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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, 2003
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 [X] No [ ]
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. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [ ]
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 $194,700,269 and is based upon the last sales price of $29.35 per
share as quoted on The Nasdaq Stock Market for March 8, 2004.
As of March 8, 2004, the Registrant had 6,633,740 shares outstanding
(excluding treasury shares).
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INDEX
PAGE
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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...................... 9
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 ................................................... 14
Item 7A. Quantitative and Qualitative Disclosures About Market Risk .............. 37
Item 8. Financial Statements and Supplementary Data ............................. 38
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure .................................................... 77
Item 9A. Controls and Procedures ................................................. 77
PART III
Item 10. Directors and Executive Officers of the Registrant ...................... 78
Item 11. Executive Compensation .................................................. 81
Item 12. Security Ownership of Certain Beneficial Owners and Management........... 86
Item 13. Certain Relationships and Related Transactions .......................... 87
Item 14. Independent Accountant Fees and Services ................................ 87
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K ........ 89
SIGNATURES ......................................................................... 91
PART I
ITEM 1. BUSINESS
GENERAL
Patriot Bank Corp. ("Patriot") is a Pennsylvania corporation and a
financial holding company for Patriot Bank (the "Bank"), Patriot Investment
Company ("PIC") and Patriot Advisors, Inc. Patriot is subject to regulation by
the Board of Governors of the Federal Reserve System (the "FRB"). Originally
organized as a Delaware corporation, Patriot became a Pennsylvania corporation
as a result of its consolidation with First Lehigh Corporation on January 22,
1999. Patriot'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, Patriot 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, 2003, the Bank had total assets of
$1.039 billion, deposits of $616 million and shareholders' equity of $81
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 and commercial small business administration 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 Patriot
on September 10, 1996. Its primary business consists of maintaining an
investment portfolio. At December 31, 2003, PIC had total assets of $1.032
million and shareholder's equity of $1.032 million.
In January 2003, Patriot acquired Bonds and Paulus Inc. a registered
investment advisor and Pension Benefits Inc. a third party administrator and
registered investment advisor. In September 2003, Patriot acquired Tyler Wealth
Counselors, a registered investment advisory firm providing investment and
financial planning services to individuals and families. These three companies
were merged into Patriot Advisors, a wealth management subsidiary of the
company. At December 31, 2003, Patriot Advisors had approximately $445 million
assets under management.
In December 2003, Patriot and Susquehanna Bancshares, Inc. ("Susquehanna")
announced the signing of a definitive merger agreement pursuant to which
Susquehanna will acquire Patriot in a stock and cash transaction valued at $212
million, based on Susquehanna's market price as of the date of the agreement.
The transaction, unanimously approved by the boards of directors of both
companies, will enhance Susquehanna's presence in Pennsylvania, particularly in
the high-growth counties of Berks, Chester, Lehigh, Montgomery and Northampton.
Upon completion of the transaction, Susquehanna will become the fifth largest
banking company headquartered in Pennsylvania with total assets of over $7
billion.
1
Under the terms of the merger agreement, shareholders of Patriot will be
entitled to elect to receive in exchange for shares of Patriot common stock
either $30.00 in cash, 1.143 common shares of Susquehanna or a combination
thereof. Patriot shareholder elections are subject to allocation procedures. The
application of these procedures will result in the exchange of 20 percent of the
Patriot shares and options for cash, and the remaining Patriot shares and
options will be exchanged for Susquehanna common stock or converted to
Susquehanna options, as appropriate. Based upon the stated value of $30.00 per
share, the transaction price represents 298 percent of Patriot's book value and
21.4 times Patriot's 2004 earnings per share estimate as reported by First Call.
It is anticipated that the transaction will be completed during the second
quarter of 2004, pending regulatory approvals and the approval of shareholders
of Patriot and Susquehanna.
MARKET AREA AND COMPETITION
Patriot 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 Patriot are primarily service and trade oriented and demographically
are comprised of middle income and upper income households.
Patriot faces significant competition both in originating loans and in
attracting deposits and managed assets. Patriot's competitors are other
financial service providers operating within its primary market area, some of
which are larger and have greater financial resources than Patriot. Patriot's
competition for loans and deposits 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, Patriot 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 Patriot'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
Patriot has three wholly-owned subsidiaries: The Bank, PIC and Patriot
Advisors. The Bank has three wholly-owned subsidiaries: Patriot Commercial
Leasing Co., Inc. ("PCLC"), Patriot Investment and Insurance Company ("PIIC")
and Marathon Management Company, Inc. ("Marathon"). PCLC is a small-ticket
commercial leasing company. At December 31, 2003, PCLC had total assets of
$82,811,000 and generated total revenues of $8,859,000 for the year ended
December 31, 2003. PIIC markets certain non-deposit investment products. At
December 31, 2003, PIIC had total assets of $981,000 and generated fee income of
$267,000 for the year ended December 31, 2003. Marathon provides title insurance
services through a joint venture partnership. At December 31, 2003, Marathon had
total assets of $348,000 and generated fee income of $53,000 for the year ended
December 31, 2003.
PERSONNEL
As of December 31, 2003, Patriot had 283 employees (including 24 part-time
employees). 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. Patriot, 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").
During 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")
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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 Patriot, the Bank and their operations. Certain of the
regulatory requirements applicable to the Bank and to Patriot 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 Patriot.
HOLDING COMPANY REGULATION. Patriot is a financial holding company
registered under the BHCA. As a financial services holding company, Patriot'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.
3
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.
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").
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
CAPITAL REQUIREMENTS. The FRB has adopted risk-based capital guidelines for
financial holding companies, such as Patriot. 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. Patriot is in compliance with these
4
guidelines. The Bank is subject to similar capital requirements adopted by the
FDIC. The Bank is in compliance with these guidelines as well. 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.
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, 2003, both Patriot 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, 2003, 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 $0.154 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, 2003, this limitation was equal to $12.2 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
Patriot are subject to the Pennsylvania Banking Code of 1965 and the Federal
Reserve Act ("FRA"). Under the Pennsylvania Banking Code, no dividends may be
paid except from "accumulated net earnings" (generally, undivided profits).
Under the FRA Act, dividends may be paid only from the current year's earnings
and the retained net income of the prior two calendar years. Under current
banking laws, the Bank would be limited to approximately $30.2 million of
dividends in 2003 plus an additional amount equal to the Bank's net profit, 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 Patriot.
5
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.
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 Patriot 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 2003, FRB regulations
generally required that reserves be maintained against aggregate transaction
accounts as follows: for accounts aggregating $36.1 million or less (subject to
adjustment by the FRB) the reserve requirement is 3%; and for accounts
aggregating greater than $36.1 million, the reserve requirement is $900,000 plus
10% (subject to adjustment by the FRB between 8% and 14%) against that portion
of total transaction accounts in excess of $36.1 million. The first $6.0 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. Patriot 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 2003 taxable year, Patriot 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 Patriot, 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 Patriot, 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 ALTERNATIVE 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).
DIVIDENDS RECEIVED DEDUCTION AND OTHER MATTERS. Patriot 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 Patriot 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.
Patriot, Patriot Advisors, PCLC, PIIC, 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
Patriot has 20 properties consisting of 17 community banking offices and 3
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
Spring Township 155 Shillington Road Leased
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 1345 Airport Road Leased
Cherryville 765 Blue Mountain Drive Owned
Walnutport 500 Main Street Leased
SALES AND OPERATIONAL OFFICES
CHESTER COUNTY
Patriot Advisors 717 Constitution Drive Leased
Exton, PA 19341
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
Patriot is a defendant in various legal actions arising from normal
business activities. Management believes that those actions are without merit or
that the ultimate liability, if any, resulting from such actions will not have a
material adverse effect on Patriot's consolidated financial position, results of
operations, or shareholders' equity.
8
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
Certain information, including principal occupation during the past five
years, relating to the principal executive officers of Patriot, as of March 8,
2004, is set forth below:
Richard A. Elko -- Age 42. Mr. Elko was elected President and Chief
Executive Officer of Patriot and the Bank in November 2000. Prior to that Mr.
Elko served as Executive Vice President since 1999 and Chief Financial Officer
of Patriot and the Bank from January 1996 to December 1999.
Joni S. Naugle -- Age 45. Ms. Naugle was elected as Executive Vice
President and Chief Operating Officer of Patriot and the Bank in February 2001.
Prior to that, Ms. Naugle served as Chief Operating Officer of Patriot 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 37. Mr. Pyle was elected as Executive Vice President
and Chief Lending Officer of Patriot 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 38. Mr. Blume was elected as Senior Vice President
and Chief Financial Officer of Patriot and the Bank in February 2001. Prior to
that, Mr. Blume served as Chief Financial Officer of Patriot since December
1999. Prior to that, Mr. Blume served as Controller of Patriot and Patriot Bank
since March 1997.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Patriot'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 8,
2004, the total number of holders of record of Patriot's common stock was 807.
The following table sets forth the high and low bid and asked information
of Patriot's common stock to the extent available as reported by NASDAQ.
2003
---------------------------------------------
BID ASKED
--------------------- ---------------------
QTR HIGH LOW HIGH LOW
- --- --------- --------- --------- ---------
1st $ 15.6727 $ 13.3000 $ 15.6818 $ 13.4000
2nd 18.5100 15.7800 18.8700 15.9000
3rd 22.2700 16.9800 22.3000 17.1200
4th 29.1100 19.7200 29.2100 19.7500
2003
---------------------------------------------
BID ASKED
--------------------- ---------------------
QTR HIGH LOW HIGH LOW
- --- --------- --------- --------- ---------
1st $ 13.7700 $ 10.4500 $ 13.7800 $ 10.5500
2nd 14.8500 13.3000 15.0000 13.4000
3rd 14.1800 12.9200 14.2400 13.0000
4th 15.3600 13.4600 15.4700 13.6500
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 Patriot, the best approximate value at the time indicated.
9
DIVIDEND INFORMATION. Dividends on Patriot's common stock are generally payable
in February, May, August and November. Set forth below are the cash dividends
paid by Patriot during 2003 and 2002. Such dividends have been adjusted to
reflect all stock dividends paid during such years.
2003 2002
------- -------
First Quarter................................ $ .1091 $ .0886
Second Quarter............................... $ .1200 $ .0909
Third Quarter................................ $ .1300 $ .0930
Fourth Quarter............................... $ .1350 $ .1000
For certain limitations on the ability of the Bank to pay dividends to
Patriot, 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
AT DECEMBER 31, 2003
---------------------------------------------------------------------
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 Compensation Plan:
Stock-based options........................ 248,809 $ 7.35 --
Stock-based incentives..................... 283,800 N/A 14,000
2002 Stock Option Plan........................ 248,522 13.07 64,515
EQUITY COMPENSATION PLANS NOT
APPROVED BY SECURITY HOLDERS............... N/A N/A N/A
----------------------- -------------------- --------------------
Total.................................... 781,131 N/A 78,515
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,
----------------------------------------------------------------
2003 2002 2001 2000 1999
---------- --------- ----------- ----------- -----------
(IN THOUSANDS)
SELECTED FINANCIAL CONDITION DATA:
Total assets .............................. $1,043,648 $ 995,143 $ 1,010,070 $ 1,124,905 $ 1,129,443
Investment and mortgage-backed
securities available for sale ........... 347,140 315,868 247,612 84,889 87,334
Investment and mortgage-backed
securities held to maturity ............. -- -- 43,637 302,489 348,047
Loans held for sale ....................... 4,363 4,314 6,652 8,564 4,972
Loans and leases receivable ............... 625,499 618,217 649,139 656,479 628,060
Allowance for credit losses ............... (6,904) (6,922) (6,199) (5,839) (6,082)
Deposits .................................. 613,555 519,120 533,863 649,958 502,002
Repurchase agreements ..................... 44,407 14,210 -- -- --
Borrowings ................................ 310,155 388,673 405,179 416,837 568,795
Shareholders' equity ...................... 65,743 65,945 61,706 51,800 49,768
Year ended December 31,
----------------------------------------------------------------
2003 2002 2001 2000 1999
---------- --------- ----------- ----------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
SELECTED OPERATING DATA:
Interest income ........................... $ 59,238 $ 66,114 $ 75,850 $ 84,143 $ 75,544
Interest expense .......................... 27,837 36,858 52,209 61,471 51,510
---------- --------- ----------- ----------- -----------
Net interest income before
provision for credit losses ............. 31,401 29,256 23,641 22,672 24,034
Provision for credit losses ............... 3,930 4,075 2,000 1,125 1,200
---------- --------- ----------- ----------- -----------
Net interest income after provision
for credit losses ....................... 27,471 25,181 21,641 21,547 22,834
Non-interest income ....................... 11,629 7,241 7,892 7,124 5,945
Non-interest expense ...................... 28,423 22,664 20,768 26,844 26,402
---------- --------- ----------- ----------- -----------
Income before taxes and cumulative
effect of change in accounting principle 10,677 9,758 8,765 1,827 2,377
Income taxes expense (benefit) ............ 2,042 2,060 2,462 (182) 177
---------- --------- ----------- ----------- -----------
Income before cumulative effect of
change in accounting principle .......... $ 8,635 $ 7,698 $ 6,303 $ 2,009 $ 2,200
Cumulative effect of change in
accounting principle, net of ($105)
in income tax ........................... -- -- (204) -- --
========== ========= =========== =========== ===========
Net income ............................... $ 8,635 $ 7,698 $ 6,099 $ 2,009 $ 2,200
========== ========= =========== =========== ===========
Diluted earnings per share ................ $ 1.28 $ 1.14 $ 0.92 $ 0.31 $ 0.34
========== ========= =========== =========== ===========
Net income before non-recurring
charges (2)(8) .......................... $ 5.233 $ 5.549
=========== ===========
Diluted earnings per share before
non-recurring charges (2) ............... $ 0.81 $ 0.85
=========== ===========
Cash earnings per share before
non-recurring charges (2)(7)(8) ......... $ 1.44 $ 1.28 $ 1.18 $ 1.06 $ 1.09
========== ========= =========== =========== ===========
11
AT DECEMBER 31,
----------------------------------------------------------------
2003 2002 2001 2000 1999
---------- --------- ----------- ----------- -----------
PERFORMANCE RATIOS (1):
Return on average equity.................... 13.12% 12.05% 10.52% 3.94% 4.00%
Return on average equity before
non-recurring charge (2)................. -- -- -- 10.30 10.10
Cash return on average equity (7)........... 19.17 16.49 16.91 18.66 12.95
Return on average assets.................... 86 0.77 0.58 0.17 0.20
Return on average assets before
non-recurring charge (2)................. -- -- -- 0.45 0.51
Average interest rate spread (3)............ 3.43 3.15 2.36 2.13 2.32
Net interest margin (4)..................... 3.66 3.35 2.50 2.25 2.44
Average interest-earning assets to
average interest bearing liabilities..... 100.81 101.14 100.47 99.09 100.39
Efficiency ratio before
non-recurring charge (2)................. 2.84 2.28 1.96 2.32 2.41
Dividend pay-out ratio...................... 38.60 32.14 36.27 105.70 86.02
REGULATORY CAPITAL RATIOS (5):
Tier 1 capital to average assets............ 7.29% 7.33% 6.45% 5.48% 5.45%
Tier 1 capital to risk-adjusted assets...... 10.67 11.23 10.49 9.45 9.39
Total risk adjusted capital to
risk-adjusted assets..................... 11.77 12.61 11.54 10.41 10.46
ASSET QUALITY RATIOS (6):
Non-performing assets as a
percent of total assets.................. 0.40% 0.67% 0.53% 0.35% 0.15%
Non-performing loans as a
percent of loans receivable.............. 0.59 1.01 0.76 0.59 0.24
Allowance for credit losses as a
percent of loans receivable.............. 1.10 1.11 0.95 0.88 0.96
Allowance for credit losses as a
percent of non-performing assets......... 166.54 103.74 116.20 147.82 354.04
- ---------------
(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. There weren't any non-recurring
changes in 2001, 2002 and 2003.
(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 2003, 2002, 2001, 2000, and 1999 was $2,886,000, $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 properly 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,
----------------------------------------------------------------
2003 2002 2001 2000 1999
---------- --------- ----------- ----------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income before non-recurring charges.... $ 8,635 $ 7,698 $ 6,099 $ 5,233 $ 5,549
Goodwill amortization....................... -- -- 730 1,036 656
Intangible amortization..................... 533 486 486 422 336
ESOP expense................................ 524 353 238 216 262
MRP expense................................. 44 40 173 377 359
---------- --------- ----------- ----------- -----------
Cash earnings $ 9,736 $ 8,577 $ 7,726 $ 7,284 $ 7,162
========== ========= =========== =========== ===========
Cash earnings per share before
non-recurring charges $ 1.44 $ 1.28 $ 1.18 $ 1.06 $ 1.09
========== ========= =========== =========== ===========
(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
=========== ===========
Patriot's earnings disclose non-recurring charges for 1999 and 2000. These
special charges are added back to net income so that Patriot's normal earnings
for 1999 through 2003 are comparative.
13
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. On April 25, 2003, Patriot paid a special 10% stock dividend. 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 372,000 $ 2,517,000
1997 1,371,000 13,554,000
1998 592,000 6,892,000
1999 415,000 4,808,000
2000 -- --
2001 -- --
2002 323,000 4,189,000
2003 349,000 7,070,000
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, 2003, goodwill and core
deposit intangibles arising from the transaction totaled $6,909,000 and
$2,413,000, 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 ACQUISITIONS. 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 subsidiary of
Patriot Bank Corp. that provides a full range of wealth and investment
management services. The acquisition was accounted for as a purchase. Bonds &
Paulus was purchased for $458,000 plus contingent consideration to be paid in
shares of Patriot Bank Corp. common stock 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 were issued at closing. Based
upon current revenue, the total purchase price will approximate $1,300,000.
Goodwill arising from the transaction totaled $1,209,000. An additional $366,000
of intangible assets acquired were assigned to customer lists subject to
amortization and having a 15-year weighted-average useful life.
14
On September 5, 2003, Patriot completed the acquisition of Tyler Wealth
Counselors, a wealth management firm headquartered in Chester County,
Pennsylvania. Tyler Wealth Counselors is a registered investment advisory firm,
providing investment advisory and financial planning services to individuals and
families. Tyler Wealth Counselors was merged into Patriot Advisors, a subsidiary
of Patriot Bank Corp. that provides a full range of wealth and investment
management services. The acquisition was accounted for as a purchase. Tyler
Wealth Counselors was purchased for $650,000 in cash. $695,000 of intangible
assets acquired were assigned to customer lists subject to amortization and
having a 5-year weighted-average useful life.
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, a subsidiary of Patriot
Bank Corp. The acquisition was accounted for as a purchase. Pension Benefits,
Inc. was purchased for $829,000 plus contingent consideration to be paid in
shares of Patriot Bank Corp. common stock 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 were issued at closing. Based upon current
revenue, the total purchase price will approximate $1,700,000. Goodwill arising
from the transaction totaled $1,454,000. An additional $460,000 of intangible
assets acquired were assigned to customer lists subject to amortization and
having a 15-year weighted-average useful life.
As of December 31, 2003, Patriot completed an impairment evaluation for
each of its acquisitions. Based on this evaluation, there was no evidence of
impairment.
15
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2003 AND 2002
SUMMARY. For the year ended December 31, 2003, Patriot reported net income
of $8,635,000 or $1.28 diluted earnings per share. For the year ended December
31, 2002, Patriot reported net income of $7,698,000 or $1.14 diluted earnings
per share which has been restated to reflect the effect of the 10% stock
dividend paid in April 2003. Return on average equity was 13.12% for 2003 and
12.05% for 2002.
NET INTEREST INCOME. Net interest income for 2003 was $31,401,000 compared
to $29,256,000 in 2002. The yield on Patriot's interest-earning assets decreased
to 6.63% for 2003 compared to 7.28% for 2002. 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 2.99% for 2003 compared to 3.98% for
2002. The decrease in funding costs resulted from generally lower interest rates
coupled with reductions in higher cost borrowings. Overall, Patriot's net
interest margin (net interest income as a percentage of average interest-earning
assets) increased to 3.66% for 2003 compared to 3.35% in 2002.
Interest on loans was $42,839,000 for 2003 compared to $49,020,000 for
2002. The average balance of loans in 2003 was $598,653,000 with an average
yield of 7.18% compared to an average balance of $635,788,000 with an average
yield of 7.73% in 2002. The decrease in average balance of loans is a result of
Patriot allowing residential mortgages to run-off, offset by growth in consumer
and commercial loans. The decrease in average yield is primarily a result of a
decrease in market rates.
Interest on Patriot's investment portfolio (investment and mortgage-backed
securities) was $16,384,000 for 2003 compared to $17,021,000 for 2002. The
average balance of the investment portfolio was $335,999,000 with an average
yield of 5.69% for 2003 compared to an average balance of $296,079,000 with an
average yield of 6.41% for 2002. The increase in average balance is primarily
due to Patriot investing funds from the repayment of residential mortgage loans.
The decrease in average yield is related to new security purchases at lower
yields as well as general decreases in market rates on adjustable rate
securities.
Interest on total deposits was $12,376,000 for 2003 compared to $14,479,000
for 2002. The average balance of total deposits was $586,524,000 with an average
cost of 2.11% for 2003 compared to an average balance of $518,051,000 with an
average cost of 2.79% for 2002. The increase in average balance is primarily the
result of aggressive marketing of money market and transaction-based deposit
accounts through new and existing branches. The overall decrease in the average
cost on deposits was primarily the result of a decrease in market rates, a
reduction in higher costing certificate of deposit accounts and emphasis placed
on lower cost core deposit accounts.
Interest on borrowings was $15,461,000 in 2003 compared to $22,379,000 in
2002. The average balance of borrowings was $343,054,000 with an average cost of
4.51% for 2003 compared to an average balance of $407,687,000 with an average
cost of 5.49% for 2002. The decrease in average balance was primarily due to
borrowings being replaced with branch deposit growth. The decrease in the cost
of borrowings was the result of a decrease in interest rates and the result of
restructured borrowed funds with a higher cost of funds. During 2003, Patriot
prepaid $55,000,0000 in FHLB borrowings and restructured $72,000,000 in FHLB
borrowings.
On June 20, 2003, Patriot entered into three pay variable, receive fixed
interest rate swaps to hedge changes in the fair value of designated fixed rate
FHLB advances. The notional amount of these contracts totals $72 million and
they mature on May 29, 2008. The company has agreed to pay 3 month LIBOR plus a
spread, with quarterly reset, and to receive a fixed rate equal to the rate paid
on the individual FHLB advances.
Since the terms of interest rate swaps mirror those of the hedged items,
FHLB advances, Patriot has adopted the short cut method, as prescribed in SFAS
No. 133, to account for these transactions. Therefore, no hedge ineffectiveness
was recognized in earnings related to these fair value hedges.
16
SPREAD ANALYSIS. The following table sets forth Patriot's average balances
and the yields on those balances for the years ended December 31, 2003, 2002 and
2001. 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,
----------------------------------------------------------------------------------------------
2003 2002 2001
------------------------------ ---------------------------- ------------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
---------- -------- ------ -------- -------- ------ ---------- -------- ------
(IN THOUSANDS)
ASSETS
Interest-earning assets:
Interest-earning deposits...... $ 2,469 $ 15 0.64% $ 4,457 $ 73 1.64% $ 13,682 $ 508 3.71%
Investment and mortgage-
backed securities (1)........ 335,999 16,384 5.69 296,079 17,021 6.41 333,872 21,220 6.73
Loans and leases
receivable, net (2).......... 598,653 42,839 7.18 635,788 49,020 7.73 653,460 54,122 8.30
---------- -------- ------ -------- -------- ------ ---------- -------- ------
Net interest-earning assets.... 937,121 59,238 6.63 936,324 66,114 7.28 1,001,014 75,850 7.71
Non-interest-earning assets.... 63,650 -- -- 59,783 -- -- 56,549 -- --
---------- -------- ------ -------- -------- ------ ---------- -------- ------
Total assets................... $1,000,771 $ 59,238 6.21% $996,107 $ 66,114 6.85% $1,057,563 $ 75,850 7.30%
========== ======== ====== ======== ======== ====== ========== ======== ======
LIABILITIES AND EQUITY
Interest-bearing liabilities:
Core deposits.................. $ 337,458 $ 4,307 1.28% $270,801 $ 4,178 1.54% $225,845 $ 5,763 2.55%
Branch certificates of deposit 214,709 7,103 3.31 214,721 8,815 4.11 243,860 14,618 5.99
Brokered certificates
of deposit................... 34,357 966 2.81 32,529 1,486 4.57 105,530 7,309 6.93
---------- -------- ------ -------- -------- ------ ---------- -------- ------
Total deposits................. 586,524 12,376 2.11 518,051 14,479 2.79 575,235 27,690 4.81
Borrowings (3)................. 343,054 15,461 4.51 407,687 22,379 5.49 421,084 24,519 5.82
---------- -------- ------ -------- -------- ------ ---------- -------- ------
Total interest-bearing
liabilities.................. 929,578 27,837 2.99% 925,738 36,858 3.98% 996,319 52,209 5.24%
Non-interest-bearing
liabilities.................. 5,393 -- -- 6,475 -- -- 3,266 -- --
---------- -------- ------ -------- -------- ------ ---------- -------- ------
Total liabilities.............. 934,971 27,837 2.98 932,213 36,858 3.95 999,585 52,209 5.22
Equity......................... 65,800 -- -- 63,894 -- -- 57,978 -- --
---------- -------- ------ -------- -------- ------ ---------- -------- ------
Total liabilities and equity- $1,000,771 $ 27,837 2.78% $996,107 $ 36,858 3.70% $1,057,563 $ 52,209 4.94%
========== ======== ====== ======== ======== ====== ========== ======== ======
Net interest income............ $ 31,401 $ 29,256 $ 23,641
======== ======== ========
Net interest rate spread(4).... 3.43% 3.15% 2.36%
====== ====== ======
Net interest margin (5)........ 3.66 3.35 2.50
Ratio of interest-earning
assets to interest
bearing liabilities......... 100.81% 101.14% 100.47%
- ---------------
(1) Includes securities available for sale and held to maturity (2001 only) 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 2003, 2002, and 2001 was
$2,719,000, $1,956,000 and $1,250,000, 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 2003, 2002, and 2001 was $167,000,
$131,000, and $115,000 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 31, 23 and
14 basis points in 2003, 2002 and 2001, respectively.
17
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, 2003 YEAR ENDED DECEMBER 31, 2003
COMPARED TO YEAR ENDED COMPARED TO YEAR ENDED
DECEMBER 31, 2002 DECEMBER 31, 2001
INCREASE (DECREASE) INCREASE (DECREASE)
DUE TO DUE TO
------------------------------ ------------------------------
VOLUME RATE NET VOLUME RATE NET
-------- -------- -------- -------- ------- ---------
(IN THOUSANDS)
INTEREST-EARNING ASSETS:
Interest-earning deposits ................... $ (33) $ (24) $ (57) $ (342) $ (93) $ (435)
Investment and mortgage-
backed securities ......................... 2,559 (3,196) (637) (2,543) (1,656) (4,199)
Loans receivable ............................ (2,871) (3,311) (6,182) (1,467) (3,635) (5,102)
-------- -------- -------- -------- ------- ---------
Total interest-earning assets ............... (345) (6,531) (6,876) (4,352) (5,384) (9,736)
-------- -------- -------- -------- ------- ---------
INTEREST-BEARING LIABILITIES:
Deposits .................................... 1,914 (4,017) (2,103) (2,748) (10,463) (13,211)
Borrowings .................................. (3,548) (3,370) (6,918) (780) (1,360) (2,140)
-------- -------- -------- -------- ------- ---------
Total interest-bearing liabilities .......... (1,634) (7,387) (9,021) (3,528) (11,823) (15,351)
-------- -------- -------- -------- ------- ---------
Net change in net interest income ........... $ 1,289 $ 856 $ 2,145 $ (824) $ 6,439 $ 5,615
======== ======== ======== ======== ======= =========
18
PROVISION FOR CREDIT LOSSES. The provision for credit losses was $3,930,000
for 2003 compared to $4,075,000 for 2002. 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,
---------------------------------------------------
2003 2002 2001 2000 1999
-------- -------- -------- -------- -------
(IN THOUSANDS)
Allowance, beginning of year................. $ 6,922 $ 6,199 $ 5,839 $ 6,082 $ 4,087
Charge-offs:
Commercial loans.......................... 1,835 1,280 640 675 443
Commercial leases......................... 1,509 1,858 798 436 130
Residential loans......................... 103 158 79 102 249
Home equity and consumer loans............ 914 347 355 268 243
-------- -------- -------- -------- -------
Total charge-offs.................... 4,361 3,643 1,872 1,481 1,065
-------- -------- -------- -------- -------
Recoveries:
Commercial loans.......................... 157 95 39 16 27
Commercial leases......................... 193 121 134 82 39
Residential loans......................... 42 71 29 -- --
Home equity and consumer loans............ 21 4 30 15 38
-------- -------- -------- -------- -------
Total recoveries..................... 413 291 232 113 104
-------- -------- -------- -------- -------
Net charge-offs.............................. 3,948 3,352 1,640 1,368 961
Acquired allowance........................... -- -- -- -- 1,756
Provision charged to operations.............. 3,930 4,075 2,000 1,125 1,200
-------- -------- -------- -------- -------
Allowance, end of year....................... $ 6,904 $ 6,922 $ 6,199 $ 5,839 $ 6,082
======== ======== ======== ======== =======
Net charge-offs to average loans
and leases.............................. .56% .53% .25% .21% .17%
Allowance for credit losses as a
percentage of year-end total loans...... 1.10% 1.11% .95% .88% .96%
NON-INTEREST INCOME. Total non-interest income was $11,629,000 for 2003
compared to $7,241,000 for 2002. The increase in non-interest income was derived
primarily from three sources:
Non-interest income from gains on the sale of loans and leases was
$2,326,000 for 2003 compared to $1,928,000 for 2002. This increase was primarily
due to gains recognized during 2003 on the sale of the guaranteed portion of
Small Business Administration (SBA) loans. Patriot did not sell SBA loans during
2002.
Patriot Advisors, a subsidiary of Patriot Bank Corp., provided $2,333,000
in non-interest income in 2003 compared to $294,000 in 2002. This increase in
Patriot Advisors' non-interest income can be attributed to the acquisitions of
Bonds & Paulus Associates, Inc. and Pension Benefits, Inc. which occurred during
the first quarter of 2003 as well as the acquistion of Tyler Wealth Counselors,
which occurred during the third quarter of 2003.
Non-interest income from service fees on deposits was $3,657,000 in 2003
compared to $2,847,000 for 2002. The increase in service fees on deposits was a
result of the implementation of an overdraft privilege product which was
implemented during the third quarter of 2002. In 2003, Patriot recognized income
on this product for the whole year versus a partial year in 2002.
During 2003, Patriot prepaid $55,000,0000 in FHLB borrowings and recorded a
$724,000 loss, representing the prepayment penalties for repaying these advances
early. In conjunction with these transactions, Patriot sold $30,859,000 of
securities and recognized $932,000 of investment gains. Overall, the combination
of these transactions allowed Patriot to improve its interest rate risk profile.
19
NON-INTEREST EXPENSE. Total non-interest expense was $28,423,000 for 2003
compared to $22,664,000 in 2002. Of this increase in non-interest expense during
2003, $3,859,000 was primarily due to higher compensation costs associated with
increases in staffing. Patriot's three acquisitons during 2003 as well as
service requirements associated with branch deposit and commercial lending
growth caused the increases in staffing. Other non-interest expenses such as
occupancy and equipment, advertising, deposit processing and office supplies and
postage were also higher during 2003 as compared to 2002, which can be
attributed to normal recurring expenses associated with Patriot's three
acquisitions in 2003 and the addition of 2 new branches in 2003.
INCOME TAX PROVISION. The income tax provision was $2,042,000 for 2003
compared to $2,060,000 for 2002. The effective tax rate for 2003 was 19.13%
compared to 21.11% for 2002. The decrease in the effective tax rate was due to
greater tax exempt income from tax-beneficial securities.
FINANCIAL CONDITION
LOAN AND LEASE 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, 2003, Patriot's total loan and lease portfolio was
$625,499,000 compared to $618,217,000 at December 31, 2002. The increase in the
portfolio is primarily the result of an increase in commercial lending
relationships offset by Patriot allowing residential mortgages to runoff.
20
The following table sets forth the composition of Patriot's loan and lease
portfolio in dollar amounts and in percentages of the respective portfolios at
the dates indicated:
AT DECEMBER 31,
----------------------------------------------------------------
2003 2002 2001
------------------- ------------------- --------------------
PERCENT PERCENT PERCENT
AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL
-------- -------- -------- -------- -------- ---------
(IN THOUSANDS)
COMMERCIAL PORTFOLIO:
Commercial loans.................. $ 348,507 55.82% $315,537 51.17% $283,848 43.79%
Commercial leases................. 82,056 13.14 77,138 12.51 77,838 12.01
CONSUMER PORTFOLIO:
Home equity loans................. 99,231 15.89 72,400 11.74 66,834 10.31
Other consumer loans.............. 5,144 0.82 7,724 1.25 8,614 1.33
MORTGAGE PORTFOLIO:
Residential mortgage loans........ 79,092 12.67 135,632 22.00 206,467 31.85
Construction loans................ 10,323 1.66 8,220 1.33 4,605 .71
-------- -------- -------- -------- -------- ---------
Total loans and leases, gross........ 624,353 100.00% 616,651 100.00% 648,206 100.00%
Deferred loan costs (1)........... 1,146 1,566 933
Allowance for credit losses....... (6,904) (6,922) (6,199)
--------- -------- --------
Total loans and leases, net..... $ 618,595 $611,295 $642,940
========= ======== ========
AT DECEMBER 31,
-----------------------------------------
2000 1999
------------------- -------------------
PERCENT PERCENT
AMOUNT OF TOTAL AMOUNT OF TOTAL
-------- -------- -------- --------
(IN THOUSANDS)
COMMERCIAL PORTFOLIO:
Commercial loans.......................... $252,837 38.47% $189,189 30.02%
Commercial leases......................... 67,094 10.21 57,808 9.17
CONSUMER PORTFOLIO:
Home equity............................... 64,733 9.85 69,785 11.07
Other consumer loans...................... 8,553 1.30 9,081 1.44
MORTGAGE PORTFOLIO:
Residential mortgages..................... 253,213 38.53 293,852 46.64
Construction.............................. 10,779 1.64 10,481 1.66
-------- -------- -------- --------
Total loans and leases, gross................ 657,209 100.00% 630,196 100.00%
Deferred loan fees (1).................... (730) (2,136)
Allowance for credit losses............... (5,839) (6,082)
-------- --------
Total loans and leases, net............. $650,640 $621,978
======== ========
- ---------------
(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 $(2,136,000) and $(730,000) in net
deferred fees in 1999 and 2000, respectively, to $933,000, $1,566,000 and
$1,146,000 in net deferred costs in 2001, 2002 and 2003 respectively.
21
LOAN AND LEASE 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, 2003
--------------------------------------------
IN ONE AFTER AFTER
YEAR ONE TO FIVE
OR LESS FIVE YEARS YEARS TOTAL
-------- ---------- -------- ---------
(IN THOUSANDS)
LOAN AND LEASE MATURITY SCHEDULE:
Commercial loans............................. $ 92,867 $ 211,625 $ 9,726 $ 314,218
Commercial construction loans................ 17,721 8,284 8,284 34,289
Commercial leases............................ 30,296 51,625 135 82,056
Residential construction loans............... 7,598 2,725 -- 10,323
-------- ---------- -------- ---------
Total..................................... $148,482 $ 274,259 $ 18,145 $ 440,886
======== ========== ======== =========
Fixed rates.................................. $ 75,231 $ 252,321 $ 11,958 $ 339,510
Adjustable rates............................. 73,251 21,938 6,187 101,376
-------- ---------- -------- ---------
Total $148,482 $ 274,259 $ 18,145 $ 440,886
======== ========== ======== =========
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 generally 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, 2003, non-performing assets ("NPAs") were $4,146,000 or
0.40% of total assets compared to $6,672,000 or 0.67% of total assets at
December 31, 2002. Patriot controls its level of non-performing assets by
quickly identifying problem assets and resolving them in an expedient manner. At
December 31, 2003, 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.
22
The following table sets forth information regarding non-performing assets:
AT DECEMBER 31,
-------------------------------------------------------
2003 2002 2001 2000 1999
-------- ---------- -------- --------- --------
(IN THOUSANDS)
Non-accrual loans and leases
greater than 90 days past due:
Commercial loans.......................... $ 2,519 $ 3,601 $ 2,047 $ 1,593 $ 189
Commercial leases......................... 605 657 686 502 56
Home equity and consumer.................. 149 58 184 255 373
Residential mortgages..................... 369 1,031 1,636 1,142 591
-------- ---------- -------- --------- --------
Total non-accrual loans and leases
greater than 90 days past due............. 3,642 5,347 4,553 3,492 1,209
-------- ---------- -------- --------- --------
Non-accrual loans and leases less
than 90 days past due:
Commercial loans.......................... 56 292 30 208 --
Commercial leases......................... 42 355 116 -- --
Home equity and consumer.................. 5 38 133 22 74
Residential mortgages .................... -- 236 154 166 242
-------- ---------- -------- --------- --------
Total non-accrual loans and
leases less than 90 days past due......... 103 921 433 396 316
-------- ---------- -------- --------- --------
Total non-performing loans................... 3,745 6,268 4,986 3,888 1,525
Real estate owned (REO)...................... 401 404 349 62 193
-------- ---------- -------- --------- --------
Total non-performing assets.................. $ 4,146 $ 6,672 $ 5,335 $ 3,950 $ 1,718
======== ========== ======== ========= ========
Allowance for credit losses as a
percent of loans receivable............... 1.10% 1.11% .95% .88% .96%
Non-performing loans as a percent
of total loans receivable................. .59 1.01 .76 .59 .24
Non-performing assets as a percent
of total assets........................... .40 .67 .53 .35 .15
ALLOWANCE FOR CREDIT LOSSES. The allowance for credit losses is based on
management's ongoing evaluation of the loan and lease 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.
23
Patriot's percentage of loss reserves to total loans and leases of
1.10% remained relatively consistent with 2002. During 2003, Patriot's loan and
lease portfolios increased from $618,217,000 at December 31, 2002, to
$625,499,000. The increase in the portfolios is attributed to growth in the
commercial and consumer loan and leasing portfolios offset by the run off of
mortgage loans. Based on management's evaluation of the impact of current
economic conditions, diversification of the portfolios, delinquency and
non-performing loan statistics, results of loan review and related
classifications, and historic loss rates, management determined a provision of
$3,930,000 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, 2003.
Patriot's total loans and leases consist of four distinct portfolios.
Each of which is monitored and analyzed seperately.
Residential mortgage loans comprise 14.32% of total loans and leases.
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 2003. The ratio of non-performing assets to
the total mortgage portfolio decreased from 0.88% at December 31, 2002 to 0.41%
at December 31, 2003. 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 16.71% of total loans and leases 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.
During the third quarter of 2003, Patriot's internal control process
uncovered what is believed to be a defalcation perpetrated by a mid-level
supervisory employee within Patriot's credit card operation. The defalcation
includes an alleged theft and the alleged falsification and destruction of
accounting records as well as the concealment of credit card delinquencies and
bankruptcies. The alleged defalcation included the concealment of approximately
$460,000 of unsecured customer bankruptcies, which, since they were not material
to any prior period, were charged off during the third quarter of 2003 through
Patriot's loan loss reserve. An additional $299,000 of credit card
delinquencies, which were subject to normal collection procedures were charged
off during the fourth quarter of 2003. At December 31, 2003, there was $80,000
of delinquent credit card receivables remaining from the defalcation. Additional
charge-offs may result from these delinquent accounts. Patriot has incorporated
these credit card charge-offs retroactively into its regression analysis.
Commercial loans comprise 55.82% of total loans and leases. 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. 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. The ratio of non-performing
assets in the commercial loan portfolio decreased from 1.23% at December 31,
2002 to 0.74% at December 31, 2003.
Commercial leases comprise 13.14% of total loans and leases. 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 trends may have on potential
losses. The ratio of non-performing assets in the leasing portfolio decreased
from 1.31% at December 31, 2002 to 0.79% at December 31, 2003.
24
The following table sets forth management's allocation of the allowance for
credit losses at the dates indicated:
AT DECEMBER 31,
---------------------------------------------------------------------------------------------------
2003 2002 2001
--------------------------------- --------------------------------- -----------------------------
PERCENT OF PERCENT OF PERCENT OF
PERCENT OF LOANS IN PERCENT OF LOANS IN PERCENT 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.................. $ 5,866 84.97% 68.96% $ 5,703 82.39% 63.68% $4,767 76.90% 55.80%
Home equity and consumer....... 698 10.11 16.71 734 10.60 12.99 654 10.55 11.64
Residential mortgages.......... 340 4.92 14.33 485 7.01 23.33 778 12.55 32.56
--------- ---------- ---------- --------- ---------- ---------- ------ --------- ----------
Total valuation allowances $ 6,904 100.00% 100.00% $ 6,922 100.00% 100.00% $6,199 100.00% 100.00%
========= ========== ========== ========= ========== ========== ====== ========= ==========
AT DECEMBER 31,
-----------------------------------------------------------------
2000 1999
------------------------------ ------------------------------
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.................. $ 4,312 73.84% 48.46% $3,605 59.27% 39.02%
Home equity and consumer..................... 624 10.69 11.15 968 15.92 12.46
Residential mortgages........................ 903 15.47 40.39 1,509 24.81 48.5
-------- ---------- ---------- ------ ---------- ----------
Total valuation allowances................ $ 5,839 100.00% 100.00% $6,082 100.00% 100.00%
======== ========== ========== ====== ========== ==========
CASH AND CASH EQUIVALENTS. Cash and cash equivalents at December 31,
2003, were $17,745,000 compared to $16,839,000 at December 31, 2002. The
increase 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, 2003,
were $347,140,000 compared to $315,868,000 at December 31, 2002. The increase in
investment and mortgage-backed securities is primarily due to Patriot investing
funds from the repayment of residential mortgage loans. Patriot purchased
$177,297,000 of investment securities, which was offset by $143,954,000 of
principal repayments, sales, calls and maturities.
25
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,
---------------------------------------------------------------
2003 2002 2001
------------------- -------------------- --------------------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE COST VALUE
--------- -------- --------- --------- --------- ---------
(IN THOUSANDS)
AVAILABLE FOR SALE:
Investment securities:
US Treasury and government
agency securities ..................... $ 27,692 $ 27,994 $ 66,304 $ 66,251 $ 31,475 $ 29,837
Corporate securities ................... 17,629 17,170 22,724 21,388 16,582 14,953
Equity securities ...................... 116,590 117,762 92,222 96,572 67,966 69,695
Mortgage-backed securities:
FHLMC ................................... 59,011 58,914 67,523 68,142 5,194 5,197
FNMA .................................... 125,156 124,859 55,821 56,127 45,466 45,446
GNMA .................................... 61 69 96 109 120 132
Collateralized mortgage obligations:
FHLMC ................................... 14 14 2,960 2,978 44,879 45,252
FNMA .................................... 357 358 3,689 3,794 33,632 34,144
Other ................................... - - 505 507 2,938 2,956
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