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 subsidiaries (the Company) as of December 31, 2019 and 2018, the related consolidated statements of operations, comprehensive (loss) income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2019, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.

 

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

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 effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

/s/ RSM US LLP

 

We have served as the Company’s auditor since 2017.

 

New Haven, Connecticut

April 29, 2020

 

46

 

 

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

 

(In thousands, except share data)

 

December 31,
2019

  

December 31,
2018

 
         

Assets

        

Cash and due from banks:

        

Noninterest bearing deposits and cash

 $2,693  $7,381 

Interest bearing deposits

  36,711   59,056 

Total cash and cash equivalents

  39,404   66,437 

Investment securities:

        

Available-for-sale securities, at fair value

  48,317   39,496 

Other investments, at cost

  4,450   4,963 

Total investment securities

  52,767   44,459 
         

Federal Reserve Bank stock, at cost

  2,897   2,866 

Federal Home Loan Bank stock, at cost

  4,477   4,928 

Loans receivable (net of allowance for loan losses: 2019: $10,115, 2018: $7,609)

  802,049   772,767 

SBA loans held for sale

  15,282   - 

Accrued interest and dividends receivable

  3,603   3,766 

Premises and equipment, net

  34,568   35,435 

Other real estate owned

  2,400   2,945 

Deferred tax asset, net

  11,133   10,851 

Goodwill

  1,107   1,728 

Core deposit intangible, net

  623   698 

Other assets

  9,526   4,816 

Total assets

 $979,836  $951,696 
         

Liabilities

        

Deposits:

        

Noninterest bearing deposits

 $88,135  $84,471 

Interest bearing deposits

  681,400   658,810 

Total deposits

  769,535   743,281 
         

Federal Home Loan Bank and correspondent bank borrowings

  100,000   100,000 

Senior notes, net

  11,853   11,778 

Subordinated debt, net

  9,752   9,723 

Junior subordinated debt owed to unconsolidated trust, net

  8,102   8,094 

Note payable

  1,193   1,388 

Advances from borrowers for taxes and insurance

  3,681   2,926 

Accrued expenses and other liabilities

  8,726   5,166 

Total liabilities

  912,842   882,356 
         

Commitments and Contingencies

        
         

Shareholders' equity

        

Preferred stock, no par value; 1,000,000 shares authorized, no shares issued and outstanding

  -   - 

Common stock, $.01 par value, 100,000,000 shares authorized; As of December 31, 2019: 4,004,410 shares issued; 3,930,669 shares outstanding As of December 31, 2018: 3,984,415 shares issued; 3,910,674 shares outstanding

  106,170   105,956 

Accumulated deficit

  (38,773)  (35,790)

Accumulated other comprehensive loss

  (403)  (826)

Total shareholders' equity

  66,994   69,340 

Total liabilities and shareholders' equity

 $979,836  $951,696 

 

See Accompanying Notes to Consolidated Financial Statements.

 

47

 

 

CONSOLIDATED STATEMENTS OF OPERATIONS
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

 

  

Year Ended December 31,

 

(In thousands, except per share amounts)

 

2019

  

2018

  

2017

 
             

Interest and Dividend Income

            

Interest and fees on loans

 $40,568  $37,546  $31,270 

Interest on investment securities

  1,667   1,306   982 

Dividends on investment securities

  453   490   383 

Other interest income

  956   1,033   214 

Total interest and dividend income

  43,644   40,375   32,849 
             

Interest Expense

            

Interest on deposits

  13,985   9,024   4,948 

Interest on Federal Home Loan Bank borrowings

  2,175   1,634   702 

Interest on senior debt

  915   915   915 

Interest on subordinated debt

  1,118   767   360 

Interest on note payable and other

  25   38   31 

Total interest expense

  18,218   12,378   6,956 
             

Net interest income

  25,426   27,997   25,893 
             

Provision (Credit) for Loan Losses

  4,971   1,303   (857)
             

Net interest income after provision for loan losses

  20,455   26,694   26,750 
             

Non-interest Income

            

Loan application, inspection and processing fees

  113   51   73 

Deposit fees and service charges

  492   524   590 

Gains on sales of loans

  891   162   4 

Rental income

  589   413   399 

Other income

  398   477   378 

Total non-interest income

  2,483   1,627   1,444 
             

Non-interest Expense

            

Salaries and benefits

  13,681   11,741   10,915 

Occupancy and equipment expense

  3,521   3,159   3,133 

Data processing expense

  1,463   1,313   1,139 

Professional and other outside services

  3,010   2,177   2,050 

Project expenses

  465   2,098   640 

Advertising and promotional expense

  380   258   322 

Loan administration and processing expense

  155   93   63 

Regulatory assessments

  1,233   1,142   844 

Insurance expense, net

  136   90   233 

Communications, stationary and supplies

  518   503   381 

Other operating expense

  2,092   1,661   1,452 

Total non-interest expense

  26,654   24,235   21,172 
             

(Loss) Income before income taxes

  (3,716)  4,086   7,022 
             

(Benefit) Provision for Income Taxes

  (899)  890   2,875 
             

Net (loss) income

 $(2,817) $3,196  $4,147 
             

Basic (loss) earnings per share

 $(0.72) $0.82  $1.06 

Diluted (loss) earnings per share

 $(0.72) $0.82  $1.06 

 

See Accompanying Notes to Consolidated Financial Statements.

 
48

 

 

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

 

(In thousands)

 

Year Ended December 31,

 
  

2019

  

2018

  

2017

 
             

Net (loss) income

 $(2,817) $3,196  $4,147 

Other comprehensive (loss) income

            

Unrealized holding gain (loss) on securities

  571   (860)  (64)

Income tax effect

  (148)  189   25 

Reclassification for realized losses on sale of investment securities, net of tax

  -   -   4 

Total other comprehensive income (loss)

  423   (671)  (35)

Comprehensive (loss) income

 $(2,394) $2,525  $4,112 

 

See Accompanying Notes to Consolidated Financial Statements.

 

49

 

 

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

 

(In thousands, except shares)

 

Number of

Shares

  

Common
Stock

  

Accumulated
Deficit

  

Accumulated Other
Comprehensive
(Loss) Income

  

Total

 

Balance at January 1, 2017

  3,891,897   105,592   (42,902)  (120)  62,570 

Comprehensive income:

                    

Net income

  -   -   4,147   -   4,147 

Unrealized holding loss on available-for-sale securities, net of tax

  -   -   -   (35)  (35)

Total comprehensive income

  -   -   4,147   (35)  4,112 

Purchase of treasury stock

  (100)  (2)  -   -   (2)

Common stock dividends

  -   -   (77)  -   (77)

Share-based compensation expense

  -   146   -   -   146 

Vesting of restricted stock

  7,878   -   -   -   - 

Balance at December 31, 2017

  3,899,675  $105,736   (38,832)  (155)  66,749 

Comprehensive income:

          ��         

Net income

  -   -   3,196   -   3,196 

Unrealized holding loss on available-for-sale securities, net of tax

  -   -   -   (671)  (671)

Total comprehensive income

  -       3,196   (671)  2,525 

Common stock dividends

  -   -   (154)  -   (154)

Share-based compensation expense

  -   220   -   -   220 

Vesting of restricted stock

  10,999   -   -   -   - 

Balance at December 31, 2018

  3,910,674  $105,956   (35,790)  (826)  69,340 

Comprehensive income:

                    

Net loss

  -   -   (2,817)  -   (2,817)

Unrealized holding gain on available-for-sale securities, net of tax

  -   -   -   423   423 

Total comprehensive income

  -   -   (2,817)  423   (2,394)

Common stock dividends

  -   -   (155)  -   (155)

Share-based compensation expense

  -   214   -   -   214 

Transition adjustment related to adoption of ASC 842, net of tax

  -   -   (11)  -   (11)

Vesting of restricted stock

  19,995   -   -   -   - 

Balance at December 31, 2019

  3,930,669  $106,170   (38,773)  (403)  66,994 

 

See Accompanying Notes to Consolidated Financial Statements.

 

50

 

 

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

(In thousands)

 

Year Ended December 31,

 
  

2019

  

2018

  

2017

 

Cash Flows from Operating Activities:

            

Net (loss) income

 $(2,817) $3,196  $4,147 

Adjustments to reconcile net income to net cash
provided by operating activities:

            

Amortization of investment premiums, net

  7   15   86 

Amortization and accretion of purchase loan premiums and discounts

  997   523   650 

Amortization of debt issuance costs

  112   97   82 

Amortization of core deposit intangible

  75   50   - 

Amortization of servicing assets of sold SBA loans

  16   -   - 

Provision (credit) for loan losses

  4,971   1,303   (857)

Depreciation and amortization

  1,600   1,486   1,269 

Loss on sales of available-for-sale securities

  -   -   (6)

Share-based compensation

  214   220   146 

(Increase) decrease in deferred income taxes

  (1,136)  (265)  2,258 

Originations of SBA loans held for sale

  (26,947)  (2,254)  - 

Proceeds from sale of SBA loans held for sale

  12,556   2,096   - 

Gains on sale of SBA loans held for sale, net

  (891)  (155)  - 

Net loss on sale of other real estate owned

  94   -   9 

Changes in assets and liabilities:

            

Decrease (increase) in accrued interest and dividends receivable

  163   (270)  (770)

Increase in other assets

  (1,180)  (981)  (2)

Increase in accrued expenses and other liabilities

  251   211   278 

Net cash (used) provided by operating activities

  (11,915)  5,272   7,290 
             

Cash Flows from Investing Activities:

            

Proceeds from maturity or sales on available-for-sale securities

  6,500   37,032   16,929 

Principal repayments on available-for-sale securities

  3,893   2,267   2,361 

Purchases of available-for-sale securities

  (18,072)  (18,562)  (20,576)

Purchases of other investments

  -   (513)  (512)

Proceeds from maturity of other investments

  513   512   - 

Purchases of Federal Reserve Bank stock

  (31)  (364)  (393)

Redemptions (purchases) of Federal Home Loan Bank stock

  451   961   (280)

Decrease (increase) in originated loans receivable, net

  18,728   5,572   (63,139)

Purchases of loans receivable

  (54,604)  (47,074)  (73,022)

Purchases of premises and equipment

  (552)  (1,142)  (3,060)

Proceeds from sale of other real estate owned

  897   -   842 

Refund of (payment for) escrow deposit related to acquisition activity

  500   (500)  - 

Net cash used in business combination

  -   (5,071)  - 

Net cash used in investing activities

  (41,777)  (26,882)  (140,850)
             

Cash Flows from Financing Activities:

            

Increase in deposits, net

  26,254   59,658   108,115 

Repayments of FHLB borrowings, net

  -   (29,800)  (18,000)

Proceeds from issuance of subordinated note, net

  -   9,709   - 

Principal repayments of note payable

  (195)  (192)  (189)

Decrease in advances from borrowers for taxes and insurance

  755   97   153 

Purchases of treasury stock

  -   -   (2)

Dividends paid on common stock

  (155)  (154)  (77)

Net cash provided by financing activities

  26,659   39,318   90,000 
             

Net (decrease) increase in cash and cash equivalents

  (27,033)  17,708   (43,560)
             

Cash and cash equivalents at beginning of period

  66,437   48,729   92,289 
             

Cash and cash equivalents at end of period

 $39,404  $66,437  $48,729 

 

51

 

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

 

(In thousands)

 

Year Ended December 31,

 
  

2019

  

2018

  

2017

 

Supplemental Disclosures of Cash Flow Information:

            

Cash paid for interest

 $17,740  $11,246  $6,424 

Cash paid for income taxes

 $22  $1,243  $515 
             

Non-cash transactions:

            

Purchase of premises and equipment

 $181  $415  $808 

Increase in accrued expense and other liabilities

 $(181) $(415) $(808)
             

Purchases of available-for-sale securities

 $578  $-  $- 

Increase in accrued expense and other liabilities

 $(578) $-  $- 
             

Transfers of loans receivable to other real estate owned

 $446  $1,954  $- 
             

Recognition of operating lease right-of-use assets

 $3,160  $-  $- 

Recognition of operating lease liabilities

 $(3,264) $-  $- 
             

Accrued rent payable - adoption ASC 842

 $93  $-  $- 
             

Capitalized servicing assets

 $180  $-  $- 
             

Business Combination Non-Cash Disclosures:

            

Assets acquired in business combination (net of cash received)

 $-  $60,173  $- 

Liabilities acquired in business combination

 $-  $56,123  $- 

Contingent liability assumed in business combination

 $621  $707  $- 

 

See Accompanying Notes to Consolidated Financial Statements.

 

52

 

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
Notes to consolidated financial statements

 

 

Note 1.

Nature of Operations and Summary of Significant Accounting Policies

 

Patriot National Bancorp, Inc. (the "Company"), a Connecticut corporation, is a bank holding company that was organized in 1999. Patriot Bank, N.A. (the "Bank") (collectively, “Patriot”) is a wholly owned subsidiary of the Company. The Bank is a nationally chartered commercial bank whose deposits are insured under the Bank Insurance Fund, which is administered by the Federal Deposit Insurance Corporation. The Bank provides a full range of banking services to commercial and consumer customers through its main office in Stamford, Connecticut, seven branch offices in Connecticut and two branch offices in New York. The Bank's customers are concentrated in Fairfield and New Haven Counties in Connecticut and Westchester County in New York.

 

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 and lease losses, the analysis and valuation of its investment securities, the valuation of deferred tax assets, the impairment of goodwill, the valuation of derivatives, and the valuation of servicing assets 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.

 

Reclassifications:

 

Certain amounts appearing in the financial statements and notes thereto for prior periods have been reclassified to conform with the current presentation. The reclassifications had no effect on net income or stockholders’ equity as previously reported.

 

Significant Changes in the Fourth Quarter of 2019:


In the fourth quarter of 2019, an addition to the allowance of loan loss reserve of $1.5 million was recorded in connection with accounting for one troubled debt restructuring in the fourth quarter. The increase in loan loss provision had the effect of reducing net income for the fourth quarter of 2019 from a net loss of $422,000 to a net loss of $1.5 million. Basic and diluted loss per share was reduced from $0.11 to a loss per share of $0.39 for the fourth quarter of 2019.

 

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.

 

53

 

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-B”), 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.

 

Shares in the FHLB-B 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-B 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-B 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-B or FRB, as applicable.

 

Included in the Bank’s investment portfolio are shares in the FHLB-B and FRB of $7.4 million and $7.8 million as of December 31, 2019 and 2018, respectively. Management has evaluated its investment in the capital stock of the FHLB-B and FRB for impairment, based on the aforementioned criteria, and has determined that as of December 31, 2019 and 2018 there is no impairment of its investment in either the FHLB-B 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, 2019 and 2018, 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, 2019 and 2018, the investment in the SBA Fund is reported in the Consolidated Balance Sheets at cost, which management believes approximates fair value.

 

54

 

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 and lease 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 less applicable selling costs.

 

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 or maturity date 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.

 

55

 

Acquired Loans

 

Acquired loans are initially recorded at their acquisition date fair values. The carryover of allowance for loan and lease 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 and lease 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 and lease losses for the acquired non-impaired loans are consistent with the policy for allowance for loan and lease losses described below.

 

56

 

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.

 

 

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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:

 

 

Changes in lending policies and procedures, including underwriting standards, collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses;

 

Changes in national, regional, and local economic and business conditions and developments that affect the collectability of the loan portfolio, including the condition of various market segments;

 

Changes in the nature and volume of the loan portfolio and terms of loans;

 

Changes in the experience, ability and depth of lending management and staff;

 

Changes in the volume and loss severity of past due loans, the volume of non-accrual loans, and the volume and loss severity of adversely classified or graded loans;

 

Changes in the quality of the loan review system;

 

Changes in the value of the underlying collateral for collateral-dependent loans;

 

The existence and effect of any concentrations of credit and changes in the level of such concentrations;

 

The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in our current loan portfolio; and

 An additional risk factor for special mention loans and substandard loans, which is designed to approximate the additional risk of these assets and is based on industry data.

 

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 and lease losses in accordance with US GAAP. The allowance for loan and lease losses consists primarily of the following three components:

 

 

(1)

Allowances are established for impaired loans (generally defined by Patriot as non-accrual loans, troubled debt restructured loans, and loans that were previously classified as troubled debt restructurings but have been upgraded). The amount of impairment provided as an allowance is represented by the deficiency, if any, between the present value of expected future cash flows discounted at the loan’s original effective interest rate or the underlying collateral value, less estimated costs to sell, if the loan is collateral dependent, and the carrying value of the loan. Impaired loans that have no discounted cash flow or collateral deficiency, if applicable, are not considered for general valuation allowances described below.

 

 

(2)

General allowances are established for loan losses on a portfolio basis for loans that do not meet the definition of impaired. The portfolio is grouped into homogeneous risk characteristics, primarily loan type and, if collateral dependent, LTV ratio. Management applies an estimated loss rate to each pool of homogeneous loans. The loss rates applied are based on Patriot’s three-year loss LBP adjusted, as appropriate, for the factors discussed above. The evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revision based on changes in economic and real estate market conditions. Actual loan losses may be more or less than the ALLL management established which could have an effect on Patriot’s financial results.

 

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.

 

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(3)

An unallocated component of the ALLL is considered when necessary to cover uncertainties that could affect management's estimate of probable losses. The unallocated component of the ALLL reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies applied to estimating specific and general losses in the loan portfolio.

 

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.

 

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 Bank’s SBA loan portfolio consists of the unguaranteed portion of certain C&I and Owner-Occupied CRE loans. An additional risk premium was assigned to those loans due to their risk parameters and profile, including higher historical loss rates (based on historical SBA data) than the rest of the C&I and Owner-Occupied CRE 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.

 

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Loans Held for Sale

 

Loans held for sale represent the guaranteed portion of Small Business Administration (“SBA”) loans and are reflected at the lower of aggregate cost or market value. Patriot originates loans to customers under a SBA program that historically has provided for SBA guarantees of 75 percent of the principal balance of each loan. Patriot generally sells the guaranteed portion of its SBA loans to a third party and retains the servicing, holding the unguaranteed portion in its portfolio. The amount of loan origination fees is included in the carrying value of loans sold and in the calculation of the gain or loss on the sale. When sales of SBA loans do occur, the premium received on the sale and the present value of future cash flows of the servicing assets, less the discount of the retained portion of the loan are recognized in income. All criteria for sale accounting must be met in order for the loan sales to occur; see details under the “Transfers of Financial Assets” heading above.

 

Servicing Assets

 

Servicing assets represent the estimated fair value of retained servicing rights, net of servicing costs, at the time loans are sold. Servicing assets are amortized in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on stratifying the underlying financial assets by date of origination and term. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Any impairment, if temporary, would be reported as a valuation allowance.

 

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 long-lived 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.

 

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Intangible Assets

 

Intangible assets include core deposit intangibles (“CDI”) 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.

 

CDI is amortized on straight-line basis over a 10-year period because that is managements’ estimate of the period Patriot will benefit from Prime Bank’s deposit base comprised of funds associated with long-term customer relationships. CDI is evaluated for impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable, with any changes in estimated useful life accounted for prospectively over the revised remaining life.

 

The Company evaluates goodwill for impairment on an annual basis, or more often if events or circumstances indicate there may be impairment. The annual impairment test is conducted as of October annually. 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.

 

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.

 

Derivatives

 

Patriot enters into interest rate swap agreements (“swaps”), to provide a facility to mitigate for the borrower the fluctuations in the variable rate on the respective loan. The customer swaps are simultaneously hedge by offsetting derivatives that Patriot entered into with an outside third party. The 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.

 

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Income taxes

 

Patriot recognizes income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities 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 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 2019 and 2018 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, 2019 and 2018.

 

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 $11.1 million at December 31, 2019 as compared to a net deferred tax asset of $10.9 million at December 31, 2018.

 

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 2016 through 2019 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.

 

As of December 31, 2019 and 2018, the Bank recorded an uncertain tax position (“UTP”) related to the utilization of certain federal net operating losses of $1.2 million and $1.1 million, respectively. Additionally, Patriot has no pending or on-going audits in any tax jurisdiction.

 

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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.

 

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 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 Board of Directors establishes terms and conditions applicable to the vesting of restricted stock awards and stock options. Restricted stock grants generally vest in quarterly or annual installments over a three, four or five year period from the date of grant. All restricted stock awards are non- participating grants.

 

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, 2019, 2018 and 2017, this segment represented all the revenues and income of Patriot.

 

Reserve for Unfunded Commitments

 

The reserve for unfunded commitments provides for probable losses inherent with funding the unused portion of legal commitments to lend. The unfunded reserve calculation includes factors that are consistent with the ALLL methodology for our loan portfolio as well as a draw down factor applied to the various commitments. The reserve for unfunded commitments is included within other liabilities in the accompanying Consolidated Balance Sheets, and changes in the reserve are reported as a component of other expense in the accompanying Consolidated Statements of Income. See Note 18: Financial Instruments with Off-Balance-Sheet Risk for further information.

 

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Related Party Transactions

 

Directors and officers of the Company and their affiliates have been customers of and have had transactions with the Company, and it is expected that such persons will continue to have such transactions in the future. Management believes that all deposit accounts, loans, services and commitments comprising such transactions were made in the ordinary course of business, on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other customers who are not directors or officers. In the opinion of management, the transactions with related parties did not involve more than normal risks of collectability, nor favored treatment or terms, nor present other unfavorable features. See Note 20 Related Party Transactions for further information.

 

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.

 

Advertising Costs

 

Patriot's policy is to expense advertising costs in the period in which they are incurred.

 

Project expenses

 

Project expenses represent non-recurring expenses, primarily legal and consulting not directly related to the core business of Community Banking. In 2019, the project expenses principally were the result of third party costs related to a formal written agreement (the “Formal Agreement”) with the OCC entered in November 2018, and of a non-recurring nature and primarily consultants and legal. In prior years, the expenses were primarily for merger, tax analysis strategy and planning.

 

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:

 

 

Service charges on deposit accounts - these represent general service fees for monthly account maintenance and activity- or transaction based fees and consist of transaction-based revenue, time-based revenue (service period), item-based revenue or some other individual attribute-based revenue. Revenue is recognized when our performance obligation is completed which is generally monthly for account maintenance services or when a transaction has been completed (such as a wire transfer). Payment for such performance obligations are generally received at the time the performance obligations are satisfied.

 

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Recently Adopted and Issued Accounting Standards

 

Accounting Standards Adopted During 2019

 

Effective January 1, 2019, the following new Accounting Standards Updates (ASUs) were adopted by the Company:

 

ASU 2016-02

In February 2016, the FASB issued ASU No. 2016-02, Leases. This ASU was issued to improve the financial reporting of leasing activities and provide a faithful representation of leasing transactions and improve understanding and comparability of a lessee's financial statements. The amendments in this ASU require lessees to recognize, on the balance sheet, assets and liabilities for the rights and obligations created by leases. Accounting by lessors will remain largely unchanged. In July 2018, the FASB issued a subsequent update which introduced a new transition method, under this new transition method, an entity initially applies the new leases standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The guidance was effective for the Company on January 1, 2019, with early adoption permitted. Management elected the transition practical expedient option. The cumulative-effect adjustment was an increase to the opening balance of accumulated deficit at the time of adoption on January 1, 2019. The Company recognized $3.4 million of right-of-use (“ROU”) assets and $3.4 million of lease liabilities for operating leases on its Consolidated Balance Sheets. ASU 2016-12 did not have an impact on its Consolidated Statements of Operations. See Note 12 to our Consolidated Financial Statements for information regarding leases.

 

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 was 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. The adoption of ASU 2017-08 did not have any impact on its 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 was effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. ASU 2017-12 and ASU 2018-16 did not have any impact on the Consolidated Financial Statements.

 

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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 by permitting the entity to complete a qualitative assessment to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Under this Update, an entity should perform its annual or quarterly goodwill impairment test by comparing the fair value of the reporting unit with its carrying amount and record an impairment charge for the excess of the carrying amount over the reporting unit’s fair value. The loss recognized should not exceed the total amount of goodwill allocated to the reporting unit and the entity must consider the income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. This guidance is effective for a public business entity that is an SEC filer for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019 and early adoption is permitted. The Company early adopted ASU 2017-04 as of June 30, 2019.

 

 

Accounting Standards Issued But Not Yet Adopted

 

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. In November 2019, the FASB issued ASU 2019-10, which amends the effective date of ASC 326 for smaller reporting companies, as defined by the SEC, and other non-SEC reporting entities, and delays the effective date to fiscal years beginning after December 31, 2022, including interim periods within those fiscal periods. As the Company is a small reporting company, the delay will be applicable to the Company. Management is currently evaluating the impact that the standard 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 effective for annual periods and interim periods within those annual periods beginning after December 15, 2019. The amendments related to changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements and the narrative description of measurement uncertainty should be applied prospectively, while all other amendments should be applied retrospectively for all periods presented upon their effective date. Management is currently evaluating the impact of adopting the new guidance on the Consolidated Financial Statements, but it is not expected to have a material impact.

 

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ASU 2018-15

In August 2018, the FASB issued ASU No. 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40) - Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. ASU 2018-15 clarifies certain aspects of ASU 2015-05, “Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement,” which was issued in April 2015. Specifically, ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). For public business entities, the ASU was effective for interim and annual reporting periods beginning after December 15, 2019, with early adoption permitted. The adoption of ASU 2018-15 will not have a significant impact on our Consolidated Financial Statements.

 

ASU 2019-12

ASU 2019-12, “Income Taxes (Topic 740) - Simplifying the Accounting for Income Taxes.” The guidance issued in this update simplifies the accounting for income taxes by eliminating certain exceptions to the guidance in ASC 740 related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition for deferred tax liabilities for outside basis differences. ASU 2019-12 also simplifies aspects of the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. The ASU will be effective for the Company on January 1, 2021, with early adoption permitted, and is not expected to have a significant impact on our financial statements.

 

 

Note 2.

Restrictions on Cash and Due from Banks

 

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, 2019 and 2018.

 

67

 

 

Note 3.

Available-for-sale securities

 

At December 31, 2019 and 2018, the amortized cost, gross unrealized gains, gross unrealized losses and approximate fair value of available-for-sale securities was as follows:

 

(In thousands)

 

Amortized
Cost

  

Gross
Unrealized
Gains

  

Gross
Unrealized
(Losses)

  

Fair
Value

 

December 31, 2019:

                

U. S. Government agency mortgage-backed securities

 $16,663  $90  $(68) $16,685 

Corporate bonds

  18,018   133   (838)  17,313 

Subordinated notes

  9,022   182   -   9,204 

SBA loan pools

  5,157   -   (42)  5,115 
  $48,860  $405  $(948) $48,317 
                 

December 31, 2018:

                

U. S. Government agency mortgage-backed securities

 $20,626  $43  $(196) $20,473 

Corporate bonds

  14,000   -   (1,026)  12,974 

Subordinated notes

  4,500   64   -   4,564 

U.S. Treasury notes

  1,484   1   -   1,485 
  $40,610  $108  $(1,222) $39,496 

 

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, 2019 and 2018:

 

(In thousands)

 

Less than 12 Months

  

12 Months or More

  

Total

 
  

Fair
Value

  

Unrealized
(Loss)

  

Fair
Value

  

Unrealized
(Loss)

  

Fair
Value

  

Unrealized
(Loss)

 

December 31, 2019:

                        

U. S. Government agency mortgage-backed securities

 $2,609  $(20) $3,919  $(48) $6,528  $(68)

Corporate bonds

  -   -   13,162   (838)  13,162   (838)

SBA loan pools

  5,115   (42)  -   -   5,115   (42)
  $7,724  $(62) $17,081  $(886) $24,805  $(948)
                         

December 31, 2018:

                        

U. S. Government agency mortgage-backed securities

 $8,024  $(38) $5,422  $(158) $13,446  $(196)

Corporate bonds

  -   -   12,974   (1,026)  12,974   (1,026)
  $8,024  $(38) $18,396  $(1,184) $26,420  $(1,222)

 

At December 31, 2019 and 2018, fifteen of twenty-seven and ten of sixteen available-for-sale securities had unrealized losses with an aggregate depreciation of 3.7% and 4.4% from amortized cost, respectively.

 

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Management believes that none of the losses on available-for-sale securities noted above constitute 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 before such recovery, none of the available-for-sale securities noted are considered to be OTTI as of December 31, 2019.

 

Available-for-sale securities of $4.8 million and $7.0 million were pledged primarily to secure municipal deposits at December 31, 2019 and 2018, respectively. As of December 31, 2019, $4.8 million available-for sale securities were pledged to the FRB of New York. As of December 31, 2018, $5.5 million available-for-sale securities of were pledged to the FRB of New York, and $1.5 million were pledged to Federal Reserve Bank of St. Louis, respectively.

 

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, 2019 and 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.

 

(In thousands)

 

Amortized Cost

  

Fair Value

 
  

Due
Within
5 years

  

Due After
5 years
through
10 years

  

Due
After
10 years

  

Total

  

Due
Within
5 years

  

Due After
5 years
through
10 years

  

Due
After
10 years

  

Total

 

December 31, 2019:

                                

Corporate bonds

 $4,018  $14,000  $-  $18,018  $4,151  $13,162  $-  $17,313 

Subordinated notes

  -   9,022   -   9,022   -   9,204   -   9,204 

SBA loan pools

  -   5,157   -   5,157   -   5,115   -   5,115 

Available-for-sale securities with stated maturity dates

  4,018   28,179   -   32,197   4,151   27,481   -   31,632 

U. S. Government agency mortgage-backed securities

  3,805   2,047   10,811   16,663   3,810   2,016   10,859   16,685 
  $7,823  $30,226  $10,811  $48,860  $7,961  $29,497  $10,859  $48,317 
                                 

December 31, 2018:

                                

Corporate bonds

 $-  $9,000  $5,000  $14,000  $-  $8,537  $4,437  $12,974 

Subordinated notes

  -   4,500   -   4,500   -   4,564   -   4,564 

U.S. Treasury notes

  1,484   -   -   1,484   1,485   -   -   1,485 

Available-for-sale securities with stated maturity dates

  1,484   13,500   5,000   19,984   1,485   13,101   4,437   19,023 

U. S. Government agency mortgage backed securities

  6,842   5,668   8,116   20,626   6,844   5,530   8,099   20,473 
  $8,326  $19,168  $13,116  $40,610  $8,329  $18,631  $12,536  $39,496 

 

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Note 4.

Loan Receivables and Allowance for Loan and Lease Losses

 

As of December 31, 2019 and 2018, loans receivable, net, consisted of the following:

 

  

December 31,

 

(In thousands)

 

2019

  

2018

 

Loan portfolio segment:

        

Commercial Real Estate

 $314,414  $274,938 

Residential Real Estate

  175,489   157,300 

Commercial and Industrial

  173,875   191,852 

Consumer and Other

  85,934   94,569 

Construction

  48,388   46,040 

Construction to Permanent - CRE

  14,064   15,677 

Loans receivable, gross

  812,164   780,376 

Allowance for loan and lease losses

  (10,115)  (7,609)

Loans receivable, net

 $802,049  $772,767 

 

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 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 the regional real estate market. Accordingly, the ultimate collectability of a substantial portion of the loan portfolio and the recovery of a substantial portion of any resulting real estate acquired is susceptible to changes in market conditions.

 

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 May 2018, loans were acquired in connection with the Prime Bank merger. 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 $176,000 as of December 31, 2019 and $615,000 as of December 31, 2018, respectively. 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.

 

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A summary of changes in the accretable discount for PCI loans for the year ended December 31, 2019 and 2018 follows:

 

(In thousands)

 

For the Year Ended December 31,

 
  

2019

  

2018

 
         

Accretable discount, beginning of period

 $(792) $(1,316)

Accretion

  47   92 

Other changes, net

  698   432 

Accretable discount, end of period

 $(47) $(792)

 

The accretion of the accretable discount for PCI loans for the year end December 31,2019 and 2018 was $47,000 and $92,000, respectively. The other changes represent primarily loans that were either fully paid-off or totally charged off.

 

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 there are declines in general economic conditions. Where the owner occupies the property, Patriot also evaluates the business’ ability to repay the loan on a timely basis and may require personal guarantees, lease assignments, and/or the guarantee of the operating company.

 

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 property securing the loan, or should there be declines in general economic conditions.

 

In 2019 and 2018, Patriot purchased $47.3 million and $25.6 million of residential real estate loans, respectively.

 

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 financing of accounts receivable, purchases of inventory, purchases of new or used equipment, or for other short- or long-term working capital purposes. These loans are generally secured by business assets but are also occasionally offered on an unsecured basis. In granting these types of loans, Patriot considers the borrower’s cash flow as the primary source of repayment, supported by the value of collateral, if any, and personal guarantees, as applicable. Repayment of commercial and industrial loans may be negatively impacted by adverse changes in economic conditions, ineffective management, claims on the borrower’s assets by others that are superior to Patriot’s claims, a loss of demand for the borrower’s products or services, or the death or disability of the borrower or other key management personnel.

 

Patriot’s syndicated and leveraged loan portfolios, which totaled $71.5 million and $81.9 million at December 31, 2019 and 2018, respectively. The syndicated and leveraged loans are included in the commercial and industrial loan classification and are primarily comprised of loan transactions led by major financial institutions and regional banks, which are the Agent Bank or Lead Arranger, and are referred to as syndicated loans or "Shared National Credits (SNC)". SNC loans were determined to be complementary to the Bank’s existing commercial and industrial loan portfolio and product offerings and provide diversification from Patriot’s typical direct-to-business lines of credit and term facilities. The Bank will participate in senior secured financings for public and privately-owned companies for acquisitions, working capital, recapitalizations, and general corporate purposes. The Bank’s strategy is to participate in these types of loan transaction in accordance with its internal policies.

 

71

 

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 consumer, a history of bankruptcies, or borrowers with questionable repayment capacity as evidenced by low credit scores or high debt-burdened ratios.

 

During 2019 and 2018, $7.3 million and $21.4 million education loans were purchased, respectively.

 

Construction Loans

 

Construction loans are of a short-term nature, generally of eighteen months or less, that are secured by land and improvements 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 the builder, the type and location of the property, and other factors. Construction loans tend to be personally guaranteed by the principal(s). Repayment of such loans may be negatively impacted by an inability to complete construction, a downturn in the market for new construction, by a significant increase in interest rates, or by decline in general economic conditions.

 

Construction to Permanent - Commercial Real Estate (“CRE”)

 

Loans in this category represent a one-time close of a construction facility with simultaneous 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 Federal Home Loan Bank (“FHLB”) rate.

 

Close 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.

 

SBA Loans:

 

Patriot originates SBA 7(a) loans, on which the SBA has historically provided guarantees of 75 percent of the principal balance. The guaranteed portion of the Company’s SBA loans is generally sold in the secondary market with the unguaranteed portion held in the portfolio as a loan held for investment. SBA loans are for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. Loans are guaranteed by the businesses' major owners. SBA loans are made based primarily on the historical and projected cash flow of the business and secondarily on the underlying collateral provided. SBA loans held for investment are included in the commercial real estate loans and commercial and industrial loan classifications, which totaled $9.6 million and $1.5 million at December 31, 2019 and 2018, respectively.

 

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Allowance for Loan and Lease Losses

 

The following tables summarize the activity in the allowance for loan and lease losses, allocated to segments of the loan portfolio, for each year in the three-year period ended December 31, 2019:

 

(In thousands)

 

Commercial
Real Estate

  

Residential
Real Estate

  

Commercial
and
Industrial

  

Consumer
and
Other

  

Construction

  

Construction
to
Permanent
- CRE

  

Unallocated

  

Total

 

As of and for the year ended
December 31, 2019

                                

Allowance for loan and lease losses:

                             

December 31, 2018

 $1,866  $1,059  $3,558  $641  $350  $108  $27  $7,609 

Charge-offs

  -   (118)  (2,418)  (123)  -   -   -   (2,659)

Recoveries

  2   10   172   10   -   -   -   194 

Provisions (credits)

  1,921   87   3,028   (187)  127   22   (27)  4,971 

December 31, 2019

 $3,789  $1,038  $4,340  $341  $477  $130  $-  $10,115 
                                 

As of and for the year ended
December 31, 2018

                                

Allowance for loan and lease losses:

                             

December 31, 2017

 $2,212  $959  $2,023  $568  $481  $54  $-  $6,297 

Charge-offs

  -   (2)  -   (33)  -   -   -   (35)

Recoveries

  7   2   34   1   -   -   -   44 

Provisions (credits)

  (353)  100   1,501   105   (131)  54   27   1,303 

December 31, 2018

 $1,866  $1,059  $3,558  $641  $350  $108  $27  $7,609 
                                 

As of and for the year ended
December 31, 2017

                                

Allowance for loan and lease losses:

                             

December 31, 2016

 $1,853  $534  $740  $641  $712  $69  $126  $4,675 

Charge-offs

  -   -   (265)  (39)  -   -   -   (304)

Recoveries

  10   -   2,769   4   -   -   -   2,783 

Provisions (credits)

  349   425   (1,221)  (38)  (231)  (15)  (126)  (857)

December 31, 2017

 $2,212  $959  $2,023  $568  $481  $54  $-  $6,297 

 

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The following tables summarize, by loan portfolio segment, the amount of loans receivable evaluated individually and collectively for impairment as of December 31, 2019 and 2018:

 

(In thousands)

 

Commercial
Real Estate

  

Residential
Real Estate

  

Commercial
and
Industrial

  

Consumer
and
Other

  

Construction

  

Construction
to
Permanent
- CRE

  

Unallocated

  

Total

 

December 31, 2019

                                

Allowance for loan and lease losses:

                             

Individually evaluated
for impairment

 $1,496  $-  $-  $-  $-  $-  $-  $1,496 

Collectively evaluated
for impairment

  2,293   1,038   4,340   341   477   130   -   8,619 

Total allowance for loan and lease losses

 $3,789  $1,038  $4,340  $341  $477  $130  $-  $10,115 
                                 

Loans receivable, gross:

                             

Individually evaluated
for impairment

 $13,034  $3,621  $2,057  $916  $-  $-  $-  $19,628 

PCI loans individually evaluated for impairment

  -   -   176   -   -   -   -   176 

Collectively evaluated
for impairment

  301,380   171,868   171,642   85,018   48,388   14,064   -   792,360 

Total loans receivable, gross

 $314,414  $175,489  $173,875  $85,934  $48,388  $14,064  $-  $812,164 

 

 

(In thousands)

 

Commercial
Real Estate

  

Residential
Real Estate

  

Commercial
and
Industrial

  

Consumer
and
Other

  

Construction

  

Construction
to
Permanent
- CRE

  

Unallocated

  

Total

 

December 31, 2018

                                

Allowance for loan and lease losses:

                             

Individually evaluated
for impairment

 $-  $216  $1,299  $30  $-  $-  $-  $1,545 

Collectively evaluated
for impairment

  1,866   843   2,259   611   350   108   27   6,064 

Total allowance for loan losses

 $1,866  $1,059  $3,558  $641  $350  $108  $27  $7,609 
                                 

Loans receivable, gross:

                             

Individually evaluated
for impairment

 $4,606  $2,302  $4,646  $864  $8,800  $-  $-  $21,218 

PCI loans individually evaluated for impairment

  -   -   615   -   -   -   -   615 

Collectively evaluated
for impairment

  270,332   154,998   186,591   93,705   37,240   15,677   -   758,543 

Total loans receivable, gross

 $274,938  $157,300  $191,852  $94,569  $46,040  $15,677  $-  $780,376 

 

Patriot monitors the credit quality of its loans receivable on an ongoing basis. Credit quality is monitored by reviewing certain indicators, including cash flow from business operations, loan to value ratios, debt service coverage ratios, and credit scores.

 

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Patriot employs a risk rating system as part of the risk assessment of its loan portfolio. At origination, lending officers are required to assign a risk rating to each loan in their portfolio, which is ratified or modified by the Loan Committee to which the loan is submitted for approval. If financial developments occur on a loan in the lending officer’s portfolio of responsibility, the risk rating is reviewed and adjusted, as applicable. In carrying out its oversight responsibilities, the Loan Committee can adjust a risk rating based on available information. In addition, the risk ratings on all commercial loans over $250,000 are reviewed annually by the Credit Department.

 

Additionally, Patriot retains an 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:

 

Substandard: An asset is classified “substandard” if it is not adequately protected by the current net worth and paying capacity of the obligor or the collateral pledged, if any. Substandard assets have well defined weaknesses based on objective evidence, and are characterized by the distinct possibility that the Company will sustain some loss, if noted deficiencies are not corrected.

Doubtful: Assets classified as “doubtful” have all of the weaknesses inherent in those classified as “substandard”, with the added characteristic that the identified weaknesses make collection or liquidation-in-full improbable, on the basis of currently existing facts, conditions, and values.

 

Charge-offs of loans to reduce the loan to its recoverable value that are solely collateral dependent, generally occur immediately upon confirmation of the partial loss amount. Loans that are cash flow dependent are modeled to reflect the expected cash flows through expected loan maturity, including any proceeds from refinancing or principal curtailment. A specific reserve is established for the amount by which the net investment in the loan exceeds the present value of discounted cash flows. Charge-offs on cash flow dependent loans also generally occur immediately upon confirmation of the partial loss amount.

 

If either type of loan is classified as “Loss”, meaning full loss on the loan is expected, 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 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.

 

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Loan Portfolio Aging Analysis

 

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, 2019.

 

(In thousands)

 

Performing (Accruing) Loans

         

As of December 31, 2019:

 

30 - 59 Days
Past Due

  

60 - 89 Days
Past Due

  

90 Days
or
Greater Past Due

  

Total
Past Due

  

Current

  

Total
Performing
Loans

  

Non-accruing
Loans

  

Loans
Receivable
Gross

 

Loan portfolio segment:

                                

Commercial Real Estate:

                                

Pass

 $-  $-  $-  $-  $295,982  $295,982  $-  $295,982 

Special mention

  -   -   -   -   385   385   -   385 

Substandard

  -   -   -   -   6,086   6,086   11,961   18,047 
   -   -   -   -   302,453   302,453   11,961   314,414 

Residential Real Estate:

                                

Pass

  658   -   -   658   169,903   170,561   -   170,561 

Special mention

  -   -   -   -   -   -   -   - 

Substandard

  -   -   -   -   1,700   1,700   3,228   4,928 
   658   -   -   658   171,603   172,261   3,228   175,489 

Commercial and Industrial:

                                

Pass

  327   350   -   677   162,711   163,388   -   163,388 

Special mention

  279   -   -   279   172   451   -   451 

Substandard

  -   -   -   -   7,942   7,942   2,094   10,036 
   606   -   -   956   170,825   171,781   2,094   173,875 

Consumer and Other:

                                

Pass

  2,805   3   19   2,827   82,341   85,168   -   85,168 

Substandard

  -   -   -   -   -   -   766   766 
   2,805   3   19   2,827   82,341   85,168   766   85,934 

Construction:

                                

Pass

  -   -   -   -   48,388   48,388   -   48,388 
   -   -   -   -   48,388   48,388   -   48,388 

Construction to Permanent - CRE:

                             

Pass

  -   -   -   -   14,064   14,064   -   14,064 
   -   -   -   -   14,064   14,064   -   14,064 
                                 

Total

 $4,069  $353  $19  $4,441  $789,674  $794,115  $18,049  $812,164 
                                 

Loans receivable, gross:

                                

Pass

 $3,790  $353  $19  $4,162  $773,389  $777,551  $-  $777,551 

Special mention

  279   -   -   279   557   836   -   836 

Substandard

  -   -   -   -   15,728   15,728   18,049   33,777 

Loans receivable, gross

 $4,069  $353  $19  $4,441  $789,674  $794,115  $18,049  $812,164 

 

76

 

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, 2018.

 

(In thousands)

 

Performing (Accruing) Loans

         

As of December 31, 2018:

 

30 - 59 Days
Past Due

  

60 - 89 Days
Past Due

  

90 Days
or
Greater Past Due

  

Total
Past Due

  

Current

  

Total
Performing
Loans

  

Non-accruing
Loans

  

Loans
Receivable
Gross

 

Loan portfolio segment:

                                

Commercial Real Estate:

                                

Pass

 $423  $-  $-  $423  $262,435  $262,858  $-  $262,858 

Special mention

  -   -   958   958   2,673   3,631   -   3,631 

Substandard

  170   -   -   170   4,754   4,924   3,525   8,449 
   593   -   958   1,551   269,862   271,413   3,525   274,938 

Residential Real Estate:

                                

Pass

  637   817   -   1,454   151,509   152,963   -   152,963 

Special mention

  -   -   -   -   850   850   -   850 

Substandard

  -   -   -   -   1,481   1,481   2,006   3,487 
   637   817   -   1,454   153,840   155,294   2,006   157,300 

Commercial and Industrial:

                                

Pass

  150   853   234   1,237   180,293   181,530   -   181,530 

Special mention

  -   -   101   101   2,378   2,479   -   2,479 

Substandard

  -   -   -   -   3,162   3,162   4,681   7,843 
   150   853   335   1,338   185,833   187,171   4,681   191,852 

Consumer and Other:

                                

Pass

  20   -   23   43   94,352   94,395   -   94,395 

Substandard

  -   -   -   -   -   -   174   174 
   20   -   23   43   94,352   94,395   174   94,569 

Construction:

                                

Pass

  -   1,000   -   1,000   36,240   37,240   -   37,240 

Substandard

  -   -   -   -   -   -   8,800   8,800 
   -   1,000   -   1,000   36,240   37,240   8,800   46,040 

Construction to Permanent -
CRE:

                                

Pass

  -   -   -   -   15,677   15,677   -   15,677 
   -   -   -   -   15,677   15,677   -   15,677 
                                 

Total

 $1,400  $2,670  $1,316  $5,386  $755,804  $761,190  $19,186  $780,376 
                                 

Loans receivable, gross:

                                

Pass

 $1,230  $2,670  $257  $4,157  $740,506  $744,663  $-  $744,663 

Special mention

  -   -   1,059   1,059   5,901   6,960   -   6,960 

Substandard

  170   -   -   170   9,397   9,567   19,186   28,753 

Loans receivable, gross

 $1,400  $2,670  $1,316  $5,386  $755,804  $761,190  $19,186  $780,376 

 

 

77

 

The following tables summarize non-performing (i.e., non-accruing) loans by aging category and status, within the applicable loan portfolio segment as of December 31, 2019 and 2018:

 

(In thousands)

 

Non-accruing Loans

     
  

30 - 59
Days
Past Due

  

60 - 89
Days
Past Due

  

90 Days or
Greater Past Due

  

Total
Past Due

  

Current

  

Total
Non-accruing
Loans

 

As of December 31, 2019:

                        

Loan portfolio segment:

                        

Commercial Real Estate:

                        

Substandard

 $-  $-  $1,636  $1,636  $10,325  $11,961 

Residential Real Estate:

                        

Substandard

  -   -   1,872   1,872   1,356   3,228 

Commercial and Industrial:

                        

Substandard

  -   -   1,724   1,724   370   2,094 

Consumer and Other:

                        

Substandard

  -   -   149   149   617   766 

Total non-accruing loans

 $-  $-  $5,381  $5,381  $12,668  $18,049 
                         

As of December 31, 2018:

                        

Loan portfolio segment:

                        

Commercial Real Estate:

                        

Substandard

 $1,580  $-  $1,945  $3,525  $-  $3,525 

Residential Real Estate:

                        

Substandard

  -   -   2,006   2,006   -   2,006 

Commercial and Industrial:

                        

Substandard

  -   15   3,941   3,956   725   4,681 

Consumer and Other:

                        

Substandard

  -   86   11   97   77   174 

Construction:

                        

Substandard

  -   - �� 8,800   8,800   -   8,800 

Total non-accruing loans

 $1,580  $101  $16,703  $18,384  $802  $19,186 

 

 

If non-accrual loans had been performing in accordance with the original contractual terms, additional interest income (net of cash collected) of approximately $302,000, $503,000, and $209,000 would have been recognized in income for the years ended December 31, 2019, 2018, and 2017, respectively.

 

Interest income collected and recognized on non-accruing loans for the year ended December 31, 2019 was $671,000. No interest income was collected and recognized on non-accruing loans during 2018 and 2017.

 

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.

 

78

 

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, after at least six months of timely payment history. Management considers all non-accrual loans and Trouble Debt Restructurings (“TDR”) impaired loans. In most cases, loan payments that are past due less than 90 days, well-secured, and in the process of collection are not considered impaired. The Bank considers consumer installment loans to be pools of smaller homogeneous loan balances, which are collectively evaluated for impairment.

 

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 also 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, 2019 and 2018 were $11.0 million and $2.1 million, respectively.

 

(In thousands)

 

December 31, 2019

  

December 31, 2018

 

Loan portfolio segment:

 

Number of

Loans

  

Recorded Investment

  

Number of

Loans

  

Recorded Investment

 

Commercial Real Estate

  2  $9,873   1  $1,081 

Residential Real Estate

  2   393   1   296 

Consumer and Other

  2   687   2   689 

Total TDR Loans

  6   10,953   4   2,066 

Less:

                

TDRs included in non-accrual loans

  2   (9,337)  -   - 

Total accrual TDR Loans

  4  $1,616   4  $2,066 

 

The following loans were modified as TDR during the year ended December 31, 2019.

 

      

Outstanding Recorded Investment

 

(In thousands)

 

Number of Loans

  

Pre-Modification

  

Post-Modification

 

Year Ended December 31,

 

2019

  

2019

  

2019

 

Loan portfolio segment:

            

Commercial Real Estate

  2  $8,912  $8,911 

Total TDR Loans

  2  $8,912  $8,911 

 

79

 

The following table provides information on how loans were modified as TDRs during the year ended December 31, 2019.

 

  

Year Ended
December 31,

 

(In thousands)

 

2019

 
     

Rate reduction

 $111 

Maturity and rate reduction

  8,800 

Total

 $8,911 

 

The loans modified in a TDR often involve reducing the interest rate for the remaining term of the loan, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, extending the interest-only payment period, or substituting or adding a co-borrower or guarantor.

 

During the years ended December 31, 2018 and 2017, no loans were modified as TDRs, and no defaults of TDRs. At December 31, 2019 and 2018, there were no commitments to advance additional funds under TDRs.

 

The balances reflected here as TDR’s are also included in the non-accruing loan balance included in the prior table - Loan Portfolio Aging Analysis.

 

Impaired Loans

 

Impaired loans may consist of non-accrual loans and/or performing and non-performing TDRs. As of December 31, 2019 and 2018, based on the on-going monitoring and analysis of the loan portfolio, impaired loans of $19.6 million and $21.2 million, respectively, were identified, for which $1.5 million and $1.5 million specific reserves were established, respectively. Loans not requiring specific reserves had sufficient collateral values, less costs to sell, supporting the net investment in the loan which includes principal balance, unamortized fees and costs and accrued interest, if any. Once a borrower is in default, Patriot is under no obligation to advance additional funds on unused commitments.

 

At December 31, 2019 and 2018, exposure to the impaired loans was related to 27 and 25 borrowers, respectively. In all cases, appraisal reports of the underlying collateral, if any, have been obtained from independent licensed appraisal firms for loans considered to be collateral dependent. For non-performing loans, the independently determined appraised values were first reduced by a 12% discount to reflect the Bank's experience selling OREO properties, and were further reduced by 8% in selling costs, 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 $176,000 PCI loans acquired from Prime Bank acquisition 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, 2019, those loans were considered individually evaluated for impairment, with no allowance recorded.

 

80

 

The following table reflects information about the impaired loans, excluding PCI loans, by class as of December 31, 2019 and 2018:

 

(In thousands)

 

December 31, 2019

  

December 31, 2018

 
  

Recorded
Investment

  

Principal
Outstanding

  

Related
Allowance

  

Recorded
Investment

  

Principal
Outstanding

  

Related
Allowance

 

With no related allowance recorded:

                        

Commercial Real Estate

 $4,234  $4,309  $-  $4,606  $5,109  $- 

Residential Real Estate

  3,621   3,623   -   670   703   - 

Commercial and Industrial

  2,057   2,060   -   488   1,281   - 

Consumer and Other

  916   1,000   -   827   867   - 

Construction

  -   -   -   8,800   8,839   - 
   10,828   10,992   -   15,391   16,799   - 
                         

With a related allowance recorded:

                        

Commercial Real Estate

  8,800   8,800   1,496   -   -   - 

Residential Real Estate

  -   -   -   1,632   1,632   216 

Commercial and Industrial

  -   -   -   4,158   4,208   1,299 

Consumer and Other

  -   -   -   37   37   30 
   8,800   8,800   1,496   5,827   5,877   1,545 
                         

Impaired Loans, Total:

                        

Commercial Real Estate

  13,034   13,109   1,496   4,606   5,109   - 

Residential Real Estate

  3,621   3,623   -   2,302   2,335   216 

Commercial and Industrial

  2,057   2,060   -   4,646   5,489   1,299 

Consumer and Other

  916   1,000   -   864   904   30 

Construction

  -   -   -   8,800   8,839   - 

Impaired Loans, Total

 $19,628  $19,792  $1,496  $21,218  $22,676  $1,545 

 

For each year in the three-year period ended December 31, 2019, 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:

 

  

Year Ended December 31,

 

(In thousands)

 

2019

  

2018

  

2017

 
  

Average
Recorded
Investment

  

Interest
Income
Recognized

  

Average
Recorded
Investment

  

Interest
Income
Recognized

  

Average
Recorded
Investment

  

Interest
Income
Recognized

 

With no related allowance recorded:

                       

Commercial Real Estate

 $9,829  $95  $3,318  $100  $5,832  $102 

Residential Real Estate

  2,531   104   3,154   11   2,016   11 

Commercial and Industrial

  1,800   45   987   -   197   - 

Consumer and Other

  901   35   750   31   593   22 

Construction

  4,062   -   1,354   503   -   - 
   19,123   279   9,563   645   8,638   135 

With a related allowance recorded:

                        

Commercial Real Estate

  888   415   -   -   -   - 

Residential Real Estate

  952   -   126   -   -   - 

Commercial and Industrial

  1,714   -   474   -   243   - 

Consumer and Other

  18   -   9   -   -   - 
   3,572   415   609   -   243   - 

Impaired Loans, Total:

                        

Commercial Real Estate

  10,717   510   3,318   100   5,832   102 

Residential Real Estate

  3,483   104   3,280   11   2,016   11 

Commercial and Industrial

  3,514   45   1,461   -   440   - 

Consumer and Other

  919   35   759   31   593   22 

Construction

  4,062   -   1,354   503   -   - 

Impaired Loans, Total

 $22,695  $694  $10,172  $645  $8,881  $135 

 

81

 

 

Note 5.

Loans Held for Sale

 

Loans held for sale represent the guaranteed portion of SBA loans originated and are reflected at the lower of aggregate cost or market value. There were $15.3 million of loans held for sale at December 31, 2019, consisting of $10.2 million commercial and industrial loans and $5.1 million commercial real estate.

 

The Company generally sells the guaranteed portion of its SBA loans to a third party and retains the servicing, holding the unguaranteed portion in its portfolio. When sales of SBA loans do occur, the premium received on the sale and the present value of future cash flows of the servicing assets, less the discount of the retained portion of the loan are recognized in income.

 

Servicing assets represent the estimated fair value of retained servicing rights, net of servicing costs, at the time loans are sold. Servicing assets are amortized in proportion to, and over the period of, estimated net servicing revenues. Impairment will be evaluated based on stratifying the underlying financial assets by date of origination and term. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Any impairment, if temporary, would be reported as a valuation allowance.

 

Serviced loans sold to others are not included in the accompanying Consolidated Balance Sheets. The total amount of such loans serviced, but owned by third party, amounted to approximately $13.6 million and $1.9 million at December 31, 2019 and 2018, respectively. The servicing asset has a carrying value of $201,000 and fair value of $280,000 at December 31, 2019. Income and fees collected for loan servicing are credited to noninterest income when earned, net of amortization on the related servicing assets.

 

The following table presents an analysis of the activity in the SBA servicing assets for the years ended December 31, 2019 and 2018:

 

(In thousands)

 

Year Ended December 31,

 
  

2019

  

2018

 

Beginning balance

 $37   - 

Servicing rights capitalized

  180   42 

Servicing rights amortized

  (16)  (5)

Ending balance

  201   37 

 

No servicing assets were recorded for the year ended December 31, 2017. The servicing assets are included in the other assets on the Consolidated Balance Sheet.

 

82

 

 

Note 6.

Premises and Equipment

 

At December 31, 2019 and 2018, premises and equipment consisted of the following:

 

(In thousands)

 

Balance as of December 31,

 
  

2019

  

2018

 

Land

 $12,819  $12,819 

Buildings

  20,287   20,200 

Leasehold Improvements

  4,024   3,891 

Furniture, equipment, and software

  11,687   11,242 

Construction-in-progress

  50   113 

Premises and equipment, gross

  48,867   48,265 

Accumulated depreciation and amortization

  (14,299)  (12,830)

Premises and equipment, net

 $34,568  $35,435 

 

For the years ended December 31, 2019, 2018 and 2017, depreciation and amortization expense related to premises and equipment totaled $1.6 million, $1.5 million, and $1.2 million, respectively.

 

 

Note 7.

Other Real Estate Owned (“OREO”)

 

As of December 31, 2019 and 2018, OREO aggregated of $2.4 million and $2.9 million, respectively. The 2019 OREO balance consists of two foreclosed residential properties that are currently being marketed for sale. At December 31, 2018, OREO consisted of one residential property acquired in connection with the acquisition of Prime Bank in May 2018, was sold in 2019 and Patriot recognized a loss of $14,000. No OREO property was sold in 2018. The recognized loss is included in the other operating expenses on the Consolidated Statements of Operations.

 

 

Note 8.

Business Combination, Goodwill and Other Intangible Assets

 

Acquisition of Prime Bank

 

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. Determining the fair value of assets and liabilities, especially the loan portfolio, is a complicated process involving significant judgment regarding methods and assumptions used to calculate estimated fair values. At date of acquisition fair values are generally preliminary and subject to refinement for up to one year after the closing date of the acquisition as additional information regarding fair values becomes available.

 

On May 10, 2018 the Company completed its acquisition of Prime Bank, a Connecticut bank headquartered in Orange, CT. The closing of the transaction added a new Patriot branch located in the Town of Orange, New Haven County, Connecticut.

 

The assets acquired and liabilities assumed from Prime Bank were recorded at their estimated 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 was further adjusted to $1.1 million as a result of reducing the estimated amount to be paid pursuant to certain problem loans pending resolution by $621,000 as of May 10, 2019. There were no income statement effects resulting from the recorded measurement period adjustments for the year ended December 31, 2019. The goodwill is all deductible for income taxes over 15 years.

 

83

 

Information on goodwill for the year ended December 31, 2019 and 2018 is as follows:

 

  

For the Year Ended December 31,

 

(In thousands)

 

2019

  

2018

 
         

Balance, resulting from acquisition

 $1,728  $1,728 

Mesurement period adjustments

  (621)  - 

Balance, end of period

 $1,107  $1,728 

 

Goodwill is evaluated for impairment annually or whenever we identify certain triggering events or circumstances that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Events or circumstances that might indicate an interim evaluation is warranted include, among other things, unexpected adverse business conditions, macro and reporting unit specific economic factors, supply costs, unanticipated competitive activities, and acts by governments and courts.

 

The Company performed a quantitative assessment as of October 31, 2019, the Company’s annual goodwill impairment measurement date, and concluded that the goodwill was not impaired as of December 31, 2019.

 

CDI was recorded as part of the Prime Bank business combination in May 2018. The CDI is amortized over a 10-year period using the straight-line method. For the year ended December 31, 2019 and 2018, the amortization was $75,000 and $50,000, respectively, which is included in the other operating expenses on the Consolidated Statements of Operations.

 

The table below provides information regarding the carrying amounts and accumulated amortization of amortized intangible assets as of the dates set forth below.

 

  

For the Year Ended December 31,

 

(In thousands)

 

2019

  

2018

 

Gross Intangible asset

 $748  $748 

Accumulated amortization

  (125)  (50)

Core deposit intangible, net

 $623  $698