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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
--------- -------- --------- --------- --------- ---------
Total investment and mortgage-
backed securities available
for sale ........................... $ 346,510 $347,140 $ 311,844 $ 315,868 $ 248,252 $ 247,612
========= ======== ========= ========= ========= =========
HELD TO MATURITY:
Investment securities:
US Treasury and government
agency securities ...................... $ - $ - $ - $ - $ 14,388 $ 14,504
Corporate securities .................... - - - - 1,000 1,001
Mortgage-backed securities:
FHLMC .................................... - - - - 1,662 1,652
FNMA ..................................... - - - - 1,680 1,709
GNMA ..................................... - - - - 2,245 2,237
Collateralized mortgage obligations:
FHLMC .................................... - - - - 16,186 15,617
FNMA. .................................... - - - - 6,476 6,358
Other .................................... - - - - - -
CMBS .................................... - - - - - -
--------- -------- --------- --------- --------- ---------
Total investment and mortgage-
backed securities held
to maturity........................... $ - $ - $ - $ - $ 43,637 $ 43,078
========= ======== ========= ========= ========= =========
Pursuant to an interest rate risk strategy to reduce the asset
sensitivity of the bank, certain adjustable rate held to maturity securities
were sold during 2002. Consequently, the remaining held to maturity portfolio of
$31,537,000 was reclassified to available for sale.
26
The following table sets forth certain information regarding the
carrying value, weighted average yield and contractual maturities of Patriot's
investment and mortgage-backed securities as of December 31, 2003.
MORE THAN ONE YEAR MORE THAN FIVE YEARS
ONE YEAR OR LESS TO FIVE YEARS TO TEN YEARS
------------------ ------------------- --------------------
WEIGHTED WEIGHTED WEIGHTED
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE
VALUE YIELD VALUE YIELD VALUE YIELD
-------- -------- -------- -------- -------- ---------
(IN THOUSANDS)
AVAILABLE FOR SALE:
Investment securities:
U.S. Treasury and
government securities ................... $ 250 1.00% $ - -% $ 558 5.19%
Corporate securities ...................... 100 2.00 - - - -
State and municipal securities............. - - 239 6.01 - -
Equity securities.......................... - - - - - -
Mortgage-backed securities:
FHLMC ..................................... 8,686 4.45 31,147 4.49 14,151 4.49
FNMA ..................................... 14,977 4.50 64,203 4.65 32,512 4.66
GNMA ..................................... 26 8.30 36 8.31 7 8.31
Collateralized mortgage obligations:
FHLMC ..................................... 14 5.96 - - - -
FNMA ..................................... 358 5.67 - - - -
Other ..................................... - - - - - -
-------- -------- -------- -------- -------- --------
Total available for sale ............ $ 24,411 4.46% $ 95,625 4.60% $ 47,228 4.62%
======== ======== ======== ======== ======== ========
MORE THAN TEN YEARS NO STATED MATURITY TOTAL
------------------- ------------------- -------------------
WEIGHTED WEIGHTED WEIGHTED
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE
VALUE YIELD VALUE YIELD VALUE YIELD
-------- -------- -------- -------- -------- --------
(IN THOUSANDS)
AVAILABLE FOR SALE:
Investment securities:
U.S. Treasury and
government securities................... $ 4,883 6.93% $ - -% $ 5,691 6.50%
Corporate securities...................... 17,070 7.68 - - 17,170 7.65
State and municipal securities............ 22,064 6.90 - - 22,303 6.89
Equity securities......................... - - 117,762 6.20 117,762 6.20
Mortgage-backed securities:
FHLMC..................................... 4,930 4.49 - - 58,914 4.48
FNMA...................................... 13,167 4.67 - - 124,859 4.64
GNMA...................................... - - - - 69 8.31
Collateralized mortgage obligations:
FHLMC..................................... - - - - 14 5.96
FNMA...................................... - - - - 358 5.67
Other..................................... - - - - - -
-------- -------- -------- -------- -------- --------
Total available for sale............. $ 62,114 6.45% $117,762 6.20% $347,140 5.47%
======== ======== ======== ======== ======== ========
27
The following table represents the securities of single issuers (other
than obligations of the United States and its political subdivisions, agencies
and corporations) having an aggregate book value in excess of 10% of Patriot's
shareholders' equity that were held at December 31, 2003:
AT DECEMBER 31, 2003
------------------------------
CARRYING VALUE FAIR VALUE
-------------- ------------
(IN THOUSANDS)
EQUITY SECURITIES:
FHLMC preferred stock.................. $ 84,884 $ 86,138
FNMA preferred stock................... $ 16,008 $ 15,966
FHLB stock............................. $ 14,399 $ 14,399
OTHER ASSETS. Other Assets at December 31, 2003, were $6,321,000
compared to $4,743,000 at December 31, 2002. The increase in other assets was
primarily attributable to adjustments to Patriot's deferred tax position related
to unrealized gains on investments and mortgage backed securities available for
sale.
DEPOSITS. Deposits are generally attracted from within Patriot's
primary market area through the offering of various deposit instruments,
including checking accounts, money market accounts, savings accounts,
certificates of deposit and retirement savings plans. Patriot also solicits
brokered deposits from various sources.
Total deposits at December 31, 2003, were $613,555,000 compared to
$519,120,000 at December 31, 2002. Of that increase, $97,758,000 was related to
lower costing core deposits, $10,817,000 was related to brokered deposits offset
by $14,140,000 of higher costing branch certificate of deposit run off.
The following table sets forth the distribution of average deposit
accounts for the periods indicated and the weighted average yield on each
category of deposit presented:
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------------------------
2003 2002 2001
----------------------------- ----------------------------- -----------------------------
PERCENT PERCENT PERCENT
OF TOTAL WEIGHTED OF TOTAL WEIGHTED OF TOTAL WEIGHTED
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE DEPOSITS YIELD BALANCE DEPOSITS YIELD BALANCE DEPOSITS YIELD
--------- -------- -------- --------- -------- -------- --------- -------- --------
(IN THOUSANDS)
Money market deposits...... $ 176,236 30.05% 1.70% $ 140,575 27.14% 2.13% $ 130,667 22.72% 3.80%
Savings deposits........... 74,721 12.74 1.57 55,726 10.76 1.87 32,351 5.62 1.92
Transaction deposits....... 86,501 14.75 0.17 74,500 14.38 0.19 62,827 10.92 0.28
Branch certificates
of deposit............... 214,709 36.60 3.31 214,721 41.44 4.11 243,860 42.39 5.99
--------- -------- -------- --------- -------- -------- --------- -------- --------
Total branch deposits...... 552,167 94.14 2.07 485,522 93.72 2.68 469,705 81.65 4.34
Jumbo certificates
of deposit............... 34,357 5.86 2.81 32,529 6.28 4.57 105,530 18.35 6.93
--------- -------- -------- --------- -------- -------- --------- -------- --------
Total deposits............. $ 586,524 100.00% 2.11% $ 518,051 100.00% 2.79% $ 575,235 100.00% 4.81%
========= ======== ======== ========= ======== ======== ========= ======== ========
At December 31, 2003, Patriot had $63,323,000 in brokered and branch
certificate of deposit accounts in amounts of $100,000 or more maturing as
follows.
(IN THOUSANDS)
Three months or less.......................... $ 13,690
Over three through six months................. 3,462
Over six through 12 months.................... 22,624
Over 12 months................................ 23,547
--------
Total....................................... $ 63,323
========
28
FHLB ADVANCES AND FEDERAL FUNDS. Patriot utilizes borrowings as a
source of funds for its growth strategy and its asset/liability management.
Patriot is eligible to obtain advances from the FHLB upon the security of
certain loan portfolios, mortgage-backed securities, and investment securities,
provided certain standards related to creditworthiness have been met. FHLB
advances are made pursuant to several different credit programs, each of which
has its own interest rate and range of maturities. The maximum amount that the
FHLB will advance to member institutions fluctuates from time to time in
accordance with the policies of the FHLB. Patriot also uses Federal Funds as a
funding source. Federal Funds are transactions that are typically between
financial institutions and are short-term unsecured borrowings. Total FHLB
advances and federal funds borrowed at December 31, 2003 were $289,655,000
compared to $368,173,000 at December 31, 2002. The decrease in FHLB advances and
federal funds was associated with the repayment of short-term FHLB advances.
During 2003, Patriot prepaid $55,000,0000 in FHLB borrowings and restructured
$72,000,000 in FHLB borrowings, which allowed Patriot to improve its interest
rate risk profile.
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
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.
REPURCHASE AGREEMENTS. Patriot uses repurchase agreements as a funding
source. Repurchase agreements are generally short-term obligations
collateralized by government agency and other securities. Total repurchase
agreements at December 31, 2003 were $44,407,000 compared to $14,210,000 at
December 31, 2002. The increase in repurchase agreements was primarily due to
the addition of $33,184,000 of brokered repurchase agreements offset by a
decrease in customer repurchase agreements. The increase in repurchase
agreements replaced FHLB advances that were repaid during 2003.
The following table presents certain information regarding borrowed
funds:
AT DECEMBER 31,
-----------------------------------------------------------
2003 2002 2001
----------------- ------------------- -------------------
AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE BALANCE RATE
-------- ------- --------- ------- --------- -------
(IN THOUSANDS)
Federal funds purchased................... $ 20,000 1.00% $ 20,000 1.22% $ - -%
FHLB advances............................. 269,655 4.24 348,173 4.59 387,179 5.57
Repurchase agreements..................... 44,407 1.19 14,210 1.79 - -
Trust preferred debt...................... 20,500 9.42 20,500 9.27 18,000 10.59
-------- ------ --------- ------- --------- -------
Total borrowings outstanding....... $354,562 3.97% $ 402,883 4.56% $ 405,179 5.79%
======== ====== ========= ======= ========= =======
Short-term (less than 1 year)............. $109,407 1.12% $ 155,210 2.56% $ 70,000 6.31%
Long-term (over 1 year)................... 245,155 5.24 247,673 5.82 335,179 5.68
-------- ------ --------- ------- --------- -------
Total borrowings outstanding......... $354,562 3.97% $ 402,883 4.56% $ 405,179 5.79%
======== ====== ========= ======= ========= =======
SHAREHOLDERS' EQUITY. Total shareholders' equity was $65,743,000 at
December 31, 2003, compared to $65,945,000 at December 31, 2002. The decrease
was primarily the result of the repurchase of shares of Patriot Bank Corp.
common stock, a decrease in accumulated other comprehensive income and cash
dividends paid to shareholders offset by net income.
29
CRITICAL ACCOUNTING POLICIES
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.
INCOME TAXES
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases, as well as operating loss carry forwards. Deferred tax assets and
liabilities 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 deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date. A valuation allowance is established against deferred tax assets
when in the judgement of management, it is more likely than not that such
deferred tax assets will not become available. Based on management's evaluation
of the likelihood of realization, no valuation allowance has been established.
Because the judgement about the level of future taxable income is dependent to a
great extent on matters that may, at least in part be beyond Patriot's control,
it is at least reasonably possible that management's judgement about the need
for a valuation allowance for deferred taxes could change in the near term.
REO AND OTHER REPOSSESSED PROPERTY
Real estate owned is defined to include real estate Patriot acquires
through foreclosure. REO is recorded on Patriot's books at the lower of
Patriot's carrying value in the loan or the fair value of the property as of the
date of transfer to REO. Any excess of the recorded investment in the loan over
the fair market value is charged against Patriot's loan loss reserve.
Other repossessed property consists mostly of leased equipment returned
to Patriot at the end of the lease. The off-lease equipment is recorded on
Patriot's books at the lower of Patriot's carrying value in the lease or the
fair value of the equipment as of the date of transfer to other repossessed
property. Any excess of the recorded investment in the lease over the fair
market value is recorded as a loss. Additionally, valuation of REO and other
repossessed property is dependent to a great extent on current economic, market
and geographic conditions, and that may, at least in part be beyond Patriot's
control. It is at least reasonably possible that management's estimates included
in the valuation of REO and other repossessed property could change in the near
term. Patriot's current judgement is that the valuation of REO and other
repossessed property remains appropriate at December 31, 2003.
30
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY. Patriot's primary sources of funds are deposits, principal
and interest payments on loans, principal and interest payments on investment
and mortgage-backed securities, FHLB advances, Federal Funds and repurchase
agreements. While maturities and scheduled amortization of loans and investment
and mortgage-backed securities are predictable sources of funds, deposit inflows
and loan and mortgage-backed security prepayments are greatly influenced by
economic conditions, general interest rates and competition. Therefore, Patriot
manages its balance sheet to provide adequate liquidity based upon various
economic, interest rate and competitive assumptions and in light of
profitability measures.
During 2003, $143,244,000 of liquidity was provided from the repayment
and sale of securities. Additional liquidity of $94,435,000 was provided by
deposit growth, $54,437,000 from the repayment of residential mortgage loans,
net of new business and $30,197,000 by short-term repurchase agreements. These
funds were used to purchase $177,297,000 of investment securities, repay
$76,720,000 of borrowings and fund $68,395,000 of additional commercial loans,
consumer loans and commercial leases, net of prepayments.
At December 31, 2003, Patriot had outstanding loan commitments of
$104,189,000. Patriot anticipates that it will have sufficient funds available
to meet its loan commitments. Certificates of deposit that are scheduled to
mature in one year or less from December 31, 2003, totaled $106,601,000.
CAPITAL RESOURCES. FDIC regulations currently require companies to
maintain a minimum leverage capital ratio of not less than 3% of tier 1 capital
to total adjusted assets, a tier 1 capital ratio of not less than 4% of
risk-adjusted assets, and a minimum risk-based total capital ratio (based upon
credit risk) of not less than 8%. The FDIC requires a minimum leverage capital
requirement of 3% for institutions rated composite 1 under the CAMELS rating
system. For all other institutions, the minimum leverage capital requirement is
3% plus at least an additional 1% to 2% (100 to 200 basis points). A bank is
considered "well capitalized" if it maintains a minimum leverage capital ratio
of not less than 5% of tier 1 capital to total adjusted assets, a tier 1 capital
ratio of not less than 6% of risk adjusted assets, and a minimum risk-based
total capital ratio (based upon credit risk) of not less than 10%. At December
31, 2003, Patriot Bank's and Patriot Bank Corp.'s capital ratios exceeded all
requirements to be considered well capitalized. The following table sets forth
the capital ratios of Patriot Bank Corp., Patriot Bank and the current
regulatory requirements at December 31, 2003:
AS OF DECEMBER 31,2003
------------------------------------------------
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION
--------------- ----------------- ----------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
-------- ----- ------- ---- ------- -----
(IN THOUSAND)
Total capital(no risk weighted assets)
Patriot capital (to risk weighted assets).......... $ 79,369 11.77% $53,960 8% $67,451 10%
Patriot Bank....................................... 77,086 11.45% 53,866 8% 67,333 10%
Tier I capital(to risk-weighted assets)
Patriot Bank Crop.................................. 71,937 10,67% 26,980 4% 40,470 6%
Patriot Bank....................................... 69,636 10,34% 26,933 4% 40,400 6%
Tier I capital (to average assets)
Patriot Bank Crop.................................. 71,937 7.29% 39,475 4% 49,344 5%
Patriot Bank....................................... 69,636 7.04% 39,582 4% 49,477 5%
31
CONTRACTUAL OBLIGATIONS AND OTHER COMMITMENTS. Patriot enters into
contractual obligations in the normal course of business as a source of funds
for its asset growth and its asset liability management, and to meet required
capital needs. These obligations require Patriot to make cash payments over time
as detailed in the table below. (For further information regarding Patriot's
contractual obligations, refer to footnotes 8 through 10 and 16 of our
Consolidated Financial Statements, herein.)
The following table represents Patriot's contractual obligation by
maturity:
PAYMENTS DUE BY PERIOD
------------------------------------------------------------
LESS THAN AFTER
TOTAL 1 YEAR 1-3 YEARS 4-5 YEARS 5 YEARS
--------- ----------- ----------- --------- ---------
(IN THOUSANDS)
CONTRACTUAL OBLIGATIONS:
Repurchase agreements......................... . $ 44,407 $ 44,407 $ - $ - $ -
FHLB advances.................................. 269,655 45,000 - 69,655 155,000
Federal funds purchased........................ 20,000 20,000 - - -
Trust preferred debt........................... 20,500 - - - 20,500
Operating leases............................... 11,613 1,075 1,884 1,744 6,910
--------- ----------- ----------- --------- ---------
Total contractual obligations.................. $ 366,175 $ 110,482 $ 1,884 $ 71,399 $ 182,410
========= =========== =========== ========= =========
OFF-BALANCE SHEET ARRANGEMENTS. Patriot is a party to financial
instruments with off-balance sheet risk in the normal course of business to meet
the financing needs of its customers, including commitments to extend credit.
Those instruments involve, to varying degrees, elements of credit and interest
rate risk in excess of the amount recognized in the consolidated balance sheets.
The contract or notional amounts of those instruments reflect the extent of
Patriot's involvement in particular classes of financial instruments.
Patriot's exposure to credit loss in the event of non-performance by
the other party to the financial instrument for commitments to extend credit is
represented by the contractual notional amount of those instruments. Patriot
uses the same credit policies in making commitments and conditional obligations
as it does for on-balance-sheet instruments. Unless noted otherwise, Patriot
requires collateral to support financial instruments with credit risk. For
interest rate swaps, the contract or notional amounts do not represent exposure
to credit loss. Patriot controls the credit risk of its interest rate swaps
through credit approvals, limits and monitoring procedures. For further
information regarding Patriot's off-balance sheet risk, refer to footnotes 15
and 17 of our Consolidated Financial Statements, herein.):
The following table represents Patriot's commercial off-balance sheet
commitments by maturity:
AMOUNT OF COMMITMENT EXPIRATION PER PERIOD
----------------------------------------------------------
TOTAL
AMOUNTS LESS THAN OVER
COMMITTED 1 YEAR 1-3 YEARS 4-5 YEARS 5 YEARS
--------- --------- ------------ --------- --------
(IN THOUSANDS)
OTHER COMMERCIAL COMMITMENTS:
Commercial loans......................... $ 46,069 $ 16,247 $ 25,953 $ 3,097 $ 772
Commercial leases........................ 20,257 20,257 - - -
Financial letters of credit.............. 584 - 574 - 10
Performance letters of credit............ 1,444 - 1,158 - 286
Interest rate swaps...................... 72,000 - - 72,000 -
--------- --------- ------------ --------- --------
Total other commitments.................. $ 140,354 $ 36,504 $ 27,685 $ 75,097 $ 1,068
========= ========= ============ ========= ========
32
MANAGEMENT OF INTEREST RATE RISK. The principal objective of Patriot's
interest rate risk management function is to evaluate the interest rate risk
included in certain on and off balance sheet accounts, determine the level of
risk appropriate given Patriot's business focus, operating environment, capital
and liquidity requirements and performance objectives, and manage the risk
consistent with Board approved guidelines. Through such management, Patriot
seeks to reduce the vulnerability of its net interest income to changes in
interest rates. Patriot's Board of Directors has established an Asset/Liability
Committee, which is responsible for reviewing its asset/liability and interest
rate position and making decisions involving asset/liability considerations. The
Asset/Liability Committee meets regularly and reports trends and Patriot's
interest rate risk position to the Board of Directors.
Patriot uses three complementary methods to analyze and measure
interest rate risk as part of the overall management of interest rate risk. They
are income simulation modeling, estimates of economic value of equity, and
static gap analysis. The combination of these three methods provides a
reasonably comprehensive summary of the level of interest rate risk of Patriot
when exposed to time factors and changes in interest rate environments.
Income simulation modeling is utilized in measuring Patriot's interest
rate risk and managing its interest rate sensitivity. Income simulation
considers not only the impact of changing market interest rates on forecasted
net interest income, but also other factors such as yield curve relationships,
the volume and mix of assets and liabilities, customer preferences and general
market conditions.
Through the use of income simulation modeling the company has
calculated an estimate of net interest income for the year ending December 31,
2003, based upon the assets, liabilities and off-balance sheet financial
instruments in existence at December 31, 2002. Patriot has also estimated
changes to that estimated net interest income based upon interest rates rising
or falling in monthly increments ("rate ramps"). Rate ramps assume that all
interest rates increase or decrease in monthly increments evenly throughout the
period modeled, with a floor of 25bp. The following table reflects the estimated
percentage change in estimated net interest income for the year ending December
31, 2003 resulting from changes in interest rates.
RATE RAMP
TO INTEREST RATES % CHANGE
- ----------------- --------
+2% (1.65%)
- -2% (1.12%)
Economic value of equity ("EVE") estimates the discounted present value
of asset and liability cash flows. Discount rates are based upon market prices
for comparable assets and liabilities. As part of this evaluation the company
has contracted with an independent consultant to perform an extensive core
deposit analysis to appropriately estimate the discounted present value of the
retail deposit franchise. Upward and downward rate shocks are used to measure
volatility in relation to such interest rate movements in relation to an
unchanged environment. This method of measurement primarily evaluates the longer
term repricing risks and options in Patriot's balance sheet. Patriot has
established policy limits for upward and downward rate shocks of 20% of economic
value of equity at risk for every 100 basis points of interest rate shock.
Additionally Patriot has a policy limit that the ratio of EVE adjusted equity to
EVE adjusted assets will be maintained above a 5% ratio. The following table
reflects the estimated economic value of equity at risk and the ratio of EVE
adjusted equity to EVE adjusted assets at December 31, 2003, resulting from
shocks to interest rates.
PERCENT CHANGE EVE EQUITY
RATE SHOCK FROM BASE EVE ASSETS
- ----------- -------------- ----------
+2% (5.35%) 12.53
+1% (1.54) 12.69%
Base - 12.56%
- -1% (7.98%) 11.36%
- -2% (29.31%) 8.63%
33
The matching of assets and liabilities may be analyzed by examining the
extent to which such assets and liabilities are "interest rate sensitive" and by
monitoring an institution's interest rate sensitivity "gap." An asset or
liability is said to be interest rate sensitive within a specific time period if
it will mature or re-price within that time period. The interest rate
sensitivity gap is defined as the difference between the amount of
interest-earning assets maturing or re-pricing within a specific time period and
the amount of interest-bearing liabilities maturing or repricing within that
time period.
The following table summarizes the amount of interest-earning assets
and interest-bearing liabilities outstanding at December 31, 2003, which are
anticipated, based upon certain assumptions, to re-price or mature in each of
the future time periods shown. Loan amounts reflect principal balances expected
to be repaid and/or re-priced as a result of contractual amortization and
anticipated prepayments of adjustable-rate loans and fixed-rate loans and as a
result of contractual rate adjustments on adjustable-rate loans. Estimated
prepayment rates were applied to mortgage loans and mortgage-backed securities
based upon industry expectations. Core deposit decay rates have been estimated
based upon a historical analysis of core deposit trends. With the exceptions
noted above, the amount of assets and liabilities shown which re-price or mature
during a particular period were determined in accordance with the earlier of
term to re-pricing or the contractual maturity of the asset or liability. The
table sets forth the gap and cumulative gap as a percentage of total assets at
December 31, 2003:
0-90 91-180 181-365
DAYS DAYS DAYS
------ ------ -------
GAP to Total Assets .............................. (4.00%) 4.46% 5.21%
Cumulative GAP to Total Assets ................... (4.00%) .46% 5.67%
As shown above, the company has a positive cumulative gap (interest
sensitive assets are greater than interest sensitive liabilities) within the
next year, which generally indicates that an increase in rates may lead to an
increase in net interest income and a decrease in rates may lead to a decrease
in net interest income. Interest sensitivity gap analysis measures whether
assets or liabilities may reprice but does not capture the ability to reprice
based on market conditions or the magnitude of the change in the repricing on
assets or liabilities. Thus indications based on a positive or negative gap
position need to be analyzed in conjunction with other interest rate risk
management tools.
Patriot's management believes that the assumptions and combination of
methods utilized in evaluating estimated net interest income are reasonable;
however, the interest rate sensitivity of Patriot's assets, liabilities and
off-balance sheet financial instruments as well as the estimated effect of
changes in interest rates on estimated net interest income could vary
substantially if different assumptions are used or actual experience differs
from the experience on which the assumptions were based.
34
QUARTERLY DATA
The following table presents selected quarterly consolidated financial data:
THREE MONTHS ENDED
------------------------------------------------------------------------------------------------
DEC. 31, SEPT. 30, JUNE 30, MARCH 31, DEC. 31, SEPT. 30, JUNE 30, MARCH 31,
2003 2003 2003 2003 2002 2002 2002 2002
-------- --------- -------- --------- -------- --------- -------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Total interest income ........ $ 14,909 $ 14,297 $ 14,700 $ 15,332 $ 15,759 $ 16,583 $ 16,815 $ 16,957
Total interest expense ....... 6,428 6,580 7,273 7,556 8,166 8,962 9,549 10,181
-------- --------- -------- --------- -------- --------- -------- ---------
Net interest income .......... 8,481 7,717 7,427 7,776 7,593 7,621 7,266 6,776
Provision for credit losses .. 1,030 900 900 1,100 1,200 1,200 1,000 675
-------- --------- -------- --------- -------- --------- -------- ---------
Net interest income after
provision for credit losses. 7,451 6,817 6,527 6,676 6,393 6,421 6,266 6,101
Other income ................. 2,800 3,095 3,088 2,646 1,793 1,985 1,803 1,661
Other expenses ............... 7,473 7,289 6,980 6,681 5,943 5,901 5,487 5,333
-------- --------- -------- --------- -------- --------- -------- ---------
Income (loss) before taxes and
cumulative effect of change
in accounting principle .... 2,778 2,623 2,635 2,641 2,243 2,505 2,582 2,429
Income tax ................... 533 484 484 541 377 493 602 589
-------- --------- -------- --------- -------- --------- -------- ---------
Net income ................... $ 2,245 $ 2,139 $ 2,151 $ 2,100 $ 1,866 $ 2,012 $ 1,980 $ 1,840
======== ========= ======== ========= ======== ========= ======== =========
DILUTED EARNINGS PER SHARE:
Net income ................... $ 0.33 $ 0.32 $ 0.32 $ 0.31 $ 0.30 $ 0.29 $ 0.28 $ 0.27
======== ========= ======== ========= ======== ========= ======== =========
Dividends per share .......... $ .1350 $ .1300 $ .1200 $ .1091 $ .1000 $ .0940 $ .0900 $ .0890
Market prices - high ......... $ 29.21 $ 22.30 $ 18.87 $ 15.61 $ 15.47 $ 14.24 $ 15.00 $ 13.78
Market prices - low .......... $ 19.74 $ 17.04 $ 15.86 $ 13.31 $ 13.46 $ 12.96 $ 13.38 $ 10.50
35
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2002 AND 2001
SUMMARY. For the year ended December 31, 2002, Patriot reported net
income of $7,698,000 or $1.14 diluted earnings per share. For the year ended
December 31, 2001, Patriot reported net income of $6,099,000 or $.92 diluted
earnings per share. Return on average equity was 12.05% for 2002 and 10.52% for
2001.
NET INTEREST INCOME. Net interest income for 2002 was $29,256,000
compared to $23,641,000 in 2001. The yield on Patriot's interest-earning assets
decreased to 7.28% for the year 2002 compared to 7.71% for 2001. The decrease in
yield on Patriot's interest-earning assets is a result of a decrease in interest
rates. The cost of Patriot's interest-bearing liabilities was 3.98% for 2002
compared to 5.24% for 2001. The decrease in funding costs resulted from
generally lower interest rates coupled with reductions in higher cost
borrowings. Overall, Patriot's net interest margin increased to 3.35% for 2002
compared to 2.50% in 2001.
Interest on loans was $49,020,000 for 2002 compared to $54,122,000 for
2001. The average balance of loans in 2002 was $635,788,000 with an average
yield of 7.73% compared to an average balance of $653,460,000 with an average
yield of 8.30% in 2001. The decrease in the average balance of loans is a result
of Patriot allowing residential mortgages to run-off, offset by increases in
commercial loans and leases. The decrease in average yield is primarily a result
of a decrease in interest rates.
Interest on Patriot's investment portfolio (investment and
mortgage-backed securities) was $17,021,000 for 2002 compared to $21,220,000 for
2001. The average balance of the investment portfolio was $296,079,000 with an
average yield of 6.41% for 2002 compared to an average balance of $333,872,000
with an average yield of 6.73% for 2001. The decrease in average balance is
primarily due to Patriot allowing the investment portfolio to amortize so that
it can be replaced with generally higher-yielding commercial loans and leases.
The decrease in average yield is related to general decreases in market rates on
securities.
Interest on total deposits was $14,479,000 for 2002 compared to
$27,690,000 for 2001. The average balance of total deposits was $518,051,000
with an average cost of 2.79% for 2002 compared to an average balance of
$575,235,000 with an average cost of 4.81% for 2001. The decrease in the average
balance of deposits is primarily the result of a decrease in Patriot's jumbo
certificate of deposits, offset by increases in branch deposits which consists
of money market accounts, transaction based deposit accounts and other
certificates of deposits. The average balance on jumbo certificates of deposit
decreased to $32,529,000 in 2002 compared to $105,530,000 in 2001. The average
balance of retail deposits (total deposits less jumbo certificate of deposits)
was $485,522,000 with an average cost of 2.68% for 2002 compared to an average
balance of $469,705,000 with an average cost of 4.34% for 2001. The increase in
average balance of retail deposits is the result of growth in savings, checking
and money market accounts offset by a decrease in branch certificates of
deposit. The overall decrease in the average cost on deposits is primarily the
result of a decrease in interest rates and emphasis placed on lower cost
transaction based deposit accounts.
Interest on borrowings was $22,379,000 in 2002 compared to $24,519,000
in 2001. The average balance of borrowings was $407,687,000 with an average cost
of 5.49% for 2002 compared to an average balance of $421,084,000 with an average
cost of 5.82% for 2001. The decrease in the average balance of borrowings is
primarily due to the use of funds provided by the run-off of the mortgage loan
portfolio and growth in Patriot's branch deposits to repay borrowings, offset by
growth in Patriot's commercial loan portfolio. The decrease in average cost is
due to lower interest rates.
PROVISION FOR CREDIT LOSSES. The provision for credit losses was
$4,075,000 for 2002 compared to $2,000,000 for 2001. See "Credit Quality" for a
detailed discussion of Patriot's asset quality and reserving methodology.
NON-INTEREST INCOME. Total non-interest income was $7,241,000 for 2002
compared to $7,892,000 for 2001. The decrease in non-interest income was
primarily due to $137,000 in losses recognized on the sale of investments
securities in 2002 compared to $558,000 in gains in 2001. Patriot adopted SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities," as of
January 1, 2001. The cumulative effect of the adoption was a $204,000 decrease
to consolidated income, net of $105,000 of tax benefit, resulting from the sale
of securities transferred into "Available for Sale" during the first quarter in
2001. Other recurring non-interest income including loan and deposit fees and
mortgage banking gains remained consistent in 2002 compared to 2001.
36
NON-INTEREST EXPENSE. Total non-interest expense was $22,664,000 for
2002 compared to $20,768,000 for 2001. The increase in non-interest expense was
primarily due to higher compensation costs due to increases in staffing
associated with branch deposit and commercial lending growth offset by lower
amortization costs. Patriot's tax effected efficiency ratio, was 58.94% in 2002
compared to 63.94% in 2001. The tax equivalent efficiency ratio is calculated by
taking non-interest expense divided by non-interest income and net interest
income before provision for credit losses. Net interest income before provision
is adjusted to take into consideration tax beneficial investments and loans.
INCOME TAX PROVISION. The income tax provision was $2,060,000 for 2002
compared to $2,462,000 for 2001. The effective tax rate for 2002 was 21.11%
compared to 28.09% for 2001. The decrease in the effective tax rate is due to
greater tax exempt interest from tax-exempt securities offset by the elimination
of non-deductible goodwill.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The discussion concerning the effects of interest rate changes on
Patriot's estimated net interest income for the year ending December 31, 2002,
set forth under "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Management of Interest Rate Risk" in Item 7 hereof, is
incorporated herein by reference.
37
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
MANAGEMENT REPORT
FINANCIAL STATEMENTS
Patriot Bank Corp. ("Patriot") is responsible for the preparation,
integrity and fair presentation of its published financial statements as of
December 31, 2003, and the year then ended. The financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America, and as such, include amounts, some of which are based
on judgments and estimates of management.
INTERNAL CONTROLS
Management of Patriot is responsible for establishing and maintaining
effective internal control over financial reporting presented in conformity with
both accounting principles generally accepted in the United States of America,
including controls over the safeguarding of assets, and the Federal Financial
Institutions Examination Council instructions for Consolidated Reports of
Condition and Income (Call Report Instructions). This internal control contains
monitoring mechanisms, and actions are taken to correct deficiencies identified.
There are inherent limitations in any internal control, including the
possibility of human error and the circumvention or overriding of controls.
Accordingly, even effective internal control can provide only reasonable
assurance with respect to financial statement preparation. Further, because of
changes in conditions, the effectiveness of internal control may vary over time.
Management assessed Patriot's internal control over financial reporting
presented in conformity with both accounting principles generally accepted in
the United States of America, including controls over the safeguarding of
assets, and call report instructions as of December 31, 2003. This assessment
was based on criteria for effective internal control over financial reporting
established in Internal Control -- Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission. Based on this
assessment, management believes that, as of December 31, 2003, the Company
maintained effective internal control over financial reporting presented in
conformity with both accounting principles generally accepted in the United
States of America, including controls over the safeguarding of assets, and Call
Report Instructions.
COMPLIANCE WITH LAWS AND REGULATIONS
Management is also responsible for compliance with the federal and
state laws and regulations concerning dividend restrictions and federal laws and
regulations concerning loans to insiders designated by the Federal Deposit
Insurance Corporation as safety and soundness laws and regulations.
Management assessed its compliance with the designated laws and
regulations relating to safety and soundness. Based on this assessment,
management believes Patriot complied, in all significant respects, with the
designated laws and regulations relating to safety and soundness for the year
ended December 31, 2003.
/s/ Richard A. Elko /s/ James G. Blume
- -------------------------- -------------------------
Richard A. Elko James G. Blume
President and Senior Vice President and
Chief Financial Officer Chief Executive Officer
38
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Patriot Bank Corp:
We have audited the accompanying consolidated balance sheets of Patriot
Bank Corp. and subsidiaries ("Patriot") as of December 31, 2003 and 2002, and
the related consolidated statements of income, shareholders' equity, and cash
flows for each of the years in the three year period ended December 31, 2003.
These consolidated financial statements are the responsibility of the Patriot's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Patriot as
of December 31, 2003 and 2002, and the results of their operations and their
cash flows for each of the years in the three year period ended December 31,
2003 in conformity with accounting principles generally accepted in the United
States of America.
As discussed in Notes 2 and 4 to the consolidated financial statements,
Patriot adopted Statement of Financial Accounting Standards (SFAS) No.142,
Goodwill and Other Intangible Assets in 2002 and SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities in 2001.
KPMG LLP
KPMG LLP
Philadelphia, Pennsylvania
February 20, 2004
39
PATRIOT BANK CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
----------------------------
2003 2002
------------ ------------
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
Cash and due from banks .................................................. $ 16,040 $ 15,741
Interest-earning deposits in other financial institutions ................ 1,705 1,098
------------ ------------
Total cash and cash equivalents ...................................... 17,745 16,839
Securities available for sale ............................................ 347,140 315,868
Loans held for sale ...................................................... 4,363 4,314
Loans and leases receivable, net of allowances for credit losses of $6,904
and $6,922 at December 31, 2003 and 2002, respectively ............... 618,595 611,295
Premises and equipment, net .............................................. 11,008 7,612
Accrued interest receivable .............................................. 3,591 3,946
Real estate owned and other repossessed property ......................... 401 404
Cash surrender value life insurance ...................................... 18,993 18,208
Goodwill ................................................................. 11,477 8,777
Amortizing intangible assets ............................................. 4,014 3,137
Other assets ............................................................. 6,321 4,743
------------ ------------
Total assets ......................................................... $ 1,043,648 $ 995,143
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits ................................................................. $ 613,555 $ 519,120
FHLB advances and federal funds .......................................... 289,655 368,173
Repurchase agreements .................................................... 44,407 14,210
Advances from borrowers for taxes and insurance .......................... 1,592 2,208
Junior subordinated debt ................................................. 20,500 20,500
Other liabilities ........................................................ 8,196 4,987
------------ ------------
Total liabilities .................................................... 977,905 929,198
============ ============
Preferred stock, $0.01 par value, 5,000,000 shares authorized, none issued
at December 31, 2003 and 2002, respectively ............................ - -
Common stock, no par value, 20,000,000 shares authorized, 7,216,077 and
7,216,480 shares issued at December 31, 2003 and 2002, respectively .... - -
Additional paid-in capital ............................................... 69,061 57,611
Common stock acquired by ESOP, 311,084 and 339,364
shares at cost at December 31, 2003 and 2002, respectively ........... (1,571) (1,638)
Common stock acquired by MRP, 4,897 and 9,051 shares
at amortized cost at December 31, 2003 and 2002, respectively ........ (55) (98)
Retained earnings ........................................................ 8,728 13,855
Treasury stock acquired, 591,071 and 516,174 shares at cost at
December 31, 2003 and 2002, respectively ............................. (10,836) (6,441)
Accumulated other comprehensive income ................................... 416 2,656
------------ ------------
Total shareholders' equity ........................................... 65,743 65,945
------------ ------------
Total liabilities and shareholders' equity ........................... $ 1,043,648 $ 995,143
============ ============
The accompanying notes are an integral part of these statements.
40
PATRIOT BANK CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31,
--------------------------------------
2003 2002 2001
---------- ---------- ----------
(IN THOUSANDS, EXCEPT SHARE DATA)
INTEREST INCOME
Interest-earning deposits ................................................. $ 15 $ 73 $ 508
Investment securities ..................................................... 16,384 17,021 21,220
Loans and leases .......................................................... 42,839 49,020 54,122
---------- ---------- ----------
Total interest income ................................................. 59,238 66,114 75,850
---------- ---------- ----------
INTEREST EXPENSE
Deposits .................................................................. 12,376 14,479 27,690
Short-term borrowings ..................................................... 1,760 4,232 2,387
Long-term borrowings ...................................................... 13,701 18,147 22,132
---------- ---------- ----------
Total interest expense ................................................ 27,837 36,858 52,209
---------- ---------- ----------
Net interest income before provision for credit losses .................... 31,401 29,256 23,641
Provision for credit losses ............................................... 3,930 4,075 2,000
---------- ---------- ----------
Net interest income after provision for credit losses ..................... 27,471 25,181 21,641
---------- ---------- ----------
NON-INTEREST INCOME
Service fees on deposits .................................................. 3,657 2,847 2,445
Fees on loans and leases .................................................. 1,792 1,176 1,565
Investment gains .......................................................... 1,324 1,351 558
Gains on sale of loans and leases ......................................... 2,326 1,928 1,791
BOLI ...................................................................... 796 912 867
Patriot Advisors' commissions ............................................. 2,333 294 283
Other non-interest income ................................................. 121 221 383
Loss on the disposition of borrowings ..................................... (720) (1,488) -
---------- ---------- ----------
Total non-interest income ............................................. 11,629 7,241 7,892
---------- ---------- ----------
NON-INTEREST EXPENSE
Salaries and employee benefits ............................................ 16,616 12,757 9,748
Occupancy and equipment ................................................... 4,380 4,065 4,538
Professional services ..................................................... 1,228 1,281 960
Advertising ............................................................... 805 745 822
Deposit processing ........................................................ 1,187 1,117 1,096
Amortization of intangible assets ......................................... 533 486 1,216
Office supplies and postage ............................................... 934 739 819
Non-income based tax ...................................................... 762 736 643
Other operating expenses .................................................. 1,978 738 926
---------- ---------- ----------
Total non-interest expense ............................................ 28,423 22,664 20,768
---------- ---------- ----------
Income before taxes and cumulative effect of change in accounting principle 10,677 9,758 8,765
Income tax expense ........................................................ 2,042 2,060 2,462
---------- ---------- ----------
Income before cumulative effect of change in accounting principle ......... 8,635 7,698 6,303
Cumulative effect of change in accounting principle,
net of ($105) in income taxes ........................................... - - (204)
---------- ---------- ----------
Net income ................................................................ $ 8,635 $ 7,698 $ 6,099
========== ========== ==========
BASIC EARNINGS PER SHARE:
Income before cumulative effect of change in accounting principle ......... $ 1.36 $ 1.18 $ 0.97
Cumulative effect of change in accounting principle ....................... - - (.03)
---------- ---------- ----------
Net income ................................................................ $ 1.36 $ 1.18 $ 0.94
========== ========== ==========
DILUTED EARNINGS PER SHARE:
Income before cumulative effect of change in accounting principle ......... $ 1.28 $ 1.14 $ 0.96
Cumulative effect of change in accounting principle ....................... - - (.04)
---------- ---------- ----------
Net income ................................................................ $ 1.28 $ 1.14 $ 0.92
========== ========== ==========
Dividends per share ....................................................... $ 0.49 $ 0.37 $ 0.34
========== ========== ==========
The accompanying notes are an integral part of these statements.
41
PATRIOT BANK CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
ACCUMULATED
NUMBER ADDITIONAL OTHER
OF PAID-IN RETAINED TREASURY COMPREHENSIVE
SHARES CAPITAL ESOP MRP EARNINGS STOCK INCOME TOTAL
------ ---------- ------- ----- -------- -------- ------------- --------
(YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001, IN THOUSANDS)
BALANCE AT JANUARY 1, 2001 ....... 5,784 $ 58,174 $(1,999) $(241) $ 4,833 $ (4,043) $ (4,924) $ 51,800
------ ---------- ------- ----- -------- -------- ------------- --------
Release and amortization of MRP .. 52 42 - 173 - - - 215
Release of ESOP shares ........... 26 58 180 - - - - 238
Sale of stock associated with ESPP 7 - - - - 59 - 59
Change in unrealized gains on
securities available for sale,
net of taxes ................... - - - - - - 5,103 5,103
Exercise of stock options ........ 111 (407) - - - 933 - 526
Net income ....................... - - - - 6,099 - - 6,099
Cash dividends paid .............. - - - - (2,334) - - (2,334)
------ ---------- ------- ----- -------- -------- ------------- --------
BALANCE AT DECEMBER 31, 2001 ..... 5,980 $ 57,867 $(1,819) $ (68) $ 8,598 $ (3,051) $ 179 $ 61,706
====== ========== ======= ===== ======== ======== ============= ========
Common stock issued .............. 5 70 - - - - - 70
Common stock acquired by MRP ..... (5) - - (70) - - - (70)
Release and amortization of MRP .. 2 - - 40 - - - 40
Purchase of treasury stock ....... (293) - - - - (4,189) - (4,189)
Release of ESOP shares ........... 26 172 181 - - - - 353
Sale of stock associated with ESPP 9 - - - - 118 - 118
Change in unrealized gains on
securities available for sale,
net of taxes ................... - - - - - - 2,477 2,477
Exercise of stock options ........ 50 (498) - - - 680 - 182
Stock awards ..................... - - - - - 1 - 1
Net income ....................... - - - - 7,698 - - 7,698
Cash dividends paid .............. - - - - (2,441) - - (2,441)
------ ---------- ------- ----- -------- -------- ------------- --------
BALANCE AT DECEMBER 31, 2002 ..... 5,774 $ 57,611 $(1,638) $ (98) $ 13,855 $ (6,441) $ 2,656 $ 65,945
====== ========== ======= ===== ======== ======== ============= ========
Release and amortization of MRP .. 4 11 - 43 - - - 54
Purchase of treasury stock ....... (349) - - - - (7,070) - (7,070)
Release of ESOP shares ........... 28 457 67 - - - - 524
Sale of stock associated with ESPP 9 - - - - 137 - 137
Change in unrealized gains on
securities available for sale,
net of taxes ................... - - - - - - (2,240) (2,240)
Exercise of stock options ........ 210 (373) - - - 1,780 - 1,407
Stock compensation tax benefit ... - 727 - - - - - 727
Issuance of stock for acquisitions 50 - - - - 758 - 758
Stock dividend ................... 583 10,628 - - (10,628) - - -
Net income ....................... - - - - 8,635 - - 8,635
Cash dividends paid .............. - - - - (3,134) - - (3,134)
------ ---------- ------- ----- -------- -------- ------------- --------
BALANCE AT DECEMBER 31, 2003 ..... 6,309 $ 69,061 $(1,571) $ (55) $ 8,728 $(10,836) $ 416 $ 65,743
====== ========== ======= ===== ======== ======== ============= ========
The accompanying notes are an integral part of these statements.
42
PATRIOT BANK CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
-------------------------------------
2003 2002 2001
--------- --------- ---------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income............................................................................... $ 8,635 $ 7,698 $ 6,099
Adjustments to reconcile net income to net cash provided by operating activities
Amortization and accretion of:
Deferred loan origination costs (fees)............................................... 926 (717) (310)
Premiums (discounts)................................................................. 712 (1,010) (1,914)
MRP shares........................................................................... 54 40 215
Goodwill and other intangible assets................................................. 533 486 1,216
Provision for credit losses............................................................ 3,930 4,075 2,000
Release of ESOP shares................................................................. 524 353 238
Gain on sale of investment securities.................................................. (1,324) (1,351) (249)
Loss on disposition of borrowings...................................................... 720 1,488 -
(Gain) Loss on sale and write down of real estate owned and other repossessed assets... (2) 194 63
Depreciation of premises and equipment................................................. 1,527 1,278 1,546
(Gain) loss on disposition of equipment................................................ (5) 57 -
Mortgage loans originated for sale..................................................... (121,905) (90,436) (81,371)
Mortgage loans sold.................................................................... 121,857 92,774 83,283
Deferred income tax (expense) benefit.................................................. (434) 155 (1,358)
Stock compensation tax benefit......................................................... 727 - -
Increase in cash surrender value of life insurance..................................... (785) (903) (822)
Decrease in accrued interest receivable................................................ 355 42 1,137
(Increase) decrease in other assets.................................................... 239 (33) 54
(Decrease) increase in other liabilities............................................... (1,862) (1,097) 3,584
--------- --------- ---------
Net cash provided by operating activities.......................................... 14,422 13,093 13,411
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Loan originations and principal payments on loans, net................................. (13,958) 26,768 4,109
Proceeds from the sale of securities-- available for sale.............................. 47,846 65,701 50,920
Proceeds from the maturity of securities-- available for sale.......................... 95,398 104,206 57,733
Proceeds from the maturity of securities-- held to maturity............................ - 11,638 38,382
Purchase of securities-- available for sale............................................ (177,297) (199,135) (41,010)
Proceeds from sale of real estate owned................................................ 1,806 1,268 1,641
Cash paid in business combination...................................................... (1,067) - -
Purchase of premises and equipment..................................................... (4,884) (2,224) (746)
Proceeds from sale of premises and equipment........................................... 12 35 16
--------- --------- ---------
Net cash (used in) provided by investing activities................................ (52,144) 8,257 111,045
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Increase (decrease) in deposits........................................................ 94,435 (14,743) (116,095)
(Repayment of) proceeds from short term borrowings..................................... (76.720) 31,000 (10,651)
Proceeds from short term repurchase agreements......................................... 30,197 14,210 -
Funding (repurchase) of junior subordinated debt....................................... - 2,500 (1,000)
Repayment of long term borrowings...................................................... (8) (51,494) (7)
Decrease in advances from borrowers for taxes and insurance............................ (616) (1,121) (564)
Cash dividends paid to shareholders.................................................... (3,134) (2,441) (2,334)
Proceeds from the sale of stock associated with ESPP................................... 137 118 59
Proceeds from the exercise of stock options, net of tax benefit........................ 1,407 182 526
Purchase of treasury stock, net of stock awards........................................ (7,070) (4,188) -
--------- --------- ---------
Net cash provided by (used in) financing activities................................ 38,628 (25,977) (130,066)
--------- --------- ---------
Increase (decrease) in cash and cash equivalents....................................... 906 (4,627) (5,610)
Cash and cash equivalents at beginning of year........................................... 16,839 21,466 27,076
--------- --------- ---------
Cash and cash equivalents at end of year................................................. $ 17,745 $ 16,839 $ 21,466
========= ========= =========
SUPPLEMENTAL DISCLOSURES
Cash paid for interest on deposits....................................................... $ 12,772 $ 14,261 $ 27,433
Cash paid (received) for income taxes.................................................... $ 2,581 $ 1,575 $ (172)
Transfers from loans and leases to real estate owned and other repossessed property...... $ 1,801 $ 1,517 $ 1,900
Transfer of securities to available for sale from held to maturity....................... $ - $ (31,357) $(220,471)
Reclassification of long-term borrowings to short-term borrowings........................ $ - $ 40,000 $ -
The accompanying notes are an integral part of these statements.
43
PATRIOT BANK CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
SUPPLEMENTAL DISCLOSURES (CONTINUED)
On January 3, 2003, Patriot purchased the stock of Bonds & Paulus
Associates, Inc. for $458,000 plus contingent consideration to be paid in shares
of Patriot Bank Corp. common stock based upon future revenues of Bonds & Paulus
Associates, Inc. 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. In conjunction with the acquisition of Bonds & Paulus Associates, Inc.,
liabilities were assumed as follows:
Fair value of assets acquired......................... $ 1,671
Cash paid ............................................ (115)
Stock issued.......................................... (343)
-------
Liabilities assumed................................... $ 1,213
On January 17, 2003, Patriot purchased the stock of Pension Benefits
Inc. 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. In conjunction with the acquisition of
Pension Benefits Inc., liabilities were assumed as follows:
Fair value of assets acquired......................... $ 2,114
Cash paid............................................. (414)
Stock issued.......................................... (415)
-------
Liabilities assumed................................... $ 1,285
On September 5, 2003, Patriot purchased the stock of Tyler Wealth
Counselors for $650,000 in cash. In conjunction with the acquisition of Tyler
Wealth Counselors liabilities were assumed as follows:
Fair value of assets acquired......................... $ 687
Cash paid............................................. (650)
Stock issued.......................................... --
-------
Liabilities assumed................................... $ 37
The accompanying notes are an integral part of these statements.
44
PATRIOT BANK CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------
2003 2002 2001
------- ------- -------
(IN THOUSANDS)
Net income .............................................................. $ 8,635 $ 7,698 $ 6,099
Other comprehensive income
Unrealized gains on securities
Unrealized gains associated with change in accounting principle...... -- -- 3,000
Unrealized holding (losses) gains arising during the period ......... (1,366) 3,368 2,267
Less: Reclassification adjustment for gains included in net income
Net gains on the sale of investment securities ...................... (1,324) (1,351) (249)
Income tax expense associated with net gains on the sale of
investment securities ............................................. 450 459 85
------- ------- -------
Comprehensive income .................................................. $ 6,395 $10,174 $11,202
======= ======= =======
The accompanying notes are an integral part of these statements.
45
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
In December 2003, Patriot Bank Corp. ("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.
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.
The following is a description of the significant accounting policies
of Patriot and its subsidiaries. Such accounting and reporting policies conform
with generally accepted accounting principles and predominant practices within
the financial institution industry.
Patriot, through its subsidiaries, offers a broad range of lending,
depository and related financial services to small businesses and consumers
primarily through 19 financial services offices located in Berks, Chester,
Lehigh, Montgomery and Northampton counties in Pennsylvania and through direct
mail and various electronic and telephonic means.
Patriot Bank principally competes with other banking and financial
institutions in its primary market communities. Commercial banks, savings banks,
savings and loan associations, credit unions, brokerage firms, asset management
companies, mutual funds and money market funds actively compete for deposits and
loans. Such institutions, as well as consumer finance and insurance companies,
may be considered competitors of Patriot with respect to one or more of the
services they render.
BASIS OF FINANCIAL PRESENTATION
The accompanying financial statements include the accounts of the
parent company, Patriot Bank Corp. and its subsidiaries: Patriot Bank and its
subsidiaries, Marathon Management Company, Patriot Investment & Insurance
Company, Patriot Commercial Leasing Company, Inc., Patriot Investment Company,
and Patriot Advisors, Inc. All material inter-company balances and transactions
have been eliminated in consolidation.
In preparing the consolidated financial statements, management makes
estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities, and the reported
amounts of revenues and expenses. Actual results could differ from those
estimates. The principal estimates that are particularly susceptible to
significant change in the near term relate to the allowance for credit losses,
valuation of deferred tax assets, and other real estate owned.
46
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECENT ACCOUNTING GUIDANCE
In April 2003, the FASB issued SFAS No. 149, Amendments of Statement
133 on Derivative Instruments and Hedging Activities, which establishes
accounting and reporting standards for derivative instruments, including
derivatives embedded in other contracts and hedging activities. This Statement
amends Statement No. 133 for decisions made by the FASB as part of its
Derivatives Implementation Group process. This Statement also amends Statement
No. 133 to incorporate clarifications of the definition of a derivative. This
Statement is effective for contracts entered into or modified and hedging
relationships designated after June 30, 2003. The adoption of this Statement did
not have an impact on Patriot's earnings, financial condition, or equity.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity. This
Statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). Some of the
provisions of this Statement are consistent with the current definition of
liabilities in FASB Concepts Statement No. 6, Elements of Financial Statements.
The remaining provisions of this Statement are consistent with the Board's
proposal to revise that definition to encompass certain obligations that a
reporting entity can or must settle by issuing its own equity shares, depending
on the nature of the relationship established between the holder and the issuer.
This Statement is effective for financial instruments entered into or modified
after May 31, 2003 and otherwise, is effective at the beginning of the first
interim period after June 15, 2003. The adoption of this Statement did not have
an impact on Patriot's earnings, financial condition, or equity.
In November 2002, the FASB issued Interpretation No. (FIN) 45,
Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. This Interpretation elaborates on
the disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued. It
also clarifies that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. This Interpretation does not prescribe a specific
approach for subsequently measuring the guarantor's recognized liability over
the term of the related guarantee. This Interpretation also incorporates,
without change, the guidance in FASB Interpretation No. 34, Disclosure of
Indirect Guarantees of Indebtedness of Others, which is being superseded. The
initial recognition and initial measurement provisions of this Interpretation
are applicable on a prospective basis to guarantees issued or modified after
December 31, 2002, irrespective of the guarantor's fiscal year-end. There was no
impact on earnings, financial condition or equity upon adoption of FIN 45. The
disclosure requirements in this Interpretation are effective for financial
statements of interim or annual periods ending after December 15, 2002. The
adoption of the disclosure requirements of FIN 45 did not have an impact on the
financial statements or notes to the financial statements.
In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),
"Consolidation of Variable Interest Entities," which addresses how a business
enterprise should evaluate whether it has a controlling financial interest in an
entity through means other than voting rights and accordingly should consolidate
the entity. FIN 46 Revised (FIN 46R), issued in December 2003, replaces FIN 46.
FIN 46R requires public entities to apply FIN 46 or FIN 46R to all entities that
are considered special-purpose entities in practice and under the FASB
literature that was applied before the issuance of FIN 46 by the end of the
first reporting period that ends after December 15, 2003. For any variable
interest entities (VIE) that must be consolidated under FIN 46R, the assets,
liabilities and noncontrolling interests of the VIE initially would be measured
at their carrying amounts with any difference between the net amount added to
the balance sheet and any previously recognized interest being recognized as the
cumulative effect of an accounting change. If determining the carrying amounts
is not practicable, fair value at the date FIN 46R first applies may be used to
measure the assets, liabilities and noncontrolling interest of the VIE. The
adoption of FIN 46R did not have a material impact on Patriot's consolidated
earnings, financial condition, or equity, nor has there been any additional
requirement for disclosure.
47
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In December 2003, the Emerging Issues Task Force issued EITF 03-1, "The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments." The EITF addresses disclosure requirements regarding information
about temporarily impaired investments. The requirements are effective for
fiscal years ending after December 15, 2003 for all entities that have debt or
marketable equity securities with market values below carrying values. The
requirements apply to investments in debt and marketable equity securities that
are accounted for under SFAS No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." The requirements apply only to annual financial
statements. As of December 31, 2003, Patriot has included the required
disclosures in their financial statements.
In December 2003, the AICPA's Accounting Standards Executive Committee
(AcSEC) issued SOP 03-3, Accounting for Certain Loans or Debt Securities
Acquired in a Transfer. The SOP is effective for loans acquired in fiscal years
beginning after December 15,2004, with early adoption encouraged. A certain
transition provision applies for certain aspects of loans currently within the
scope of Practice Bulletin 6, Amortization of Discounts on Certain Acquired
Loans. The SOP addresses accounting for differences between contractual cash
flows and cash flows expected to be collected from an investor's initial
investment in loans or debt securities (loans) acquired in a transfer if those
differences are attributable, at least in part, to credit quality. It includes
loans acquired in business combinations and applies to all nongovernmental
entities, including not-for-profit organizations. The SOP does not apply to
loans originated by the entity. The adoption of this Statement did not have an
impact on Patriot's earnings, financial condition, or equity.
In December 2002, the FASB issued Statement No. 148, Accounting for
Stock-Based Compensation -- Transition and Disclosure. This statement amends
FASB Statement No. 123, Accounting for Stock-Based Compensation, to provide
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. In addition, this
Statement amends the disclosure requirements of Statement 123 to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The requirements of Statement No. 148 are
effective for fiscal years ending after December 15,2002, except for financial
reports containing condensed financial statements for interim periods. Patriot
continues to account for stock based compensation under APB No. 25. If Statement
No. 123 would have been applied it would have had the following impact:
YEAR ENDED DECEMBER 31,
-------------------------------
2003 2002 2001
------- ------- -------
(IN THOUSANDS)
Net income, as reported.............................................. $ 8,635 $ 7,698 $ 6,099
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of related tax effects........................................ (182) (131) (198)
------- ------- -------
Pro forma net income................................................. $ 8,453 $ 7,567 $ 5,901
======= ======= =======
Earnings per share:
Basic -- as reported.............................................. $ 1.36 $ 1.18 $ .94
======= ======= =======
Basic -- pro forma................................................ $ 1.33 $ 1.15 $ .91
======= ======= =======
Diluted -- as reported............................................ $ 1.28 $ 1.14 $ .92
======= ======= =======
Diluted -- pro forma.............................................. $ 1.25 $ 1.13 $ .89
======= ======= =======
On April 22, 2003, the FASB announced its intention to require that all
companies expense the value of employee stock options. The FASB plans to issue a
new exposure draft that could become effective in 2004. Until the new Statement
is issued, the provisions of Statement No. 123 remain in effect.
48
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CASH AND CASH EQUIVALENTS
Cash and cash equivalents are defined as cash on hand, cash items in
process of collection, amounts due from banks, and interest earning deposits in
other financial institutions. Interest-earning deposits consist of deposit
accounts with the Federal Home Loan Bank (FHLB) of Pittsburgh and deposits with
other financial institutions generally having maturities of three months or
less.
SECURITIES
Securities for which Patriot has the intent and ability to hold to
maturity are classified as held to maturity and reported at amortized cost.
Securities expected to be held for an indefinite period of time are classified
as available for sale and are carried at fair value, with unrealized gains and
losses reported as a separate component of shareholders' equity, net of
estimated income taxes. Securities that are bought and held principally for the
purpose of selling are classified as trading and reported at fair value, with
unrealized gains and losses included in earnings. Patriot has no securities held
for trading. Gains or losses on the sales of securities are recognized at trade
date utilizing the specific identification method. The amortization of premiums
and the accretion of discounts on Patriot's investment securities are accounted
for using a method, which approximates a level yield based on principal
amortizations or call dates on non-amortizing callable securities
LOANS HELD FOR SALE
Loans held for sale consist of residential mortgage loans originated by
Patriot. They are recorded at the lower of cost or estimated fair value on an
aggregate basis.
LOANS, LEASES AND ALLOWANCE FOR CREDIT LOSSES
Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are stated at unpaid principal
balances and net of deferred loan origination fees and discounts. Interest is
accrued and credited to operations based upon the principal amount of loans
outstanding. Loan origination fees and certain direct loan origination costs are
deferred, and the net fee or cost is recognized as an adjustment to interest
income using the interest method over the contractual life of the loans,
adjusted for estimated prepayments based on Patriot's historical prepayment
experience. Patriot discontinues the amortization of deferred fees and costs on
non-accrual loans.
Direct finance leases have terms ranging from three to five years.
Under direct finance lease accounting, the balance sheet includes the gross
minimum lease payments receivable, unguaranteed estimated residual values of the
leased equipment, and capitalized indirect costs, reduced by unearned lease
income.
The lease residual values represent the expected proceeds from the sale
of leased equipment at the end of the initial term of the lease and are
determined on the basis of analyses prepared by Patriot based upon professional
appraisals, historical experience and industry data. Management reviews the
estimated residual values on a periodic basis, and impairments in value, if any,
are recognized as an immediate charge to income.
Management's evaluation of the allowance for credit losses includes,
among other factors, an analysis of historical loss rates, by category, applied
to current loan and lease totals. However, actual losses may be higher or lower
than historical trends, which vary. Actual losses on specified problem loans and
leases, which also are provided for in the valuation, may vary from estimated
loss percentages, which are established based upon a limited number of potential
loss classifications.
49
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
An allowance for credit losses is maintained at a level that represents
management's best estimate of known and inherent losses in the loan and lease
portfolios. Management's periodic evaluation of the allowance for credit losses
is based upon evaluation of individual loans and leases, the overall risk
characteristics of the various portfolio segments, regression analyses using
past loss experience, current and projected financial status and
creditworthiness of its borrowers, the adequacy of collateral, the level and
nature of non-performing loans, current economic conditions, the results of the
most recent regulatory examination and other relevant factors. This evaluation
is inherently subjective. While management uses the best information available
to make such evaluations, future adjustments to the allowance may be necessary
if conditions differ substantially from the assumptions used in making the
evaluations. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the allowance for credit losses.
Such agencies may require Patriot to recognize additions to the allowance for
credit losses based on their judgments of information which is available to them
at the time of their examinations.
Impaired loans, as defined by SFAS No. 114, Accounting by Creditors for
Impairment of a Loan, are measured based on the present value of expected future
cash flows discounted at a loan's effective interest rate, or at a loan's
observable market price or fair value of the collateral if the loan is
collateral dependent. A loan is considered to be impaired if upon management's
assessment of the relevant facts and circumstances, it is probable that Patriot
will be unable to collect all proceeds due according to the contractual terms of
the loan agreement.
Uncollectible interest on loans and leases that are generally past due
ninety days or greater is charged off. Loans are returned to an accrual status
when payments become current and other factors indicating doubtful
collectibility cease to exist. Patriot records payments on non-accrual loans
according to the loan amortization schedule, therefore, recognizing interest
income at the time of payment.
PREMISES AND EQUIPMENT
Land is carried at cost. Buildings, leasehold improvements and
furniture, fixtures and equipment are carried at cost less accumulated
depreciation. Depreciation is provided for by the straight-line method over the
estimated useful lives of the assets.
INCOME TAXES
Deferred income taxes are determined based on the differences between
the financial statement and tax basis of assets and liabilities as measured by
the enacted tax rates which will be in effect when the differences reverse.
Deferred tax expense is the result of changes in deferred tax assets and
liabilities.
EARNINGS PER SHARE
Basic earnings per share excludes dilution and is computed by dividing
income available to common shares by the weighted average common shares
outstanding during the period. Diluted earnings per share takes into account the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised and converted into common stock. Prior periods'
earnings per share calculations have been restated to reflect stock splits and
stock dividends.
GOODWILL
Goodwill represents the excess of the purchase price over the estimated
fair value of identifiable net assets acquired through purchase acquisitions.
In accordance with Statement No. 142, goodwill is no longer amortized but is
subject to periodic impairment testing. Prior to the adoption of Statement No.
142, goodwill was amortized straight-line based on a 15-year useful life.
RECLASSIFICATIONS
Certain prior period amounts have been reclassified to conform with the
current year's presentation. These reclassifications had no effect on net
income.
50
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 2 -- INTANGIBLE ASSETS
A summary of non-amortizing and amortizing intangible assets at
December 31 is as follows:
2003 2002
------------------------------------ ------------------------------------
GROSS NET GROSS NET
CARRYING ACCUMULATED CARRYING CARRYING ACCUMULATED CARRYING
AMOUNT AMORTIZATION AMOUNT AMOUNT AMORTIZATION AMOUNT
--------- ------------ -------- --------- ------------ --------
(IN THOUSANDS)
NON-AMORTIZING INTANGIBLE ASSETS:
GOODWILL ............................... $ 13,675 $ 2,198 $ 11,477 $ 10,975 $ 2,198 $ 8,777
AMORTIZING INTANGIBLE ASSETS:
Core deposit intangible ................. 4,606 2,193 2,413 4,606 1,729 2,877
Customer lists .......................... 1,521 70 1,451 -- -- --
Originated mortgage servicing rights..... 664 514 150 664 404 260
--------- ------------ -------- --------- ------------ --------
Total amortizing intangible assets....... 6,791 2,777 4,014 5,270 2,133 3,137
--------- ------------ -------- --------- ------------ --------
Total intangible assets ................. $ 20,466 $ 4,975 $ 15,491 $ 16,245 $ 4,331 $ 11,914
========= ============ ======== ========= ============ ========
Amortization expense of goodwill and core deposit intangible for the years ended
December 31 is as follows:
2003 2002 2001
--------- --------- ---------
(IN THOUSANDS)
AMORTIZATION EXPENSE....................... $ 533 $ 486 $ 1,216
THE ESTIMATED AMORTIZATION EXPENSE OF INTANGIBLE ASSETS FOR EACH OF THE FIVE
SUCCEEDING FISCAL YEARS IS AS FOLLOWS:
ESTIMATED EXPENSE
-----------------
FOR THE YEAR ENDED (IN THOUSANDS)
December 31, 2004 ........................................... $ 614
December 31, 2005............................................ 567
December 31, 2006............................................ 552
December 31, 2007............................................ 398
December 31. 2008............................................ 384
51
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 2 -- INTANGIBLE ASSETS (CONTINUED)
The changes in the carrying amount of goodwill for the years ended December 31
are as follows:
MORTGAGE FINANCIAL COMMERCIAL
BANKING BANKING ADVISORS LEASING TOTAL
-------- -------- --------- ---------- -------
(IN THOUSANDS)
BALANCE AS OF JANUARY 1, 2002 ................ $ 6,909 $ -- $ -- $ 1,779 $ 8,688
Goodwill acquired during the year ............ -- -- -- 89 89
Impairment losses ............................ -- -- -- -- --
-------- -------- --------- ---------- -------
Balance as of December 31, 2002 .............. $ 6,909 $ -- $ -- $ 1,868 $ 8,777
======== ======== ========= ========== =======
BALANCE AS OF JANUARY 1, 2003 ................ $ 6,909 $ -- $ -- $ 1,868 $ 8,777
Goodwill acquired during the year ............ -- -- 2,663 37 2,700
Impairment losses ............................ -- -- -- -- --
-------- -------- --------- ---------- -------
Balance as of December 31, 2003 .............. $ 6,909 $ -- $ 2,663 $ 1,905 $11,477
======== ======== ========= ========== =======
The following table sets forth the computation of basic and diluted net
income per share adjusted for the adoption of SFAS No. 142.
2003 2002 2001
------- ------ ------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Reported net income................................................ $ 8,635 $7,698 $6,099
Add back: goodwill amortization ................................... -- -- 730
Tax effect......................................................... -- -- (248)
------- ------ ------
Adjusted net income................................................ $ 8,635 $7,698 $6,581
======= ====== ======
NET INCOME PER SHARE - BASIC:
Reported net income.............................................. $ 1.36 $ 1.18 $ 0.94
Goodwill amortization............................................ -- -- 0.08
------- ------ ------
Adjusted net income per share - basic.............................. $ 1.36 $ 1.18 $ 1.02
======= ====== ======
NET INCOME PER SHARE - DILUTED:
Reported net income.............................................. $ 1.28 $ 1.14 $ 0.92
Goodwill amortization............................................ -- -- 0.08
------- ------ ------
Adjusted net income per share - diluted............................ $ 1.28 $ 1.14 $ 1.00
======= ====== ======
An impairment evaluation has been completed as of December 31, 2003.
Based on this evaluation, there was no indication of impairment.
NOTE 3 -- RESTRICTIONS ON CASH AND AMOUNTS DUE FROM DEPOSITORY INSTITUTIONS
Patriot is required to maintain certain average reserve balances as
established by the Federal Reserve Board. The amounts of those reserve balances
for the reserve computation periods which include December 31, 2003 and 2002,
were $176,000 and $218,000, respectively.
52
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 4 -- SECURITIES
The amortized cost and estimated fair value of investment and
mortgage-backed securities are as follows:
2003
------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSS FAIR VALUE
--------- ---------- ---------- ----------
(IN THOUSANDS)
AVAILABLE FOR SALE:
Investment securities:
U.S. Treasury and government agency securities........................ $ 27,692 $ 397 $ 95 $ 27,994
Corporate debt securities............................................. 17,629 269 728 17,170
FHLMC/FNMA preferred stock............................................ 100,892 1,559 347 102,104
FHLB /FRB stock....................................................... 15,399 -- -- 15,399
Equity securities..................................................... 299 -- 40 259
Mortgage-backed securities:
FHLMC................................................................. 59,011 338 435 58,914
FNMA.................................................................. 125,156 651 948 124,859
GNMA.................................................................. 61 8 -- 69
Collateralized mortgage obligations:
FHLMC................................................................. 14 -- -- 14
FNMA.................................................................. 357 1 -- 458
--------- ---------- ---------- ---------
Total securities available for sale............................... $ 346,510 $ 3,223 $ 2,593 $ 347,140
========= ========== ========== =========
2002
------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSS FAIR VALUE
--------- ---------- ---------- ----------
(IN THOUSANDS)
AVAILABLE FOR SALE:
Investment securities:
U.S. Treasury and government agency securities........................ $ 66,304 $ 599 $ 652 $ 66,251
Corporate debt securities............................................. 22,724 131 1,467 21,388
FHLMC preferred stock................................................. 67,626 3,715 -- 71,341
FHLB stock............................................................ 17,949 -- -- 17,949
Equity securities..................................................... 6,647 799 164 7,282
Mortgage-backed securities:
FHLMC................................................................. 67,523 700 81 68,142
FNMA.................................................................. 55,821 373 67 56,127
GNMA.................................................................. 96 13 -- 109
Collateralized mortgage obligations:
FHLMC................................................................. 2,960 18 -- 2,978
FNMA.................................................................. 3,689 105 -- 3,794
Other................................................................. 505 2 -- 507
--------- ---------- ---------- ---------
Total securities available for sale............................... $ 311,844 $ 6,455 $ 2,431 $ 315,868
========= ========== ========== =========
53
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 4 -- SECURITIES (CONTINUED)
The following table discloses information regarding Patriot's
temporarily impaired investments:
LESS THAN 12 MONTHS 12 MONTHS OR LONGER TOTAL
-------------------- ------------------ --------------------
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
DESCRIPTION OF SECURITIES VALUE LOSS VALUE LOSS VALUE LOSS
--------------------------------------------------------------
(DOLLARS IN THOUSANDS)
U.S. Treasury and government
agency securities (MUNIs) ......... $ 5,563 $ 94 $ 251 $ 1 $ 5,814 $ 95
Corporate (Trust Pref.) ............. 7,630 728 7,630 728
Equity securities ................... 15,697 347 259 40 15,956 387
Mortgage-backed securities:
FHLMC.............................. 18,173 435 -- -- 18,173 435
FNMA .............................. 65,710 945 150 3 65,860 948
-------- ---------- ------ ---------- -------- ----------
$105,143 $ 1,821 $8,290 $ 772 $113,433 $ 2,593
======== ========== ====== ========== ======== ==========
At December 31, 2003, the Patriot's investment portfolio had 174
holdings with an estimated market value of $347,140,000 and unrealized losses of
$2,593,000. Of the 174 holdings, 27 securities, consisting of government agency,
municipal, and mortgage-backed securities, preferred stock and common stock
litigation warrants, carried unrealized losses for less than 12 months and 10
securities, consisting of trust preferred and mortgage-backed securities,
carried unrealized losses for 12 months or longer.
Patriot monitors and prices the investment portfolio on a monthly
basis. On a quarterly basis the company performs a detailed analysis on the
trust preferred portfolio to determine the underlying credit quality of the
issuers and their ability to continue to meet obligations. As of December 31,
2003, management has determined that there is no impairment other than
temporary.
54
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 4 -- SECURITIES (CONTINUED)
The amortized cost and estimated fair value of investment and
mortgage-backed securities at December 31, 2003, by contractual maturity, are
shown below. Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties:
AVAILABLE FOR SALE
--------------------
AMORTIZED FAIR
COST VALUE
--------- --------
(IN THOUSANDS)
Due in one year or less .................... $ 24,798 $ 24,411
Due after one year through five years ...... 95,609 95,625
Due after five years through ten years ..... 47,191 47,228
Due after ten years ........................ 62,322 62,114
FHLMC/FNMA preferred stock ................. 100,892 102,104
FHLB /FRB stock ............................ 15,399 15,399
Equity securities .......................... 299 259
-------- --------
Total securities ......................... $346,510 $347,140
======== ========
For purposes of the maturity table, mortgage-backed securities, which
are not due at a single maturity date, have been allocated over maturity
groupings based on the contractual maturities. The mortgage-backed securities
may mature earlier than their contractual maturities because of principal
prepayments.
Proceeds from sales of available for sale investment and
mortgage-backed securities and the realized gross gains and losses from those
sales are as follows:
2003 2002 2001
-------- -------- --------
(IN THOUSANDS)
Proceeds from sales ............... $ 47,846 $ 65,701 $ 50,920
======== ======== ========
Gross realized gains .............. 1,366 1,362 653
Gross realized losses ............. (42) (11) (95)
-------- -------- --------
Net realized gain ............... $ 1,324 $ 1,351 $ 558
======== ======== ========
Patriot adopted SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities," as of January 1, 2001. At the time of adoption, Patriot
reclassified approximately $220,471,000 of fixed rate mortgage backed
securities, Collateralized Mortgage Obligation's ("CMOs") and agency securities
from held to maturity to available for sale and equity resulting in a net of tax
increase of approximately $3,000,000 in accumulated other comprehensive income.
During 2001, Patriot sold $30,333,000 of the securities reclassified resulting
in a cumulative change in accounting principle with a $204,000 loss, net of
$105,000 of tax benefit.
Securities having an aggregate amortized cost of $62,273,000,
$7,664,400, and $9,510,058 were pledged to secure public deposits at December
31, 2003, 2002 and 2001, respectively.
55
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 4 -- SECURITIES (CONTINUED)
During 2002, Patriot sold certain securities classified as held to
maturity as part of an interest rate risk strategy. Consequently in accordance
with SFAS No. 115, Accounting for Certain Investments in Debt and Equity
Securities, Patriot reclassified the remaining portfolio of held to maturity
securities to available for sale which are carried at fair value, with
unrealized gains and losses reported as a separate component of shareholders'
equity, net of estimated taxes. Securities that are bought and held principally
for the purpose of selling are classified as trading and reported at fair market
value, with unrealized gains and losses included in earnings. Patriot has no
securities held for trading. Gains or losses on the sales of securities are
recognized at trade date utilizing the specific identification method.
At December 31, 2003, investments with a fair market value totaling
$73,150,000 were pledged as collateral for retail customer repurchase
agreements, securities sold under agreements to repurchase and FHLB advances.
(See footnote 8 for further clarification of collateral securing FHLB advances.)
NOTE 5 -- LOANS AND LEASES RECEIVABLE
Loans and leases receivable are summarized as follows:
DECEMBER 31,
-------------------------
2003 2002
--------- ---------
(IN THOUSANDS)
Commercial Portfolio:
Commercial loans ............................. $ 348,507 $ 315,537
Commercial leases ............................ 82,056 77,138
Consumer Portfolio:
Home equity .................................. 99,231 72,400
Other consumer loans ......................... 5,144 7,724
Mortgage Portfolio:
Residential mortgages ........................ 79,092 135,632
Construction ................................. 10,323 8,220
--------- ---------
Total loans and leases, gross .................. 624,353 616,651
Deferred loan origination costs, net ......... 1,146 1,566
Allowance for credit losses .................. (6,904) (6,922)
--------- ---------
Total loans and leases, net .............. $ 618,595 $ 611,295
========= =========
Patriot services a $10,900,000 portfolio of sold mortgage loans with
corresponding originated mortgage servicing rights totaling $150,000. During
2003, Patriot amortized $110,000 of originated mortgage servicing rights.
Patriot's loan portfolio is principally concentrated in eastern Pennsylvania.
Activity in the allowance for credit losses is summarized as follows:
2003 2002 2001
------- ------- -------
(IN THOUSANDS)
Balance at beginning of year ......... $ 6,922 $ 6,199 $ 5,839
Provision for credit losses .......... 3,930 4,075 2,000
Loans and leases charged off ......... (4,361) (3,643) (1,872)
Recoveries ........................... 413 291 232
------- ------- -------
Balance at end of year ............... $ 6,904 $ 6,922 $ 6,199
======= ======= =======
56
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 5 -- LOANS AND LEASES RECEIVABLE (CONTINUED)
Impaired loans are measured based on the present value of expected
future cash flows discounted at a loan's effective interest rate or at a loan's
observable market price or fair value of the collateral if the loan is
collateral dependent. A loans is considered to be impaired if upon management's
assessment of the relevant facts and circumstances, it is probable that Patriot
will be unable to collect all proceeds due according to the contractual terms of
the loan agreement. Patriot had impaired loans at December 31, 2003, of $24,000
compared to $48,000 at December 31, 2002. The average recorded investment in
impaired loans was $39,000, $160,000, and $156,000 during 2003, 2002, and 2001,
respectively. The allowance for loan losses on impaired loans was $4,000 at
December 31, 2003, compared to $9,000 at December 31, 2002. Patriot recognizes
interest income on a cash basis method on impaired loans. Total interest income
recognized on impaired loans totaled $2,000, $6,000, and $11,000 for the years
ended December 31, 2003, 2002 and 2001, respectively. All of Patriot's impaired
loans were included as non-performing loans at December 31, 2003, 2002 and 2001
as well.
Non-performing loans, consisting of all loans 90 days past due and
certain other loans for which the accrual of interest has been discontinued,
were $3,745,000 and $6,268,000 at December 31, 2003 and 2002, respectively.
Interest income that would have been recorded under the original terms of such
loans and the interest income actually recognized are summarized as follows:
2003 2002 2001
----- ----- -----
(IN THOUSANDS)
Interest income that would have been recorded ....... $ 383 $ 578 $ 411
Interest income recognized .......................... (64) (259) (204)
----- ----- -----
Interest income foregone ............................ $ 319 $ 319 $ 207
===== ===== =====
At December 31, 2003, residential mortgages with a book value totaling
$894,000 were pledged as collateral for FHLB advances. (See footnote 8 for
further clarification of collateral securing FHLB advances.)
The Bank has granted loans to officers, directors, and principal
stockholders of Patriot and to their associates. Related party loans are made
in the ordinary course of business. The aggregate dollar amount of these loans
was $1,041,000 and $1,018,000 at December 31, 2003 and 2002. During 2003,
$251,000 of new loans were funded to officers and directors of Patriot.
NOTE 6 -- PREMISES AND EQUIPMENT
Premises and equipment are summarized as follows:
DECEMBER 31,
ESTIMATED --------------------
USEFUL LIVES 2003 2002
------------ -------- --------
(IN THOUSANDS)
Land........................................ -- $ 1,200 $ 1,222
Buildings................................... 30-40 6,376 3,502
Furniture, fixtures and equipment........... 3-7 11,547 9,588
Leasehold improvements...................... 15 1,535 1,425
-------- --------
Less accumulated depreciation............... 20,658 15,737
Premises and equipment, net................. (9,650) (8,125)
-------- --------
$ 11,008 $ 7,612
======== ========
57
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 7 -- DEPOSITS
Deposits and average rates are summarized as follows:
2003 2002
--------------------- -----------------------
AVERAGE AVERAGE
BALANCE RATE BALANCE RATE
--------- ------- --------- -------
(IN THOUSANDS)
Transaction deposits ..... $ 91,748 0.15% $ 84,976 0.17%
Money market deposits .... 210,576 1.55 143,565 2.00
Savings deposits ......... 83,003 1.37 59,029 1.87
--------- ------ --------- -----
Total core deposits ...... 385,327 1.19 287,570 1.46
Certificates of deposit .. 228,228 2.90 231,550 3.48
--------- ------ --------- -----
Total ................. $ 613,555 1.81% $ 519,120 2.35%
========= ====== ========= =====
The aggregate amount of certificates of deposit with minimum
denominations of $100,000 or more totaled approximately $63,323,000 and
$51,719,000 at December 31, 2003 and 2002, respectively. At December 31, 2003,
Patriot had brokered certificates of deposits in the amount of $40,349,000,
compared to $29,532,000 at December 31, 2002.
At December 31, 2003, scheduled maturities of certificates of deposit
were as follows:
SCHEDULED MATURITIES
--------------------
(IN THOUSANDS)
2004 ...................... $106,601
2005 ...................... 94,868
2006 ...................... 12,047
2007 ...................... 9,266
2008 ...................... 4,204
Thereafter................. 1,242
--------
$228,228
========
58
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31,2003
NOTE 8 -- FHLB ADVANCES AND FEDERAL FUNDS PURCHASED
Pursuant to its collateral agreement with the FHLB, advances are
secured by qualifying loan portfolios, mortgage-backed securities, FHLB stock,
and other investment securities. The Bank is required to maintain unencumbered
qualifying collateral with a haircut market value at least equal to the amount
of its advances from the FHLB. In addition, as of December 31, 2003, the Bank
has delivered residential mortgage loans with a book value of $894,000 and
investment securities with a fair market value of $20,586,000 to the FHLB, as
per the terms of the collateral agreement.
SHORT TERM FHLB ADVANCES
Short-term FHLB advances have maturities of less than one year.
Short-term FHLB advances are summarized as follows:
2003 2002 2001
-------- -------- --------
(IN THOUSANDS)
Balance at year-end ............................................. $ 45,000 $121,000 $ 70,000
Maximum amount outstanding at any month-end during the period ... 58,000 121,000 70,000
Average amount outstanding during each period ................... 36,420 76,497 33,648
Weighted average interest rate on short-term borrowings ......... 2.84% 5.19% 5.81%
SHORT TERM FEDERAL FUNDS PURCHASED
Patriot began purchasing overnight Federal Funds as a low cost funding
source during the second quarter of 2002. These transactions are typically
between financial institutions and are short term unsecured borrowings.
Short-term Federal Funds Purchases are summarized as follows:
2003 2002 2001
------- ------ ----
(IN THOUSANDS)
Balance at year-end ............................................. $20,000 $20,000 $ --
Maximum amount outstanding at any month-end during the period ... 20,000 20,000 --
Average amount outstanding during each period ................... 18,885 10,892 --
Weighted average interest rate on short-term borrowings ......... 1.18% 1.72% --%
Interest expense associated with Federal Funds Purchased for 2002 and
2003 was $187,000 and $223,000, respectively. Patriot did not purchase Federal
Funds during 2001, therefore, did not incur any interest expense.
LONG TERM FHLB ADVANCES
At December 31, 2003 and 2002, long-term advances from the FHLB totaled
$224,655,000 and $ 227,173,000, respectively. At December 31, 2003, outstanding
long-term borrowings mature as follows:
WEIGHTED
AMOUNT AVERAGE RATE
-------- ------------
(IN THOUSANDS)
2005 ............. $ -- --%
2006 ............. -- --
2007 ............. 165 6.20
2008 ............. 69,490 3.69
Thereafter........ 155,000 5.39
-------- --------
$224,655 4.86%
======== ========
59
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31,2003
NOTE 9 -- SECURITIES SOLD UNDER SHORT-TERM REPURCHASE AGREEMENTS
Patriot enters into sales of securities under agreements to repurchase.
These transactions are reflected as a liability on the accompanying Consolidated
Balance Sheets. At December 31, 2003, all of the agreements were to repurchase
identical securities. Short-term repurchase agreements generally have maturities
of less than one year
WHOLESALE
Patriot enters into sales of securities under agreements to repurchase
with other financial institutions and broker dealers. Wholesale repurchase
agreements are summarized as follows:
2003 2002 2001
-------- ---- -------
(IN THOUSANDS)
Balance at year-end ................................................. $ 33,184 $-- $ --
Maximum amount outstanding at any month-end during the period ....... 33,755 -- --
Average amount outstanding during each period ....................... 30,360 -- 6,051
Weighted average interest rate on short-term borrowings ............. 1.25% --% 6.62%
Investment and mortgage-backed securities
underlying the agreements at year-end:
Carrying value .................................................... $ 34,319 $-- $
Estimated fair value .............................................. 34,319 -- --
Interest expense associated with Wholesale repurchase agreements for
2003 was $379,000. Patriot did not enter into Wholesale repurchase agreements
in 2001 and 2002, therefore, did not incur any interest expense for these
periods.
CUSTOMER
Patriot enters into sales of securities under agreements to repurchase
with its commercial customers. Customer repurchase agreements are summarized as
follows:
2003 2002 2001
-------- -------- ----
(IN THOUSANDS)
Balance at year-end ................................................. $ 11,223 $ 14,210 $ --
Maximum amount outstanding at any month-end during the period ....... 15,198 14,210 --
Average amount outstanding during each period ....................... 9,104 3,944 --
Weighted average interest rate on short-term borrowings ............. 1.34% 1.90% --%
Investment and mortgage-backed securities
underlying the agreements at year-end:
Carrying value .................................................... $ 18,244 $ 20,069 $ --
Estimated fair value .............................................. 18.244 20.069 --
Interest expense associated with Customer repurchase agreements for 2002 and
2003 was $75,000 and $122,000, respectively. Patriot did not enter into
Customer repurchase agreements in 2001, therefore, did not incur any interest
expense for this period.
60
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 10 -- JUNIOR SUBORDINATED DEBENTURES
On May 29, 1997, Patriot issued $19,000,000 of 10.30% junior
subordinated debentures to Patriot Capital Trust I, a Delaware Business Trust,
in which Patriot owns all of the common equity. The Trust issued $19,000,000 of
preferred securities to investors, secured by the junior subordinated debentures
and the guarantee of Patriot. Although the junior subordinated debentures will
be treated as debt of Patriot, they currently qualify for Tier I capital
treatment, subject to certain limitations, under risk-based capital guidelines
of the Federal Reserve. The junior subordinated debentures are callable by
Patriot on or after July 1, 2007, or earlier in the event the deduction of
related interest for federal income taxes is prohibited, treatment as Tier I
capital is no longer permitted or certain other contingencies arise. The junior
subordinated debentures must be redeemed upon maturity of the debentures in
2027, or earlier, if they are called. Patriot Bank repurchased $1,000,000 and
$2,500,000 of these junior subordinated debentures in the open market in 2001
and 2002, respectively.
On April 10, 2002, Patriot issued $5,000,000 of floating rate junior
subordinated debt securities to Patriot Capital Trust II, a Delaware Business
Trust, in which Patriot owns all of the common equity. The Trust issued
$5,000,000 of preferred securities to investors, secured by the junior
subordinated debentures and the guarantee of Patriot. The current rate is
5.319%. Although the junior subordinated debentures will be treated as debt of
Patriot, they currently qualify for Tier I capital treatment, subject to certain
limitations, under risk-based capital guidelines of the Federal Reserve. The
junior subordinated debentures are callable by Patriot on any April 22 or
October 22 after April 22, 2007, or earlier in the event the deduction of
related interest for federal income taxes is prohibited, treatment as Tier I
capital is no longer permitted or certain other contingencies arise. The junior
subordinated debentures must be redeemed upon maturity of the debentures in
2032, or earlier, if they are called.
61
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 11 -- INCOME TAXES
Applicable income taxes in the consolidated statements of income are as
follows:
2003 2002 2001
------- ------- -------
(IN THOUSANDS)
CURRENT
Federal ................................. $ 2,447 $ 2,186 $ 938
State ................................... 29 29 166
------- ------- -------
Total current ......................... 2,476 2,215 1,104
------- ------- -------
DEFERRED
Federal ................................. (438) (131) 1,394
State ................................... 4 (24) (36)
------- ------- -------
Total deferred ........................ (434) (155) 1,358
------- ------- -------
Applicable income taxes .................... $ 2,042 $ 2,060 $ 2,462
======= ======= =======
Effective tax rate ......................... 19.13% 21.11% 28.09%
======= ======= =======
Patriot adopted SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities," as of January 1, 2001. The cumulative effect of the
adoption was a $204,000 decrease to consolidated income, net of $105,000 of tax
benefit for the year ended December 31, 2001.
The income tax provision reconciled to taxes computed at the statutory
federal rate is as follows:
2003 2002 2001
---- ---- ----
Federal tax expense at statutory rate ...... 34.00% 34.00% 34.00%
Adjustment resulting from:
State tax, net of federal tax benefit.... 0.21 0.05 0.85
Bank owned life insurance ............... (2.53) (3.18) (3.36)
Tax-exempt interest and dividend income.. (17.94) (12.85) (8.71)
ESOP expense ............................ 1.22 0.73 0.37
Intangible amortization / goodwill ...... 1.66 1.69 4.10
Other ................................... 2.51 0.67 0.84
------ ------ ------
Income taxes ............................... 19.13% 21.11% 28.09%
====== ====== ======
62
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 11 -- INCOME TAXES (CONTINUED)
2003 2002
------- -------
(IN THOUSANDS)
DEFERRED TAX ASSETS
Allowance for credit losses ........................ $ 2,475 $ 2,464
Uncollectible interest ............................. 160 125
MRP expense ........................................ 7 8
Deferred compensation .............................. 31 197
Acquired NOLs ...................................... 23 359
Reserves other ..................................... -- 13
Intangibles amortization ........................... 302 383
Alternative minimum tax credits .................... 1,681 771
------- -------
Total deferred tax assets ........................ $ 4,679 $ 4,320
======= =======
DEFERRED TAX LIABILITIES
Depreciation ....................................... $ 426 $ 441
Discount accretion ................................. 327 224
Originated mortgage servicing rights ............... 51 88
Purchase accounting ................................ 88 111
Deferred loan costs ................................ 812 812
Other .............................................. -- 103
Unrealized gain on securities available for sale ... 214 1,369
------- -------
Total deferred tax liabilities ................... 1,918 3,146
------- -------
Net deferred tax asset ........................... $ 2,761 $ 1,172
======= =======
Based on management's evaluation of the likelihood of realization, no
valuation allowance has been provided against deferred tax assets, as management
believes that it is more likely than not that Patriot will realize such deferred
tax assets.
For federal income tax purposes, Patriot has approximately $67,000 of
acquired net operating loss carryforwards, resulting in a $23,000 deferred tax
asset as of December 31, 2003. The net operating loss will begin to expire after
the year ended December 31, 2010, if not utilized. Patriot has alternative
minimum tax credits of $1,681,000 as of December 31, 2003. The credits have an
indefinite life.
The Small Business Job Protection Act of 1996, enacted on August
20,1996, provides for the repeal of the tax bad debt deduction computed under
the percentage of taxable income method. Upon repeal, the Bank is required to
recapture into income, over a six-year period, the portion of its tax bad debt
reserves that exceed its base year reserves (i.e., tax reserves for tax years
beginning before 1988). The base year tax reserves, which may be subject to
recapture if the Bank ceases to qualify as a bank for federal income tax
purposes, are restricted with respect to certain distributions. The Bank's total
tax bad debt reserves at December 31, 2003, are approximately $4,046,000, all of
which represents the base year amount.
63
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 12 -- EARNINGS PER SHARE
Patriot's calculation of earnings per share is as follows:
FOR YEAR ENDED DECEMBER 31, 2003
-----------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
(IN THOUSANDS EXCEPT PER SHARE DATA)
BASIC EPS
Net income available to common shareholders.......... $ 8,635 6,348 $ 1.36
EFFECT OF DILUTIVE SECURITIES
Dilutive options .................................... -- 412 (.08)
------- ----- ------
DILUTED EPS
Net income available to common shareholders
plus assumed conversions........................ $ 8,635 6,760 $ 1.28
======= ===== ======
FOR YEAR ENDED DECEMBER 31, 2002
-----------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
(IN THOUSANDS EXCEPT PER SHARE DATA)
BASIC EPS
Net income available to common shareholders.......... $ 7,698 6,542 $ 1.18
EFFECT OF DILUTIVE SECURITIES
Dilutive options..................................... -- 190 (.04)
------- ----- ------
DILUTED EPS
Net income available to common shareholders
plus assumed conversions........................ $ 7,698 6,732 $ 1.14
======= ===== ======
FOR YEAR ENDED DECEMBER 31, 2003
-----------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
(IN THOUSANDS EXCEPT PER SHARE DATA)
BASIC EPS
Net income available to common shareholders.......... $ 6,099 6,481 $ 0.94
EFFECT OF DILUTIVE SECURITIES
Dilutive options..................................... -- 117 (.02)
------- ----- ------
DILUTED EPS
Net income available to common shareholders
plus assumed conversions........................ $ 6,099 6,598 $ 0.92
======= ===== ======
NON-DILUTIVE OPTIONS. Patriot had 0, 226,555, and 40,000 non-dilutive
options at December 31, 2003, 2002 and 2001, respectively.
64
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 13 -- SEGMENT REPORTING
Patriot has four reportable segments: Banking, Mortgage Banking,
Financial Advisors and Commercial Leasing. Banking operates a network of 17
community banking offices providing deposit and loan services to customers.
Mortgage Banking originates and sells residential mortgages into the secondary
market to generate fee income. Financial Advisors results for 2001 and 2002
reflect only brokerage services. In January 2003, Patriot completed its
acquisition of two companies and another acquisition in September 2003, which is
disclosed in Note 20 - Business Combinations. As a result of these business
combinations, Financial Advisors' now offers wealth and investment management,
pension benefits, and insurance services in addition to brokerage services. The
impact of these three acquisitions was a $6,478,000 increase to total assets and
a $2,066,000 increase to other income for 2003. Commercial Leasing originates
small ticket leases.
The following table highlights income statement and balance sheet
information for each of the segments at or for the year ended December 31, 2003,
2002 and 2001.
AT OR FOR THE YEAR-ENDED DECEMBER 31, 2003
----------------------------------------------------------------
MORTGAGE FINANCIAL COMMERCIAL
BANKING BANKING ADVISORS LEASING TOTAL
---------- ---------- ----------- ---------- ----------
(IN THOUSANDS)
Net interest income ............................ $ 26,646 $ 314 $ 134 $ 4,307 $ 31,401
Non interest income ............................ 6,379 1,574 2,333 1,343 11,629
Total net income (loss) ........................ 6,428 499 (65) 1,773 8,635
Total assets ................................... 948,969 4,409 7,459 82,811 1,043,648
Total loans and leases, net(1) ................. 536,539 4,363 82,056 622,958
Intersegment interest income (expense) ......... 2,761 314 134 (3,209) --
Intersegment other income (expense) ............ 240 -- -- (240) --
AT OR FOR THE YEAR-ENDED DECEMBER 31, 2002
----------------------------------------------------------------
MORTGAGE FINANCIAL COMMERCIAL
BANKING BANKING ADVISORS LEASING TOTAL
---------- ---------- ----------- ---------- ----------
(IN THOUSANDS)
Net interest income (expense) .................. $ 25,972 $ 609 $ (13) $ 2,688 $ 29,256
Non interest income ............................ 4,170 1,660 294 1,117 7,241
Total net income (loss) ........................ 7,315 359 (71) 95 7,698
Total assets ................................... 912,111 4,354 747 77,931 995,143
Total loans and leases, net(1) ................. 534,157 4,314 -- 77,138 615,609
Intersegment interest income (expense) ......... 4,300 609 (13) (4,896) --
Intersegment other income (expense) ............ 240 -- -- (240) --
AT OR FOR THE YEAR-ENDED DECEMBER 31, 2001
----------------------------------------------------------------
MORTGAGE FINANCIAL COMMERCIAL
BANKING BANKING ADVISORS LEASING TOTAL
---------- ---------- ----------- ---------- ----------
(IN THOUSANDS)
Net interest income (expense) ................... $ 20,965 $ 303 $ (8) $ 2,381 $ 23,641
Non interest income ............................. 4,689 1,563 283 1,357 7,892
Total net income (loss) ......................... 5,246 123 (28) 758 6,099
Total assets .................................... 924,046 6,660 458 78,906 1,010,070
Total loans and leases, net(1) .................. 565,102 6,652 -- 77,838 649,592
Intersegment interest income (expense) .......... 4,121 303 (8) (4,416) --
Intersegment other income (expense) ............. 240 -- -- (240) --
(1) Total loans and leases includes loans held for sale.
65
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 14 -- EMPLOYEE BENEFIT PLANS
401(K) PLAN
Patriot maintains a 401(k) plan covering all of its employees who have
attained age 21 and have completed at least one year of service. Under the plan.
Patriot contributes 100% of an employee's contribution up to 6% of base salary.
Patriot's contributions were $446,000, $301,000 and $273,000 for the years ended
December 31, 2003, 2002 and 2001, respectively.
EMPLOYEE STOCK OWNERSHIP PLAN
In 1995, Patriot established an internally leveraged Employee Stock
Ownership Plan (ESOP) for eligible employees who have completed one year of
service with Patriot or its subsidiaries. In December 1995, the ESOP borrowed
$3,015,000 from Patriot to purchase 597,000 (as adjusted for subsequent stock
dividends and stock split) newly issued shares of common stock. Patriot makes
contributions to the ESOP equal to the ESOP's debt service less any dividends
received by the ESOP. Any dividends received by the ESOP are used to pay debt
service. The ESOP shares are pledged as collateral for its debt. As the debt is
repaid, shares are released from collateral and allocated to qualifying
employees based on the proportion of debt service paid in the year. Accordingly,
the shares pledged as collateral are reported as unearned ESOP shares in the
consolidated Balance Sheets. As shares are committed to be released from
collateral. Patriot reports compensation expense equal to the current market
price of the shares, and the allocated shares are included in outstanding shares
for earnings per share computations. Dividends on allocated ESOP shares are
recorded as a reduction of retained earnings; dividends on unallocated ESOP
shares are recorded as a reduction of debt and accrued interest. ESOP
compensation expense was $524,000, $353,000 and $238,000 in 2003, 2002 and 2001,
respectively. The ESOP shares as of December 31, 2003, were as follows:
SHARES
------
(IN THOUSANDS)
Allocated ...................................................... 286
Unreleased ..................................................... 311
------
Total ESOP ..................................................... 597
======
Fair value of unreleased shares ................................ $8,898
STOCK-BASED COMPENSATION
Patriot maintains a Management Recognition Plan (MRP) as part of its
1996 Stock Compensation Plan. The MRP provides that up to 298,000 (as adjusted
for subsequent stock dividends and stock split) shares of common stock may be
granted, at the discretion of the Board, to key directors and officers at no
cost to the individuals. Patriot granted 0, 5,500 and 0 shares during 2003, 2002
and 2001, respectively in the form of restricted stock payable over five years
from the date of grant. The recipients of the restricted stock are entitled to
all voting and other shareholder rights, except that the shares, while
restricted, may not be sold, pledged or otherwise disposed of and are required
to be held in escrow. In the event the recipient terminates association with
Patriot for reasons other than death, disability or change in control, the
recipient forfeits all rights to the allocated shares under restriction which
are canceled and revert to Patriot for re-issuance under the plan. Shares
acquired by the MRP were newly issued shares and were recorded at the date of
award based on the market value of shares. Shares acquired by the MRP, which are
shown as a separate component of shareholders' equity, are being amortized to
expense over the five-year vesting period. As shares are vested during this
five-year period, Patriot records compensation expense equal to the shares being
amortized. For the years ended December 31, 2003, 2002 and 2001, $43,000,
$40,000 and $173,000 were amortized to expense, respectively. At December 31,
2003, 14,000 shares were reserved for future grants under the plan.
66
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 14 -- EMPLOYEE BENEFIT PLANS (CONTINUED)
Patriot maintains a stock option plan. Patriot's employee stock option
plan is accounted for under the intrinsic value method of APB Opinion No. 25.
Accordingly, Patriot is required to make pro forma disclosures of net income and
earnings per share, as if the fair value-based method of accounting defined in
SFAS No. 123 "Accounting for Stock-Based Compensation," had been applied. The
plan permits the grant of options to employees and directors for up to 1,100,000
(as adjusted for subsequent stock dividends and stock split) shares of common
stock. The options have a term of 10 years and vest over a five-year period. The
exercise price of each option equals the market price of Patriot Bank Corp.'s
common stock on the date of grant. Accordingly, no compensation cost has been
recognized for the plan.
A summary status of Patriot's option plans as of December 31, 2003, 2002
and 2001 and the charges during the years ending on those dates is presented
below:
2003 2002 2001
------------------- ------------------- ------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
SHARES PRICE SHARES PRICE SHARES PRICE
------ ------- ------ -------- ------ --------
(SHARES IN THOUSANDS)
Outstanding at beginning of year......... 677 $ 9.07 558 $ 6.69 744 $ 6.65
Granted.................................. 44 14.21 249 12.82 23 6.56
Exercised................................ 219 7.45 119 6.54 209 6.54
Canceled................................. 5 12.82 11 10.68 -- --
--- ------ --- ------ ------ ------
Outstanding at year-end.................. 497 $10.21 677 $ 8.95 558 $ 6.69
=== ====== === ====== ====== ======
Options exercisable at year-end.......... 235 366 447
=== === ======
Weighted average fair value of
options granted during the year....... $ 3.17 $ 3.01 $ 2.33
====== ====== ======
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes options-pricing model as follows:
2003 2002 2001
---- ---- ----
Assumptions:
Dividend yield............. 2.67% 2.98% 3.94%
Expected volatility........ 28.74% 20.75% 37.53%
Estimated life............. 10 yrs 10 yrs 10 yrs
Risk-free interest rate.... 4.25% 3.81% 5.05%
67
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 14 -- EMPLOYEE BENEFIT PLANS (CONTINUED)
The following table summarizes information about stock options
outstanding at December 31, 2003:
OPTIONS OUTSTANDING OPTIONS EXCERCISABLE
--------------------------------------------------- ------------------------------
NUMBER WEIGHTED NUMBER
OUTSTANDING AT AVERAGE WEIGHTED OUTSTANDING AT WEIGHTED
RANGE OF DECEMBER 31, REMAINING AVERAGE DECEMBER 31, AVERAGE
EXERCISE PRICES 2003 CONTRACTUAL LIFE EXERCISE PRICE 2003 EXERCISE PRICE
- --------------- -------------- ---------------- -------------- -------------- --------------
(IN THOUSANDS) (IN THOUSANDS)
$ 5.00 - $ 7.50 205 3.71 years $ 6.40 173 $ 6.45
7.51 - 10.00 6 5.61 years 9.05 4 9.15
10.01 - 12.50 18 4.61 years 11.39 16 11.48
12.51 - 15.00 263 8.45 years 12.97 42 12.89
15.01 - 17.50 5 9.44 years 17.48 -- --
--- ---
497 235
EMPLOYEE STOCK PURCHASE PLAN
Patriot maintains an Employee Stock Purchase Plan ("ESPP") which
permits eligible employees to purchase Patriot common stock directly from
Patriot through payroll deduction. Purchases of common stock are made at 90% of
the market value of Patriot common stock on the last day of each quarter.
Purchases are limited annually to $25,000 per participant and shares are issued
from treasury stock. In 2003, 2002 and 2001, Patriot recorded expense of
$13,000, $12,000 and $5,000, respectively, related to the ESPP.
The ESPP was terminated, effective December 31, 2003, as required by
the definitive merger agreement between Patriot and Susquehanna.
NOTE 15 -- FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND CONCENTRATIONS
OF CREDIT RISK
Patriot is a party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of its customers,
including commitments to extend credit. Those instruments involve, to varying
degrees, elements of credit and interest rate risk in excess of the amount
recognized in the consolidated Balance Sheets. The contract or notional amounts
of those instruments reflect the extent of Patriot's involvement in particular
classes of financial instruments.
Patriot's exposure to credit loss in the event of non-performance by
the other party to the financial instrument for commitments to extend credit is
represented by the contractual notional amount of those instruments. Patriot
uses the same credit policies in making commitments and conditional obligations
as it does for on-balance-sheet instruments. Unless noted otherwise, Patriot
requires collateral to support financial instruments with credit risk.
68
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 15 -- FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS
OF CREDIT RISK (CONTINUED)
The contractual or notional amounts of outstanding loan commitments as
of December 31, 2003, are as follows:
TOTAL
FIXED RATE VARIABLE RATE COMMITMENTS
COMMITMENTS COMMITMENTS OUTSTANDING
----------- ------------- -----------
(IN THOUSANDS)
Financial instruments whose contract amounts represent credit risk
Mortgage loans ........................................................ $ 1,597 $ -- $ 1,597
Consumer and other loans .............................................. 142 28,933 29,075
Commercial lines of credit ............................................ 2,093 43,976 46,069
Commercial leases ..................................................... 20,257 -- 20,257
Construction loans .................................................... 5,163 -- 5,163
Financial letters of credit ........................................... -- 584 584
Performance letters of credit ......................................... 80 1,364 1,444
-------- -------- --------
Total ............................................................... $ 29,332 $ 74,857 $104,189
======== ======== ========
Fees received in connection with these commitments are recognized as
income over the life of the commitment or the life of the loan.
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Patriot evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by Patriot upon extension of credit, is based on management's
credit evaluation of the borrower. Collateral for commitments generally includes
residential real estate, commercial real estate, or business equipment related
to the lease.
NOTE 16 -- COMMITMENTS AND CONTINGENCIES
LEASE COMMITMENTS
Patriot is committed to various operating leases related to branch
facilities having initial or remaining terms in excess of one year. The minimum
annual rental commitments under these leases outstanding at December 31, 2003
are as follows:
COMMITMENTS
--------------
(IN THOUSANDS)
2004 ................................................................... $ 1,075
2005 ................................................................... 1,020
2006 ................................................................... 864
2007 ................................................................... 861
2008 ................................................................... 883
Thereafter .............................................................. 6,910
-------
$11,613
=======
Total rental expense for all leases for the year ended December 31,
2003, 2002, and 2001 totaled $1,269,000, $1,120,000, and $1,098,000,
respectively.
OTHER
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.
69
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 17 -- DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
Patriot is required to disclose the estimated fair value of Patriot's
assets and liabilities considered to be financial instruments. As with most
financial institutions, the majority of Patriot's assets and liabilities are
considered financial instruments. However, many of such instruments lack an
available trading market, as characterized by a willing buyer and seller
engaging in an exchange transaction. Therefore, Patriot has used significant
estimates and present value calculations to prepare this disclosure. Changes in
the assumptions or methodologies used to estimate fair value may affect the
estimated amounts.
Estimates of fair value are made at a specific point in time based
upon, where available, relevant market prices and information about the
financial instrument. Such estimates do not include any premium or discount that
could result from offering for sale at one time Patriot's entire holdings of a
particular financial instrument. For a substantial portion of Patriot's
financial instruments, no quoted market exists. Therefore, estimates of fair
value are necessarily based on a number of significant assumptions (many of
which involve events outside the control of management). Such assumptions
include assessments of current economic conditions, perceived risks associated
with these financial instruments and their counterparties, future expected loss
experience, and other factors. Given the uncertainties surrounding these
assumptions, the reported fair values represent estimates only, and therefore
cannot be compared to the historical accounting model. Use of different
assumptions or methodologies are likely to result in significantly different
fair value estimates.
The estimated fair values presented neither include nor give effect to
the values associated with Patriot's banking, or other business, existing
customer relationships, extensive branch banking network, property, equipment,
goodwill, or certain tax implications related to the realization of unrealized
gains or losses. Excluding securities available for sale and certain residential
mortgages, it is Patriot's general practice and intent to hold the preponderance
of its financial instruments to maturity and not to engage in trading or sales
activities. The fair value of demand deposits, savings, and money market deposit
accounts is equal to the carrying amount because these deposits have no stated
maturity. Obviously, this approach to estimating fair value excludes the
significant benefit that results from the low-cost funding provided by such
deposit liabilities, as compared to alternative sources of funding. As a
consequence, the fair value of individual assets and liabilities may not be
reflective of the fair value of a banking organization that is a going concern.
Fair values have been estimated using data which management considered
the best available. Fair value of financial instruments actively traded in a
secondary market has been estimated using quoted market prices. The fair value
of loans receivable has been estimated using present value cash flow, discounted
at an interest rate that gives effect to estimated prepayment risk and credit
loss factors. The carrying amount of accrued interest receivable and accrued
interest payable approximate its fair market value. Fair value of financial
instrument liabilities with no stated maturities has been estimated to equal the
carrying amount. Fair value of financial instrument liabilities with stated
maturities has been estimated using present value cash flow, discounted at a
rate approximating current market rates for similar assets and liabilities. The
fair value of letters of credit and outstanding commitments approximate the fees
charged for providing such services. The resulting estimated fair values and
carrying amounts at December 31, 2003 and 2002, respectively were as follows:
70
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 17 -- DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
2003 2002
----------------------- -------------------------
ESTIMATED ESTIMATED
FAIR CARRYING FAIR CARRYING
VALUE AMOUNT VALUE AMOUNT
-------- -------- -------- ---------
(IN THOUSANDS)
FINANCIAL ASSETS:
Cash and cash equivalents ........... $ 17,745 $ 17,745 $ 16,839 $ 16,839
Securities available for sale ....... 347,140 347,140 315,868 315,868
Loans held for sale and loans
and leases receivable, net of
allowances for credit losses ...... 633,906 622,958 629,355 615,609
Accrued interest receivable ......... 3,591 3,591 3,946 3,946
FINANCIAL LIABILITIES:
Deposits with no stated maturities... 385,327 385,327 287,570 287,570
Deposits with stated maturities ..... 231,015 228,228 233,619 231,550
Borrowings .......................... 375,901 354,562 429,016 402,883
Accrued interest payable ............ 1,545 1,545 2,028 2,028
2003 2002
-------------------------------------- -------------------------------
ESTIMATED ESTIMATED
NOTIONAL FAIR CARRYING NOTIONAL FAIR CARRYING
AMOUNT VALUE AMOUNT AMOUNT VALUE AMOUNT
-------- -------- -------- -------- --------- --------
(IN THOUSANDS)
OFF-BALANCE SHEET ITEMS:
Commitments to extend credit........... 104,189 2,282 -- 90,337 471 --
Interest rate swaps.................... 72,000 (2,510) (2,510) -- -- --
71
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 18 -- REGULATORY MATTERS
Patriot and Patriot Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory, and possible
additional discretionary, actions by regulators that, if undertaken, could have
a direct material effect on Patriot's consolidated financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, Patriot and Patriot Bank must meet specific capital guidelines that
involve quantitative measures of assets, liabilities and certain off-balance
sheet items as calculated under regulatory accounting practices. Patriot and
Patriot Bank's capital amounts are also subject to qualitative judgments by the
regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require Patriot Bank Corp. and Patriot Bank to maintain minimum amounts
and ratios (set forth in the table below) of total and core capital (as defined
in the regulations) to risk-weighted assets, and of core capital to average
assets. Management believes, as of December 31, 2003, that Patriot and Patriot
Bank each meet all capital adequacy requirements to which it is subject.
As of December 31, 2003, the most recent notification from the
Department of Banking of the Commonwealth of Pennsylvania categorized Patriot
Bank as well capitalized under the regulatory framework for prompt corrective
action. To be categorized as well capitalized, Patriot and Patriot Bank must
maintain minimum total risk-based, core risk-based and core leverage ratios as
set forth in the table. At December 31, 2003, Patriot and Patriot Bank met these
ratio requirements. There are no conditions or events since that notification
that management believes have changed the institution's category.
The following schedule summarizes the actual capital balances and
ratios of Patriot and Patriot Bank as of December 31, 2002 and 2003:
AS OF DECEMBER 31, 2003
-------------------------------------------------------
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION
--------------- ----------------- ------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------- ----- ------- ----- ------- ------
(IN THOUSANDS)
Total capital (to risk-weighted assets)
Patriot Bank Corp. ............................ $79,369 11.77% $53,960 8% $67,451 10%
Patriot Bank .................................. 77,086 11.45% 53,866 8% 67,333 10%
Tier I capital (to risk-weighted assets)
Patriot Bank Corp. ............................ 71,937 10.67% 26,980 4% 40,470 6%
Patriot Bank .................................. 69,636 10.34% 26,933 4% 40,400 6%
Tier I capital (to average assets)
Patriot Bank Corp. ............................ 71,937 7.29% 39,475 4% 49,344 5%
Patriot Bank .................................. 69,636 7.04% 39,582 4% 49,477 5%
Patriot and Patriot Bank are subject to regulations of certain
regulatory agencies and, accordingly, are periodically examined by such
regulatory authorities. As a consequence of the regulation of banking
activities, Patriot and Patriot Bank's operations are susceptible to changes in
legislation and regulations.
72
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 18 -- REGULATORY MATTERS (CONTINUED)
AS OF DECEMBER 31, 2002
-------------------------------------------------------
TO BE WELL
FOR CAPITAL CAPITALIZED
ADEQUACY UNDER PROMPT
ACTUAL PURPOSES CORRECTIVE ACTION
--------------- ----------------- -----------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------- ----- ------- ----- -------- -----
(IN THOUSANDS)
Total capital (to risk-weighted assets)
Patriot Bank Corp. ............................. $81,013 12.61% $51,376 8% $64,220 10%
Patriot Bank ................................... 79,350 12.35% 51,400 8% 64,250 10%
Tier I capital (to risk-weighted assets) ......
Patriot Bank Corp. ............................. 72,134 11.23% 25,688 4% 38,532 6%
Patriot Bank ................................... 70,398 10.96% 25,700 4% 38,550 6%
Tier I capital (to average assets)
Patriot Bank Corp. ............................. 72,134 7.33% 39,378 4% 49,223 5%
Patriot Bank ................................... 70,398 7.15% 39,378 4% 49,223 5%
At the time of Patriot's initial public offering, a "liquidation
account" was established for Patriot Bank at its conversion to the stock form of
ownership. In the unlikely event of a complete liquidation of Patriot Bank,
holders of savings accounts with qualifying deposits, who continue to maintain
their savings accounts, would be entitled to a distribution from the
"liquidation account" in an amount equal to the then current adjusted savings
account balance before any liquidation distribution could be made with respect
to capital stock. The balance in the "liquidation account" was $4,524,000 at
December 31, 2003. This amount may not be utilized for the payment of cash
dividends to the holding company.
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.
73
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 19 -- PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information for Patriot Bank Corp. is as follows:
CONDENSED BALANCE SHEETS
DECEMBER 31,
----------------------------
2003 2002
------------ ------------
(IN THOUSANDS)
ASSETS
Cash and cash equivalents ................................... $ 43 $ 342
Loans to subsidiaries ....................................... 4,620 1,703
Investment in subsidiaries .................................. 82,199 85,776
Other assets ................................................ 521 396
------------ ------------
Total assets ............................................. $ 87,383 $ 88,217
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Other liabilities ........................................... $ 1,140 $ 1,772
Junior subordinated debt .................................... 20,500 20,500
Shareholders' equity ........................................ 65,743 65,945
------------ ------------
Total liabilities and shareholders' equity ............... $ 87,383 $ 88,217
============ ============
CONDENSED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31,
---------------------------------------------
2003 2002 2001
------------ ------------ -----------
(IN THOUSANDS)
Interest income.............................................. $ 61 $ 87 $ 24
Earnings of subsidiaries .................................... 10,383 9,388 7,733
Other ....................................................... -- -- 9
------------ ------------ -----------
Total income............................................. 10,444 9,475 7,766
Interest expense............................................. 2,090 2,220 2,185
Other........................................................ 674 429 321
------------ ------------ -----------
Total expense............................................ 2,764 2,649 2,506
Income before income taxes.................................. 7,680 6,826 5,260
Income tax benefit.......................................... (955) (872) (839)
------------ ------------ -----------
Net income............................................... $ 8,635 $ 7,698 $ 6,099
============ ============ ===========
74
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 19 -- PARENT COMPANY FINANCIAL INFORMATION (CONTINUED)
CONDENSED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
2003 2002 2001
-------- -------- --------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income ............................................................ $ 8,635 $ 7,698 $ 6,099
Adjustments to reconcile net income to net cash
provided by operating activities
Earnings from subsidiaries ............................................ (10,383) (9,388) (7,733)
Dividends from subsidiaries ........................................... 11,720 5,418 4,450
Change in other assets ................................................ (125) 1,654 (1,490)
Change in other liabilities ........................................... (632) (1,127) 2,142
Release of MRP/ESOP shares ............................................ 578 393 453
-------- -------- --------
Net cash provided by operating activities .................... 9,793 4,648 3,921
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in / loans to subsidiary ................................... (2,159) 1,482 (1,646)
-------- -------- --------
Net cash (used in) provided by investing activities .......... (2,159) 1,482 (1,646)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Cash dividends paid to shareholders ................................... (3,134) (2,441) (2,334)
Proceeds from the exercise of stock options, net of tax benefit .... 2,134 182 526
Proceeds from the sale of stock associated with ESPP .................. 137 118 59
Purchase of treasury stock, net of stock awards ....................... (7,070) (4,188) --
-------- -------- --------
Net cash used in financing activities ........................ (7,933) (6,329) (1,749)
(Decrease) increase in cash and cash equivalents ...................... (299) (199) 526
Cash and cash equivalents at beginning of year ........................... 342 541 15
-------- -------- --------
Cash and cash equivalents at end of year ................................. $ 43 $ 342 $ 541
======== ======== ========
NOTE 20 -- BUSINESS COMBINATIONS
BONDS & PAULUS ASSOCIATES, INC. ACQUISITION. On January 3, 2003,
Patriot completed the acquisition of Bonds & Paulus Associates, Inc. (Bonds &
Paulus), a wealth management firm headquartered in Chester County, Pennsylvania.
Founded in 1993, Bonds & Paulus is a registered investment advisory firm,
providing investment advisory and financial planning services to high net-worth
individuals and families. Bonds & Paulus was merged into Patriot Advisors, a
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.
75
PATRIOT BANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2003
NOTE 20 -- BUSINESS COMBINATIONS (CONTINUED)
PENSION BENEFITS, INC. 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.
TYLER WEALTH COUNSELORS ACQUISITION. 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 15-year weighted-average useful life.
Supplemental pro forma information that discloses the results of
operations for Patriot Bank Corp. and its subsidiaries for the year ended
December 31, 2003 compared to the same period in 2002 and 2001 is provided
below. The pro forma information assumes the business combinations of Bonds &
Paulus Associates, Inc., Pension Benefits, Inc. and Tyler Wealth Counselors had
been completed as of the beginning of each period and illustrates the impact on
Patriot's non-interest income, net income and EPS for each period.
FOR THE PERIOD ENDED DECEMBER 31,
----------------------------------
2003 2002 2001
------- ------- -------
(IN THOUSANDS)
Revenue.................................. $71,520 $75,941 $86,328
Net income............................... $ 8,640 $ 7,716 $ 6,117
======= ======= =======
Earnings per share - basic............... $ 1.36 $ 1.18 $ 0.94
======= ======= =======
Earnings per share - diluted............. $ 1.28 $ 1.15 $ 0.93
======= ======= =======
NOTE 21 -- DERIVATIVE FINANCIAL INSTRUMENTS
Patriot uses interest rate swaps to hedge the impact of changing
interest rates on the market values of certain fixed rate FHLB borrowings. Under
the terms of the swaps, Patriot receives fixed rate payments and pays variable
rate payments based on three month LIBOR. The fixed interest swap payments
received by Patriot equal the amounts payable to to the FHLB, effectively
converting the FHLB borrowings to a variable rate. Changes in the fair value of
the swaps are highly effective in offsetting changes in the fair value of the
FHLB borrowings, since the structure of the critical terms of the swaps match
the FHLB borrowings.
76
The following table summarizes Patriot's derivative financial
instruments as of December 31, 2003:
NOTIONAL MARKET MATURITY RECEIVE
AMOUNT VALUE YEAR FIXED PAY FLOATING
- -------- ------- -------- ------- --------------------------
(IN THOUSANDS)
$ 35,000 $(1,219) 2008 4.69% Three month LIBOR + 2.2125%
22,000 (769) 2008 5.01% Three month LIBOR + 2.535%
15,000 (522) 2008 5.04% Three month LIBOR + 2.5625%
- -------- -------
$ 72,000 $(2,510)
======== =======
In the past, Patriot has not used derivative instruments, however, 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 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.
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
N/A
ITEM 9A. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. Patriot's principal
executive officer and principal financial officer have concluded that Patriot's
disclosure controls and procedures (as defined in Rule 13a-15 under the
Securities Exchange Act of 1934, as amended), based on their evaluation of these
controls and procedures as of December 31, 2003, are effective.
CHANGES IN INTERNAL CONTROLS. 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 total amount of the alleged
theft is approximately $982,000. The company maintains an insurance policy which
management believes covers the majority of the alleged theft, and as a result,
Patriot has recorded an after-tax charge of $367,000 related to the deductible
on that insurance policy and losses and operating expenses associated with the
falsification and destruction of accounting records. 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.
Subsequent to the discovery of the alleged defalcation, Management has
implemented staffing changes designed to improve the training of the individuals
involved in the daily operations. Procedural changes were also implemented to
enhance the segregation of duties, which strengthen the review, authorization
and reconciliation process so that the probability of employee defalcations
occurring in the future is reduced. The Chief Executive Officer and Chief
Financial Officer believe that the corrective actions taken should be adequate
to remedy the aforementioned control inadequacies.
Except as discussed above, there have been no significant changes in
Patriot's internal controls or in other factors that could significantly affect
these controls subsequent to the date of the evaluation of those controls.
77
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth, as of March 8, 2004, the names of the
Directors and Named Executive Officers (as defined below) as well as their ages,
a brief description of their recent business experience, including present
occupations and employment, certain directorships held by each, the year in
which each director became a director of Patriot and the year in which their
terms as director of Patriot expire.
EXPIRATION
NAME AND PRINCIPAL OCCUPATION DIRECTOR OF TERM AS
AT PRESENT AND FOR PAST FIVE YEARS AGE SINCE (1) DIRECTOR
- ---------------------------------------------- --- -------- -----------
DIRECTORS
Russell J. Kunkel 61 2000 2006
Director of Patriot and the Bank. Vice
Chairman of National Penn Bank
from April 1996 to September 1997.
Vice Chairman of Meridian Bancorp, Inc.
and Meridian Bank from 1985 to 1995.
James A. Bentley, Jr. 45 1998 2005
Director of Patriot and the Bank. President,
Chief Executive Officer and owner of
Bentley Graphic Communications since
1989.
Richard A. Elko 42 1999 2005
Director of Patriot and the Bank. President
and Chief Executive Officer
of Patriot and the Bank since November 3,
2000. Prior thereto, Executive Vice
President since December 1999 and Chief
Financial Officer of Patriot
and the Bank from January 1996 to
December 1999.
James B. Elliott 63 1990 2004
Chairman of the Board of Patriot
and the Bank since July 1998. President
of Strategic Business Concepts, Inc.
Prior thereto, Director of Communications
and Marketing for St. Joseph Medical
Center from 1994 to 1997.
Larry V. Thren 61 1992 2004
Director of Patriot and the Bank. Vice
President of Human Resources and Support
Services, Pottstown Memorial Medical
Center from 1988 to 2003.
78
EXPIRATION
NAME AND PRINCIPAL OCCUPATION DIRECTOR OF TERM AS
AT PRESENT AND FOR PAST FIVE YEARS AGE SINCE (1) DIRECTOR
- --------------------------------------------- --- -------- ----------
NAMED EXECUTIVE OFFICERS
WHO ARE NOT DIRECTORS
Kevin R. Pyle
Executive Vice President and Chief Lending 37
Officer of Patriot and the Bank since -
February 2001. Prior thereto, Chief Credit
Officer of the Bank since March 1996.
Joni S. Naugle 45 - -
Executive Vice President and Chief
Operating Officer of Patriot and the Bank
since February 2001. Prior thereto, Chief
Operating Officer of Patriot and the Bank
since December 1998, Senior Vice President
for Marketing and Retail Sales at Sovereign
Bank from 1979 to
April 1998 and a consultant from
April 1998 to December 1998.
James G. Blume 38 - -
Senior Vice President and Chief Financial
Officer of Patriot and the Bank since
February 2001. Prior thereto, Chief
Financial Officer of Patriot and the Bank
since December 1999, Corporate Controller
of Patriot and the Bank from March 1997 to
December 1999.
(1) Includes years of service as a director of Patriot's predecessor, the Bank.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act requires Patriot's officers and
directors, and any persons owning ten percent or more of the Common Stock, to
file in their personal capacity initial statements of beneficial ownership,
statements of change in beneficial ownership and annual statements of beneficial
ownership with the SEC. Persons filing such beneficial ownership statements are
required by SEC regulation to furnish Patriot with copies of all such statements
filed with the SEC. The rules of the SEC regarding the filing of such statements
require that "late filings" of such statements be disclosed in Patriot's proxy
statement. To the best of Patriot's knowledge, there were no late filings during
2003.
MEETINGS OF THE BOARD OF DIRECTORS AND COMMITTEES OF THE BOARD OF DIRECTORS
Patriot conducts its business through meetings of the Board of
Directors and through activities of its committees. The Board of Directors of
Patriot meets monthly and may have additional meetings as needed. During 2003,
the Board of Directors of Patriot held fifteen (15) meetings. All of the
directors of Patriot attended at least 75% of the total number of Patriot's
Board meetings held and committee meetings on which such directors served during
2003. The Board of Directors of Patriot maintains committees, the composition of
which are described below.
79
Audit Committee. The Audit Committee of Patriot consists of Messrs.
Bentley, Elliott, Kunkel and Thren. The Audit Committee met seven (7) times in
2003. The Board has designated Mr. Kunkel as the Committee's "audit committee
financial expert."
Nominating Committee. The Nominating Committee of Patriot consists of
Messrs. Bentley, Elko and Kunkel. The Nominating Committee met two (2) times in
2003.
Personnel Compensation/Benefits Committee. The Personnel
Compensation/Benefits Committee of Patriot consists of Messrs. Bentley, Elliott,
Kunkel and Thren. The Personnel Compensation/Benefits Committee met six (6)
times in 2003. No executive officers of Patriot served as a director of another
for profit entity and therefore there are no interlocking compensation committee
positions.
Corporate Governance and Ethics Committee. The Corporate Governance and
Ethics Committee of Patriot consists of Messrs. Bentley, Elliott, Kunkel and
Thren. The Corporate Governance and Ethics Committee met four (4) times in 2003.
Executive Committee. The Executive Committee of Patriot consists of
Messrs. Bentley, Elko, Elliott and Thren. The Executive Committee is responsible
for conducting the business of Patriot in the absence of the entire Board of
Directors. The Executive Committee did not meet in 2003.
CORPORATE GOVERNANCE DOCUMENTS
A copy of Patriot's Code of Ethics and Legal Code of Conduct, Patriot's
Code of Ethics for the Chief Executive Officer and Senior Financial Officers and
the charters of Patriot's Audit Committee, Nominating Committee, and Management
Compensation Committee are available on Patriot's website under Investor
Relations at www.patriotbank.com and any shareholder may obtain a printed copy
of these documents by writing to Diane M. Davidheiser, Patriot Bank Corp., High
and Hanover Streets, Pottstown, Pennsylvania 19464, by e-mail at
ddavidhe@patriobank.com or by calling at (610) 970-4604.
DIRECTORS' COMPENSATION
Outside director compensation is based on accepted practices of the
banking industry, Patriot's current size and scope of operation, level of
personal risk, liability associated with directorship responsibilities and the
need to pay a competitive remuneration to retain and attract qualified
individuals.
Outside directors are paid an annual retainer of $18,000, in addition
to $500 to attend each Board meeting and $100 to attend each committee meeting.
The committee chairperson retainer is $3,000. Mr. Elliott receives an additional
$25,000 annually as Chairman of the Board.
On June 7, 1996, shareholders approved the 1996 Stock-Based Incentive
Plan ("1996 Incentive Plan"), under which all directors who are not also
employees of Patriot are eligible to receive stock awards and options to
purchase common stock. Under the 1996 Incentive Plan, Messrs. Elliott and Thren
were each granted non-statutory options to purchase 37,313 shares of common
stock at an exercise price of $6.53 per share. On January 1, 1999, Mr. Bentley
was awarded a non-statutory option to purchase 11,000 shares of common stock at
an exercise price of $10.68 per share, and on November 27, 2000, he was awarded
a non-statutory option to purchase 20,729 shares of common stock at an exercise
price of $5.63 per share. On December 28, 2000, Mr. Kunkel was granted a
non-statutory option to purchase 11,000 shares of common stock at an exercise
price of $5.94 per share. On April 23, 2002, shareholders approved the 2002
Stock Option Plan, which provides that all non-employee directors are eligible
to receive stock options to purchase common stock. Under the 2002 Stock Option
Plan, Messrs. Bentley, Elliott, Kunkel and Thren were each granted non-statutory
options to purchase 11,000 shares of common stock at an exercise price of $12.82
per share. The exercise price of all options was equal to the fair market value
of common stock on the date of the grant. All options are exercisable in five
equal annual installments, commencing one year from the date of grant, except
that upon a change in control of Patriot, all options immediately vest. All
shares have been adjusted for subsequent stock splits and stock dividends.
80
ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table. The following table shows, for the years
ended December 31, 2003, 2002 and 2001, the cash compensation paid by Patriot,
as well as certain other compensation paid or accrued for those years, to the
President and Chief Executive Officer, the Executive Vice President and Chief
Lending Officer, the Executive Vice President and Chief Operating Officer and
Senior Vice President and Chief Financial Officer ("Named Executive Officers").
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION LONG TERM COMPENSATION
-------------------------------- -----------------------------------
AWARDS PAYOUTS
------------------------- --------
OTHER RESTRICTED SECURITIES
ANNUAL STOCK UNDERLYING LTIP ALL OTHER
SALARY BONUS COMPENSATION AWARDS OPTIONS/SARS PAYOUTS COMPENSATION
NAME AND PRINCIPAL POSITION(1) YEAR ($)(2) ($) ($)(3) ($)(4) (#)(5)(6) ($)(7) ($)(8)
- ------------------------------ ---- -------- -------- ------------ ---------- ------------- -------- ------------
Richard A. Elko 2003 $321,346 $140,000 -- -- -- -- $33,829
President, Chief Executive 2002 $253,885 $116,566 -- -- 56,481 -- $24,956
Officer and Director 2001 $233,269 $128,968 -- -- -- -- $15,893
Kevin R. Pyle 2003 $193,788 $ 61,513 -- -- -- -- $32,442
Executive Vice President 2002 $175,000 $ 52,247 -- -- 29,247 -- $23,395
and Chief Lending Officer 2001 $155,000 $ 60,397 -- -- 5,500 -- $17,621
Joni S. Naugle 2003 $193,788 $ 61,513 -- -- -- -- $28,905
Executive Vice President 2002 $175,000 $ 52,247 -- -- 31,716 -- $22,520
and Chief Operating Officer 2001 $175,000 $ 39,843 -- -- 5,500 -- $12,985
James G. Blume 2003 $156,346 $ 52,500 -- -- -- -- $28,361
Senior Vice President and 2002 $124,068 $ 39,392 -- $ 70,500 22,000 -- $17,969
Chief Financial Officer 2001 $102,654 $ 38,128 -- -- 11,000 -- $13,857
(1) Mr. Elko was appointed President and Chief Executive Officer of Patriot
and the Bank on November 3, 2000. Mr. Pyle was appointed Chief Lending
Officer of Patriot and the Bank in March 1996. Ms. Naugle was appointed
Chief Operating Officer of Patriot and the Bank in December 1998. Mr.
Blume was appointed Chief Financial Officer of Patriot and the Bank in
December 1999.
(2) Includes compensation deferred at the election of Messrs. Elko and
Pyle, Ms. Naugle and Mr. Blume through Patriot's 401(k) plan.
(3) There were no: (a) perquisites in excess of the lesser of $50,000 or
10% of the individual's total salary and bonus for the last year, (b)
payments of above-market preferential earnings on deferred
compensation, (c) payments of earnings with respect to long-term
incentive plans prior to settlement or maturation, (d) tax payment
reimbursements, or (e) preferential discounts on stock.
(4) In 2002, pursuant to the 1996 Incentive Plan, Mr. Blume was awarded
5,500 shares that had a market value of $70,500 on the date of grant
and a market value of $157,355 at December 31, 2003. Stock awarded
under the 1996 Incentive Plan vest in five equal annual installments on
each anniversary of the effective date of the stock award.
(5) Includes 56,481, 29,247, 31,716 and 550 shares subject to options
granted to Messrs. Elko, Pyle, Ms. Naugle and Mr. Blume, respectively,
under the 2002 Stock Option Plan in 2002; of those amounts 6,981 of Mr.
Elko's shares, 1,747 of Mr. Pyle's shares and 4,216 of Ms. Naugle's
shares were immediately exercisable upon their grant. Includes 21,450
shares subject to options granted to Mr. Blume under the 1996 Incentive
Plan in 2002. Includes 5,500, 5,500 and 11,000 shares subject to
options granted to Mr. Pyle, Ms. Naugle and Mr. Blume, respectively,
under the 1996 Incentive Plan in 2001. Except for those options
described above which vest immediately, all options granted under both
Plans are exercisable in five equal annual installments on each
anniversary of the effective date of the grant.
81
(6) Shares have been adjusted for subsequent stock dividends.
(7) For 2003, 2002 and 2001, Patriot had no long-term incentive plans in
existence. Accordingly, there were no payments or awards under any
long-term incentive plan.
(8) Includes 763, 750, 694, and 711 shares allocated to Messrs. Elko and
Pyle, Ms. Naugle and Mr. Blume, respectively, for 2003 pursuant to the
ESOP with a market value of $21,829, $21,458, $19,855 and $20,342,
respectively. Includes $12,000, $10,985, $9,050 and $8,019 in matching
and discretionary contributions by Patriot to Patriot's 401 (k) plan
during 2003 for Messrs. Elko and Pyle, Ms. Naugle and Mr. Blume,
respectively. Includes 998, 976, 877, and 760 shares allocated to
Messrs. Elko and Pyle, Ms. Naugle and Mr. Blume, respectively, for 2002
pursuant to the ESOP with a market value of $13,956, $13,649, $12,265
and $10,621, respectively. Includes $11,000, $9,746, $10,255 and $7,348
in matching and discretionary contributions by Patriot to Patriot's 401
(k) plan during 2002 for Messrs. Elko and Pyle, Ms. Naugle and Mr.
Blume, respectively. Includes 1,194, 1,155, 972 and 718 shares
allocated to Messrs. Elko and Pyle, Ms. Naugle and Mr. Blume,
respectively, for 2001 pursuant to the ESOP with a market value of
$11,566, $11,183, $9,415 and $6,954, respectively. Includes $4,327,
$6,438, $4,442 and $6,031 in matching and discretionary contributions
by Patriot to Patriot's 401(k) plan during 2001 for Messrs. Elko and
Pyle, Ms. Naugle and Mr. Blume, respectively. Shares have been adjusted
for subsequent stock dividends.
The following table provides certain information with respect to the
number of shares of Common Stock represented by outstanding options held by the
Named Executive Officers at December 31, 2003. Also reported are the values for
"in-the-money" options that represent the positive difference between the
exercise price of any such options and the closing sale price of the Common
Stock at December 31, 2003.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND
FISCAL YEAR END OPTION/SAR VALUES
NUMBER OF SECURITIES
SHARES UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
ACQUIRED VALUE OPTIONS/SARS IN-THE-MONEY OPTION/SARS
ON EXERCISE (#)(1) REALIZED ($) AT FISCAL YEAR END (#)(1)(2) AT FISCAL YEAR END ($)(3)
------------------- ------------ ---------------------------- --------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- --------------- ----------- ------------- ----------- -------------
RICHARD A. ELKO 109,570 $ 1,553,191 19,253 39,600 $ 318,918 $ 625,284
KEVIN R. PYLE 17,038 $ 211,378 -- 26,510 -- $ 444,285
JONI S. NAUGLE 22,916 $ 410,177 -- 25,300 -- $ 420,145
JAMES G. BLUME 8,975 $ 175,153 1,200 24,200 $ 18,948 $ 423,434
(1) Shares have been adjusted for subsequent stock splits and stock
dividends.
(2) The 111,941 options granted to Mr. Elko on June 7, 1996, have an
exercise price of $6.53 and became exercisable at an annual rate of 20%
beginning June 7, 1997. The 6,050 options granted to Mr. Pyle on June
7, 1999, have an exercise price of $8.66 and became exercisable at an
annual rate of 20% beginning June 7, 2000. The 5,500, 5,500 and 11,000
options granted to Mr. Pyle, Ms. Naugle and Mr. Blume, respectively, on
February 22, 2001, have an exercise price of $6.56 and became
exercisable at an annual rate of 20% beginning February 22, 2002. The
49,500, 27,500, 27,500 and 22,000 options granted to Messrs. Elko and
Pyle and Ms. Naugle and Mr. Blume, respectively, on May 15, 2002, have
an exercise price of $12.82 and became exercisable at an annual rate of
20% beginning May 15, 2003. The 6,982 options granted to Mr. Elko on
May 15, 2002, have an exercise price of $12.82 and were immediately
vested on May 15, 2002, the date of the grant.
(3) Based on market value of the Common Stock at year end, minus the
exercise price. The market price on December 31, 2003, was $28.61.
82
EMPLOYMENT AGREEMENTS
Patriot and the Bank have entered into separate employment agreements
with Mr. Elko. The employment agreements are intended to ensure that Patriot and
the Bank will be able to maintain a stable and competent management base. The
continued success of Patriot and the Bank depends to a significant degree on the
skills and competence of Mr. Elko.
The employment agreements provide for a three-year term for Mr. Elko.
The terms of Patriot's employment agreement shall be extended on a daily basis
unless written notice of nonrenewal is given by the Board of Patriot. The
employment agreements provide that Mr. Elko's base salary will be reviewed
annually. The current base salary for Mr. Elko is $312,000. In addition to the
base salary, the employment agreements provide for, among other things,
participation in stock benefits plans and other fringe benefits applicable to
executive personnel. The employment agreements provide for termination by
Patriot or the Bank for cause, as defined in the employment agreements, at any
time. In the event Patriot or the Bank chooses to terminate Mr. Elko's
employment for reasons other than for cause, or in the event of Mr. Elko's
resignation from Patriot and the Bank upon: (i) failure to re-elect Mr. Elko to
his current offices; (ii) a material change in Mr. Elko's functions, duties or
responsibilities; (iii) a relocation of Mr. Elko's principal place of employment
by more than 20 miles; (iv) a material reduction in the benefits and perquisites
provided to Mr. Elko; (v) liquidation or dissolution of Patriot or the Bank;
(vi) a breach of the agreement by Patriot or the Bank; (vii) the refusal of
Patriot or the Bank to extend the agreement as described above; or (viii) the
voluntary or involuntary termination following a change in control of Patriot or
the Bank, Mr. Elko or, in the event of death, his beneficiary, would be entitled
to receive an amount equal to the greater of: (a) the remaining payments due to
Mr. Elko, or (b) three times Mr. Elko's average annual compensation as defined
in the employment agreements. Patriot and the Bank also would continue and pay
for Mr. Elko's life, health and disability coverage for the remaining term of
the agreement.
Any payments under the employment agreements in the event of a change
in control may constitute some portion of an excess parachute payment under
Section 280G of the Internal Revenue Code (the "Code"), resulting in the
imposition of an excise tax on the recipient and denial of the deduction for
such excess amounts to Patriot and the Bank. Under the employment agreements
Patriot and the Bank have agreed to pay to Mr. Elko such additional amount, if
any, as is necessary, after the deduction of any applicable taxes, to pay any
such excise tax imposed on Mr. Elko.
Payments to Mr. Elko under the Bank's agreement will be guaranteed by
Patriot in the event that payments or benefits are not paid by the Bank.
Payments to Mr. Elko under Patriot's agreement would be made by Patriot. All
reasonable costs and legal fees paid or incurred by Mr. Elko pursuant to any
dispute or question of interpretation relating to the employment agreements
shall be paid by Patriot or the Bank, respectively, if Mr. Elko is successful
pursuant to a legal judgment, arbitration or settlement. The employment
agreements also provide that Patriot and the Bank shall indemnify Mr. Elko to
the fullest extent allowable under federal and Pennsylvania law.
In February 2001, the Bank entered into employment agreements with Mr.
Pyle, Ms. Naugle and Mr. Blume (individually, the "Executive") each having a
term of three years (individually, an "Employment Agreement"). The Employment
Agreement provides that, commencing on the first anniversary date and continuing
on each anniversary date thereafter, the disinterested members of the Board of
Directors of the Bank may extend the Employment Agreement for an additional year
so that the remaining term shall be three years, unless written notice of
nonrenewal is given by the Board of Directors after conducting a performance
evaluation of the Executive. The current base salaries for Mr. Pyle, Ms. Naugle
and Mr. Blume are $192,400, $192,400 and $156,000, respectively. In addition to
the base salary, the Employment Agreement provides for, among other things,
participation in stock benefit plans and other fringe benefits applicable to
executive personnel.
The Employment Agreements of Mr. Pyle, Ms. Naugle and Mr. Blume provide
for termination by the Bank for cause, as defined in the Employment Agreement,
at any time. In the event the Bank chooses to terminate the Executive's
full-time employment for reasons other than for cause, or in the event of the
Executive's resignation from the Bank upon: (i) failure to re-elect, appoint or
reappoint the Executive to office; (ii) material change in the Executive's
functions, duties or responsibilities which change would cause the Executive's
position to become one of lesser responsibility, importance or scope, unless
consented to by the Executive; (iii) a relocation of the Executive's principal
place of employment by more than 20 miles; (iv) a material reduction in the
benefits and perquisites provided to the Executive; (v) liquidation or
dissolution of Patriot or the Bank; (vi) a breach of the Employment Agreement by
the Bank; (vii) the refusal of the Bank to extend the term of the Employment
Agreement; or (viii) the voluntary or
83
involuntary termination of the Executive's employment following a change in
control of Patriot or the Bank, the Executive, or the Executive's beneficiary in
the event of the Executive's death, would be entitled to receive an amount equal
to the greater of: (a) the remaining payments due to the Executive, or (b) three
times the Executive's average annual compensation us defined in the Employment
Agreement. The Bank also would continue and pay for the Executive's life, health
and disability coverage for three years following the date of termination. Any
amounts payable under the Employment Agreement resulting from termination of
employment following a change in control would be reduced to the extent
necessary to avoid such payments constituting an excess parachute payment under
the Code.
COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION
This report of the Personnel Compensation/Benefits Committee (the
"Committee") and the stock performance graph shall not be deemed incorporated by
reference by any general statement incorporating by reference this proxy
statement into any filing under the Securities Act of 1933, as amended (the
"Securities Act") or the Exchange Act, except to the extent that Patriot
specifically incorporates this information by reference, and shall not otherwise
be deemed filed under such Acts.
Under rules established by the SEC, Patriot is required to provide
certain information regarding the compensation and benefits provided to
Patriot's CEO and other executive officers of Patriot. The disclosure
requirements for the CEO and other executive officers include the use of tables
and a report explaining the rationale and considerations that led to fundamental
compensation decisions affecting those individuals. In fulfillment of this
requirement, the Committee, at the direction of the Board of Directors, has
prepared the following report for inclusion in this proxy statement.
COMPENSATION POLICIES
The Committee has established a policy for executive compensation,
taking into account both subjective performance criteria and selected objective
performance measures. The purpose of the policy is to: (i) provide compensation
programs and opportunities which are competitive with other similar financial
services companies; (ii) support Patriot's goal setting and strategic planning
process; (iii) motivate the executive management of Patriot to achieve profit
and other key goals of the institution, including but not limited to Patriot's
commitment to the communities it serves and to its employees, customers and
investors; (iv) motivate the executive management to operate Patriot in a safe
and sound manner and in compliance with all pertinent governmental and
regulatory requirements; and (v) minimize potential overhead by designating a
significant portion of the annual compensation of executives as variable and
performance oriented rather than fixed.
In determining an Executive Compensation Plan for 2003, the Committee
of Patriot established certain objectives for executive management which
included the creation and execution of a strategic business plan, attaining
certain financial goals based on net income, earnings per share, return on
equity, return on assets, strengthening senior management, reaching certain
volume goals for loans and core deposits, achieving certain asset quality
targets, achieving certain customer satisfaction criteria, initiating several
business objectives and maintaining positive relationships with external
constituents.
Additionally, Patriot utilized a number of subjective elements as part
of the decision making process regarding executive compensation. The individual
skills and talents of the executive managers of Patriot, including but not
limited to, experience, leadership ability, planning and organizational skills,
administrative talent, vision for the future and work ethic were given
consideration in establishing executive compensation.
The Committee set Mr. Elko's 2004 base salary at $312,000 and
established specific Company financial performance objectives and individual
performance objectives under the 2004 Annual Bonus Plan for Mr. Elko. Mr. Elko's
total base compensation target for 2004 will be at 100% of the total
compensation peer marketplace for 2003 for the CEO position within the newly
designed peer group. This peer group is not necessarily comprised of the same
institutions used in the peer group for the stock performance graph.
THE PERSONNEL COMPENSATION/BENEFITS COMMITTEE
Larry V. Thren, Chairman
James A. Bentley, Jr.
James B. Elliott
84
Stock Performance Graph. The following graph shows a comparison of
total shareholder return on the Common Stock, based on the market price of the
Common Stock, with the cumulative total return of companies on The Nasdaq Stock
Market (U.S.) Index and The Nasdaq Banking Index for the period beginning on
January 1, 1999, through December 31, 2003.
COMPARISON OF CUMULATIVE TOTAL RETURNS FOR PATRIOT BANK CORP. COMMON STOCK,
THE NASDAQ STOCK MARKET (U.S.) INDEX AND THE NASDAQ BANKING INDEX.
[LINE GRAPHIC]
Company/Index/Market 12/31/98 12/31/99 12/31/00 12/31/01 12/31/02 12/31/03
- -------------------- -------- -------- -------- -------- -------- --------
Patriot Bank Corp. Common Stock $100.00 $ 94.26 $ 62.36 $101.81 $150.85 $314.22
The Nasdaq Stock Market (U.S.) Index
(Broad Market) $100.00 $185.95 $113.19 $ 89.64 $ 61.67 $ 92.90
The Nasdaq Banking Index
(Industry Index) $100.00 $ 94.28 $110.50 $124.34 $133.01 $176.36
Notes:
A. The lines represent annual index levels derived from compounded daily
returns that include all dividends.
B. The indexes are reweighed daily, using the market capitalization on
the previous trading day.
C. If the year-end is not a trading day, the proceding trading day is
used.
D. The index level for all the series was set to $100.00 on December 31,
1998.
85
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information regarding management and
those persons believed by management to be beneficial owners of more than 5% of
the Common Stock on December 31, 2003, or as disclosed in reports regarding
ownership filed by persons with Patriot and with the SEC, in accordance with
Sections 13(d) and 13(g) of the Exchange Act. Other than those persons listed
below, Patriot is not aware of any person, as such term is defined in the
Exchange Act, that owns more than 5% of the Common Stock as of December 31,
2003.
NAME AND ADDRESS OF AMOUNT AND NATURE OF PERCENT
TITLE OF CLASS BENEFICIAL OWNER BENEFICIAL OWNERSHIP OF CLASS
- ---------------------- ----------------------------- --------------------- ---------
Common Stock Patriot Bank Employee Stock 597,000 (1) 9.0%
Ownership Plan ("ESOP")
High & Hanover Streets
Pottstown, PA 19464
Common Stock Jeffrey L. Gendell 55 366,430 5.5%
Railroad Avenue, 3rd Floor
Greenwich, CT 06830
Common Stock James A. Bentley, 60,987 (2)(3)(4) *
Jr. Director
Common Stock Richard A. Elko 180,887 (2)(4) 2.7%
Director, President and
Chief Executive Officer
Common Stock James B. Elliott 76,312 (2)(4) 1.2%
Chairman of the Board
Common Stock Russell J. Kunkel 14,300 (2)(4) *
Director
Common Stock Larry V. Thren 103,933 (2)(4) 1.6%
Director
Common Stock James G. Blume Senior 22,799 (2)(3)(4) *
Vice President and Chief
Financial Officer
Common Stock Joni S. Naugle Executive 19,724 (2)(4) *
Vice President and Chief
Operating Officer
Common Stock Kevin R. Pyle Executive 57,331 (2)(3)(4) *
Vice President and Chief
Lending Officer
* Represents less than one percent of the outstanding Common Stock.
(1) Shares of Common Stock were acquired by the ESOP in the 1995 conversion
of Patriot Savings Bank (a predecessor of the Bank) from mutual to
stock form. The Personnel Compensation/Benefits Committee of the Board
of Directors administers the ESOP. Investors Trust Company is the
corporate trustee for the ESOP ("ESOP Trustee"). The ESOP Trustee,
subject to its fiduciary duty, must vote all allocated shares held in
the ESOP in accordance with the instructions of the participants. At
December 31, 2003, 286,000 shares had been allocated under the ESOP and
311,000 shares remain unallocated. Unallocated shares will be voted by
the ESOP Trustee in a manner calculated to most accurately reflect the
instructions received from participants regarding the allocated stock
so long as such vote is in accordance with the provisions of the
Employee Retirement Income Security Act of 1974, as amended ("ERISA").
86
(2) Each person effectively exercises sole (or shares with his/her spouse
or other immediate family member) voting or dispositive power as to
shares reported herein (except as noted).
(3) Includes 2,216, 4,400 and 387 shares awarded to Messrs. Bentley, Blume
and Pyle, respectively, under the 1996 Incentive Plan. Stock awards
granted under the 1996 Incentive Plan vest in five equal annual
installments. However, recipients have the right to direct the voting
of all awarded shares.
(4) Includes 25,637, 19,253, 11,200, 4,400 and 39,513 shares subject to
options granted to directors Bentley, Elko, Elliott, Kunkel and Thren,
respectively, that are exercisable within 60 days. Includes 3,400,
1,100 and 1,100 shares subject to options granted to officers Blume,
Naugle and Pyle, respectively, that are exercisable within 60 days.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Patriot's current policy provides that all loans made by Patriot to its
directors and officers are made in the ordinary course of business on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with other persons and do not
involve more than the normal risk of collectibility or present other unfavorable
features. All loans made to directors and officers comply with this policy.
ITEM 14. INDEPENDENT ACCOUNTANT FEES AND SERVICES
The following table sets forth the aggregate fees payable by Patriot
for the fiscal years ended December 31, 2003 and December 31, 2002 to Patriot's
independent accounting firm KPMG LLP.
DECEMBER 31, 2003 DECEMBER 31, 2002
----------------- -----------------
Audit Fees ............................... $187,922 $160,847
Audit-Related Fees ....................... 9,873 --
Tax Fees ................................. 47,400 45,475
All Other Fees ........................... -- --
-------- --------
$245,195 $206,322
======== ========
Audit fees include fees for services that are customary under auditing
standards generally accepted in the United States of America or that are
customary for the purposes of rendering an opinion or review report on the
registrant's financial statements. This also includes services that generally
only an independent accountant reasonably can provide, such as comfort letters,
statutory audit and attest services (including reports on an issuer's internal
controls and procedures for financial reporting required under FDICIA and
Section 404), consents and assistance with and review of documents filed with
the Securities and Exchange Commission.
Audit-related fees are assurance and related services that
traditionally are performed by the independent accountant. More specifically,
these services included, among others: due diligence related to mergers and
acquisitions and accounting consultations in connection with acquisitions.
Tax fees consist of all tax services that do not relate to "audit
assist work." This includes tax compliance, tax advice and tax planning.
All other fees are any other fees for services not covered in previous
categories.
The Audit Committee considered whether the provision of nonaudit
services by Patriot's principal auditors during 2003 was compatible with
maintaining auditor independence.
The Audit Committee began considering whether the non-audit services
proposed to be performed by KPMG LLP in advance of such performance for
compatibility with their independence beginning in September 2002.
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AUDIT COMMITTEE PRE-APPROVAL OF AUDIT AND PERMISSIBLE NON-AUDIT SERVICES BY
INDEPENDENT AUDITORS
The Audit Committee pre-approves all audit and non-prohibited,
non-audit services provided by the independent auditors. These services may
include audit services, audit-related services, tax services and other services.
The Audit Committee has adopted a policy for the pre-approval of services
provided by the independent auditors. Under the policy, pre-approval is
generally provided for up to one year and any pre-approval is detailed as to the
particular service or category of services and is subject to a specific budget.
In addition, the Audit Committee may also pre-approve particular services on a
case-by-case basis. For each proposed service, the independent auditor is
required to provide detailed back-up documentation at the time of approval or
such other detailed information as the Audit Committee deems appropriate. The
Audit and Finance Committee may delegate pre-approval authority to one or more
of its members. Such a member must report any decisions to the Audit Committee
at the next scheduled meeting. There were no waivers by the Audit Committee of
the pre-approval requirement for permissible non-audit services in 2003.
AUDIT COMMITTEE REPORT AND RELATED MATTERS
Pursuant to rules adopted by the SEC designed to improve disclosures
related to the functioning of corporate audit committees and to enhance the
reliability and credibility of financial statements of public companies, the
Audit Committee of Patriot's Board of Directors submits the following report:
AUDIT COMMITTEE REPORT TO SHAREHOLDERS
The Audit Committee of the Board of Directors is responsible for
providing independent, objective oversight of Patriot's accounting functions and
internal controls. The Audit Committee is composed of directors Bentley,
Elliott, Kunkel and Thren, each of whom is independent. The Audit Committee
operates under a written charter approved by the Board of Directors. Revisions
to the charter were adopted in December 2002 to strengthen the role of the
Committee and assure compliance with the Sarbanes-Oxley Act of 2002.
Management is responsible for Patriot's internal controls and financial
reporting process. The independent accountants are responsible for performing an
independent audit of Patriot's consolidated financial statements in accordance
with generally accepted auditing standards and to issue a report thereon. The
Audit Committee's responsibility is to monitor and oversee these processes.
In connection with these responsibilities, the Audit Committee met with
management and the independent accountants to review and discuss the December
31, 2003, financial statements. The Audit Committee also discussed with the
independent accountants the matters required by Statement on Auditing Standards
No. 61 (Communication with Audit Committees). The Audit Committee also received
written disclosures from the independent accountants required by Independence
Standards Board Standard No. 1 (Independence Discussions with Audit Committees),
and the Audit Committee discussed with the independent accountants that firm's
independence.
Based upon the Audit Committee's discussions with management and the
independent accountants, and the Audit Committee's review of the representations
of management and the independent accountants, the Audit Committee recommended
that the Board of Directors include the audited consolidated financial
statements in Patriot's Annual Report on Form 10-K for the year ended December
31, 2003, to be filed with the SEC.
THE AUDIT COMMITTEE
Russell J. Kunkel, Chairman
James A. Bentley, Jr.
James B. Elliott
Larry V. Thren
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PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. FINANCIAL STATEMENTS.
Consolidated financial statements are omitted because the required
information is either not applicable, not required or is shown in the
respective financial statements or in the notes thereto.
2. FINANCIAL STATEMENT SCHEDULES.
Financial statement schedules are omitted because the required
information is either not applicable, not required or is shown in the
respective financial statements or in the notes thereto.
3. EXHIBITS.
(a)THE FOLLOWING EXHIBITS ARE FILED AS PART OF THIS REPORT.
3.1 Certificate of Incorporation of the Patriot Bank Corp.
(Incorporated by reference to Exhibit 3.1 to Patriot Bank
Corp.'s Registration Statement No. 333-650-45 on Form S-4.)
3.2 Bylaws of the Patriot Bank Corp. (Incorporated by reference to
Exhibit 3.2 to Patriot Bank Corp.'s Registration Statement No.
333-650-45 on Form S-4.)
10.1 Employment Agreement between Patriot Bank Corp. and Richard A.
Elko dated February 22, 2001, (Incorporated by reference to
Patriot Bank Corp.'s 2000 10-K filed March 29, 2001.) ***
10.2 Employment Agreement between Kevin R. Pyle and Patriot Bank
dated February 22, 2001, (Incorporated by reference to Patriot
Bank Corp.'s 2000 10-K filed March 29, 2001.) ***
10.3 Employment Agreement between Richard A. Elko and Patriot Bank
dated February 22, 2001, (Incorporated by reference to Patriot
Bank Corp.'s 2000 10-K filed March 29, 2001.) ***
10.4 Employment Agreement between Joni S. Naugle and Patriot Bank
dated February 22, 2001, (Incorporated by reference to Patriot
Bank Corp.'s 2000 10-K filed March 29, 2001.) ***
10.5 Employment Agreement between James G. Blume and Patriot Bank
dated February 22, 2001, (Incorporated by reference to Patriot
Bank Corp.'s 2000 10-K filed March 29, 2001.) ***
10.6 The Patriot Bank Corp. 1996 Stock Incentive Plan.
(Incorporated by reference to Patriot Bank Corp.'s Proxy
Statement for the 1996 Annual Meeting of Shareholders filed
April 26, 1996).***
10.7 The Patriot Bank Corp. 2002 Stock-Based Option Plan.
(Incorporated by reference to Patriot Bank Corp.'s Proxy
Statement for the 2002 Annual Meeting of Shareholders filed
April 26, 2002).***
21.0 Subsidiaries.
23.0 Consent of KPMG LLP
31.1 Rule 13(a)- 14(a) CEO Certification
31.2 Rule 13(a)- 14(a) CFO Certification
32.1 Section 1350 CEO Certification
32.2 Section 1350 CFO Certification
- -----------------------
*** Denotes a management contract or a compensatory plan or arrangement.
89
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(CONTINUED)
(b) REPORTS ON FORM 8-K.
On April 1, 2003, the registrant filed a Form 8-K reporting
the declaration of a 10% stock dividend.
-- On April 16, 2003, the registrant filed a Form 8-K announcing
earnings for the first quarter of 2003.
-- On April 24, 2003, the registrant filed a Form 8-K reporting
the declaration of a cash dividend of 12 cents per share.
-- On July 22, 2003, the registrant filed a Form 8-K announcing
earnings for the second quarter of 2003.
-- On July 25, 2003, the registrant filed a Form 8-K reporting
the declaration of a cash dividend of 13 cents per share.
-- On September 5, 2003, the registrant filed a Form 8-K
reporting the acquisition of Tyler Wealth Counselors, Inc.
-- On October 21,2003, the registrant filed a Form 8-K announcing
earnings for the third quarter of 2003.
-- On October 24, 2003, the registrant filed a Form 8-K reporting
the declaration of a cash dividend of 13.5 cents per share.
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SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
PATRIOT BANK CORP.
Dated: March 15, 2004 By /s/ RICHARD A. ELKO
-------------------
Richard A. Elko
President and Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed by the following persons in the capacities and
on the dates indicated.
NAME TITLE DATE
/s/ JAMES B. ELLIOTT Chairman of the Board March 15, 2004
- ------------------------------------
James B. Elliott
/s/RICHARD A. ELKO President and Chief March 15, 2004
- ------------------------------------
Richard A. Elko Executive Officer and Director
/s/ LARRY V. THREN Director March 15, 2004
- ------------------------------------
Larry V. Thren
/s/ JAMES A. BENTLEY, JR. Director March 15,2004
- ------------------------------------
James A. Bentley, Jr.
/s/ RUSSELL J. KUNKEL Director March 15, 2004
- ------------------------------------
Russell J. Kunkel
/s/ JAMES G. BLUME Chief Financial Officer March 15, 2004
- ------------------------------------
James G. Blume
91