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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
COMMISSION FILE NO.: 0-26744
PATRIOT BANK CORP.
(Exact name of Registrant as specified in its charter)
PENNSYLVANIA 23-2820537
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
HIGH AND HANOVER STREETS, POTTSTOWN, PENNSYLVANIA 19464
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (610) 323-1500
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, NO PAR VALUE
(Title of class)
The registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days. Yes H. No h.
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. h
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes h. No H.
The aggregate market value of the voting stock held by non-affiliates
of the registrant, i.e., persons other than directors and executive officers of
the registrant is $91,862,851 and is based upon the last sales price of $16.35
per share as quoted on The Nasdaq Stock Market for March 3, 2003.
As of March 3, 2003, the Registrant had 6,136,577 shares outstanding
(excluding treasury shares).
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement for the 2003
Annual Meeting of Shareholders are incorporated by reference into Part III of
this Form 10-K.
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INDEX
PAGE
PART I
Item 1. Business..................................................................................... 1
Item 2. Properties................................................................................... 8
Item 3. Legal Proceedings............................................................................ 8
Item 4. Submission of Matters to a Vote of Security Holders.......................................... 8
Item 4A. Executive Officers of the Registrant......................................................... 9
PART II
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters........................ 9
Item 6. Selected Financial Data...................................................................... 11
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations........ 13
Item 7A. Quantitative and Qualitative Disclosures About Market Risk................................... 35
Item 8. Financial Statements and Supplementary Data ................................................. 36
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure..................................................................... 74
PART III
Item 10. Directors and Executive Officers of the Registrant .......................................... 74
Item 11. Executive Compensation....................................................................... 74
Item 12. Security Ownership of Certain Beneficial Owners and Management............................... 74
Item 13. Certain Relationships and Related Transactions............................................... 74
Item 14. Controls and Procedures...................................................................... 74
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K ............................ 75
SIGNATURES ..................................................................................................... 76
CERTIFICATIONS.................................................................................................. 77
PART I
ITEM 1. BUSINESS
GENERAL
Patriot Bank Corp. (the "Company") is a Pennsylvania corporation and a
financial holding company for Patriot Bank (the "Bank") and Patriot Investment
Company ("PIC"). The Company is subject to regulation by the Board of Governors
of the Federal Reserve System (the "FRB"). Originally organized as a Delaware
corporation, the Company became a Pennsylvania corporation as a result of its
consolidation with First Lehigh Corporation on January 22, 1999. The Company's
executive offices are located at the corporate offices of the Bank at High and
Hanover Streets, Pottstown, Pennsylvania 19464.
The Bank was founded in 1905. In 1991, the Bank's predecessor converted
from a federally-chartered mutual savings bank to a Pennsylvania-chartered
mutual savings bank and changed its name to Patriot Savings Bank. In August
1995, the Bank converted from a Pennsylvania-chartered mutual savings bank to a
federally-chartered mutual savings bank. On December 1, 1995, the Company
acquired the Bank as part of the Bank's conversion from a mutual to stock form
of ownership (the "Conversion"). In connection with the Conversion, the Bank
changed its name to Patriot Bank. On May 23, 1997, the Bank converted to a
Pennsylvania-chartered commercial bank. In 2003 the bank became a member of the
Federal Reserve. The Bank conducts business through its network of 17 community
banking offices located in Berks, Chester, Lehigh, Montgomery and Northampton
counties, Pennsylvania. The majority of the Bank's deposits are insured by the
Savings Association Insurance Fund ("SAIF") and administered by the Federal
Deposit Insurance Corp. ("FDIC"). As a result of its acquisition of First Lehigh
Bank, the acquired deposits are insured by the Bank Insurance Fund ("BIF")
administered by the FDIC. At December 31, 2002, the Bank had total assets of
$996 million, deposits of $519 million and shareholder's equity of $85 million.
The Bank is a community-oriented financial services provider whose
business primarily consists of attracting deposits from the general public,
small businesses and other enterprises and originating commercial loans and
leases, consumer loans, and mortgage loans in the Bank's market area. The bank
also sells non-deposit investment products to consumers and invests in
investment and mortgage-backed securities. In addition to deposits, the Bank
uses advances from the Federal Home Loan Bank of Pittsburgh ("FHLB") and
repurchase agreements as sources of funds.
The Bank's revenues are derived principally from interest and fees on
loans and leases, interest on investment and mortgage-backed securities and
other fees and service charges. Additional revenues are derived from the sale of
certain leases, mortgage loans and investments as well as the sale of
non-deposit investment products to consumers. The Bank's primary sources of
funds are deposits, FHLB advances, repurchase agreements, interest on loans and
investment and mortgage-backed securities and principal repayments on loans and
leases, and investment and mortgage-backed securities.
PIC is a Delaware investment corporation that was incorporated by the
Company on September 10, 1996. Its primary business consists of maintaining an
investment portfolio. At December 31, 2002, PIC had total assets of $960,000 and
shareholder's equity of $960,000.
In January 2003 the company acquired Bonds and Paulus Inc. a registered
investment advisor and Pension Benefits Inc. a third party administrator and
registered investment advisor and merged those companies into Patriot Advisors,
a wealth management division of the company. Patriot Advisors has approximately
$250 million of assets under management.
MARKET AREA AND COMPETITION
The Company is headquartered approximately 45 miles northwest of
Philadelphia, Pennsylvania and its market consists primarily of Berks, Chester,
Lehigh, Montgomery and Northampton counties in Pennsylvania. The segment of the
markets served by the Company are primarily service and trade oriented and
demographically are comprised of middle income and upper income households.
The Company faces significant competition both in originating loans,
attracting deposits and managed assets. The Company's competitors are other
financial service providers operating within its primary market area, some of
which are larger and have greater financial resources than the Company. The
Company's competition for loans and deposits
1
comes principally from commercial banks, savings and loan associations, savings
banks, credit unions, and mortgage banking companies (some of which are
subsidiaries of major financial institutions). In addition, the Company faces
increasing competition for managed assets from non-bank institutions such as
brokerage firms and insurance firms with investment and other products such as
money market funds, mutual funds and annuities. Management considers the
Company's community-oriented reputation, superior customer service and personal
relationships, convenience and product offerings as a competitive advantage in
attracting and retaining customers.
SUBSIDIARY ACTIVITIES
The Company has two wholly-owned subsidiaries: The Bank and PIC. The
Bank has three wholly-owned subsidiaries: Patriot Commercial Leasing Co., Inc.
("PCLC"), Patriot Advisors and Marathon Management Company, Inc. ("Marathon").
PCLC is a small-ticket commercial leasing company. At December 31, 2002, PCLC
had total assets of $77,931,000 and generated total revenues of $8,700,000 for
the year ended December 31, 2002. Patriot Advisors markets certain non-deposit
investment products. At December 31, 2002, Patriot Advisors had total assets of
$747,000 and generated fee income of $294,000 for the year ended December 31,
2002. Marathon provides title insurance services through a joint venture
partnership. At December 31, 2002, Marathon had total assets of $295,000 and
generated fee income of $43,000 for the year ended December 31, 2002.
PERSONNEL
As of December 31, 2002, the Company had 242 employees (including 13
part-time employees, adjusted to include the employees from the January 2003
acquisitions of Bonds and Paulus Inc. and Pension Benefits Inc., none of whom
was covered by a collective bargaining agreement). Management believes that the
Bank has good relations with its employees and there are no pending or
threatened labor disputes with its employees.
REGULATION AND SUPERVISION
GENERAL. The Company, as a registered financial holding company, is
required to file certain reports with, and otherwise comply with the rules and
regulations of, the FRB under the Bank Holding Company Act, as amended (the
"BHCA"). In addition, the activities of Pennsylvania-chartered commercial banks,
such as the Bank, are governed by the Pennsylvania Banking Code and the Federal
Deposit Insurance Act ("FDI Act").
In the first quarter of 2003 the Bank was approved and became a member
of the FRB. Becoming a member of the FRB changed the Bank's primary federal
regulator from the FDIC to the FRB.
The Bank is subject to extensive regulation and supervision by the
Federal Reserve System (the "FRB"), and the Pennsylvania Department of Banking
("PDB"). The Bank is a member of the Federal Home Loan Bank ("FHLB") System.
Certain of the Bank's deposits are insured by the BIF while most of its deposit
accounts are insured by the SAIF. The Bank must file reports with the PDB and
the FRB concerning its activities and financial condition in addition to
obtaining regulatory approvals prior to entering into certain transactions such
as mergers with, or acquisitions of, other banking institutions. The PDB and the
FRB conduct periodic examinations to test the Bank's safety and soundness and
compliance with various regulatory requirements. This regulation and supervision
establishes a comprehensive framework of activities in which an institution can
engage and is intended primarily for the protection of the insurance fund and
depositors. The regulatory structure also gives the regulatory authorities
extensive discretion in connection with their supervisory and enforcement
activities and examination policies, including policies with respect to the
classification of assets and the establishment of adequate loan loss reserves
for regulatory purposes. Any change in such regulatory requirements and
policies, whether by the FRB, the FDIC or the Congress, could have a material
adverse impact on the Company, the Bank and their operations. Certain of the
regulatory requirements applicable to the Bank and to the Company are referred
to below or elsewhere herein. The description of statutory provisions and
regulations applicable to banking institutions and their holding companies set
forth in this Form 10-K does not purport to be a complete description of such
statutes and regulations and their effects on the Bank and the Company.
2
HOLDING COMPANY REGULATION. The Company is a financial holding company
registered under the BHCA. As a financial services holding company, the
Company's activities and those of the Bank are limited to the business of
banking and activities closely related or incidental to banking.
The BHCA prohibits a financial holding company, directly or indirectly,
or through one or more subsidiaries, from acquiring more than 5% of the voting
stock of another banking institution or holding company thereof, without prior
written approval of the FRB; acquiring or retaining, with certain exceptions,
more than 5% of a nonsubsidiary company engaged in activities other than those
permitted by the BHCA; or acquiring or retaining control of a depository
institution that is not insured by the FDIC.
Under FRB policy, a financial holding company is expected to act as a
source of financial strength to its subsidiary bank and to commit resources to
support its subsidiary bank, i.e., to downstream funds to its subsidiary bank.
This support may be required at times when, absent such policy, the financial
holding company might not otherwise provide such support. Any capital loans by a
financial holding company to its subsidiary bank are subordinate in right of
payment to deposits and to certain other indebtedness of its subsidiary bank. In
the event of a financial services holding company's bankruptcy, any commitment
by the financial services holding company to a federal bank regulatory agency to
maintain the capital of its subsidiary bank will be assumed by the bankruptcy
trustee and entitled to a priority of payment.
The Gramm-Leach-Bliley Act was enacted in 1999. The Gramm-Leach-Bliley
Act amended the BHCA and created a new category of bank holding company called a
"financial holding company." In order to become a financial holding company a
bank holding company must notify the FRB that it elects to be a financial
holding company. A bank holding company can make this election if it, and all
its bank subsidiaries, are well capitalized, well managed, and have at least a
satisfactory Community Reinvestment Act ("CRA") rating, each in accordance with
the definitions prescribed by the FRB and the regulators of the subsidiary
banks. The Gramm-Leach-Bliley Act provides a list of activities that are defined
as being financial in nature:
- Lending and deposit activities
- Issuance and sale of money orders, travelers' checks and U.S. savings
bonds
- Financial advisory services
- Consumer financial counseling services
- Tax planning and preparation advice
- Insurance activities, including underwriting
- Insurance company portfolio investment
- Merchant banking
- Investments of equity or debt in corporations or projects for the
promotion of community welfare
Once a bank holding company becomes a financial holding company, the
holding company or its affiliates may engage in any financial activities that
are financial in nature as determined by the FRB by simply giving notice to the
FRB within thirty days after beginning such business or acquiring a company
engaged in such business. This makes the regulatory approval process to engage
in financial activities much more streamlined than it was under prior law.
In addition to the foregoing provisions of this law, this legislation
also made a number of additions and revisions to numerous federal laws that
affect the business of banking. There is now a federal law on privacy with
respect to customer information held by banks. Federal banking regulators are
authorized to adopt rules regarding privacy for customer information. Banks must
establish a disclosure policy for non-public customer information, disclose the
policy to their customers, and give their customers the opportunity to object to
non-public information being disclosed to a third party. Also, the CRA has been
amended by this law to provide that small banks (those under $250 million in
assets) that previously received an "outstanding" on their last CRA exam will
not have to undergo another CRA exam for five years or for four years if their
last exam was "satisfactory." In addition, any CRA agreement entered into
between a bank and a community group must be disclosed, with both the bank and
the community group detailing the amount of funding provided and its purpose.
This law also requires a bank's policy on fees for transactions at Automated
Teller Machines ("ATM") for non-customers to be conspicuously posted on the ATM.
A number of other provisions affecting other general regulatory requirements for
banking institutions were also adopted.
3
The Sarbanes-Oxley Act of 2002 ("SOA") was signed into law on July 30,
2002. The stated goals of the SOA are to increase corporate responsibility, to
provide for enhanced penalties for accounting and auditing improprieties at
publicly traded companies and to protect investors by improving the accuracy and
reliability of corporate disclosures pursuant to the securities laws.
The SOA generally applies to all companies, both U.S. and non-U.S.,
that file or are required to file periodic reports with the Securities and
Exchange Commission ("SEC") under the Securities Exchange Act of 1934, (the
"Exchange Act"). Given the extensive SEC role in implementing rules relating to
many of the SOA's new requirements, the final scope of these requirements
remains to be determined.
The SOA includes very specific additional disclosure requirements and
new corporate governance rules, requires the SEC and securities exchanges to
adopt extensive additional disclosure, corporate governance and other related
rules and mandates further studies of specified issues by the SEC and the
Comptroller General. The SOA allows federal oversight in matters traditionally
left to state regulatory systems, such as the regulation of the accounting
profession, and to state corporate law, the relationships between the board of
directors and management and between the board of directors and its committees.
The SOA addresses, among other matters:
- The role and responsibilities of audit committees
- Certification of financial statements by the chief executive officer
and the chief financial officer
- The forfeiture of bonuses or other incentive-based compensation and
profits from the sale of an issuer's securities by directors and
senior officers in the twelve month period following initial
publication of any financial statements that later require
restatement
- Prohibitions on insider trading during employee benefit plan black
out periods
- Disclosure of off-balance sheet transactions
- Prohibitions on personal loans to directors and officers, except in
the case of financial institutions to the extent any loans comply
with federal banking regulations
- Expedited filing requirements for Forms 4s, Statement of Changes in
Beneficial Ownership
- Disclosure of a code of ethics and filing a Form 8-K for a change or
waiver of such code
- "Real time" filing of periodic reports
- The formation of a public accounting oversight board
- Auditor independence
- Various increased criminal penalties for violations of securities
laws
The SOA contains provisions that became effective upon enactment on
July 30, 2002, and provisions that will become effective from within 30 days to
one year from enactment. The SEC has been delegated the task of enacting rules
to implement various provisions with respect to, among other matters, disclosure
in periodic filings pursuant to the Exchange Act.
CAPITAL REQUIREMENTS. The FRB has adopted risk-based capital guidelines
for financial holding companies, such as the Company. The required minimum ratio
of total capital to risk-weighted assets (including off-balance sheet
activities, such as standby letters of credit) is 8.0%. At least half of the
total capital is required to be "Tier 1 capital," consisting principally of
common shareholders' equity, noncumulative perpetual preferred stock and
minority interests in the equity accounts of consolidated subsidiaries, less
certain intangible assets. The remainder ("Tier 2 capital") may consist of a
limited amount of subordinated debt and intermediate-term preferred stock,
certain hybrid capital instruments and other debt securities, perpetual
preferred stock, and a limited amount of the allowance for credit losses.
In addition to the risk-based capital guidelines, the FRB established
minimum leverage ratio (Tier 1 capital to average total assets) guidelines for
financial holding companies. These guidelines provide for a minimum leverage
ratio of 3% for those financial holding companies which have the highest
regulatory examination ratings and are not contemplating or experiencing
significant growth or expansion. All other financial holding companies are
required to maintain a leverage ratio of at least 1% to 2% above the 3% stated
minimum. The Company is in compliance with these guidelines. The Bank is subject
to similar capital requirements adopted by the FDIC. The risk-based capital
standards are required to take adequate account of interest rate risk,
concentration of credit risk and the risks of non-traditional activities.
4
Under the FDIC prompt corrective action regulations, the FDIC is
required to take certain supervisory actions against undercapitalized
institutions, the severity of which depends upon the institution's degree of
undercapitalization. Generally, a bank is considered "well capitalized" if its
ratio of total capital to risk-weighted assets is at least 10%, its ratio of
Tier I (core) capital to risk-weighted assets is at least 6%, its ratio of core
capital to total assets (tier 1 leverage ratio) is at least 5%, and it is not
subject to any order or directive by the FDIC to meet a specific capital level.
A bank generally is considered "adequately capitalized" if its ratio of total
capital to risk-weighted assets is at least 8%, its ratio of Tier I (core)
capital to risk-weighted assets is at least 4%, and its ratio of core capital to
total assets is at least 4% (3% if the institution receives the highest CAMEL
rating). A bank that has lower ratios of capital is categorized as
"undercapitalized," "significantly under capitalized," or "critically
undercapitalized." Subject to a narrow exception, the banking regulator is
required to appoint a receiver or conservator for an institution that is
"critically undercapitalized." The regulation also provides that a capital
restoration plan must be filed with the FDIC within 45 days of the date a bank
receives notice that it is "undercapitalized," "significantly undercapitalized"
or "critically undercapitalized." Compliance with the plan must be guaranteed by
any parent holding company. In addition, numerous mandatory supervisory actions
become immediately applicable to an undercapitalized institution, including, but
not limited to, increased monitoring by regulators and restrictions on growth,
capital distributions and expansion. The FDIC could also take any one of a
number of discretionary supervisory actions, including the issuance of a capital
directive and the replacement of senior executive officers and directors.
At December 31, 2002, both the Company and the Bank were "well
capitalized."
INSURANCE OF DEPOSIT ACCOUNTS. Although most of the deposits of the
Bank are presently insured by the SAIF, certain of its deposits are insured by
the BIF. Both the BIF and the SAIF are statutorily required to maintain a ratio
of reserves to insured deposits of 1.25%. Both the BIF and the SAIF currently
exceed the 1.25% ratio. Currently, the Bank does not pay any deposit insurance
premiums; however, this could change. In 2002, the FDIC disclosed that it
anticipated the BIF fund would decline below a 1.25% ratio triggering an
increase in deposit insurance premiums or a one time assessment. As of December
31, 2002 the fund had not declined below the 1.25% ratio. If the 1.25% ratio is
not met, the FDIC must assess deposit insurance premiums and also may impose
premiums on under-capitalized or unsafe institutions.
All institutions are assessed for payment of the FICO bonds, which were
issued to finance regulatory resolution of insolvency that occurred in the late
1980s and early 1990s. Full pro rata sharing of the FICO payments between BIF
and SAIF members began on January 1, 2000. The FDIC resets the FICO assessment
rate each calendar quarter. The current annual rate is $0.168 per each $1,000 of
deposits.
Under the FDI Act, insurance of deposits may be terminated by the FDIC
upon a finding that the institution has engaged in unsafe or unsound practices,
is in an unsafe or unsound condition to continue operations or has violated any
applicable law, regulation, rule, order or condition imposed by the FDIC. The
management of the Bank does not know of any practice, condition or violation
that might lead to termination of deposit insurance.
LOANS TO ONE BORROWER. Applicable regulations limit the dollar amount
of loans that the Bank may have outstanding to any one borrower, or group of
affiliated borrowers, to 15% of the capital and surplus of the Bank. As of
December 31, 2002, this limitation was equal to $12.7 million. There are
exceptions from the limitation for certain secured loans, depending upon the
amount and type of collateral.
LIMITATION ON CAPITAL DISTRIBUTIONS. Dividend payments by the Bank to
the Company are subject to the Pennsylvania Banking Code of 1965 and the FDI
Act. Under the Pennsylvania Banking Code, no dividends may be paid except from
"accumulated net earnings" (generally, undivided profits). Under the FDI Act, no
dividends may be paid by an insured bank if the bank is in arrears in the
payment of any insurance assessment due to the FDIC. Under current banking laws,
the Bank would be limited to approximately $31.4 million of dividends in 2003
plus an additional amount equal to the Bank's net profit for 2003, up to the
date of any such dividend declaration.
State and federal regulatory authorities have adopted standards for the
maintenance of adequate levels of capital by banks. Adherence to such standards
further limits the ability of the Bank to pay dividends to the Company.
INTERSTATE BANKING. The Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 (the "Interstate Banking Law") amended various federal
banking laws to provide for nationwide interstate banking, interstate bank
mergers and interstate branching. The interstate banking law allows for the
acquisition by a bank holding company of a bank located in another state.
5
TRANSACTIONS WITH RELATED PARTIES. The Bank's authority to engage in
transactions with related parties or "affiliates" (e.g., any company that
controls or is under common control with an institution, including the Company
and its non-banking subsidiaries) is limited by Sections 23A and 23B of the
Federal Reserve Act ("FRA"). Section 23A limits the aggregate amount of covered
transactions with any individual affiliate to 10% of the capital and surplus of
the Bank. The aggregate amount of covered transactions with all affiliates is
limited to 20% of the Bank's capital and surplus. Certain transactions with
affiliates are required to be secured by collateral in an amount and of a type
described in Section 23A, and the purchase of low quality assets from affiliates
is generally prohibited. Section 23B generally provides that certain
transactions with affiliates, including loans and asset purchases, must be on
terms and under circumstances, including credit standards, that are
substantially the same or at least as favorable to the institution as those
prevailing at the time for comparable transactions with non-affiliated
companies. In addition, banks are prohibited from lending to any affiliate that
is engaged in activities that are not permissible for bank holding companies and
no bank may purchase the securities of any affiliate other than a subsidiary.
The Bank's authority to extend credit to executive officers, directors
and 10% shareholders ("insiders"), as well as entities such persons control, is
governed by Sections 22(g) and 22(h) of the FRA and Regulation O thereunder.
Among other things, such loans are required to be made on terms substantially
the same as those offered to unaffiliated individuals and to not involve more
than the normal risk of repayment. There is an exception for loans made pursuant
to a benefit or compensation program that is widely available to all employees
of the institution and does not give preference to insiders over other
employees. Regulation O also places individual and aggregate limits on the
amount of loans the Bank may make to insiders based, in part, on the Bank's
capital position and requires certain board approval procedures to be followed.
ENFORCEMENT. Under the FDI Act, the FRB has primary enforcement
responsibility over state member banks and has the authority to bring actions
against the institution and all institution-affiliated parties, including
shareholders, and any attorneys, appraisers and accountants who knowingly or
recklessly participate in wrongful action likely to have an adverse effect on an
insured institution. Formal enforcement action may range from the issuance of a
capital directive or cease and desist order and removal of officers and/or
directors to institution of receivership or conservatorship or termination of
deposit insurance. Civil penalties cover a wide range of violations and can
amount to $25,000 per day, or even $1 million per day in especially egregious
cases. Federal law also establishes criminal penalties for certain violations.
STANDARDS FOR SAFETY AND SOUNDNESS. The federal banking agencies have
adopted Interagency Guidelines Prescribing Standards for Safety and Soundness
("Interagency Guidelines") and a final rule to implement safety and soundness
standards required under the FDI Act. The Interagency Guidelines set forth the
safety and soundness standards that the federal banking agencies use to identify
and address problems at insured depository institutions before capital becomes
impaired. The standards set forth in the Interagency Guidelines address internal
controls and information systems; internal audit system; credit underwriting;
loan documentation; interest rate risk exposure; asset growth; and compensation,
fees and benefits. If the appropriate federal banking agency determines that an
institution fails to meet any standard prescribed by the Interagency Guidelines,
the agency may require the institution to submit to the agency an acceptable
plan to achieve compliance with the standard, as required by the FDI Act. The
final rule establishes deadlines for the submission and review of such safety
and soundness compliance plans when such plans are required.
FEDERAL RESERVE SYSTEM. FRB regulations require depositary institutions
to maintain non-interest earning reserves against their transaction accounts
(primarily NOW and regular checking accounts). During fiscal 2002, FRB
regulations generally required that reserves be maintained against aggregate
transaction accounts as follows: for accounts aggregating $41.3 million or less
(subject to adjustment by the FRB) the reserve requirement is 3%; and for
accounts aggregating greater than $41.3 million, the reserve requirement is
$1.068 million plus 10% (subject to adjustment by the FRB between 8% and 14%)
against that portion of total transaction accounts in excess of $41.3 million.
The first $5.7 million of otherwise reservable balances (subject to adjustments
by the FRB) were exempted from the reserve requirements. The Bank is in
compliance with the foregoing requirements. The balances maintained to meet the
reserve requirements imposed by the FRB may be used to satisfy liquidity
requirements imposed by the FDIC.
6
FEDERAL AND STATE TAXATION
Federal Taxation
GENERAL. The Company and its subsidiaries report their income on a
consolidated basis using the accrual method of accounting and are subject to
federal income taxation in the same manner as other corporations with some
exceptions, including particularly the Bank's reserve for bad debts. As a large
commercial bank, the Bank is permitted to recognize bad debt expense based on
actual charge-offs. For its 2002 taxable year, the Company is subject to a
maximum federal income tax rate of 34%.
DISTRIBUTIONS. Under the Small Business Job Protection Act of 1996, if
the Bank makes "non-dividend distributions" to the Company, such distributions
will be considered to have been made from the Bank's unrecaptured tax bad debt
reserves (including the balance of its reserves as of December 31, 1987) to the
extent thereof, and then from the Bank's supplemental reserve for losses on
loans, to the extent thereof, and an amount based on the amount distributed (but
not in excess of the amount of such reserves) will be included in the Bank's
income. Non-dividend distributions include distributions in excess of the Bank's
current and accumulated earnings and profits, as calculated for federal income
tax purposes, distributions in redemption of stock, and distributions in partial
or complete liquidation. Dividends paid out of the Bank's current or accumulated
earnings and profits will not be included in the Bank's income.
The amount of additional taxable income triggered by a non-dividend is
an amount that, when reduced by the tax attributable to the income, is equal to
the amount of the distribution. Thus, if the Bank makes a non-dividend
distribution to the Company, approximately one and one-half times the amount of
such distribution (but not in excess of the amount of such reserves) would be
included in income for federal income tax purposes, assuming a 34% federal
corporate income tax rate. The Bank does not intend to pay dividends that would
result in a recapture of any portion of its bad debt reserves.
CORPORATE ALERNATIVE MINIMUM TAX. The Internal Revenue Code of 1986, as
amended (the "Code") imposes a tax on a corporation's Alternative Minimum
Taxable Income ("AMTI") at a rate of 20% if such Alternative Minimum Tax ("AMT")
exceeds the income tax the corporation would otherwise pay for the taxable year.
Only 90% of AMTI can be offset by net operating loss carryovers. AMTI is
increased by an amount equal to 75% of the amount by which the Bank's adjusted
current earnings exceeds its AMTI (determined without regard to this preference
and prior to reduction for net operating losses). The Bank does not typically
expect to be subject to the AMT.
DIVIDENDS RECEIVED DEDUCTION AND OTHER MATTERS. The Company may exclude
from its income 100% of dividends received from the Bank as a member of the same
affiliated group of corporations. The corporate dividends received deduction is
generally 70% in the case of dividends received from unaffiliated corporations,
except that if the Company owns more than 20% of the stock of a corporation
distributing a dividend, 80% of any dividends received may be deducted.
State Taxation
COMMONWEALTH OF PENNSYLVANIA. The Bank is subject to a "Bank Shares
Tax" that is imposed on every bank having capital stock located within
Pennsylvania. The Bank Shares Tax is based on the value of the bank's shares as
of the preceding January 1st. The taxable amount is computed by adding the book
value of capital stock paid in, the book value of the surplus and the book value
of undivided profits, and then deducting from that total an amount equal to the
percentage that the book value of the bank's federal obligations and state
obligations bears to the book value of the bank's total assets. This value is
calculated on the basis of the current year and the preceding five years, but,
if a bank has not been in existence for six years, the taxable amount is
computed by adding the value for the number of years that the bank has been in
existence and dividing the resulting sum by that number of years. The Bank
Shares Tax rate is 1.25% of the taxable amount. Banks subject to the Bank Shares
Tax are exempt from all other corporate taxes imposed by Pennsylvania.
PIC, PCLC, Patriot Advisors, and Marathon are subject to Pennsylvania
Corporate Net Income Tax ("CNIT") and to the Pennsylvania Capital Stock and
Foreign Franchise Tax. Corporations doing business in Pennsylvania and not
subject to Bank Shares Tax are subject to CNIT. The CNIT is an annual excise tax
and is measured by a corporation's taxable income as determined under the
Pennsylvania Tax Code. When a domestic or foreign corporation's entire business
is not transacted wholly within Pennsylvania, such taxable income must be
allocated and apportioned to determine that portion subject to the CNIT. The
CNIT rate is 9.99%.
7
ITEM 2. PROPERTIES
The Company has 20 properties consisting of 16 community banking
offices and 4 sales and operational offices.
BANKING OFFICES
BERKS COUNTY
Boyertown E. Philadelphia Ave & Chestnut Street Leased
Exeter 4915 Perkiomen Ave Owned
Fleetwood 46 West Main Street Leased
Muhlenberg 4930 5th Street Highway Owned
Wyomissing 2228 State Hill Road Leased
CHESTER COUNTY
Phoenixville 119 Nutt Road Leased
LEHIGH COUNTY
Allentown 3920 Tilghman Street Owned
Allentown 740 Hamilton Mall Leased
Emmaus 1130 Chestnut Street Leased
Whitehall 2541 Mickley Ave Leased
MONTGOMERY COUNTY
Limerick 536 Lewis Road Leased
Pottstown High and Hanover Streets Leased
NORTHHAMPTON COUNTY
Bethlehem 3650 Nazareth Pike Leased
Bethlehem 2126 W. Union Blvd. Leased
Cherryville 765 Blue Mountain Drive Owned
Walnutport 500 Main Street Leased
SALES AND OPERATIONAL OFFICES
CHESTER COUNTY
Patriot Advisors 707 Eagleview Blvd. Suite 104 Leased
Exton, PA 19341
Patriot Advisors Two West Market Street Leased
West Chester, PA 19382
MONTGOMERY COUNTY
Patriot Commercial Leasing 1566 Medical Drive Leased
Pottstown, PA 19464
Patriot Mortgage 300 Old Reading Pike Leased
Stowe, PA 19464
ITEM 3. LEGAL PROCEEDINGS
The Company is a defendant in various lawsuits wherein various amounts
are claimed. In the opinion of the Company's management, these suits should not
result in judgements that, in the aggregate, would have a material adverse
effect on the Company's consolidated financial statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
8
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
Certain information, including principal occupation during the past
five years, relating to the principal executive officers of the Company, as of
March 3, 2003, is set forth below:
Richard A. Elko -- Age 41. Mr. Elko was elected President and Chief
Executive Officer of the Company and the Bank in November 2000. Prior to that
Mr. Elko served as Executive Vice President since 1999 and Chief Financial
Officer of the Company and the Bank from January 1996 to December 1999.
Joni S. Naugle -- Age 44. Ms. Naugle was elected as Executive Vice
President and Chief Operating Officer of the Company and the Bank in February
2001. Prior to that, Ms. Naugle served as Chief Operating Officer of the Company
and the Bank since December 1998. Prior to that, Ms. Naugle was a Senior Vice
President for Marketing and Retail Sales at another financial institution from
1979 to April 1998 and a consultant from April 1998 to December 1998.
Kevin R. Pyle -- Age 36. Mr. Pyle was elected as Executive Vice
President and Chief Lending Officer of the Company and the Bank in February
2001. Prior to that, Mr. Pyle served as Chief Credit Officer of the Bank since
March 1996.
James G. Blume -- Age 37. Mr. Blume was elected as Senior Vice
President and Chief Financial Officer of the Company and the Bank in February
2001. Prior to that, Mr. Blume served as Chief Financial Officer of the Company
since December 1999. Prior to that, Mr. Blume served as Controller of the
Company and Patriot Bank since March 1997.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Company's common stock is traded in the over-the-counter market and
is quoted on the National Association of Securities Dealers Automated Quotation
System ("NASDAQ") National Market System under the symbol "PBIX". At March 3,
2003, the total number of holders of record of the Company's common stock was
701.
The following table sets forth the high and low bid and asked
information of the Company's common stock to the extent available as reported by
NASDAQ.
2002 2001
------------------------------------------- ---------------------------------------------
BID ASKED BID ASKED
-------------------- -------------------- -------- -------- -------------------
QTR HIGH LOW HIGH LOW QTR HIGH LOW HIGH LOW
- --- -------- -------- -------- -------- --- -------- -------- -------- --------
1st $13.7700 $10.4500 $13.7800 $10.5500 1st $ 8.0000 $ 6.7500 $ 8.1875 $ 7.0000
2nd 14.8500 13.3000 15.0000 13.4000 2nd 10.2600 7.5313 10.3200 7.6250
3rd 14.1800 12.9200 14.2400 13.0000 3rd 11.7100 8.9500 11.9000 9.1500
4th 15.3600 13.4600 15.4700 13.6500 4th 10.7500 10.0000 10.8900 10.1900
The bid quotations reflect inter-dealer quotations, do not include
retail markups, markdowns or commissions and may not necessarily represent
actual transactions. The bid information as stated is, to the knowledge of
management of the Company, the best approximate value at the time indicated.
9
DIVIDEND INFORMATION. Dividends on the Company's common stock are generally
payable in February, May, August and November. Set forth below are the cash
dividends paid by the Company during 2002 and 2001. Such dividends have been
adjusted to reflect all stock dividends paid during such years.
2002 2001
---- ----
First Quarter....................................... $ .0975 $ .0925
Second Quarter...................................... $ .1000 $ .0925
Third Quarter....................................... $ .1025 $ .0925
Fourth Quarter...................................... $ .1100 $ .0925
For certain limitations on the ability of the Bank to pay dividends to
the Company, see Part I, Item I "Business -- Regulation and Supervision --
Limitation on Capital Distributions" and Note 18 at Item 8 "Financial Statements
and Supplementary Data" herein.
EQUITY COMPENSATION PLANS
NUMBER OF SECURITIES NUMBER OF SECURITIES
TO BE ISSUED UPON WEIGHTED-AVERAGE REMAINING AVAILABLE
EXERCISE OF OUTSTANDING EXERCISE PRICE OF FOR FUTURE ISSUANCE
OPTIONS, WARRANTS OUTSTANDING OPTIONS, UNDER EQUITY
PLAN CATEGORY AND RIGHTS WARRANTS AND RIGHTS COMPENSATION PLANS
- ---------------------------------------------------- ----------------------- -------------------- --------------------
Equity compensation plans
approved by security holders:
1996 Stock-Based Option Plan ....................... 400,425 $ 7.81 --
1996 Stock-Based Incentive Plan..................... 258,000 N/A 13,000
2002 Stock-Based Option Plan........................ 205,805 $14.10 94,195
Equity compensation plans not
approved by security holders:................... N/A N/A N/A
----------------------- -------------------- --------------------
Total...................................... 864,230 N/A 107,195
10
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
The selected consolidated financial and other data and management's
discussion and analysis set forth below is derived in part from, and should be
read in conjunction with, the Consolidated Financial Statements and Notes
thereto, contained elsewhere herein.
AT DECEMBER 31,
---------------------------------------------------------------------
2002 2001 2000 1999 1998
--------- ----------- ----------- ----------- ---------
(IN THOUSANDS)
SELECTED FINANCIAL CONDITION DATA:
Total assets......................................... $ 995,143 $ 1,010,070 $ 1,124,905 $ 1,129,443 $ 980,761
Investment and mortgage-backed
securities available for sale .................... 315,868 247,612 84,889 87,334 386,380
Investment and mortgage-backed
securities held to maturity ...................... -- 43,637 302,489 348,047 29,639
Loans held for sale ................................. 4,314 6,652 8,564 4,972 5,576
Loans and leases receivable ......................... 618,217 649,139 656,479 628,060 509,080
Allowance for credit losses ......................... (6,922) (6,199) (5,839) (6,082) (4,087)
Deposits ............................................ 519,120 533,863 649,958 502,002 377,796
Customer repurchase agreements ...................... 14,210 -- -- -- --
Borrowings........................................... 388,673 405,179 416,837 568,795 549,321
Shareholders'equity.................................. 65,945 61,706 51,800 49,768 42,260
AT DECEMBER 31,
------------------------------------------------------
2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
SELECTED OPERATING DATA:
Interest income ......................................... $ 66,114 $ 75,850 $ 84,143 $ 75,544 $ 63,107
Interest expense ........................................ 36,858 52,209 61,471 51,510 46,236
-------- -------- -------- -------- --------
Net interest income before
provision for credit losses .......................... 29,256 23,641 22,672 24,034 16,871
Provision for credit losses ............................. 4,075 2,000 1,125 1,200 1,200
-------- -------- -------- -------- --------
Net interest income after provision
for credit losses .................................... 25,181 21,641 21,547 22,834 15,671
Non-interest income...................................... 7,241 7,892 7,124 5,945 3,873
Non-interest expense .................................... 22,664 20,768 26,844 26,402 14,267
-------- -------- -------- -------- --------
Income before taxes and cumulative
effect of change in accounting principle ............. 9,758 8,765 1,827 2,377 5,277
Income taxes expense (benefit) ......................... 2,060 2,462 (182) 177 1,222
-------- -------- -------- -------- --------
Income before cumulative effect of
change in accounting principle ....................... $ 7,698 $ 6,303 $ 2,009 $ 2,200 $ 4,055
Cumulative effect of change in
accounting principle, net of ($105)
in income tax ... .................................... -- (204) -- -- --
======== ======== ======== ======== ========
Net income .............................................. $ 7,698 $ 6,099 $ 2,009 $ 2,200 $ 4,055
======== ======== ======== ======== ========
Diluted earnings per share .............................. $ 1.26 $ 1.02 $ 0.34 $ 0.37 $ 0.78
======== ======== ======== ======== ========
Net income before non-recurring
charges (2)(8) ....................................... $ 5,233 $ 5,549
======== ========
Diluted earnings per share before
non-recurring charges (2) ............................ $ 0.89 $ 0.94
======== ========
Cash earnings per share before
non-recurring charges (2)(7)(8)....................... $ 1.41 $ 1.30 $ 1.17 $ 1.20 $ 0.92
======== ======== ======== ======== ========
11
AT DECEMBER 31,
-------------------------------------------------
2002 2001 2000 1999 1998
-------------------------------------------------
PERFORMANCE RATIOS(1):
Return on average equity ....................... 12.05% 10.52% 3.94% 4.00% 8.72%
Return on average equity before
non-recurring charge(2) .................... -- -- 10.30 10.10 --
Cash return on average equity(7)............... 16.49 16.91 18.66 12.95 10.27
Return on average assets........................ 0.77 0.58 0.17 0.20 0.45
Return on average assets before
non-recurring charge(2)..................... -- -- 0.45 0.51 --
Average interest rate spread(3)................ 3.15 2.36 2.13 2.32 1.98
Net interest margin(4)......................... 3.35 2.50 2.25 2.44 2.01
Average interest-earning assets to
average interest bearing liabilities......... 101.14 100.47 99.09 100.39 103.72
Total non-interest expense to average
assets before non-recurring charge(2)....... 2.28 1.96 2.32 2.41 1.58
Dividend pay-out ratio.......................... 32.14 36.27 105.70 86.02 35.91
REGULATORY CAPITAL RATIOS(5):
Tier 1 capital to average assets................ 7.33% 6.45% 5.48% 5.45% 5.37%
Tier 1 capital to risk-adjusted assets.......... 11.23 10.49 9.45 9.39 10.00
Total risk adjusted capital to
risk-adjusted assets......................... 12.61 11.54 10.41 10.46 12.46
ASSET QUALITY RATIOS(6):
Non-performing assets as a
percent of total assets...................... 0.67% 0.53% 0.35% 0.15% 0.11%
Non-performing loans as a
percent of loans receivable.................. 1.01 0.76 0.59 0.24 0.21
Allowance for credit losses as a
percent of loans receivable.................. 1.11 0.95 0.88 0.96 0.79
Allowance for credit losses as a
percent of non-performing loans.............. 103.74 116.20 147.82 354.04 362.63
- ----------------
(1) All ratios are based on average balances during the indicated periods.
(2) In 2000, non-recurring after-tax charges of $3,224,000 were recorded
including $1,453,000 in connection with restructuring of operations,
$986,000 of expenses incurred by the restructured operations and $785,000 in
connection with the resignation of Patriot's former President and CEO. In
1999, a non-recurring after-tax charge of $3,349,000 was recorded in
connection with an internet initiative.
(3) The average interest rate spread represents the difference between the
weighted average yield on interest-earning assets and the weighted average
cost of interest-bearing liabilities and equity.
(4) The net interest margin represents tax-equivalent net interest income as a
percent of average interest-earning assets. The amount of tax beneficial
income for 2002, 2001, 2000, and 1999 was $2,088,000, $1,365,000, $1,401,000
and $1,335,000, respectively.
(5) For definitions and further information relating to regulatory capital
requirements, see footnote 18 of the consolidated financial statements.
(6) Non-performing assets consist of non-performing loans, real estate owned
(REO) and other repossessed property. Non-performing loans consist of
non-accrual loans, while REO consists of real estate acquired through
foreclosure and real estate acquired by acceptance of a deed in lieu of
foreclosure. Other repossessed property consists of commercial equipment
acquired at the termination of loans and leases.
(7) Cash earnings per share is calculated by the elimination of non-cash
expenses such as goodwill amortization, core deposit intangible
amortization, ESOP and MRP expense, as shown below.
12
Reconciliation of cash earnings.
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------------
2002 2001 2000 1999 1998
------ ------ ------ ------ -----
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income before non-recurring charges .............. $7,698 $6,099 $5,233 $5,549 $4,055
Goodwill amortization ................................ -- 730 1,036 656 7
Core deposit intangible amortization ................. 486 486 422 336 --
ESOP expense .......................................... 353 238 216 262 363
MRP expense ........................................... 40 173 377 359 360
------ ------ ------ ------ ------
Cash earnings......................................... $8,577 $7,726 $7,284 $7,162 $4,785
====== ====== ====== ====== ======
Cash earnings per share before
non-recurring charges ............................ $ 1.41 $ 1.30 $ 1.17 $ 1.20 $ 0.92
====== ====== ====== ====== ======
(8) Reconciliation of net income before non-recurring charges to net income.
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------
2000 1999
------- -------
(IN THOUSANDS)
Net income before non-recurring charges.................... $ 5,233 $ 5,549
Non-recurring charge....................................... 4,885 5,074
Income tax benefit associated with non-recurring charge.... (1,661) (1,725)
------- -------
Net income................................................. $ 2,009 $ 2,200
======= =======
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
In addition to historical information, this discussion and analysis of
Patriot Bank Corp. and Subsidiaries (Patriot) contains forward-looking
statements. The forward-looking statements contained in this discussion and
analysis are subject to certain risks and uncertainties that could cause actual
results to differ materially from those projected in the forward-looking
statements. Important factors that might cause such a difference include, but
are not limited to, those discussed in the "Management's Discussion and Analysis
of Financial Condition and Results of Operations." Readers are cautioned not to
place undue reliance on these forward-looking statements, which reflect
management's analysis only as of the date of this report. Patriot undertakes no
obligation to publicly revise or update these forward-looking statements to
reflect events or circumstances that arise after the date of this report.
Patriot's financial results include the following significant events:
CAPITAL TRANSACTIONS. Patriot became a publicly owned company on
December 1, 1995, when it issued 3,769,125 shares of common stock and raised net
proceeds of $36,652,000. On November 21, 1996 and September 22, 1997, Patriot
paid special 20% stock dividends. On May 14, 1998, Patriot distributed a 25%
stock split. For comparative purposes, per share amounts, as presented herein,
have been adjusted to reflect the stock split/dividends. Patriot repurchased
shares as adjusted for stock split/dividends of its common stock in the
following years:
SHARES COST OF
YEAR REPURCHASED REPURCHASE
- ---- ----------- -----------
1996 338,000 $ 2,517,000
1997 1,246,000 13,554,000
1998 538,000 6,892,000
1999 377,000 4,808,000
2000 -- --
2001 -- --
2002 293,516 4,189,000
13
LEASING ACQUISITION. On November 6, 1998, Patriot completed the
acquisition of Keystone Financial Leasing Company (KFL). KFL was a small-ticket
commercial leasing company, which had total assets of $43,327,000 including
lease receivables of $42,764,000 at the date of acquisition. KFL was purchased
for $6,258,000 in cash plus contingent consideration based upon future revenues
of KFL. The acquisition was accounted for as a purchase. Goodwill arising from
the transaction totaled $2,267,000. In accordance with the Statement of
Financial Accounting Standards (SFAS) No. 142, goodwill is subject to periodic
impairment testing.
BANK ACQUISITION. On January 22, 1999, Patriot completed the
acquisition of First Lehigh Corporation ("First Lehigh"), a commercial banking
company with $104,478,000 in total assets and $93,905,000 in total deposits.
Patriot issued 1,640,000 shares of common stock for all the outstanding common
and preferred stock of First Lehigh. The transaction had a total value of
$21,047,000. The acquisition was accounted for as a purchase, and accordingly,
the results of operations of First Lehigh are included in Patriot's consolidated
statement of income from the date of acquisition. At December 31, 2002, goodwill
and core deposit intangibles arising from the transaction totaled $6,909,281 and
$2,876,611, respectively. During 2001, the Financial Accounting Standards Board
(FASB) issued Statement No. 142. In accordance with Statement No. 142, Patriot
continues to amortize the core deposit intangible, while goodwill is no longer
amortized but is subject to periodic impairment testing.
WEALTH MANAGEMENT FIRM ACQUISITION. On January 3, 2003, Patriot
completed the acquisition of Bonds & Paulus Associates, Inc. (Bonds & Paulus), a
wealth management firm headquartered in Chester County, Pennsylvania. Founded in
1993, Bonds & Paulus is a registered investment advisory firm, providing
investment advisory and financial planning services to high net-worth
individuals and families. Bonds & Paulus was merged into Patriot Advisors, a
division of Patriot Bank Corp. that provides a full range of wealth and
investment management services. The acquisition was accounted for as a purchase
in 2003. Bonds & Paulus was purchased for $458,000 plus contingent consideration
to be paid in shares of Patriot Bank Corp. common stock and will be based upon
future revenues of Bonds & Paulus. Of the $458,000, $115,000 was paid in cash
and 22,810 shares of Patriot Bank Corp. common stock having a value of $343,000
was issued at closing. Based upon current revenue levels, the total purchase
price will approximate $1,300,000.
PENSION BENEFITS SERVICE PROVIDER ACQUISITION. On January 17, 2003,
Patriot completed the acquisition of Pension Benefits, Inc., a pension benefits
service provider headquartered in West Chester, Pennsylvania. Founded in 1986,
Pension Benefits Inc. is a third party administrator and a registered investment
advisory firm, providing comprehensive retirement plan solutions to businesses.
Pension Benefits, Inc. was merged into Patriot Advisors as well. The acquisition
was accounted for as a purchase in 2003. Pension Benefits, Inc. was purchased
for $829,000 plus contingent consideration to be paid in shares of Patriot Bank
Corp. common stock and will be based upon future revenues of Pension Benefits,
Inc. Of the $829,000, $414,500 was paid in cash and 27,338 shares of Patriot
Bank Corp. common stock was issued at closing. Based upon current revenue
levels, the total purchase price will approximate $1,600,000.
14
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2002 AND 2001
SUMMARY. For the year ended December 31, 2002, Patriot reported net
income of $7,698,000 or $1.26 diluted earnings per share. For the year ended
December 31, 2001, Patriot reported net income of $6,099,000 or $1.02 diluted
earnings per share. Return on average equity was 12.05% for 2002 and 10.52% for
2001.
NET INTEREST INCOME. Net interest income for 2002 was $29,256,000
compared to $23,641,000 in 2001. The yield on Patriot's interest-earning assets
decreased to 7.28% for the year 2002 compared to 7.71% for 2001. The decrease in
yield on Patriot's interest-earning assets is a result of a decrease in interest
rates. The cost of Patriot's interest-bearing liabilities was 3.98% for 2002
compared to 5.24% for 2001. The decrease in funding costs resulted from
generally lower interest rates coupled with reductions in higher cost
borrowings. Overall, Patriot's net interest margin increased to 3.35% for 2002
compared to 2.50% in 2001.
Interest on loans was $49,020,000 for 2002 compared to $54,122,000 for
2001. The average balance of loans in 2002 was $635,788,000 with an average
yield of 7.73% compared to an average balance of $653,460,000 with an average
yield of 8.30% in 2001. The decrease in the average balance of loans is a result
of Patriot allowing residential mortgages to run-off, offset by increases in
commercial loans and leases. The decrease in average yield is primarily a result
of a decrease in interest rates.
Interest on Patriot's investment portfolio (investment and
mortgage-backed securities) was $17,021,000 for 2002 compared to $21,220,000 for
2001. The average balance of the investment portfolio was $296,079,000 with an
average yield of 6.41% for 2002 compared to an average balance of $333,872,000
with an average yield of 6.73% for 2001. The decrease in average balance is
primarily due to Patriot allowing the investment portfolio to amortize so that
it can be replaced with generally higher-yielding commercial loans and leases.
The decrease in average yield is related to general decreases in market rates on
securities.
Interest on total deposits was $14,479,000 for 2002 compared to
$27,690,000 for 2001. The average balance of total deposits was $518,051,000
with an average cost of 2.79% for 2002 compared to an average balance of
$575,235,000 with an average cost of 4.81% for 2001. The decrease in the average
balance of deposits is primarily the result of a decrease in Patriot's jumbo
certificate of deposits, offset by increases in branch deposits which consists
of money market accounts, transaction based deposit accounts and other
certificates of deposits. The average balance on jumbo certificates of deposit
decreased to $32,529,000 in 2002 compared to $105,530,000 in 2001. The average
balance of retail deposits (total deposits less jumbo certificate of deposits)
was $485,522,000 with an average cost of 2.68% for 2002 compared to an average
balance of $469,705,000 with an average cost of 4.34% for 2001. The increase in
average balance on retail deposits is the result of growth in savings, checking
and money market accounts offset by a decrease in branch certificates of
deposit. The overall decrease in the average cost on deposits is primarily the
result of a decrease in interest rates and emphasis placed on lower cost
transaction based deposit accounts.
Interest on borrowings was $22,379,000 in 2002 compared to $24,519,000
in 2001. The average balance of borrowings was $407,687,000 with an average cost
of 5.49% for 2002 compared to an average balance of $421,084,000 with an average
cost of 5.82% for 2001. The decrease in the average balance of borrowings is
primarily due to the use of funds provided by the run-off of the mortgage loan
portfolio and growth in Patriot's branch deposits to repay borrowings, offset by
growth in Patriot's commercial loan portfolio. The decrease in average cost is
due to lower interest rates.
15
SPREAD ANALYSIS. The following table sets forth Patriot's average
balances and the yields on those balances for the years ended December 31, 2002,
2001 and 2000. The yields and costs are derived by dividing income or expense by
the average balance of assets or liabilities, respectively, for the periods
shown, except where noted otherwise. The yields and costs include fees, which
are considered adjustments to yields.
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------
2002
---------------------------- -------------
AVERAGE YIELD/ AVERAGE
BALANCE INTEREST RATE BALANCE
-------- -------- ------ -------
ASSETS:
Interest-earning assets:
Interest-earning deposits..... $ 4,457 $ 73 1.64% $ 13,682
Investment and mortgage-
backed securities(1) ...... 296,079 17,021 6.41 333,872
Loans and leases
receivable, net(2)......... 635,788 49,020 7.73 653,460
-------- ------- ---- ----------
Net interest-earning assets... 936,324 66,114 7.28 1,001,014
Non-interest-earning assets... 59,783 -- -- 56,549
-------- ------- ---- ----------
Total assets ................. $996,107 $66,114 6.85% $1,057,563
======== ======= ==== ==========
LIABILITIES AND EQUITY:
Interest-bearing liabilities:
Core deposits.................. $270,801 $ 4,178 1.54% $ 225,845
Retail Certificates of deposit. 214,721 8,815 4.11 243,860
Brokered Certificates
of deposit.................. 32,529 1,486 4.57 105,530
-------- ------- ---- ----------
Total deposits................. 518,051 14,479 2.79 575,235
Borrowings(3).................. 407,687 22,379 5.49 421,084
-------- ------- ---- ----------
Total interest-bearing
liabilities................. 925,738 36,858 3.98 996,319
Non-interest-bearing
liabilities ................ 6,475 - - 3,266
-------- ------- ---- ----------
Total liabilities.............. 932,213 36,858 3.95 999,585
Equity......................... 63,894 - - 57,978
-------- ------- ---- ----------
Total liabilities and equity... $996,107 $36,858 3.70% $1,057,563
======== ======= ==== ==========
Net interest income............ $29,256
=======
Net interest rate spread(4).... 3.15%
====
Net interest margin(5)......... 3.35
Ratio of interest-earning......
assets to interest
bearing liabilities......... 101.14% 100.47%
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------
2001 2000
--------------------------------------------------
YIELD/ AVERAGE YIELD/
INTEREST RATE BALANCE INTEREST RATE
-------- ------ ------- -------- ------
(IN THOUSANDS)
ASSETS:
Interest-earning assets:
Interest-earning deposits..... $ 508 3.71% $ 12,330 $ 422 3.42%
Investment and mortgage-
backed securities(1) ...... 21,220 6.73 412,712 28,190 7.17
Loans and leases
receivable, net(2)......... 54,122 8.30 666,171 55,531 8.33
-------- ---- ---------- ---------- ----
Net interest-earning assets... 75,850 7.71 1,091,213 84,143 7.82
Non-interest-earning assets... -- -- 62,104 -- --
-------- ---- ---------- ---------- ----
Total assets ................. $ 75,850 7.30% $1,153,317 $ 84,143 7.42%
======== ==== ========== ========== ====
LIABILITIES AND EQUITY:
Interest-bearing liabilities:
Core deposits.................. $ 5,763 2.55% $ 199,543 $ 6,016 3.01%
Retail Certificates of deposit 14,618 5.99 201,899 11,558 5.72
Brokered Certificates
of deposit.................. 7,309 6.93 195,176 13,140 6.73
-------- ---- ---------- ---------- ----
Total deposits................. 27,690 4.81 596,618 30,714 5.15
Borrowings(3).................. 24,519 5.82 504,666 30,757 6.01
-------- ---- ---------- ---------- ----
Total interest-bearing
liabilities................. 52,209 5.24 1,101,284 61,471 5.58
Non-interest-bearing
liabilities ................ -- -- 1,213 -- --
-------- ---- ---------- ---------- ----
Total liabilities.............. 52,209 5.22 1,102,497 61,471 5.58
Equity......................... -- -- 50,820 -- --
-------- ---- ---------- ---------- ----
Total liabilities and equity... $ 52,209 4.94% $1,153,317 $ 61,471 5.34%
======== ==== ========== ========== ====
Net interest income............ $ 23,641 $ 22,672
======== ==========
Net interest rate spread(4).... 2.36% 2.08%
==== ====
Net interest margin(5)......... 2.50 2.25
Ratio of interest-earning
assets to interest
bearing liabilities......... 99.09%
----------------
(1) Includes securities available for sale and held to maturity and unamortized
discounts and premiums. The yield is presented on a tax equivalent basis for
tax beneficial investments. The amount of tax beneficial interest associated
with securities for 2002, 2001, and 2000 was $1,956,000, $1,250,000 and
$1,401,000, respectively.
(2) Amount is net of deferred loan and lease fees, loans in process, discounts
and premiums, and allowance for loan and lease losses and includes loans
held for sale and non-performing loans and leases for which the accrual of
interest has been discontinued. The yield is presented on a tax equivalent
basis for tax beneficial loans. The amount of tax beneficial interest
associated with loans and leases for 2002, 2001, and 2000 was $131,000,
$115,000, and $118,000 respectively.
(3) Includes short-term, long-term and trust preferred borrowings.
(4) Net interest rate spread represents the difference between the average yield
on total assets and the average cost of total liabilities and equity.
(5) Net interest margin represents the tax-equivalent net interest income
divided by average interest-earning assets. The impact of the tax-equivalent
calculation increased the net interest margin by .23% in 2002, .14% in 2001
and .13% in 2000 due to tax equivalent calculations.
16
RATE/VOLUME ANALYSIS. The following table presents the extent to which
net interest income changed due to changes in interest rates and changes in the
volume of interest-earning assets and interest-bearing liabilities during the
periods indicated. Information is provided in each category with respect to
changes attributable to changes in rate (changes in rate multiplied by prior
volume), and the net change. The changes attributable to the combined impact of
volume and rate have been allocated proportionally to the changes due to volume
and the changes due to rate.
YEAR ENDED DECEMBER 31, 2002 YEAR ENDED DECEMBER 31, 2001
COMPARED TO YEAR ENDED COMPARED TO YEAR ENDED
DECEMBER 31 2001 DECEMBER 31, 2000
INCREASE (DECREASE) INCREASE(DECREASE)
DUE TO DUE TO
------------------------------------ ----------------------------------
VOLUME RATE NET VOLUME RATE NET
---------- --------- -------- -------- -------- -------
(IN THOUSANDS)
INTEREST-EARNING ASSETS:
Interest-earning deposits............... $ (342) $ (93) $ (435) $ 46 $ 40 $ 86
Investment and mortgage-
backed securities.................... (2,543) (1,656) (4,199) (5,653) (1,317) (6,970)
Loans receivable........................ (1,467) (3,635) (5,102) (1,058) (351) (1,409)
---------- --------- -------- -------- -------- -------
Total interest-earning assets........... (4,352) (5,384) (9,736) (6,665) (1,628) (8,293)
---------- --------- -------- -------- -------- -------
INTEREST-BEARING LIABILITIES:
Deposits................................ (2,748) (10,463) (13,211) (1,100) (1,924) (3,024)
Borrowings.............................. (780) (1,360) (2,140) (5,024) (1,214) (6,238)
---------- --------- -------- -------- -------- -------
Total interest-bearing liabilities...... (3,528) (11,823) (15,351) (6,124) (3,138) (9,262)
---------- --------- -------- -------- -------- -------
Net change in net interest income....... $ (824) $ 6,439 $ 5,615 $ (541) $ 1,510 $ 969
========== ========= ======== ======== ======== =======
17
PROVISION FOR CREDIT LOSSES. The provision for credit losses was
$4,075,000 for 2002 compared to $2,000,000 for 2001. See "Credit Quality" for a
detailed discussion of Patriot's asset quality and reserving methodology.
The following table sets forth the activity in the allowance for credit
losses for the years indicated:
AT OR FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------------
2002 2001 2000 1999 1998
------ ------ ------ ------ ------
(IN THOUSANDS)
Allowance, beginning of year ............................... $6,199 $5,839 $6,082 $4,087 $2,512
Charge-offs:
Commercial loans......................................... 1,280 640 675 443 253
Commercial leases ....................................... 1,858 798 436 130 --
Residential loans........................................ 158 79 102 249 114
Home equity and consumer loans .......................... 347 355 268 243 145
------ ------ ------ ------ ------
Total charge-offs ................................... 3,643 1,872 1,481 1,065 512
------ ------ ------ ------ ------
Recoveries:
Commercial loans......................................... 95 39 16 27 --
Commercial leases........................................ 121 134 82 39 --
Residential loans........................................ 71 29 -- -- --
Home equity and consumer loans .......................... 4 30 15 38 9
------ ------ ------ ------ ------
Total recoveries .................................... 291 232 113 104 9
------ ------ ------ ------ ------
Net charge-offs............................................. 3,352 1,640 1,368 961 503
Acquired allowance.......................................... -- -- -- 1,756 878
Provision charged to operations ............................ 4,075 2,000 1,125 1,200 1,200
------ ------ ------ ------ ------
Allowance, end of year...................................... $6,922 $6,199 $5,839 $6,082 $4,087
====== ====== ====== ====== ======
Net charge-offs to average loans
and leases............................................... .53% .25% .21% .17% .11%
Allowance for credit losses as a
percentage of year-end total loans ...................... 1.11% .95% .88% .96% .79%
NON-INTEREST INCOME. Total non-interest income was $7,241,000 for 2002
compared to $7,892,000 for 2001. The decrease in non-interest income was
primarily due to $137,000 in losses recognized on the sale of investments
securities in 2002 compared to $558,000 in gains in 2001. Patriot adopted SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities," as of
January 1, 2001. The cumulative effect of the adoption was a $204,000 decrease
to consolidated income, net of $105,000 of tax benefit, resulting from the sale
of securities transferred into "Available for Sale" during the first quarter in
2001. Other recurring non-interest income including loan and deposit fees and
mortgage banking gains remained consistent in 2002 compared to 2001.
NON-INTEREST EXPENSE. Total non-interest expense was $22,664,000 for
2002 compared to $20,768,000 for 2001. The increase in non-interest expense was
primarily due to higher compensation costs due to increases in staffing
associated with branch deposit and commercial lending growth offset by lower
amortization costs. Patriot's tax effected efficiency ratio, was 58.94% in 2002
compared to 63.94% in 2001. The tax equivalent efficiency ratio is calculated by
taking non-interest expense divided by non-interest income and net interest
income before provision for credit losses. Net interest income before provision
is adjusted to take into consideration tax beneficial investments and loans.
INCOME TAX PROVISION. The income tax provision was $2,060,000 for 2002
compared to $2,462,000 for 2001. The effective tax rate for 2002 was 21.11%
compared to 28.09% for 2001. The decrease in the effective tax rate is due to
greater tax exempt interest from tax-exempt securities offset by the elimination
of non-deductible goodwill.
18
FINANCIAL CONDITION
LOAN PORTFOLIO. Patriot's primary portfolio loan products are
commercial loans and leases and home equity loans on existing owner-occupied
residential real estate. Patriot also offers residential construction loans and
other consumer loans. Patriot has sold substantially all new residential
mortgage (fixed and adjustable rate) originations since 2000.
COMMERCIAL LENDING. Patriot originates commercial loans with an
emphasis on small businesses, professionals and entrepreneurs within Patriot's
local markets. Most of Patriot's commercial loan relationships have exposure of
$500,000 or less. Commercial loans are generally secured by real estate and
personal guarantees.
COMMERCIAL LEASING. Patriot's subsidiary, Patriot Commercial Leasing
Company (PCLC), is a small-ticket commercial leasing company. PCLC originates
leases to businesses predominantly located on the East Coast. Transaction sizes
generally range from $5,000 to $500,000 with the average transaction being less
than $50,000. PCLC is owned 100% by Patriot Bank. PCLC's leases are considered
financing leases for accounting purposes.
CONSUMER LENDING. Patriot offers variable rate (based upon prime rate)
home equity lines of credit and fixed-rate home equity loans, which are
generally secured by single-family, owner-occupied residential properties.
Patriot also offers a variety of other consumer loans, which primarily consist
of installment loans secured by automobiles, credit cards, unsecured lines of
credit and other loans secured by deposit accounts.
MORTGAGE LENDING. Patriot offers both fixed-rate and adjustable-rate
mortgage loans secured by one- to four-family residences, primarily
owner-occupied, located in Patriot's primary market area. Patriot generally
underwrites its first mortgage loans in accordance with underwriting standards
set by the Federal Home Loan Mortgage Corp. (FHLMC) and the Federal National
Mortgage Association (FNMA). Patriot also originates residential construction
loans. Substantially all of the residential mortgage loans originated by Patriot
are sold into the secondary markets; therefore, Patriot's mortgage loan
portfolio consists mainly of seasoned mortgage loans originated prior to 2000.
At December 31, 2002, Patriot's total loan portfolio was $618,217,000
compared to a total loan portfolio of $649,139,000 at December 31, 2001. The
decrease in the loan portfolio is primarily the result of Patriot allowing
residential mortgages to runoff, offset by an increase in commercial lending
relationships.
19
The following table sets forth the composition of Patriot's loan
portfolio in dollar amounts and in percentages of the respective portfolios at
the dates indicated:
AT DECEMBER 31,
-------------------------------------------------------------------
2002 2001 2000
--------------------- -------------------- --------------------
PERCENT PERCENT PERCENT
AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL
------ -------- ------ -------- ------ --------
(IN THOUSANDS)
Commercial Portfolio:
Commercial loans............................... $315,537 51.17% $283,848 43.79% $252,837 38.47%
Commercial leases ............................. 77,138 12.51 77,838 12.01 67,094 10.21
Consumer Portfolio:
Home equity.................................... 72,400 11.74 66,834 10.31 64,733 9.85
Other consumer loans........................... 7,724 1.25 8,614 1.33 8,553 1.30
Mortgage Portfolio:
Residential mortgages ......................... 135,632 22.00 206,467 31.85 253,213 38.53
Construction................................... 8,220 1.33 4,605 .71 10,779 1.64
-------- ------- -------- ------- -------- -------
Total loans and leases, gross.................... 616,651 100.00% 648,206 100.00% 657,209 100.00%
Deferred loan costs (fees)(1).................. 1,566 933 (730)
Allowance for credit losses.................... (6,922) (6,199) (5,839)
-------- -------- --------
Total loans and leases, net.................. $611,295 $642,940 $650,640
======== ======== ========
AT DECEMBER 31,
-------------------------------------------
1999 1998
-------------------- --------------------
PERCENT PERCENT
AMOUNT OF TOTAL AMOUNT OF TOTAL
------ -------- ------ --------
(IN THOUSANDS)
Commercial Portfolio:
Commercial loans........................................................ $189,189 30.02% $ 92,367 18.06%
Commercial leases....................................................... 57,808 9.17 44,301 8.66
Consumer Portfolio:
Home equity ............................................................ 69,785 11.07 64,807 12.67
Other consumer loans.................................................... 9,081 1.44 4,336 0.85
Mortgage Portfolio:
Residential mortgages .................................................. 293,852 46.64 300,232 58.73
Construction............................................................ 10,481 1.66 5,267 1.03
-------- ------- -------- -------
Total loans and leases, gross............................................. 630,196 100.00% 511,310 100.00%
Deferred loan fees(1)................................................... (2,136) (2,230)
Allowance for credit losses ............................................ (6,082) (4,087)
Total loans and leases, net .......................................... $621,978 $504,993
======== ========
- ------------
(1) Patriot's focus is on growing its commercial loan, lease and consumer
portfolios while allowing mortgage loans to run-off. There tends to be more
deferred costs associated with originating commercial loans and leases as
compared to originating mortgage loans, which have more deferred fees. As a
result, Patriot's position transitioned from $(2,230,000), $(2,136,000) and
$(730,000), in net deferred fees in 1998, 1999 and 2000, respectively, to
$933,000 and $1,566,000, in net deferred costs in 2001 and 2002,
respectively.
20
LOAN MATURITY. The following table sets forth the maturity schedule for
Patriot's loan portfolio (excluding residential mortgages and consumer loans):
AMOUNTS MATURING AT DECEMBER 31, 2002
--------------------------------------------
IN ONE AFTER AFTER
YEAR ONE TO FIVE
OR LESS FIVE YEARS YEARS TOTAL
-------- ---------- ----- -----
(IN THOUSANDS)
Loan Maturity Schedule:
Commercial loans................................. $ 75,053 $198,144 $ 21,137 $294,334
Commercial construction loans.................... 13,236 7,235 732 21,203
Commercial leases................................ 28,523 48,178 437 77,138
Residential construction loans................... 8,220 -- -- 8,220
-------- -------- -------- --------
Total....................................... $125,032 $253,557 $ 22,306 $400,895
======== ======== ======== ========
Fixed rates...................................... $ 69,100 $235,606 $ 13,836 $318,542
Adjustable rates................................. 55,932 17,951 8,470 82,353
-------- -------- -------- --------
Total....................................... $125,032 $253,557 $ 22,306 $400,895
======== ======== ======== ========
CREDIT QUALITY. Patriot's Asset Review and Credit Administration
Committee establishes acceptable credit risks to be undertaken, the policies and
procedures to be used to control credit risk and the corrective actions to be
taken when credit challenges are encountered. This committee also reviews credit
quality on a monthly basis, classifies assets in accordance with applicable
management guidelines and regulations and makes recommendations to Patriot's
Board of Directors with regard to placing assets on non-accrual status,
charge-offs and write-downs and the appropriate level of credit reserves.
Patriot accrues interest on all loans and leases until management
determines that the collection of interest is doubtful (generally when a loan or
lease is 90 days or more delinquent). Upon discontinuance of interest accrual,
all unpaid accrued interest is reversed. Patriot generally requires appraisals
on an annual basis on foreclosed properties. Patriot generally conducts
inspections on foreclosed properties on at least a quarterly basis.
At December 31, 2002, non-performing assets ("NPAs") were $6,672,000 or
0.67% of total assets compared to $5,335,000 or .53% of total assets at December
31, 2001. The ratio of non-performing assets to total assets has grown during
the past year. The increase is predominantly associated with generally weaker
economic conditions in Patriot's lending markets. Patriot controls its level of
non-performing assets by quickly identifying problem assets and resolving them
in an expedient manner. At December 31, 2002, Patriot had no restructured loans
within the meaning of SFAS No. 15 and no potential problem loans within the
meaning of the Securities and Exchange Commission Guide 3.
21
The following table sets forth information regarding non-performing
assets:
AT DECEMBER 31,
-------------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(IN THOUSANDS)
Non-accrual loans and leases
greater than 90 days past due:
Commercial loans............................... $ 3,601 $ 2,047 $ 1,593 $ 189 $ 159
Commercial leases.............................. 657 686 502 56 75
Home equity and consumer....................... 58 184 255 373 212
Residential mortgages.......................... 1,031 1,636 1,142 591 494
-------- -------- -------- -------- --------
Total non-accrual loans and leases
greater than 90 days past due................ 5,347 4,553 3,492 1,209 940
-------- -------- -------- -------- --------
Non-accrual loans and leases less
than 90 days past due:
Commercial loans............................... 292 30 208 -- --
Commercial leases.............................. 355 116 -- -- --
Home equity and consumer....................... 38 133 22 74 31
Residential mortgages.......................... 236 154 166 242 98
-------- -------- -------- -------- --------
Total non-accrual loans and
leases less than 90 days past due.............. 921 433 396 316 129
-------- -------- -------- -------- --------
Total non-performing loans....................... 6,268 4,986 3,888 1,525 1,069
Real Estate Owned (REO).......................... 404 349 62 193 58
-------- -------- -------- -------- --------
Total non-performing assets...................... $ 6,672 $ 5,335 $ 3,950 $ 1,718 $ 1,127
======== ======== ======== ======== ========
Allowance for credit losses as a
percent of loans receivable.................... 1.11% .95% .88% .96% .79%
Non-performing loans as a percent
of total Loans receivable...................... 1.01 .76 .59 .24 .21
Non-performing assets as a percent
of total assets................................ .67 .53 .35 .15 .11
ALLOWANCE FOR CREDIT LOSSES. The allowance for losses on loans is based
on management's ongoing evaluation of the loan portfolio and reflects an amount
considered by management to be its best estimate of known and inherent losses in
the portfolio. Management considers a variety of factors when establishing the
allowance, such as the impact of current economic conditions, diversification of
the portfolios, delinquency statistics, results of loan review and related
classifications, and historic loss rates. In addition, certain individual loans
which management has identified as problematic are specifically provided for,
based upon an evaluation of the borrower's perceived ability to pay, the
estimated adequacy of the underlying collateral and other relevant factors. In
addition, regulatory authorities, as an integral part of their examinations,
periodically review the allowance for credit losses. They may require additions
to the allowance based upon their judgements about information available to them
at the time of examination. Although provisions have been established and
segmented by type of loan, based upon management's assessment of their differing
inherent loss characteristics, the entire allowance for losses on loans is
available to absorb further loan losses in any category.
Management uses significant estimates to determine the allowance for
credit losses. Since the allowance for credit losses is dependent, to a great
extent, on conditions that may be beyond Patriot's control, it is at least
reasonably possible that management's estimate of the allowance for credit
losses and actual results could differ in the near term.
22
Patriot's total loans consist of four distinct portfolios. Each of
which is monitored and analyzed seperately.
Residential mortgage loans comprise 23.33% of total loans. The mortgage
loan portfolio is seasoned as Patriot has been in the mortgage lending business
for many years and has sold substantially all new mortgage originations in the
past three years. The level of non-performing assets in the mortgage portfolio
decreased during 2002 in correlation to the overall mortgage portfolio. The
ratio of non-performing assets to the total mortgage portfolio remained
relatively stable from 2001 to 2002. Management believes current levels can be
attributed to the current recessionary phase of the credit cycle and a
relatively low reference point in previous years' balances. Patriot's mortgage
loans are generally well collateralized and historically Patriot has experienced
minimal losses on these loans. Because of Patriot's consistent history in
mortgage lending and the long-term nature of this portfolio, Patriot
predominately relies upon an internal regression analysis that uses historical
data to estimate losses inherent in the portfolio.
Consumer loans comprise 12.99% of total loans and consist mostly of
home equity loans and home equity lines of credit. The consumer loan portfolio
also is mature as Patriot has been in the consumer lending business for many
years. As with mortgage lending Patriot predominantly uses an internal
regression analysis that uses historical data to estimate losses inherent in the
portfolio.
Commercial loans comprise 51.17% of total loans. Patriot entered the
commercial lending business in 1996 and has grown the portfolio into a
substantial portion of total loans. Patriot uses historical data to prepare
regression models to monitor trends of charge-offs and recoveries and establish
appropriate allowance levels. The level of non-performing assets in the
commercial lending portfolio increased during 2002. Patriot attributes recent
recessionary conditions to the increase in non-performing commercial assets.
Patriot also closely monitors local economic and business trends relative to its
commercial lending portfolio to estimate the effect those trends may have on
potential losses. Patriot's commercial loan portfolio contains some loans that
are substantially larger than the loans within other portfolios. The potential
loss associated with an individual loan could have a significant impact on the
allowance and charge-off levels at Patriot. Therefore Patriot closely monitors
these loans and will specifically reserve for individual loans which exhibit
weakness.
Commercial leases comprise 12.51% of total loans. Patriot entered the
commercial leasing business in 1998 principally through the acquisition of KFL.
Patriot's leasing portfolio has a short, approximately 3-year life. Patriot
performs an internal regression analysis on this portfolio using historical data
(including KFL data). Patriot also closely monitors regional and national
economic business trends relative to its commercial leasing portfolio to
estimate the effects those trend may have on potential losses.
During 2002 Patriot experienced an increase in the level of chargeoffs
in the commercial leasing portfolio. Patriot attributes the increase to a
general weakness in the overall economy, relatively low previous year levels and
higher delinquency trends in certain sectors of the portfolio. In response to
the elevated levels Patriot enhanced it's policies, procedures and resources
related to the credit administration for the leasing portfolio. The result of
these enhancements has been a steady improvement in charge-offs, delinquencies
and nonperforming leases in the latter part of 2002.
Patriot's percentage of loan loss reserves to total loans increased
from .95% in 2001 to 1.11% in 2002, which correlates to Patriot's growth in its
higher risk commercial loan and lease portfolios. During 2002, Patriot's loan
and lease portfolios decreased from $649,139,000 at December 31, 2001, to
$618,217,000. The decrease in the loan portfolios is attributed to the run-off
of mortgage loans offset by growth in the commercial loan portfolio. Based on
the growth in the commercial loan portfolio and the increased level of
non-performing loans and leases, management determined a provision of $4,075,000
was necessary to adequately address the losses inherent in Patriot's loan and
lease portfolios. Patriot believes that the allowance provides for known and
inherent credit losses at December 31, 2002.
23
The following table sets forth management's allocation of the allowance
for credit losses at the dates indicated:
AT DECEMBER 31,
------------------------------------------------------------------------------------------------------
2002 2001 2000
------------------------------ -------------------------------- ---------------------------------
PERCENT OF PERCENT OF PERCENT OF
PERCENT LOANS IN PERCENT OF LOANS IN PERCENT OF LOANS IN
ALLOWANCE EACH ALLOWANCE EACH ALLOWANCE EACH
TO CATEGORY TO CATEGORY TO CATEGORY
TOTAL TO TOTAL TOTAL TO TOTAL TOTAL TO TOTAL
AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS
------ --------- ---------- ------ ---------- ---------- ------ --------- ----------
(IN THOUSANDS)
Commercial loans
and leases................. $5,703 82.39% 63.68% $4,767 76.90% 55.80% $4,312 73.84% 48.46%
Home equity and consumer 734 10.60 12.99 654 10.55 11.64 624 10.69 11.15
Residential mortgages....... 485 7.01 23.33 778 12.55 32.56 903 15.47 40.39
------ ------ ------ ------ ------ ------ ------ ------ ------
Total valuation allowances $6,922 100.00% 100.00% $6,199 100.00% 100.00% $5,839 100.00% 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ======
AT DECEMBER 31,
--------------------------------------------------------------------
1999 1998
---------------------------------- --------------------------------
PERCENT OF PERCENT OF
PERCENT OF LOANS IN PERCENT OF LOANS IN
ALLOWANCE EACH ALLOWANCE EACH
TO CATEGORY TO CATEGORY
TOTAL TO TOTAL TOTAL TO TOTAL
AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS
------ ---------- ---------- ------ ---------- ----------
(IN THOUSANDS)
Commercial loans and leases................................... $3,605 59.27% 39.02% $2,131 52.13% 26.72%
Home equity and consumer...................................... 968 15.92 12.46 683 16.72 13.52
Residential mortgages......................................... 1,509 24.81 48.52 1,273 31.15 59.76
------ ------ ------ ------ ------ ------
Total valuation allowances.................................. $6,082 100.00% 100.00% $4,087 100.00% 100.00%
====== ====== ====== ====== ====== ======
CASH AND CASH EQUIVALENTS. Cash and cash equivalents at December 31,
2002, were $16,839,000 compared to $21,466,000 at December 31, 2001. The
decrease in cash and cash equivalents was primarily due to temporary timing
differences.
SECURITIES. Investment securities consist of US Treasury and government
agency securities, corporate debt and equity securities. Mortgage-backed
securities consist of securities generally issued by either the FHLMC, FNMA or
the Government National Mortgage Association ("GNMA"). Collateralized Mortgage
Obligations ("CMOs") consist of securities issued by the FHLMC, FNMA or private
issuers.
Total investment and mortgage-backed securities at December 31, 2002,
were $315,868,000 compared to $291,249,000 at December 31, 2001. The increase in
investment and mortgage-backed securities is primarily due to $199,135,000 of
investment purchases offset by $180,193,000 of principal repayments, sales,
calls and maturities.
24
The following table sets forth certain information regarding the
amortized cost and market value of investment and mortgage-backed securities at
the dates indicated:
AT DECEMBER 31,
----------------------------------------------------------------------
2002 2001 2000
--------------------- --------------------- ---------------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE
--------- ----- --------- ----- --------- -----
(IN THOUSANDS)
AVAILABLE FOR SALE:
Investment securities:
US Treasury and government
agency se