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PNBK > SEC Filings for PNBK > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for PATRIOT NATIONAL BANCORP INC | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for PATRIOT NATIONAL BANCORP INC


14-Nov-2012

Quarterly Report


Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations

"SAFE HARBOR" STATEMENT UNDER PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

Certain statements contained in Bancorp's public reports, including this report, and in particular in "Management's Discussion and Analysis of Financial Condition and Results of Operations," may be forward looking and subject to a variety of risks and uncertainties. These factors include, but are not limited to; (1) changes in prevailing interest rates which would affect the interest earned on Bancorp's interest earning assets and the interest paid on its interest bearing liabilities; (2) the timing of repricing of Bancorp's interest earning assets and interest bearing liabilities; (3) the effect of changes in governmental monetary policy; (4) the effect of changes in regulations applicable to Bancorp and the Bank and the conduct of its business; (5) changes in competition among financial service companies, including possible further encroachment of non-banks on services traditionally provided by banks; (6) the ability of competitors that are larger than Bancorp to provide products and services which it is impracticable for Bancorp to provide; (7) the state of the economy and real estate values in Bancorp's market areas, and the consequent effect on the quality of Bancorp's loans, customers, vendors and communities;
(8) recent governmental initiatives that are expected to have a profound effect on the financial services industry and could dramatically change the competitive environment of Bancorp; (9) other legislative or regulatory changes, including those related to residential mortgages, changes in accounting standards, and Federal Deposit Insurance Corporation ("FDIC") premiums that may adversely affect Bancorp.

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

CRITICAL ACCOUNTING POLICIES

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 the accounting for the allowance for loan losses, the analysis of its investment securities and the valuation of deferred income 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 of operations. They require management's most subjective and complex judgment as a result of the need to make an estimate about the effect of matters that are inherently uncertain. These accounting policies, including the nature of the estimates and types of assumptions used, are described throughout this Management's Discussion and Analysis.

Summary

Bancorp realized net income of $18,000 ($0.00 basic and diluted income per share) for the quarter ended September 30, 2012, compared to a net income of $255,000 ($0.01 basic and diluted loss per share) for the quarter ended September 30, 2011. For the nine-month period ended September 30, 2012, Bancorp realized net income of $909,000 ($0.02 basic and diluted income per share) compared to a net loss of $15.9 million ($0.41 basic and diluted loss per share) for the nine months ended September 30, 2011. The primary reason for the decrease in the quarterly comparison is the decline in interest and fees on loans of $652,000 due to the lower interest rate environment, partially offset by lower interest expense of $211,000. Gains on sale of investment securities increased $145,000, when compared to the same period last year, primarily due to the sale of government agency mortgage-backed securities and corporate bonds of $36.8 million and $3.3 million respectively. Operating expenses decreased $301,000, primarily due to lower salaries of $220,000 due to the ongoing impact of the prior year's reduction-in-force. Bancorp's net interest income for the quarter ended September 30, 2012 was $4.2 million compared to $4.9 million for the quarter ended September 30, 2011. Interest income and interest expense decreased by 13% and 11%, respectively, for the quarter ended September 30, 2012 compared to the quarter ended September 30, 2011. The significant decline in interest income is due primarily to the lower interest rate environment. The decline in interest expense is primarily due to the reduction of total deposits and substantially lower interest rates paid on term deposits.

Total assets decreased $50.5 million from $665.8 million at December 31, 2011 to $615.3 million at September 30, 2012. Cash and cash equivalents decreased $10.9 million from $55.4 million at December 31, 2011 to $44.5 million at September 30, 2012. Securities decreased $48.3 million from $76.2 million at December 31, 2011 to $27.9 million September 30, 2012. This decrease is primarily due to sales of $45.2 million of available for sale securities, comprised of $41.9 million of mortgage-backed securities and $3.3 million in corporate bonds. In addition, there were principal paydowns of $7.6 million on mortgage backed securities and $5.0 million from proceeds on a called government agency bond, partially offset by purchases of government agency bonds and mortgage backed securities of $7.5 million and $2.5 million, respectively. The net loan portfolio decreased $8.1 million from $501.2 million at December 31, 2011 to $493.1 million at September 30, 2012. This decrease is primarily a result of $81.2 million in sales of residential loans, partially offset with loan growth of $39.9 million and $31.8 million in commercial and residential real estate, respectively. Deposits decreased $61.0 million from $544.9 million at December 31, 2011 to $483.9 million at September 30, 2012. The Bank continued to reduce its concentration in high costs of certificates of deposit. The overall cost of deposits decreased from 1.28% at December 31, 2011 to 1.07% at September 30, 2012. Borrowings increased $10.0 million from $57.0 million at December 31, 2011 to $67.0 million at September 30, 2012.

FINANCIAL CONDITION

Cash and Cash Equivalents

Cash and cash equivalents decreased $10.9 million, or 20%, to $44.5 million at September 30, 2012 compared to $55.4 million at December 31, 2011. This decrease is primarily the result of the reduction in high cost term deposits.


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Investments

The following table is a summary of Bancorp's available-for-sale securities
portfolio, at fair value, at the dates shown:



                                                        September 30,        December 31,
                                                            2012                 2011
U.S. Government bonds                                  $     7,491,913       $   5,037,085
U.S. Government agency mortgage- backed securities           2,505,107          50,049,429
Corporate bonds                                              8,317,911          11,383,458

Total Available-for-Sale Securities                    $    18,314,931       $  66,469,972

Available-for-sale securities decreased $48.2 million, or 72%, from $66.5 million at December 31, 2011 to $18.3 million at September 30, 2012. This decrease is primarily due to sales of $41.9 million of government agency mortgage-backed securities and $3.3 million of corporate bonds, principal pay downs of $7.6 million on mortgage backed securities and $5.0 million in proceeds from a called government agency bond. These were partially offset by purchases of government agency bonds and mortgage-backed securities of $7.5 million and $2.5 million, respectively.

Loans

The following table is a summary of Bancorp's loan portfolio at the dates shown:



                                         September 30,       December 31,
                                              2012               2011
           Real Estate
           Commercial                    $  255,551,934      $ 215,659,837
           Residential                      138,666,279        188,108,855
           Construction                       6,213,797         12,306,922
           Construction to permanent          4,312,597         10,012,022
           Commercial                        41,100,960         31,810,735
           Consumer home equity              51,011,804         49,694,546
           Consumer installment               2,184,273          2,164,972

           Total Loans                      499,041,644        509,757,889
           Premiums on purchased loans          221,710            231,125
           Net deferred costs                   537,948            622,955
           Allowance for loan losses         (6,691,731 )       (9,384,672 )

           Loans receivable, net         $  493,109,571      $ 501,227,297


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Bancorp's net loan portfolio decreased $8.1 million, or 2%, from $501.2 million at December 31, 2011 to $493.1 million at September 30, 2012. The decrease is primarily a result of $81.2 million in residential loan sales, partially offset by new loan growth in residential mortgages of $31.8 million. Commercial real estate increased $39.9 million. There were increases in commercial loans of $9.3 million and consumer home equity loans of $1.3 million. These were partially offset with decreases in construction and construction to permanent of $6.1 million and $5.7 million, respectively.

At September 30, 2012, the net loan to deposit ratio was 102% and the net loan to total assets ratio was 80%. At December 31, 2011, these ratios were 92% and 76%, respectively.

Allowance for Loan Losses

The allowance for loan losses is established to provide for expected future losses based on the Bank's loss history and the application of qualitative risk adjustment factors to compensate for estimated differences between anticipated potential losses and those predicted by the bank's specific loss history. The allowance is established 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 $2.7 million from December 31, 2011 to September 30, 2012 primarily due to a reduction in loan balances, improved credit quality of the loan portfolio and a change in methodology in estimating the allowance as described more fully below. These factors resulted in a release of excess reserves of $2.6 million after net charge-offs of $134,000.

As of the first quarter of 2012, the Bank had used a 12 quarter un-weighted average to calculate loss history. Beginning in the second quarter of 2012, the Bank implemented changes to the allowance methodology, resulting in a reduction of the allowance for loan losses of $1.1 million. In making this transition, the changes serve to update and enhance the methodology to better reflect the direction of the current loan portfolio. The changes are threefold:

First, the Bank adopted a two year, instead of a three year, weighted average historical loss factor as the basis for the calculation of its historical loss experience. This is used to calculate expected losses in the ASC 450-20 pools prior to the application of qualitative risk adjustment factors. Weightings were allocated 59% to the last four quarters and 41% to the previous four quarters. This change was made to be more responsive to the changing credit environment. Net charge-offs have declined, especially in 2012 when they averaged $76,000 per quarter. This shorter average historical loss period will produce results more indicative of the current and expected behavior of the portfolio.

Second, the Bank adopted an Internal Risk Ratings Based (IRB) approach to calculating historical loss rates. This approach calibrates expected losses with actual risk assessment and equates the likelihood of loss to the level of risk in a credit facility rating. All loans are reviewed annually. Similarly, the Loan Committee can adjust a risk rating. Previously, loss history was applied to categories of loans and qualitative adjustments were apportioned by risk rating within the categories.

Third, the Bank increased the detail of analysis within the segments, particularly within Commercial Real Estate lending, which is currently the Bank's largest concentration overall, by expanding the number of ASC 450-20 pools. In all, ten sub-concentrations have been added to the analysis. The greater level of detail enables the Bank to better apply qualitative risk adjustment factors to the segments affected and to monitor changes in credit risk within the portfolio.


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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. Any interest paid 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, troubled debt restructurings and loans that were previously classified as TDRs that have been upgraded, 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.

The changes in the allowance for loan losses for the periods shown are as follows:

                                                  Three months ended                               Nine months ended
                                        September 30,            September 30,           September 30,           September 30,
(Thousands of dollars)                       2012                    2011                    2012                    2011
Balance at beginning of period         $          6,674         $        11,400         $         9,385         $        15,374
Charge-offs                                          (4 )                  (218 )                  (197 )                (7,406 )
Recoveries                                           22                      16                      63                     780

Net Charge-offs                                      18                    (202 )                  (134 )                (6,626 )

Transferred to loans
held-for-sale                                        -                      (40 )                    -                   (6,054 )
Provision charged to operations                      -                       -                   (2,559 )                 8,464

Balance at end of period               $          6,692         $        11,158         $         6,692         $        11,158

Ratio of net charge-offs during
the period to average loans
outstanding during the period                      0.00 %                  0.04 %                  0.03 %                  1.36 %

Ratio of ALLL / Gross Loans                        1.34 %                  2.40 %                  1.34 %                  2.40 %

Based upon the overall assessment and evaluation of the loan portfolio, management believes the allowance for loan losses of $6.7 million, at September 30, 2012, which represents 1.34% of gross loans outstanding, is adequate under prevailing economic conditions, to absorb existing losses in the loan portfolio.


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Non-Accrual, Past Due and Restructured Loans

The following table presents non-accruing loans and loans past due 90 days or
more and still accruing:



                                                September 30,        December 31,
  (Thousands of dollars)                            2012                 2011
  Loans past due over 90 days still accruing   $         2,498      $        9,461
  Non accruing loans                                    30,020              20,683

  Total                                        $        32,518      $       30,144

  % of Total Loans                                        6.51 %              5.91 %
  % of Total Assets                                       5.28 %              4.53 %

Loans delinquent over 90 days and still accruing aggregating $2.5 million are comprised of seven loans, all of which have matured and continue to make payments. Six of these loans are currently in the process of being renewed and one has since been renewed. Impaired loans, which are comprised of non-accruing loans, troubled debt restructured loans, and loans previously classified as TDRs that have been upgraded, increased by $4.4 million to $39.1 million for the quarter ended September 30, 2012 and increased $2.3 million for the nine months ended September 30, 2012. Impaired loans are attributable to the lingering effects of the downturn in the economy, which has severely impacted the real estate market and placed unprecedented stress on credit markets. The Bank's customers, many of whom are associated with the financial services industry, have been affected by the impact of the poor economy on employment and real estate values.

The $30.0 million of non-accrual loans at September 30, 2012 is comprised of twenty-seven loans, for which a specific reserve of $806,000 has been established. In all cases, the Bank has obtained appraisal reports from independent licensed appraisal firms and discounted those values for estimated selling costs to determine estimated impairment. Of the $30.0 million of non-accrual loans at September 30, 2012 borrowers of three loans with aggregate balances of $3.8 million continue to make loan payments and these loans are current within one and two months as to payments.

Potential Problem Loans

In addition to the above, there are $24.4 million of substandard accruing loans comprised of twenty-two loans and $32.3 million of special mention loans comprised of thirty-nine loans for which management has a concern as to the ability of the borrowers to comply with the present repayment terms. All but $3.5 million of the substandard accruing loans and $7.9 million of the special mention loans continue to make timely payments and are within 30 days at September 30, 2012.


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Other Real Estate Owned

The following table is a summary of Bancorp's other real estate owned at the
dates shown:



                                        September 30,       December 31,
                                            2012                2011
            Residential construction   $     1,252,024     $    1,140,560
            Commercial                              -           1,622,080

            Other real estate owned    $     1,252,024     $    2,762,640

The balance of other real estate owned at September 30, 2012 is comprised of one property with an aggregate carrying value of $1.3 million that was obtained through loan foreclosure proceedings. During the nine months ended September 30, 2012, three OREO properties were sold with an aggregate carrying value of $1.9 million.

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 the Company at September 30, 2012. The deferred tax position has been affected by several significant transactions in the prior years. These transactions include increased provision for loan losses, the 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 September 30, 2012, 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 $13.7 million against its deferred tax asset at September 30, 2012. The valuation allowance is analyzed quarterly for changes affecting the deferred tax asset. In the future, if 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.


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Deposits

The following table is a summary of Bancorp's deposits at the dates shown:



                                               September 30,      December 31,
                                                    2012              2011
       Non-interest bearing                    $   59,309,584     $  65,613,374

       Interest bearing
       NOW                                         24,859,524        24,396,210
       Savings                                     70,807,709        59,396,310
       Money market                                44,092,847        52,889,642
       Time certificates, less than $100,000      166,654,722       198,207,998
       Time certificates, $100,000 or more        118,228,921       144,405,859

       Total interest bearing                     424,643,723       479,296,019

       Total Deposits                          $  483,953,307     $ 544,909,393

Total deposits decreased $61.0 million, or 11%, from $544.9 million at December 31, 2011 to $483.9 million at September 30, 2012. Interest bearing accounts decreased $54.7 million. This was primarily due to decreases in certificates of deposit (CD's) of $57.7 million and money market accounts of $8.8 million due to the low interest rate environment and the planned reduction of higher cost deposit accounts. These were partially offset by increases of $11.4 million and $463,000 respectively in savings and NOW accounts. Demand deposits decreased $6.3 million primarily as a result decreases in commercial and personal checking accounts of $5.2 million and $1.1 million, respectively.

Borrowings

At September 30, 2012, total borrowings increased $10.0 million to $67.0 million from $57.0 million at December 31, 2011. In addition to the outstanding borrowings disclosed in the consolidated balance sheet, the Bank has the ability to borrow approximately $45.0 million in additional advances from the Federal Home Loan Bank of Boston, including a $2.0 million overnight line of credit. The Bank has also established a line of credit at the Federal Reserve Bank.

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, provides a full and unconditional guarantee of amounts on the capital securities. The subordinated debentures, which bear interest at three-month LIBOR plus 3.15% (3.517250% at September 30, 2012), matures 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. The deferral in the third quarter of 2012 represented the fourteenth consecutive quarter of deferral. The Company continues to accrue and charge interest to operations. The Company may defer the payment of interest through March 2014, and all accrued interest must be paid at the completion of the deferral period, June 2014.


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Capital

Capital increased $583,000 compared to December 31, 2011 primarily as a result of the net income earned of $909,000 for the nine months ended September 30, 2012, partially offset the by the change in other comprehensive income.

Off-Balance Sheet Arrangements

Bancorp's off-balance sheet arrangements, which primarily consist of commitments to lend, decreased by $52.5 million from $140.4 million at December 31, 2011 to $87.9 million at September 30, 2012, due to decreases of $71.0 million in future loan commitments, partially offset by increases of $16.2 million in unused lines of credit. The decrease in future loan commitments was primarily due to the closings in the first quarter of 2012 of the loan originations from the fourth quarter of 2011.


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RESULTS OF OPERATIONS

Interest and dividend income and expense

The following tables present average balance sheets (daily averages), interest
income, interest expense and the corresponding yields earned and rates paid for
major balance sheet components:



                                                                   Three months ended September 30,
                                                          2012                                         2011
                                                         Interest                                     Interest
. . .
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