PATRIOT NATIONAL BANCORP INC annual report, FY2015

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Patriot National Bancorp, Inc. — 2015 Form 10-K

Reporting period: Fiscal year ended December 31, 2015. The company is a one-bank holding company operating Patriot Bank, N.A., with branches in Connecticut and New York. This is an annual report, not a standalone fourth-quarter filing. Financial figures below are in U.S. dollars; amounts are in millions unless stated otherwise.

Financial performance and condition

  • Profitability: Net income was $2.1 million ($0.55 per share), versus $15.7 million ($4.08 per share) in 2014. However, pretax income increased to $3.5 million from $1.0 million. The prior-year result included a $16.8 million tax benefit from releasing most of the deferred-tax-asset valuation allowance; 2015 included $1.4 million of income tax expense.
  • Interest income and margins: Interest and dividend income rose 16.6% to $23.7 million, while interest expense declined to $2.7 million from $3.0 million. Net interest income increased 21.0% to $21.1 million. Net interest margin improved to 3.60% from 3.37%; net interest spread was 3.51%, versus 3.29%.
  • Other income and costs: Non-interest income fell to $1.6 million from $1.8 million. Non-interest expense increased 3.2% to $18.9 million, including higher salaries and benefits and advertising, partly offset by lower professional fees and regulatory assessments.
  • Assets and loans: Total assets increased 3.3% to $653.5 million. Net loans grew 1.5% to $479.1 million; commercial real estate loans were $273.9 million, and commercial real estate plus construction loans represented 60.8% of total loans. Cash and cash equivalents rose 16.6% to $85.4 million.
  • Credit quality: The allowance for loan losses was $5.2 million, or 1.08% of gross loans, compared with $4.9 million, or 1.03%, in 2014. Net charge-offs were negative $68,000, reflecting net recoveries. Nonaccrual loans rose to $1.6 million from $866,000; loans over 90 days past due and still accruing rose to $2.0 million from $279,000. Total impaired loans were $12.9 million, with $3,000 of specific reserves.
  • Funding, debt and liquidity: Deposits increased 0.9% to $447.0 million, including non-interest-bearing deposits up 34.2% to $85.1 million. Brokered deposits rose to $48.2 million from $30.7 million. Total borrowings increased to $142.2 million from $128.2 million, including $132.0 million of FHLB advances, $8.2 million of junior subordinated debt and a $1.9 million note payable. All FHLB advances were due within one year. The reported liquidity ratio was 16.4%, versus 15.7%; management said short-term assets were sufficient for anticipated needs. The Bank reported $13.9 million of additional FHLB borrowing capacity.
  • Capital: At year-end, the Bank’s Tier 1 leverage, Common Equity Tier 1, Tier 1 risk-based and total risk-based capital ratios were 9.83%, 11.72%, 11.72% and 12.74%, respectively. These exceeded the stated “well-capitalized” thresholds. Shareholders’ equity rose to $61.5 million from $58.7 million.
  • Cash flow: Operating activities provided $5.9 million, compared with $22.5 million in 2014. Investing activities used $9.7 million, primarily reflecting loan growth and property and equipment purchases; financing activities provided $16.0 million, including $12.0 million of additional FHLB advances and $4.0 million of deposit growth. Cash and cash equivalents increased $12.1 million to $85.4 million.

Material changes versus 2014

  • Pretax income improved by $2.5 million, driven mainly by higher net interest income, but reported net income was substantially lower because 2014 included the large deferred-tax benefit.
  • Average loan balances increased, particularly commercial and commercial real estate loans; the loan portfolio shifted away from residential lending. Year-end residential loans fell by $25.7 million while commercial real estate loans increased by $19.3 million.
  • Non-interest-bearing deposits increased, while interest-bearing deposits declined, principally as time deposits ran off under the Bank’s deposit-pricing strategy. Brokered deposits and FHLB funding increased.
  • Nonaccrual balances and accruing loans more than 90 days past due increased, despite management’s broader assessment that classified assets and portfolio risk ratings had improved.
  • Premises and equipment increased by $7.1 million, reflecting property purchases, branch construction and technology investment. The Bank changed its name to Patriot Bank, N.A. in September 2015.

Outlook, risks and unusual items

The filing provides no specific earnings, revenue or margin guidance. Management attributed the return to profitability to restructuring and balance-sheet initiatives, including lower-cost funding, deposit repricing, expense reductions, exiting residential mortgage origination and purchasing certain branch properties. Management also cited improved portfolio risk ratings and increased non-interest-bearing deposits.

  • Key risks: Concentration in commercial real estate and construction lending; regional real estate and economic conditions; potential loan losses and allowance-estimation uncertainty; interest-rate and securities-value changes; deposit withdrawals and wholesale-funding availability; competition; regulatory and compliance costs; cybersecurity and vendor risks; and reliance on Bank dividends to fund parent-company obligations.
  • Regulatory status: The OCC terminated the Bank’s 2009 formal agreement in September 2014, citing satisfactory asset quality, liquidity, management and capital. The Bank remained subject to regulatory capital and dividend restrictions.
  • Internal controls: Management concluded disclosure controls and internal control over financial reporting were not effective at December 31, 2015 because of a material weakness in controls over accounting for loan prepayment fees receivable. One non-routine transaction led to improper revenue recognition in December; the error was corrected before the financial statements were issued, with no restatement or change to previously released results. Management initiated compensating controls and planned control-design improvements. The auditor did not attest to internal controls.
  • Tax asset: The company reported a $13.8 million net deferred tax asset, supported in part by forecasts of future taxable income and tax-loss carryforwards. Management cautioned that a future valuation allowance could be necessary if realization prospects deteriorate.
  • Other items: The Bank recorded a $250,000 loan-loss provision in 2015, attributed to loan growth. It also recorded a $133,000 noncash charge related primarily to abandoned leasehold improvements. No cash dividends were declared in 2015 or 2014. The 2014 earnings comparison is affected by the one-time deferred-tax valuation-allowance release and BOLI liquidation-related items.

Important facts for investors to verify

  • Reconcile the reported 2015 net income with pretax operating performance and the $16.8 million tax benefit recognized in 2014; assess the sustainability of earnings excluding that benefit.
  • Review the material weakness, the corrected prepayment-fee revenue error, remediation steps and any subsequent control-effectiveness disclosures.
  • Track past-due accruing loans, nonaccrual loans, impaired credits, criticized/classified assets and allowance coverage, especially in commercial real estate and construction.
  • Assess dependence on short-term FHLB advances, brokered deposits and deposit renewals, including the $132.0 million of FHLB advances reported due within one year.
  • Evaluate whether the $13.8 million deferred tax asset is realizable and whether future taxable income supports that assessment.
  • Confirm current regulatory capital and dividend restrictions, and the parent company’s ability to service its subordinated debt without Bank dividends.
  • Check the share-count disclosures: the cover reports 4,067,642 shares outstanding at February 29, 2016, while the year-end balance sheet reports 3,956,207 shares outstanding at December 31, 2015.