Patriot National Bancorp Inc: Form 10-Q for the period ended Sep 30, 2024

"Safe Harbor" Statement Under Private Securities Litigation Reform Act of 1995

This Quarterly Report on Form 10-Q contains statements that relate to future events and expectations and, as such, constitute forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995. Certain statements, other than purely historical information, including estimates, projections, statements relating to our strategies, outlook, business and financial prospects, business plans, objectives, and expected operating results, and the assumptions upon which those statements are based, are “forward-looking statements.” These forward-looking statements generally are identified by the words “believes,” “project,” “expects,” “anticipates,” “estimates,” “intends,” “strategy,” “plan,” “may,” “will,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. Forward-looking statements are not guarantees of future performance. Although Patriot believes that the expectations reflected in any forward-looking statements are based on reasonable assumptions, these expectations may not be attained and it is possible that actual results may differ materially from those indicated by these forward-looking statements due to a variety of risks, uncertainties and changes in circumstances, many of which are beyond Patriot’s control.

Many possible events or factors could affect Patriot’s future financial results and performance and could cause the actual results, performance or achievements of Patriot to differ materially from any anticipated results expressed or implied by such forward-looking statements. Such risks and uncertainties include, among others:

(1) changes in prevailing interest rates which would affect the interest earned on the Company’s interest earning assets and the interest paid on its interest bearing liabilities;

(2) the timing of re-pricing of the Company’s interest earning assets and interest bearing liabilities;

(3) the effect of changes in governmental monetary policy;

(4) the effect of changes in regulations applicable to the Company and the Bank and the conduct of its business;

(5) changes in competition among financial service companies, including possible further encroachment of non-banks on services traditionally provided by banks;

(6) the ability of competitors that are larger than the Company to provide products and services which it is impracticable for the Company to provide;

(7) the state of the economy and real estate values in the Company’s market areas, and the consequent effect on the quality of the Company’s loans;

(8) demand for loans and deposits in our market area;

(9) recent governmental initiatives that are expected to have a profound effect on the financial services industry and could dramatically change the competitive environment of the Company;

(10) other legislative or regulatory changes, including those related to residential mortgages, changes in accounting standards, and Federal Deposit Insurance Corporation (“FDIC”) premiums that may adversely affect the Company;

(11) the application of generally accepted accounting principles in the United States of America (“U.S. GAAP”), consistently applied;

(12) the fact that one period of reported results may not be indicative of future periods;

(13) the state of the economy in the greater New York metropolitan area and its particular effect on the Company's customers, vendors and communities and other such factors, including risk factors, as may be described in the Company’s other filings with the Securities and Exchange Commission (the “SEC”);

(14) political, social, legal and economic instability, civil unrest, war, catastrophic events, acts of terrorism;

(15) possible future outbreaks of infectious diseases, including the ongoing novel coronavirus (COVID-19) outbreak;

(16) changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of the allowance for c losses;

(17) our ability to access cost-effective funding;

(18) our ability to implement and change our business strategies;

(19) changes in the quality or composition of our loan or investment portfolios;

(20) technological changes that may be more difficult or expensive than expected;

(21) our ability to manage market risk, credit risk and operational risk in the current economic environment;

(22) our ability to enter new markets successfully and capitalize on growth opportunities;

(23) changes in consumer spending, borrowing and savings habits;

(24) our ability to retain key employees;

(25) our compensation expense associated with equity allocated or awarded to our employees;

(26) the premiums paid for the guaranteed portion of SBA loans by third party investors; and

(27) our ability to meet regulatory capital requirements.

The risks and uncertainties included here are not exhaustive. In addition to those included herein further information concerning our business, including additional factors that could materially affect our financial results, is included in our other filings with the SEC, including our Annual Report on Form 10-K for the year ended December 31, 2023 (the “2023 Form 10-K”). Further, it is not possible to assess the effect of all risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results. In addition, we disclaim any obligation to update any forward-looking statements to reflect events or circumstances that occur after the date of this report.

Critical Accounting Policies

The preparation of consolidated financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and to disclose contingent assets and liabilities. Actual results could differ from those estimates. Management has identified the accounting for the allowance for credit losses, the analysis and valuation of its investment securities, the valuation of deferred tax assets, the valuation of derivatives, and the valuation of servicing assets as certain of the Company’s most critical accounting policies and estimates in that they are important to the portrayal of the Company’s financial condition and results of operations. They require management’s most subjective and complex judgment as a result of the need to make estimates about the effect of matters that are inherently uncertain. Refer to the 2023 Form 10-K for additional information.

Summary

The Company reported net loss of $27.0 million ($6.78 basic and diluted loss per share) for the quarter ended September 30, 2024, compared to a net loss of $3.8 million ($0.95 basic and diluted loss per share) for the quarter ended September 30, 2023. The $23.2 million increase in net loss for the quarter was primarily driven by a full valuation allowance on deferred tax assets ("DTA") of $25.1 million, see Note 2 - Summary of Significant Accounting Policies for more information. This increase was partially offset by a pretax $3.7 million reduction in provision for credit losses and a pretax $1.5 million decrease in net interest income.

For the nine months ended September 30, 2024, the net loss was $30.3 million, or $7.63 basic and diluted loss per share, compared to a net loss of $5.1 million, ($1.28 basic and diluted loss per share) for the nine months ended September 30, 2023. This represents a year-over-year increase in net loss of $25.3 million. The primary driver of this increase was the same $25.1 million DTA valuation allowance, see Note 2 - Summary of Significant Accounting Policies for more information. This increase is offset by fluctuations including lower pretax net interest income of $6.8 million, lower pretax provision for credit losses of $3.5 million and higher pretax noninterest income of $3.6 million, primarily from revenue on the Digital Payments Division.

FINANCIAL CONDITION

Total assets decreased $119.3 million to $974.1 million as of September 30, 2024, compared to $1.09 billion at December 31, 2023, primarily due to the decline in loans receivable of $93.2 million as of September 30, 2024.

Cash, Cash Equivalents and Restricted Cash

Cash, cash equivalents and restricted cash increased from $66.5 million at December 31, 2023 to $72.8 million at September 30, 2024. The increase in 2024 reflects the intention to boost balance sheet liquidity. For further details, refer to the Consolidated Statements of Cash Flows.

Investments

The following table is a summary of the Company’s investment securities portfolio, at fair value, at the dates shown:

(In thousands)

Total investments increased by $0.4 million, from $93.6 million at December 31, 2023 to $94.0 million at September 30, 2024. The increase in the nine months ended September 30, 2024 was primarily attributable to a $2.3 million increase in purchase of available-for-sale securities and a $3.3 million unrealized gain on securities, partially offset by the sale and repayment of securities totaling $5.3 million. During the nine months ended September 30, 2024, the Bank sold available-for-sale securities of $2.3 million and recognized a net loss of $24,000.

Loans held for investment

The following table provides the composition of the Company’s loan held for investment portfolio as of September 30, 2024 and December 31, 2023:

(In thousands)

The Company’s loan portfolio decreased $93.2 million, from $848.9 million at December 31, 2023 to $755.7 million at September 30, 2024. The Company has continued the trend of restricting loan growth and allowing loans to pay down as the balance sheet is reduced in order to strengthen capital ratios.

SBA loans held for investment were included in the commercial real estate loans and commercial and industrial loan classifications above. As of September 30, 2024 and December 31, 2023, SBA loans included in the commercial and industrial loans were $11.6 million and $17.1 million, respectively. SBA loans included in the commercial real estate loans were $19.5 million and $12.9 million, respectively.

At September 30, 2024, the net loan to deposit ratio was 89.8% and the net loan to total assets ratio was 76.0%. At December 31, 2023, these ratios were 99.1% and 76.2%, respectively.

The following table provides the composition of the commercial real estate loan portfolio segment as of September 30, 2024 and December 31, 2023:

(In thousands)

The following table provides the commercial real estate loan portfolio segment by geographic concentrations as of September 30, 2024 and December 31, 2023:

(In thousands)

(1) Outside Market consists of loans in all other states, none of which are greater than 5% of the total.

Allowance for Credit Losses ("ACL") on Loans

The allowance for credit losses on loans was $15.0 million as of September 30, 2024, compared to $15.9 million as of December 31, 2023, a reduction of $941,000. The decrease in allowance was mainly due to reduction in loan balances and the recognition of charge-offs on the unsecured consumer loan portfolio. Based upon the overall assessment and evaluation of the loan portfolio at September 30, 2024, management believes $15.0 million in the allowance for credit losses, which represented 1.98% of gross loans outstanding, is adequate under prevailing economic conditions to absorb existing losses in the loan portfolio.

The following table provides detail of activity in the allowance for credit losses on loans for the three and nine months ended September 30, 2024 and 2023:

(In thousands)

For the three months ended September 30, 2024, net charge-offs decreased $2.1 million to $1.1 million, with a net charge-offs to average loans ratio of 0.56%, compared to $3.2 million and 1.40% for the three months ended September 30, 2023.

For the nine months ended September 30, 2024, net charge-offs declined $1.4 million to $5.8 million, with a net charge-offs to average loans ratio of 0.96% , down from $7.2 million and 1.07% for the nine months ended September 30, 2023.

The reduction in net charge-offs for both three and nine months ended September 30, 2024 was primary driven by a $1.7 million decrease in charge-offs related to purchased unsecured consumer loans as the portfolio balances have declined.

The average loan balance decreased by $137.4 million, from $921.2 million for the three months ended September 30, 2023, to $783.8 million for the three months ended September 30, 2024. For the nine-month period, the average loan balance decreased $89.4 million, from $899.5 million in 2023 to $810.1 million in 2024. This decrease in average loan balance for the three and nine months ended September 30, 2024, reflects the Company's continued approach of limiting loan growth and allowing loans to pay down to strengthen capital ratios as the balance sheet is reduced.

As of September 30, 2024 and September 30, 2023, the ACL was $15.0 million and $25.7 million, respectively. The decrease was due to significant charge-offs of reserved CRE and consumer loans after September 30, 2023, which also impacted the ACL to loans ratio of 1.98%, compared to an ACL of $25.7 million and an ACL to loans ratio of 2.88% as of September 30, 2023.

The nonaccrual loan was $36.5 million as of September 30, 2024, compared to $30.8 million as of September 30, 2023. The allowance for credit losses to nonaccrual loans ratio was 41.01% as of September 30, 2024, compared to 83.26% as of September 30, 2023. The rate at September 30, 2023 was significantly higher due to reserves on individually evaluated CRE loans that were subsequently charged-off after September 30, 2023.

The following table provides an allocation of allowance for credit losses on loans by portfolio segment:

(In thousands)

Non-performing Assets

The following table presents non-performing assets as of September 30, 2024 and December 31, 2023:

49

As of September 30, 2024, non-accrual loans increased to $36.5 million, compared to $18.1 million as of December 31, 2023. The non-accrual loans at September 30, 2024 was comprised of 116 borrowers. Of these, 14 loans were individually evaluated, and a specific reserve of $7.0 million was established for them. For collateral dependent loans, the Bank has obtained appraisal reports from independent licensed appraisal firms and discounted those values based on the Bank’s experience selling OREO properties and for estimated selling costs to determine estimated impairment. For cash flow dependent loans, the Bank determined the reserve based on the present value of expected future cash flows discounted at the loan's effective interest rate.

As of December 31, 2023, the $18.1 million of non-accrual loans was comprised of 139 borrowers. Of which, 19 loans were individually evaluated, and a specific reserve of $4.2 million was established.

Loans held for sale

SBA loans held for sale totaled nil and $9.9 million as of September 30, 2024 and December 31, 2023, respectively. SBA loans held for sale represent the guaranteed portion of SBA loans and are reflected at the lower of aggregate cost or market value. SBA loans held for sale at December 31, 2023, consisted of $3.5 million SBA commercial and industrial loans and $6.4 million SBA commercial real estate loans, respectively.For the three and nine months ended September 30, 2024, total gain on sale of $67,000 and $378,000 was recorded. A servicing asset of $791,000 and $857,000 was recognized as of September 30, 2024 and December 31, 2023, respectively.

As of September 30, 2024, the credit card loans held for sale from Digital Payments division totaled $10.2 million. The credit card loans expected to be held for no longer than three days before being sold. The credit card receivable are fully cash-secured by deposits at Patriot. The credit card loans are sold to the third party as a whole loan sale transaction, priced at Par, thus there is no servicing asset or gain or loss on sale.

In 2024, the Bank reentered the residential mortgage business. The Residential Mortgage Division, located in Jacksonville, FL, generates the loans and typically sells them to third parties. As of September 30, 2024, the Company reported residential mortgage loans held for sale totaling $3.5 million. These loans are recorded at the lower of aggregate cost or market value. For the three and nine months ended September 30, 2024, a total gain on sale of $10,000 and $24,000 was recorded. A servicing asset of $8,000 was recognized as of September 30, 2024.

Deferred Taxes

As of September 30, 2024 the carrying value of the deferred tax assets is nil as there is a full valuation allowance against all of the DTAs. As of December 31, 2023, DTAs were $24.1 million, consisting predominately of Federal and state net operating losses, capitalized costs and allowance for credit losses.

The effective tax provision rate for the three months ended September 30, 2024 was 1067.85%, compared to the effective tax benefit rate for the three months ended September 30, 2023 of (26.12)%. The effective tax provision and benefit rates for the nine months ended September 30, 2024 and September 30, 2023 were 363.40% and (26.37)%, respectively. The Company’s effective rates for both periods were affected by state taxes and non-deductible expenses and the full valuation allowance against all of the DTAs in the third quarter of 2024.

As of September 30, 2024, Patriot has $54.7 million of net operating losses ("NOLs") available for Connecticut tax purposes at September 30, 2024, which may be used to offset up to 50% of taxable income in any year. The NOLs expire between 2030 and 2044.

Valuation Allowance against Deferred Tax Assets

Patriot recognizes income taxes under the asset and liability method. Under this method, deferred tax assets (DTAs) and liabilities (DTLs) are recognized for the estimated tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and loss carry forwards. DTAs and DTLs are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on DTAs and DTLs of a change in tax rates is recognized in income in the period that includes the enactment date.

In certain circumstances DTAs are subject to reduction by a valuation allowance. A valuation allowance is subject to ongoing adjustment based on changes in circumstances that affect management’s judgment about the realizability of the deferred tax asset. Adjustments to increase or decrease the valuation allowance are charged or credited to the deferred tax component of the income tax provision or benefit.

The Company recognize deferred tax assets to the extent we believe it is more likely than not the asset will be realized. Quarterly, management assesses the available positive and negative evidence to estimate whether sufficient future taxable income will be generated to permit the use of existing deferred tax assets, including future reversals of existing taxable temporary differences, projected taxable income, tax-planning strategies, carryback potential if permitted, and the results of recent operations. A significant piece of objective negative evidence is the existence of a three or four year cumulative loss. Such objective negative evidence limits the ability of management to consider other subjective evidence, such as projected taxable income. When appropriate, the Company records a valuation allowance to reduce deferred tax assets to the amount that is more likely than not to be realized.

Based on our assessment performed as of September 30, 2024, we determined that a full valuation allowance was appropriate against the Company’s U.S. federal and state deferred tax assets. This resulted in an increase in our income tax expense of approximately $25.1 million for the nine months ended September 30, 2024. Currently, the key factor on the Company’s assumption of providing 100% valuation allowance was purely based on our historical operating losses. Once we begin generating profits, we will re-evaluate whether providing 100% valuation allowance is appropriate or if we can reassess that allowance. As deferred tax assets associated with NOL carryforwards are already a direct reduction to Tier 1 Capital, the valuation allowance at September 30, 2024 resulted in a reduction of Tier 1 Capital of $19.9 million.

Deposits

The following table is a summary of the Company’s deposits at the dates shown:

(In thousands)

Non-GAAP Financial Measures:

In addition to evaluating the Company's financial performance in accordance with U.S. generally accepted accounting principles ("GAAP"), management may evaluate certain non-GAAP financial measures, such as uninsured deposits to total deposits excluding Digital Payments deposits. A computation and reconciliation of non-GAAP financial measures used for these purposes is contained in the accompanying Reconciliation of GAAP to Non-GAAP Measures tables. We believe that by excluding Digital Payments deposits, management can present a view of uninsured deposits that better reflects the Company's traditional deposit base, providing investors with useful information for understanding our uninsured deposits position and financial stability. Digital Payments deposits are analyzed for FDIC insurance at the Program Manager level. Certain accounts are reciprocal deposits through the IntraFi network and therefore the entire deposit balances qualify for FDIC insurance. The remaining deposit balances are aggregated at the Program Manager level, and any deposits exceeding $250,000 are considered uninsured.

The non-GAAP financial measures should not be considered a substitute for GAAP basis measures and results, and we strongly encourage investors to review our consolidated financial statements in their entirety and not to rely on any single financial measure.

Reconciliation of GAAP to Non-GAAP Measures (unaudited):

(Dollars in thousands)

Borrowings

Total borrowings were $123.9 million and $201.1 million as of September 30, 2024 and December 31, 2023, respectively. Borrowings consist primarily of FHLB advances, senior notes, subordinated notes, junior subordinated debentures and a note payable. The senior notes, subordinated notes and junior subordinated debentures contain affirmative covenants that require the Company to maintain its and its subsidiaries’ legal entity and tax status, pay its income tax obligations on a timely basis, and comply with SEC and FDIC reporting requirements.

Federal Home Loan Bank borrowings

The Company is a member of the Federal Home Loan Bank of Boston ("FHLB-B"). Borrowings from the FHLB-B are limited to a percentage of the value of qualified collateral, as defined on the FHLB-B Statement of Products Policy. Qualified collateral, as defined, primarily consists of mortgage-backed securities and loans receivable that are required to be free and clear of liens and encumbrances, and may not be pledged for any other purposes.

FHLB-B advances are structured to facilitate the Bank’s management of its balance sheet and liquidity requirements. During the three months ended September 30, 2024, the Company repaid $30.0 million in long-term advances. As a result, the outstanding advances decreased from $101.0 million as of December 31, 2023, to $93.8 million as of September 30, 2024. At September 30, 2024, the FHLB-B advances carried a fixed interest rates of 5.03% with maturities of 1 day.

At September 30, 2024, collateral for FHLB-B borrowings consisted of a mixture of real estate loans and securities with book value of $221.2 million. Remaining unused borrowing capacity under this line totaled $5.4 million at September 30, 2024.

In addition, Patriot has a $2.0 million revolving line of credit with the FHLB-B. For the three and nine months ended September 30, 2024 and 2023, no funds had been borrowed under the line of credit.

Interest expense incurred for the three and nine months ended September 30, 2024 were $292,000 and $1.0 million, respectively. Interest expense incurred for the three and nine months ended September 30, 2023 were $748,000 and $3.8 million, respectively.

Correspondent Bank - Line of Credit

Patriot has entered into unsecured federal funds sweep and federal funds line of credit facility agreements with certain correspondent banks. Borrowings available under the agreements totaled $5.0 million and $22.0 million at September 30, 2024 and December 31, 2023, respectively. The purpose of the agreements is to provide a credit facility intended to satisfy overnight federal account balance requirements and to provide for daily settlement of FRB, Automated Clearing House (ACH), and other clearinghouse transactions.

There was no outstanding balance under the agreements at September 30, 2024 and December 31, 2023. Interest expense incurred for the three and nine months ended September 30, 2024 was $2,000 and $4,000, respectively. For three and nine months ended September 30, 2023, interest expense incurred was nil and $117,000, respectively.

Other Borrowing

The Federal Reserve Bank of New York (“FRBNY”) accepts loan pledges from qualifying depository institutions to secure borrowings from the Discount Window. Patriot has pledged eligible loans as collateral to support its borrowing capacity at the FRBNY. As of September 30, 2024, the book value of the pledged loans totaled $25.5 million, with a collateral value of $19.4 million. No funds were borrowed from the Discount Window under the FRBNY's Borrower-in-Custody ('BIC") program, and no interest expense was incurred for the three and nine months ended September 30, 2024. For the three and nine months ended September 30, 2023, a total of $12.0 million was borrowed, and interest expense incurred was $43,000 and $48,000, respectively.

In July 2023, the Bank established a collateralized funding line of $73.8 million at par value under the Federal Reserve's newly established Bank Term Funding Program ("BTFP"). The program provided additional funding to eligible depository institutions, assuring they can meet the needs of all their depositors. The program served as an additional source of liquidity against high-quality securities, eliminating the need of an institution to quickly sell those securities in times of stress. The line allowed for a fixed rate borrowing at market rates, for up to one year, with repayment permitted at any time without penalty. The BTFP ceased allowing any new advances after March 11, 2024. As of September 30, 2024, Patriot paid off the BTFP borrowing of $70.0 million that was outstanding as of December 31, 2023. Interest expense incurred for the three and nine months ended September 30, 2024 was $632,000 and $2.3 million, respectively. Interest expense incurred for the three and nine months ended September 30, 2023 was $833,000.

Senior notes

On December 22, 2016, the Company issued $12 million of senior notes ("2016 Senior Notes") bearing interest at 7% per annum. On November 17, 2021, the original maturity date of the 2016 Senior Notes was extended from December 22, 2021 to June 30, 2022.

On June 22, 2022, the Company amended and restated the 2016 Senior Notes. The maturity date of the Senior Notes was further extended to December 31, 2022, and the interest rate increased from (i) 7% to 7.25% from July 1, 2022 until September 30, 2022 and (ii) from 7.25% to 7.50% thereafter. The 2016 Senior Notes was repaid in December 2022.

On December 21, 2022, the Company completed an issuance and sale of $12 million in aggregate principal amount of 8.50% fixed rate senior notes due January 15, 2026 (“2022 Senior Notes”). In connection with the issuance of the 2022 Senior Notes, the Company incurred $326,000 of costs, which are being amortized over the term of the 2022 Senior Notes to recognize a constant rate of interest expense. At September 30, 2024 and December 31, 2023, $173,000 and $277,000 of unamortized debt issuance costs were deducted from the face amount of the 2022 Subordinated Notes included in the Consolidated Balance Sheet, respectively.

The 2022 Senior Note Purchase Agreement contains certain customary representations, warranties, and covenants made by each of the Company and the Purchasers. The 2022 Senior Notes are not subject to any sinking fund and are not convertible into or exchangeable for any other securities or assets of the Company or any of its subsidiaries. The 2022 Senior Notes are not subject to redemption at the option of the holders. Principal and interest on the 2022 Senior Notes are subject to acceleration only in limited circumstances. The 2022 Senior Notes are an unsecured, unsubordinated obligation and ranks equally in right of payment to all of the Company’s existing and future unsecured indebtedness, liabilities and other obligations that are not subordinated in right of payment to the Senior Note, and will be effectively subordinated to any of the Company’s existing and future secured indebtedness, to the extent of the value of the collateral securing such indebtedness. The 2022 Senior Notes are the obligations of the Company only and are not obligations of, and are not guaranteed by, any of the Company’s affiliates.

For the three and nine months ended September 30, 2024, the Company recognized interest expense of $290,000 and $869,000, respectively. Interest expense incurred for the three and nine months ended September 30, 2023 was $290,000 and $869,000, respectively.

Subordinated notes

On June 29, 2018, the Company entered into certain subordinated note purchase agreements with two institutional accredited investors and completed a private placement of $10 million of fixed-to-floating rate subordinated notes with the maturity date of September 30, 2028 (the “Subordinated Notes”) pursuant to Section 4(a)(2) of the Securities Act of 1933, as amended, and Rule 506(b) of Regulation D promulgated thereunder.

The Subordinated Notes initially bore interest at 6.25% per annum, from and including June 29, 2018, to but excluding, June 30, 2023, payable semi-annually in arrears. From and including June 30, 2023, until but excluding June 30, 2028 or an early redemption date, the interest rate shall reset quarterly to an interest rate per annum equal to the then current three-month LIBOR, which was replaced by SOFR in 2023 (but not less than zero) plus 332.5 basis points, payable quarterly in arrears. The Company may, at its option, beginning on June 30, 2023 and on any scheduled interest payment date thereafter, redeem the Subordinated Notes.

In connection with the issuance of the Subordinated Notes, the Company incurred $291,000 of debt issuance costs, which are being amortized over the term of the Subordinated Notes to recognize a constant rate of interest expense. At September 30, 2024 and December 31, 2023, $109,000 and $131,000 of unamortized debt issuance costs were deducted from the face amount of the Subordinated Notes included in the consolidated balance sheet, respectively.

For the three and nine months ended September 30, 2024, the Company recognized interest expense of $229,000 and $680,000, respectively. Interest expense incurred for the three and nine months ended September 30, 2023 was $229,000 and $556,000, respectively.

Junior subordinated debt owed to unconsolidated trust

In 2003, the Patriot National Statutory Trust I (“the Trust”), which has no independent assets and is wholly-owned by the Company, issued $8.0 million of trust preferred securities. The proceeds, net of a $240,000 placement fee, were invested in junior subordinated debentures issued by the Company, which invested the proceeds in the Bank. The Bank used the proceeds to fund its operations.

Trust preferred securities currently qualify for up to 25% of the Company’s Tier I Capital, with the excess qualifying as Tier 2 Capital.

The junior subordinated debentures are unsecured obligations of the Company. The debentures are subordinate and junior in right of payment to all present and future senior indebtedness of the Company. In addition to its obligations under the junior subordinated debentures and in conjunction with the Trust, the Company issued an unconditional guarantee of the trust preferred securities.

The junior subordinated debentures bear interest at three-month SOFR plus 3.15% and mature on March 26, 2033, at which time the principal amount borrowed will be due. The placement fee of $240,000 is amortized and included as a component of the periodic interest expense on the junior subordinated debentures, in order to produce a constant rate of interest expense. As of September 30, 2024 and December 31, 2023, the unamortized placement fee deducted from the face amount of the junior subordinated debt owed to the unconsolidated trust amounted to $104,000 and $111,000, respectively, and accrued interest on the junior subordinated debentures was $9,000 and $12,000, respectively.

For the three and nine months ended September 30, 2024, the Company recognized interest expense of $180,000 and $539,000, respectively. Interest expense incurred for the three and nine months ended September 30, 2023 was $180,000 and $512,000, respectively.

At its option, exercisable on a quarterly basis, the Company may redeem the junior subordinated debentures from the Trust, which would then redeem the trust preferred securities.

Note Payable

In September 2015, the Bank purchased the property in which its Fairfield, Connecticut branch is located for approximately $2.0 million, a property it had been leasing until that date. The purchase price was primarily satisfied by issuing the seller a $2.0 million, nine-year, promissory note bearing interest at a fixed rate of 1.75% per annum. As of September 30, 2024 and December 31, 2023, the outstanding balance on the note was $216,000 and $376,000, respectively. The note is secured by a first Mortgage Deed and Security Agreement on the purchased property. The note originally set to mature in August 2024, was extended from August 25, 2024 to September 1, 2025, with the Bank continuing its scheduled principal and interest payments.

For the three and nine months ended September 30, 2024, the Company recognized interest expense of $1,000 and $4,000, respectively. Interest expense incurred for the three and nine months ended September 30, 2023 was $2,000 and $7,000, respectively.

Derivatives

As of September 30, 2024, Patriot has two interest rate swaps (“swaps”). One swap is with a loan customer to provide a facility to mitigate the fluctuations in the variable rate on the respective loan. The other swap is with an outside third party. The customer interest rate swap is matched in offsetting terms to the third party interest rate swap. The swaps are reported at fair value in other assets or other liabilities on the consolidated balance sheets. Patriot’s swaps are derivatives, but are not designated as hedging instruments, thus any net gain or loss resulting from changes in the fair value is recognized in other noninterest income. The Company recognized no gain on the swaps for the three and nine months ended September 30, 2024 and 2023.

Further discussion of the fair value of derivatives is set forth in Note 8 to the consolidated financial statements.

Equity

Equity decreased $28.0 million, from $44.4 million at December 31, 2023 to $16.4 million at September 30, 2024. This decrease was primarily due to a net loss of $30.3 million for the nine months ended September 30, 2024, partially offset by a net unrealized gain in investments of $2.2 million.

Off-Balance Sheet Commitments

The Company’s off-balance sheet commitments primarily consist of commitments to lend of $96.6 million and $92.5 million as of September 30, 2024 and December 31, 2023, respectively.

As of September 30, 2024, the Bank has an irrevocable stand-by letter of credit for a maximum of $45 million, issued by the Federal Home Loan Bank of Boston on behalf of the Bank, with Mastercard as the beneficiary, which expires on April 30, 2025.

Average Balances

The following tables present daily average balance sheets, interest income, interest expense and the corresponding yields earned and rates paid for the three and nine months ended September 30, 2024 and 2023:

(In thousands)

57

(In thousands)

58

The following table presents the change in interest-earning assets and interest-bearing liabilities by major category and the related change in the interest income earned and interest expense incurred thereon attributable to the change in transactional volume in the financial instruments and the rates of interest applicable thereto, comparing the three and nine months ended September 30, 2024 and 2023.

(In thousands)

Results of Operations

For the three months ended September 30, 2024, interest income and dividend income was $12.8 million, which decreased $2.3 million as compared to $15.1 million for the quarter ended September 30, 2023. Total interest expense was $7.8 million for the three months ended September 30, 2024, which decreased $730,000 as compared to $8.5 million for the three months ended September 30, 2023. Net interest income decreased $1.5 million from $6.5 million for the three months ended September 30, 2023 to $5.0 million for the three months ended September 30, 2024.

For the nine months ended September 30, 2024, interest income and dividend income was $40.0 million, which decreased $4.0 million as compared to $44.0 million for the nine months ended September 30, 2023. Total interest expense was $24.6 million, which increased $2.8 million as compared to $21.8 million for the nine months ended September 30, 2023. Net interest income was $15.4 million for the nine months ended September 30, 2024, which decreased $6.8 million from $22.3 million for the nine months ended September 30, 2023.

The decline for both three and nine months ended September 30, 2024 reflects a lower loan balance and narrower net interest margin due to higher deposit costs and increase in nonaccrual loans.

The net interest margin was 2.18% for the quarter ended September 30, 2024, compared to 2.48% for the quarter ended September 30, 2023. For the nine months ended September 30, 2024 and 2023, the net interest margin was 2.18% and 2.90%, respectively. The decline in interest margins for the three and nine months ended September 30, 2024 compared to the same periods in 2023, was primarily associated with an increase in the cost of deposits and other borrowings due to the significant rise in market interest rates and a decline in loan interest income due to the declining loan balance and the increase in nonaccrual loans, partially mitigated by the rise in variable rate interest earning assets.

Provision for Credit Losses ("PCL")

For the three months ended September 30, 2024, the provision for credit losses was $1.0 million, consisting of a $1.1 million loan provision and a $58,000 credit for off-balance-sheet exposure reserves. In comparison, for the three months ended September 30, 2023, the provision for credit losses was $4.7 million, including a $4.8 million loan provision and a $112,000 credit for off-balance-sheet exposure reserves.

For the nine months ended September 30, 2024, the PCL was $4.8 million, which included a $4.9 million loan provision and a $94,000 credit for off-balance-sheet exposure reserves. For the nine months ended September 30, 2023, the provision was $8.2 million, consisting of a $9.6 million provision and a $1.4 million credit for off-balance-sheet exposure reserves.

For the three months ended September 30, 2024, the Bank has been selectively managing down its credit exposure in certain higher-risk areas. The loan portfolio declined from $889.9 million as of September 30, 2023, to $755.7 million as of September 30, 2024. This reduction in credit exposure has required a lower level of reserves. Consequently, the ACL for loans outstanding decreased from $25.7 million as of September 30, 2023, to $15.0 million as of September 30, 2024.

One key driver in both the level of outstanding loans and reserves is the pool of purchased unsecured consumer loans, which decreased from $58.3 million as of September 30, 2023 to $26.1 million as of September 30, 2024. Correspondingly, the reserves for this pool also fell, declining from $9.2 million as of September 30, 2023 to $3.8 million as of September 30, 2024. Additionally, as of September 30, 2023, the Bank had obligations of $18.1 million yet to fund under these same pools, against which the bank held $1.1 million of reserves. During the fourth quarter of 2023, the Bank entered into an agreement with the originator and servicer that released the Bank from any obligation for further funding, thereby freeing up the aforementioned $1.1 million of reserves.

As of September 30, 2023, the ACL also included $6.2 million of reserves against an $8.9 million loan that had been originated in part for community development purposes. The loan was used to finance a special-use property and was charged-off during the fourth quarter of 2023, resulting in a loss of approximately $5.9 million.

Non-interest income

Non-interest income for the three months ended September 30, 2024 was $2.1 million, compared to $1.2 million for the three months ended September 30, 2023. For the nine months ended September 30, 2024 and 2023, non-interest income was $6.4 million and $2.8 million, respectively. The increase was primarily attributable to higher non-interest income from the Bank's Digital Payments Division.

Non-interest expense

Non-interest expense for the three months ended September 30, 2024 increased to $8.4 million, compared to $8.1 million for the three months ended September 30, 2023. Non-interest expense for the nine months ended September 30, 2024 was $23.6 million, compared to $23.8 million for the nine months ended September 30, 2023.

Provision for income taxes

The Company reported a provision for income taxes of $24.6 million and $23.8 million for the three and nine months ended September 30, 2024, respectively, compared to a benefit for income taxes of $1.3 million and $1.8 million for the three and nine months ended September 30, 2023, respectively. The provision for income taxes for the third quarter of 2024 included a valuation allowance recorded against all deferred tax assets of $25.1 million, See Note 2 - Summary of Significant Accounting Policies.

Liquidity

The Company measures liquidity in two primary ratios: on-hand liquidity to total liabilities, and total liquidity to total liabilities. On-hand liquidity is comprised of interest-bearing cash and cash equivalents and unpledged available-for-sale securities. Total liquidity includes on-hand liquidity, plus total available credit lines, plus availability of brokered deposits which is subject to internal limitations. The Company monitors other metrics in addition to on-hand liquidity and total liquidity to manage concentration risk in certain types of liabilities.

The Company's on-hand liquidity and total liquidity ratios for the periods ending September 30, 2024 and December 31, 2023, are as follows:

(In thousands)

On-hand liquidity increased $53 million from December 31, 2023 to September 30, 2024 due to the payoff of the $70 million Federal Reserve BTFP borrowing, which released the pledge of certain available-for-sale securities. The payoff of the BTFP will have a slight benefit on the Company's Net Interest Income as the rate on the BTFP was slightly higher than the current replacement funding. Both on-hand liquidity to total liabilities and total liquidity to total liabilities increased at September 30, 2024 compared to December 31, 2023 due to the increased total liquidity and the reduction in total liabilities as the overall balance sheet has shrunk in an effort to improve the Bank's capital ratios.

Liquidity is a measure of the Company’s ability to generate adequate cash to meet its financial obligations. The principal cash requirements of a financial institution are to cover downward fluctuations in deposit accounts. Management believes the Company’s liquid assets provide sufficient coverage to satisfy loan demand, cover potential fluctuations in deposit accounts, and to meet other anticipated operational cash requirements.

Net cash provided by operating activities increased by $15.8 million in the nine months ended September 30, 2024 compared to the nine months ended September 30, 2023. Within this activity there was a significant increase in originations of loans held for sale and proceeds from sale of assets held for sale. This activity is primarily related to the Digital Payments Division credit card loans. This program started in the third quarter of 2023 and continues today. The activity generates non-interest income and only requires short term liquidity as the loans are originated and expected to be sold within three days.

Net cash provided by investing activities increased by $149 million for the nine months ended September 30, 2024 compared to the nine months ended September 30, 2023. The increase is primarily due to lower originations of loans receivable and purchases of loans receivable as the Company is focused on lowering total assets to improve the Company's capital ratios.

Net cash provided by financing activities decreased by $199 million for the nine months ended September 30, 2024 compared to the nine months ended September 30, 2023. The decrease is primarily due to activity in proceeds from FRB and correspondent bank borrowings and repayments of FRB and correspondent bank borrowings. The Company did not require as much funding from FRB and correspondent bank borrowings due to the net cash provided by lower loan originations and loan purchases.

Management manages its capital resources by seeking to maintain a capital structure that will ensure an adequate level of capital to support anticipated asset growth and absorb potential losses while effectively leveraging capital to enhance profitability and return to shareholders. Dividends have not been paid to shareholders since 2020 but may resume in future periods.

The primary source of liquidity at the Company is returns of capital from the Bank. These capital returns are subject to OCC approval and are needed periodically to provide funds needed to service debt payments at the Company.

Capital

The following tables illustrate the Company’s and the Bank’s regulatory capital ratios at September 30, 2024 and December 31, 2023:

(Dollar amounts in thousands)

Capital adequacy is one of the most important factors used to determine the safety and soundness of individual banks and the banking system. From September 2021 to September 30, 2023, the Company elected to adopt the CBLR framework. In the fourth quarter of 2023, the Company elected to use the instituted regulatory risk-based capital approach.

Under the regulatory framework for prompt correction action, to be considered “well capitalized,” an institution must generally have a leverage capital ratio of at least 5.0%, CET1 capital ratio at least 6.5%, a Tier 1 risk-based capital ratio of at least 8.0% and a total risk-based capital ratio of at least 10%. However, the OCC has the discretion to require increased capital ratios. Management continuously assesses the adequacy of the Bank’s capital with the goal to maintain a “well capitalized” classification.

On April 17, 2024, based on its supervisory profile, the Bank was notified by the OCC that it established individual minimum capital ratios ("IMCR") for the Bank. Specifically, the Bank is required to maintain the following ratios: a common equity tier 1 capital ratio of 10.00%, a Tier 1 capital ratio of 10.00%, a Tier 1 leverage ratio of 9.00% and a total capital ratio of 11.50%.

As of September 30, 2024, the Bank did not meet all of its regulatory capital requirements. The common equity tier 1 capital was $64.5 million, or 8.19% of risk-weighted assets, below the required level of 10.00%. The Tier 1 capital was $64.5 million, or 8.19% of risk-weighted assets, also below the required level of 10.00%. However, the Tier 1 leverage capital was $64.5 million, or 6.53% of average assets, falling short of the required 9.00%. The total risk-based capital was $73.2 million, or 9.29% of risk-weighted assets, below the required 11.50%. During the second quarter, the Bank significantly reduced its total and risk-based assets to work towards achieving the IMCR targets. This trend will continue through the remainder of 2024 with a goal of achieving the IMCR in 2025. The Company has restricted new loan originations significantly to allow the loan portfolio to decline in order to lower average assets and risk weighted assets. Average assets are down $100 million to $984 million at September 30, 2024 from $1,083 million at December 31, 2023, reflecting the actions of the Company during the year to lower assets.

If a bank fails to maintain its capital ratios above the higher minimums established in the IMCR, the OCC may issue a capital directive requiring the bank to submit and adhere to an acceptable plan to achieve or maintain its required capital levels. Additionally, the OCC may deem a bank’s failure to maintain capital ratios above the IMCR an unsafe or unsound practice within the meaning of 12 USC 1818.1

Impact of Inflation and Changing Prices

The Company’s Consolidated Financial Statements have been prepared in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than the effect of general levels of inflation. Interest rates do not necessarily move in the same direction or with the same magnitude as the prices of goods and services. Notwithstanding this, inflation can directly affect the value of loan collateral, in particular, real estate. Inflation, deflation or disinflation could significantly affect the Company’s earnings in future periods.

Market risk is defined as the sensitivity of income to fluctuations in interest rates, foreign exchange rates, equity prices, commodity prices and other market-driven rates or prices. The Company’s market risk is primarily limited to interest rate risk.

The Company’s goal is to maximize long term profitability while minimizing its exposure to interest rate fluctuations. The first priority is to structure and price the Company’s assets and liabilities to maintain an acceptable interest rate spread while reducing the net effect of changes in interest rates. In order to accomplish this, the focus is on maintaining a proper balance between the timing and volume of assets and liabilities re-pricing within the balance sheet. One method of achieving this balance is to originate variable rate loans for the portfolio and purchase short-term investments to offset the increasing short-term re-pricing of the liability side of the balance sheet. In fact, a number of the interest-bearing deposit products have no contractual maturity. Therefore, deposit balances may run off unexpectedly due to changing market conditions. Additionally, loans and investments with longer term rate adjustment frequencies can be matched against longer term deposits and borrowings to lock in a desirable spread.

The exposure to interest rate risk is monitored by the Management Asset and Liability Committee consisting of senior management personnel. The Committee reviews the interrelationships within the balance sheet to maximize net interest income within acceptable levels of risk. This Committee reports to the Board of Directors. In addition to the Management Asset and Liability Committee, there is a Board Asset and Liability Committee (“ALCO”), which meets quarterly. ALCO monitors the interest rate risk analyses, reviews investment transactions during the period and determines compliance with the Company’s Investment, ALCO and Liquidity policies.

Management analyzes the Company’s interest rate sensitivity position to manage the risk associated with interest rate movements through the use of interest income simulation and gap analysis. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest sensitive.” An asset or liability is said to be interest sensitive within a specific time period if it will mature or reprice within that time period.

1 The Office of the Comptroller of Currency Policy and Procedure Manual, PPM 5310-3.

Management’s goal is to manage asset and liability positions to moderate the effects of interest rate fluctuations on net interest income. Interest income simulations are completed quarterly and presented to ALCO. The simulations provide an estimate of the impact of changes in interest rates on net interest income under a range of assumptions. Changes to these assumptions can significantly affect the results of the simulations. The simulation incorporates assumptions regarding the potential timing in the repricing of certain assets and liabilities when market rates change and the changes in spreads between different market rates.

Simulation analysis is only an estimate of the Company’s interest rate risk exposure at a particular point in time. Management regularly reviews the potential effect changes in interest rates could have on the repayment of rate-sensitive assets and funding requirements of rate-sensitive liabilities.

The tables below set forth examples of changes in estimated net interest income and the estimated net portfolio value based on projected scenarios of interest rate increases and decreases. The analyses indicate the rate risk embedded in the Company’s portfolio at the dates indicated should all interest rates instantaneously rise or fall. The results of these changes are added to or subtracted from the base case; however, there are certain limitations to these types of analyses. Rate changes are rarely instantaneous and these analyses may therefore overstate the impact of short-term repricings. In certain low interest rate environments, the calculated effects of the 100 and 200 basis point downward shocks cannot absolutely reflect the risk to earnings and equity, since the interest rates on certain balance sheet items have approached their minimums. Therefore, it is not possible for the analyses to fully measure the true impact of these downward shocks.

(In thousands)

(In thousands)

64

Evaluation of Disclosure Controls and Procedures

Patriot maintains disclosure controls and procedures that are designed to provide reasonable assurance that information that is required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and accumulated and communicated to management in a timely fashion.

Patriot’s management, with the participation of its Chief Executive Officer and its Chief Financial Officer, conducted an evaluation, as of the end of the period covered by this report, of the effectiveness of its disclosure controls and procedures, as such term is defined in Exchange Act Rule 13a-15(e). Based on this evaluation, Patriot’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this report, Patriot’s disclosure controls and procedures, as defined in Rule 13a-15(e), were effective at the reasonable assurance level.

Changes in Internal Control Over Financial Reporting

There was no change in the Company’s internal control over financial reporting during the Company’s fiscal quarter ended September 30, 2024 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Limitations on the Effectiveness of Controls

Due to its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. In addition, projections of any evaluations of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and/or procedures may deteriorate.