Item 1. Business
General
Patriot National Bancorp, Inc. (“Bancorp or Company”), a Connecticut corporation, was organized in 1999 for the purpose of becoming a one-bank holding company (the “Reorganization”) for Patriot National Bank, a national banking association headquartered in Stamford, Fairfield County, Connecticut (the “Bank”). Following receipt of regulatory and shareholder approvals, the Reorganization became effective as of the opening of business on December 1, 1999. Upon consummation of the Reorganization, each outstanding share of Common Stock, par value $2.00 per share, of the Bank (“Bank Common Stock”), was converted into the right to receive one share of Common Stock, par value $2.00 per share, of Bancorp (“Bancorp Common Stock”), and each outstanding option or warrant to purchase Bank Common Stock became an option or warrant to purchase an equal number of shares of Bancorp Common Stock.
The Bank was granted preliminary approval by the Comptroller of the Currency (the “OCC”) on March 5, 1993. It received its charter and commenced operations as a national bank on August 31, 1994. The Bank currently has twelve branch offices in Connecticut. The Bank also expanded into New York State through the purchase of a small branch office in New York City and the opening of branch offices in Bedford and Scarsdale, both located in Westchester County, New York.
On March 11, 2003, Bancorp 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 Bancorp. Bancorp primarily invested the funds from the issuance of the debt in the Bank. The Bank in turn used the proceeds to fund general operations.
On November 17, 2006 the Bank acquired a small branch office and related deposits at 45 West End Avenue, New York, New York, from Millennium bcpbank, a national bank headquartered in Newark, New Jersey. The Bank assumed the existing lease and operates from the branch at 45 West End Avenue. The acquisition permitted the Bank to establish two additional branches in New York State.
On April 1, 2008, the Bank acquired a 20% interest in a de novo insurance agency. The impact on the Bank’s operations in 2009, 2010 and 2011 has been minimal.
On October 15, 2010, pursuant to a Securities Purchase Agreement (the “Securities Purchase Agreement”), the Company issued and sold to PNBK Holdings LLC (“Holdings”), an investment limited liability company controlled by Michael Carrazza, 33,600,000 shares of its common stock at a purchase price of $1.50 per share for an aggregate purchase price of $50,400,000. The shares sold to Holdings represent 87.6% of the Company’s currently issued and outstanding common stock. The par value of the common stock was changed to $0.01 per share. Also in connection with that sale, certain directors and officers of both the Company and the Bank resigned and were replaced with nominees of Holdings and Michael Carrazza became Chairman of the Board of the Company.
As of the date hereof, the only business of Bancorp 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 Bancorp’s business is a description of the Bank’s business.
Commercial Banking
The Bank conducts business at its main office located at 900 Bedford Street in Stamford, Connecticut and at other Connecticut branch offices located in Darien, Fairfield, Greenwich, Milford, Norwalk, Stamford, Southport, Trumbull, Westport and Wilton. In New York State, the Bank conducts business at branch offices located in: New York City, Bedford and Scarsdale. The Bank also operates a loan origination office at 1177 Summer Street in Stamford, Connecticut.
The Bank offers a broad range of consumer and commercial banking services with an emphasis on serving the needs of individuals, small and medium-sized businesses and professionals. The Bank offers consumer and commercial deposit accounts that include: checking accounts, interest-bearing “NOW” accounts, insured money market accounts, time certificates of deposit, savings accounts, IRAs (Individual Retirement Accounts) and HSAs (Health Savings Accounts). Other services include internet banking, bill paying, remote deposit capture, debit cards, money orders, traveler’s checks and ATMs. The Bank is a member of CDARS (Certificates of Deposit Account Registry Service) whereby customers can obtain complete FDIC insurance coverage by placing large deposits into smaller-denomination CDs in multiple institutions. The single bank FDIC limits have been permanently increased to $250,000 per eligible account. In addition, the Bank may in the future offer other financial services.
The Bank offers commercial loans to small and medium-sized businesses including secured and unsecured loans to service companies, manufacturers, restaurants, wholesalers, retailers and professionals doing business in the region. Other personal loans include lines of credit, installment loans, overdraft protection and credit cards. Real estate loans made to individuals include home mortgages, home improvement loans, bridge loans and home equity loans and lines of credit. Other loans offered include commercial real estate loans to area businesses. In addition to offering residential real estate mortgage loans for its own portfolio, the Bank also solicits and processes mortgage loan applications from consumers on behalf of permanent investors and originates loans for sale to generate fee income.
Competition
The Bank competes with a variety of financial institutions in its market area. Many have greater financial resources and capitalization, which gives them higher legal lending limits as well as the ability to conduct larger advertising campaigns to attract business. Generally the larger institutions 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 institutions to provide such services. In the future, if the Bank desires to offer trust services, prior approval of the OCC will be required. To attract business in this competitive environment, the Bank relies on local promotional activities and personal contact by officers, directors and shareholders and on its ability to distinguish itself by offering personalized services.
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, a single person or groups of people. The Bank is not dependent on one or a few major customers for either its deposit or lending activities, the loss of any one of which would have a material adverse effect on the business of the Bank.
Residents and businesses in Stamford, Greenwich, Norwalk, Wilton, Darien, Southport, Fairfield, Trumbull, Westport, and Milford Connecticut provide the majority of the Bank’s deposits. The Bank has expanded its footprint by establishing branch offices in the Westchester County, New York towns of Bedford and Scarsdale, as well as a branch in New York City. The Bank has focused its attention on serving the segments of its market area historically served by community banks. The Bank competes in its market by providing a high level of personalized and responsive banking service for which the Bank believes there is a need.
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, New York City and Long Island in New York, although the Bank’s loan business is not necessarily limited to these areas. The Bank’s plans for future lending contemplate the diversification of the portfolio away from its historical emphasis on construction lending. While the Bank does not currently hold or intend to attract significant deposit or loan business from major corporations with headquarters in the its market area, the Bank believes that the service, professional and related businesses which have been attracted to this area, as well as the individuals that reside in this area, represent current and potential customers of the Bank.
In the normal course of business and subject to applicable government regulations, the Bank invests a portion of its assets in investment securities, which may include certain debt and equity securities, including government securities. An objective of the Bank’s investment policy is to maintain a balance of high quality diversified investments to minimize risk while limiting its exposure to interest rate movements and credit risk, as well as maintaining adequate levels of liquidity. The Bank’s investment portfolio is currently comprised primarily of government agency issues.
The Bank’s employees perform most routine day-to-day banking transactions at the Bank. The Bank has entered into a number of arrangements with third parties for banking services such as correspondent banking, check clearing, data processing services, credit card processing and armored car carrier service.
The cities of Stamford and Norwalk and the towns of Greenwich, Wilton, Darien, Southport, Milford, Fairfield, Trumbull, and Westport, CT are presently served by over 242 branches of commercial and savings banks along with 25 in the New York towns of Bedford and Scarsdale. Most of these branches are offices of banks, which have headquarters outside of the states or areas served by the Bank or are subsidiaries of bank or financial holding companies whose headquarters are outside of the areas served by the Bank. In addition to banks with branches in the same areas as the Bank, there are numerous banks and financial institutions serving the communities surrounding these areas, which also draw customers from the cities and towns mentioned above and pose significant competition to the Bank for deposits and loans. Many of those banks and financial institutions are well established and well capitalized.
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 institutions including non-bank competitors. This increase in competition has caused banks and other financial service institutions to diversify their services and become more cost effective. The impact on Bancorp of federal legislation authorizing increased services by financial holding companies and interstate branching of banks has also resulted in increased competition. These events have resulted in increasing homogeneity in the financial services offered by banks and other financial institutions. The impact on banks and other financial institutions of these market dynamics and legislative and regulatory changes has been increased customer awareness of product and service differences among competitors and increased merger activity.
Supervision and Regulation
As a bank holding company, Bancorp’s operations are subject to regulation, supervision and examination by the Board of Governors of the Federal Reserve Board (the “Federal Reserve Board”). The Federal Reserve Board has established capital adequacy guidelines for bank holding companies that are similar to the OCC’s capital guidelines applicable to the Bank. The Bank Holding Company Act of 1956, as amended (the “BHC Act”), 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 to date has had no significant impact on Bancorp.
Under the BHC Act, Bancorp is required to file annually with the Federal Reserve Board a report of its operations. Bancorp, the Bank and any other subsidiaries are subject to examination by the Federal Reserve Board. In addition, Bancorp will be required to obtain the prior approval of the Federal Reserve Board 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, Bancorp, the Bank and any other 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 Bancorp 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 Bancorp wants to engage in businesses permitted to financial holding companies but not to bank holding companies, it would need to register with the Federal Reserve Board as a financial holding company.
The Federal Reserve Board 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 Federal Reserve Board has also indicated that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. Furthermore, under the prompt corrective action regulations adopted by the Federal Reserve Board pursuant to applicable law, the Federal Reserve Board may prohibit a bank holding company from paying any dividends if its bank subsidiary is classified as “undercapitalized.”
A bank holding company is required to give the Federal Reserve Board 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 Federal Reserve Board may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, Federal Reserve Board order, or any condition imposed by, or written agreement with, the Federal Reserve Board.
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, (“Riegle-Neal Act”) was enacted to ease restrictions on interstate banking. Effective September 29, 1995, the Riegle-Neal Act allows the Federal Reserve Board to approve an application of an adequately capitalized and adequately managed bank holding company to acquire control of, or acquire all or substantially all of the assets of, a bank located in a state other than such holding company’s state, without regard to whether the transaction is prohibited by the laws of any state. The Federal Reserve Board may not approve the acquisition of a bank that has not been in existence for the minimum time period (not exceeding five years) specified by the statutory law of the host state. The Riegle-Neal Act also prohibits the Federal Reserve Board from approving an application if the applicant (and its depository institution affiliates) controls or would control more than 10% of the insured deposits in the United States or 30% or more of the deposits in the target bank’s home state or in any state in which the target bank maintains a branch. The Riegle-Neal Act does not affect the authority of states to limit the percentage of total insured deposits in the state which may be held or controlled by a bank or bank holding company to the extent that such limitation does not discriminate against out-of-state banks or bank holding companies. Individual states may also waive the 30% statewide concentration limits contained in the Riegle-Neal Act. The Riegle-Neal Act also allows banks to establish branch offices in other than the bank’s home state if the target state has “opted in” to interstate branching.
Bancorp is subject to capital adequacy rules and guidelines issued by the OCC, the Federal Reserve Board and the Federal Deposit Insurance Corporation (“FDIC”), and the Bank is subject to capital adequacy rules and guidelines issued by the OCC. These substantially identical rules and guidelines require Bancorp to maintain certain minimum ratios of capital to adjusted total assets and/or risk-weighted assets. Under the provisions of the Federal Deposit Insurance Corporation Improvements Act of 1991, the Federal regulatory agencies are required to implement and enforce these rules in a stringent manner. Bancorp 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.
Bancorp 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 Securities and Exchange Commission (the “SEC”). The Bank’s operations are subject to regulation, supervision and examination by the OCC and the FDIC.
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 Federal Reserve System 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 to prevent banks from engaging in unsafe and unsound practices, as well as various other federal and state laws 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 the 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 town with a population of less than 50,000 if another bank is headquartered in the town.
The earnings and growth of Bancorp, the Bank and the banking industry are affected by the monetary and fiscal policies of the United States Government and its agencies, particularly the Federal Reserve Board. The Open Market Committee of the Federal Reserve Board implements national monetary policy to curb inflation and combat recession. The Federal Reserve Board uses its power to adjust interest rates in United States Government securities, the Discount Rate and deposit reserve retention rates. The actions of the Federal Reserve Board 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, Bancorp and the Bank are subject to the Community Reinvestment Act (“CRA”), which requires the federal bank regulatory agencies, when considering certain applications involving Bancorp or the Bank, to consider Bancorp’s and the Bank’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 over unwarranted geographic differences in lending patterns. Existing banks have sought to comply with 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. Bancorp 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.
On October 26, 2001, the United and Strengthening America by Providing Tools Required to Intercept and Obstruct Terrorism Act of 2001, or the USA Patriot Act, was enacted to further strengthen domestic security following the September 11, 2001 attacks. This Act amends 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 Act also requires that financial institutions in the United States 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.
On July 20, 2002, the Sarbanes-Oxley Act of 2002 was enacted, the primary purpose of which is to protect investors through improved corporate governance and responsibilities of, and disclosures by, public companies. The Act contains provisions for the limitations of services that external auditors may provide as well as requirements for the credentials of Audit Committee members. In addition, the principal executive and principal financial officers are required to certify in quarterly and annual reports that they have reviewed the report; and based on the officers’ knowledge, the reports accurately present the financial condition and results of operations of the company and contain no untrue statement or omission of material fact. The officers also certify their responsibility for establishing and maintaining a system of internal controls, which insure that all material information is made known to the officers; this certification also includes the evaluation of the effectiveness of disclosure controls and procedures and their impact upon financial reporting. Section 404 of the Act, 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.
Emergency Economic Stabilization Act of 2008
On October 3, 2008, the Emergency Economic Stabilization Act (“EESA”) was signed into law, which includes the Troubled Asset Relief Program (“TARP”). The legislation was in response to the financial crises affecting the banking system and financial markets. The TARP gave the United States Department of the Treasury (the “Treasury”) authority to deploy up to $700 billion into the financial system with an objective of improving liquidity in the capital markets. This was initially done by infusing billions of dollars into financial and insurance institutions as well as U.S. automakers. Since 2008, the U.S. Department of the Treasury has established several programs under the TARP, including the Financial Stability Program, to further stabilize the financial system, restore the flow of credit to consumers and businesses and tackle the foreclosure crisis to keep millions of Americans in their homes. Since this program began, many banks, large and small have accessed the program. However, due to constraints attendant to participation, many banks have repaid capital received from the government. The Bank did not participate in the TARP program, which is now closed to new entrants.
Temporary Liquidity Guarantee Program
On November 21, 2008, the FDIC adopted the Final Rule implementing the Temporary Liquidity Guarantee Program (“TLGP”) inaugurated October 14, 2008. The TLGP consists of two basic components: (1) the Debt Guarantee Program which guarantees newly issued senior unsecured debt of banks, thrifts, and certain holding companies and (2) the Transaction Account Guarantee Program which guarantees certain non-interest bearing deposit transaction accounts, such as business payroll accounts, regardless of dollar amount. The purpose of the TLGP was to provide an initiative to counter the system-wide crisis in the nation’s financial sector by promoting financial stability by preserving confidence in the banking system and encouraging liquidity in order to ease lending to creditworthy businesses and consumers.
Patriot National Bank participated in the FDIC Transaction Account Guarantee Program which guaranteed full coverage on certain noninterest-bearing deposit transaction accounts, such as business accounts, until the expiration date of the program on December 31, 2010. Effective December 31, 2010 through December 31, 2012. The Board of Directors of the FDIC implemented a new final rule under section 343 of the Dodd-Frank Wall Street Reform and Consumer Protection Act that provides temporary unlimited coverage in addition to, and separate from, the coverage of at least $250,000 available to depositors of noninterest-bearing transaction accounts, under the FDIC’s general rules. The term “noninterest-bearing transaction account” includes a traditional checking account or demand deposit account on which the Bank pays no interest. It also includes Interest on Lawyer Trust Accounts (“IOLTAs”). It does not include other accounts, such as Traditional checking or demand deposit accounts that may earn interest, NOW accounts or money market deposit accounts. Bancorp did not participate in the Debt Guarantee portion of the TLGP.
Helping Families Save Their Homes Act of 2009
The Helping Families Save Their Homes Act of 2009 became effective May 20, 2009. This act was a step towards stabilizing and reforming the United States financial and housing markets by helping American homeowners and increasing the flow of credit. It expands the reach of the Making Home Affordable Program (a TARP initiative) with an emphasis on reducing foreclosures. The act also contains provisions to help restore and support the flow of credit by increasing the borrowing authority of the FDIC and the National Credit Union Administration as well as extending the temporary increase in deposit insurance. The increase in deposit insurance may provide additional confidence to depositors and allow depository institutions to better maintain this source of funding.
Real Estate Settlement Procedures Act
The U.S. Department of Housing and Urban Development (“HUD”) issued a final rule effective January 1, 2010 that implements significant changes to the Real Estate Settlement Procedures Act (“RESPA”). The new rules require a standard form of Good Faith Estimate to disclose key terms and closing costs, including items such as the loan term, fixed or adjustable interest rate, prepayment penalty, total closing cost and cost of homeowners insurance. Additionally, changes to the settlement statement are also required and will allow borrowers to compare their final closing costs and loan terms against their good faith estimate. There are also limitations on third-party costs and a 30 day window from the date of closing to correct any errors or violations and reimburse the borrower for any overcharges.
Regulation E, Electronic Fund Transfers
The Board of Governors of the FRB amended Regulation E, Electronic Fund Transfers. The final rules, announced November 12, 2009, prohibit affected financial institutions from charging consumers fees for paying overdrafts on automated teller machine (“ATM”) and one-time debit card transactions, unless a consumer consents, or opts in, to the overdraft service for those types of transactions. The mandatory compliance date was July 1, 2010.
Bancorp does not anticipate that compliance with applicable federal and state banking laws will have a material adverse effect on its business or the business of the Bank. Neither Bancorp nor the Bank has any material patents, trademarks, licenses, franchises, concessions and royalty agreements or labor contracts, other than the charter granted to the Bank by the OCC.
Recent Legislative Developments
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Act”) was signed into law on July 21, 2010. The Act is a significant piece of legislation that has had a major impact on the financial services industry, including the organization, financial condition and operations of banks and bank holding companies. Management is currently evaluating the impact of the Act; however, uncertainty remains as to its operational impact, which could have a material adverse impact on the Company’s business, results of operations and financial condition. Many of the provisions of the Act are aimed at financial institutions that are significantly larger than the Company and the Bank. Notwithstanding this, there are many other provisions that the Company and the Bank are subject to and will have to comply with, including any new rules applicable to the Company and the Bank promulgated by the Bureau of Consumer Financial Protection, a new regulatory body dedicated to consumer protection. As rules and regulations are promulgated by the agencies responsible for implementing and enforcing the Act, the Company and the Bank will have to address each to ensure compliance with applicable provisions of the Act and compliance costs are expected to increase.
The Dodd-Frank Act broadens the base for Federal Deposit Insurance Corporation 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. This did not have a material impact on the Company.
On June 28, 2011, the Federal Reserve Board approved a final debit-card interchange rule. This primarily impacts larger banks and should not have a material impact on the Company.
It is difficult to predict at this time what specific impact the Dodd-Frank Act and the yet to be written implementing rules and regulations will have on the Company. The financial reform legislation and any implementing rules that are ultimately issued could have adverse implications on the financial industry, the competitive environment, and our ability to conduct business. Management will have to apply resources to ensure compliance with all applicable provisions of the Dodd-Frank Act and any implementing rules, which may increase our costs of operations and adversely impact our earnings.
In February 2009 the Bank entered into a formal written agreement (the “Agreement”) with the Office of the Comptroller of the Currency. Under the terms of the Agreement, the Bank has appointed a Compliance Committee of outside directors and the Chief Executive Officer. The Committee must report quarterly to the Board of Directors and to the OCC on the Bank’s progress in complying with the Agreement. The Agreement requires the Bank to review, adopt and implement a number of policies and programs related to credit and operational issues. The Agreement further provides limitations on the acceptance of certain brokered deposits and the extension of credit to borrowers whose loans are criticized. The Bank may pay dividends during the term of the Agreement only with prior written permission from the OCC. The Agreement also requires that the Bank develop and implement a three-year capital plan. The Bank has taken or put into process many of the steps required by the Agreement, and does not anticipate that the restrictions included within the Agreement will impair its current business plan.
In June 2010 the company entered into a formal written agreement (the “Reserve Bank Agreement”) with the Federal Reserve Bank of New York (the “Reserve Bank”). Under the terms of the Reserve Bank Agreement, the Board of Directors of the Company are required to take appropriate steps to fully utilize the Company’s financial and managerial resources to serve as a source of strength to the Bank including taking steps to insure that the Bank complies with the Agreement with the OCC. The Reserve Bank Agreement requires the Company to submit, adopt and implement a capital plan that is acceptable to the Reserve Bank. The Company must also report to the Reserve Bank quarterly on the Company’s progress in complying with the Reserve Bank Agreement. The Agreement further provides for certain restrictions on the payment or receipt of dividends, distributions of interest or principal on subordinate debentures or trust preferred securities and the Company’s ability to incur debt or to purchase or redeem its stock without the prior written approval of the Reserve Bank. The Company has taken or put into process many of the steps required by the Reserve Bank Agreement, and does not anticipate that the restrictions included within the Reserve Bank Agreement will impair its current business plan.
Available Information
Our website address is http://www.pnbdirectonline.com; however, information found on, or that can be accessed through, our website is not incorporated by reference into this Form 10-K. Bancorp makes available free of charge on our website (under the links entitled “For Investors”, then “SEC filings” and then “Documents”), our annual report on Form 10-K, our quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements on Schedule 14A, and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934 as soon as practicable after we electronically file such reports with or furnish it to the SEC. Because Bancorp 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, NE, Washington, DC 20549. Information about the Public Reference Room can be obtained by calling 1-800-SEC-0330.
Employees
As of December 31, 2011, Bancorp had 132 full-time employees and 4 part-time employees. None of the employees of Bancorp is covered by a collective bargaining agreement.
Item 1A.
Item 1A. Risk Factors
The risks involved in Bancorp’s construction and commercial real estate loan portfolios are material.
Bancorp’s commercial real estate loan portfolio constitutes a material portion of the Bank’s assets and generally has more risk 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 as have been experienced in Bancorp’s market area. The downturn in the real estate market within Bancorp’s market area has, and may continue to, adversely impact the value of properties securing these loans.
Real estate lending in Bancorp’s core Fairfield County, Connecticut 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 the real estate is located. A significant portion of Bancorp’s total loan portfolio is secured by real estate located in Fairfield County, Connecticut and New York City, Long Island and Westchester County, New York, areas historically of high affluence that have been materially impacted by the financial troubles experienced by large financial service companies on Wall Street and other companies in recent years. Credit markets have become tight 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 losses.
Bancorp’s business is subject to various lending and other economic risks that could adversely impact Bancorp’s 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 hurt Bancorp’s financial performance. A further deterioration in economic conditions, in particular an economic slowdown within Fairfield County, Connecticut and/or the New York metropolitan area, could result in the following consequences, any of which may hurt the business of Bancorp materially: loan delinquencies may increase; problem assets and foreclosures may increase; demand for the Bank’s products and services may decline; and assets and collateral associated with the Bank’s loans, especially real estate, may decline in value, thereby reducing a customer’s borrowing power. During the years 2007 through 2009, the general economic conditions and specific business conditions in the United States including Fairfield County, Connecticut 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 and 2011, the economic climate improved marginally resulting in decreases in the Bank’s non-performing assets. A prolonged period of economic recession or worsening of these adverse economic conditions may have a materially adverse effect on our results of operations and financial condition.
Bancorp is Subject to a Formal Agreement with the OCC and the Federal Reserve Bank of New York.
The Bank is subject to a formal agreement with the OCC entered into in February 2009. The agreement provides for, among other things, the enhancement and implementation of certain programs to reduce the Bank’s credit risk, commercial real estate loan concentration and the level of criticized assets, along with the augmentation of a profit plan and three-year capital program. Additionally, the agreement provides for certain asset growth restrictions for a limited period of time. The Bank does not anticipate that these restrictions will impair its current business plan. However, failure to comply with the provisions of the agreement could result in more severe enforcement actions and further restrictions.
In June 2010 the Company entered into a formal written agreement (the “Reserve Bank Agreement”) with the Federal Reserve Bank of New York (the “Reserve Bank”). Under the terms of the Reserve Bank Agreement, the Board of Directors of the Company are required to take appropriate steps to fully utilize the Company’s financial and managerial resources to serve as a source of strength to the Bank including taking steps to insure that the Bank complies with the agreement with the OCC. The Reserve Bank Agreement requires the Company to submit, adopt and implement a capital plan that is acceptable to the Reserve Bank. The Company must also report to the Reserve Bank quarterly on the Company’s progress in complying with the Reserve Bank Agreement. The Agreement further provides for certain restrictions on the payment or receipt of dividends, distributions of interest or principal on subordinate debentures or trust preferred securities and the Company’s ability to incur debt or to purchase or redeem its stock without the prior written approval of the Reserve Bank. The Company has taken or put into process many of the steps required by the Reserve Bank Agreement, and does not anticipate that the restrictions included within the Reserve Bank Agreement will impair its current business plan.
Bancorp’s allowance for loan losses may not be adequate to cover actual losses.
Like all financial institutions, the Bank maintains an allowance for loan losses to provide for loan defaults and non-performance. The allowance for loan 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 will have an adverse effect on borrowers’ capacity to repay timely their obligations before risk grades could reflect those changing conditions.
The previous adverse changes in economic and market conditions in the Bank’s market areas increase the risk that the allowance will become inadequate if borrowers continue to experience economic and other conditions adverse to their incomes and businesses. Maintaining the adequacy of the Bank’s allowance for loan 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 these losses may exceed current estimates. The current economic environment is 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 loans and assess the adequacy of the allowance for loan losses. The regulatory agencies may require us to change classifications or grades on loans, increase the allowance for loan losses with additional provisions for loan losses and to recognize further loan charge-offs based upon their judgments, which may differ from ours. Any increase in the allowance for loan losses required by these regulatory agencies could have a negative effect on our results of operations and financial condition. During 2009, the Bank significantly increased its allowance for loan losses based on management’s evaluation of the current economic crisis and its impact on the real estate market in the Bank’s market area. During 2010, the Bank’s allowance for loan losses remained comparatively constant based on management’s current assessment. During 2011, the Bank significantly reduced the amount of non-performing loans with the bulk sale of non-performing assets. While management believes that the allowance for loan losses is currently adequate to cover inherent losses, further loan deterioration could occur and therefore management cannot assure shareholders that there will not be a need to increase the allowance for loan losses or that the regulators will not require management to increase this allowance. Either of these occurrences could materially and adversely affect Bancorp’s earnings and profitability.
Bancorp is subject to certain risks with respect to liquidity.
“Liquidity” refers to our ability to generate sufficient cash flows to support our operations and to fulfill our obligations, including commitments to originate loans, to repay our wholesale borrowings and other liabilities, and to satisfy the withdrawal of deposits by our customers.
Our primary sources of liquidity are the deposits we acquire organically through our branch network, borrowed funds, primarily in the form of wholesale borrowings; the cash flows generated through the repayment of loans and securities; and the cash flows from the sale of loans and securities. In addition, and depending on current market conditions, we may have the ability to access the capital markets from time to time.
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 we serve. Furthermore, changes to the underwriting guidelines for wholesale borrowings or lending policies may limit or restrict our ability to borrow, and could therefore have a significant adverse impact on our liquidity. A decline in available funding could adversely impact our ability to originate loans, invest in securities, and meet our expenses, or to fulfill such obligations as repaying our borrowings or meeting deposit withdrawal demands.
Bancorp’s business is subject to interest rate risk and variations in interest rates may negatively affect Bancorp’s financial performance.
Bancorp is unable to predict 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 Bancorp’s profits. Bancorp 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. Like most financial institutions, Bancorp is affected by changes in interest rates, which are currently at record low levels, and by other economic factors beyond Bancorp’s control. Although Bancorp 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 Bancorp’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.
Mortgage brokerage activity is also affected by interest rate fluctuations. Generally, increases in interest rates often lead to decreases in home refinancing activity, thus reducing the number of mortgage loans that Bancorp originates.
Bancorp’s investment portfolio includes securities which are sensitive to interest rates and variations in interest rates may adversely impact Bancorp’s profitability.
Bancorp’s security portfolio is classified as available-for-sale, and is comprised primarily of debt and mortgage-backed securities, which are insured or guaranteed by U.S. government agencies, and corporate bonds. These securities are sensitive to interest rate fluctuations. Unrealized gains or losses in the available-for-sale portfolio for 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 maturity, or until payments are received on mortgage-backed securities, or until market conditions are favorable for a sale, could adversely affect Bancorp’s earnings and profitability.
Bancorp is dependent on its 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.
Bancorp’s success is dependent upon the continued services and skills of its management team. The unexpected loss of services of one or more of these key personnel, without experienced and suitable replacements could have an adverse impact on Bancorp’s business because of their skills, knowledge of Bancorp’s market, years of industry experience and the difficulty of promptly finding qualified replacement personnel.
Bancorp’s success also depends, in part, on its continued ability to attract and retain experienced commercial lenders and residential mortgage originators, as well as other management personnel. The loss of the services of several of such key personnel could adversely affect Bancorp’s growth and prospects to the extent it is unable to quickly replace such personnel. Competition for commercial lenders and residential mortgage originators is strong within the commercial banking and mortgage banking industries, and Bancorp may not be successful in retaining or attracting personnel.
A breach of information security could negatively affect Bancorp’s earnings.
Bancorp increasingly depends upon data processing, communications and information exchange on a variety of computing platforms and networks, and over the internet to conduct its business. Bancorp cannot be certain that all of its systems are entirely free from vulnerability to attack, despite safeguards it has instituted. In addition, Bancorp 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; this could result in financial loss or costs to Bancorp or damages to others. These costs or losses could materially exceed the amount of insurance coverage, if any, which would have an adverse effect on Bancorp’s results of operations and financial condition. In addition, the Bank’s reputation could be harmed, which also could materially adversely affect Bancorp’s financial condition and results of operation.
We are subject to environmental liability risk associated with our lending activities.
A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we 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. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. In addition, we own and operate certain properties that may be subject to similar environmental liability risks.
Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our 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 our exposure to environmental liability. Although we have policies and procedures requiring the performance of an environmental site assessment before 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 our financial condition and results of operations.
Our business may be adversely impacted by acts of war or terrorism.
Acts of war or terrorism could have a significant adverse impact on our ability to conduct our business. Such events could affect the ability of our borrowers to repay their loans, could impair the value of the collateral securing our loans, and could cause significant property damage, thus increasing our expenses and/or reducing our revenues. In addition, such events could affect the ability of our depositors to maintain their deposits with the Bank. Although we have established disaster recovery policies and procedures, the occurrence of any such event could have a material adverse effect on our business which, in turn, could have a material adverse effect on our financial condition and results of operations.
We rely on the dividends we receive from our subsidiary.
Bancorp is a separate and distinct legal entity from the Bank, and all of the revenues Bancorp receives consist of dividends from the Bank. These dividends are the primary funding source for the interest and principal payments on our debt. Various federal and state laws and regulations limit the amount of dividends that a bank may pay to its parent company. In addition, our right to participate in a distribution of assets upon the liquidation or reorganization of a subsidiary may be subject to the prior claims of the subsidiary’s creditors. If the Bank is unable to pay dividends to Bancorp, we may not be able to pay our obligations. The inability to receive dividends from the Bank could therefore have a material adverse effect on our business, our financial condition, and our results of operations, as well as our ability to maintain or increase the current level of cash dividends paid to our shareholders. Beginning in the second quarter of 2009, the Company began deferring interest payments on the subordinated debentures as permitted under the terms of the debentures. The deferral in the fourth quarter of 2011 represented the eleventh consecutive quarter of deferral. The Company continues to accrue and charge interest to operations. The Company may only defer the payment of interest for 20 consecutive quarters, until March 2014, and all accrued interest must be paid prior to or at completion of the deferral period.
The price of our common stock may fluctuate.
The market price of our common stock could be subject to significant fluctuations due to changes in sentiment in the market regarding our operations or business prospects. Among other factors, these risks may be affected by:
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operating results that vary from the expectations of our management or of securities analysts and investors;
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developments in our business or in the financial services sector generally;
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regulatory or legislative changes affecting our industry generally or our business and operations;
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operating and securities price performance of companies that investors consider to be comparable to us;
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changes in estimates or recommendations by securities analysts or rating agencies;
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announcements of strategic developments, acquisitions, dispositions, financings, and other material events by us or our competitors; and
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changes or volatility in global financial markets and economies, general market conditions, interest or foreign exchange rates, stock, commodity, credit, or asset valuations.
Furthermore, given recent and ongoing market and economic conditions, the market price of our common stock may be subject to further significant market fluctuations. The effects of the recession that began in the second half of 2007 has continued to have an adverse impact on real estate values; in addition, foreclosure filings are increasing and unemployment remains atypically high. These factors have negatively affected the credit performance of mortgage and other loans, and resulted in significant write-downs of asset values by financial institutions. The resulting economic pressure on property owners and other borrowers, and the lack of confidence in the financial markets in general, has adversely affected, and may continue to adversely affect, our business and results of operations.
In addition, stock markets around the world have experienced significant price and trading volume volatility, with shares of financial services firms being adversely impacted, in particular. While the U.S. and other governments continue to take action to restore confidence in the financial markets and to promote job creation and economic growth, continued or further market and economic turmoil could occur in the near or long term, which could negatively affect our business, financial condition and results of operations, and volatility in the price and trading volume of our common stock.
Difficult market conditions have adversely affected Bancorp’s industry.
Bancorp is exposed to downturns in the U.S. economy, and particularly the local markets in which it operates in Connecticut and New York. Declines in the housing market with falling home prices and increasing foreclosures, unemployment and under-employment, have negatively impacted the credit performance of mortgage and construction loans and resulted in significant write-downs of asset values by financial institutions, including government-sponsored enterprises as well as major commercial and investment banks. These write-downs have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. Many lenders and institutional investors have reduced or ceased providing funding to borrowers, including other financial institutions. This market turmoil and the tightening of credit have 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 Bancorp’s business, financial condition and results of operations. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and other financial institutions. In particular:
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Economic conditions may continue to affect market confidence levels and may cause adverse changes in payment patterns, causing increases in delinquencies, which could affect our charge-offs and provision for loan losses.
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The ability to assess the creditworthiness of the Bank’s customers or to estimate the values of collateral for loans may be impaired if the models and approaches we use become less predictive of future behaviors, valuations, assumptions or estimates due to the unpredictable economic climate.
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Increasing consolidation of financial services companies as a result of current market conditions could have unexpected adverse effects upon our ability to compete effectively.
We may be required to pay significantly higher FDIC premiums, special assessments, or taxes that could adversely affect our earnings.
Market developments have significantly impacted the insurance fund of the FDIC. As a result, we may be required to pay higher premiums or additional special assessments or taxes that could adversely affect our earnings. We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance. If there are additional banks or financial institution failures, we may be required to pay even higher FDIC premiums than are currently assessed. These increases and any future increases or required prepayments in FDIC insurance premiums or taxes may materially adversely affect our results of operations.
We are subject to risks associated with taxation.
The amount of income taxes we are required to pay on our earnings is based on federal and state legislation and regulations. We provide for current and deferred taxes in our financial statements, based on our results of operations, business activity, legal structure, interpretation of tax statutes, assessment of risk of adjustment upon audit, and application of financial accounting standards. We may take tax return filing positions for which the final determination of tax is uncertain. Our net income and earnings per share may be reduced if a federal, state, or local authority assesses additional taxes that have not been provided for in our consolidated financial statements. There can be no assurance that we will achieve our anticipated effective tax rate either due to a change to tax law, a change in regulatory or judicial guidance, or an audit assessment which denies previously recognized tax benefits.
Risks associated with changes in technology.
Financial products and services have become increasingly technology-driven. Our ability to meet the needs of our customers competitively, and in a cost-efficient manner, is dependent on our ability to keep pace with technological advances and to invest in new technology as it becomes available. Many of our competitors have greater resources to invest in technology than we do and may be better equipped to market new technology-driven products and services. The ability to keep pace with technological change is important, and the failure to do so on our part could have a material adverse impact on our business and therefore on our financial condition and results of operations.
Strong competition within Bancorp’s market area may limit the growth and profitability of the Company.
Competition in the banking and financial services industry is intense. The 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 Bancorp’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 Bancorp and may offer certain services that Bancorp does not or cannot provide. Price competition for loans and deposits might result in the Bank earning less on its loans and paying more for deposits, which reduces net interest income. Bancorp expects competition to increase in the future as a result of legislative, regulatory and technological changes. Bancorp’s profitability depends upon its continued ability to successfully compete in its market area.
Government regulation may have an adverse effect on Bancorp’s profitability and growth.
Bancorp is subject to extensive regulation, supervision and examination by the Office of the Comptroller of the Currency as the Bank’s chartering authority, by the FDIC, as insurer of its deposits, and by the Federal Reserve Board as regulator of Bancorp. Changes in state and federal banking laws and regulations or in federal monetary policies could adversely affect the Bank’s ability to maintain profitability and continue to grow and, in light of recent economic conditions, such changes are expected but cannot be predicted. For example, new legislation or regulation could limit the manner in which Bancorp may conduct its business, including the Bank’s ability to obtain financing, attract deposits, make loans and achieve satisfactory interest spreads. One proposal that was passed implemented a new federal agency devoted to the rights of consumers that would regulate banks on a parallel track with banking regulatory authorities. The laws, regulations, interpretations and enforcement policies that apply to Bancorp have been subject to significant, and sometimes retroactively applied, changes in recent years, and are likely to change significantly in the future.
Legislation proposing significant structural reforms to the financial services industry considered in the U.S. Congress has, among other things, created the Consumer Financial Protection Bureau, which gives broad authority to regulate financial service providers and financial products. In addition, the Federal Reserve Bank has passed guidance on incentive compensation at the banking organizations it regulates and the United States Department of the Treasury and the federal banking regulators have issued statements calling for higher capital and liquidity requirements for banking organizations. Complying with any new legislative or regulatory requirements, and any programs established there under by federal and state governments to address the current economic crisis, could have an adverse impact on our results of operations and our ability to fill positions with the most qualified candidates available.
Changing regulation of corporate governance and public disclosure.
Laws, regulations and standards relating to corporate governance and public disclosure, SEC regulations and NASDAQ rules, have added to the responsibilities that companies, such as Bancorp, have. These laws, regulations and standards are subject to varying interpretations, and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies, which could make compliance more difficult and result in higher costs. Bancorp is committed to maintaining high standards of corporate governance and public disclosure. As a result, Bancorp’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 time and attention from revenue-generating activities to compliance activities. Bancorp’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, Bancorp’s operations and profitability are impacted by general business and economic conditions in the United States and abroad. These conditions include short-term and long-term interest rates, inflation, money supply, political issues, legislative and regulatory changes and the strength of the U.S. economy and the local economies in which we operate, all of which are beyond Bancorp’s control. In recent years, the banking world has experienced unprecedented upheaval, including the failure of some of the leading financial institutions in 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 Bancorp’s results of operations and financial condition and for which Bancorp cannot currently predict or implement plans to combat.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
Patriot National Bancorp Inc.’s corporate headquarters and main branch banking office is located at 900 Bedford Street in Stamford, Connecticut. The building is leased by the Bank, as are its fifteen other branch banking offices, one loan origination office and additional administrative and operational office space. The Bank also leases space at its main office for additional parking. Lease commencement dates for office locations range from April 2003 to July 2011 and lease expiration dates fall between August 2012 and July 2017. Most of the leases contain rent escalation provisions, as well as renewal options for one or more periods.
The Bank has sublet and licensed excess space in one of its locations to an attorney and an independent company. See also “Item 12. Certain Relationships and Related Transactions.” For additional information regarding the Bank’s lease obligations, see Note 9 to the Consolidated Financial Statements.
All leased properties are in good condition.
Item 3.
Item 3. Legal Proceedings
Neither Bancorp nor the Bank has any pending legal proceedings, other than ordinary routine litigation incidental to its business, to which Bancorp or the Bank is a party or any of its property is subject.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
Market Information
Bancorp Common Stock is traded on the NASDAQ Global Market under the Symbol “PNBK.” On December 31, 2011, the last sale price for Bancorp Common Stock on the NASDAQ Global Market was $1.75.
The following table sets forth the high and low sales price and dividends per share of Bancorp Common Stock for the last two fiscal years for each quarter as reported on the NASDAQ Global Market.
Holders
There were approximately 581 shareholders of record of Bancorp Common Stock as of December 31, 2011. This number does not reflect the number of persons or entities holding stock in nominee name through banks, brokerage firms or other nominees.
Dividends
Bancorp’s ability to pay dividends is dependent on the Bank’s ability to pay dividends to Bancorp. Pursuant to the February 9, 2009 Agreement between the Bank and the Office of the Comptroller of the Currency, the Bank can pay dividends to Bancorp only 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 Agreement, certain other restrictions exist regarding the ability of the Bank to transfer funds to Bancorp in the form of cash dividends, loans or advances. The approval of the Comptroller of the Currency is required to pay dividends in excess of the Bank’s earnings retained in the current year plus retained net earnings for the preceding two years. As of December 31, 2011, the Bank had no retained earnings available for distribution to Bancorp as dividends. The Bank is also prohibited from paying dividends that would reduce its capital ratios below minimum regulatory requirements. The Federal Reserve Bank has imposed further dividend restrictions on Bancorp.
Recent Sales of Unregistered Securities
During the fourth quarter of 2011, Bancorp did not have any sales of unregistered securities.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
None.
Securities Authorized for Issuance under Equity Compensation Plans
As of December 31, 2011, Bancorp did not have any securities authorized for issuance under equity compensation plans. In December 2011, the Board of Directors approved the Company’s 2012 Stock Plan, authorizing 3,000,000 shares to be issued. No awards were granted in 2011.
Performance Graph
The performance graph compares the yearly percentage change in Bancorp’s cumulative total shareholder return on its common stock over the last five fiscal years to the cumulative total return of the S&P 500 Index and the NASDAQ Bank 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 difference between Bancorp’s share price at the end and the beginning of the measurement period, by the share price at the beginning of the measurement period.
Item 6.
Item 6. Selected Financial Data
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation
Critical Accounting Policies
Bancorp’s significant accounting policies are described in Note 1 to the Consolidated Financial Statements included in this 2011 Annual Report on Form 10-K. The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and to disclose contingent assets and liabilities. Actual results could differ from those estimates. Management has identified accounting for the allowance for loan losses, the analysis and valuation of its investment securities, and the valuation of deferred tax assets, as Bancorp’s most critical accounting policies and estimates in that they are important to the portrayal of Bancorp’s financial condition and results. They require management’s most subjective and complex judgment as a result of the need to make estimates about the effect of matters that are inherently uncertain.
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
The allowance consists of allocated and general components. The allocated component relates to loans that are considered impaired. For such impaired loans, an allowance is established when the discounted cash flows (or collateral value if the loan is collateral dependent or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers all other loans, segregated generally by loan type, and is based on historical loss experience with adjustments for qualitative factors which are made after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss data. In addition, a risk rating system is utilized to evaluate the general component of the allowance for loan losses. Under this system, management assigns risk ratings between one and nine. Risk ratings are assigned based upon the recommendations of the credit analyst and the originating loan officer and confirmed by the Loan Committee at the initiation of the 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.
The Company provides for loan losses based on the consistent application of our documented allowance for loan loss methodology. Loan losses are charged to the allowance for loans losses and recoveries are credited to it. Additions to the allowance for loan losses are provided by charges against income based on various factors which, in our judgment, deserve current recognition in estimating probable losses. Loan losses are charged-off in the period the loans, or portion thereof, are deemed uncollectible. Generally, the Company 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 cost to sell, for collateral dependent loans. The Company regularly reviews the loan portfolio and makes adjustments for loan losses in order to maintain the allowance for loan losses in accordance with U.S. generally accepted accounting principles. The allowance for loan losses consists primarily of the following two components:
(1) Allowances are established for impaired loans (generally defined by the Company as non-accrual loans). The amount of impairment provided for as an allowance is represented by the deficiency, if any, between the present value of expected future cash flows discounted at the original loan’s 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 impairment losses 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 similar risk characteristics, primarily loan type, loan-to-value, if collateral dependent, and internal risk ratings. Management applies an estimated loss rate to each loan group. The loss rates applied are based on the Company’s cumulative prior three year loss experience adjusted, as appropriate, for the environmental factors discussed below. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revisions based upon changes in economic and real estate market conditions. Actual loan losses may be more or less than the allowance for loan losses management has established, which could have an effect on the Company’s financial results.
The adjustments to the Company’s loss experience are based on Management’s evaluation of several environmental factors, including:
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Changes in local, regional, national and international economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments;
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Changes in the nature and volume of the portfolio and in the terms of the loans;
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Changes in the experience, ability, and depth of lending management and other relevant staff;
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Changes in the volume and severity of past due loans, the volume of nonaccrual loans, and the volume and severity of adversely classified or graded loans;
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Changes in the quality of the loan review system;
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Changes in the value of the underlying collateral for collateral-dependent loans;
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The existence and effect of any concentrations of credit, and changes in the level of such concentrations; and
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The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the existing portfolio.
In evaluating the estimated loss factors to be utilized for each loan group, management also reviews actual loss history over an extended period of time as reported by the OCC and FDIC for institutions both in the Company’s market area and nationally for periods that are believed to have experienced similar economic conditions.
In underwriting a loan secured by real property, we require an appraisal of the property by an independent licensed appraiser approved by the Company’s Board of Directors. For loans in excess of $2.5 million, the appraisal is subject to review by an independent third party hired by the Company. Management reviews and inspects properties before disbursement of funds during the term of a construction loan. Generally, management obtains updated appraisals when a loan is deemed impaired and if a construction loan, within 120 days prior to the scheduled maturity date. These appraisals may be more limited than those prepared for the underwriting of a new loan. All appraisals are also reviewed by qualified parties independent from the firm preparing the appraisals.
Management evaluates the allowance for loan losses based on the combined total of the impaired and general components. Generally, when the loan portfolio increases, absent other factors, the allowance for loan loss methodology results in a higher dollar amount of estimated probable losses. Conversely, when the loan portfolio decreases, absent other factors, the allowance for loan loss methodology results in a lower dollar amount of estimated probable losses.
Each quarter management evaluates the allowance for loan losses and adjust the allowance as appropriate through a provision for loan losses. While the Company uses the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the information used in making the evaluations. In addition, as an integral part of their examination process, the Office of the Comptroller of the Currency will periodically review the allowance for loan losses. The OCC may require the Company to adjust the allowance based on their analysis of information available to them at the time of their examination.
Fair Value Measurements
Bancorp uses fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. 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 settlement of the asset or liability. Fair value measurements focus on exit prices in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment.
The Company’s fair value measurements are classified into a fair value hierarchy based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. The three categories within the hierarchy are as follows:
• Level 1 Inputs-Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
• Level 2 Inputs-Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.
• Level 3 Inputs-Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.
The asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lower level of any input that is significant to the fair value measurement. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs.
Bancorp performs a quarterly analysis of those securities that are in an unrealized loss position to determine if those losses qualify as other-than-temporary impairments. This analysis considers the following criteria in its determination: the ability of the issuer to meet its obligations, the impairment due to a deterioration in credit, management’s plans and ability to maintain its investment in the security, the length of time and the amount by which the security has been in a loss position, the interest rate environment, the general economic environment and prospects or projections for improvement or deterioration.
Management has made the determination that none of the Bank’s investment securities are other-than-temporarily impaired at December 31, 2011, and no impairment charges were recorded during the year ended December 31, 2011.
Income taxes
The Company recognizes income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and loss carry forwards. Deferred tax assets and liabilities 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 deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. 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.
The Company 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 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.
The periods subject to examination for the Company’s Federal returns are the tax years 2006 through 2011. The periods subject to examination for the Company’s significant state return, which is Connecticut, are the tax years 2008 through 2011. The Company believes that its income tax filing positions and deductions will be sustained upon examination and does not anticipate any adjustments that will result in a material change in its financial statements. As a result, no reserve for uncertain income tax positions has been recorded.
The Company’s policy for recording interest and penalties related to uncertain tax positions is to record such items as part of its provision for federal and state income taxes.
Recent Economic Developments
There have been significant and historical disruptions in the financial system during the past few years and many lenders and financial institutions have reduced or ceased to provide funding to borrowers, including other lending institutions. The availability of credit, confidence in the entire financial sector, and volatility in financial markets has been adversely affected. The Federal Reserve Bank has been providing vast amounts of liquidity into the banking system to compensate for weaknesses in short-term borrowing markets and other capital markets.
The Federal Deposit Insurance Corporation (FDIC) insures deposits at FDIC-insured financial institutions up to certain limits. The FDIC charges insured financial institutions premiums to maintain the Deposit Insurance Fund. Based on the Bank’s current capital classification, a higher level of FDIC insurance premiums is assessed. In addition, the Bank paid a special assessment of $453,500 in the second quarter of 2009. Special assessments were levied on all financial institutions.
Patriot National Bank participated in the FDIC Transaction Account Guarantee Program which guaranteed full coverage on certain noninterest-bearing deposit transaction accounts, such as business accounts, until the expiration date of the program on December 31, 2010. Effective December 31, 2010 through December 31, 2012. The Board of Directors of the FDIC implemented a new final rule under section 343 of the Dodd-Frank Wall Street Reform and Consumer Protection Act that provides temporary unlimited coverage in addition to, and separate from, the coverage of at least $250,000 available to depositors of noninterest-bearing transaction accounts, under the FDIC’s general rules. The term “noninterest-bearing transaction account” includes a traditional checking account or demand deposit account on which the Bank pays no interest. It also includes Interest on Lawyer Trust Accounts (“IOLTAs”). It does not include other accounts, such as traditional checking or demand deposit accounts that may earn interest, NOW accounts or money market deposit accounts. The Company did not participate in the Debt Guarantee portion of the TLGP.
Summary
In a year of continued economic uncertainty, Bancorp reported a net loss of $15.5 million ($0.40 loss per share) for 2011 compared to a net loss of $15.4 million ($1.30 loss per share) for 2010. This is primarily the result of a $6.0 million adjustment to the provision for loan losses due to the bulk sale of $66.8 million of non-performing assets in the first quarter, and $3.0 million of restructuring charges and asset disposals recorded in the second quarter. Total assets ended the year at $665.8 million, which represents a decrease of $118.5 million from 2010. Management strategically planned for a reduction in assets in 2011, as part of the Company’s turnaround plan, to reduce exposures in certain loan concentrations and to maintain regulatory capital ratios.
Net interest income for the year ended December 31, 2011 decreased $2.3 million, or 10%, to $19.8 million as compared to $22.1 million for the year ended December 31, 2010. This is the result of a reduced level of average earning assets and the lower interest rate environment.
Total assets decreased 15% during the year as the loan portfolio decreased $33.3 million from $534.5 million at December 31, 2010 to $501.2 million at December 31, 2011. The available-for-sale securities portfolio increased $25.9 million, or 64%, to $66.5 million at December 31, 2011 as compared to $40.6 million at December 31, 2010. Total deposits decreased $101.9 million from $646.8 million at December 31, 2010 to $544.9 million at December 31, 2011. This is reflective of management’s pricing strategy to lower the cost of funds and reduce the reliance on higher cost funding products. FHLB advances are unchanged from December 31, 2010. Shareholders’ equity decreased $16.7 million from $67.2 million at December 31, 2010 as compared to $50.5 million at December 31, 2011. This is the result of the net loss of $15.5 million and the $1.2 million reduction of accumulated other comprehensive income.
FINANCIAL CONDITION
Assets
Bancorp’s total assets decreased $118.5 million, or 15%, from $784.3 million at December 31, 2010 to $665.8 million at December 31, 2011 as the Bank reduced its concentration in high risk loan products as construction loans and commercial real estate loans were reduced by $51.6 million and $13.2 million respectively. Cash and due from banks decreased $81.6 million compared to December 31, 2010. This decrease is primarily a result of a decrease in high cost deposits. The decrease in cash was used to fund new loan growth and the purchases of available for sale securities.
Investments
The following table is a summary of Bancorp’s investment portfolio at fair value at December 31 for the years shown.
Total investments increased $26.4 million, or 53%, primarily due to purchases of $53.2 million of government agency mortgage-backed securities and bonds, corporate bonds of $12.3 million and Federal Reserve Bank stock of $1.2 million. These were partially offset with proceeds from sales of government agency mortgage-backed securities of $23.8 million, $2.5 million in Auction Rate preferred equity securities, and $700,000 from the sale of Federal Reserve Bank stock. In addition, there were principal payments of $12.0 million on the government agency mortgage-backed securities.
The following table presents the maturity distribution of available-for-sale investment securities at December 31, 2011 and the weighted average yield of the amortized cost of such securities. The weighted average yields were calculated on the amortized cost and effective yields to maturity of each security. Actual maturities of mortgage-backed securities may differ from contractual maturities because the mortgages underlying the securities may be called or repaid without any penalties. As mortgage-backed securities are not due at a single maturity date, they are included in the “No maturity” category in the following maturity summary.
The following table presents a summary of investments for any issuer that exceeds 10% of shareholders’ equity at December 31, 2011:
Loans
The following table is a summary of Bancorp’s loan portfolio at December 31 for each of the years shown:
Bancorp’s net loan portfolio decreased $33.3 million, or 6%, to $501.2 million at December 31, 2011 from $534.5 million at December 31, 2010. The decline in the loan portfolio was primarily a result of a bulk sale of non-performing assets and loan payoffs, including some that were impaired and on non-accrual status. Significant decreases in the portfolio include a $51.6 million decrease in construction loans, a $13.2 million decrease in commercial real estate loans, and a $319,000 decrease in construction to permanent loans. These were partially offset with a $17.2 million increase in commercial loans, a $6.8 million increase in consumer home equity loans and $1.1 million increase in residential real estate loans because of refinances due to a lower rate environment. The net decrease in the portfolio also reflects net charge-offs of $7.4 million of which $3.4 million were related to the loans which had specific reserves in the bulk sale. The decline in the loan portfolio in 2011 reflects management’s strategic decision to reduce its concentration in speculative construction loans. Bancorp has continued its moratorium on originating new speculative construction loans.
On March 24, 2011, the Bank completed the sale of certain non-performing assets that included 21 non-accruing loans with an aggregate net book value of $52.4 million (net of related specific reserves) and 4 other real estate owned (“OREO”) properties with an aggregate carrying value of $14.4 million. The sale of $66.8 million of non-performing assets was consummated for a cash purchase price of $60.6 million which represented 90.7% of the Bank’s net book value for these assets.
At December 31, 2011, the net loan to deposit ratio was 92% and the net loan to asset ratio was 75%. At December 31, 2010, the net loan to deposit ratio was 83%, and the net loan to asset ratio was 68%.
Maturities and Sensitivities of Loans to Changes in Interest Rates
The following table presents the maturities of loans in Bancorp’s portfolio at December 31, 2011, by type of loan:
Loan Concentrations
The Bank has no concentrations of loans other than those disclosed in the above summary loan portfolio table. Commercial real estate plus construction represents 46.7% of total loans, down from 55.2% at December 31, 2010.
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a quarterly basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The allowance for loan losses decreased $6.0 million from December 31, 2010 to December 31, 2011 primarily due to net charge-offs of $7.4 million, of which $3.4 million were related to specific reserves on loans in the bulk sale.
Based on the significant reduction in the loan portfolio and management’s most recent evaluation of the adequacy of the allowance for loan losses, the provision for loan losses charged to operations for the year ended December 31, 2011 of $7.5 million, of which $6.0 million related to loans transferred to held-for-sale in connection with bulk loan sale, represents a decrease of $250,000 when compared to the provision of $7.7 million for the year ended December 31, 2010.
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 nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not collected for loans that are placed on nonaccrual 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 and future payments are reasonably assured.
Management considers all non-accrual loans and troubled debt restructurings to be impaired. In most cases, loan payments that are past due less than 90 days, based on contractual terms, are considered collection delays and the related loans are not considered to be impaired. The Bank considers consumer installment loans to be pools of smaller balance homogeneous loans, which are collectively evaluated for impairment.
Analysis of Allowance for Loan Losses
Allocation of the Allowance for Loan Losses
Non-Accrual, Past Due and Restructured Loans
The following table is a summary of non-accrual and past due loans at the end of each of the last five years.
Included in non-accruing loans were loans of $7.7 million and $31.5 million as of December 31, 2011 and 2010, respectively that were current within 30 days as to payments. Loans past due ninety days or more, and still accruing interest were $9.5 million and $3.4 million at December 31, 2011, and December 31, 2010 respectively. Ten of these loans totaling $4.9 million were current as to loan payments, but past the loan’s maturity dates. Three loans totaling $4.6 million were over 30 days but under 60 days past due as to payments.
During 2011, 2010 and 2009, interest income collected and recognized on impaired loans was $464,785, $1,806,759 and $424,745, respectively.
At December 31, 2011, there were 12 loans totaling $25.5 million that were considered troubled debt restructurings, as compared to 19 loans totaling $38.0 million that were considered troubled debt restructurings at December 31, 2010, all of which are considered impaired loans. Loan modifications, which resulted in these loans being considered troubled debt restructurings, are primarily in the form of rate concessions or term extensions. There were no commitments to advance additional funds under modified terms for these loans.
The Company’s most recent impairment analysis resulted in identification of $36.8 million of impaired loans, for which specific reserves of $1.3 million were required at December 31, 2011, compared to $100.7 million of impaired loans at December 31, 2010, for which specific reserves of $6.0 million were required. The $36.8 million of impaired loans at December 31, 2011 is comprised of exposure to 31 borrowers, compared to the $100.7 million of impaired loans at December 31, 2010 which was comprised of exposure to 44 borrowers. In all cases, the Bank has obtained current appraisal reports from independent licensed appraisal firms and reduced those values for estimated selling expenses to determine estimated impairment.
The non-performing loans decreased from $89.2 million at December 31, 2010 to $20.7 million at December 31, 2011. The primary reason for the 77% decline was the bulk loan sale of 21 non-performing loans with an aggregate net book value of $52.4 million (net of specific reserves). Additionally, the riskiest portion of the non-accruing loans was charged-off in conjunction with our monthly impairment analysis. The non-performing loans peaked at $137.9 million at September 30, 2009 and have been steadily declining since. The focus of the Bank’s attention continues to be on the workout effort.
Loans delinquent over 90 days and still accruing aggregating $9.5 million are comprised of 13 loans which matured and are in the process of being renewed or awaiting payoff. Ten of these loans totaling $4.9 million were current as to loan payments, but past the loan’s maturity dates. Three loans totaling $4.6 million were over 30 days but under 60 days past due as to payments.
All potential problem loans are reviewed by a board-level committee.
Based upon the overall assessment and evaluation of the loan portfolio, management believes the allowance for loan losses of $9.4 million, at December 31, 2011, which represents 1.84% of gross loans outstanding, is adequate under prevailing economic conditions, to absorb existing losses in the loan portfolio. At December 31, 2010, the allowance for loan losses was $15.4 million, or 2.80%, of gross loans outstanding. The loan portfolio was reduced by $39.8 million, or 7.23%.
Other Real Estate Owned
The following table is a summary of Bancorp’s other real estate owned as of December 31, 2011 and 2010.
The balance of other real estate owned at December 31, 2011 and 2010 was comprised of three and seven properties, respectively, all of which were obtained through loan foreclosure proceedings. During the year ended December 31, 2011, the Bank sold eight properties with an aggregate carrying value of $19.4 million; four of which were included in the March 2011 bulk sale of non-performing assets with an aggregate carrying value of $14.4 million. In addition, the Bank purchased the remaining interest in one property and acquired four other properties during 2011.
Deferred Taxes
The determination of the amount of deferred income tax assets which are more likely than not to be realized is primarily dependent on projections of future earnings, which are subject to uncertainty and estimates that may change given economic conditions and other factors. A valuation allowance related to deferred tax assets is required when it is considered more likely than not that all or part of the benefit related to such assets will not be realized. Management has reviewed the deferred tax position of Bancorp at December 31, 2011. The deferred tax position has been affected by several significant transactions in the past several years. These transactions include the change in ownership, in addition to, the increased provision for loan losses, the levels of non-accrual loans and other-than-temporary impairment write-offs of certain investments. As a result, the Company is in a cumulative net loss position at December 31, 2011, and under the applicable accounting guidance, has concluded that it is not more-likely-than-not that the Company will be able to realize its deferred tax assets and accordingly has established a full valuation allowance totaling $14.4 million against its deferred tax asset at December 31, 2011. The valuation allowance is analyzed quarterly for changes affecting the deferred tax asset. If, in the future, the Company generates taxable income on a sustained basis, management’s conclusion regarding the need for a deferred tax asset valuation allowance could change, resulting in the reversal of all or a portion of the deferred tax asset valuation allowance.
Deposits
The following table is a summary of Bancorp’s deposits at December 31 for each of the years shown:
Total deposits decreased $101.9 million, or 16%, to $544.9 million at December 31, 2011. Interest bearing deposits decreased $116.5 million, or 20%, to $479.3 million while non-interest bearing deposits increased $14.6 million, or 29%, to $65.6 million at December 31, 2011.
Certificates of deposit decreased by $84.1 million, which represents a decrease of 20% when compared to last year. Certificates of deposit less than $100,000 and certificates of deposit greater than $100,000 decreased by $53.1 million, or 21%, and $31.0 million, or 18%, respectively. This is a result of management intentionally allowing higher rate certificates of deposit to mature. Money market fund accounts decreased $39.8 million, or 43%. This is a result of the lower interest rates paid on these products in the current environment. Savings accounts increased $2.4 million, or 4%, as compared to last year and NOW accounts increased $5.1 million, or 26%. Demand deposits increased $14.6 million, or 29%, as the bank expanded its relationships with new and existing customers.
As of December 31, 2011, the Bank’s maturities of time deposits were:
Borrowings
Borrowings remain unchanged at $65.2 million at December 31, 2011 as compared to December 31, 2010. Borrowings are comprised of $50 million in Federal Home Loan Bank Advances, $8.2 million in junior subordinated debentures and $7 million in securities sold under repurchase agreements.
The Bank had no short-term borrowings from the Federal Home Loan Bank outstanding at December 31, 2011 and 2010. In addition, at December 31, 2011, the Bank has advances of $50.0 million from the Federal Home Loan Bank with maturities greater than one year.
Shareholders’ Equity
Shareholders’ equity decreased $16.7 million from $67.2 million at December 31, 2010 as compared to $50.5 million at December 31, 2011. This is the result of the net loss of $15.5 million and the $1.2 million reduction of accumulated other comprehensive income.
Other
The aggregate cash surrender value of the bank-owned life insurance at December 31, 2011 increased $636,000 to $20,984,604 due to income earned of $636,000 for the year.
The decrease in accrued interest receivable is due to lower outstanding balances in loans at year end.
Premises and equipment decreased $1.2 million from $5.3 million at December 31, 2010 to $4.1 million at December 31, 2011. This is due to the asset disposals of $570,000 related to four branch closings, in addition to the amortization associated with leasehold improvements, furniture and fixtures, and equipment.
The following table presents average balance sheets (daily averages), interest income, interest expense and the corresponding yields earned and rates paid:
Distribution of Assets, Liabilities and Shareholder’s Equity
Interest Rates and Interest Differential and Rate Volume Variance Analysis (1)
(thousands of dollars)
(1) The rate volume analysis reflects the changes in net interest income arising from changes in interest rates and from asset and liability volume, including mix . The change in interest attributable to volume includes changes in interest attributable to mix .
(2) Includes non-accruing loans
(3)
Favorable/(unfavorable) fluctuations.
(4) Yields are calculated at historical cost and excludes the effects of unrealized gains or losses on available-for-sale securities.
RESULTS OF OPERATIONS
Comparison of Results of Operations for the years 2011 and 2010
For the year ended December 31, 2011, Bancorp recorded a loss of $15.5 million ($0.40 loss per share), compared to 2010 when Bancorp reported a net loss of $15.4 million ($1.30 loss per share).
Interest and dividend income decreased $7.3 million, or 20%, to $28.3 million in 2011 as compared to 2010 when interest and dividend income was $35.6 million. The decline in interest income on loans is primarily the result of a $129.6 million decrease in average loans outstanding during the year. Interest income on investments increased due to a rise in the average balance of investments outstanding, but was partially offset by a decline in the yield on the investment portfolio.
Interest expense decreased $5.0 million, or 37%, to $8.5 million in 2011 compared to $13.5 million in 2010. The decrease in interest expense is primarily a result of decreases in interest rates paid, in conjunction with a decrease in the average balance of interest bearing liabilities. The decrease in interest rates was driven primarily by management’s plan to reduce the reliance placed on higher rate certificates of deposit.
Noninterest income was $3.4 million in 2011 as compared to $2.4 million in 2010. The change is due largely to the gain on the sale of investment securities of $1.1 million recorded in 2011; there were no such sales in 2010.
Noninterest expense for 2011 totaled $31.2 million, which represents a decrease of $720,000, or 2%, less than the prior year. The decrease in noninterest expense is primarily a result of a $1.4 million decrease in costs relating to other real estate operations, and a $1.0 million decrease in regulatory assessments. In addition, there were decreases of $801,000 and $624,000 in salaries and benefits and occupancy and equipment expenses. These were partially offset by $3.0 million in restructuring charges and asset disposals related to the reduction in force and branch closings.
The following are measurements relating to Bancorp’s earnings:
Interest income and expense
Bancorp’s net interest income decreased $2.3 million, or 10%, to $19.8 million in 2011 from $22.1 million in 2010. Bancorp’s interest income decreased by $7.3 million, or 20%, from $35.6 million in 2010 to $28.3 million in 2011 due to a decrease in average earning assets of $130.6 million, or 17%. Average loans outstanding decreased $129.6 million, or 21%. The income on investments increased $439,000 due to the rise in the average balance of investments outstanding, but was partially offset by lower yields during 2011. This resulted in an increase in interest income of approximately $503,000 due to volume, and a decrease of $64,000 related to the change in interest rates. The average balances of federal funds sold and short-term investments decreased $18.9 million to $62.5 million for 2011 as compared to $81.4 million for 2010 due to a reduction in excess liquidity on the balance sheet.
Total average interest bearing liabilities decreased by $164.5 million, or 23%. Average balances of certificates of deposit decreased $121.6 million, or 26%. The decrease in certificates of deposit accounts is attributable to customers refraining from locking into long-term rates in the current lower rate environment and lower offered rates on new certificates of deposit. Average money market accounts decreased $41.5 million, or 38%. Average balances in savings accounts decreased approximately $2.9 million. Total interest expense decreased $5.0 million, or 37%, from $13.5 million in 2010 to $8.5 million in 2011. Interest expense on certificates of deposit decreased $3.8 million and the cost of funds for this portfolio decreased from 2.09% in 2010 to 1.73% in 2011. This is primarily the result of the maturity of higher rate certificates of deposit due to lower interest rates being paid on current renewals. The average balances outstanding of FHLB advances remained unchanged from 2010, resulting in interest expense of $1.6 million, which is $67,000 less than 2010. The cost of funds for these advances decreased from 3.40% in 2010 to 3.26% in 2011 due to the restructuring that took place in the fourth quarter. The decrease in the index to which the junior subordinated debt interest rate is tied resulted in a decline in interest expense of approximately $2,000, or less than 1%.
Management regularly reviews loan and deposit rates and attempts to price Bancorp’s products competitively. Bancorp tracks its mix of asset/liability maturities and strives to maintain a reasonable match. Performance ratios are reviewed monthly by management and the Board and are used to set strategies.
Provision for loan losses
Based on management’s most recent evaluation of the adequacy of the allowance for loan losses, the provision for loan losses charged to operations for the year ended December 31, 2011 of $7.5 million, of which $6.0 million related to loans transferred to held-for-sale in connection with bulk loan sale, represents a decrease of $250,000 when compared to the provision of $7.7 million for the year ended December 31, 2010.
The decreased provision for the current year was based on the lower level of non-accrual and past due loans, and management’s assessment of the impact that changes in the national, regional and local economic and business conditions have had on the Bank’s loan portfolio. Additionally, the total loan portfolio has decreased by 6.2% in 2011. There continues to be major displacement in the national and global credit markets. The secondary mortgage market continues to be impacted by economic events. These macro issues have impacted local real estate markets. It appears the local real estate prices have stabilized and market activity has increased. The Bank continues to maintain conservative underwriting standards including low loan to value ratio guidelines.
An analysis of the changes in the allowance for loan losses is presented under the discussion entitled “Allowance for Loan Losses.”
Non-interest income
Non-interest income increased by $1.1 million from $2.4 million in 2010 to $3.4 million in 2011. The increase is primarily due to the gain on the sale of investment securities of approximately $1.1 million recorded in 2011; there were no such sales in 2010. There was also higher revenue from the Bank-owned life insurance of $89,000 and a gain recognized on sale of loan of $80,000. These were partially offset by a reduction in activity based deposit fees and service charges of $210,000, a decrease in loan originations and processing fees of $77,000, and a decrease in mortgage brokerage referral fee income of $32,000.
Non-interest expense
Non-interest expense decreased $720,000, or 2%, from $31.9 million in 2010 to $31.2 million in 2011. Other real estate operations expenses decreased $1.4 million to $878,000 for the year ended December 31, 2011 from $2.3 million for the year ended December 31, 2010. This decrease is largely due to the sale of eight OREO properties for $19.6 million; four of which were included in the March 2011 bulk sale of non-performing assets with an aggregate carrying value of $14.4 million. This resulted in net gains on the sale of OREO properties of $194,000. Net carrying costs were $906,000 and there was one write-down of $166,000 during 2011. Regulatory assessments decreased $1.0 million from $3.0 million for the year ended December 31, 2010 to $2.0 million for the year ended December 31, 2011, due to a lower assessment base. Salaries and benefits decreased $801,000, or 6%, in 2011 compared to 2010, and occupancy and equipment expenses decreased $624,000, or 11%, from $5.6 million in 2010 to $4.8 million in 2011. This primarily reflects lower salaries, lease and depreciation expense as a result of the $3.0 million in restructuring and asset disposal charges related to the reduction in force and branch closings.
Income Taxes
During the year ended December 31, 2011, Bancorp established a full valuation allowance against the net deferred tax asset, which resulted in a $4.1 million decrease from prior year to the valuation allowance to $14.4 million. The possibility of further loan losses and higher cost levels associated with carrying nonperforming assets, coupled with Bancorp’s losses beginning in the third quarter of 2008, creates sufficient uncertainty regarding the Company’s ability to realize these deferred tax assets. In future periods, if it becomes more likely that these assets can be utilized, Bancorp may reverse some or all of the valuation allowance. Evidence to substantiate reversing the allowance would include sustained profitability.
Comparison of Results of Operations for the years 2010 and 2009
For the year ended December 31, 2010, Bancorp recorded a loss of $15.4 million ($1.30 loss per share), as compared to 2009 when Bancorp reported a net loss of $23.9 million ($5.02 loss per share). For the year ended December 31, 2010, Bancorp had a pre-tax loss of $15.2 million with a tax provision of $225,000 as compared to a pre-tax loss of $21.7 million with a tax provision of $2.2 million for the year ended December 31, 2009.
Interest and dividend income decreased $7.4 million, or 17%, to $35.6 million in 2010 as compared to 2009 when interest and dividend income was $43.0 million. The decline in interest income on loans is primarily the result of a $132.7 million decrease in the average loan portfolio and average loans outstanding during the year. Interest income on investments increased due to a rise in the average balance of investments outstanding, but was partially offset by a decline in the yield on the investment portfolio.
Interest expense decreased $10.9 million, or 45%, to $13.5 million in 2010 compared to $24.4 million in 2009. The decrease in interest expense is primarily a result of decreases in interest rates paid, in conjunction with a decrease in the average balance of interest bearing liabilities. The decrease in interest rates was driven primarily by management’s plan to reduce the reliance placed on higher rate certificates of deposit.
Noninterest income was $2.4 million in 2010 as compared to $2.9 million in 2009. The change is due largely to the gain on the sale of investment securities of $434,000 recorded in 2009; there were no such sales in 2010.
Noninterest expenses for 2010 totaled $31.9 million, which represents an increase of $1.8 million, or 6%, over the prior year. The increase in noninterest expenses is primarily a result of a $1.5 million increase in costs relating to other real estate operations and a $1.3 million growth in salaries and benefit expenses. These were partially offset by a decrease of $1.0 million in professional fees and other outside services, which essentially pertain to the decrease in capital raising efforts, regulatory matters and non-performing assets.
The following are measurements relating to Bancorp’s earnings:
Interest income and expense
Bancorp’s net interest income increased $3.5 million, or 19%, to $22.1 million in 2010 from $18.6 million in 2009. Bancorp’s interest income decreased by $7.4 million, or 17%, from $43.0 million in 2009 to $35.6 million in 2010 due to a decrease in average earning assets of $137.8 million, or 15%. Average loans outstanding decreased $132.7 million, or 18%, and there was a decline in the yield on loans of four basis points due to the payoffs on loans made in a higher rate environment. The income on investments increased slightly due to the rise in the average balance of investments outstanding, but was partially offset by lower yields during 2010. This resulted in an increase in interest income of approximately $162,000. The average balances of federal funds sold and short-term investments decreased $23.3 million to $81.4 million for 2010 as compared to $104.7 million for 2009 due to a reduction in excess liquidity on the balance sheet.
Total average interest bearing liabilities decreased by $124.1 million, or 15%. Average balances of certificates of deposit decreased $127.5 million, or 22%. Average balances in savings accounts increased slightly by approximately $167,000, which is reflective of Bancorp providing a competitively priced commercial statement savings product. Average money market accounts increased $3.2 million, or 3%, which is a result of the growth in the consumer money market product. The increase in money market accounts is attributable to customers refraining from locking into long-term rates in the current lower rate environment. The growth is also attributable to depositors placing funds in FDIC-insured products during uncertain economic times. Total interest expense decreased $10.9 million, or 45%, from $24.4 million in 2009 to $13.5 million in 2010. Interest expense on certificates of deposit decreased $9.1 million and the cost of funds for this portfolio decreased from 3.18% in 2009 to 2.09% in 2010. This is primarily the result of the maturity of higher rate certificates of deposit due to lower interest rates being paid on current renewals. The average balances outstanding of FHLB advances resulted in interest expense of $1.7 million, which is the same as 2009, as the cost of funds for these advances remained at 3.40%. The decrease in the index to which the junior subordinated debt interest rate is tied resulted in a decline in interest expense of approximately $43,000, or 13%.
Management regularly reviews loan and deposit rates and attempts to price Bancorp’s products competitively. Bancorp tracks its mix of asset/liability maturities and strives to maintain a reasonable match. Performance ratios are reviewed monthly by management and the Board and are used to set strategies.
Provision for loan losses
Based on management’s most recent evaluation of the adequacy of the allowance for loan losses, the provision for loan losses charged to operations for the year ended December 31, 2010 of $7.7 million represents a decrease of $5.4 million when compared to the provision of $13.1 million for the year ended December 31, 2009.
The decreased provision for the current year was based on the lower level of non-accrual and past due loans, and management’s assessment of the impact that changes in the national, regional and local economic and business conditions have had on the Bank’s loan portfolio. Additionally, the total loan portfolio has decreased by 16.9% in 2010. There continues to be major displacement in the national and global credit markets. The secondary mortgage market continues to be impacted by economic events. These macro issues have impacted local real estate markets. It appears the local real estate prices have stabilized and market activity has increased. The Bank continues to maintain conservative underwriting standards including low loan to value ratio guidelines.
An analysis of the changes in the allowance for loan losses is presented under the discussion entitled “Allowance for Loan Losses.”
Non-interest income
Non-interest income declined by $0.6 million from $2.9 million in 2009 to $2.4 million in 2010. The decrease is primarily due to the gain on the sale of investment securities of approximately $434,000 recorded in 2009; there were no such sales in 2010. There was also lower revenue from the Bank-owned life insurance of $178,000, a reduction in mortgage brokerage referral fee income of $77,000, and a decrease in loan origination and processing fees of $77,000. These were partially offset by an increase in activity based deposit fees and service charges of $149,000.
Non-interest expense
Non-interest expense increased $1.8 million, or 6%, from $30.1 million in 2009 to $31.9 million in 2010. Salaries and benefits increased $1.3 million, or 11%, in 2010 compared to 2009, due primarily to an increase in headcount resulting from offering permanent positions to contract employees and a growth in employee benefit costs. Occupancy and equipment expenses decreased $103,000, or 2%, from $5.7 million in 2009 to $5.6 million in 2010. For the year ended December 31, 2010, data processing increased $83,000, or 6%, to $1.5 million from $1.4 million for the year ended December 31, 2009. Regulatory assessments decreased $209,000 from $3.2 million for the year ended December 31, 2009 to $3.0 million for the year ended December 31, 2010. Most of this decrease is due to a special FDIC assessment fee of $453,500 that was paid in the second quarter of 2009. Professional and other outside services decreased $954,000 from $4.0 million for the year ended December 31, 2009 to $3.1 million for the year ended December 31, 2010. This is due primarily to decreases in internal and external audit fees of $194,000, legal fees of $388,000 and consulting fees of $513,000, as they pertain to the level of non-performing assets, regulatory matters and capital raising efforts. Other real estate operations expenses increased $1.5 million to $2.3 million for the year ended December 31, 2010 from $794,000 for the year ended December 31, 2009. This increase is largely due to six write-downs on five OREO properties of $1.1 million, net losses on the sale of seven OREO properties of $164,000 and carrying costs on the OREO properties of $245,000.
Income Taxes
During the year ended December 31, 2010, Bancorp established a full valuation allowance against the net deferred tax asset, which resulted in a $6.3 million increase to the valuation allowance to $18.5 million. The possibility of further loan losses and higher cost levels associated with carrying nonperforming assets, coupled with Bancorp’s losses beginning in the third quarter of 2008, creates sufficient uncertainty regarding the Company’s ability to realize these deferred tax assets. In future periods, if it becomes more likely that these assets can be utilized, Bancorp may reverse some or all of the valuation allowance. Evidence to substantiate reversing the allowance would include sustained profitability.
LIQUIDITY
Bancorp’s liquidity position was 18% and 24% at December 31, 2011 and 2010, respectively. The liquidity ratio is defined as the percentage of liquid assets to total assets. The following categories of assets as described in the accompanying consolidated balance sheets are considered liquid assets: cash and due from banks, federal funds sold, short-term investments and available-for-sale securities. Liquidity is a measure of Bancorp’s ability to generate adequate cash to meet financial obligations. The principal cash requirements of a financial institution are to cover increases in its loan portfolio and downward fluctuations in deposit accounts. Management believes Bancorp’s short-term assets provide sufficient liquidity to satisfy loan demand, cover potential fluctuations in deposit accounts and to meet other anticipated cash requirements.
Historically, the Company has had a high retention rate of maturing certificates of deposit; however, with the implementation of management’s strategy to price these deposits lower, the Company is projecting a lower retention rate of these deposits as they mature. Even if the runoff rate meets management’s expectations, the Company will still have ample liquidity to meet all of its funding requirements.
At December 31, 2011, cash and cash equivalents and securities classified as available-for-sale were $55.4 million and $66.5 million, respectively. In addition to Federal Home Loan Bank advances outstanding at December 31, 2011, the Bank had the ability to borrow an additional $76.0 million from the Federal Home Loan Bank of Boston, which included a $2.0 million overnight line of credit. At December 31, 2011 the Bank had $50.0 million in Federal Home Loan Bank advances, none of which were under the overnight line of credit. The Bank also has the ability to borrow from the Federal Reserve Bank.
The following table presents Bancorp’s contractual obligations as of December 31, 2011:
OFF-BALANCE SHEET ARRANGEMENTS
The following table presents Bancorp’s off-balance sheet commitments as of December 31, 2011. These 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.
REGULATORY CAPITAL REQUIREMENTS
The Company’s and the Bank’s actual capital amounts and ratios at December 31, 2011 and 2010 were:
Capital adequacy is one of the most important factors used to determine the safety and soundness of individual banks and the banking system. Based on the above ratios, the Bank is considered to be “well capitalized” at December 31, 2011 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%, a Tier 1 risk-based capital ratio of at least 6% and a total risk-based capital ratio of at least 10%. However, the OCC has the discretion to require increased capital levels.
Management continuously assesses the adequacy of the Bank’s capital with the goal to maintain a “well capitalized” classification.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
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. Based upon the nature of Bancorp’s business, market risk is primarily limited to interest rate risk, which is the impact that changing interest rates have on current and future earnings.
Qualitative Aspects of Market Risk
Bancorp’s goal is to maximize long term profitability while minimizing its exposure to interest rate fluctuations. The first priority is to structure and price Bancorp’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 are matched against longer term deposits and borrowings when possible 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 meets on a monthly basis, but may convene more frequently as conditions dictate. 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 on a monthly basis regarding its activities. In addition to the Management Asset 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 Bank policies.
Quantitative Aspects of Market Risk
Management analyzes Bancorp’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 Bancorp’s interest rate risk exposure at a particular point in time. Management regularly reviews the potential effect changes in interest rates could have on the repayment of rate sensitive assets and funding requirements of rate sensitive liabilities.
The table below sets 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 Bancorp’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 also 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, and, therefore, it is not possible for the analyses to fully measure the entire impact of these downward shocks.
Impact of Inflation and Changing Prices
Bancorp’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 a financial institution’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 Bancorp’s earnings in future periods.
Item 8.
Item 8. Financial Statements and Supplementary Data
The consolidated balance sheets of Bancorp as of December 31, 2011 and December 31, 2010 and the related consolidated statements of operations, shareholders’ equity and cash flows for the years ended December 31, 2011, December 31, 2010 and December 31, 2009, together with the Report of Independent Registered Public Accounting Firms thereon are included as part of this Form 10-K in the “Financial Report” following page 68 hereof.
The following table presents selected quarterly financial information (unaudited):
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Based on an evaluation of the effectiveness of Bancorp’s disclosure controls and procedures performed by Bancorp’s management, with the participation of Bancorp’s Chief Executive Officer and its Chief Financial Officer as of the end of the period covered by this report, Bancorp’s Chief Executive Officer and Chief Financial Officer concluded that Bancorp’s disclosure controls and procedures have been effective.
As used herein, “disclosure controls and procedures” mean controls and other procedures of Bancorp that are designed to ensure that information required to be disclosed by Bancorp in the reports that it files or submits under the Securities Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by Bancorp in the reports that it files or submits under the Securities Exchange Act is accumulated and communicated to Bancorp’s management, including its principal executive, and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
There were no changes in Bancorp’s internal control over financial reporting identified in connection with the evaluation described in the preceding paragraph that occurred during Bancorp’s fiscal year ended December 31, 2011 that has materially affected, or is reasonably likely to materially affect, Bancorp’s internal controls over financial reporting.
Item 9B.
Item 9B. Other Information
Management’s Report on Internal Control Over Financial Reporting
The management of Patriot National Bancorp, Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process designed so as to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America.
The Company’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 the assets of the Company and also provide reasonable assurance that transactions are recorded in a timely manner to enable the preparation of financial statements in accordance with accounting principles generally accepted in the United States of America and that receipts and disbursements of the Company are made only in compliance with the authorizations established by management and the directors of the Company, and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
Due to its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. 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.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2011, based on the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control - Integrated Framework. Based on that assessment, management concluded that as of December 31, 2011, the Company’s internal control over financial reporting is effective based on the criteria established in Internal Control - Integrated Framework.
The effectiveness of the Company’s internal control over financial reporting as of December 31, 2011, has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their report appearing on page 61, which expresses an unqualified opinion of the Company’s internal control over financial reporting as of December 31, 2011.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Patriot National Bancorp, Inc.:
We have audited Patriot National Bancorp, Inc. and subsidiary’s (the Company) internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation 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 or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Patriot National Bancorp, Inc. and subsidiary as of December 31, 2011 and 2010, and the related consolidated statements of operations, shareholders’ equity, and cash flows for the years then ended, and our report dated March 29, 2012 expressed an unqualified opinion on those consolidated financial statements.
/s/ KPMG LLP
Stamford, Connecticut
March 29, 2012
PART III
Item 10.
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 Bancorp’s definitive proxy statement (the “Definitive Proxy Statement”) for its 2012 Annual Meeting of Shareholders, to be filed within 120 days following December 31, 2011.
The Company has adopted a Code of Ethics for its senior financial officers. The information required by Item 406 is contained in Exhibit 14 to this Form 10-K. A copy of this Code of Ethics will be provided to any person so requesting by writing to Patriot National Bancorp, Inc., 900 Bedford Street, Stamford, Connecticut 06901, Attn: Robert F. O’Connell, Chief Financial Officer.
Item 11.
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 Definitive Proxy Statement.
Item 12.
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 Definitive Proxy Statement.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by Items 404 and 407(a) of Regulation S-K is incorporated into this Form 10-K by reference to the Definitive Proxy Statement.
Item 14.
Item 14. Principal Accountant Fees and Services
The information required by Item 9(e) of Schedule 14A of Regulation S-K is incorporated into this Form 10-K by reference to the Definitive Proxy Statement.
Part IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) Exhibits
The exhibits marked with the section symbol (#) are interactive data files. Pursuant to Rule 406T of Regulations S-T, these interactive data files (i) are not deemed filed or part of a registration statement of prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, are not deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934, irrespective of any general incorporation language included in any such filings, and otherwise are not subject to liability under these sections; and (ii) are deemed to have complied with Rule 405 of Regulations S-T (“Rule 405”) and are not subject to liability under the anti-fraud provisions of the Section 17(a)(1) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 or under any other liability provision if we have made a good faith attempt to comply with Rule 405 and, after we become aware that the interactive data files fail to comply with Rule 405, we promptly amend the interactive data files.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Patriot National Bancorp, Inc.
(Registrant)
By:
/s/ Christopher D. Maher
Name: Christopher D. Maher
Title: Chief Executive Officer
Date: March 29, 2012
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in capacities and on the dates indicated.
Form 10 K - Signatures continued
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Patriot National Bancorp, Inc.:
We have audited the accompanying consolidated balance sheets of Patriot National Bancorp, Inc. and subsidiary (the Company) as of December 31, 2011 and 2010, and the related consolidated statements of operations, shareholders’ equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Patriot National Bancorp, Inc. and subsidiary as of December 31, 2011 and 2010, and the results of their operations and their cash flows for the years then ended in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 29, 2012 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ KPMG LLP
Stamford, Connecticut
March 29, 2012
McGladrey & Pullen, LLP
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors
Patriot National Bancorp, Inc. and Subsidiary
We have audited the accompanying consolidated statements of operations, shareholders’ equity and cash flows of Patriot National Bancorp, Inc. and Subsidiary (the “Company”) for the year ended December 31, 2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used in significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Patriot National Bancorp, Inc. and Subsidiary for the year ended December 31, 2009, in conformity with U.S. generally accepted accounting principles.
/s/ McGladrey & Pullen, LLP
New Haven, Connecticut
March 15, 2010
Member of the the RSM International network of independent accounting, tax and consulting firms.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 2011 and 2010
See Accompanying Notes to Consolidated Financial Statements.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2011, 2010 and 2009
See Accompanying Notes to Consolidated Financial Statements.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
Years Ended December 31, 2011, 2010 and 2009
See Accompanying Notes to Consolidated Financial Statements.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2011, 2010 and 2009
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
Years Ended December 31, 2011, 2010 and 2009
CONSOLIDATED STATEMENTS OF CASH FLOWS
See Accompanying Notes to Consolidated Financial Statements.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
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. On December 1, 1999, all the issued and outstanding shares of Patriot National Bank (the “Bank”) were converted into Company common stock and the Bank became 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, eleven other branch offices in Connecticut and three branch offices in New York. The Bank’s customers are concentrated in Fairfield and New Haven Counties in Connecticut and Westchester County, New York City and Long Island, New York. The Bank also conducts mortgage brokerage operations through a loan production office in Stamford, Connecticut.
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 generally accepted accounting principles, the Trust is not included in the Company’s consolidated financial statements.
The following is a summary of the Company’s significant accounting policies:
Significant group concentrations of credit risk
Most of the Company’s activities are with customers located within Fairfield and New Haven Counties in Connecticut and Westchester County, New York City and Long Island, New York. Note 3 discusses the types of securities in which the Company invests. Note 4 discusses the types of lending in which the Company engages. The Company does not have any significant concentrations to any one industry or customer; however, the Company’s investment in life insurance is in a separate account of a single insurance carrier.
Principles of consolidation and basis of financial statement presentation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, the Bank, and the Bank’s wholly owned subsidiary, PinPat Acquisition Corporation, and have been prepared in conformity with U.S. generally accepted accounting principles. All significant intercompany balances and transactions have been eliminated. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosures of contingent assets and liabilities, as of the balance sheet date and reported amounts of revenues and expenses for the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of investment securities, deferred tax assets, and the evaluation of investment securities for impairment. Certain prior year balances have been reclassified to conform to the current year presentation.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Cash and cash equivalents
Cash and due from banks, federal funds sold and short-term investments are recognized as cash equivalents in the consolidated balance sheets. Federal funds sold generally mature in one day. For purposes of reporting cash flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. The Company maintains amounts due from banks and federal funds sold which, at times, may exceed federally insured limits. The Company has not experienced any losses from such concentrations. The short-term investments represent an investment in a money market mutual fund of a single issuer.
Investments in debt and marketable equity 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.
The Bank is required to maintain an investment in capital stock of the FHLB, as collateral, in an amount equal to a percentage of its outstanding mortgage loans and contracts secured by residential properties, including mortgage-backed securities. The stock is purchased from and redeemed by the FHLB based upon its $100 par value. The stock is a non-marketable equity security and as such is classified as restricted stock, carried at cost and evaluated for impairment in accordance with relevant accounting guidance. In accordance with this guidance, the stock’s value is 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 the following: (a) the significance of the decline in net assets of the FHLB as compared to the capital stock amount and the length of time this situation has persisted; (b) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance; (c) the impact of legislative and regulatory changes on the customer base of the FHLB; and (d) the liquidity position of the FHLB.
Management evaluated the stock and concluded that the stock was not impaired for the periods presented herein. Consideration was given to the long-term prospects for the FHLB. Management also considered that the FHLB’s regulatory capital ratios have increased from the prior year, liquidity appears adequate, and new shares of FHLB stock continue to exchange hands at $100 par value.
The Bank is required to maintain an investment in capital stock of the FRB, as collateral, in an amount equal to one percent of six percent of the Bank’s total equity capital as per the latest Report of Condition (Call Report). The stock is purchased from and redeemed by the FRB based upon its $100 par value. The stock is a non-marketable equity security and as such is classified as restricted stock, carried at cost and evaluated for impairment in accordance with relevant accounting guidance. In accordance with this guidance, the stock’s value is 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 the following: (a) the significance of the decline in net assets of the FRB as compared to the capital stock amount and the length of time this situation has persisted; (b) the impact of legislative and regulatory changes on the customer base of the FRB; and (c) the liquidity position of the FRB.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Member banks may carry over changes within a calendar year until the cumulative change exceeds the lesser of 15% or 100 shares of Federal Reserve Bank stock. However, any change required by a member bank’s capital and surplus, as shown in its Report of Condition as of December 31 of each year, must be applied for even if the change is less than 100 shares of Federal Reserve Bank stock and less than 15% of the Federal Reserve Bank stock held by the member bank.
Management evaluated the stock and concluded that the stock was not impaired for the periods presented herein. Consideration was given to the long-term prospects for the FRB. Management also considered that liquidity appears adequate and new shares of FRB stock continue to exchange hands at the $100 par value.
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 not classified as held to maturity or trading, including equity securities with readily determinable fair values, are classified as “available for sale” and 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 over the contractual lives of the securities.
The Company 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 other-than-temporary. Our evaluation of other-than-temporary impairment, or OTTI, considers the duration and severity of the impairment, our intent and ability to hold 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 other-than-temporary, the security is written down to a new cost basis and the resulting loss is charged to earnings as a component of non-interest income, except for the amount of the total OTTI for a debt security that does not represent credit losses which is recognized in other comprehensive income/loss, net of applicable taxes.
Security transactions are recorded on the trade date. Realized gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method and reported in non-interest income.
The sale of a held to maturity security within three months of its maturity date or after collection of at least 85% of the principal outstanding at the time the security was acquired is considered a maturity for purposes of classification and disclosure.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Loans held for sale
Loans held for sale, are those loans the Company has the intent to sell in the foreseeable future, and are carried at the lower of aggregate cost or fair value, less estimated selling costs. Gains and losses on sales of loans are recognized on the trade dates, and are determined by the difference between the sales proceeds and the carrying value of the loans. Once loans are transferred to held for sale, any subsequent impairment in loans held for sale is recorded in non-interest income.
Loans receivable
Loans that the Company has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for unearned income, the allowance for loan losses, and any unamortized deferred fees or costs.
Interest income is accrued based on the unpaid principal balance. Loan origination fees, and certain direct origination costs, are deferred and amortized as a level yield adjustment over the respective term of the loan and reported in interest income.
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 nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful.
All interest accrued but not collected for loans that are placed on nonaccrual status or charged off are reversed against interest income. The interest on these loans is accounted for on the cash-basis method until qualifying for return to accrual status. Upon receipt of cash, all cash received is first applied to satisfy principal and then applied to interest. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
The Company’s real estate loans are collateralized by real estate located principally in Fairfield and New Haven Counties in Connecticut and Westchester County, New York City and Long Island, New York, and accordingly, the ultimate collectability of a substantial portion of the Company’s loan portfolio is susceptible to changes in regional real estate market conditions.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and real estate loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
Impaired loans also include loans modified in troubled debt restructurings (TDRs), where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. TDRs are 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 performance with the restructured term of the loan agreement for a minimum of six months.
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer installment loans for impairment disclosures, unless such loans are the subject of a restructuring agreement due to financial difficulties of the borrower.
Allowance for loan losses
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
The allowance consists of specific and general components. The specific component relates to loans that are considered impaired. For such impaired loans, an allowance is established when the discounted cash flows (or collateral value if the loan is collateral dependent or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers all other loans, segregated generally by loan type, and is based on historical loss experience with adjustments for qualitative factors which are made after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss data. In addition, a risk rating system is utilized to evaluate the general component of the allowance for loan losses. Under this system, management assigns risk ratings between one and nine based upon the recommendations of the credit analyst and the originating loan officer and confirmed by the Loan Committee at the initiation of the transaction 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.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Included in the valuation allowance are disposition discount adjustments made to real estate appraisals on collateral dependent impaired loans anticipated to become other real estate owned (“OREO”) in the coming quarter, as the Company’s recent experience has indicated that the ultimate sales prices of the underlying collateral have been less than the appraisal amounts. The appraisal adjustment percentage will be reviewed quarterly for those loans anticipated to become OREO in the subsequent quarter, based on an analysis of actual variances between appraised values as of the date the loan is transferred into OREO and the actual sales prices of the OREO properties. Generally, the sales prices have been below the appraised values due to the fact that buyers become aware that the Bank owns those properties, and, therefore, attempt to offer less than fair market value. In the future, additional revisions may be made to the methodology and assumptions based on historical information related to charge-off and recovery experience and management’s evaluation of the current loan portfolio, and prevailing internal and external factors including but not limited to current economic conditions and local real estate markets.
The Company provides for loan losses based on the consistent application of our documented allowance for loan loss methodology. Loan losses are charged to the allowance for loans losses and recoveries are credited to it. Additions to the allowance for loan losses are provided by charges against income based on various factors which, in our judgment, deserve current recognition in estimating probable losses. Loan losses are charged-off in the period the loans, or portion thereof, are deemed uncollectible. Generally, the Company 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 cost to sell, for collateral dependent loans. The Company regularly reviews the loan portfolio and makes adjustments for loan losses in order to maintain the allowance for loan losses in accordance with U.S. generally accepted accounting principles. The allowance for loan losses consists primarily of the following two components:
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
(1) Allowances are established for impaired loans (generally defined by the Company as non-accrual loans and troubled debt restructurings). The amount of impairment provided for as an allowance is represented by the deficiency, if any, between the present value of expected future cash flows discounted at the original loan’s 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 impairment losses 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 similar risk characteristics, primarily loan type, loan-to-value, if collateral dependent, and internal risk ratings. Management applies an estimated loss rate to each loan group. The loss rates applied are based on the Company’s cumulative prior three year loss experience adjusted, as appropriate, for the environmental factors discussed below. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revisions based upon changes in economic and real estate market conditions. Actual loan losses may be more or less than the allowance for loan losses management has established, which could have an effect on the Company’s financial results.
The adjustments to the Company’s loss experience are based on management’s evaluation of several environmental factors, including:
•
Changes in local, regional, national and international economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments;
•
Changes in the nature and volume of the portfolio and in the terms of the loans;
•
Changes in the experience, ability, and depth of lending management and other relevant staff;
•
Changes in the volume and severity of past due loans, the volume of nonaccrual loans, and the volume and 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; and
•
The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the existing portfolio.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
In evaluating the estimated loss factors to be utilized for each loan group, management also reviews actual loss history over an extended period of time as reported by the Office of the Comptroller of the Currency (“OCC”) and Federal Deposit Insurance Corporation (“FDIC”) for institutions both in the Company’s market area and nationally for periods that are believed to have experienced similar economic conditions.
In underwriting a loan secured by real property, we require an appraisal of the property by an independent licensed appraiser approved by the Company’s Board of Directors. For loans in excess of $2.5 million, the appraisal is subject to review by an independent third party hired by the Company. Management reviews and inspects properties before disbursement of funds during the term of a construction loan. Generally, management obtains updated appraisals when a loan is deemed impaired and if a construction loan, within 120 days prior to the scheduled maturity date. These appraisals may be more limited than those prepared for the underwriting of a new loan. All appraisals are also reviewed by qualified parties independent from the firm preparing the appraisals.
Management evaluates the allowance for loan losses based on the combined total of the impaired and general components. Generally, when the loan portfolio increases, absent other factors, the allowance for loan loss methodology results in a higher dollar amount of estimated probable losses. Conversely, when the loan portfolio decreases, absent other factors, the allowance for loan loss methodology results in a lower dollar amount of estimated probable losses.
Each quarter management evaluates the allowance for loan losses and adjusts the allowance, as appropriate, through a provision for loan losses. While the Company uses the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the information used in making the evaluations. In addition, as an integral part of their examination process, the Office of the Comptroller of the Currency will periodically review the allowance for loan losses. The OCC may require the Company to adjust the allowance based on their analysis of information available to them at the time of their examination.
Loan brokerage activities
The Company receives loan brokerage fees for soliciting and processing conventional loan applications on behalf of investors. Brokerage fee income is recognized upon closing of loans for permanent investors.
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 the Company-put presumptively beyond the reach of the transferor 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 the transferor, and (3) the transferor does not maintain effective control over the transferred assets through either (a) an agreement that both entitles and obligates the transferor 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.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
In June 2009, the FASB issued guidance which modifies certain guidance relating to transfers and servicing of financial assets. This guidance eliminates the concept of qualifying special purpose entities, provides guidance as to when a portion of a transferred financial asset can be evaluated for sale accounting, provides additional guidance with regard to accounting for transfers of financial assets and requires additional disclosures. This guidance was effective for the Company as of January 1, 2010, with adoption applied prospectively for transfers that occur on and after the effective date. The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.
Other real estate owned
Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at the lower of cost or estimated fair value less cost to sell at the date of foreclosure, establishing a new cost basis. In addition, when the Company 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 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 required upon transfer to other real estate owned are charged to the allowance for loan losses. Thereafter, an allowance for other real estate owned losses is established for any further declines in the property’s value. These losses are included in non-interest expenses in the consolidated statement of operations.
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 furniture, equipment and software using the straight-line method over the estimated useful lives of the related assets which range from three to ten years. Gains and losses on dispositions are recognized upon realization. Maintenance and repairs are expensed as incurred and improvements are capitalized.
Impairment of assets
Long-lived assets, which are held and used by the Company, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If impairment is indicated by that review, the asset is written down to its estimated fair value through a charge to non-interest expense.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Other intangible assets
Other intangible assets with indefinite lives represent the cost in excess of net assets of businesses acquired and are not subject to amortization. Other identified intangible assets with finite lives consist of a core deposit intangible recorded in connection with a branch acquisition and is amortized over its estimated useful life. The Company’s other intangible assets are tested for impairment annually, or more frequently under prescribed conditions.
Cash surrender value of life insurance
Cash surrender value of life insurance represents life insurance on certain employees who have consented to allow the Bank to be the beneficiary of those policies. Increases in the cash value of the policies, as well as insurance proceeds received above the carrying value, are recorded in other non-interest income and are not subject to income tax. Management reviews the financial strength of the insurance carrier on an annual basis.
Income taxes
The Company recognizes income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and loss carry forwards. Deferred tax assets and liabilities 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 deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. 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.
The Company 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.
The periods subject to examination for the Company’s Federal returns are the tax years 2006 through 2011. The periods subject to examination for the Company’s significant state return, which is Connecticut, are the tax years 2008 through 2011. The Company believes that its income tax filing positions and deductions will be sustained upon examination and does not anticipate any adjustments that will result in a material change in its consolidated financial statements. As a result, no reserve for uncertain income tax positions has been recorded.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
The Company’s policy for recording interest and penalties related to uncertain tax positions is to record such items as part of its provision for federal and state income taxes.
Related party transactions
Directors and officers of the Company and the Bank and their affiliates have been customers of and have had transactions with the Bank, and it is expected that such persons and entities 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, and on substantially the same terms, including interest rates and collateral requirements, 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 or favored treatment or terms, or present other unfavorable features. Note 17 contains details regarding related party transactions.
Loss per share
Basic loss per share represents loss available to common stockholders and is computed by dividing net loss by the weighted-average number of common shares outstanding. Diluted loss per share reflects additional common shares that would have been outstanding if potential dilutive common shares had been issued, as well as any adjustment to income that would result from the assumed issuance unless such assumed issuance is antidilutive. Potential common shares that may be issued by the Company relate to any stock options and warrants that may be outstanding, and are determined using the treasury stock method.
Treasury shares are not deemed outstanding for loss per share purposes.
Stock compensation plan
The Company accounts for share-based compensation transactions at fair-value and recognizes the related expense in the consolidated statements of operations. The Company had no outstanding shares related to stock-based compensation plans at December 31, 2011, 2010 and 2009.
In December 2011, the Board of Directors approved the Company’s 2012 Stock Plan, authorizing 3,000,000 shares to be issued. No awards were granted in 2011.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Comprehensive income (loss)
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income (loss). 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
The Company’s only business segment is Community Banking. During the years ended 2011, 2010 and 2009, this segment represented all the revenues and income of the consolidated group and therefore, is the only reported segment.
Fair value
The Company uses fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. 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 settlement of the asset or liability.
Fair value measurements focus on exit prices in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact business at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment.
The Company’s fair value measurements are classified into a fair value hierarchy based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. The three categories within the hierarchy are as follows:
•
Level 1 Inputs-Unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
•
Level 2 Inputs-Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.
•
Level 3 Inputs-Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.
In April 2009, the FASB issued guidance which addressed concerns that fair value measurements emphasized the use of an observable market transaction even when that transaction may not have been orderly or the market for that transaction may not have been active. This guidance relates to the following: (a) determining when the volume and level of activity for the asset or liability has significantly decreased; (b) identifying circumstances in which a transaction is not orderly; and (c) understanding the fair value measurement implications of both (a) and (b). The Company adopted this new guidance in 2009, and the adoption had no impact on the Company’s consolidated financial statements.
In February 2010, the FASB issued ASU No. 2010-06 Topic 820 “Improving Disclosures about Fair Value Measurements” which amends the existing guidance related to Fair Value Measurements and Disclosures. The amendments required the following new fair value disclosures:
•
Separate disclosure of the significant transfers in and out of Level 1 and Level 2 fair value measurements, and a description of the reasons for the transfers.
•
In the rollforward of activity for Level 3 fair value measurements (significant unobservable inputs), purchases, sales, issuances, and settlements should be presented separately (on a gross basis rather than as one net number).
In addition, the amendments clarify existing disclosure requirements, as follows:
•
Fair value measurements and disclosures should be presented for each class of assets and liabilities within a line item in the statement of financial position.
•
Reporting entities should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements that fall in either Level 2 or Level 3.
The new disclosures and clarifications of existing disclosures were effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures included in the rollforward of activity for Level 3 fair value measurements, for which the effective date was for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The Company adopted this guidance during the quarters ended March 31, 2010 and March 31, 2011 respectively, and has included these disclosures in these financial statements.
See Note 19 for additional information regarding fair value.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Recently issued accounting pronouncements
In April 2011, the FASB issued ASU No. 2011-02, “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” The amendments in this update apply to all creditors, both public and nonpublic, that restructure receivables that fall within the scope of Subtopic 310-40, Receivables - Troubled Debt Restructurings by Creditors. The amendments in this ASU clarify the guidance on a creditor’s evaluation of whether it has granted a concession and whether a debtor is experiencing financial difficulties. In addition, the amendments clarify that a creditor is precluded from using the effective interest rate test in the debtor’s guidance on restructuring of payables when evaluating whether a restructuring constitutes a troubled debt restructuring. These amendments are effective for the first interim or annual period beginning on or after June 15, 2011. The Company adopted this guidance in the first quarter ended March 31, 2011 and the guidance did not have a material impact on the Company’s results of operations or financial position.
The FASB issued ASU No. 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses in July 2010. The amendments in this ASU apply to all entities, both public and nonpublic, with financing receivables, excluding short-term trade accounts receivable or receivables measured at fair value or lower of cost or fair value. The amendments in this ASU enhance disclosures about the credit quality of financing receivables and the allowance for credit losses. This ASU amends existing disclosure guidance to require entities to provide a greater level of disaggregated information about the credit quality of its financing receivables and its allowance for credit losses. In addition, this ASU requires entities to disclose credit quality indicators, past due information, and modifications of its financing receivables. For public entities, the disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. An entity should disclose the information required by paragraphs 310-10-50-33 through 50-34, which was deferred by ASU No. 2011-01, Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20, for interim and annual periods beginning on or after June 15, 2011. The adoption of this guidance did not have an impact on the Company’s results of operations or financial position.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Note 2. Restrictions on Cash and Due From Banks
At December 31, 2011 and 2010, the Company was required to maintain $25,000 in the Federal Reserve Bank for clearing purposes for its transaction accounts and non-personal time deposits.
Note 3. Available-for-Sale Securities
The amortized cost, gross unrealized gains, gross unrealized losses and approximate fair values of available-for-sale securities at December 31, 2011 and 2010 are as follows:
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
The following table presents the Company’s 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, at December 31, 2011 and 2010:
At December 31, 2011, nine securities had unrealized losses with aggregate depreciation of 6.3% from the amortized cost, compared to two securities at December 31, 2010 with aggregate depreciation of 1.0% from the amortized cost.
Management believes that none of the unrealized losses on available-for-sale securities noted above are other than temporary due to the fact that they relate to market interest rate changes on corporate debt and mortgage-backed securities issued by U.S. Government agencies. Management considers the issuers of the securities to be financially sound, the corporate bonds are investment grade and the Company expects to receive all contractual principal and interest related to these investments. Because the Company does not intend to sell the investments, and it is not more-likely-than-not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2011.
At December 31, 2011 and 2010, available-for-sale securities with a carrying value of $8,041,000 and $2,811,000, respectively, were pledged to secure obligations under municipal deposits. At December 31, 2011 and 2010, available-for-sale securities with a carrying value of $10,309,000 and $9,486,000, respectively, were pledged to secure securities sold under agreements to repurchase.
The amortized cost and fair value of available-for-sale debt securities at December 31, 2011 by contractual maturity are presented below. Actual maturities of mortgage-backed securities may differ from contractual maturities because the mortgages underlying the securities may be repaid without any penalties. Because mortgage-backed securities are not due at a single maturity date, they are not included in the maturity categories in the following maturity summary.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
During 2011 there were ten sales of available-for-sale securities, which resulted in the Company recognizing gross proceeds from the sales of $26,349,070 and gross gains of $1,109,305. During 2010 there were no sales of available-for-sale securities. During 2009, there were six sales of available-for-sale securities, which resulted in the Company recognizing proceeds from the sales of $19,852,541 and gains of $434,334.
Note 4. Loans Receivable and Allowance for Loan Losses
Loans receivable, net, consists of the following at December 31, 2011 and 2010:
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
A summary of changes in the allowance for loan losses for the years ended December 31, 2011, 2010 and 2009 are as follows:
At December 31, 2011 and 2010, the unpaid principal balances of loans 90 days or more past due, and still accruing were approximately $9,461,106 and $3,374,242, respectively, and the unpaid principal balances of loans placed on non-accrual status and considered impaired were $20,683,165 and $89,150,000, respectively. Ten of these loans totaling $4.9 million were current as to loan payments, but past the loan’s maturity dates. Three loans totaling $4.6 million were over 30 days but under 60 days past due as to payments. On March 24, 2011, the Company completed the sale of certain non-performing assets that included 21 non-accruing loans with an aggregate net book value of $52.4 million (net of related specific reserves) and 4 OREO properties with an aggregate carrying value of $14.4 million. The sale of $66.8 million of non-performing assets was consummated for a cash purchase price of $60,602,036 which represented 90.7% of the Bank’s net book value for these assets.
At December 31, 2011, there were 12 loans totaling $25.5 million that were considered “troubled debt restructurings”, as compared to 19 loans totaling $38.0 million that were considered “troubled debt restructurings” at December 31, 2010, all of which are included in impaired loans. At December 31, 2011, 6 of the 12 loans aggregating $16.1 million were accruing and 6 loans aggregating $9.4 million were non-accruing loans. Loan modifications, which resulted in these loans being considered troubled debt restructurings, are primarily in the form of rate concessions or term extensions. At December 31, 2011, there were no commitments to advance additional funds under troubled debt restructured loans, as compared to total approximately $115,000 at December 31, 2010.
If impaired loans had been performing in accordance with their original terms, the Company would have recorded $2,274,604, $6,844,986 and $5,312,327, of additional income during the years ended December 31, 2011, 2010 and 2009, respectively.
During 2011, 2010 and 2009, interest income collected and recognized on impaired loans was $464,785 $1,806,759 and $424,745, respectively. The average recorded investment in impaired loans for the years ending December 31, 2011, 2010 and 2009 were $49,758,263, $104,946,719 and $105,309,710, respectively.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
The Company’s lending activities are conducted principally in Fairfield and New Haven Counties in Connecticut and Westchester County, New York City and Long Island, New York. The Company originates commercial real estate loans, commercial business loans and a variety of consumer loans. In addition, the Company had originated loans for the construction of residential homes, residential developments and for land development projects. A moratorium on all new speculative construction loans was instituted by management in July 2008. All residential and commercial mortgage 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 in large part upon the status of the regional economy and 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.
The Company has established credit policies applicable to each type of lending activity in which it engages, evaluates the creditworthiness of each customer and, in most cases, extends credit of up to 75% of the market value of the collateral at the date of the credit extension depending on the Company’s evaluation of the borrowers’ creditworthiness and type of collateral. In the case of construction loans, the maximum loan-to-value was 65% of the “as completed” market value. The market value of collateral is monitored on an ongoing basis and additional collateral is obtained when warranted. Real estate is the primary form of collateral. Other important forms of collateral are accounts receivable, inventory, other business assets, marketable securities and time deposits. While collateral provides assurance as a secondary source of repayment, the Company ordinarily requires the primary source of repayment to be based on the borrower’s ability to generate continuing cash flows on all loans not related to construction.
Risk characteristics of the Company’s portfolio classes include the following:
Commercial Real Estate Loans - In underwriting commercial real estate loans, the Company 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 or should there be a substantial decline in the value of the property securing the loan or a decline in the general economic conditions. Where the owner occupies the property, the Company also evaluates the business’s ability to repay the loan on a timely basis. In addition, the Company may require personal guarantees, lease assignments and/or the guarantee of the operating company when the property is owner occupied. These types of loans may involve greater risks than other types of lending, because payments on such loans are often dependent upon the successful operation of the business involved, therefore, repayment of such loans may be negatively impacted by adverse changes in economic conditions affecting the borrowers’ business.
Construction Loans - Construction loans are short-term loans (generally up to 18 months) secured by land for both residential and commercial development. The loans are generally made for acquisition and improvements. Funds are disbursed as phases of construction are completed.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
In the past, the Company funded construction of single family homes, when no contract of sale exists, based upon the experience of the builder, the financial strength of the owner, the type and location of the property and other factors. Construction loans are generally personally guaranteed by the principal(s). Repayment of such loans may be negatively impacted by the builders’ inability to complete construction, by a downturn in the new construction market, by a significant increase in interest rates or by a decline in general economic conditions. The Company has had a moratorium in place since mid-2008 on new speculative construction loans.
Residential Real Estate Loans - Various loans secured by residential real estate properties are offered by the Company, including 1-4 family residential mortgages, multi-family residential loans and a variety of home equity line of credit products. Repayment of such loans may be negatively impacted should the borrower default, should there be a significant decline in the value of the property securing the loan or should there be a decline in general economic conditions.
Commercial and Industrial Loans - The Company’s commercial and industrial loan portfolio consists primarily of commercial business loans and lines of credit to businesses and professionals. These loans are usually made to finance the purchase of inventory, new or used equipment or other short or long-term working capital purposes. These loans are generally secured by corporate assets, often with real estate as secondary collateral, but are also offered on an unsecured basis. In granting this type of loan, the Company primarily looks to the borrower’s cash flow as the source of repayment with collateral and personal guarantees, where obtained, as a secondary source. Commercial loans are often larger and may involve greater risks than other type of loans offered by the Company. Payments on such loans are often dependent upon the successful operation of the underlying business involved and, therefore, repayment of such loans may be negatively impacted by adverse changes in economic conditions, management’s inability to effectively manage the business, claims of others against the borrower’s assets which may take priority over the Company’s claims against assets, death or disability of the borrower or loss of market for the borrower’s products or services.
Other Loans - The Company also offers installment loans and reserve lines of credit to individuals. Repayments of such loans are often dependent on the personal income of the borrower which may be negatively impacted by adverse changes in economic conditions. The Company does not place an 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 typically characterized by payment delinquencies, previous charge-offs, judgments, bankruptcies, or borrowers with questionable repayment capacity as evidenced by low credit scores or high debt-burdened ratios.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
The following tables set forth activity in our allowance for loan losses, by loan type, for the years ended December 31, 2011 and 2010. The following tables also detail the amount of loans receivable, net, that are evaluated individually, and collectively, for impairment, and the related portion of the allowance for loan losses that is allocated to each loan portfolio segment.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
The Company continuously monitors the credit quality of its loans receivable. Credit quality is monitored by reviewing certain credit quality indicators. Management has determined that loan-to-value ratios (LTVs), (at period end) and internally assigned risk ratings are the key credit quality indicators that best help management monitor the credit quality of the Company’s loans receivable. Loan-to-value ratios used by management in monitoring credit quality are based on current period loan balances and original values at time of originations (unless a current appraisal has been obtained as a result of the loan being deemed impaired or the loan is a maturing construction loan).
Appraisals on properties securing impaired loans and OREO are updated annually. Additionally, appraisals on construction loans are updated four months in advance of scheduled maturity dates. We update our impairment analysis monthly based on the most recent appraisal as well as other factors (such as senior lien positions, e.g. property taxes), and we are using published information regarding actual median home sales prices in the towns/counties where our collateral is located in CT and NY.
The majority of the Company’s impaired loans have been resolved through courses of action other than via bank liquidations of real estate collateral through OREO. These include normal loan payoffs, the traditional workout process, triggering personal guarantee obligations, and troubled debt restructurings. However, as loan workout efforts progress to a point where the bank’s liquidation of real estate collateral is the likely outcome, the impairment analysis is updated to reflect actual recent experience with bank sales of OREO properties.
A disposition discount is built into our impairment analysis and reflected in our allowance once a property is determined to be a likely OREO (e.g. foreclosure is probable). To determine the discount we compare the actual sales prices of our OREO properties to the appraised value that was obtained as of the date when we took title to the property. The difference is the bank-owned disposition discount.
The Company has a risk rating system as part of the risk assessment of its loan portfolio. The Company’s lending officers are required to assign a risk rating to each loan in their portfolio at origination. When the lender learns of important financial developments, the risk rating is reviewed accordingly, and adjusted if necessary. Similarly, the Loan Committee can adjust a risk rating. The Loan Workout Committee meets on a regular basis and reviews loans rated “special mention” or worse. In addition, the Company engages a third party independent loan reviewer that performs semi-annual reviews of a sample of loans, validating the Bank’s risk ratings assigned to such loans. The risk ratings play an important role in the establishment of the loan loss provision and to confirm the adequacy of the allowance for loan losses.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
When assigning a risk rating to a loan, management utilizes the Bank’s internal nine-point risk rating system. Loans deemed to be “acceptable quality” are rated 1 through 5, with a rating of 1 established for loans with minimal risk and borrowers exhibiting the strongest financial condition. Loans rated 1-5 are considered “Pass”. Loans that are deemed to be of “questionable quality” are rated 6 (special mention). 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. Loans with adverse classifications (substandard, doubtful or loss) are rated 7, 8 or 9, respectively. An asset is considered “substandard” if it is not adequately protected by the current net worth and paying capacity of the obligor or of 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 the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.”
Charge-off generally commences in the month that the loan is classified “doubtful” and is fully charged off within six months of such classification. If the account is classified “loss” the full balance is charged off immediately. The full balance is charged off regardless of the potential recovery from the sale of the collateral. This amount is recognized as a recovery once the collateral is sold.
In accordance with FFIEC (“Federal Financial Institutions Examination Council”) published policies establishing uniform criteria for the classification of retail credit based on delinquency status, “Open-end” credits are charged-off when 180 days delinquent and “Closed-end” credits are charged-off when 120 days delinquent. Typically, consumer installment loans are charged off no later than 90 days past due.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
The following table details the credit risk exposure of loans receivable, by loan type and credit quality indicator at December 31, 2011:
CREDIT RISK PROFILE BY CREDITWORTHINESS CATEGORY
CREDIT RISK PROFILE
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
The following table details the credit risk exposure of loans receivable, by loan type and credit quality indicator at December 31, 2010:
CREDIT RISK PROFILE BY CREDITWORTHINESS CATEGORY
CREDIT RISK PROFILE
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Included in loans receivable are loans for which the accrual of interest income has been discontinued due to deterioration in the financial condition of the borrowers. The recorded balance of these nonaccrual loans was $20.7 million and $89.1 million at December 31, 2011, and December 31, 2010 respectively. Generally, loans are placed on non-accruing status when they become 90 days or more delinquent, and remain on non-accrual status until they are brought current, have six months of performance under the loan terms, and factors indicating reasonable doubt about the timely collection of payments no longer exist. Therefore, loans may be current in accordance with their loan terms, or may be less than 90 days delinquent and still be on a non-accruing status. Additionally, certain loans that cannot demonstrate sufficient global cash flow to continue loan payments in the future and certain troubled debt restructures (TDRs) are placed on non-accrual status.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
The following table sets forth the detail, and delinquency status, of non-accrual loans and past due loans at December 31, 2011:
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
The following table sets forth the detail, and delinquency status, of non-accrual loans and past due loans at December 31, 2010:
These non-accrual amounts included loans deemed to be impaired of $20.7 million and $89.1 million at December 31, 2011, and December 31, 2010, respectively. Loans past due ninety days or more, and still accruing interest were $9.5 million and $3.4 million at December 31, 2011, and December 31, 2010 respectively. Ten of these loans totaling $4.9 million were current as to loan payments, but past the loan’s maturity dates. Three loans totaling $4.6 million were over 30 days but under 60 days past due as to payments.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
The following table sets forth the detail and delinquency status of loans receivable, net, by performing and non-performing loans at December 31, 2011.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
The following table sets forth the detail and delinquency status of loans receivable, net, by performing and non-performing loans at December 31, 2010.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
The following table summarizes impaired loans as of December 31, 2011:
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
The following table summarizes impaired loans as of December 31, 2010:
At December 31, 2011 and 2010, the recorded investment of impaired loans was $36.8 million and $100.7 million, with related allowances of $1.3 million and $6.0 million, respectively.
Included in the tables above at December 31, 2011 and 2010, are loans with carrying balances of $23.3 million and $53.9 million respectively that required no specific reserves in our allowance for loan losses. Loans that did not require specific reserves have sufficient collateral values, less costs to sell, supporting the carrying balances of the loans. In some cases, there may be no specific reserves because the Company already charged-off the specific impairment. Once a borrower is in default, the Company is under no obligation to advance additional funds on unused commitments.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
On a case-by-case basis, the Company may agree to modify the contractual terms of a borrower’s loan to remain competitive and assist customers who may be experiencing financial difficulty, as well as preserve the Company’s position in the loan. If the borrower is experiencing financial difficulties and a concession has been made at the time of such modification, the loan is classified as a troubled debt restructured loan.
As a result of the adoption of ASU 2011-02, the Company reassessed all restructurings occurred on or after January 1, 2011 for identification as TDRs and has concluded that there were no additional TDRs identified that have not been previously disclosed.
The following table presents the total troubled debt restructured loans as of December 31, 2011:
The following table summarizes loans that were modified in a troubled debt restructuring during the year ended December 31, 2011.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
The eight loans represented above have been reclassified as troubled debt restructurings during the year ended December 31, 2011.
Substantially all of our troubled debt restructured 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 these two methods. These modifications rarely result in the forgiveness of principal or accrued interest. In addition, we frequently obtain additional collateral or guarantor support when modifying commercial loans. If the borrower had demonstrated performance under the previous terms and our underwriting process shows the borrower has the capacity to continue to perform under the restructured terms, the loan will continue to accrue interest. Non-accruing restructured loans may be returned to accrual status when there has been a sustained period of repayment performance (generally six consecutive months of payments) and both principal and interest are deemed collectible.
In addition to the above, during the year ended December 31, 2011, there was one commercial real estate loan modified on March 31, 2011 for $3.3 million that released a guarantor having financial difficulty to allow the borrower to recapitalize and provide additional time in which to develop an exit plan to pay off the debt. The loan was reduced by a $1.0 million paydown that was applied to the specific reserve established in the second quarter. The impairment was eliminated and the $1.0 million was taken as a credit to the loan loss provision.
During the year ended December 31, 2011, two of the troubled debt restructurings modified had a payment default. One default was a residential loan for $3.5 million and was subsequently sold as an OREO. The other default was a commercial construction loan for $1.1 million, and is currently an OREO, after a charge-off of $255,000 in November 2011.
All troubled debt restructurings are impaired loans, which are individually evaluated for impairment, as discussed above, and were included in the allowance for loan losses.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Note 5. Premises and Equipment
At December 31, 2011 and 2010, premises and equipment consisted of the following:
For the years ended December 31, 2011, 2010 and 2009, depreciation and amortization expense related to premises and equipment totaled $1,272,660, $1,498,334 and $1,660,803, respectively.
Note 6. Other Real Estate Operations
At December 31, 2011 and 2010, the Company had other real estate owned of $2,762,640 and $16,408,787 respectively. For the years ended December 31, 2011, 2010 and 2009, amounts charged to operations for other real estate owned totaled $877,969, $2,286,948 and $793,781 respectively. A summary of other real estate operations for the years ended December 31, 2011, 2010 and 2009 is as follows:
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Note 7. Deposits
At December 31, 2011 and 2010, deposits consisted of the following:
Included in time certificates are certificates of deposit through the Certificate of Deposit Account Registry Service (CDARS) network of $1,361,544 and $2,879,838 at December 31, 2011 and 2010, respectively. These are considered brokered deposits. Pursuant to the Agreement described in Note 16, the level of deposits accepted from Bank customers, and the Bank’s participation in the CDARS program as an issuer of deposits to customers of other banks in the CDARS program, may not exceed 10% of total deposits.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Interest expense on deposits consists of the following:
Contractual maturities of time certificates of deposit as of December 31, 2011 are summarized below:
Note 8. Borrowings
Federal Home Loan Bank borrowings
The Bank is a member of the Federal Home Loan Bank of Boston (“FHLB”). At December 31, 2011, the Bank has the ability to borrow from the FHLB based on a certain percentage of the value of the Bank’s qualified collateral, as defined in the FHLB Statement of Products Policy, comprised mainly of mortgage-backed securities and loans delivered under collateral safekeeping to the FHLB at the time of the borrowing. The additional amount available under this agreement as of December 31, 2011 was $76,000,000. In accordance with an agreement with the FHLB, the qualified collateral must be free and clear of liens, pledges and encumbrances. In addition, the Company has a $2,000,000 available line of credit with the FHLB. At December 31, 2011 and 2010, there were no advances outstanding under this line of credit. During the fourth quarter of 2011, $30,000,000 of FHLB advances with interest rates ranging from 2.49% to 3.94%, were restructured. The restructured advances allowed the Company to reduce the effective interest rates, ranging from 2.20% to 2.86%, and to extend the maturities for two years, in accordance with ASC 47.-50, “Debt Modifications and Extinguishments”. At December 31, 2011 and 2010, outstanding advances from the FHLB aggregated $50,000,000 with interest rates ranging from 1.17% to 3.69%.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Repurchase agreements
At both December 31, 2011 and 2010, the Company had $7,000,000 of securities sold under agreements to repurchase bearing interest at a fixed rate of 4.3475%.
Junior subordinated debt owed to unconsolidated trust
During 2003, the Company formed the Trust of which 100% of the Trust’s common securities are owned by the Company. The Trust has no independent assets, and exists for the sole purpose of issuing trust securities and investing the proceeds thereof in an equivalent amount of junior subordinated debentures issued by the Company. The Trust issued $8,000,000 of trust preferred securities in 2003.
Trust preferred securities currently qualify for up to 25% of the Company’s Tier I Capital, with the excess qualifying as Tier 2 Capital. On March 1, 2005, the Federal Reserve Board of Governors, which is the banking regulator for the Holding Company, approved final rules that allowed for the continued inclusion of outstanding and prospective issuances of trust preferred securities in regulatory capital, subject to new, stricter limitations, which became effective March 31, 2009 and had no impact on the Company.
The subordinated debentures of $8,248,000 are unsecured obligations of the Company and are subordinate and junior in right of payment to all present and future senior indebtedness of the Company. The Company has entered into a guarantee, which together with its obligations under the subordinated debentures and the declaration of trust governing the Trust, including its obligations to pay costs, expenses, debts and liabilities, other than trust securities, provides a full and unconditional guarantee of amounts on the capital securities. The subordinated debentures, which bear interest at the three-month LIBOR plus 3.15% (3.723750% at December 31, 2011), mature on March 26, 2033. Beginning in the second quarter of 2009, the Company began deferring interest payments on the subordinated debentures as permitted under the terms of the debentures. Interest is still being accrued and charged to operations. The Company may only defer the payment of interest for 20 consecutive quarters, or until March, 2014, and all accrued interest must be paid prior to or at completion of the deferment period.
The duration of the Trust is 30 years, with an early redemption feature at the Company’s option on a quarterly basis which commenced March 26, 2008. The Trust securities also bear interest at the three month LIBOR plus 3.15%.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Maturity of borrowings
The contractual maturities of the Company’s borrowings at December 31, 2011, by year, are as follows:
Note 9. Commitments and Contingencies
Operating leases
The Company has non-cancelable operating leases for its main office, fifteen other branch banking offices and additional space for administrative and operational activities, which expire on various dates through 2022. Most of the leases contain rent escalation provisions, as well as renewal options for one or more periods. Under these lease agreements, the Company is required to pay certain executory costs such as insurance and property taxes. The Company also leases parking space under a non-cancelable operating lease agreement and certain equipment under cancelable and non-cancelable arrangements.
Future minimum rental commitments under the terms of these leases by year and in the aggregate, are as follows:
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Total rental expense, which is charged to operations on a straight line basis, for cancelable and non-cancelable operating leases was $2,838,066, $3,239,518 and $3,347,551 for the years ended December 31, 2011, 2010 and 2009, respectively. The Company subleases excess space at one location. Income from subleases included in non-interest expense was $33,326, $26,715 and $37,735 for the years ended December 31, 2011, 2010 and 2009, respectively.
Employment Agreements
Three executive officers of the Company have change of control agreements that entitle such officers to receive up to two and one-half times the greater of the officer’s base salary at the time or total compensation for the most recently completed fiscal year if a change of control occurs while such officers are full time officers of the Company or within six months following termination of employment other than for cause or by reason of death or disability. The three officers waived their right to payment for the recapitalization of the company transaction on October 15, 2010.
Legal Matters
Neither the Company nor the Bank has any pending legal proceedings, other than ordinary routine litigation, incidental to its business, to which the Company or the Bank is a party or any of its property is subject. Management and its legal counsel are of the opinion that the ultimate disposition of these matters will not have a material adverse effect on the Company’s consolidated financial condition, results of operations or liquidity.
Note 10. Income Taxes
The components of the income tax provision (benefit) for the years ended December 31, 2011, 2010 and 2009 are as follows:
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
A reconciliation of the anticipated income tax benefit (computed by applying the statutory Federal income tax rate of 34% to loss before income taxes) to the income tax provision (benefit) as reported in the statements of operations for the years ended December 31, 2011, 2010 and 2009 is as follows:
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
At December 31, 2011 and 2010, the tax effects of temporary differences that give rise to the Company’s deferred tax assets and deferred tax liabilities are as follows:
The net deferred tax liability at December 31, 2011 and 2010 is included in accrued expenses and other liabilities in the consolidated balance sheets.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
The allocation of the deferred tax (benefit) provision items charged to operations and items charged directly to equity for the years ended December 31, 2011, 2010 and 2009 are as follows:
The determination of the amount of deferred income tax assets which are more likely than not to be realized is primarily dependent on projections of future earnings, which are subject to uncertainty and estimates that may change given economic conditions and other factors. A valuation allowance related to deferred tax assets is required when it is considered more likely than not that all or part of the benefit related to such assets will not be realized. Management has reviewed the deferred tax position of the Company at December 31, 2011. The deferred tax position has been affected by several significant transactions in recent years. These transactions include increased provision for loan losses, the increasing levels of non-accrual loans and other-than-temporary impairment write-offs of certain investments, as well as a loss on the bulk sale of loans in 2011. As a result, the Company is in a cumulative net loss position at December 31, 2011, and under the applicable accounting guidance, has concluded that it is not more-likely-than-not that the Company will be able to realize its deferred tax assets and, accordingly, has established a full valuation allowance totaling $14.4 million against its deferred tax asset at December 31, 2011. The valuation allowance is analyzed quarterly for changes affecting the deferred tax asset. If, in the future, the Company generates taxable income on a sustained basis, management’s conclusion regarding the need for a deferred tax asset valuation allowance could change, resulting in the reversal of all or a portion of the deferred tax asset valuation allowance.
As measured under the rules of the Tax Reform Act of 1986, the Company has undergone a greater than 50% change of ownership in 2010. Consequently, use of the Company’s net operating loss carryforward and certain built in deductions available against future taxable income in any one year are limited. The maximum amount of carryforwards available in a given year is limited to the product of the Company’s fair market value on the date of ownership change and the federal long-term tax-exempt rate, plus any limited carryforward not utilized in prior years.
The Company has analyzed the impact of its recent ownership change and has calculated the annual limitation under IRC 382 to be $284,000. Based on the analysis, the Company has determined that the pre-change net operating losses and net unrealized built-in deductions are approximately $36.2 million. Based on a 20 year carryforward period, the Company may utilize approximately $5.6 million of the pre change net operating losses and built-in deductions. Therefore, the Company wrote-off approximately $10.4 million of deferred tax assets. Accordingly, the write-off of the deferred tax asset did not affect the consolidated financial statements as there is a full valuation allowance against the deferred tax asset.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Note 11. Other intangible assets
The changes in the carrying amount of core deposit intangibles for the years ended December 31, 2011 and 2010 are as follows:
Amortization expense for the years ended December 31, 2011, 2010 and 2009 was $15,012, $15,900 and $16,788, respectively. Expected future amortization expenses are as follows:
Note 12. Cash Surrender Value of Life Insurance
The Bank has an investment in, and is the beneficiary of, life insurance policies. The purpose of these life insurance investments is to provide income through the appreciation in the cash surrender value of the policies on the lives of certain officers, directors and employees of the Bank. These policies have an aggregate cash surrender value of $20,984,604 and $20,348,332 at December 31, 2011 and 2010, respectively. These assets are unsecured and maintained in a separate account with one insurance carrier. Income earned on these life insurance policies aggregated $636,272, $546,910 and $724,627 for the years ended December 31, 2011, 2010 and 2009, respectively, and is included in non-interest income.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Note 13. Shareholders’ Equity
Common Stock
On December 16, 2009, the Company entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) with the Bank and PNBK Holdings, LLC, a limited liability company controlled by Michael Carrazza (“Holdings”). Pursuant to the Securities Purchase Agreement, on October 15, 2010, the Company issued and sold to Holdings 33,600,000 shares of its common stock at a purchase price of $1.50 per share for an aggregate purchase price of $50,400,000. The shares sold to Holdings represent 87.6% of the Company’s current issued and outstanding common stock. Also in connection with that sale, certain directors and officers of both the Company and the Bank resigned and were replaced with nominees of Holdings and Michael Carrazza became Chairman of the Board of the Company.
In connection with that sale, the Company reduced the par value of its common stock to $0.01 per share and increased the number of its authorized common shares to 100,000,000. Also in connection with that sale, the Company entered into a Registration Rights Agreement with Holdings. The Registration Rights Agreement provides Holdings with customary demand, shelf and piggyback registration rights.
The Bank is currently party to an agreement with the Office of the Comptroller of the Currency (“OCC”), which restricts the Bank’s ability to pay dividends without the consent of the OCC. To date, the OCC has not consented to the Bank paying any dividends. In addition, the Company is party to an agreement with the Federal Reserve Bank of New York which also restricts the ability of the Company to pay dividends.
During 2009, there were no options exercised and 19,318 shares were issued to directors in payment of directors’ fees in the amount of $55,833.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Loss Per Share
The following tables represent information about the computation of basic and diluted loss per share for the years ended December 31, 2011, 2010 and 2009:
For the years ended December 31, 2011, 2010 and 2009, there were no dilutive securities. In December 2011, the Board of Directors approved the Company’s 2012 Stock Plan, authorizing 3,000,000 shares to be issued. No awards were granted in 2011.
Note 14. 401(k) Savings Plan
The Company offers employees participation in the Patriot National Bank 401(k) Savings Plan (the “401(k) Plan”) under Section 401(k) of the Internal Revenue Code. The 401(k) Plan covers substantially all employees who have completed six months of service, are 21 years of age and who elect to participate. Under the terms of the 401(k) Plan, participants can contribute up to the maximum amount allowed, subject to Federal limitations. The Company may make discretionary matching contributions of 50% up to 6% of the participants’ salary to the 401(k) Plan. Participants are immediately vested in their contributions and the Company’s contributions. The Company contributed approximately $201,000, $206,000 and $205,000 to the 401(k) Plan in 2011, 2010 and 2009, respectively.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Note 15. Financial Instruments with Off-Balance-Sheet Risk
In the normal course of business, the Company is a party to financial instruments with off-balance-sheet risk to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit and involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the balance sheets. The contractual amounts of these instruments reflect the extent of involvement the Company has in particular classes of financial instruments.
The contractual amounts of commitments to extend credit and standby letters of credit represent the amounts of potential accounting loss should: the contract be fully drawn upon; the customer default; and the value of any existing collateral becomes worthless. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments and evaluates each customer’s creditworthiness on a case-by-case basis. Management believes that the Company controls the credit risk of these financial instruments through credit approvals, credit limits, monitoring procedures and the receipt of collateral as deemed necessary.
Financial instruments whose contract amounts represent credit risk are as follows at December 31, 2011 and 2010:
Standby letters of credit are written commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Guarantees that are not derivative contracts have been recorded on the Company’s consolidated balance sheet at their fair value at inception.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments to extend credit generally have fixed expiration dates or other termination clauses and may require payment of a fee by the borrower. Since these commitments could expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held varies, but may include residential and commercial property, deposits and securities. Based on the significant growth in the unfunded commitments, the bank has established a reserve of $44,000 as of December 31, 2011. No liability was required to be recorded at December 31, 2010.
Note 16. Regulatory and Operational Matters
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory-and possibly additional discretionary-actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). As of December 31, 2011 the Company and the Bank are categorized as “well capitalized” for these purposes. In addition, due to the Bank’s asset profile and current economic conditions in its markets, the Bank’s capital plan pursuant to the Agreement described below does target a minimum 9% Tier 1 leverage capital ratio.
The most recent notification from the Office of the Comptroller of the Currency categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since then that management believes have changed the Bank’s classification.
In February 2009 the Bank entered into a formal written agreement (the “Agreement”) with the Office of the Comptroller of the Currency. Under the terms of the Agreement, the Bank has appointed a Compliance Committee of outside directors and the Chief Executive Officer. The Committee must report quarterly to the Board of Directors and to the OCC on the Bank’s progress in complying with the Agreement. The Agreement requires the Bank to review, adopt and implement a number of policies and programs related to credit and operational issues. The Agreement further provides for certain asset growth restrictions for a limited period of time together with limitations on the acceptance of certain brokered deposits and the extension of credit to borrowers whose loans are criticized. The Bank may pay dividends during the term of the Agreement only with prior written permission from the OCC. The Agreement also requires that the Bank develop and implement a three-year capital plan. The Bank has taken or put into process many of the steps required by the Agreement, and does not anticipate that the restrictions included within the Agreement will impair its current business plan.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
In June 2010 the company entered into a formal written agreement (the “Reserve Bank Agreement”) with the Federal Reserve Bank of New York (the “Reserve Bank”). Under the terms of the Reserve Bank Agreement, the Board of Directors of the Company are required to take appropriate steps to fully utilize the Company’s financial and managerial resources to serve as a source of strength to the Bank including taking steps to insure that the Bank complies with the Agreement with the OCC. The Reserve Bank Agreement requires the Company to submit, adopt and implement a capital plan that is acceptable to the Reserve Bank. The Company must also report to the Reserve Bank quarterly on the Company’s progress in complying with the Reserve Bank Agreement. The Agreement further provides for certain restrictions on the payment or receipt of dividends, distributions of interest or principal on subordinate debentures or trust preferred securities and the Company’s ability to incur debt or to purchase or redeem its stock without the prior written approval of the Reserve Bank. The Company has taken or put into process many of the steps required by the Reserve Bank Agreement, and does not anticipate that the restrictions included within the Reserve Bank Agreement will impair its current business plan.
The Company’s and the Bank’s actual capital amounts and ratios at December 31, 2011 and 2010 were (dollars in thousands):
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
On October 15, 2010, the Company issued and sold to PNBK Holdings LLC, 33,600,000 shares of its common stock at a purchase price of $1.50 per share. The shares sold to PNBK Holdings LLC represent 87.6% of the Company’s current issued and outstanding common stock. As a result of the additional capital, the Bank’s capital ratios increased significantly and helped return it to a “well capitalized” classification under the regulatory framework for prompt correction action. Another factor of this transaction is that the Company has a new Chairman of the Board of Directors, as well as a new President and CEO. These changes to management are key components to the recovery plan and will help the Bank reach its goal of restored profitability.
Restrictions on dividends, loans and advances
The Company’s ability to pay dividends is dependent on the Bank’s ability to pay dividends to the Company. Pursuant to the February 9, 2009 Agreement between the Bank and the OCC, the Bank can pay dividends to the Company only 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 Agreement, certain other restrictions exist regarding the ability of the Bank to transfer funds to the Company in the form of cash dividends, loans or advances. The approval of the OCC is required to pay dividends in excess of the Bank’s earnings retained in the current year plus retained net earnings for the preceding two years. As of December 31, 2011, the Bank had an accumulated deficit; therefore, dividends may not be paid to the Company. The Bank is also prohibited from paying dividends that would reduce its capital ratios below minimum regulatory requirements.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
The Company’s ability to pay dividends and incur debt is also restricted by the Reserve Bank Agreement. Under the terms of the Reserve Bank Agreement, the Company has agreed that it shall not declare or pay any dividends or incur, increase or guarantee any debt without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation (the “Director”) of the Board of Governors.
Loans or advances to the Company from the Bank are limited to 10% of the Bank’s capital stock and surplus on a secured basis.
Recent Legislative Developments
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Act”) was signed into law on July 21, 2010. The Act is a significant piece of legislation that will continue to have a major impact on the financial services industry, including the organization, financial condition and operations of banks and bank holding companies. Management continues to evaluate the impact of the Act; however, uncertainty remains as to its operational impact, which could have a material adverse impact on the Company’s business, results of operations and financial condition. Many of the provisions of the Act are aimed at financial institutions that are significantly larger than the Company and the Bank. Notwithstanding this, there are many other provisions that the Company and the Bank are subject to and will have to comply with, including any new rules applicable to the Company and the Bank promulgated by the Bureau of Consumer Financial Protection, a new regulatory body dedicated to consumer protection. As rules and regulations are promulgated by the agencies responsible for implementing and enforcing the Act, the Company and the Bank will have to address each to ensure compliance with applicable provisions of the Act and compliance costs are expected to increase.
The Dodd-Frank Act broadens the base for Federal Deposit Insurance Corporation 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. This did not have a material impact on the Company.
On June 28, 2011, the Federal Reserve Board approved a final debit-card interchange rule. This primarily impacts larger banks and should not have a material impact on the Company.
It is difficult to predict at this time what specific impact the Dodd-Frank Act and the yet to be written implementing rules and regulations will have on the Company. The financial reform legislation and any implementing rules that are ultimately issued could have adverse implications on the financial industry, the competitive environment, and our ability to conduct business. Management will have to apply resources to ensure compliance with all applicable provisions of the Dodd-Frank Act and any implementing rules, which may increase our costs of operations and adversely impact our earnings.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Note 17. Related Party Transactions
In the normal course of business, the Company grants loans to executive officers, directors and members of their immediate families, as defined, and to entities in which these individuals have more than a 10% equity ownership. Such loans are transacted at terms, including interest rates, similar to those available to unrelated customers.
Changes in loans outstanding to such related parties during 2011 and 2010 are as follows:
Related party deposits aggregated approximately $3,520,901 and $3,131,000 as of December 31, 2011 and 2010, respectively.
The Company leases office space to a director of the Company under one lease at December 31, 2011 and under two leases in 2010 and 2009. Rental income under these leases for the years ended December 31, 2011, 2010 and 2009, was approximately $25,601, $26,700 and $26,700 respectively.
During 2009, the Company paid legal fees of approximately $2,700 to an attorney who is a director of the Company. During 2010, the Company did not have a need for his legal services. The Company paid legal fees of approximately $75 for his services during 2011.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Note 18. Other Comprehensive Income
Other comprehensive income, which is comprised solely of the change in unrealized gains and losses on available for sale securities, is as follows:
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Note 19. Fair Value and Interest Rate Risk
As described in Note 1, the Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. A description of the valuation methodologies used for assets and liabilities recorded at fair value, and for estimating fair value for financial and non-financial instruments not recorded at fair value, is set forth below.
Cash and due from banks, federal funds sold, short-term investments and accrued interest receivable and payable: The carrying amount is a reasonable estimate of fair value. These financial instruments are not recorded at fair value on a recurring basis.
Available-for-Sale Securities: These financial instruments are recorded at fair value in the financial statements. Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. If quoted prices are not available, then fair values are estimated by using pricing models (i.e., matrix pricing) or quoted prices of securities with similar characteristics and are classified within Level 2 of the valuation hierarchy. Examples of such instruments include U.S. government agency bonds and mortgage-backed securities, corporate bonds and money market preferred equity securities. The prices for these instruments are obtained through an independent pricing service or dealer market participants with whom the Company has historically transacted both purchases and sales of investment securities. Prices obtained from these sources include prices derived from market quotations and matrix pricings. The fair value measurements considered observable data may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. Management reviews the data and assumptions used in pricing the securities by its third party provider to ensure the highest level of significant inputs are derived from market observable data. Level 3 securities are instruments for which significant unobservable input are utilized. Available-for-sale securities are recorded at fair value on a recurring basis.
Loans: For variable rate loans, which reprice frequently and have no significant change in credit risk, carrying values are a reasonable estimate of fair values, adjusted for credit losses inherent in the portfolios. The fair value of fixed rate loans is estimated by discounting the future cash flows using the period end rates, estimated by using local market data, at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities, adjusted for credit losses inherent in the portfolios. The Company does not record loans at fair value on a recurring basis. However, from time to time, nonrecurring fair value adjustments to collateral-dependent impaired loans are recorded to reflect partial write-downs based on the observable market price or current appraised value of collateral. Fair values estimated in this manner do not fully incorporate an exit-price approach to fair value, but instead are based on a comparison to current market rates for comparable loans.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Other Real Estate Owned: The fair value of the Company’s OREO properties is based on the estimated current property valuations less estimated selling costs. When the fair value is based on current observable appraised values, OREO is classified within Level 2. The Company classifies the OREO within Level 3 when unobservable adjustments are made to appraised values. The Company does not record other real estate owned at fair value on a recurring basis.
Deposits: The fair value of demand deposits, regular savings and certain money market deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposit and other time deposits is estimated using a discounted cash flow calculation that applies interest rates currently being offered for deposits of similar remaining maturities, estimated using local market data, to a schedule of aggregated expected maturities on such deposits. The Company does not record deposits at fair value on a recurring basis.
Short-term borrowings: The carrying amounts of borrowings under short-term repurchase agreements and other short-term borrowings maturing within 90 days approximate their fair values. The Company does not record short-term borrowings at fair value on a recurring basis.
Junior Subordinated Debt: Junior subordinated debt reprices quarterly and as a result the carrying amount is considered a reasonable estimate of fair value. The Company does not record junior subordinated debt at fair value on a recurring basis.
Federal Home Loan Bank Borrowings: The fair value of the advances is estimated using a discounted cash flow calculation that applies current Federal Home Loan Bank interest rates for advances of similar maturity to a schedule of maturities of such advances. The Company does not record these borrowings at fair value on a recurring basis.
Other Borrowings: The fair values of longer term borrowings and fixed rate repurchase agreements are estimated using a discounted cash flow calculation that applies current interest rates for transactions of similar maturity to a schedule of maturities of such transactions. The Company does not record these borrowings at fair value on a recurring basis.
Off-balance sheet instruments: Fair values for the Company’s off-balance-sheet instruments (lending commitments) are based on interest rate changes and fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The Company does not record its off-balance-sheet instruments at fair value on a recurring basis.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
The following table details the financial assets measured at fair value on a recurring basis as of December 31, 2011 and 2010, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine fair value:
Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
The following table reflects assets measured at fair value on a non-recurring basis as of December 31, 2011 and 2010, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
(1) Represents carrying value for which adjustments are based on the appraised value of the collateral.
(2) Represents carrying value for which adjustments are based on the appraised value of the property.
The Company discloses fair value information about financial instruments, whether or not recognized in the consolidated balance sheet, for which it is practicable to estimate that value. Certain financial instruments are excluded from disclosure requirements and, accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.
The estimated fair value amounts have been measured as of December 31, 2011 and have not been reevaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than amounts reported on those dates.
The information presented should not be interpreted as an estimate of the fair value of the Company since a fair value calculation is only required for a limited portion of the Company’s assets and liabilities. Due to the wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other bank holding companies may not be meaningful.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
The following is a summary of the carrying amounts and estimated fair values of the Company’s financial instruments at December 31, 2011 and 2010 (in thousands):
The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall interest rate risk.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Off-balance-sheet instruments
Loan commitments on which the committed interest rate is less than the current market rate were insignificant at December 31, 2011 and 2010. The estimated fair value of fee income on letters of credit at December 31, 2011 and 2010 was insignificant.
Note 20. Restructuring Charges and Asset Disposals
The Company recorded restructuring charges and asset disposals of $3.0 million for the twelve months ended December 31, 2011. These costs are included in restructuring charges and asset disposals expense in the Consolidated Statements of Operations.
During 2011, the Company announced that it would be undertaking a series of initiatives that are designed to transform and enhance its operations. In order to strengthen the Company’s competitive position and return it to its goal of restored health and profitability, it executed one initiative to consolidate four branch locations and vacate other office space, and a second plan to reduce workforce by approximately 10% of employees.
On March 3, 2011, the Company announced that it would consolidate four branches, effective June 2011, to reduce operating expenses. All customer accounts in the affected branches were transferred to nearby Patriot branches to minimize any inconvenience to customers. The consolidation of these branches resulted in an earnings charge of $1.8 million, which is comprised of lease termination expenses of $1.2 million, lease liabilities charges of $400,000, and severance payments of $200,000 to affected employees. In addition, there was a $600,000 write-off of leasehold improvements and other fixed assets for these branches that were closed.
In order to further reduce operating expenses, the Company announced on May 16, 2011 that it would be executing a workforce reduction plan with employees in the back office operational areas. There were a total of eighteen employees affected by this reduction. This initiative resulted in an earnings charge of $600,000, which is comprised exclusively of severance payments to affected employees.
On September 23, 2011, the Company subleased vacant office space at 900 Bedford Street, Stamford, CT, effective October 1, 2011 for a term of two years.
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
Restructuring reserves at December 31, 2011 for the restructuring activities taken in connection with these initiatives are comprised of the following:
The restructuring reserves at December 31, 2011 are included in accrued expenses and other liabilities in the Consolidated Balance Sheet, with all severance and benefit costs to be paid out within twelve months.
Note 21. Condensed Parent Company Only Financial Statements
The following represent the condensed parent company only balance sheets as December 31, 2011 and 2010, and condensed statements of operations and cash flows for the years ended December 31, 2011, 2010, and 2009.
CONDENSED BALANCE SHEETS
December 31, 2011 and 2010
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
CONDENSED STATEMENTS OF OPERATIONS
Years Ended December 31, 2011, 2010 and 2009
PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
December 31, 2011, 2010 and 2009
CONDENSED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2011, 2010 and 2009