Patriot National Bancorp, Inc. — Second-Quarter 2018 Form 10-Q
Business context and period: This unaudited filing covers the quarter and six months ended June 30, 2018. Patriot is a Connecticut community bank focused on commercial lending and retail banking. It completed its acquisition of Prime Bank on May 10, 2018; Prime’s results are included from that date. Unless otherwise stated, financial amounts below are in millions of dollars.
Financial performance and position
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Interest and dividend income | $9.89 | $7.95 | $19.20 | $14.87 |
| Net interest income | $7.04 | $6.31 | $14.10 | $11.84 |
| Provision (credit) for loan losses | $0.05 | $0.26 | $0.24 | ($1.49) |
| Non-interest income | $0.39 | $0.35 | $0.71 | $0.63 |
| Non-interest expense | $5.96 | $5.01 | $11.75 | $9.71 |
| Income before taxes | $1.42 | $1.38 | $2.83 | $4.25 |
| Net income | $1.04 | $0.80 | $2.10 | $2.53 |
| Diluted earnings per share | $0.26 | $0.21 | $0.54 | $0.65 |
| Net interest margin | 3.34% | 3.61% | 3.44% | 3.56% |
- Balance sheet at June 30: Total assets were $930.2 million, up from $852.1 million at December 31, 2017. Net loans were $750.8 million, deposits $712.3 million, and shareholders’ equity $68.4 million. Prime contributed approximately $61.4 million of acquired assets, $46.2 million of deposits, and $21.6 million of loans.
- Cash and cash flow: Cash and cash equivalents were $85.6 million, compared with $49.2 million at year-end. First-half operating cash flow was $4.4 million, investing cash flow was positive $13.7 million, and financing cash flow was positive $18.3 million. Cash increased $36.4 million.
- Funding, debt, and liquidity: Total deposits increased 11.8% to $712.3 million. Brokered deposits were $177.9 million. Borrowings totaled approximately $140.9 million, including $110.0 million of FHLB and correspondent borrowings, $11.7 million of senior notes, $9.6 million of subordinated debt, $8.1 million of junior subordinated debt, and a $1.5 million note payable. Patriot issued $10 million of subordinated notes in June. Balance-sheet liquidity was 11.5% of assets; total available liquidity, including identified funding sources, was 22.8%.
- Capital: Patriot Bank reported total risk-based capital of 11.85%, Tier 1 risk-based capital of 11.05%, CET1 of 11.05%, and Tier 1 leverage of 10.03%. The holding company’s total risk-based capital ratio was 9.58%; the filing notes that the “well capitalized” designation applies to the Bank, not the holding company. Management stated the Bank met capital requirements on a fully phased-in basis.
Material changes versus comparable periods
- Q2 net income rose about 29% year over year, while pretax income was nearly flat. Higher net interest income and lower loan-loss provision supported earnings; acquisition and tax-initiative project costs, higher compensation, and increased funding costs weighed on results.
- First-half net income declined about 17%. The comparison is affected by a $2.8 million insurance recovery credited to the loan-loss allowance in Q1 2017 and $1.1 million of 2018 merger and tax-initiative expenses.
- Q2 net interest margin fell 27 basis points year over year to 3.34%; management attributed margin pressure to higher deposit pricing and borrowing costs. Interest expense increased 74% in the quarter, faster than interest income’s 24% increase.
- Nonperforming assets rose to $19.6 million, or 2.10% of assets, from $5.1 million, or 0.60%, at year-end. This included $6.6 million of nonaccrual loans, $12.0 million of loans over 90 days past due but still accruing, and $1.0 million of acquired other real estate owned. The $12.0 million past-due balance was primarily two construction loans that management said were well secured and under monitoring.
- The allowance for loan losses was $6.5 million, about 0.87% of gross loans, versus $6.3 million at year-end. Acquired loans had no separate allowance at June 30; acquired credit-impaired loans were initially recorded at fair value.
Outlook, commentary, and risks
- Management described Q2 as strong and said the loan pipeline was strong, with continued loan growth expected. It characterized acquisition-related spending as temporary and expressed confidence that the investments would be accretive in the second half of 2018 and in 2019; this is management’s expectation, not a guarantee.
- The planned acquisition of Hana Small Business Lending’s SBA lending business—approximately $120 million of SBA loans and servicing rights on a $370 million pool, with about $83 million cash consideration and assumption of about $41 million of liabilities—was not completed. An August 2, 2018 amendment extended the expected closing date from August 2, 2018 to August 1, 2019. The deal remains subject to due diligence, purchase-price adjustments, and regulatory approvals.
- Prime Bank acquisition accounting remained provisional, including valuations of loans, other real estate owned, deposits, taxes, and other liabilities. Prime-related contingent consideration was estimated at $1.761 million, with a contractual maximum of $2.858 million; final adjustments may change recorded amounts.
- Key risks include interest-rate changes and deposit repricing or runoff, competition for deposits, regional economic and real-estate conditions affecting loan quality and collateral, loan concentrations, regulatory or accounting changes, and execution and integration of acquisitions. Management also identified deferred tax asset valuation, loan-loss allowance estimates, securities valuation, and business-combination accounting as significant judgment areas.
- Off-balance-sheet commitments totaled $131.8 million, including unused credit lines, construction loans, future loan commitments, and standby letters of credit. The company recorded an $8,000 reserve for credit losses on these commitments. The filing reports no material pending legal proceedings beyond routine litigation.
- Management judged unrealized securities losses to be temporary and reported no other-than-temporary impairment. Available-for-sale securities had $1.016 million of gross unrealized losses at June 30; the first-half unrealized loss reduced other comprehensive income by $0.519 million after tax.
Important facts for investors to verify
- Whether the two large construction loans past due over 90 days remain current in collection efforts, and whether their collateral supports full recovery.
- Progress in reducing nonperforming assets and maintaining allowance adequacy as impaired and acquired loan exposures are monitored.
- Deposit mix and funding costs, particularly brokered deposits, rate-sensitive deposits, and the effect of competition on net interest margin.
- Whether the Hana SBL transaction closes by the revised date, its final purchase economics and funding needs, and the costs and benefits of integration.
- Final Prime Bank purchase-accounting adjustments and any change in the contingent-consideration estimate.
- Whether management’s expected acquisition-related earnings accretion and continued loan growth materialize without weakening credit quality or capital and liquidity positions.