Edgar Filing: PATRIOT NATIONAL BANCORP INC

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

10-K

U. S.

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10 – K

x	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2013

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 000-29599

PATRIOT NATIONAL BANCORP, INC.

(Exact name of registrant as specified in its charter)


Connecticut		06-1559137
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification Number)

900 Bedford Street Stamford, Connecticut		06901
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (203) 324-7500

Securities registered under Section 12(b) of the Exchange Act: None

Securities registered under Section 12(g) of the Exchange Act: Common Stock, par value $0.01 per share

Indicate by check mark if the registrant in a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933. Yes ¨ No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 of 15(d) of the Securities Exchange Act of 1934. Yes ¨ No x

Check whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 ¨

Check if disclosure of delinquent filers in response to Item 405 of Regulation S-K is not contained in this form, and no disclosure will be contained, to the best of 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Check whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer in Rule 12(b) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12B-2 of the Act). Yes ¨ No x

Aggregate market value of the voting stock held by non-affiliates of the registrant as of June 30, 2013 based on the last sale price as reported on the NASDAQ Global Market: $5,934,992.

Number of shares of the registrant’s Common Stock, par value $0.01 per share, outstanding as of February 28, 2014: 38,774,975.

Documents Incorporated by Reference

Proxy Statement for 2014 Annual Meeting of Shareholders. (A definitive proxy statement will be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year covered by this Form 10-K.)

Incorporated into Part III of this Form 10-K.

Patriot National Bancorp, Inc.

2013 Form 10-K Annual Report

TABLE OF CONTENTS


Part I

Item 1.	Business	2
Item 1A.	Risk Factors	12
Item 1B.	Unresolved Staff Comments	22
Item 2.	Properties	22
Item 3.	Legal Proceedings	22

Part II

Item 5.	Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities	23
Item 6.	Selected Financial Data	26
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operation	27
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	54
Item 8.	Financial Statements and Supplementary Data	57
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	59
Item 9A.	Controls and Procedures	59
Item 9B.	Other Information	60

Part III

Item 10.	Directors, Executive Officers and Corporate Governance	61
Item 11.	Executive Compensation	61
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters	61
Item 13.	Certain Relationships and Related Transactions, and Director Independence	61
Item 14.	Principal Accountant Fees and Services	61

Part IV

Item 15.	Exhibits and Financial Statement Schedules	62

“Safe Harbor” Statement Under Private Securities Litigation Reform Act of 1995

Certain statements contained in Bancorp’s public reports, including this report, and in particular in “Management’s Discussion and Analysis of Financial Condition and Results of Operation,” may be forward looking and subject to a variety of risks and uncertainties. These factors include, but are not limited to, (1) changes in prevailing interest rates which would affect the interest earned on Bancorp’s interest earning assets and the interest paid on its interest bearing liabilities, (2) the timing of repricing of Bancorp’s interest earning assets and interest bearing liabilities, (3) the effect of changes in governmental monetary policy, (4) the effect of changes in regulations applicable to Bancorp and the Bank and the conduct of its business, (5) changes in competition among financial service companies, including possible further encroachment of non-banks on services traditionally provided by banks, (6) the ability of competitors that are larger than Bancorp to provide products and services which it is impracticable for Bancorp to provide, (7) the state of the economy and real estate values in Bancorp’s market areas, and the consequent affect on the quality of Bancorp’s loans, (8) recent governmental initiatives are expected to have a profound effect on the financial services industry and could dramatically change the competitive environment of the Company; (9) other legislative or regulatory changes, including those related to residential mortgages, changes in accounting standards, and Federal Deposit Insurance Corporation (“FDIC”) premiums may adversely affect the Company; (10) the state of the economy in the greater New York metropolitan area and its particular effect on the Company’s customers, vendors and communities and other such factors, including risk factors, as may be described in Bancorp’s other filings with the SEC.

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

PART I

Item 1.

Business

General

Patriot National Bancorp, Inc. (“Bancorp or Company”), a Connecticut corporation, is a one-bank holding company for Patriot National Bank, a national banking association headquartered in Stamford, Fairfield County, Connecticut (the “Bank”).

The Bank received its charter and commenced operations as a national bank on August 31, 1994. The Bank currently has eight branch offices in Connecticut. The Bank also expanded into New York State on November 17, 2006 through the purchase of a small branch office and related deposits in New York City and the subsequent opening of branch offices in Bedford and Scarsdale, both located in Westchester County, New York. In June 2012, the Bank closed the New York City branch.

On March 11, 2003, Bancorp formed Patriot National Statutory Trust I (the “Trust”) for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures issued by Bancorp. Bancorp primarily invested the funds from the issuance of the debt in the Bank. The Bank in turn used the proceeds to fund general operations.

On April 1, 2008, the Bank acquired a 20% interest in a de novo insurance agency. The impact on the Bank’s operations in 2011, 2012 and 2013 has been minimal. During the fourth quarter of 2013, the Bank sold its interest in the de novo insurance agency.

On October 15, 2010, pursuant to a Securities Purchase Agreement (the “Securities Purchase Agreement”), the Company issued and sold to PNBK Holdings LLC (“Holdings”), an investment limited liability company controlled by Michael Carrazza, 33,600,000 shares of its common stock at a purchase price of $1.50 per share for an aggregate purchase price of $50,400,000. The shares sold to Holdings represented 87.6% of the Company’s then issued and outstanding common stock. The par value of the common stock was changed to $0.01 per share. Also in connection with that sale, certain directors and officers of both the Company and the Bank resigned and were replaced with nominees of Holdings and Michael Carrazza became Chairman of the Board of the Company.

As of the date hereof, the only business of Bancorp is its ownership of all of the issued and outstanding capital stock of the Bank and the Trust. Except as specifically noted otherwise herein, the balance of the description of Bancorp’s business is a description of the Bank’s business.

On February 26, 2013, the Company announced the appointment of Kenneth T. Neilson as President and Chief Executive Officer of both the Company and the Bank effective March 18, 2013. This is following the departure of Christopher Maher, who resigned as President, CEO and director for personal reasons. Mr. Neilson has served as a director of Patriot since 2010. He is the retired President, Chairman and CEO of Hudson United Bank and Hudson United Bancorp where he served for 23 years.

Commercial Banking

The Bank conducts business at its main office located at 900 Bedford Street in Stamford, Connecticut and at other Connecticut branch offices located in Darien, Fairfield, Greenwich, Milford, Norwalk, Trumbull, and Westport. In New York State, the Bank conducts business at branch offices located in Bedford and Scarsdale. The Bank also operates a loan origination office at 1177 Summer Street in Stamford, Connecticut.

The Bank offers a broad range of consumer and commercial banking services with an emphasis on serving the needs of individuals, small and medium-sized businesses and professionals. The Bank offers consumer and commercial deposit accounts that include: checking accounts, interest-bearing “NOW” accounts, insured money market accounts, time certificates of deposit, savings accounts, IRAs (Individual Retirement Accounts) and HSAs (Health Savings Accounts). Other services include internet banking, bill paying, remote deposit capture, debit cards, money orders, traveler’s checks and ATMs. The Bank is a member of CDARS (Certificates of Deposit Account Registry Service) whereby customers can obtain complete FDIC insurance coverage by placing large deposits into smaller-denomination CDs in multiple institutions. The single bank FDIC limits have been permanently increased to $250,000 per eligible account. In addition, the Bank may in the future offer other financial services.

The Bank offers commercial loans to small and medium-sized businesses including secured and unsecured loans to service companies, manufacturers, restaurants, wholesalers, retailers and professionals doing business in the region. Other personal loans include lines of credit, installment loans, overdraft protection and credit cards. Real estate loans made to individuals include home mortgages, home improvement loans, bridge loans and home equity loans and lines of credit. Other loans offered include commercial real estate loans to area businesses. The Bank acts as a mortgage broker to satisfy the needs of its customers.

Competition

The Bank competes with a variety of financial institutions in its market area. Many have greater financial resources and capitalization, which gives them higher legal lending limits as well as the ability to conduct larger advertising campaigns to attract business. Generally, the larger institutions offer additional services such as trust and international banking which the Bank is not equipped to offer directly. When the need arises, arrangements are made with correspondent institutions to provide such services. In the future, if the Bank desires to offer trust services, prior approval of the OCC will be required. To attract business in this competitive environment, the Bank relies on local promotional activities and personal contact by officers, directors and shareholders and on its ability to distinguish itself by offering personalized services.

The customer base of the Bank generally is meant to be diversified so that there is not a concentration of either loans or deposits within a single industry, a group of industries, a single person or groups of people. The Bank is not dependent on one or a few major customers for either its deposit or lending activities, the loss of any one of which would have a material adverse effect on the business of the Bank.

Residents and businesses in Stamford, Greenwich, Norwalk, Darien, Fairfield, Trumbull, Westport, and Milford Connecticut provide the majority of the Bank’s deposits. The Bank has expanded its footprint by establishing branch offices in the Westchester County, New York towns of Bedford and Scarsdale. The Bank has focused its attention on serving the segments of its market area historically served by community banks. The Bank competes in its market by providing a high level of personalized and responsive banking service for which the Bank believes there is a need.

The Bank’s loan customers extend beyond the towns and cities in which the Bank has branch offices, including nearby towns in Fairfield and New Haven Counties in Connecticut, and Westchester County and New York City in New York, although the Bank’s loan business is not necessarily limited to these areas. The Bank’s plans for future lending contemplate the diversification of the portfolio away from its historical emphasis on construction lending. While the Bank does not currently hold or intend to attract significant deposit or loan business from major corporations with headquarters in its market area, the Bank believes that the service industries, professionals and related businesses which have been attracted to this area, as well as the individuals that reside in this area, represent current and potential customers of the Bank.

In the normal course of business and subject to applicable government regulations, the Bank invests a portion of its assets in investment securities, which may include certain debt and equity securities, including government securities. An objective of the Bank’s investment policy is to maintain a balance of high quality diversified investments to minimize risk while limiting its exposure to interest rate movements and credit risk, as well as maintaining adequate levels of liquidity. The Bank’s investment portfolio is currently comprised primarily of government agency issues.

The Bank’s employees perform most routine day-to-day banking transactions at the Bank. The Bank has entered into a number of arrangements with third parties for banking services such as correspondent banking, check clearing, data processing services, credit card processing and armored car carrier service.

The cities of Stamford and Norwalk and the towns of Greenwich, Darien, Milford, Fairfield, Trumbull, and Westport, CT are presently served by over 229 branches of commercial and savings banks along with approximately 27 in the New York towns of Bedford and Scarsdale. Most of these branches are offices of banks, which have headquarters outside of the states or areas served by the Bank or are subsidiaries of bank or financial holding companies whose headquarters are outside of the areas served by the Bank. In addition to banks with branches in the same areas as the Bank, there are numerous banks and financial institutions serving the communities surrounding these areas, which also draw customers from the cities and towns mentioned above and pose competition to the Bank for deposits and loans. Many of those banks and financial institutions are well established and well capitalized.

In recent years, intense market demands, economic pressures and significant legislative and regulatory actions have eroded banking industry classifications which were once clearly defined and have increased competition among banks, as well as other financial institutions including non-bank competitors. This increase in competition has caused banks and other financial service institutions to diversify their services and become more cost effective. The impact on Bancorp of federal legislation authorizing increased services by financial holding companies and interstate branching of banks has also resulted in increased competition. These events have resulted in increasing homogeneity in the financial services offered by banks and other financial institutions. The impact on banks and other financial institutions of these market dynamics and legislative and regulatory changes has been increased customer awareness of product and service differences among competitors and increased merger activity.

Supervision and Regulation

As a bank holding company, Bancorp’s operations are subject to regulation, supervision and examination by the Board of Governors of the Federal Reserve Board (the “Federal Reserve Board”). The Federal Reserve Board has established capital adequacy guidelines for bank holding companies that are similar to the OCC’s capital guidelines applicable to the Bank. The Bank Holding Company Act of 1956, as amended (the “BHC Act”), limits the types of companies that a bank holding company may acquire or organize and the activities in which it or they may engage. In general, bank holding companies and their subsidiaries are only permitted to engage in, or acquire direct control of, any company engaged in banking or in a business so closely related to banking as to be a proper incident thereto. Federal legislation enacted in 1999 authorizes certain entities to register as financial holding companies. Registered financial holding companies are permitted to engage in businesses, including securities and investment banking businesses, which are prohibited to bank holding companies. The creation of financial holding companies to date has had no significant impact on Bancorp.

Under the BHC Act, Bancorp is required to file quarterly with the Federal Reserve Board a report of its operations. Bancorp, the Bank and any other subsidiaries are subject to examination by the Federal Reserve Board. In addition, Bancorp will be required to obtain the prior approval of the Federal Reserve Board to acquire, with certain exceptions, more than 5% of the outstanding voting stock of any bank or bank holding company, to acquire all or substantially all of the assets of a bank or to merge or consolidate with another bank holding company. Moreover, Bancorp, the Bank and any other subsidiaries are prohibited from engaging in certain tying arrangements in connection with any extension of credit or provision of any property or services. The Bank is also subject to certain restrictions imposed by the Federal Reserve Act on issuing any extension of credit to Bancorp or any of its subsidiaries or making any investments in the stock or other securities thereof and on the taking of such stock or securities as collateral for loans to any borrower. If Bancorp wants to engage in businesses permitted to financial holding companies but not to bank holding companies, it would need to register with the Federal Reserve Board as a financial holding company.

The Federal Reserve Board has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses its view that a bank holding company should pay cash dividends only to the extent that the bank holding company’s net income for the past year is sufficient to cover both the cash dividend and a rate of earnings retention that is consistent with the bank holding company’s capital needs, asset quality and overall financial condition. The Federal Reserve Board has also indicated that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. Furthermore, under the prompt corrective action regulations adopted by the Federal Reserve Board, the Federal Reserve Board may prohibit a bank holding company from paying any dividends if its bank subsidiary is classified as “undercapitalized.”

A bank holding company is required to give the Federal Reserve Board prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of its consolidated retained earnings. The Federal Reserve Board may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, Federal Reserve Board order, or any condition imposed by, or written agreement with, the Federal Reserve Board.

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (“Riegle-Neal Act”), was enacted to ease restrictions on interstate banking. Effective September 29, 1995, the Riegle-Neal Act allows the Federal Reserve Board to approve an application of an adequately capitalized and adequately managed bank holding company to acquire control of, or acquire all or substantially all of the assets of, a bank located in a state other than such holding company’s state, without regard to whether the transaction is prohibited by the laws of any state. The Federal Reserve Board may not approve the acquisition of a bank that has not been in existence for the minimum time period (not exceeding five years) specified by the statutory law of the host state. The Riegle-Neal Act also prohibits the Federal Reserve Board from approving an application if the applicant (and its depository institution affiliates) controls or would control more than 10% of the insured deposits in the United States or 30% or more of the deposits in the target bank’s home state or in any state in which the target bank maintains a branch. The Riegle-Neal Act does not affect the authority of states to limit the percentage of total insured deposits in the state which may be held or controlled by a bank or bank holding company to the extent that such limitation does not discriminate against out-of-state banks or bank holding companies. Individual states may also waive the 30% statewide concentration limits contained in the Riegle-Neal Act. The Riegle-Neal Act also allows banks to establish branch offices in other than the bank’s home state if the target state has “opted in” to interstate branching.

Bancorp is subject to capital adequacy rules and guidelines issued by the OCC, the Federal Reserve Board and the Federal Deposit Insurance Corporation (“FDIC”), and the Bank is subject to capital adequacy rules and guidelines issued by the OCC. These substantially identical rules and guidelines require Bancorp to maintain certain minimum ratios of capital to adjusted total assets and/or risk-weighted assets. Under the provisions of the Federal Deposit Insurance Corporation Improvements Act of 1991, the Federal regulatory agencies are required to implement and enforce these rules in a stringent manner. Bancorp is also subject to applicable provisions of Connecticut law insofar as they do not conflict with, or are not otherwise preempted by, Federal banking law.

Bancorp is subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and, in accordance with the Exchange Act, files periodic reports, proxy statements and other information with the Securities and Exchange Commission (the ”SEC”). The Bank’s operations are subject to regulation, supervision and examination by the OCC and the FDIC.

Federal and state banking regulations govern, among other things, the scope of the business of a bank, a bank holding company or a financial holding company, the investments a bank may make, deposit reserves a bank must maintain, the establishment of branches and the activities of a bank with respect to mergers and acquisitions. The Bank is a member of the Federal Reserve System and as such, is subject to applicable provisions of the Federal Reserve Act and regulations there-under. The Bank is subject to the federal regulations promulgated pursuant to the Financial Institutions Supervisory Act to prevent banks from engaging in unsafe and unsound practices, as well as various other federal and state laws and consumer protection laws. The Bank is also subject to the comprehensive provisions of the National Bank Act.

The OCC regulates the number and locations of the branch offices of a national bank. The OCC may only permit a national bank to maintain branches in locations and under the conditions imposed by state law upon state banks. At this time, applicable Connecticut banking laws do not impose any material restrictions on the establishment of branches by Connecticut banks throughout Connecticut. New York State law is similar; however, the Bank cannot establish a branch in a town with a population of less than 50,000 if another bank is headquartered in the town.

The earnings and growth of Bancorp, the Bank and the banking industry are affected by the monetary and fiscal policies of the United States Government and its agencies, particularly the Federal Reserve Board. The Open Market Committee of the Federal Reserve Board implements national monetary policy to curb inflation and combat recession. The Federal Reserve Board uses its power to adjust interest rates in United States Government securities, the Discount Rate and deposit reserve retention rates. The actions of the Federal Reserve Board influence the growth of bank loans, investments and deposits. They also affect interest rates charged on loans and paid on deposits. The nature and impact of any future changes in monetary policies cannot be predicted.

In addition to other laws and regulations, Bancorp and the Bank are subject to the Community Reinvestment Act (“CRA”), which requires the federal bank regulatory agencies, when considering certain applications involving Bancorp or the Bank, to consider Bancorp’s and the Bank’s record of helping to meet the credit needs of its entire community, including low- and moderate-income neighborhoods. The CRA was originally enacted because of concern over unfair treatment of prospective borrowers by banks and over unwarranted geographic differences in lending patterns. Existing banks have sought to comply with CRA in various ways; some banks have made use of more flexible lending criteria for certain types of loans and borrowers (consistent with the requirement to conduct safe and sound operations), while other banks have increased their efforts to make loans to help meet identified credit needs within the consumer community, such as those for home mortgages, home improvements and small business loans. Compliance may also include participation in various government insured lending programs, such as Federal Housing Administration insured or Veterans Administration guaranteed mortgage loans, Small Business Administration loans, and participation in other types of lending programs such as high loan-to-value ratio conventional mortgage loans with private mortgage insurance. To date, the market area from which the Bank draws much of its business is in the towns and cities in which the Bank has branch offices, which are characterized by a very diverse ethnic, economic and racial cross-section of the population. As the Bank expands further, the market areas served by the Bank will continue to evolve. Bancorp and the Bank have not and will not adopt any policies or practices, which discourage credit applications from, or unlawfully discriminate against, individuals or segments of the communities served by the Bank.

On October 26, 2001, the United and Strengthening America by Providing Tools Required to Intercept and Obstruct Terrorism Act of 2001, or the USA Patriot Act, was enacted to further strengthen domestic security following the September 11, 2001 attacks. This Act amends various federal banking laws, particularly the Bank Secrecy Act, with the intent to curtail money laundering and other activities that might be undertaken to finance terrorist actions. The Act also requires that financial institutions in the United States enhance already established anti-money laundering policies, procedures and audit functions and ensure that controls are reasonably designed to detect instances of money laundering through certain correspondent or private banking accounts. Verification of customer identification, maintenance of said verification records and cross checking names of new customers against government lists of known or suspected terrorists is also required. The Patriot Act was reauthorized and modified with the enactment of The USA Patriot Act Improvement and Reauthorization Act of 2005.

On July 20, 2002, the Sarbanes-Oxley Act of 2002 was enacted, the primary purpose of which is to protect investors through improved corporate governance and responsibilities of, and disclosures by, public companies. The Act contains provisions for the limitations of services that external auditors may provide as well as requirements for the credentials of Audit Committee members. In addition, the principal executive and principal financial officers are required to certify in quarterly and annual reports that they have reviewed the report; and based on the officers’ knowledge, the reports accurately present the financial condition and results of operations of the company and contain no untrue statement or omission of material fact. The officers also certify their responsibility for establishing and maintaining a system of internal controls, which insure that all material information is made known to the officers; this certification also includes the evaluation of the effectiveness of disclosure controls and procedures and their impact upon financial reporting. Section 404 of the Act, entitled Management Assessment of Internal Controls, requires that each annual report include an internal control report which states that it is the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting, as well as an assessment by management of the effectiveness of the internal control structure and procedures for financial reporting. This section further requires that the external auditors attest to, and report on, the Company’s internal controls over financial reporting. The Dodd-Frank Wall Street Reform and Consumer Protection Act enacted an exemption to the attestation and the reporting on the Company’s internal controls over financial reporting by the external auditors for non-accelerated filers, those with public float of less than $75 million.

Recent Legislative Developments

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Act”) was signed into law on July 21, 2010. The Act is a significant piece of legislation that has had a major impact on the financial services industry, including the organization, financial condition and operations of banks and bank holding companies. Management is currently evaluating the impact of the Act; however, uncertainty remains as to its operational impact, which could have a material adverse impact on the Company’s business, results of operations and financial condition. Many of the provisions of the Act are aimed at financial institutions that are significantly larger than the Company and the Bank. Notwithstanding this, there are many other provisions that the Company and the Bank are subject to and will have to comply with, including any new rules applicable to the Company and the Bank promulgated by the Bureau of Consumer Financial Protection, a new regulatory body dedicated to consumer protection. As rules and regulations are promulgated by the agencies responsible for implementing and enforcing the Act, the Company and the Bank will have to address each to ensure compliance with applicable provisions of the Act and compliance costs are expected to increase.

The Dodd-Frank Act broadens the base for Federal Deposit Insurance Corporation insurance assessments. Under rules issued by the FDIC in February 2011, the base for insurance assessments changed from domestic deposits to consolidated assets less tangible equity. Assessment rates are calculated using formulas that take into account the risks of the institution being assessed. The rule was effective beginning April 1, 2011. This did not have a material impact on the Company.

On June 28, 2011, the Federal Reserve Board approved a final debit-card interchange rule. This primarily impacts larger banks and should not have a material impact on the Company.

It is difficult to predict at this time what specific impact the Dodd-Frank Act and the yet to be written implementing rules and regulations will have on the Company. The financial reform legislation and any implementing rules that are ultimately issued could have adverse implications on the financial industry, the competitive environment, and our ability to conduct business. Management will have to apply resources to ensure compliance with all applicable provisions of the Dodd-Frank Act and any implementing rules, which may increase our costs of operations and adversely impact our earnings.

On July 2013, the FRB, the OCC and the FDIC approved final rules (the “New Capital Rules”) establishing a new comprehensive capital framework for U.S. Banking organizations. The New Capital Rules generally implement the Basel Committee on Banking Supervision’s (the “Basel Committee”) December 2010 final capital framework referred to as “Basel III” for strengthening international capital standards. The New Capital Rules substantially revise the risk-based capital requirements applicable to BHC’s and their depository institution subsidiaries, including the Company and the Bank, as compared to the current U.S. general risk-based capital rules. The New Capital Rules revise the definitions and the components of regulatory capital, as well as address other issues affecting the numerator in banking institutions’ regulatory capital ratios. The New Capital Rules also address asset risk weights and other matters affecting the denominator in banking institutions’ regulatory capital ratios and replace the existing general risk-weighting approach with a more risk-sensitive approach based, in part, on the “standardized approach” in the Basel Committee’s 2004 capital accords. In addition, the New Capital Rules implement certain provisions of the Dodd-Frank Act. The New Capital Rules are not yet effective for the Company. We are still in the process of assessing the impacts of these complex New Capital Rules.

Recent Agreement with Regulators

In February 2009 the Bank entered into a formal written agreement (the “Agreement”) with the Office of the Comptroller of the Currency. Under the terms of the Agreement, the Bank has appointed a Compliance Committee of outside directors and the Chief Executive Officer. The Committee must report quarterly to the Board of Directors and to the OCC on the Bank’s progress in complying with the Agreement. The Agreement requires the Bank to review, adopt and implement a number of policies and programs related to credit and operational issues. The Agreement further provides limitations on the acceptance of certain brokered deposits and the extension of credit to borrowers whose loans are criticized. The Bank may pay dividends during the term of the Agreement only with prior written permission from the OCC. The Agreement also requires that the Bank develop and implement a three-year capital plan. The Bank has taken or put into process all of the steps required by the Agreement, and does not anticipate that the restrictions included within the Agreement will impair its current business plan.

In June 2010 the company entered into a formal written agreement (the “Reserve Bank Agreement”) with the Federal Reserve Bank of New York (the “Reserve Bank”). Under the terms of the Reserve Bank Agreement, the Board of Directors of the Company are required to take appropriate steps to fully utilize the Company’s financial and managerial resources to serve as a source of strength to the Bank including taking steps to insure that the Bank complies with the Agreement with the OCC. The Reserve Bank Agreement requires the Company to submit, adopt and implement a capital plan that is acceptable to the Reserve Bank. The Company must also report to the Reserve Bank quarterly on the Company’s progress in complying with the Reserve Bank Agreement. The Agreement further provides for certain restrictions on the payment or receipt of dividends, distributions of interest or principal on subordinate debentures or trust preferred securities and the Company’s ability to incur debt or to purchase or redeem its stock without the prior written approval of the Reserve Bank. The Company has taken or put into process all of the steps required by the Reserve Bank Agreement, and does not anticipate that the restrictions included within the Reserve Bank Agreement will impair its current business plan.

Available Information

Our website address is http://www.pnbdirectonline.com; however, information found on, or that can be accessed through, our website is not incorporated by reference into this Form 10-K. Bancorp makes available free of charge on our website (under the links entitled “For Investors”, then “SEC filings” and then “Documents”), our annual report on Form 10-K, our quarterly reports on Form 10-Q, current reports on Form 8-K, information statements on Schedule 14C, and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934 as soon as practicable after we electronically file such reports with or furnish it to the SEC. Because Bancorp is an electronic filer, such reports are filed with the SEC and are also available on their website (http://www.sec.gov). The public may also read and copy any materials filed with the SEC at the SEC’s Public Reference Room, 100 F Street, NE, Washington, DC 20549. Information about the Public Reference Room can be obtained by calling 1-800-SEC-0330.

Employees

As of December 31, 2013, Bancorp had 89 full-time employees and 11 part-time employees. None of the employees of Bancorp are covered by a collective bargaining agreement.

Item 1A.

Risk Factors

The risks involved in Bancorp’s commercial real estate loan portfolio are material.

Bancorp’s commercial real estate loan portfolio constitutes a material portion of the Bank’s assets and generally has more risk than residential mortgage loans. Commercial real estate loans often involve larger loan balances concentrated with single borrowers or groups of related borrowers as compared to single-family residential loans.

Because the repayment of commercial real estate loans depends on the successful management and operation of the borrower’s properties or related businesses, repayments of such loans can be affected by adverse conditions in the real estate market or local economy as have been experienced in Bancorp’s market area. The downturn in the real estate market within Bancorp’s market area has, and may continue to, adversely impact the value of properties securing these loans.

Real estate lending in Bancorp’s core market involves risks related to a decline in value of commercial and residential real estate.

The market value of real estate can fluctuate significantly in a relatively short period of time as a result of market conditions in the geographic area in which the real estate is located. A significant portion of Bancorp’s total loan portfolio is secured by real estate located in Fairfield County, Connecticut and New York City and Westchester County, New York, areas historically of high affluence that have been materially impacted by the financial troubles experienced by large financial service companies on Wall Street and other companies in recent years. Credit markets have become tight and underwriting standards more stringent, and the inability of purchasers of real estate to obtain financing will continue to impact the real estate market. Therefore, these loans may be subject to changes in grade, classification, accrual status, foreclosure, or loss which could have an effect on the adequacy of the allowance for loan losses.

Bancorp’s business is subject to various lending and other economic risks that could adversely impact Bancorp’s results of operations and financial condition.

Changes in economic conditions, particularly a continued economic slowdown in Fairfield County, Connecticut and the New York metropolitan area, could hurt Bancorp’s financial performance. A further deterioration in economic conditions, in particular an economic slowdown within Fairfield County, Connecticut and/or the New York metropolitan area, could result in the following consequences, any of which may hurt the business of Bancorp materially: loan delinquencies may increase; problem assets and foreclosures may increase; demand for the Bank’s products and services may decline; and assets and collateral associated with the Bank’s loans, especially real estate, may decline in value, thereby reducing a customer’s borrowing power. During the years 2007 through 2009, the general economic conditions and specific business conditions in the United States, including Fairfield County, Connecticut and the New York metropolitan area, deteriorated, resulting in increases in loan delinquencies, problem assets and foreclosures and declines in the value and collateral associated with the Bank’s loans. During 2010 through 2013, the economic climate improved marginally resulting in decreases in the Bank’s non-performing assets. A prolonged period of economic recession or worsening of these economic conditions may have an adverse effect on our results of operations and financial condition.

Bancorp is Subject to a Formal Agreement with the OCC and the Federal Reserve Bank of New York.

The Bank is subject to a formal agreement with the OCC entered into in February 2009. The agreement provides for, among other things, the enhancement and implementation of certain programs to reduce the Bank’s credit risk, commercial real estate loan concentration and the level of criticized assets, along with the augmentation of a profit plan and three-year capital program. The Bank does not anticipate that the restrictions within the agreement will impair its current business plan. However, failure to comply with the provisions of the agreement could result in more severe enforcement actions and further restrictions.

In June 2010 the Company entered into a formal written agreement (the “Reserve Bank Agreement”) with the Federal Reserve Bank of New York (the “Reserve Bank”). Under the terms of the Reserve Bank Agreement, the Board of Directors of the Company are required to take appropriate steps to fully utilize the Company’s financial and managerial resources to serve as a source of strength to the Bank including taking steps to insure that the Bank complies with the agreement with the OCC. The Reserve Bank Agreement requires the Company to submit, adopt and implement a capital plan that is acceptable to the Reserve Bank. The Company must also report to the Reserve Bank quarterly on the Company’s progress in complying with the Reserve Bank Agreement. The Agreement further provides for certain restrictions on the payment or receipt of dividends, distributions of interest or principal on subordinate debentures or trust preferred securities and the Company’s ability to incur debt or to purchase or redeem its stock without the prior written approval of the Reserve Bank. The Company has taken or put into process all of the steps required by the Reserve Bank Agreement, and does not anticipate that the restrictions included within the Reserve Bank Agreement will impair its current business plan.

Bancorp’s allowance for loan losses may not be adequate to cover actual losses.

Like all financial institutions, the Bank maintains an allowance for loan losses to provide for loan defaults and non-performance. The allowance for loan losses is based on an evaluation of the risks associated with the Bank’s loans receivable as well as the Bank’s prior loss experience. Deterioration in general economic conditions and unforeseen risks affecting customers will have an adverse effect on borrowers’ capacity to repay timely their obligations before risk grades could reflect those changing conditions.

The previous adverse changes in economic and market conditions in the Bank’s market areas increase the risk that the allowance will become inadequate if borrowers continue to experience economic and other conditions adverse to their incomes and businesses. Maintaining the adequacy of the Bank’s allowance for loan losses may require that the Bank make significant and unanticipated increases in the provision for loan losses, which would materially affect the results of operations and capital adequacy. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates that may be beyond the Bank’s control and these losses may exceed current estimates. Although the current economic environment has improved, conditions remain uncertain which may result in additional risk of loan losses.

Federal regulatory agencies, as an integral part of their examination process, review the Bank’s loans and assess the adequacy of the allowance for loan losses. The regulatory agencies may require us to change classifications or grades on loans, increase the allowance for loan losses with additional provisions for loan losses and to recognize further loan charge-offs based upon their judgments, which may differ from ours. Any increase in the allowance for loan losses required by these regulatory agencies could have a negative effect on our results of operations and financial condition. While management believes that the allowance for loan losses is currently adequate to cover inherent losses, further loan deterioration could occur and therefore management cannot assure shareholders that there will not be a need to increase the allowance for loan losses or that the regulators will not require management to increase this allowance. Either of these occurrences could materially and adversely affect Bancorp’s earnings and profitability.

Bancorp is subject to certain risks with respect to liquidity.

“Liquidity” refers to our ability to generate sufficient cash flows to support our operations and to fulfill our obligations, including commitments to originate loans, to repay our wholesale borrowings and other liabilities, and to satisfy the withdrawal of deposits by our customers.

Our primary sources of liquidity are the deposits we acquire organically through our branch network, borrowed funds, primarily in the form of wholesale borrowings; the cash flows generated through the repayment of loans and securities; and the cash flows from the sale of loans and securities. In addition, and depending on current market conditions, we may have the ability to access the capital markets from time to time.

Deposit flows, calls of investment securities and wholesale borrowings, and prepayments of loans and mortgage-related securities are strongly influenced by such external factors as the direction of interest rates, whether actual or perceived; local and national economic conditions; and competition for deposits and loans in the markets we serve. Furthermore, changes to the underwriting guidelines for wholesale borrowings or lending policies may limit or restrict our ability to borrow, and could therefore have a significant adverse impact on our liquidity. A decline in available funding could adversely impact our ability to originate loans, invest in securities, and meet our expenses, or to fulfill such obligations as repaying our borrowings or meeting deposit withdrawal demands.

Bancorp’s business is subject to interest rate risk and variations in interest rates may negatively affect Bancorp’s financial performance.

Bancorp is unable to predict fluctuations of market interest rates, which are affected by many factors including: inflation, recession, a rise in unemployment, a tightening money supply, domestic and international disorder and instability in domestic and foreign financial markets. Changes in the interest rate environment may reduce Bancorp’s profits. Bancorp realizes income from the differential or “spread” between the interest earned on loans, securities and other interest-earning assets, and interest paid on deposits, borrowings and other interest-bearing liabilities. Net interest spreads are affected by the difference between the maturities and repricing characteristics of interest-earning assets and interest-bearing liabilities. In addition, an increase in the general level of interest rates may adversely affect the ability of some borrowers to pay the interest on and principal of their obligations. Like most financial institutions, Bancorp is affected by changes in interest rates, which are currently at record low levels, and by other economic factors beyond Bancorp’s control. Although Bancorp has implemented strategies which are designed to reduce the potential effects of changes in interest rates on operations, these strategies may not always be successful. Accordingly, changes in levels of market interest rates could materially and adversely affect Bancorp’s net interest spread, asset quality, levels of prepayments and cash flow as well as the market value of its securities portfolio and overall profitability.

Bancorp’s investment portfolio includes securities which are sensitive to interest rates and variations in interest rates may adversely impact Bancorp’s profitability.

Bancorp’s security portfolio is classified as available-for-sale, and is comprised primarily of debt and mortgage-backed securities, which are insured or guaranteed by U.S. government agencies, and corporate bonds. These securities are sensitive to interest rate fluctuations. Unrealized gains or losses in the available-for-sale portfolio for securities are reported as a separate component of shareholders’ equity. As a result, future interest rate fluctuations may impact shareholders’ equity, causing material fluctuations from quarter to quarter. The inability to hold its securities until maturity, or until payments are received on mortgage-backed securities, or until market conditions are favorable for a sale, could adversely affect Bancorp’s earnings and profitability.

Bancorp is dependent on its management team and the loss of its senior executive officers or other key employees could impair its relationship with its customers and adversely affect its business and financial results.

Bancorp’s success is dependent upon the continued services and skills of its management team. The unexpected loss of services of one or more of these key personnel, without experienced and suitable replacements could have an adverse impact on Bancorp’s business because of their skills, knowledge of Bancorp’s market, years of industry experience and the difficulty of promptly finding qualified replacement personnel.

Bancorp’s success also depends, in part, on its continued ability to attract and retain experienced commercial lenders and retail bankers, as well as other management personnel. The loss of the services of several of such key personnel could adversely affect Bancorp’s growth and prospects to the extent it is unable to quickly replace such personnel. Competition for commercial lenders and retail bankers is strong within the commercial banking, and Bancorp may not be successful in retaining or attracting personnel.

A breach of information security could negatively affect Bancorp’s earnings.

Bancorp increasingly depends upon data processing, communications and information exchange on a variety of computing platforms and networks, and over the internet to conduct its business. Bancorp cannot be certain that all of its systems are entirely free from vulnerability to attack, despite safeguards it has instituted. In addition, Bancorp relies on the services of a variety of vendors to meet its data processing and communication needs. If information security is breached, information can be lost or misappropriated; this could result in financial loss or costs to Bancorp or damages to others. These costs or losses could materially exceed the amount of insurance coverage, if any, which would have an adverse effect on Bancorp’s results of operations and financial condition. In addition, the Bank’s reputation could be harmed, which also could materially affect Bancorp’s financial condition and results of operations.

We are subject to environmental liability risk associated with our lending activities.

A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on, and take title to, properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. In addition, we own and operate certain properties that may be subject to similar environmental liability risks.

Environmental laws may require us to incur substantial expense and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Although we have policies and procedures requiring the performance of an environmental site assessment before initiating any foreclosure action on real property, these assessments may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our financial condition and results of operations.

Our business may be adversely impacted by acts of war or terrorism.

Acts of war or terrorism could have a significant adverse impact on our ability to conduct our business. Such events could affect the ability of our borrowers to repay their loans, could impair the value of the collateral securing our loans, and could cause significant property damage, thus increasing our expenses and/or reducing our revenues. In addition, such events could affect the ability of our depositors to maintain their deposits with the Bank. Although we have established disaster recovery policies and procedures, the occurrence of any such event could have a material adverse effect on our business which, in turn, could have a material adverse effect on our financial condition and results of operations.

We rely on the dividends we receive from our subsidiary.

Bancorp is a separate and distinct legal entity from the Bank, and all of the revenues Bancorp receives consist of dividends from the Bank. These dividends are the primary funding source for the interest and principal payments on our debt. Various federal and state laws and regulations limit the amount of dividends that a bank may pay to its parent company. In addition, our right to participate in a distribution of assets upon the liquidation or reorganization of a subsidiary may be subject to the prior claims of the subsidiary’s creditors. If the Bank is unable to pay dividends to Bancorp, we may not be able to pay our obligations. The inability to receive dividends from the Bank could therefore have a material adverse effect on our business, our financial condition, and our results of operations, as well as our ability to pay or increase the current level of cash dividends paid to our shareholders. Beginning in the second quarter of 2009, the Company began deferring interest payments on the subordinated debentures as permitted under the terms of the debentures. The deferral in the fourth quarter of 2013 represented the nineteenth consecutive quarter of deferral. The Company continues to accrue and charge interest to operations. The Company may only defer the payment of interest for 20 consecutive quarters, or thru March 2014, and all accrued interest must be paid at the completion of the deferral period, June 2014. As of December 31, 2013, the accrued interest payable is approximately $1.4 million.

The price of our common stock may fluctuate.

The market price of our common stock could be subject to significant fluctuations due to changes in sentiment in the market regarding our operations or business prospects. Among other factors, these risks may be affected by:

•

operating results that vary from the expectations of our management or of securities analysts and investors;

•

developments in our business or in the financial services sector generally;

•

regulatory or legislative changes affecting our industry generally or our business and operations;

•

operating and securities price performance of companies that investors consider to be comparable to us;

•

changes in estimates or recommendations by securities analysts or rating agencies;

•

announcements of strategic developments, acquisitions, dispositions, financings, and other material events by us or our competitors; and

•

changes or volatility in global financial markets and economies, general market conditions, interest or foreign exchange rates, stock, commodity, credit, or asset valuations.

In addition, stock markets around the world have experienced significant price and trading volume volatility, with shares of financial services firms being adversely impacted, in particular. While the U.S. and other governments continue to take action to restore confidence in the financial markets and to promote job creation and economic growth, continued or further market and economic turmoil could occur in the near or long term, which could negatively affect our business, financial condition and results of operations, and volatility in the price and trading volume of our common stock.

Difficult market conditions have adversely affected Bancorp’s industry.

Bancorp is exposed to downturns in the U.S. economy, and particularly the local markets in which it operates in Connecticut and New York. Declines in the housing market with falling home prices and increasing foreclosures, unemployment and under-employment, have negatively impacted the credit performance of mortgage and construction loans and resulted in significant write-downs of asset values by financial institutions, including government-sponsored enterprises as well as major commercial and investment banks. These write-downs have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. Many lenders and institutional investors have reduced or ceased providing funding to borrowers, including other financial institutions. This market turmoil and the tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and generally widespread reductions in business activity. The resulting economic pressure on consumers and lack of confidence in the financial markets has adversely affected Bancorp’s business, financial condition and results of operations. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and other financial institutions. In particular:

•

Economic conditions may continue to affect market confidence levels and may cause adverse changes in payment patterns, causing increases in delinquencies, which could affect our charge-offs and provision for loan losses.

•

The ability to assess the creditworthiness of the Bank’s customers or to estimate the values of collateral for loans may be impaired if the models and approaches we use become less predictive of future behaviors, valuations, assumptions or estimates due to the unpredictable economic climate.

•

Increasing consolidation of financial services companies as a result of current market conditions could have unexpected adverse effects upon our ability to compete effectively.

We may be required to pay significantly higher FDIC premiums, special assessments, or taxes that could adversely affect our earnings.

Market developments have significantly impacted the insurance fund of the FDIC. As a result, we may be required to pay higher premiums or additional special assessments or taxes that could adversely affect our earnings. We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance. If there are additional banks or financial institution failures, we may be required to pay even higher FDIC premiums than are currently assessed. These increases and any future increases or required prepayments in FDIC insurance premiums or taxes may materially adversely affect our results of operations.

We are subject to risks associated with taxation.

The amount of income taxes we are required to pay on our earnings is based on federal and state legislation and regulations. We provide for current and deferred taxes in our financial statements, based on our results of operations, business activity, legal structure, interpretation of tax statutes, assessment of risk of adjustment upon audit, and application of financial accounting standards. We may take tax return filing positions for which the final determination of tax is uncertain. Our net income and earnings per share may be reduced if a federal, state, or local authority assesses additional taxes that have not been provided for in our consolidated financial statements. There can be no assurance that we will achieve our anticipated effective tax rate either due to a change in a tax law, a change in regulatory or judicial guidance, or an audit assessment which denies previously recognized tax benefits.

Risks associated with changes in technology.

Financial products and services have become increasingly technology-driven. Our ability to meet the needs of our customers competitively, and in a cost-efficient manner, is dependent on our ability to keep pace with technological advances and to invest in new technology as it becomes available. Many of our competitors have greater resources to invest in technology than we do and may be better equipped to market new technology-driven products and services. The ability to keep pace with technological change is important, and the failure to do so on our part could have a material adverse impact on our business and therefore on our financial condition and results of operations.

Strong competition within Bancorp’s market area may limit the growth and profitability of the Company.

Competition in the banking and financial services industry is intense. The Fairfield County, Connecticut and the New York City metropolitan areas have a high concentration of financial institutions including large money center and regional banks, community banks and credit unions. Some of Bancorp’s competitors offer products and services that the Bank currently does not offer, such as private banking and trust services. Many of these competitors have substantially greater resources and lending limits than Bancorp and may offer certain services that Bancorp does not or cannot provide. Price competition for loans and deposits might result in the Bank earning less on its loans and paying more for deposits, which reduces net interest income. Bancorp expects competition to increase in the future as a result of legislative, regulatory and technological changes. Bancorp’s profitability depends upon its continued ability to successfully compete in its market area.

Government regulation may have an adverse effect on Bancorp’s profitability and growth.

Bancorp is subject to extensive regulation, supervision and examination by the Office of the Comptroller of the Currency as the Bank’s chartering authority, by the FDIC, as insurer of its deposits, and by the Federal Reserve Board as regulator of Bancorp. Changes in state and federal banking laws and regulations or in federal monetary policies could adversely affect the Bank’s ability to maintain profitability and continue to grow and, in light of recent economic conditions, such changes are expected but cannot be predicted. For example, new legislation or regulation could limit the manner in which Bancorp may conduct its business, including the Bank’s ability to obtain financing, attract deposits, make loans and achieve satisfactory interest spreads. The laws, regulations, interpretations and enforcement policies that apply to Bancorp have been subject to significant, and sometimes retroactively applied, changes in recent years, and are likely to change significantly in the future.

Legislation proposing significant structural reforms to the financial services industry considered in the U.S. Congress has, among other things, created the Consumer Financial Protection Bureau, which gives broad authority to regulate financial service providers and financial products. In addition, the Federal Reserve Bank has passed guidance on incentive compensation at the banking organizations it regulates and the United States Department of the Treasury and the federal banking regulators have issued statements calling for higher capital and liquidity requirements for banking organizations. Complying with any new legislative or regulatory requirements, and any programs established there under by federal and state governments to address the current economic crisis, could have an adverse impact on our results of operations and our ability to fill positions with the most qualified candidates available.

Changing regulation of corporate governance and public disclosure.

Laws, regulations and standards relating to corporate governance and public disclosure, SEC regulations and NASDAQ rules, have added to the responsibilities that companies, such as Bancorp, have. These laws, regulations and standards are subject to varying interpretations, and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies, which could make compliance more difficult and result in higher costs. Bancorp is committed to maintaining high standards of corporate governance and public disclosure. As a result, Bancorp’s efforts to comply with evolving laws, regulations and standards have resulted in, and are likely to continue to result in, increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities. Bancorp’s reputation may be harmed if it does not continue to comply with these laws, regulations and standards.

The earnings of financial institutions are significantly affected by general business and economic conditions.

As a financial institution, Bancorp’s operations and profitability are impacted by general business and economic conditions in the United States and abroad. These conditions include short-term and long-term interest rates, inflation, money supply, political issues, legislative and regulatory changes and the strength of the U.S. economy and the local economies in which we operate, all of which are beyond Bancorp’s control. In recent years, the banking world has experienced unprecedented upheaval, including the failure of some of the leading financial institutions in the world. Further deterioration in economic conditions could result in an increase in loan delinquencies and non-performing assets, decreases in loan collateral values and a decrease in demand for the Bank’s products and services, among other things, any of which could have a material adverse impact on Bancorp’s results of operations and financial condition and for which Bancorp cannot currently predict or implement plans to combat.

We are a “controlled company” within the meaning of the Nasdaq rules and, as a result, we qualify for, and rely on, exemptions from certain corporate governance requirements.

PNBK Holdings LLC controls a majority of our voting common stock. As a result, we are a “controlled company” within the meaning of Nasdaq corporate governance standards. Under the Nasdaq rules, a company of which more than 50% of the voting power is held by an individual, group or another company is a “controlled company” and we utilize exemptions relating to certain Nasdaq corporate governance requirements, including:

•

The requirement that we have a Nominating and Governance Committee that is composed entirely of independent directors;

•

The requirement that we have a Compensation Committee that is composed entirely of independent directors; and

•

The requirement for an annual performance evaluation of the Nominating and Governance and Compensation Committees.

As a result of these exemptions, our Nominating and Governance Committee and Compensation Committee do not consist entirely of independent directors and we are not required to have an annual performance evaluation of the Nominating and Governance and Compensation Committees. Accordingly, a holder of our common stock will not have the same protections afforded to stockholders of companies that are subject to all of the Nasdaq corporate goverance requirements.

Item 1B.

Unresolved Staff Comments

None.

Item 2.

Properties

Patriot National Bancorp Inc.’s corporate headquarters and main branch banking office is located at 900 Bedford Street in Stamford, Connecticut. The Bank purchased the main Stamford branch and the Greenwich branch in 2013. One branch is owned and the Bank’s eight other branch banking offices, additional administrative and operational office space are leased. The Bank also leases space at its main office for additional parking. Lease commencement dates for office locations range from April 2003 to July 2012 and lease expiration dates fall between August 2014 and July 2017. Most of the leases contain rent escalation provisions, as well as renewal options for one or more periods.

The Bank has licensed excess space in two of its locations to an attorney and three independent companies. See also “Item 13. Certain Relationships and Related Transactions.” For additional information regarding the Bank’s lease obligations, see Note 9 to the Consolidated Financial Statements.

All leased properties are in good condition.

Item 3.

Legal Proceedings

Neither Bancorp nor the Bank has any pending legal proceedings, other than ordinary routine litigation incidental to its business, to which Bancorp or the Bank is a party or any of its property is subject.

Item 4.

Mine Safety Disclosures

Not applicable.

PART II

Item 5.

Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

Market Information

Bancorp Common Stock is traded on the NASDAQ Global Market under the Symbol “PNBK.” On December 31, 2013, the last sale price for Bancorp Common Stock on the NASDAQ Global Market was $1.04

The following table sets forth the high and low sales price and dividends per share of Bancorp Common Stock for the last two fiscal years for each quarter as reported on the NASDAQ Global Market.


	2013						2012
					Cash						Cash
	Sales Price				Dividends		Sales Price				Dividends
Quarter Ended	High		Low		Declared		High		Low		Declared
March 31	$	1.72	$	1.05	$	—	$	1.88	$	1.69	$	—
June 30		1.63		1.17		—		1.88		1.52		—
September 30		1.48		1.29		—		1.75		1.45		—
December 31		1.39		1.01		—		1.63		1.03		—

Holders

There were approximately 774 shareholders of record of Bancorp Common Stock as of December 31, 2013. This number does not reflect the number of persons or entities holding stock in nominee name through banks, brokerage firms or other nominees.

Dividends

Bancorp’s ability to pay dividends is dependent on the Bank’s ability to pay dividends to Bancorp. Pursuant to the February 9, 2009 Agreement between the Bank and the Office of the Comptroller of the Currency, the Bank can pay dividends to Bancorp only pursuant to a dividend policy requiring compliance with the Bank’s OCC-approved capital program, in compliance with applicable law and with the prior written determination of no supervisory objection by the Assistant Deputy Comptroller. In addition to the Agreement, certain other restrictions exist regarding the ability of the Bank to transfer funds to Bancorp in the form of cash dividends, loans or advances. The approval of the Comptroller of the Currency is required to pay dividends in excess of the Bank’s earnings retained in the current year plus retained net earnings for the preceding two years. As of December 31, 2013, the Bank had no retained earnings available for distribution to Bancorp as dividends. The Bank is also prohibited from paying dividends that would reduce its capital ratios below minimum regulatory requirements. The Federal Reserve Bank has also imposed dividend restrictions on Bancorp.

Recent Sales of Unregistered Securities

During the fourth quarter of 2013, Bancorp did not have any sales of unregistered securities.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

None.

Performance Graph

The performance graph compares the yearly percentage change in Bancorp’s cumulative total shareholder return on its common stock over the last five fiscal years to the cumulative total return of the S&P 500 Index and the NASDAQ Bank Index. Total shareholder return is measured by dividing the sum of the cumulative amount of dividends for the measurement period (assuming dividend reinvestment) and the difference between Bancorp’s share price at the end and the beginning of the measurement period, by the share price at the beginning of the measurement period.

LOGO

Total Return

12/31/2008

12/31/2009

12/31/2010

12/31/2011

12/31/2012

12/31/2013

PNBK

100

22.6

30.7

25.5

18.2

15.2

.BANK

100

81.5

91.2

79.9

92.5

128.4

.SPX

100

123.5

139.2

157.9

204.6

Item 6.

Selected Financial Data


At or for the year ended December 31,
	2013			2012			2011			2010			2009
Operating Data:
Interest and dividend income	$	21,654,103		$	25,216,517		$	28,332,309		$	35,608,891		$	42,968,080
Interest expense		4,853,585			7,419,452			8,510,443			13,474,543			24,359,828
Net interest income		16,800,518			17,797,065			19,821,866			22,134,348			18,608,252
Provision for loan losses		970,214			(2,379,223	)		7,464,427			7,714,000			13,089,000
Non-interest income		2,425,715			3,273,496			3,411,477			2,354,240			2,946,480
Non-interest expense		25,883,749			23,985,948			31,228,402			31,948,533			30,131,588
(Benefit) provision for income taxes		(338,784	)		—			—			225,000			2,213,750
Net loss		(7,288,946	)		(536,164	)		(15,459,486	)		(15,398,945	)		(23,879,606	)
Per Share Data:
Basic loss per share		(0.19	)		(0.01	)		(0.40	)		(1.30	)		(5.02	)
Diluted loss per share		(0.19	)		(0.01	)		(0.40	)		(1.30	)		(5.02	)
Dividends per share		—			—			—			—			—
Balance Sheet Data:
Cash and due from banks		34,865,881			70,303,641			54,715,809			136,324,258			97,535,593
Federal funds sold		—			—			—			10,000,000			10,000,000
Short-term investments		—			710,766			709,567			453,400			263,839
Investment securities		47,738,256			51,293,320			76,185,272			49,765,000			55,177,931
Loans, net		418,148,323			458,793,536			501,227,297			534,531,213			645,205,943
Total assets (2)		541,248,126			617,855,135			665,816,278			784,324,854			866,416,921
Total deposits (1)		430,204,082			497,282,898			544,909,393			646,808,829			761,334,292
Total borrowings		65,248,000			65,248,000			65,248,000			65,248,000			65,248,000
Total shareholders’ equity		41,840,688			49,567,798			50,549,660			67,172,188			35,861,310

(1)	Includes $24.7 million of deposits held for sale at December 31, 2012.

(2)	Includes $88,000 of branch assets held for sale at December 31, 2012.

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operation

Critical Accounting Policies

Bancorp’s significant accounting policies are described in Note 1 to the Consolidated Financial Statements included in this 2013 Annual Report on Form 10-K. The preparation of consolidated financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and to disclose contingent assets and liabilities. Actual results could differ from those estimates. Management has identified accounting for the allowance for loan losses, the analysis and valuation of its investment securities, and the valuation of deferred tax assets, as Bancorp’s most critical accounting policies and estimates in that they are important to the portrayal of Bancorp’s financial condition and results. They require management’s most subjective and complex judgment as a result of the need to make estimates about the effect of matters that are inherently uncertain.

Allowance for Loan Losses

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of allocated and general components. The allocated component relates to loans that are considered impaired. For such impaired loans, an allowance is established when the discounted cash flows (or collateral value if the loan is collateral dependent or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers all other loans, segregated generally by loan type, and is based on historical loss experience with adjustments for qualitative factors which are made after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss data. In addition, a risk rating system is utilized to evaluate the general component of the allowance for loan losses. Under this system, management assigns risk ratings between one and eleven. Risk ratings are assigned based upon the recommendations of the credit analyst and the originating loan officer and confirmed by the Loan Committee at the initiation of the transactions and are reviewed and changed, when necessary, during the life of the loan. Loans assigned a risk rating of six or above are monitored more closely by the credit administration officers and the Loan Committee.

The Company provides for loan losses based on the consistent application of our documented allowance for loan loss methodology. Loan losses are charged to the allowance for loans losses and recoveries are credited to it. Additions to the allowance for loan losses are provided by charges against income based on various factors which, in our judgment, deserve current recognition in estimating probable losses. Loan losses are charged-off in the period the loans, or portion thereof, are deemed uncollectible. Generally, the Company will record a loan charge-off (including a partial charge-off) to reduce a loan to the estimated fair value of the underlying collateral, less cost to sell, for collateral dependent loans. The Company regularly reviews the loan portfolio and makes adjustments for loan losses in order to maintain the allowance for loan losses in accordance with U.S. generally accepted accounting principles. The allowance for loan losses consists primarily of the following two components:

(1)

Allowances are established for impaired loans (generally defined by the Company as non-accrual loans, troubled debt restructured loans and loans that were previously classified as troubled debt restructurings but have been upgraded). The amount of impairment provided for as an allowance is represented by the deficiency, if any, between the present value of expected future cash flows discounted at the original loan’s effective interest rate or the underlying collateral value, less estimated costs to sell, if the loan is collateral dependent, and the carrying value of the loan. Impaired loans that have no impairment losses are not considered for general valuation allowances described below.

(2)

General allowances are established for loan losses on a portfolio basis for loans that do not meet the definition of impaired. The portfolio is grouped into similar risk characteristics, primarily loan type, loan-to-value if collateral dependent, and internal risk ratings. Management applies an estimated loss rate to each loan group. The loss rates applied are based on the Company’s cumulative prior two year loss experience adjusted, as appropriate, for the environmental factors discussed below. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revisions based upon changes in economic and real estate market conditions. Actual loan losses may be more or less than the allowance for loan losses management has established, which could have an effect on the Company’s financial results.

The adjustments to the Company’s loss experience are based on Management’s evaluation of several environmental factors, including:

•

Changes in local, regional, national and international economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments;

•

Changes in the nature and volume of the portfolio and in the terms of the loans;

•

Changes in the experience, ability, and depth of lending management and other relevant staff;

•

Changes in the volume and severity of past due loans, the volume of nonaccrual loans, and the volume and severity of adversely classified or graded loans;

•

Changes in the quality of the loan review system;

•

Changes in the value of the underlying collateral for collateral-dependent loans;

•

The existence and effect of any concentrations of credit, and changes in the level of such concentrations; and

•

The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the existing portfolio.

In underwriting a loan secured by real property, we require an appraisal of the property by an independent licensed appraiser approved by the Company’s Board of Directors. All appraisals are reviewed by qualified parties independent from the firm preparing the appraisals. The appraisal is subject to review by an independent third party hired by the Company. Management reviews and inspects properties before disbursement of funds during the term of a construction loan. Generally, management obtains updated appraisals when a loan is deemed impaired and if a construction loan, within 120 days prior to the scheduled maturity date. These appraisals may be more limited than those prepared for the underwriting of a new loan.

Each quarter management evaluates the allowance for loan losses and adjust the allowance as appropriate through a provision for loan losses. While the Company uses the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the information used in making the evaluations. In addition, as an integral part of their examination process, the Office of the Comptroller of the Currency will periodically review the allowance for loan losses. The OCC may require the Company to adjust the allowance based on their analysis of information available to them at the time of their examination.

Fair Value Measurements

Bancorp uses fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in certain instances, there are no quoted market prices for certain assets or liabilities. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the asset or liability.

Fair value measurements focus on exit prices in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment.

The Company’s fair value measurements are classified into a fair value hierarchy based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. The three categories within the hierarchy are as follows:

•

Level 1 Inputs—Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

•

Level 2 Inputs—Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

•

Level 3 Inputs—Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

The asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lower level of any input that is significant to the fair value measurement. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs.

Bancorp performs a quarterly analysis of those securities that are in an unrealized loss position to determine if those losses qualify as other-than-temporary impairments. This analysis considers the following criteria in its determination: the ability of the issuer to meet its obligations, the impairment due to a deterioration in credit, management’s plans and ability to maintain its investment in the security, the length of time and the amount by which the security has been in a loss position, the interest rate environment, the general economic environment and prospects or projections for improvement or deterioration.

Management has made the determination that none of the Bank’s investment securities are other-than-temporarily impaired at December 31, 2013, and no impairment charges were recorded during the year ended December 31, 2013.

Income taxes

The Company recognizes income taxes under the asset and liability method. Under this method, 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, and 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. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

The Company recognizes a benefit from its tax positions only if it is more-likely-than-not that the tax position will be sustained on examination by taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information.

The Company’s policy for recording interest and penalties related to uncertain tax positions is to record such items as part of its provision for federal and state income taxes.

The periods subject to examination for the Company’s Federal returns are the tax years 2008 through 2013. The periods subject to examination for the Company’s significant state return, which is Connecticut, are the tax years 2009 through 2013. The Company believes that its income tax filing positions and deductions will be sustained upon examination and does not anticipate any adjustments that will result in a material change in its financial statements. As a result, no reserve for uncertain income tax positions has been recorded.

Recent Economic Developments

There have been significant and historical disruptions in the financial system during the past few years and many lenders and financial institutions have reduced or ceased to provide funding to borrowers, including other lending institutions. The availability of credit, confidence in the entire financial sector, and volatility in financial markets has been adversely affected. The Federal Reserve Bank has been providing vast amounts of liquidity into the banking system to compensate for weaknesses in short-term borrowing markets and other capital markets.

The Federal Deposit Insurance Corporation (FDIC) insures deposits at FDIC-insured financial institutions up to certain limits. The FDIC charges insured financial institutions premiums to maintain the Deposit Insurance Fund. Based on the Bank’s current financial condition, a higher level of FDIC insurance premiums is assessed.

Summary

During the year ended December 31, 2013, Bancorp took several steps to restructure its balance sheet and operations intended to result in future profitable operations. First, Bancorp repaid $57.0 million of high cost borrowings incurring a prepayment penalty of $4.1 million. Second, Bancorp purchased two branch buildings where the cost of the leases exceeded the cost to own the properties. Third, Bancorp streamlined the branch operations, back office personnel and changed strategy relating to originating mortgages for sale where we had not been able to achieve the scale necessary for success. In this process, Bancorp incurred $522,000 of one-time restructuring expenses. Based on the steps taken during the year, we believe we have positioned Bancorp for profitability and to entertain growth opportunities.

Bancorp reported a net loss of $7.3 million ($.19 loss per share) for 2013 compared to a net loss of $536,000 ($0.01 loss per share) for 2012. The primary reason for the decrease, in addition to the $4.6 million in non-interest expense discussed above, is the decrease in interest and dividend income of $3.6 million due to the lower interest rate environment and smaller investment portfolio than in the prior year, partially offset by a decrease of $2.6 million in interest expense. The provision for loan losses increased $3.3 million when compared to prior year primarily due to an increase of $1.0 million due to additional specific reserves for certain impaired loans and the release of $2.4 million in excess reserves in 2012. Non-interest income decreased $848,000 primarily due to gains recognized in the prior year on the sale of investment securities and loans of $911,000 and $336,000, respectively, partially offset by gains recognized on the sale of branch assets and deposits of $51,000 and increases in loan application fees and mortgage banking activity of $147,000 and $92,000 respectively. Non-interest expenses increased $1.9 million, primarily due to the $4.1 million in prepayment penalties mentioned above, partially offset by the impact of the restructuring charges incurred in 2012 and 2013. Primarily as a result of restructuring charges, salaries and benefits and occupancy and equipment expense decreased $891,000 and $509,000 respectively in 2013. In addition, restructuring charges and asset disposals recorded in 2013 were $522,000 compared to $939,000 recorded in 2012. Regulatory assessments and insurance expense decreased $565,000 and $157,000 respectively. Total assets ended the year at $541.2 million, which represents a decrease of $76.6 million from 2012. Management strategically planned for the reduction in assets in 2013, as part of the Company’s ongoing turnaround plan to maintain regulatory capital ratios while incurring the $4.1 million prepayment penalties on borrowings and $0.5 million in restructuring charges.

Net interest income for the year ended December 31, 2013 decreased $1 million, or 5.6%, to $16.8 million as compared to $17.8 million for the year ended December 31, 2012. This is the result of a reduced level of average earning assets and the overall lower interest rate environment.

Total assets decreased $76.6 million, or 12%, from $617.9 million at December 31, 2012 to $541.2 million during the year as the loan portfolio decreased $40.7 million from $458.8 million at December 31, 2012 to $418.1 million at December 31, 2013. Cash and cash equivalents decreased $36.1 million, or $51%, from $71.0 million at December 31, 2012 to $34.9 million at December 31, 2013 primarily due to a significant but intentional decline in deposits, resulting from the Company’s strategic initiative to restructure the balance sheet and the purchase of two branch buildings. The available-for-sale securities portfolio decreased $4.0 million, or 10%, to $37.7 million at December 31, 2013 as compared to $41.7 million at December 31, 2012. Premises and equipment net increased $10.8 million primarily due to the purchase of two branch buildings. Other real estate owned decreased $4.9 million. As of December 31, 2013, for the first time since December 31, 2008, Bancorp had no other real estate owned properties on its balance sheet. Total deposits decreased $67.1 million, or 13%, partially due to a branch sale from $497.3 million at December 31, 2012 to $430.2 million at December 31, 2013. This is reflective of management’s pricing strategy to lower the cost of funds and reduce the reliance on higher cost funding products. Total borrowings remain unchanged from December 31, 2012. Shareholders’ equity decreased $7.7 million from $49.6 million at December 31, 2012 as compared to $41.8 million at December 31, 2013. This is primarily the result of the net loss of $7.3 million and the $569,000 reduction of accumulated other comprehensive income, partially offset by equity award grants of $131,000.

FINANCIAL CONDITION

Assets

Bancorp’s total assets decreased $76.6 million, or 12%, from $617.9 million at December 31, 2012 to $541.2 million at December 31, 2013 as the Bank reduced its concentration of residential loans by $12.8 million primarily through loan sales. Commercial real estate loans decreased $24.3 million, primarily due to loan payoffs. Consumer home equity loans decreased $5.1 million and construction loans continued to pay off and overall balances were reduced by $4.7 million or 94.8%. Construction to permanent loans increased $6.5 million. Interest bearing deposits decreased $34.3 million compared to December 31, 2012, primarily due to a branch sale and the planned reduction of higher cost deposit accounts to achieve net interest margin and the low interest rate environment.

Investments

The following table is a summary of Bancorp’s investment portfolio at fair value at December 31 for the years shown.


	2013		2012		2011
U. S. Government Agency bonds	$	7,079,350	$	7,526,170	$	5,037,085
U. S. Government Agency mortgage-backed securities		21,752,212		25,706,891		50,049,429
Corporate bonds		8,869,794		8,486,259		11,383,458
Federal Reserve Bank stock		1,444,300		1,730,200		1,707,000
Federal Home Loan Bank stock		4,142,600		4,343,800		4,508,300
Other investments		4,450,000		3,500,000		3,500,000

Total Investments	$	47,738,256	$	51,293,320	$	76,185,272

Total investments decreased $3.6 million, or 6.9%, primarily due to principal payments of $3.3 million on the government agency mortgage-backed securities and an increase in the unrealized loss of $569,000 on available for sale securities. In addition, there were stock repurchases of $286,000 and $201,000 in Federal Reserve Bank stock and Federal Home Loan Bank stock, respectively. These were partially offset with a purchase of other investments of $950,000.

The following table presents the maturity distribution of available-for-sale investment securities at December 31, 2013 and the weighted average yield of the amortized cost of such securities. The weighted average yields were calculated on the amortized cost and effective yields to maturity of each security. Actual maturities of mortgage-backed securities may differ from contractual maturities because the mortgages underlying the securities may be repaid without any penalties. As mortgage-backed securities are not due at a single maturity date, they are included in the “No maturity” category in the following maturity summary.


			Over one			Over five											Weighted
	One year		through			through			Over ten								Average
	or less		five years			ten years			years		No maturity			Total			Yield
U. S. Government Agency bonds	$	—	$	2,500,000		$	5,000,000		$	—	$	—		$	7,500,000			1.83	%
U. S. Government Agency mortgage-backed securities		—		—			—			—		22,387,986			22,387,986			2.15	%
Corporate bonds		—		—			9,000,000			—		—			9,000,000			1.71	%

Total	$	—	$	2,500,000		$	14,000,000		$	—	$	22,387,986		$	38,887,986			1.99	%

Weighted average yield		—		1.34	%		1.84	%		—		2.15	%		1.99	%

The following table presents a summary of investments for any issuer that exceeds 10% of shareholders’ equity at December 31, 2013:


	Amortized Cost		Fair Value
Available for sale securities:
U. S. Government Agency mortgage-backed securities and bonds	$	29,887,986	$	28,831,562
Other Investments:
Solomon Hess SBA Loan Fund LLC	$	4,450,000	$	4,450,000

Loans

The following table is a summary of Bancorp’s loan portfolio at December 31 for each of the years shown:


	2013			2012			2011			2010			2009
Real Estate
Commercial	$	223,165,092		$	247,495,321		$	215,659,837		$	228,842,489		$	230,225,306
Residential		106,198,275			119,033,025			188,108,855			187,058,318			195,571,225
Construction		260,000			4,997,991			12,306,922			63,889,083			154,457,082
Construction to permanent		11,303,002			4,851,768			10,012,022			10,331,043			15,989,976
Commercial		35,061,249			36,428,751			31,810,735			14,573,790			19,298,505
Consumer home equity		44,080,895			49,180,908			49,694,546			42,884,962			44,309,265
Consumer and other		2,989,662			2,162,718			2,164,972			1,932,763			1,155,059

Total loans		423,058,175			464,150,482			509,757,889			549,512,448			661,006,418
Premiums on purchased loans		200,180			219,649			231,125			242,426			131,993
Net deferred costs (fees)		570,657			439,041			622,955			150,440			(138,350	)
Allowance for loan losses		(5,680,689	)		(6,015,636	)		(9,384,672	)		(15,374,101	)		(15,794,118	)

Loans, net	$	418,148,323		$	458,793,536		$	501,227,297		$	534,531,213		$	645,205,943

Bancorp’s net loan portfolio decreased $40.6 million, or 8.9%, to $418.1 million at December 31, 2013 from $458.8 million at December 31, 2012. The decline in the loan portfolio was primarily the result of sales of residential real estate loans and loan payoffs. Significant decreases in the portfolio include a $24.3 million decrease in commercial loans, $12.8 million decrease in residential loans, $5.1 million decrease in consumer home equity loans and a $4.7 million decrease in construction loans. These were partially offset with a $6.5 million increase in construction to permanent loans. The allowance for loan losses decreased by $335,000. The decline in the loan portfolio in 2013 primarily reflects management’s decision to reduce a growing concentration in lower yielding residential real estate loans.

At December 31, 2013, the net loan to deposit ratio was 97% and the net loan to asset ratio was 77%. At December 31, 2012, the net loan to deposit ratio was 92%, and the net loan to asset ratio was 74%. Excluding the deposits held for sale at December 31, 2012, the net loan to deposit ratio was 97%.

Maturities and Sensitivities of Loans to Changes in Interest Rates

The following table presents the maturities of loans in Bancorp’s portfolio at December 31, 2013, by type of loan:


			Due after
	Due in		one year
	one year		through		Due after
(thousands of dollars)	or less		five years		five years		Total
Commercial real estate	$	4,374,526	$	30,856,845	$	187,933,721	$	223,165,092
Residential real estate		—		—		106,198,275		106,198,275
Construction loans		260,000		—		—		260,000
Construction to permanent loans		1,197,474		—		10,105,528		11,303,002
Commercial loans		8,322,710		16,454,884		10,283,655		35,061,249
Consumer home equity		—		97,520		43,983,375		44,080,895
Consumer and other		9,981		1,491,833		1,487,848		2,989,662

Total	$	14,164,691	$	48,901,082	$	359,992,402	$	423,058,175

Fixed rate loans	$	992,370	$	30,566,049	$	26,698,925	$	58,257,344
Variable rate loans		13,172,321		18,335,033		333,293,477		364,800,831

Total	$	14,164,691	$	48,901,082	$	359,992,402	$	423,058,175

Loan Concentrations

The Bank has no concentrations of loans other than those disclosed in the above summary loan portfolio table. Commercial real estate plus construction represents 55.5% of total loans, up from 55.4% at December 31, 2012.

Allowance for Loan Losses

The allowance for loan losses is evaluated on a quarterly basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The allowance for loan losses decreased $335,000 from December 31, 2012 to December 31, 2013 primarily due to a reduction in loan balances and the improved credit quality of the loan portfolio.

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

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

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

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

The accrual of interest on loans is discontinued at the time the loan is 90 days past due for payment unless the loan is well-secured and in process of collection. Consumer installment loans are typically charged off no later than 180 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not collected for loans that are placed on nonaccrual status or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis method until qualifying for return to accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current, future payments are reasonably assured, and there is 6 months of performance.

Management considers all non-accrual loans and troubled debt restructurings to be impaired. In most cases, loan payments that are past due less than 90 days, based on contractual terms, are considered collection delays and the related loans are not considered to be impaired. The Bank considers consumer installment loans to be pools of smaller balance homogeneous loans, which are collectively evaluated for impairment.

Analysis of Allowance for Loan Losses


	2013			2012			2011			2010			2009
	(thousands of dollars)
Balance at beginning of period	$	6,016		$	9,385		$	15,374		$	15,794		$	16,247

Charge-offs:
Commercial real estate		(403	)		(50	)		(2,941	)		(2,560	)		(2,380	)
Residential real estate		(918	)		(85	)		(1,458	)		(600	)		(356	)
Construction		(205	)		(101	)		(3,305	)		(4,726	)		(9,097	)
Commercial		(63	)		(48	)		(375	)		(396	)		(468	)
Consumer home equity		(58	)		(745	)		(150	)		(46	)		(1,378	)
Consumer		(21	)		(41	)		(24	)		(42	)		(51	)

Total charge-offs		(1,668	)		(1,070	)		(8,253	)		(8,370	)		(13,730	)
Recoveries		363			80			854			236			188

Net charge-offs		(1,305	)		(990	)		(7,399	)		(8,134	)		(13,542	)

Additions charged to operations		970			(2,379	)		7,464			7,714			13,089
Transferred to held-for-sale		—			—			(6,054	)		—			—

Balance at end of period	$	5,681		$	6,016		$	9,385		$	15,374		$	15,794

Ratio of net charge-offs during the period to average loans outstanding during the period		0.29	%		0.20	%		1.52	%		1.32	%		1.81	%

Ratio of ALLL / Gross Loans		1.34	%		1.29	%		1.84	%		2.80	%		2.39	%

Allocation of the Allowance for Loan Losses


											Percent of loans in each
Balance at end of each	Amounts (thousands of dollars)										category to total loans
period applicable to:	2013		2012		2011		2010		2009		2013			2012			2011			2010			2009
Real Estate:
Commercial	$	1,585	$	3,509	$	4,019	$	7,633	$	5,752		52.75	%		53.32	%		42.31	%		41.64	%		34.83	%
Residential		795		897		2,551		2,364		1,575		25.10	%		25.65	%		36.90	%		34.04	%		29.59	%
Construction		260		311		867		3,478		6,557		0.06	%		1.08	%		2.41	%		11.63	%		23.37	%
Construction to permanent		25		19		547		492		93		2.67	%		1.05	%		1.96	%		1.88	%		2.42	%
Commercial		2,285		942		882		441		521		8.29	%		7.85	%		6.24	%		2.65	%		2.92	%
Consumer installment		101		33		55		80		47		10.42	%		10.60	%		0.42	%		0.35	%		0.17	%
Consumer home equity		433		184		404		498		703		0.71	%		0.47	%		9.76	%		7.81	%		6.70	%
Unallocated		197		121		60		388		546		N/A			N/A			N/A			N/A			N/A

Total	$	5,681	$	6,016	$	9,385	$	15,374	$	15,794		100.00	%		100.00	%		100.00	%		100.00	%		100.00	%

Non-Accrual, Past Due and Restructured Loans

The following table is a summary of non-accrual and past due loans at the end of each of the last five years.


	2013			2012			2011			2010			2009
	(thousands of dollars)
Loans delinquent over 90 days still accruing	$	866		$	2,234		$	9,461		$	3,374		$	3,571
Non-accrual loans		12,308			23,810			20,683			89,150			113,537

	$	13,174		$	26,044		$	30,144		$	92,524		$	117,108

% of Total Loans		3.11	%		5.60	%		5.91	%		16.83	%		17.72	%
% of Total Assets		2.44	%		4.22	%		4.53	%		11.80	%		13.52	%
Additional income on non-accrual loans if recognized on an accrual basis	$	545		$	1,172		$	2,275		$	6,618		$	5,312

Included in non-accruing loans were loans of $7.8 million and $3.5 million as of December 31, 2013 and 2012, respectively that were current within 30 days as to payments. Loans past due ninety days or more, and still accruing interest were $866,000 and $2.2 million at December 31, 2013 and December 31, 2012, respectively. Loans over 90 days past due were comprised of two loans as of December 31, 2013; one loan for $841,000 was current and a $25,000 loan was current within 60 days as to interest payments. Both loans were past the loan’s maturity date and are in the process of being renewed. Four of the five loans as of December 31, 2012, totaling $1,667,000, were making payments, but past the loan’s maturity date and are in the process of being renewed. The other loan totaling $567,000 was over 90 days past due as to payments and past the loan’s maturity date, but was subsequently paid off in 2013.

During 2013, 2012 and 2011, interest income collected and recognized on impaired loans was $773,637, $230,900 and $464,785 respectively.

At December 31, 2013, there were two loans totaling $2.2 million that were considered troubled debt restructurings, as compared to 8 loans totaling $11.6 million that were considered troubled debt restructurings at December 31, 2012, all of which are considered impaired loans. Loan modifications, which resulted in these loans being considered troubled debt restructurings, are primarily in the form of rate concessions or term extensions. There were no commitments to advance additional funds under modified terms for these loans.

The Company’s most recent impairment analysis resulted in identification of $22.0 million of impaired loans, for which specific reserves of $1.9 million were required at December 31, 2013, compared to $33.4 million of impaired loans at December 31, 2012, for which specific reserves of $968,000 were required. The $22.0 million of impaired loans at December 31, 2013 is comprised of exposure to 22 borrowers, compared to the $33.4 million of impaired loans at December 31, 2012 which was comprised of exposure to 30 borrowers. In all cases, the Bank has obtained current appraisal reports from independent licensed appraisal firms and reduced those values for estimated selling expenses to determine estimated impairment.

The non-performing loans decreased from $23.8 million at December 31, 2012 to $12.3 million at December 31, 2013. The $12.3 million of non-performing loans was comprised of 15 borrowers at December 31, 2013, compared to 24 borrowers at December 31, 2012. The non-performing loans peaked at $137.9 million at September 30, 2009. The decrease in the number of non-performing loans represents the Bank’s continuous focus on the workout effort.

Based upon the overall assessment and evaluation of the loan portfolio, management believes the allowance for loan losses of $5.7 million, at December 31, 2013, which represents 1.34% of gross loans outstanding, is adequate under prevailing economic conditions, to absorb existing losses in the loan portfolio. At December 31, 2012, the allowance for loan losses was $6.0 million, or 1.29%, of gross loans outstanding. The loan portfolio was reduced by $40.6 million, or 8.9%.

Other Real Estate Owned

The following table is a summary of Bancorp’s other real estate owned as of December 31, 2013 and 2012.


	December 31,		December 31,
	2013		2012
Residential construction	$	—	$	1,109,204
Commercial		—		—
Residential real estate		—		3,764,640

Other real estate owned	$	—	$	4,873,844

There was no other real estate owned at December 31, 2013. The balance of other real estate owned at December 31, 2012 was comprised of two properties, all of which were obtained through loan foreclosure proceedings. During the year ended December 31, 2013, the Bank did not acquire any properties and two properties were sold with an aggregate carrying value of $5.0 million. During the year ended December 31, 2012, the Bank acquired three properties and sold four properties with an aggregate carrying value of $3.2 million.

Deferred Taxes

The determination of the amount of deferred income tax assets which are more likely than not to be realized is primarily dependent on projections of future earnings, which are subject to uncertainty and estimates that may change given economic conditions and other factors. A valuation allowance related to deferred tax assets is required when it is considered more likely than not that all or part of the benefit related to such assets will not be realized. Management has reviewed the deferred tax position of Bancorp at December 31, 2013. The deferred tax position has been affected by several significant transactions in prior years. These transactions include the change in ownership, in addition to, the increased provision for loan losses, the levels of non-accrual loans and other-than-temporary impairment write-offs of certain investments. As a result, the Company is in a cumulative net loss position at December 31, 2013, and under the applicable accounting guidance, has concluded that it is not more-likely-than-not that the Company will be able to realize its deferred tax assets and, accordingly, has established a full valuation allowance totaling $18.1 million against its deferred tax asset at December 31, 2013. The valuation allowance is analyzed quarterly for changes affecting the deferred tax asset. If, in the future, the Company generates taxable income on a sustained basis, management’s conclusion regarding the need for a deferred tax asset valuation allowance could change, resulting in the reversal of all or a portion of the deferred tax asset valuation allowance.

Deposits

The following table is a summary of Bancorp’s deposits at December 31 for each of the years shown:


	2013		2012		2011
Non-interest bearing	$	55,358,161	$	65,176,125	$	65,613,374

Interest bearing
Certificates of deposit, less than $100,000		129,548,033		160,610,601		198,207,998
Certificates of deposit, $100,000 or more		106,387,098		121,142,374		144,405,859
Money markets		29,309,657		42,401,428		52,889,642
Savings		80,982,920		77,760,967		59,396,310
NOW		28,618,213		30,191,403		24,396,210

Total interest bearing		374,845,921		432,106,773		479,296,019

Total deposits (1)	$	430,204,082	$	497,282,898	$	544,909,393

(1)	Included in total deposits are $24.7 million of deposits held for sale at December 31, 2012.

Total deposits decreased $67.1 million, or 14%, to $430.2 million at December 31, 2013. During the second quarter, the bank sold $14.5 million of branch deposits. Interest bearing deposits decreased $57.3 million, or 13%, to $374.8 million while non-interest bearing deposits decreased $9.8 million, or 15%, to $55.4 million at December 31, 2013.

Certificates of deposit decreased by $45.8 million, which represents a decrease of 16% when compared to last year. Certificates of deposit less than $100,000 and certificates of deposit greater than $100,000 decreased by $31.1 million, or 19%, and $14.8 million, or 12%, respectively. This is a result of management intentionally allowing higher rate certificates of deposit to mature. Money market fund accounts decreased $13.1 million, or 31%. This is a result of the lower interest rates paid on these products in the current environment. NOW accounts decreased $1.6 million, or 5%. These were partially offset by an increase in savings accounts of $3.2 million, or 4% as compared to last year.

As of December 31, 2013, the Bank’s maturities of time deposits were:


	Less than		$100,000 or
	$100,000		greater		Totals
	(thousands of dollars)
Three months or less	$	45,351	$	37,461	$	82,812
Four to six months		33,323		22,055		55,378
Seven months to one year		32,417		29,948		62,365
Over one year		18,457		16,922		35,380

Total	$	129,548	$	106,387	$	235,935

Borrowings

Borrowings remain unchanged at $65.2 million at December 31, 2013 as compared to December 31, 2012. Borrowings at December 31, 2013 are comprised of $57 million in Federal Home Loan Bank Advances and $8.2 million in junior subordinated debentures. Borrowings at December 31, 2012 are comprised of $50 million in Federal Home Loan Bank Advances, $7 million in securities sold under repurchase agreements and $8.2 million in junior subordinated debentures.

The Bank had $57 million in short-term borrowings from the Federal Home Loan Bank outstanding at December 31, 2013 compared to no short-term borrowings at December 31, 2012. In addition, at December 31, 2013, the Bank had no advances from the Federal Home Loan Bank with maturities greater than one year, compared to $50 million in Federal Home Loan Bank advances for the same period in 2012.

Shareholders’ Equity

Shareholders’ equity decreased $7.7 million from $49.6 million at December 31, 2012 as compared to $41.8 million at December 31, 2013. This is the result of the net loss of $7.3 million and the $569,000 reduction of accumulated other comprehensive income, partially offset by equity award grants of $131,000.

Other

The aggregate cash surrender value of the bank-owned life insurance at December 31, 2013 increased $523,000 to $22.0 million due to income earned of $523,000 for the year.

The decrease in accrued interest receivable is due to lower outstanding balances in loans at year end and lower yields on the current portfolio.

Premises and equipment increased $10.8 million from $4.3 million at December 31, 2012 to $15.1 million at December 31, 2013. This is due primarily to the purchases of two branch locations of $11.3 million and equipment and software licenses of $278,000 and $125,000 respectively, partially offset by asset disposals of $616,000, in addition to the amortization associated with leasehold improvements, furniture and fixtures, and equipment.

The following table presents average balance sheets (daily averages), interest income, interest expense and the corresponding yields earned and rates paid:

Distribution of Assets, Liabilities and Shareholder’s Equity

Interest Rates and Interest Differential and Rate Volume Variance Analysis ⁽¹⁾

(thousands of dollars)


	2013								2012								2011								2013 vs. 2012 Fluctuations									2012 vs. 2011 Fluctuations
				Interest								Interest								Interest					Interest Income/Expense ⁽³⁾									Interest Income/Expense (3)
	Average			Income/		Average			Average			Income/		Average			Average			Income/		Average			Due to Change in:									Due to Change in:
	Balance			Expense		Rate			Balance			Expense		Rate			Balance			Expense		Rate			Volume			Rate			Total			Volume			Rate			Total
Interest earning assets:
Loans ⁽²⁾	$	454,849		$	20,706		4.55	%	$	494,333		$	23,482		4.75	%	$	487,826		$	25,958		5.32	%	$	(1,817	)	$	(959	)	$	(2,776	)	$	341		$	(2,817	)	$	(2,476	)
Federal funds sold and other cash equivalents		32,022			60		0.19	%		55,638			98		0.18	%		62,519			144		0.23	%		(42	)		4			(38	)		(16	)		(30	)		(46	)
Investments		49,070			888		1.81	%		60,799			1,636		2.69	%		80,121			2,230		2.78	%		(278	)		(469	)		(747	)		(524	)		(70	)		(594	)

Total interest earning assets	$	535,941		$	21,654		4.04	%	$	610,770		$	25,216		4.13	%	$	630,466		$	28,332		4.49	%		(2,137	)		(1,424	)		(3,561	)		(199	)		(2,917	)		(3,116	)

Cash and due from banks		3,337								4,660								19,695
Allowance for loan losses		(5,813	)							(7,771	)							(12,386	)
Other assets		35,328								32,206								37,572

Total Assets	$	568,793							$	639,865							$	675,347

Interest bearing liabilities:
Time certificates	$	253,714		$	3,422		1.35	%	$	313,693		$	4,932		1.57	%	$	343,625		$	5,947		1.73	%	$	(872	)	$	(638	)	$	(1,510	)	$	(492	)	$	(523	)	$	(1,015	)
Savings accounts		87,676			350		0.40	%		66,137			331		0.50	%		56,391			235		0.42	%		94			(75	)		19			36			60			96
Money market accounts		35,268			40		0.11	%		46,944			72		0.15	%		67,815			89		0.13	%		(15	)		(17	)		(32	)		(24	)		7			(17	)
NOW accounts		29,337			9		0.03	%		25,617			16		0.06	%		23,086			12		0.05	%		2			(9	)		(7	)		1			3			4
FHLB advances		43,818			666		1.52	%		54,320			1,459		2.69	%		50,000			1,632		3.26	%		(244	)		(549	)		(793	)		131			(304	)		(173	)
Subordinated debt		8,248			284		3.44	%		8,248			300		3.64	%		8,248			286		3.47	%		—			(16	)		(16	)		—			14			14
Other borrowings		1,860			82		4.41	%		7,000			309		4.41	%		7,000			309		4.41	%		(227	)		(0	)		(227	)		—			—			—

Total interest bearing liabilities	$	459,921		$	4,853		1.06	%	$	521,959		$	7,419		1.42	%	$	556,165		$	8,510		1.53	%		(1,262	)		(1,304	)		(2,566	)		(348	)		(743	)		(1,091	)

Demand deposits		59,892								61,586								57,548
Accrued expenses and other liabilities		4,606								5,370								5,705
Shareholder’s equity		44,374								50,950								55,929

Total liabilities and equity	$	568,793							$	639,865							$	675,347

Net interest income				$	16,801							$	17,797							$	19,822				$	(875	)	$	(120	)	$	(995	)	$	149		$	(2,174	)	$	(2,025	)

Interest margin							3.13	%							2.91	%							3.14	%

Interest spread							2.98	%							2.71	%							2.96	%

⁽¹⁾	The rate volume analysis reflects the changes in net interest income arising from changes in interest rates and from asset and liability volume, including mix. The change in interest attributable to volume includes changes in interest attributable to mix.

⁽²⁾	Includes non-accruing loans

⁽³⁾	Favorable/(unfavorable) fluctuations.

RESULTS OF OPERATIONS

Comparison of Results of Operations for the years 2013 and 2012

For the year ended December 31, 2013, Bancorp recorded a net loss of $7.3 million ($0.19 per share) compared to a net loss of $536,000 ($0.01 per share) for the year ended December 31, 2012.

Net interest income decreased 5.6% from $17.8 million for the year ended December 31, 2012 to $16.8 million for the year ended December 31, 2013. Total interest and dividend income was $3.6 million, or 14.13%, lower in 2013 compared to the prior year as a result of lower outstanding average earning assets, loan payoffs on loans carrying interest rates higher than current market rates and new loan originations at rates lower than maintained in the portfolios in 2012.

Total interest expense decreased from $7.4 million for the year ended December 31, 2012 to $4.9 million for the year ended December 31, 2013. Interest expense was lower in 2013 as a result of a decrease in the level of outstanding average interest bearing deposits, reduced dependence upon high cost term deposits as a funding source, the reduction in interest rates due to the prepayment of high cost FHLB borrowings and the overall lower interest rate environment.

Noninterest income was $2.4 million for the year ended December 31, 2013 compared to $3.3 million for the year ended December 31, 2012. The decrease was caused primarily from the gain on the sale of investment securities in 2012 of $911,000.

Total non-interest expense of $25.9 million for 2013 was $1.9 million higher than the $24.0 million recorded for 2012. Prepayment penalties on the high cost borrowings were $4.1 million. Restructuring charges relating to branch closings, asset disposals and reduction in back office personnel accounted for $522,000, compared to $939,000 in 2012. Salaries and benefits, occupancy and equipment expense and insurance expense all showed significant improvement primarily as a result of restructuring initiatives implemented in 2013. Regulatory assessments decreased $565,000 as a result of management’s ongoing strategies.

The following are measurements relating to Bancorp’s earnings:


	2013			2012			2011
Loss on average assets		(1.28	%)		(0.08	%)		(2.29	%)
Loss on average equity		(16.43	%)		(1.05	%)		(27.64	%)
Dividend payout ratio		N / A			N / A			N / A
Average equity to average assets		7.80	%		7.96	%		8.28	%
Loss per share	$	(0.19	)	$	(0.01	)	$	(0.40	)

Interest income and expense

Bancorp’s net interest income of $16.8 million for the year ended December 31, 2013 was $1.0 million, or 5.60% less than the $17.8 million recorded for the year ended December 31, 2012. Total interest and dividend income of $21.7 million was $3.4 million, or 14.13%, lower than the $25.2 million recorded in 2012. Average interest earning assets decreased from $610.8 million in 2012 to $535.9 million in 2013. Average loans outstanding decreased from $494.3 million to $454.8 million. The average yield on the portfolio decreased from 4.75% in 2012 to 4.55% in 2013. The lower yield on the portfolio was due to the pay off of loans in the portfolio at rates currently higher than market and the closing of new loans at rates currently lower than the average yield of the portfolio. Average investments outstanding during the year were $11.8 million lower than the $60.8 million maintained during 2012 as Bancorp did not want to commit additional funds to longer term investments during this historically low interest rate environment. The yield on the portfolio declined from 2.69% in 2012 to 1.81% in 2013 due to sales of higher yielding instruments in 2012. Cash equivalents decreased from an average outstanding of $55.6 million in 2012 to $32.0 million in 2013 with a corresponding yield of 18 basis points for both years. The reduction in excess liquidity was used to pay off higher yielding certificates of deposits and high cost borrowings, and therefore, had a positive impact on the net interest margin.

Total interest expense decreased from $7.4 million in 2012 to $4.9 million in 2013. The variance of $2.6 million, or 35%, was due to both lower levels of average outstanding interest bearing liabilities and a significant reduction in the cost of funds for the deposit portfolio and FHLB advances. Total interest expense on certificates of deposit decreased by $1.5 million, or 31%, from $4.9 million in 2012 to $3.4 million in 2013. The portfolio dropped from $313.7 million with a cost of funds of 1.57% to $253.7 million in 2013 at a cost of 1.35%. The reduction in the portfolio was based upon management’s strategy to use overnight investments to pay off rate sensitive certificates of deposit as they mature thereby improving the net interest margin and strengthening the overall capital position. Savings accounts increased by $21.5 million during the year based upon the growth in a new core relationship product with a short term promotional introductory rate. The overall cost of funds for savings decreased by 10 basis points during the year and interest expense increased by $19,000. Interest expense on FHLB advances decreased by $793,000, or 54%, as Bancorp restructured certain high cost advances in 2013 by lowering the average cost of funds from 2.69% to 1.52%. Total borrowings remain unchanged at $57.0 million as of both December 31, 2012 and December 31, 2013.

Management regularly reviews loan and deposit rates and attempts to price Bancorp’s products competitively. Bancorp tracks its mix of asset/liability maturities and strives to maintain a reasonable match. Performance ratios are reviewed monthly by management and the Board and are used to set strategies.

Provision for loan losses

During 2013 Bancorp recorded a provision of $1.0 million compared to a credit to the provision of approximately $2.4 million in 2012. The $1.0 million charge to the provision was a specific reserves for one loan. The $2.4 million credit to the provision for 2012 was based upon management’s evaluation of the adequacy of the allowance for loan losses. Overall credit quality has improved and recoveries from previously charged-off loans were $363,000 in 2013 compared to $80,000 in 2012. Total criticized loans decreased by $39.6 million from $67.8 million at December 31, 2012 to $28.2 million at December 31, 2013. Bancorp continues to maintain conservative underwriting standards including minimum loan to value ratios. In addition, the size of the loan portfolio has been reduced with loans receivable of $418.1 million at December 31, 2013 being $40.6 million, or 9%, lower than the prior year end. During the second quarter of 2012 management implemented changes to the methodology for calculating the allowance for loan losses in order to enhance the methodology and better reflect the direction of the loan portfolio.

A more detailed description of the change in methodology and an analysis of the change in the allowance for loan losses is presented under the discussion entitled “Allowance for Loan Losses” within the critical accounting policies section above.

Non-interest income

Non-interest income decreased by $848,000, or 26%, from $3.3 million in 2012 to $2.4 million in 2013. Gains on the sale of investment securities and loans were lower by $911,000 and $308,000, respectively, primarily due to investment sales and bulk loan sales in 2012. Excluding these non-recurring items non-interest income increased in 2013. Fees and service charges were lower by $113,000, or 13%, primarily due to a reduction in the size of the balance sheet. These decreases in non-interest income were more than offset by an increase in loan applications, inspection and processing fees of $147,000, an increase in mortgage banking activity of $92,000 and the gain recognized on the sale of branch assets and deposits of $51,000.

Non-interest expense

Non-interest expense increased $1.9 million, or 8%, from $24.0 million for the year ended December 31, 2012 to $25.9 million for the year ended December 31, 2013. Prepayment penalties on the high cost borrowings were $4.1 million of the increase, partially offset with lower restructuring charges of $418,000. Excluding these non-recurring expenses, non-interest expense decreased by 1.8 million. Salaries and benefits were reduced by $0.9 million, or 8%, in 2013, occupancy and equipment expense was lower by $509,000, or 12% and insurance expense decreased $157,000, primarily due to fewer branch facilities requiring property and casualty insurance. Regulatory assessments decreased $565,000. Data processing expense decreased $173,000 primarily due to changes in a service contract.

Income Taxes

As of December 31, 2013, Bancorp continued to maintain a full valuation allowance of $18.1 million against the net deferred tax asset. The possibility of further loan losses, coupled with Bancorp’s losses which began in the third quarter of 2008, creates sufficient uncertainty regarding the Company’s ability to realize these deferred tax assets. In future periods, if it becomes more likely that these assets can be utilized, Bancorp may reverse some or all of the valuation allowance. Evidence to substantiate reversing the allowance would include sustained profitability.

Comparison of Results of Operations for the years 2012 and 2011

Bancorp recorded improved operating results for the year ended December 31, 2012, reporting a net loss of $536,000 ($0.01 per share) compared to a net loss of $15.5 million ($0.40 per share) for the year ended December 31, 2011. The primary reasons for the improved operating performance were a reduction in the provision for loan losses of $9.8 million, a decrease in restructuring charges and asset disposals of $2.0 million, lower salaries and benefits and occupancy and equipment expense of $2.3 million as a result of the restructuring charges recorded in 2011 and an improvement of $936,000 in other real estate operations due to fewer properties acquired through foreclosure.

Net interest income decreased 10% from $19.8 million for the year ended December 31, 2011 to $17.8 million for the year ended December 31, 2012. Total interest and dividend income was $3.1 million, or 11%, lower in 2012 compared to the prior year as a result of lower outstanding average earning assets, loan payoffs on loans carrying interest rates higher than current market rates and new loan originations and investment purchases at rates lower than maintained in the portfolios in 2011.

Total interest expense decreased from $8.5 million for the year ended December 31, 2011 to $7.4 million for the year ended December 31, 2012. Interest expense was lower in 2012 as a result of a decrease in the level of outstanding average interest bearing deposits, reduced dependence upon high cost term deposits as a funding source and the overall lower interest rate environment.

Noninterest income was $3.3 million for the year ended December 31, 2012 compared to $3.4 million for the year ended December 31, 2011. The variance was caused primarily from a reduction of $108,000 in fees and service charges.

Total non-interest expense of $24.0 million for 2012 was $7.2 million lower than the $31.2 million recorded for 2011. Restructuring charges relating to branch closings and asset disposals and reduction in back office personnel accounted for $2.0 million of the reduction. Lower expenses from other real estate operations accounted for a $936,000 improvement in total operating costs. Salaries and benefits, occupancy and equipment expense, professional and outside services and advertising and promotional expense all showed significant improvement as a result of cost containment programs implemented in 2011.

The following are measurements relating to Bancorp’s earnings:


	2012			2011			2010
Loss on average assets		(0.08	%)		(2.29	%)		(1.89	%)
Loss on average equity		(1.05	%)		(27.64	%)		(37.88	%)
Dividend payout ratio		N / A			N / A			N / A
Average equity to average assets		7.96	%		8.28	%		4.98	%
Loss per share	$	(0.01	)	$	(0.40	)	$	(1.30	)

Interest income and expense

Bancorp’s net interest income of $17.8 million for the year ended December 31, 2012 was $2.0 million, or 10% less than the $19.8 million recorded for the year ended December 31, 2011. Total interest and dividend income of $25.2 million was $3.1 million, or 11%, lower than the $28.3 million recorded in 2011. Average interest earning assets decreased from $630.5 million in 2011 to $610.8 million in 2012. Average loans outstanding increased slightly from $487.8 million to $494.3 million. The average yield on the portfolio decreased from 5.32% in 2011 to 4.75% in 2012. The lower yield on the portfolio was due to the pay off of loans in the portfolio at rates currently higher than market and the closing of new loans at rates currently lower than the average yield of the portfolio. Average investments outstanding during the year were $19.3 million lower than the $80.1 million maintained during 2011 as Bancorp did not want to commit additional funds to longer term investments during this historically low interest rate environment. The yield on the portfolio declined slightly from 2.78% in 2011 to 2.69% in 2012 due to sales of higher yielding instruments. Cash equivalents decreased from an average outstanding of $62.5 million in 2011 to $55.6 million in 2012 with a corresponding drop in yield from 23 basis points to 18 basis points. The reduction in excess liquidity was used to pay off higher yielding certificates of deposit, and therefore, had a positive impact on the net interest margin.

Total interest expense decreased from $8.5 million in 2011 to $7.4 million in 2012. The variance of $1.1 million, or 13%, was due to both lower levels of average outstanding interest bearing liabilities and a significant reduction in the cost of funds for the certificates of deposit portfolio. Total interest expense on certificates of deposit decreased by $1.0 million, or 17%, from $5.9 million in 2011 to $4.9 million in 2012. The portfolio dropped from $343.6 million with a cost of funds of 1.73% to $313.7 million in 2012 at a cost of 1.57%. The reduction in the portfolio was based upon management’s strategy to use overnight investments to pay off rate sensitive certificates of deposit as they mature thereby improving the net interest margin and strengthening the overall capital position. Savings accounts increased by $9.7 million during the year based upon the growth in a new core relationship product with a short term promotional introductory rate. The overall cost of funds for savings increased by 8 basis points during the year and interest expense increased by $100,000. Interest expense on FHLB advances decreased by $173,000, or 11%, as Bancorp restructured certain outstanding advances in the fourth quarter of 2011 by extending the term and lowering the rate. Outstanding advances remain at $50 million as of both December 31, 2011 and December 31, 2012.

Provision for loan losses

During 2011 Bancorp recorded a charge to the provision for loan losses of $7.5 million compared to a credit to the provision of $2.4 million in 2012. The $7.5 million provision in 2011 was primarily related to $6.0 million of loans transferred to held-for-sale in connection with a bulk loan sale of problem assets. The $2.4 million credit to the provision for 2012 was based upon management’s evaluation of the adequacy of the allowance for loan losses. Overall credit quality has improved and charge offs are down from $8.3 million in 2011 to $1.1 million in 2012. Bancorp continues to maintain conservative underwriting standards including low loan to value ratio guidelines. In addition, the size of the loan portfolio has been significantly reduced with loans receivable of $458.8 million at December 31, 2012 being $42.4 million, or 8%, lower than the prior year end. During the second quarter of 2012 management implemented changes to the methodology for calculating the allowance for loan losses in order to enhance the methodology and better reflect the direction of the loan portfolio.

Non-interest income

Non-interest income decreased by $138,000, or 4%, from $3.4 million in 2011 to $3.3 million in 2012. Fees and service charges were lower by $108,000, or 11%, primarily due to a reduction in the size of the balance sheet. Gain on the sale of investment securities was lower by $199,000. Earnings on the cash surrender value of life insurance were down by $119,000, or 19%, due to the lower interest rate environment. These decreases in non-interest income were partially offset by an increase in the gain on the bulk sale of residential loans of $257,000 and an increase in mortgage banking activity of $105,000.

Non-interest expense

Non-interest expense decreased $7.2 million, or 23%, from $31.2 million for the year ended December 31, 2011 to $24.0 million for the year ended December 31, 2012. Restructuring charges and asset disposals accounted for $2.0 million of the decrease as total charges in 2011 of $3.0 million related to the closing of four branches and the reduction in force of back office personnel. Primarily as a result of that restructuring, salaries and benefits were reduced by $1.8 million, or 15%, in 2012 and occupancy and equipment expense was lower by $512,000, or 10%. As a result of improved credit quality and reduced foreclosure activity, other real estate operations were reduced by $936,000. Professional and other outside services decreased from $3.4 million in 2011 to $2.6 million, or 24%, consisting primarily of legal and consulting services relating to loan collection activity. Advertising and promotional expense was lower by $487,000, or 85%, as marketing activities were scaled back in accordance with the overall plan to reduce the size of the balance sheet. The decrease of $398,000, or 46%, in insurance expense is primarily related to lower premiums on D&O insurance coverage and fewer branch facilities requiring property and casualty insurance.

Income Taxes

As of December 31, 2012, Bancorp continued to maintain a full valuation allowance of $15.0 million against the net deferred tax asset. The possibility of further loan losses and higher cost levels associated with carrying nonperforming assets, coupled with Bancorp’s losses beginning in the third quarter of 2008, creates sufficient uncertainty regarding the Company’s ability to realize these deferred tax assets. In future periods, if it becomes more likely that these assets can be utilized, Bancorp may reverse some or all of the valuation allowance. Evidence to substantiate reversing the allowance would include sustained profitability.

LIQUIDITY

Bancorp’s liquidity position was 13% and 18% at December 31, 2013 and 2012, respectively. The liquidity ratio is defined as the percentage of liquid assets to total assets. The following categories of assets as described in the accompanying consolidated balance sheets are considered liquid assets: cash and due from banks, federal funds sold, short-term investments and available-for-sale securities. Liquidity is a measure of Bancorp’s ability to generate adequate cash to meet financial obligations. The principal cash requirements of a financial institution are to cover increases in its loan portfolio and downward fluctuations in deposit accounts. Management believes Bancorp’s short-term assets provide sufficient liquidity to satisfy loan demand, cover potential fluctuations in deposit accounts and to meet other anticipated cash requirements.

In addition, the Company has historically had a high retention rate of maturing certificates of deposit. The Company has the ability to modify the rate of retention by adjusting rates and terms on various deposit products.

At December 31, 2013, cash and cash equivalents and securities classified as available-for-sale were $34.9 million and $37.7 million, respectively. In addition to Federal Home Loan Bank advances outstanding at December 31, 2013, the Bank had the ability to borrow an additional $39.0 million from the Federal Home Loan Bank of Boston, which included a $2.0 million overnight line of credit. At December 31, 2013 the Bank had $57.0 million in Federal Home Loan Bank advances, none of which were under the overnight line of credit. The Bank also has the ability to borrow from the Federal Reserve Bank.

The following table presents Bancorp’s contractual obligations as of December 31, 2013:


			Less than		One to		Three to		Over five
	Total		one year		three years		five years		years
Certificates of deposit	$	235,935,131	$	200,555,373	$	22,176,069	$	13,203,689	$	—
Junior subordinated debt owed to unconsolidated trust		8,248,000		—		—		—		8,248,000
FHLB Advances		57,000,000		57,000,000		—		—		—
Operating lease obligations		3,812,637		1,638,568		1,991,091		182,978		—

Total contractual obligations	$	304,995,768	$	259,193,941	$	24,167,160	$	13,386,667	$	8,248,000

OFF-BALANCE SHEET ARRANGEMENTS

The following table presents Bancorp’s off-balance sheet commitments as of December 31, 2013. These commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee by the borrower. Since these commitments could expire without being drawn upon or are contingent upon the customer adhering to the terms of the agreements, the total commitment amounts do not necessarily represent future cash requirements.


Future loan commitments	$	7,102,437
Home equity lines of credit		28,707,608
Unused lines of credit		40,207,868
Undisbursed construction loans		2,187,752
Financial standby letters of credit		1,117,997

Total commitments	$	79,323,662

REGULATORY CAPITAL REQUIREMENTS

The Company’s and the Bank’s actual capital amounts and ratios at December 31, 2013 and 2012 were:


											To Be Well
											Capitalized Under
						For Capital					Prompt Corrective
	Actual					Adequacy Purposes					Action Provisions
2013	Amount		Ratio			Amount		Ratio			Amount		Ratio
The Company:
Total Capital (to Risk Weighted Assets)	$	56,060		13.95	%	$	43,300		8.00	%	$	N/A		N/A
Tier 1 Capital (to Risk Weighted Assets)		51,027		12.70	%		21,650		4.00	%		N/A		N/A
Tier 1 Capital (to Average Assets)		51,027		9.33	%		21,888		4.00	%		N/A		N/A
The Bank:
Total Capital (to Risk Weighted Assets)	$	55,758		13.86	%	$	43,270		8.00	%	$	54,087		10.00	%
Tier 1 Capital (to Risk Weighted Assets)		50,730		12.61	%		21,635		4.00	%		32,452		6.00	%
Tier 1 Capital (to Average Assets)		50,730		9.28	%		21,872		4.00	%		27,340		5.00	%


											To Be Well
											Capitalized Under
						For Capital					Prompt Corrective
	Actual					Adequacy Purposes					Action Provisions
2012	Amount		Ratio			Amount		Ratio			Amount		Ratio
The Company:
Total Capital (to Risk Weighted Assets)	$	63,253		15.64	%	$	49,447		8.00	%	$	N/A		N/A
Tier 1 Capital (to Risk Weighted Assets)		58,186		14.39	%		24,724		4.00	%		N/A		N/A
Tier 1 Capital (to Average Assets)		58,186		9.33	%		24,948		4.00	%		N/A		N/A
The Bank:
Total Capital (to Risk Weighted Assets)	$	61,908		15.31	%	$	49,447		8.00	%	$	61,808		10.00	%
Tier 1 Capital (to Risk Weighted Assets)		56,840		14.05	%		24,723		4.00	%		37,085		6.00	%
Tier 1 Capital (to Average Assets)		56,840		9.11	%		24,952		4.00	%		31,190		5.00	%

Capital adequacy is one of the most important factors used to determine the safety and soundness of individual banks and the banking system. Under the regulatory framework for prompt correction action, to be considered “well capitalized,” an institution must generally have a leverage capital ratio of at least 5%, a Tier 1 risk-based capital ratio of at least 6% and a total risk-based capital ratio of at least 10%. However, the OCC has the discretion to require increased capital levels.

Management continuously assesses the adequacy of the Bank’s capital with the goal to maintain a “well capitalized” classification.

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

MARKET RISK

Market risk is defined as the sensitivity of income to fluctuations in interest rates, foreign exchange rates, equity prices, commodity prices and other market-driven rates or prices. Based upon the nature of Bancorp’s business, market risk is primarily limited to interest rate risk, which is the impact, that changing interest rates have on current and future earnings.

Qualitative Aspects of Market Risk

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

The exposure to interest rate risk is monitored by the Management Asset and Liability Committee consisting of senior management personnel. The Committee meets on a monthly basis, but may convene more frequently as conditions dictate. The Committee reviews the interrelationships within the balance sheet to maximize net interest income within acceptable levels of risk. This Committee reports to the Board of Directors on a monthly basis regarding its activities. In addition to the Management Asset Liability Committee, there is a Board Asset and Liability Committee (“ALCO”), which meets quarterly. ALCO monitors the interest rate risk analyses, reviews investment transactions during the period and determines compliance with Bank policies.

Quantitative Aspects of Market Risk

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

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

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

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


Net Interest Income and Economic Value
Summary Performance
December 31, 2013
	Net Interest Income								Net Portfolio Value
Projected Interest	Estimated		$ Change			% Change			Estimated		$ Change			% Change
Rate Scenario	Value		from Base			from Base			Value		from Base			from Base
+ 200		16,147		(780	)		-4.61	%		59,238		(11,808	)		-16.62	%
+ 100		16,656		(271	)		-1.60	%		65,079		(5,967	)		-8.40	%
BASE		16,927		—			—			71,046		—			—
- 100		17,124		197			1.16	%		78,332		7,286			10.26	%
- 200		16,864		(63	)		-0.37	%		82,687		11,641			16.39	%

December 31, 2012
	Net Interest Income								Net Portfolio Value
Projected Interest	Estimated		$ Change			% Change			Estimated		$ Change			% Change
Rate Scenario	Value		from Base			from Base			Value		from Base			from Base
+ 200		21,113		2,434			13.03	%		46,403		(8,067	)		-14.81	%
+ 100		20,011		1,332			7.13	%		50,576		(3,894	)		-7.15	%
BASE		18,679		—			—			54,470		—			—
- 100		18,873		194			1.04	%		58,725		4,255			7.81	%
- 200		18,819		140			0.75	%		69,726		15,256			28.01	%

Impact of Inflation and Changing Prices

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

Item 8.

Financial Statements and Supplementary Data

The consolidated balance sheets of Bancorp as of December 31, 2013 and December 31, 2012 and the related consolidated statements of operations, comprehensive income, shareholders’ equity and cash flows for the years ended December 31, 2013, December 31, 2012 and December 31, 2011, together with the Report of Independent Registered Public Accounting Firm thereon are included as part of this Form 10-K in the “Financial Report” following page 67 hereof.

The following table presents selected quarterly financial information (unaudited):


	First			Second			Third			Fourth
	Quarter			Quarter			Quarter			Quarter
2013:
Interest income	$	5,500,846		$	5,309,621		$	5,613,497		$	5,230,139
Interest expense		1,626,444			1,276,840			1,082,335			867,966
Net interest income		3,874,402			4,032,781			4,531,162			4,362,173
Provision for loan losses		(29,786	)		—			1,000,000			—
Non-interest income		487,481			768,502			560,023			609,709
Non-interest expense		6,369,716			8,713,114			6,461,133			4,339,786
(Loss) income before income taxes		(1,978,047	)		(3,911,831	)		(2,369,948	)		632,096
Benefit for income taxes		(21,080	)		—			—			(317,704	)
Net (loss) income	$	(1,956,967	)	$	(3,911,831	)	$	(2,369,948	)	$	949,800
Net (loss) income per common share:
Basic and diluted	$	(0.05	)	$	(0.10	)	$	(0.06	)	$	0.03

2012:
Interest income	$	7,186,581		$	6,310,430		$	5,983,118		$	5,736,388
Interest expense		2,027,174			1,927,365			1,750,642			1,714,271
Net interest income		5,159,407			4,383,065			4,232,476			4,022,117
Provision for loan losses		(845,402	)		(1,713,425	)		—			179,604
Non-interest income		749,997			455,100			1,456,712			611,687
Non-interest expense		6,209,276			6,206,308			5,671,163			5,899,201
Income (loss) before income taxes		545,530			345,282			18,025			(1,445,001	)
Provision for income taxes		—			—			—			—
Net income (loss)	$	545,530		$	345,282		$	18,025		$	(1,445,001	)
Net income (loss) per common share:
Basic and diluted	$	0.01		$	0.01		$	—		$	(0.03	)

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

Item 9A.

Controls and Procedures

Based on an evaluation of the effectiveness of Bancorp’s disclosure controls and procedures performed by Bancorp’s management, with the participation of Bancorp’s Chief Executive Officer and its Chief Financial Officer as of the end of the period covered by this report, Bancorp’s Chief Executive Officer and Chief Financial Officer concluded that Bancorp’s disclosure controls and procedures have been effective.

As used herein, “disclosure controls and procedures” mean controls and other procedures of Bancorp that are designed to ensure that information required to be disclosed by Bancorp in the reports that it files or submits under the Securities Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by Bancorp in the reports that it files or submits under the Securities Exchange Act is accumulated and communicated to Bancorp’s management, including its principal executive, and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

There were no changes in Bancorp’s internal control over financial reporting identified in connection with the evaluation described in the preceding paragraph that occurred during Bancorp’s fiscal year ended December 31, 2013 that has materially affected, or is reasonably likely to materially affect, Bancorp’s internal controls over financial reporting.

Item 9B.

Other Information

Management’s Report on Internal Control Over Financial Reporting

The management of Patriot National Bancorp, Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process designed so as to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America.

The Company’s internal control over financial reporting includes those policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and deployment of the assets of the Company and also provide reasonable assurance that transactions are recorded in a timely manner to enable the preparation of financial statements in accordance with accounting principles generally accepted in the United States of America and that receipts and disbursements of the Company are made only in compliance with the authorizations established by management and the directors of the Company, and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

Due to its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. In addition, projections of any evaluations of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and/or procedures may deteriorate.

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2013, based on the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control – Integrated Framework (1992). Based on that assessment, management concluded that as of December 31, 2013, the Company’s internal control over financial reporting is effective based on the criteria established in Internal Control – Integrated Framework (1992).

PART III

Item 10.

Directors, Executive Officers and Corporate Governance

The information required by Items 401, 405, 406 and 407 (c)(3); (d)(4) and (d)(5) of Regulation S-K is incorporated into this Form 10-K by reference to Bancorp’s definitive proxy statement (the “Definitive Proxy Statement”) for its 2014 Annual Meeting of Shareholders, to be filed within 120 days following December 31, 2013.

The Company has adopted a Code of Ethics for its senior financial officers. The information required by Item 406 is contained in Exhibit 14 to this Form 10-K. A copy of this Code of Ethics will be provided to any person so requesting by writing to Patriot National Bancorp, Inc., 900 Bedford Street, Stamford, Connecticut 06901, Attn: Christina L. Maier, Chief Financial Officer.

Item 11.

Executive Compensation

The information required by Item 402 of Regulation S-K is incorporated into this Form 10-K by reference to the Definitive Proxy Statement.

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters

The information required by Item 201(d) and Item 403 of Regulation S-K is incorporated into this Form 10-K by reference to the Definitive Proxy Statement, which section is incorporated herein by reference.

The table below provides information as of December 31, 2013, with respect to the compensation plan under which equity securities of the Company are authorized for issuance to directors, officers or employees.


Plan category	Number of common shares to be issued upon vesting of restricted stock shares		Weighted average grant date fair value		Number of common shares remaining available for future issuance under the share-based compensation plan (excluding common shares reflected in first column)
Equity compensation plans approved by security holders		281,835	$	1.26		2,552,964
Equity compensation plans not approved by security holders		—		—		—

Total		281,835	$	1.26		2,552,964

Item 13.

Certain Relationships and Related Transactions, and Director Independence

The information required by Items 404 and 407(a) of Regulation S-K is incorporated into this Form 10-K by reference to the Definitive Proxy Statement.

Item 14.

Principal Accountant Fees and Services

The information required by Item 9(e) of Schedule 14A of Regulation S-K is incorporated into this Form 10-K by reference to the Definitive Proxy Statement.

Part IV

Item 15.

Exhibits and Financial Statement Schedules

(a) Exhibits


Exhibit No.		Description

2.1		Securities Purchase Agreement by and among Patriot National Bancorp, Inc., Patriot National Bank and PNBK Holdings LLC dated as of December 16, 2009 (incorporated by reference to Exhibit 10.1 to Bancorp’s Current Report on Form 8-K dated December 17, 2009).

2.2		Amendment to Securities Purchase Agreement by and among Patriot National Bancorp, Inc., Patriot National Bank and PNBK Holdings LLC dated as of May 3, 2010 (incorporated by reference to Exhibit 10(a) to Bancorp’s Current Report on Form 8-K dated May 4, 2010).

3(i)		Certificate of Incorporation of Bancorp, (incorporated by reference to Exhibit 3(i) to Bancorp’s Current Report on Form 8-K dated December 1, 1999 (Commission File No. 000-29599)).

3(i)(A)		Certificate of Amendment of Certificate of Incorporation of Patriot National Bancorp, Inc. dated July 16, 2004 (incorporated by reference to Exhibit 3(i)(A) to Bancorp’s Annual Report on Form 10-KSB for the year ended December 31, 2004 (Commission File No. 000-29599)).

3(i)(B)		Certificate of Amendment of Certificate of Incorporation of Patriot National Bancorp, Inc. dated June 15, 2006 (incorporated by reference to Exhibit 3(i)(B) to Bancorp’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2006 (Commission File No. 000-29599)).

3(i)(C)		Certificate of Amendment of Certificate of Incorporation of Patriot National Bancorp, Inc. (incorporated by reference to Exhibit 3(i) to Bancorp’s current report Form 8-K dated October 21, 2010.

3(ii)		Amended and Restated By-laws of Bancorp (incorporated by reference to Exhibit 3(ii) to Bancorp’s Current Report on Form 8-K dated November 1, 2010 (Commission File No. 000-29599)).

10(a)(2)		2012 Stock Plan of Bancorp (incorporated by reference from Annex A to the Proxy Statement on Form 14C filed November 1, 2011.


Exhibit No.		Description

10(a)(14)		Change of Control Agreement, dated as of January 1, 2007 among Philip W. Wolford, Patriot National Bank and Bancorp (incorporated by reference to Exhibit 10(a)(14) to Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2006 (Commission File No. 000-29599)).

10(a)(15)		Formal Written Agreement between Patriot National Bank and the Office of the Comptroller of the Currency (incorporated by reference to Exhibit 10(a)(15) to Bancorp’s Current Report on Form 8-K dated February 9, 2009 (Commission File No. 000-29599)).

10(a)(16)		Formal Written Agreement between Patriot National Bank and the Federal Reserve Bank of New York (incorporated by reference to Exhibit 10(a)(16) to Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2010 (Commission File No. 000-29599)).

10(a)(17)		Financial Services Agreement dated November 8, 2011 of Bancorp (incorporated by reference to Exhibit10(a)(20) on the Quarterly Report on Form10-Q dated November 10, 2011. (Commission File No. 000-29599)).

10(a)(18)		Employment letter between Kenneth T. Neilson, Bancorp and Patriot National Bank dated July 9, 2013 (incorporated by reference to Exhibit 10(a)(18) on the Quarterly Report on Form 10-Q dated August 12, 2013 (Commission File No. 000-29599)).

10(a)(19)		Employment agreement, dated as of July 9, 2013, by and among Patriot National Bancorp, Inc., Patriot National Bank and Kenneth T. Neilson (incorporated by reference to Exhibit 10.1 on Bancorp’s Current Report on Form 8-K dated February 5, 2014 (Commission File No. 000-29599)).

10(a)(20)		Letter Agreement, dated as of February 3, 2014, by and among Patriot National Bancorp, Inc., Patriot National Bank and Kenneth T. Neilson (incorporated by reference to Exhibit 10.2 on Bancorp’s Current Report on Form 8-K dated February 5, 2014 (Commission File No. 000-29599)).

14		Code of Conduct for Senior Financial Officers (incorporated by reference to Exhibit 14 to Bancorp’s Annual Report on Form 10-KSB for the year ended December 31, 2004 (Commission File No. 000-29599)).

21		Subsidiaries of Bancorp (Incorporated by reference to Exhibit 21 to Bancorp’s Annual Report on Form 10-KSB for the year ended December 31, 1999 (Commission File No. 000-29599)).

23.1		Consent of KPMG LLP

31(1)		Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer

31(2)		Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer

32		Section 1350 Certification


Exhibit No.		Description

101.INS#		XBRL Instance Document

101.SCH#		XBRL Schema Document

101.CAL#		XBRL Calculation Linkbase Document

101.LAB#		XBRL Labels Linkbase Document

101.PRE#		XBRL Presentation Linkbase Document

101.DEF#		XBRL Definition Linkbase Document

The exhibits marked with the section symbol (#) are interactive data files.

SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


Patriot National Bancorp, Inc.
(Registrant)

By:		/s/ Kenneth T. Neilson
		Name: Kenneth T. Neilson
		Title: Chief Executive Officer

Date: March 25, 2014

In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in capacities and on the dates indicated.


/s/ Kenneth T. Neilson				March 25, 2014
Kenneth T. Neilson				Date
President, Chief Executive Officer and
Director

/s/ Christina L. Maier				March 25, 2014
Christina L. Maier				Date
Executive Vice President and
Chief Financial Officer

/s/ Michael A. Carrazza				March 25, 2014
Michael A. Carrazza				Date
Chairman of the Board

Form 10 K – Signatures continued


/s/ Edward Constantino				March 25, 2014
Edward Constantino				Date
Director

/s/ Raymond Smyth				March 25, 2014
Raymond Smyth				Date
Director

/s/ Emile Van den Bol				March 25, 2014
Emile Van den Bol				Date
Director

/s/ Michael Weinbaum				March 25, 2014
Michael Weinbaum				Date
Director

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders

Patriot National Bancorp, Inc.:

We have audited the accompanying consolidated balance sheets of Patriot National Bancorp, Inc. and subsidiary (the Company) as of December 31, 2013 and 2012 and the related consolidated statements of operations, comprehensive income, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2013. These consolidated financial statements are the responsibility of the Company’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 the standards of the Public Company Accounting Oversight Board (United States). 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 National Bancorp, Inc. and subsidiary as of December 31, 2013 and 2012, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2013, in conformity with U.S. generally accepted accounting principles.

KPMG LLP

Stamford, Connecticut

March 25, 2014

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

December 31, 2013 and 2012


	2013			2012
ASSETS
Cash and due from banks (Note 2):
Noninterest bearing deposits and cash	$	1,570,411		$	2,736,486
Interest bearing deposits		33,295,470			67,567,155
Short-term investments		—			710,766

Total cash and cash equivalents		34,865,881			71,014,407
Securities
Available for sale securities, at fair value (Note 3)		37,701,356			41,719,320
Other Investments		4,450,000			3,500,000
Federal Reserve Bank stock, at cost		1,444,300			1,730,200
Federal Home Loan Bank stock, at cost (Note 8)		4,142,600			4,343,800

Total securities		47,738,256			51,293,320
Loans receivable (net of allowance for loan losses: 2013: $5,680,689 2012: $6,015,636) (Notes 4 and 18)		418,148,323			458,793,536
Loans held for sale		—			1,527,299
Accrued interest and dividends receivable		1,566,415			1,894,292
Premises and equipment, net (Notes 5 and 9)		15,061,438			4,288,372
Cash surrender value of bank owned life insurance (Note 12)		22,024,770			21,501,703
Other real estate owned (Note 6)		—			4,873,844
Deferred tax asset, net of valuation allowance (Note 10)		—			—
Other assets (Note 11)		1,843,043			2,580,118
Other branch related assets held for sale		—			88,244

Total assets	$	541,248,126		$	617,855,135

LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits (Notes 7 and 18):
Noninterest bearing deposits	$	55,358,161		$	61,459,959
Interest bearing deposits		374,845,921			411,117,558
Deposits held for sale		—			24,705,381

Total deposits		430,204,082			497,282,898
Borrowings (Note 8)
Repurchase agreements		—			7,000,000
Federal Home Loan Bank borrowings		57,000,000			50,000,000

Total borrowings		57,000,000			57,000,000
Junior subordinated debt owed to unconsolidated trust (Note 8)		8,248,000			8,248,000
Accrued expenses and other liabilities		3,955,356			5,756,439

Total liabilities		499,407,438			568,287,337

Commitments and Contingencies (Notes 8, 9 and 15)
Shareholders’ equity (Notes 13 and 17)
Preferred stock, no par value; 1,000,000 shares authorized, no shares issued and outstanding		—			—
Common stock, $.01 par value, 100,000,000 shares authorized; 2013: 38,786,680 shares issued; 38, 774, 975 shares outstanding. 2012: 38,491,819 shares issued; 38,480,114 shares outstanding		387,867			384,918
Additional paid-in capital		105,483,417			105,355,680
Accumulated deficit		(62,683,941	)		(55,394,995	)
Less: Treasury stock, at cost: 2013 and 2012 11,705 shares		(160,025	)		(160,025	)
Accumulated other comprehensive (loss) income		(1,186,630	)		(617,780	)

Total shareholders’ equity		41,840,688			49,567,798

Total liabilities and shareholders’ equity	$	541,248,126		$	617,855,135

See Accompanying Notes to Consolidated Financial Statements.

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS

Years Ended December 31, 2013, 2012 and 2011


	2013			2012			2011
Interest and Dividend Income
Interest and fees on loans	$	20,705,543		$	23,482,365		$	25,957,563
Interest on investment securities		774,590			1,507,614			1,990,248
Dividends on investment securities		113,467			128,297			240,025
Interest on federal funds sold		—			—			6,875
Other interest income		60,503			98,241			137,598

Total interest and dividend income		21,654,103			25,216,517			28,332,309

Interest Expense
Interest on deposits		3,821,307			5,351,477			6,283,578
Interest on Federal Home Loan Bank borrowings		666,176			1,458,894			1,632,378
Interest on subordinated debt		284,103			299,683			285,936
Interest on other borrowings		81,999			309,398			308,551

Total interest expense		4,853,585			7,419,452			8,510,443

Net interest income		16,800,518			17,797,065			19,821,866
Provision for Loan Losses (Note 4)		970,214			(2,379,223	)		7,464,427

Net interest income after provision for loan losses		15,830,304			20,176,288			12,357,439

Non-interest Income
Mortgage banking activity		255,580			163,804			58,440
Loan application, inspection and processing fees		248,647			101,339			78,613
Fees and service charges		743,895			856,604			964,796
Gain on sale of loans		28,310			336,274			79,729
Net gain on sale of investment securities		—			910,591			1,109,305
Gain on sale of branch asets and deposits		50,643			—			—
Earnings on cash surrender value of bank owned life insurance		523,067			517,099			636,272
Other income		575,573			387,785			484,322

Total non-interest income		2,425,715			3,273,496			3,411,477

Non-interest Expense
Salaries and benefits (Notes 9,13 and 15)		9,702,350			10,593,018			12,395,120
Occupancy and equipment expense		3,910,515			4,419,260			4,931,152
Data processing expense		1,296,273			1,468,551			1,286,170
Advertising and promotional expense		217,099			86,338			573,495
Professional and other outside services		2,835,423			2,601,133			3,406,640
Loan administration and processing expense		220,370			137,192			271,025
Regulatory assessments		1,159,387			1,724,224			1,992,865
Insurance expense		314,534			471,057			869,479
Other real estate operations (Note 6)		211,687			(58,044	)		877,969
Material and communications		396,840			503,513			684,778
Restructuring charges and asset disposals (Note 21)		521,903			939,492			2,986,441
Prepayment penalty on borrowings		4,116,446			—			—
Other operating expense		980,922			1,100,214			953,268

Total non-interest expense		25,883,749			23,985,948			31,228,402

Loss before income taxes		(7,627,730	)		(536,164	)		(15,459,486	)
Provision for Income Taxes (Note 10)		(338,784	)		—			—

Net loss	$	(7,288,946	)	$	(536,164	)	$	(15,459,486	)

Loss per share (Note 14)	$	(0.19	)	$	(0.01	)	$	(0.40	)

Dividends per share	$	—		$	—		$	—

See Accompanying Notes to Consolidated Financial Statements.

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Years Ended December 31, 2013, 2012 and 2011


	2013			2012			2011
Net loss	$	(7,288,946	)	$	(536,164	)	$	(15,459,486	)
Other comprehensive (loss) income: (Note 19)
Unrealized holding (losses) gains on securities, net of taxes:
Unrealized holding gains (losses) arising during the period		(568,850	)		47,204			(475,273	)
Less reclassification adjustment for net gains included in net income		—			(799,323	)		(687,769	)

Total		(568,850	)		(752,119	)		(1,163,042	)

Comprehensive loss	$	(7,857,796	)	$	(1,288,283	)	$	(16,622,528	)

See Accompanying Notes to Consolidated Financial Statements.

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

Years Ended December 31, 2013, 2012 and 2011


														Accumulated
	Number of				Additional									Other
	Outstanding		Common		Paid-in			Accumulated			Treasury			Comprehensive
	Shares		Stock		Capital			Deficit			Stock			Income (Loss)			Total
Balance, December 31, 2010		38,362,727		383,744		105,050,433			(39,399,345	)		(160,025	)		1,297,381			67,172,188
Comprehensive loss
Net loss		—		—		—			(15,459,486	)		—			—			(15,459,486	)
Unrealized holding loss on available for sale securities, net of taxes (Note 19)		—		—		—			—			—			(1,163,042	)		(1,163,042	)

Total comprehensive loss																		(16,622,528	)

Balance, December 31, 2011		38,362,727		383,744		105,050,433			(54,858,831	)		(160,025	)		134,339			50,549,660
Comprehensive loss
Net loss		—		—		—			(536,164	)		—			—			(536,164	)
Unrealized holding loss on available for sale securities, net of taxes (Note 19)		—		—		—			—			—			(752,119	)		(752,119	)

Total comprehensive loss																		(1,288,283	)
Share-based compensation expense		—		—		306,421			—			—			—			306,421
Issuance of restricted stock		117,387		1,174		(1,174	)											—

Balance, December 31, 2012		38,480,114	$	384,918	$	105,355,680		$	(55,394,995	)	$	(160,025	)	$	(617,780	)	$	49,567,798
Comprehensive loss
Net loss		—		—		—			(7,288,946	)		—			—			(7,288,946	)
Unrealized holding loss on available for sale securities, net of taxes (Note 19)		—		—		—			—			—			(568,850	)		(568,850	)

Total comprehensive loss																		(7,857,796	)
Share-based compensation expense		—		—		130,686			—			—			—			130,686
Issuance of restricted stock		294,861		2,949		(2,949	)											—

Balance, December 31, 2013		38,774,975	$	387,867	$	105,483,417		$	(62,683,941	)	$	(160,025	)	$	(1,186,630	)	$	41,840,688

See Accompanying Notes to Consolidated Financial Statements.

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31, 2013, 2012 and 2011


	2013			2012			2011
Cash Flows from Operating Activities
Net loss	$	(7,288,946	)	$	(536,164	)	$	(15,459,486	)
Adjustments to reconcile net loss to net cash used in operating activities
Restructuring charges and asset disposals		(163,417	)		(63,680	)		951,659
Amortization and accretion of investment premiums and discounts, net		186,605			310,830			409,511
Amortization and accretion of purchase loan premiums and discounts, net		19,469			11,477			11,301
Amortization of core deposit intangible		—			6,962			15,012
Provision for loan losses		970,214			(2,379,223	)		7,464,427
Net gain on sale of investment securities		—			(910,591	)		(1,109,305	)
Gain on sale of loans		(28,310	)		(336,274	)		(79,729	)
Gain on sale of mortgage loans		(254,796	)		(83,823	)		—
Orginations of mortgage loans held for sale		(35,647,133	)		(5,206,497	)		—
Proceeds from sales of mortgage loans held for sale		37,429,228			3,763,021			—
Loss on disposal of fixed assets		—			16,406			4,644
Gain on sale of other real estate owned		(113,963	)		(185,143	)		(193,786	)
Impairment write-down on other real estate owned		—			—			165,764
Proceeds from sale of branch assets and deposits		126,875			—			—
Gain on sale of branch assets and deposits		(50,643	)		—			—
Depreciation and amortization of premises and equipment		1,215,278			1,215,774			1,272,660
Share-based compensation expense		130,686			306,421			—
Earnings on cash surrender value of bank owned life insurance		(523,067	)		(517,099	)		(636,272	)
Change in assets and liabilities:
(Increase) decrease in net deferred loan costs		(131,616	)		183,914			(472,515	)
Decrease in accrued interest and dividends receivable		327,877			558,887			59,007
Decrease (increase) in other assets		737,075			(167,488	)		6,276,762
(Decrease) increase in accrued expenses and other liabilities		(1,637,666	)		858,272			344,279

Net cash used in operating activities		(4,696,250	)		(3,154,018	)		(976,067	)

Cash Flows from Investing Activities
Purchases of available for sale securities		—			(44,485,312	)		(65,459,630	)
Purchases of other investments		(950,000	)		—			—
Proceeds from sale of available for sale securities		—			45,226,033			26,349,070
Proceeds from redemptions of available for sale securities		—			15,999,814			—
Principal repayments on available for sale securities		3,262,509			7,775,420			12,029,209
Purchase of Federal Reserve Bank stock		—			(48,850	)		(1,174,100	)
Proceeds from repurchase of excess stock by the Federal Reserve Bank		285,900			25,650			659,100
Proceeds from repurchase of excess stock by the Federal Home Loan Bank		201,200			164,500			—
Proceeds from sale of loans		10,655,482			99,737,524			55,089,794
Net decrease (increase) in loans		25,462,402			(60,645,644	)		(34,363,332	)
Purchase of other real estate owned		—			—			(481,165	)
Capital improvements to other real estate owned		(80,401	)		(111,463	)		(20,000	)
Proceeds from sale of other real estate owned		5,068,208			3,347,391			19,579,304
Purchases of premises and equipment, net		(8,278,760	)		(615,519	)		(685,029	)

Net cash provided by investing activities		35,626,540			66,369,544			11,523,221

Cash Flows from Financing Activities
Net (decrease) increase in demand, savings and money market deposits		(17,298,660	)		13,234,388			(17,785,483	)
Net decrease in time certificates of deposit		(35,241,951	)		(60,860,883	)		(84,113,953	)
Decrease in deposits held for sale		(14,538,205	)
Increase in FHLB borrowings		7,000,000			—			—
Decrease in repurchase agreements		(7,000,000	)		—			—

Net cash used in financing activities		(67,078,816	)		(47,626,495	)		(101,899,436	)

Net (decrease) increase in cash and cash equivalents		(36,148,526	)		15,589,031			(91,352,282	)

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued

Years Ended December 31, 2013, 2012 and 2011


	2013			2012			2011
Cash and cash equivalents at
Beginning of year		71,014,407			55,425,376			146,777,658

End of year	$	34,865,881		$	71,014,407		$	55,425,376

Supplemental Disclosures of Cash Flow Information
Interest paid	$	4,706,226		$	7,127,255		$	8,290,544

Income taxes paid	$	2,750		$	10,319		$	10,534

Supplemental Disclosure of Noncash Investing and Financing Activities
Unrealized holding losses on available for sale securities arising during the period	$	(568,850	)	$	(834,456	)	$	(1,875,874	)

Transfer of loans to other real estate owned	$	—		$	6,111,989		$	5,403,970

Transfer of loans to premises and equipment	$	3,697,572		$	—		$	—

Transfer of other real estate owned to premises and equipment	$	—		$	950,000		$	—

Transfer of loans to held for sale	$	—		$	—		$	250,000

Transfer of deposits to held for sale	$	10,167,176		$	24,705,381		$	—

Transfer of branch assets held for sale	$	12,012		$	88,244		$	—

See Accompanying Notes to Consolidated Financial Statements.

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2013, 2012 and 2011

Note 1. Nature of Operations and Summary of Significant Accounting Policies

Patriot National Bancorp, Inc. (the “Company”), a Connecticut corporation, is a bank holding company that was organized in 1999. On December 1, 1999, all the issued and outstanding shares of Patriot National Bank (the “Bank”) were converted into Company common stock and the Bank became a wholly owned subsidiary of the Company. The Bank is a nationally chartered commercial bank whose deposits are insured under the Bank Insurance Fund, which is administered by the Federal Deposit Insurance Corporation. The Bank provides a full range of banking services to commercial and consumer customers through its main office in Stamford, Connecticut, seven other branch offices in Connecticut and two branch offices in New York. The Bank’s customers are concentrated in Fairfield and New Haven Counties in Connecticut and Westchester County and New York City.

On March 11, 2003, the Company formed Patriot National Statutory Trust I (the “Trust”) for the purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures issued by the Company, and on March 26, 2003, the first series of trust preferred securities were issued. In accordance with generally accepted accounting principles, the Trust is not included in the Company’s consolidated financial statements.

The following is a summary of the Company’s significant accounting policies:

Significant group concentrations of credit risk

Most of the Company’s activities are with customers located within Fairfield and New Haven Counties in Connecticut and Westchester County and New York City. Note 3 discusses the types of securities in which the Company invests. Note 4 discusses the types of lending in which the Company engages. The Company does not have any significant concentrations to any one industry or customer.

Principles of consolidation and basis of financial statement presentation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, the Bank, and the Bank’s wholly owned subsidiary, PinPat Acquisition Corporation, and have been prepared in conformity with U.S. generally accepted accounting principles. All significant intercompany balances and transactions have been eliminated. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosures of contingent assets and liabilities, as of the balance sheet date and reported amounts of revenues and expenses for the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of investment securities, the realization of deferred tax assets, and the evaluation of investment securities for impairment. Certain prior year balances have been reclassified to conform to the current year presentation.

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Cash and cash equivalents

Cash and due from banks, federal funds sold and short-term investments are recognized as cash equivalents in the consolidated balance sheets. Federal funds sold generally mature in one day. For purposes of reporting cash flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. The Company maintains amounts due from banks and federal funds sold which, at times, may exceed federally insured limits. The Company has not experienced any losses from such concentrations. The short-term investments represent an investment in a money market mutual fund.

Investments in debt and marketable equity securities

Management determines the appropriate classification of securities at the date individual investment securities are acquired, and the appropriateness of such classification is reassessed at each balance sheet date.

The Bank is required to maintain an investment in capital stock of the Federal Home Loan Bank of Boston (“FHLB”), as collateral, in an amount equal to a percentage of its outstanding mortgage loans and loans secured by residential properties, including mortgage-backed securities. The stock is purchased from and redeemed by the FHLB based upon its $100 par value. The stock is a non-marketable equity security and as such is classified as restricted stock, carried at cost and evaluated for impairment in accordance with relevant accounting guidance. In accordance with this guidance, the stock’s value is determined by the ultimate recoverability of the par value rather than by recognizing temporary declines. The determination of whether the par value will ultimately be recovered is influenced by criteria such as the following: (a) the significance of any decline in net assets of the FHLB as compared to the capital stock amount and the length of time this situation has persisted; (b) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance; (c) the potential impact of legislative and regulatory changes on the customer base of the FHLB; and (d) the liquidity position of the FHLB.

Management evaluated the stock and concluded that the stock was not impaired for the periods presented herein. Consideration was given to the long-term prospects for the FHLB. Management also considered that the FHLB’s regulatory capital ratios have increased from the prior year, liquidity appears adequate, and new shares of FHLB stock continue to exchange hands at $100 par value.

The Bank is required to maintain an investment in capital stock of the Federal Reserve Bank (“FRB”), as collateral, in an amount equal to one percent of six percent of the Bank’s total equity capital as per the latest Report of Condition (Call Report). The stock is purchased from and redeemed by the FRB based upon its $100 par value. The stock is a non-marketable equity security and as such is classified as restricted stock, carried at cost and evaluated for impairment in accordance with relevant accounting guidance. In accordance with this guidance, the stock’s value is determined by the ultimate recoverability of the par value rather than by recognizing temporary declines. The determination of whether the par value will ultimately be recovered is influenced by criteria such as the following: (a) the significance of any decline in net assets of the FRB as compared to the capital stock amount and the length of time this situation has persisted; (b) the potential impact of legislative and regulatory changes on the customer base of the FRB; and (c) the liquidity position of the FRB.

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Member banks may carry over changes within a calendar year until the cumulative change exceeds the lesser of 15% or 100 shares of Federal Reserve Bank stock. However, any change required by a member bank’s capital and surplus, as shown in its Report of Condition as of December 31 of each year, must be applied for even if the change is less than 100 shares of Federal Reserve Bank stock and less than 15% of the Federal Reserve Bank stock held by the member bank.

Management evaluated the stock and concluded that the stock was not impaired for the periods presented herein. Consideration was given to the long-term prospects for the FRB. Management also considered that liquidity appears adequate and new shares of FRB stock continue to exchange hands at the $100 par value.

Debt securities, if any, that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and are recorded at amortized cost. “Trading” securities, if any, are carried at fair value with unrealized gains and losses recognized in earnings. Securities classified as “available for sale” are recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income (loss), net of taxes. Purchase premiums and discounts are recognized in interest income using the interest method over the contractual lives of the securities.

The Company conducts a quarterly review and evaluation of the securities portfolio to determine if a decline in the fair value of any security below its cost basis is other-than-temporary. Our evaluation of other-than-temporary impairment, or OTTI, considers the duration and severity of the impairment, our intent and ability to hold the securities and our assessments of the reason for the decline in value and the likelihood of a near-term recovery. If such decline is deemed other-than-temporary, the security is written down to a new cost basis and the resulting loss is charged to earnings as a component of non-interest income, except for the amount of the total OTTI for a debt security that does not represent credit losses which is recognized in other comprehensive income/loss, net of applicable taxes.

Security transactions are recorded on the trade date. Realized gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method and reported in non-interest income.

Loans held for sale

Loans held for sale, are those loans the Company has the intent to sell in the foreseeable future, and are carried at the lower of aggregate cost or fair value, less estimated selling costs. Gains and losses on sales of loans are recognized on the trade dates, and are determined by the difference between the sales proceeds and the carrying value of the loans. Once loans are transferred to held for sale, any subsequent impairment in loans held for sale is recorded in non-interest income.

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Loans receivable

Loans that the Company has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for unearned income, the allowance for loan losses, and any unamortized deferred fees or costs.

Interest income is accrued based on the unpaid principal balance. Loan origination fees, and certain direct origination costs, are deferred and amortized as a level yield adjustment over the respective term of the loan and reported in interest income.

All interest accrued but not collected for loans that are placed on nonaccrual status or charged off are reversed against interest income. The interest on these loans is accounted for on the cash-basis method until qualifying for return to accrual status. Upon receipt of cash, the cash received is first applied to satisfy principal and then applied to interest unless the loan is in a cure period and Management believes there will be a loss. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

The Company’s real estate loans are collateralized by real estate located principally in Fairfield and New Haven Counties in Connecticut and Westchester County and New York City in New York, and accordingly, the ultimate collectability of a substantial portion of the Company’s loan portfolio is susceptible to changes in regional real estate market conditions.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and real estate loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Impaired loans also include loans modified in troubled debt restructurings (TDRs), where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. TDRs are normally placed on non-accrual status until the loan qualifies for return to accrual status. Loans qualify for return to accrual status once they have demonstrated performance with the restructured term of the loan agreement for a minimum of six months.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer installment loans for impairment disclosures, unless such loans are individually evaluated for impairment due to financial difficulties of the borrower.

Allowance for loan losses

The allowance consists of specific and general components. The specific component relates to loans that are considered impaired. For such impaired loans, an allowance is established when the discounted cash flows (or collateral value if the loan is collateral dependent) or observable market price of the impaired loan is lower than the carrying value of that loan. The general component covers all other loans, segregated generally by loan type, and is based on historical loss experience with adjustments for qualitative factors which are made after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss data. In addition, a risk rating system is utilized to evaluate the general component of the allowance for loan losses. Under this system, management assigns risk ratings between one and eleven based upon the recommendations of the credit analyst and the originating loan officer and confirmed by the Loan Committee at the initiation of the transaction and are reviewed and changed, when necessary, during the life of the loan. Loans assigned a risk rating of six or above are monitored more closely by the credit administration officers and the Loan Committee.

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Included in the valuation allowance are disposition discount adjustments made to real estate appraisals on collateral dependent impaired loans anticipated to become other real estate owned (“OREO”) in the coming quarter, as the Company’s recent experience has indicated that the ultimate sales prices of the underlying collateral have been less than the appraisal amounts. The appraisal adjustment percentage will be reviewed quarterly for those loans anticipated to become OREO in the subsequent quarter, based on an analysis of actual variances between appraised values as of the date the loan is transferred into OREO and the actual sales prices of the OREO properties. Generally, the sales prices have been below the appraised values due to the fact that buyers become aware that a bank owns those properties, and, therefore, attempt to offer less than fair market value. In the future, additional revisions may be made to the methodology and assumptions based on historical information related to charge-off and recovery experience and management’s evaluation of the current loan portfolio, and prevailing internal and external factors including but not limited to current economic conditions and local real estate markets.

The Company provides for loan losses based on the consistent application of our documented allowance for loan loss methodology. Loan losses are charged to the allowance for loan losses and recoveries are credited to it. Additions to the allowance for loan losses are provided by charges against income based on various factors which, in our judgment, deserve current recognition in estimating probable losses. Loan losses are charged-off in the period the loans, or portion thereof, are deemed uncollectible. Generally, the Company will record a loan charge-off (including a partial charge-off) to reduce a loan to the estimated fair value of the underlying collateral, less cost to sell, for collateral dependent loans. The Company regularly reviews the loan portfolio and makes adjustments for loan losses in order to maintain the allowance for loan losses in accordance with U.S. generally accepted accounting principles. The allowance for loan losses consists primarily of the following two components:

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

(1)

Allowances are established for impaired loans (defined by the Company as non-accrual loans, troubled debt restructurings and loans that were previously classified as troubled debt restructurings but have been upgraded). The amount of impairment provided for as an allowance is represented by the deficiency, if any, between the present value of expected future cash flows discounted at the original loan’s effective interest rate or the underlying collateral value (less estimated costs to sell,) if the loan is collateral dependent, and the carrying value of the loan. Impaired loans that have no impairment losses are not considered for general valuation allowances described below.

(2)

General allowances are established for loan losses on a portfolio basis for loans that do not meet the definition of impaired. The portfolio is grouped into similar risk characteristics, primarily loan type, loan-to-value, if collateral dependent, and internal risk ratings. Management applies an estimated loss rate to each loan group. The loss rates applied are based on the Company’s cumulative prior two year loss experience adjusted, as appropriate, for the environmental factors discussed below. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revisions based upon changes in economic and real estate market conditions. Actual loan losses may be more or less than the allowance for loan losses management has established, which could have an effect on the Company’s financial results.

The adjustments to the Company’s loss experience are based on management’s evaluation of several environmental factors, including:

•

Changes in the nature and volume of the portfolio and in the terms of the loans;

•

Changes in the experience, ability, and depth of lending management and other relevant staff;

•

Changes in the volume and severity of past due loans, the volume of nonaccrual loans, and the volume and severity of adversely classified or graded loans;

•

Changes in the quality of the loan review system;

•

Changes in the value of the underlying collateral for collateral-dependent loans;

•

The existence and effect of any concentrations of credit, and changes in the level of such concentrations; and

•

The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the existing portfolio.

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

In underwriting a loan secured by real property, we require an appraisal of the property by an independent licensed appraiser approved by the Company’s Board of Directors. All appraisals are reviewed by qualified parties independent from the firm preparing the appraisals. Management reviews and inspects properties before disbursement of funds during the term of a construction loan. Generally, management obtains updated appraisals when a loan is deemed impaired. These appraisals may be more limited than those prepared for the underwriting of a new loan.

Management evaluates the allowance for loan losses based on the combined total of the impaired and general components. Generally, when the loan portfolio increases, absent other factors, the allowance for loan loss methodology results in a higher dollar amount of estimated probable losses. Conversely, when the loan portfolio decreases, absent other factors, the allowance for loan loss methodology results in a lower dollar amount of estimated probable losses.

Each quarter management evaluates the allowance for loan losses and adjusts the allowance, as appropriate, through a provision for loan losses. While the Company uses the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the information used in making the evaluations. In addition, as an integral part of their examination process, the Office of the Comptroller of the Currency will periodically review the allowance for loan losses. The OCC may require the Company to adjust the allowance based on their analysis of information available to them at the time of their examination.

Mortgage banking activities

The Company originated residential loans from various sources to be held for sale into the secondary market. The Company renders a credit decision and issues a loan commitment. The loan is then closed and funded by the Company. The loan is subsequently sold to a predetermined secondary market investor and servicing is released. The gain on sale fee income is recognized upon the purchase of the loan by an investor. A reserve is established for prepayments, early payment defaults and other potential investor claims.

The Company receives loan brokerage fees for soliciting and processing conventional loan applications on behalf of investors. Brokerage fee income is recognized upon closing of loans for permanent investors.

Transfers of financial assets

Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company—put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and no condition both constrains the transferee from taking advantage of that right and provides more than a trivial benefit for the transferor, and (3) the transferor does not maintain effective control over the transferred assets through either (a) an agreement that both entitles and obligates the transferor to repurchase or redeem the assets before maturity or (b) the ability to unilaterally cause the holder to return specific assets, other than through a cleanup call.

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Other real estate owned

Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at the lower of cost or estimated fair value less cost to sell at the date of foreclosure, establishing a new cost basis. In addition, when the Company acquires other real estate owned (“OREO”), it obtains a current appraisal to substantiate the net carrying value of the asset. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in operations. Costs relating to the development and improvement of the property are capitalized, subject to the limit of fair value of the collateral. Gains or losses are included in non-interest expenses upon disposal.

Write-downs required upon transfer to other real estate owned are charged to the allowance for loan losses. Thereafter, an allowance for other real estate owned losses is established for any further declines in the property’s value. These losses are included in non-interest expenses in the consolidated statement of operations.

Premises and equipment

Premises and equipment are stated at cost, net of accumulated depreciation and amortization. Leasehold improvements are capitalized and amortized over the shorter of the terms of the related leases or the estimated economic lives of the improvements. Depreciation is charged to operations for buildings, furniture, equipment and software using the straight-line method over the estimated useful lives of the related assets which range from three to thirty years. Gains and losses on dispositions are recognized upon realization. Maintenance and repairs are expensed as incurred and improvements are capitalized.

Impairment of assets

Long-lived assets, which are held and used by the Company, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If impairment is indicated by that review, the asset is written down to its estimated fair value through a charge to non-interest expense.

Cash surrender value of bank owned life insurance

Cash surrender value of bank owned life insurance represents life insurance on certain employees who have consented to allow the Bank to be the beneficiary of those policies. Changes in the cash value of the policies, as well as insurance proceeds received above the carrying value, are recorded in other non-interest income and are not subject to income tax. Management reviews the financial strength of the insurance carrier on an annual basis. The funds are held in a segregated account and invested in marketable securities.

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Income taxes

The Company recognizes a benefit from its tax positions only if it is more-likely-than-not that the tax position will be sustained on examination by taxing authorities, based on the technical merits of the position. The tax benefits recognized in the consolidated financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information.

The Company’s policy for recording interest and penalties related to uncertain tax positions is to record such items as part of its provision for federal and state income taxes.

The Company has no unrecognized tax benefits and related interest or penalties at December 31, 2013. Management does not believe that there is any tax position for which it is reasonably possible that will result in unrecognized tax benefits within the next 12 months.

The Company’s returns for tax years 2010 and 2012 are subject to examination by the Internal Revenue Service (“IRS”) for U.S. federal tax purposes, and by its major state tax authority, Connecticut. During 2013, the IRS has completed its examination of the U.S. federal tax returns of the Company for tax years ended December 31, 2004 thru 2009. There were no changes made by the IRS to the Company’s reported tax. There are no other on-going audits in other tax jurisdictions.

Related party transactions

Directors and officers of the Company and the Bank and their affiliates have been customers of and have had transactions with the Bank, and it is expected that such persons and entities will continue to have such transactions in the future. Management believes that all deposit accounts, loans, services and commitments comprising such transactions were made in the ordinary course of business, and on substantially the same terms, including interest rates and collateral requirements, as those prevailing at the time for comparable transactions with other customers who are not directors or officers. In the opinion of management, the transactions with related parties did not involve more than normal risks of collectability or favored treatment or terms, or present other unfavorable features. Note 18 contains details regarding related party transactions.

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Loss per share

Basic loss per share represents loss relating to common shareholders and is computed by dividing the net loss by the weighted-average number of common shares outstanding. Diluted loss per share reflects additional common shares that would have been outstanding if potential dilutive common shares had been issued, as well as any adjustment to income that would result from the assumed issuance unless such assumed issuance is antidilutive. Potential common shares that may be issued by the Company relate to any stock options and warrants that may be outstanding, and are determined using the treasury stock method.

Treasury shares are not deemed outstanding for loss per share purposes.

Share-based compensation plan

The Company accounts for share-based compensation transactions at fair-value and recognizes the related expense in the consolidated statements of operations.

The Compensation Committee establishes terms and conditions applicable to the vesting of restricted stock awards and stock options. Restricted stock grants vest in quarterly or annual installments over a three, four or five year period from the date of grant. The fair value of stock options granted are estimated utilizing the Black-Scholes options pricing modeling. The Company is expensing the grant date fair value of all share-based compensation over the requisite vesting periods on a straight-line basis.

Comprehensive income (loss)

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income (loss). Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of shareholders’ equity in the consolidated balance sheets, such items, along with net income, are components of comprehensive income.

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Segment reporting

The Company’s only business segment is Community Banking. During the years ended 2013, 2012 and 2011, this segment represented all the revenues and income of the consolidated group and therefore, is the only reported segment.

Fair value

The Company uses fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in certain instances, there are no quoted market prices for certain assets or liabilities. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the asset or liability.

Fair value measurements focus on exit prices in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact business at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment.

•

Level 1 Inputs—Unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

•

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

•

See Note 20 for additional information regarding fair value.

Recently issued accounting pronouncements

ASU No. 2013-02, “Comprehensive Income (Topic 220) – Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income,” requires an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. GAAP to be reclassified in its entirety to net income. ASU No. 2013-12 is effective prospectively for reporting periods beginning after December 15, 2012. The Company adopted this guidance on January 1, 2013 and it did not have a material impact on the consolidated financial statements.

Accounting Standards Update (“ASU”) No. 2011-04, “Fair Value Measurements (Topic 820) – Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs,” was issued as a result of the effort to develop common fair value measurement and disclosure requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”). While ASU No. 2011-04 is largely consistent with existing fair value measurement principles in U.S. GAAP, it expands the existing disclosure requirements for fair value measurements and clarifies the existing guidance or wording changes to align with IFRS No. 13. Many of the requirements for the amendments in ASU No. 2011-04 do not result in a change in the application of the requirements in Topic 820. The Company adopted ASU No. 2011-04 on January 1, 2012 and it did not have a material impact on the consolidated financial statements.

ASU No. 2011-05, “Comprehensive Income (Topic 220) – Presentation of Comprehensive Income,” requires an entity to present components of comprehensive income either in a single continuous statement of comprehensive income or in two separate consecutive statements. These amendments made the financial statement presentation of other comprehensive income more prominent by eliminating the alternative to present comprehensive income within the statement of equity. As originally issued, ASU No. 2011-05 required entities to present reclassification adjustments out of accumulated other comprehensive income by component in the statement in which net income is presented and the statement in which other comprehensive income is presented (for both interim and annual financial statements). This requirement was deferred by ASU No.2011-12, “Comprehensive Income (Topic 220) – Deferral of the Effective Date for Amendments to the Presentation of Reclassification of Items Out of Accumulated Other Comprehensive Income in Accounting Standards”. ASU No. 2011-05 is effective for all interim and annual periods beginning on or after December 15, 2011. The Company adopted this guidance in the first quarter of 2012 and elected to present comprehensive income in a separate consolidated statement of comprehensive income.

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Note 2. Restrictions on Cash and Due From Banks

At December 31, 2013 and 2012, the Company was required to maintain $25,000 in the Federal Reserve Bank for clearing purposes for its transaction accounts and non-personal time deposits.

Note 3. Available-for-Sale Securities

The amortized cost, gross unrealized gains, gross unrealized losses and approximate fair value of available-for-sale securities at December 31, 2013 and 2012 are as follows:


			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
2013	Cost		Gains		Losses			Value
U. S. Government agency bonds	$	7,500,000	$	—	$	(420,650	)	$	7,079,350
U. S. Government agency mortgage-backed securities		22,387,986		—		(635,774	)		21,752,212
Corporate bonds		9,000,000		—		(130,206	)		8,869,794

	$	38,887,986	$	—	$	(1,186,630	)	$	37,701,356


			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
2012	Cost		Gains		Losses			Value
U. S. Government agency bonds	$	7,500,000	$	26,170	$	—		$	7,526,170
U. S. Government agency mortgage-backed securities		25,837,100		—		(130,209	)		25,706,891
Corporate bonds		9,000,000		—		(513,741	)		8,486,259

	$	42,337,100	$	26,170	$	(643,950	)	$	41,719,320

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

The following table presents the Company’s available for sale securities’ gross unrealized losses and fair value, aggregated by the length of time the individual securities have been in a continuous loss position, at December 31, 2013 and 2012:


	Less Than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
2013	Value		Loss			Value		Loss			Value		Loss
U. S. Government agency bonds	$	7,079,350	$	(420,650	)	$	—	$	—		$	7,079,350	$	(420,650	)
U. S. Government agency mortgage-backed securities		8,870,860		(291,233	)		12,855,648		(344,541	)		21,726,508		(635,774	)
Corporate bonds		—		—			8,869,794		(130,206	)		8,869,794		(130,206	)

Totals	$	15,950,210	$	(711,883	)	$	21,725,442	$	(474,747	)	$	37,675,652	$	(1,186,630	)


	Less Than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
2012	Value		Loss			Value		Loss			Value		Loss
U. S. Government agency mortgage-backed securities	$	25,670,832	$	(130,209	)	$	—	$	—		$	25,670,832	$	(130,209	)
Corporate bonds		2,842,368		(157,632	)		5,643,891		(356,109	)		8,486,259		(513,741	)

Totals	$	28,513,200	$	(287,841	)	$	5,643,891	$	(356,109	)	$	34,157,091	$	(643,950	)

At December 31, 2013, eleven securities had unrealized losses with an aggregate depreciation of 3.2% from the amortized cost, compared to nine securities at December 31, 2012 with an aggregate depreciation of 1.9% from the amortized cost.

The Company performs a quarterly analysis of those securities that are in an unrealized loss position to determine if those losses qualify as other-than-temporary impairments. This analysis considers the following criteria in its determination: the ability of the issuer to meet its obligations, when the loss position is due to a deterioration in credit quality, management’s plans and ability to maintain its investment in the security, the length of time and the amount by which the security has been in a loss position, the interest rate environment, the general economic environment and prospects for improvement or deterioration.

Management believes that none of the unrealized losses on available-for-sale securities noted above are other than temporary due to the fact that they relate to market interest rate changes on U.S. Government agency debt, corporate debt and mortgage-backed securities issued by U.S. Government agencies. Management considers the issuers of the securities to be financially sound, the corporate bonds are investment grade and the Company expects to receive all contractual principal and interest related to these investments. Because the Company does not intend to sell the investments, and it is not more-likely-than-not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2013.

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

At December 31, 2013 and 2012, available-for-sale securities with a carrying value of $5,758,916 and $6,913,797, respectively, were pledged to secure municipal deposits. At December 31, 2013, no securities were pledged to secure securities sold under agreements to repurchase. At December 31, 2012, available- for-sale securities with a carrying value of $9,088,000 were pledged to secure securities sold under agreements to repurchase.

The amortized cost and fair value of available-for-sale debt securities at December 31, 2013 by contractual maturity are presented below. Actual maturities of mortgage-backed securities may differ from contractual maturities because the mortgages underlying the securities may be repaid without any penalties. Because mortgage-backed securities are not due at a single maturity date, they are not included in the maturity categories in the following maturity summary.


	Amortized		Fair
	Cost		Value
Maturity:
Corporate bonds 5 to 10 years	$	9,000,000	$	8,869,794
U.S. Government bonds 5 to 10 years		7,500,000		7,079,350
Mortgage-backed securities		22,387,986		21,752,212

Total	$	38,887,986	$	37,701,356

During 2013 there were no sales of available-for-sale securities. During 2012, sales of available-for-sale securities resulted in the Company recognizing proceeds of $45,226,033, and gross gains and gross losses of $910,591 and $9,651 respectively. During 2011 there were ten sales of available-for-sale securities, which resulted in the Company recognizing gross proceeds from the sales of $26,349,070 and gross gains of $1,109,305.

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Note 4. Loan Receivables and Allowance for Loan Losses

Loans receivable, net, consists of the following at December 31, 2013 and 2012:


	December 31,			December 31,
	2013			2012
Real Estate:
Commercial	$	223,165,092		$	247,495,321
Residential		106,198,275			119,033,025
Construction		260,000			4,997,991
Construction-to-permanent		11,303,002			4,851,768
Commercial		35,061,249			36,428,751
Consumer home equity		44,080,895			49,180,908
Consumer installment		2,989,662			2,162,718

Total loans		423,058,175			464,150,482
Premiums on purchased loans		200,180			219,649
Net deferred costs		570,657			439,041
Allowance for loan losses		(5,680,689	)		(6,015,636	)

Loans receivable, net	$	418,148,323		$	458,793,536

During 2013, the Bank completed bulk loan sales of $10.5 million of residential loans consummated for a cash purchase price of $10.7 million, which represented 101.5% of the Bank’s net book value for these assets. During 2012, the Bank completed bulk loan sales of $97.0 million of residential loans consummated for a cash purchase price of $98.5 million, which represented 101.5% of the Bank’s net book value for these assets.

A summary of changes in the allowance for loan losses for the years ended December 31, 2013, 2012 and 2011 are as follows:


	2013			2012			2011
Balance, beginning of year	$	6,015,636		$	9,384,672		$	15,374,101
Provision for loan losses		970,214			(2,379,223	)		7,464,427
Transferred to loans held-for-sale		—			—			(6,054,660	)
Recoveries of loans previously charged-off		363,225			80,543			853,578
Loans charged-off		(1,668,386	)		(1,070,356	)		(8,252,774	)

Balance, end of year	$	5,680,689		$	6,015,636		$	9,384,672

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

At December 31, 2013 and 2012, the unpaid principal balances of loans 90 days or more past due, and still accruing interest were $866,000 and $2.2 million respectively, and the unpaid principal balances of loans on non-accrual status and considered impaired were $12.3 million and $23.8 million respectively. Loans over 90 days past due were comprised of two loans as of December 31, 2013. One loan for $841,000 was current and a second loan for $25,000 was current within 60 days as to interest payments, both were past the loan’s maturity date and in the process of being renewed. Four of the five loans as of December 31, 2012, totaling $1,667,000, were making payments, but past the loan’s maturity date and were in the process of being renewed. The other loan totaling $567,000 was over 90 days past due as to payments and past the loan’s maturity date, but was subsequently paid off.

At December 31, 2013, there were two loans totaling $2.2 million that were considered “troubled debt restructurings”, as compared to 8 loans totaling $11.6 million that were considered “troubled debt restructurings” at December 31, 2012, all of which are included in impaired loans. At December 31, 2013, one of the two loans for $991,000 was accruing and the other for $1.2 million was a non-accruing loan. At December 31, 2012, 1 of the 8 loans aggregating $0.5 million was accruing and 7 loans aggregating $11.1 million were non-accruing loans. Loan modifications, which resulted in these loans being considered troubled debt restructurings, are primarily in the form of rate concessions or term extensions. At December 31, 2013 and 2012, there were no commitments to advance additional funds under troubled debt restructured loans.

If non-accrual loans had been performing in accordance with their original terms, the Company would have recorded $1.2 million, $1.5 million and $2.3 million of additional income during the years ended December 31, 2013, 2012 and 2011, respectively.

During 2013, 2012 and 2011, interest income collected and recognized on non-accrual loans was approximately $774,000, $231,000 and $465,000 respectively. The average recorded investment in impaired loans for the years ending December 31, 2013, 2012 and 2011 were $30.8 million, $35.0 million and $49.8 million respectively.

The Company’s lending activities are conducted principally in Fairfield and New Haven Counties in Connecticut and Westchester County and New York City. The Company originates commercial real estate loans, commercial business loans, residential real estate loans and a variety of consumer loans. In addition, the Company had originated loans for the construction of residential homes, residential developments and for land development projects. A moratorium on new speculative construction loans was instituted by management in July 2008. All residential and commercial mortgage loans are collateralized primarily by first or second mortgages on real estate. The ability and willingness of borrowers to satisfy their loan obligations is dependent to some degree on the status of the regional economy as well as upon the regional real estate market. Accordingly, the ultimate collectability of a portion of the loan portfolio and the recovery of any resulting real estate acquired is susceptible to changes in market conditions.

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

The Company has established credit policies applicable to each type of lending activity in which it engages, evaluates the creditworthiness of each customer and, in most cases, extends credit of up to 75% of the market value of the collateral for commercial real estate at the date of the credit extension depending on the Company’s evaluation of the borrowers’ creditworthiness and type of collateral. In the case of construction loans, the maximum loan-to-value was 65% of the “as completed” market value. The market value of collateral is monitored on an ongoing basis and additional collateral is obtained when warranted. Real estate is the primary form of collateral. Other important forms of collateral are accounts receivable, inventory, other business assets, marketable securities and time deposits. While collateral provides assurance as a secondary source of repayment, the Company ordinarily requires the primary source of repayment to be based on the borrower’s ability to generate continuing cash flows on all loans not related to construction.

Risk characteristics of the Company’s portfolio classes include the following:

Commercial Real Estate Loans – In underwriting commercial real estate loans, the Company evaluates both the prospective borrower’s ability to make timely payments on the loan and the value of the property securing the loans. Repayment of such loans may be negatively impacted should there be a substantial decline in the value of the property securing the loan or a decline in the general economic conditions. Where the owner occupies the property, the Company also evaluates the business’s ability to repay the loan on a timely basis. In addition, the Company may require personal guarantees, lease assignments and/or the guarantee of the operating company when the property is owner occupied. These types of loans involve different risks because payments on such loans are dependent upon the successful operation of the business involved, therefore, repayment of such loans may be negatively impacted by adverse changes in economic conditions affecting the borrowers’ businesses.

Commercial and Industrial Loans – The Company’s commercial and industrial loan portfolio consists primarily of commercial business loans and lines of credit to businesses and professionals. These loans are usually made to finance the purchase of inventory or new or used equipment and for other short or long-term working capital purposes. These loans are generally secured by corporate assets, often with real estate as secondary collateral, but are also occasionally offered on an unsecured basis. In granting this type of loan, the Company primarily looks to the borrower’s cash flow as the source of repayment with collateral and personal guarantees as a secondary source as needed. Commercial loans are often larger and may involve greater risks than other type of loans offered by the Company. Payments on such loans are often dependent upon the successful operation of the underlying business. Repayment of such loans may therefore be negatively impacted by adverse changes in economic conditions, management’s inability to effectively manage the business, claims of others against the borrower’s assets, death or disability of the borrower or loss of market for the borrower’s products or services.

Residential Real Estate Loans – Various loans secured by residential real estate properties are offered by the Company, including 1-4 family residential mortgages, multi-family residential loans and a variety of home equity line of credit products. Repayment of such loans may be negatively impacted should the borrower default, should there be a significant decline in the value of the property securing the loan or should there be a decline in general economic conditions.

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Construction Loans – Construction loans are short-term loans (generally up to 18 months) secured by land for both residential and commercial development. The loans are generally made for acquisition and improvements. Funds are disbursed as phases of construction are completed. In the past, the Company funded construction of single family homes, when no contract of sale existed, based upon the experience and the financial strength of the builder, the type and location of the property and other factors. Construction loans are generally personally guaranteed by the principal(s). Repayment of such loans may be negatively impacted by the builders’ inability to complete construction, by a downturn in the new home sales market, by a significant increase in interest rates or by decline in general economic conditions. The Company has had a moratorium in place since mid-2008 on new speculative construction loans.

Other Loans – The Company also offers installment loans and reserves lines of credit to individuals. Repayments of such loans are often dependent on the personal income of the borrower which may be negatively impacted by adverse changes in economic conditions or personal circumstances. The Company does not place an emphasis on originating these types of loans.

The Company does not have any lending programs commonly referred to as subprime lending. Subprime lending generally targets borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments, bankruptcies, or borrowers with questionable repayment capacity as evidenced by low credit scores or high debt-burdened ratios.

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

The following tables set forth activity in our allowance for loan losses, by loan type, for the years ended December 31, 2013 and 2012. The following tables also detail the amount of loans receivable, net, that are evaluated individually, and collectively, for impairment, and the related portion of the allowance for loan losses that is allocated to each loan portfolio segment.


2013	Commercial			Commercial Real Estate			Construction			Construction to Permanent		Residential			Consumer			Unallocated		Total
Allowance for loan losses:
Beginning Balance	$	941,456		$	3,509,395		$	311,297		$	18,720	$	897,368		$	216,698		$	120,702	$	6,015,636
Charge-offs		(62,779	)		(403,124	)		(204,868	)		—		(918,853	)		(78,762	)		—		(1,668,386	)
Recoveries		3,920			334,951			20,000			—		612			3,742			—		363,225
Provision		1,402,088			(1,855,894	)		133,571			6,659		815,829			392,117			75,844		970,214

Ending Balance	$	2,284,685		$	1,585,328		$	260,000		$	25,379	$	794,956		$	533,795		$	196,546	$	5,680,689

Ending balance: individually evaluated for impairment	$	1,500,000		$	31,097		$	260,000		$	—	$	97,829		$	1,811		$	—	$	1,890,737
Ending balance: collectively evaluated for impairment		784,685			1,554,231			—			25,379		697,127			531,984			196,546		3,789,952

Total Allowance for Loan Losses	$	2,284,685		$	1,585,328		$	260,000		$	25,379	$	794,956		$	533,795		$	196,546	$	5,680,689

Total Loans ending balance	$	35,061,249		$	223,165,092		$	260,000		$	11,303,002	$	106,198,275		$	47,070,557		$	—	$	423,058,175

Ending balance:
individually evaluated for impairment		6,151,799			7,767,224			260,000			1,197,474		6,024,266			592,636			—		21,993,399

Ending balance :
collectively evaluated for impairment	$	28,909,450		$	215,397,868		$	—		$	10,105,528	$	100,174,009		$	46,477,921		$	—	$	401,064,776

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011


2012	Commercial			Commercial Real Estate			Construction			Construction to Permanent			Residential			Consumer			Unallocated		Total
Allowance for loan losses:
Beginning Balance	$	882,062		$	4,018,746		$	867,159		$	547,333		$	2,550,588		$	458,762		$	60,022	$	9,384,672
Charge-offs		(48,414	)		(49,922	)		(101,391	)		—			(84,711	)		(785,918	)		—		(1,070,356	)
Recoveries		10,861			66,951			—			—			—			2,731			—		80,543
Provision		96,947			(526,380	)		(454,471	)		(528,613	)		(1,568,509	)		541,123			60,680		(2,379,223	)

Ending Balance	$	941,456		$	3,509,395		$	311,297		$	18,720		$	897,368		$	216,698		$	120,702	$	6,015,636

Ending balance: individually evaluated for impairment	$	33,280		$	728,607		$	120,616		$	—		$	83,543		$	2,368		$	—	$	968,414
Ending balance: collectively evaluated for impairment		908,176			2,780,788			190,681			18,720			813,825			214,330			120,702		5,047,222

Total Allowance for Loan Losses	$	941,456		$	3,509,395		$	311,297		$	18,720		$	897,368		$	216,698		$	120,702	$	6,015,636

Total Loans ending balance	$	36,428,751		$	247,495,321		$	4,997,991		$	4,851,768		$	119,033,025		$	51,343,626		$	—	$	464,150,482

Ending balance:
individually evaluated for impairment		219,509			15,909,103			1,862,038			1,258,710			13,567,175			566,543			—		33,383,078

Ending balance :
collectively evaluated for impairment	$	36,209,242		$	231,586,218		$	3,135,953		$	3,593,058		$	105,465,850		$	50,777,083		$	—	$	430,767,404

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

The Company monitors the credit quality of its loans receivable on an ongoing basis. Credit quality is monitored by reviewing certain credit quality indicators. Management has determined that internally assigned risk ratings and loan-to-value ratios (LTVs), at period end, are the key credit quality indicators that best help management monitor the credit quality of the Company’s loans receivable. Loan-to-value ratios used by management in monitoring credit quality are based on current period loan balances and original values at time of origination (unless a current appraisal has been obtained as a result of the loan being deemed impaired or the loan is a maturing construction loan).

Appraisals on properties securing impaired loans and Other Real Estate Owned (“OREO”) are updated annually. Additionally, appraisals on construction loans are updated four months in advance of scheduled maturity dates. We update our impairment analysis monthly based on the most recent appraisal as well as other factors (such as senior lien positions, e.g. property taxes). We are subscribers to a national real estate valuation database service and use published information regarding home sales prices in the towns/counties where our collateral is located in CT and NY.

The majority of the Company’s impaired loans have been resolved through courses of action other than via bank liquidations of real estate collateral through OREO. These include normal loan payoffs, the traditional workout process, triggering personal guarantee obligations, and troubled debt restructurings. However, as loan workout efforts progress to a point where the bank’s liquidation of real estate collateral is the likely outcome, the impairment analysis is updated to reflect actual recent experience with bank sales of OREO properties.

A disposition discount is built into our impairment analysis and reflected in our allowance once a property is determined to be a likely OREO (e.g. foreclosure is probable). To determine the discount we compare the average sales prices of our prior OREO properties to the appraised value that was obtained as of the date we took title to the property. The difference is the bank-owned disposition discount.

The Company has a risk rating system as part of the risk assessment of its loan portfolio. The Company’s lending officers are required to assign an Obligor and a Facility risk rating to each loan in their portfolio at origination, which is ratified or modified by the Committee to which the loan is submitted for approval. When the lender learns of important financial developments, the risk rating is reviewed accordingly, and adjusted if necessary. All loans are reviewed annually. Similarly, the Loan Committee can adjust a risk rating.

In addition, the Company engages a third party independent loan reviewer that performs quarterly reviews of a sample of loans, validating the Bank’s risk ratings assigned to such loans. The risk ratings play an important role in the establishment of the loan loss provision and to confirm the adequacy of the allowance for loan losses. Any upgrades to classified loans must be approved by the Board Loan Committee.

When assigning a risk rating to a loan, management utilizes the Bank’s internal eleven-point risk rating system.

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

An asset is considered “special mention” when it has a potential weakness based on objective evidence, but does not currently expose the Company to sufficient risk to warrant classification in one of the following categories: An asset is considered “substandard” if it is not adequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard assets have well defined weaknesses based on objective evidence, and are characterized by the “distinct possibility” that the Company will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.”

During the quarter ended June 30, 2012, the Bank implemented changes to the allowance methodology, resulting in a reduction of the allowance for loan losses of $1.1 million for that period. In making this transition, the changes served to update the methodology to reflect the direction of the current loan portfolio. The changes were threefold:

•

First, the Bank adopted a two year, instead of a three year, weighted average historical loss factor as the basis for the calculation of its historical loss experience. This is used to calculate expected losses in the pools identified in the Accounting Standards Codification (“ASC”) (Topic 450-20), “Loss Contingencies” pools prior to the application of qualitative risk adjustment factors. This change was made to be more responsive to the changing credit environment. This shorter average historical loss period will produce results more indicative of the current period and expected behavior of the portfolio.

•

Second, the Bank adopted an Internal Risk Ratings Based (IRB) approach to calculating historical loss rates. This approach calibrates expected losses with actual risk assessment and equates the likelihood of loss to the level of risk in a credit facility rating. Previously, loss history was applied to categories of loans and adjusted by qualitative factors apportioned by risk rating within the categories.

•

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

Charge-off generally commences after the loan is classified “doubtful” to reduce the loan to its recoverable balance. If the account is classified as “loss”, the full balance is charged off regardless of the potential recovery from the sale of the collateral. This amount is recognized as a recovery once the collateral is sold.

In accordance with FFIEC (“Federal Financial Institutions Examination Council”) published policies establishing uniform criteria for the classification of retail credit based on delinquency status, “Open-end” credits are charged-off when 180 days delinquent and “Closed-end” credits are charged-off when 120 days delinquent.

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

The following table details the credit risk exposure of loans receivable, by loan type and credit quality indicator at December 31, 2013:

CREDIT RISK PROFILE BY CREDIT WORTHINESS CATEGORY


	Commercial				Commercial Real Estate				Construction				Construction to Permanent				Residential Real Estate				Consumer
LTVs:	< 75%		>= 75%		< 75%		>= 75%		< 75%		>= 75%		< 75%		>= 75%		< 75%		>= 75%		< 75%		>= 75%		Other		Total
Internal Risk Rating
Pass	$	23,492,659	$	3,898,173	$	199,117,577	$	7,950,793	$	—	$	—	$	10,105,528	$	—	$	82,704,363	$	20,592,131	$	42,541,721	$	3,839,030		650,234	$	394,892,209
Special Mention		167,095		—		6,573,089		2,502,204		—		—		—		—		—		—		—		—		—		9,242,388
Substandard		7,503,322		—		3,690,308		3,331,121		60,000		200,000		1,197,474		—		1,975,907		925,874		8,696		30,876		—		18,923,578

	$	31,163,076	$	3,898,173	$	209,380,974	$	13,784,118	$	60,000	$	200,000	$	11,303,002	$	—	$	84,680,270	$	21,518,005	$	42,550,417	$	3,869,906	$	650,234	$	423,058,175

CREDIT RISK PROFILE


	Commercial		Commercial Real Estate		Construction		Construction to Permanent		Residential Real Estate		Consumer		Totals
Performing	$	28,909,450	$	221,400,483	$	—	$	10,105,528	$	103,296,494	$	47,037,870	$	410,749,825
Non Performing		6,151,799		1,764,609		260,000		1,197,474		2,901,781		32,687		12,308,350

Total	$	35,061,249	$	223,165,092	$	260,000	$	11,303,002	$	106,198,275	$	47,070,557	$	423,058,175

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

The following table details the credit risk exposure of loans receivable, by loan type and credit quality indicator at December 31, 2012:

CREDIT RISK PROFILE BY CREDIT WORTHINESS CATEGORY


	Commercial				Commercial Real Estate				Construction				Construction to Permanent				Residential Real Estate				Consumer
LTVs:	< 75%		>= 75%		< 75%		>= 75%		< 75%		>= 75%		< 75%		>= 75%		< 75%		>= 75%		< 75%		>= 75%		Other		Total
Internal Risk Rating
Pass	$	25,563,777	$	1,241,109	$	203,149,356	$	9,182,622	$	—	$	—	$	3,593,058	$	—	$	77,368,459	$	25,617,355	$	46,102,332	$	3,752,752		765,469	$	396,336,289
Special Mention		7,234,814		164,191		11,554,971		5,374,265		3,135,953		—		—		—		5,310,178		—		98,530		564,175		—		33,437,077
Substandard		2,014,401		210,459		8,503,630		9,730,477		—		1,862,038		—		1,258,710		2,524,186		8,212,847		2,368		58,000		—		34,377,116

	$	34,812,992	$	1,615,759	$	223,207,957	$	24,287,364	$	3,135,953	$	1,862,038	$	3,593,058	$	1,258,710	$	85,202,823	$	33,830,202	$	46,203,230	$	4,374,927	$	765,469	$	464,150,482

CREDIT RISK PROFILE


	Commercial		Commercial Real Estate		Construction		Construction to Permanent		Residential Real Estate		Consumer		Totals
Performing	$	36,209,242	$	237,764,844	$	3,135,953	$	3,593,058	$	108,295,992	$	51,341,258	$	440,340,347
Non Performing		219,509		9,730,477		1,862,038		1,258,710		10,737,033		2,368		23,810,135

Total	$	36,428,751	$	247,495,321	$	4,997,991	$	4,851,768	$	119,033,025	$	51,343,626	$	464,150,482

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

The following table sets forth the detail, and delinquency status, of non-accrual loans and past due matured loans at December 31, 2013:


	Non-Accrual and Past Due Loans
	Non-Accrual Loans										>90 Days		Total Non-
2013	31-60 Days Past Due		61-90 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Past Due and Accruing		Accrual and Past Due Loans
Commercial
Pass	$	—	$	—	$	—	$	—	$	—	$	25,000	$	25,000
Substandard		—		—		1,799		1,799		6,150,000		—		6,151,799

Total Commercial	$	—	$	—	$	1,799	$	1,799	$	6,150,000	$	25,000	$	6,176,799

Commercial Real Estate
Substandard	$	—	$	—	$	1,764,609	$	1,764,609	$	—	$	840,962	$	2,605,571

Total Commercial Real Estate	$	—	$	—	$	1,764,609	$	1,764,609	$	—	$	840,962	$	2,605,571

Construction
Substandard	$	—	$	—	$	260,000	$	260,000	$	—	$	—	$	260,000

Total Construction	$	—	$	—	$	260,000	$	260,000	$	—	$	—	$	260,000

Construction to Permanent
Substandard	$	—	$	—	$	—	$	—	$	1,197,474	$	—	$	1,197,474

Total Construction to Permanent	$	—	$	—	$	—	$	—	$	1,197,474	$	—	$	1,197,474

Residential Real Estate
Substandard	$	—	$	—	$	2,523,233	$	2,523,233	$	378,548	$	—	$	2,901,781

Total Residential Real Estate	$	—	$	—	$	2,523,233	$	2,523,233	$	378,548	$	—	$	2,901,781

Consumer
Substandard	$	—	$	—	$	1,811	$	1,811	$	30,876	$	—	$	32,687

Total Consumer	$	—	$	—	$	1,811	$	1,811	$	30,876	$	—	$	32,687

Total	$	—	$	—	$	4,551,452	$	4,551,452	$	7,756,898	$	865,962	$	13,174,312

100

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

The following table sets forth the detail, and delinquency status, of non-accrual loans and past due matured loans at December 31, 2012:


	Non-Accrual and Past Due Loans
	Non-Accrual Loans										>90 Days		Total Non-
2012	31-60 Days Past Due		61-90 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Past Due and Accruing		Accrual and Past Due Loans
Commercial
Pass	$	—	$	—	$	—	$	—	$	—	$	300,000	$	300,000
Substandard		—		—		182,258		182,258		37,251		500,000		719,509

Total Commercial	$	—	$	—	$	182,258	$	182,258	$	37,251	$	800,000	$	1,019,509

Commercial Real Estate
Pass	$	—	$	—	$	—	$	—	$	—	$	566,936	$	566,936
Substandard		—		—		7,629,819		7,629,819		2,100,658		867,361		10,597,838

Total Commercial Real Estate	$	—	$	—	$	7,629,819	$	7,629,819	$	2,100,658	$	1,434,297	$	11,164,774

Construction
Substandard	$	—	$	—	$	1,862,038	$	1,862,038	$	—	$	—	$	1,862,038

Total Construction	$	—	$	—	$	1,862,038	$	1,862,038	$	—	$	—	$	1,862,038

Construction to Permanent
Substandard	$	—	$	—	$	—	$	—	$	1,258,710	$	—	$	1,258,710

Total Construction to Permanent	$	—	$	—	$	—	$	—	$	1,258,710	$	—	$	1,258,710

Residential Real Estate
Substandard	$	—	$	358,123	$	10,231,542	$	10,589,665	$	147,368	$	—	$	10,737,033

Total Residential Real Estate	$	—	$	358,123	$	10,231,542	$	10,589,665	$	147,368	$	—	$	10,737,033

Consumer
Substandard	$	—	$	—	$	—	$	—	$	2,368	$	—	$	2,368

Total Consumer	$	—	$	—	$	—	$	—	$	2,368	$	—	$	2,368

Total	$	—	$	358,123	$	19,905,657	$	20,263,780	$	3,546,355	$	2,234,297	$	26,044,432

101

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Included in loans receivable are loans for which the accrual of interest income has been discontinued due to deterioration in the financial condition of the borrowers. The recorded balance of these nonaccrual loans was $12.3 million and $23.8 million at December 31, 2013, and December 31, 2012 respectively. Generally, loans are placed on non-accruing status when they become 90 days or more delinquent, and remain on non-accrual status until they are brought current, have six months of performance under the loan terms, and factors indicating reasonable doubt about the timely collection of payments no longer exist. Therefore, loans may be current in accordance with their loan terms, or may be less than 90 days delinquent and still be on a non-accruing status. Additionally, certain loans that cannot demonstrate sufficient global cash flow to continue loan payments in the future and certain troubled debt restructures (TDRs) are placed on non-accrual status.

Loans past due ninety days or more, and still accruing interest, were $866,000 and $2.2 million at December 31, 2013, and December 31, 2012 respectively. Loans over 90 days past due were comprised of two loans as of December 31, 2013. One loan for $841,000 was current and the second loan for $25,000 was current within 60 days as to interest payments, both were past the loan’s maturity date and in the process of being renewed. At December 31, 2012, four of the five loans totaling $1,667,000, were making payments, but past the loan’s maturity date and were in the process of being renewed. The other loan totaling $567,000 was over 90 days past due as to payments and past the loan’s maturity date, but was subsequently paid off.

102

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

The following table sets forth the detail and delinquency status of loans receivable, net, by performing and non-performing loans at December 31, 2013.


	Performing (Accruing) Loans
2013	31-60 Days Past Due		61-89 Days Past Due		Total Past Due		Current		Total Loan Balances		Total Non- Accrual and > 90 Days Past Due Loans		Total Loans Receivable
Commercial
Pass	$	725,000	$	—	$	725,000	$	26,640,833	$	27,365,833	$	25,000	$	27,390,833
Special Mention		—		—		—		167,095		167,095		—		167,095
Substandard		—		—		—		1,351,522		1,351,522		6,151,799		7,503,321

Total Commercial	$	725,000	$	—	$	725,000	$	28,159,450	$	28,884,450	$	6,176,799	$	35,061,249

Commercial Real Estate
Pass	$	1,858,402	$	266,250	$	2,124,652	$	204,943,717	$	207,068,369	$	—	$	207,068,369
Special Mention		—		—		—		9,075,293		9,075,293		—		9,075,293
Substandard		—		—		—		4,415,859		4,415,859		2,605,571		7,021,430

Total Commercial Real Estate	$	1,858,402	$	266,250	$	2,124,652	$	218,434,869	$	220,559,521	$	2,605,571	$	223,165,092

Construction
Substandard	$	—	$	—	$	—	$	—	$	—	$	260,000	$	260,000

Total Construction	$	—	$	—	$	—	$	—	$	—	$	260,000	$	260,000

Construction to Permanent
Pass	$	—	$	—	$	—	$	10,105,528	$	10,105,528	$	—	$	10,105,528
Substandard		—		—		—		—		—		1,197,474		1,197,474

Total Construction to Permanent	$	—	$	—	$	—	$	10,105,528	$	10,105,528	$	1,197,474	$	11,303,002

Residential Real Estate
Pass	$	31,951	$	—	$	31,951	$	103,264,543	$	103,296,494	$	—	$	103,296,494
Substandard		—		—		—		—		—		2,901,781		2,901,781

Total Residential Real Estate	$	31,951	$	—	$	31,951	$	103,264,543	$	103,296,494	$	2,901,781	$	106,198,275

Consumer
Pass	$	349,999	$	559,949	$	909,948	$	46,121,037	$	47,030,985	$	—	$	47,030,985
Substandard		6,885		—		6,885		—		6,885		32,687		39,572

Total Consumer	$	356,884	$	559,949	$	916,833	$	46,121,037	$	47,037,870	$	32,687	$	47,070,557

Total	$	2,972,237	$	826,199	$	3,798,436	$	406,085,427	$	409,883,863	$	13,174,312	$	423,058,175

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PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

The following table sets forth the detail and delinquency status of loans receivable, net, by performing and non-performing loans at December 31, 2012.


	Performing (Accruing) Loans
2012	31-60 Days Past Due		61-89 Days Past Due		Total Past Due		Current		Total Loan Balances		Total Non- Accrual and > 90 Days Past Due Loans		Total Loans Receivable
Commercial
Pass	$	10,171	$	—	$	10,171	$	26,494,715	$	26,504,886	$	300,000	$	26,804,886
Special Mention		—		—		—		7,399,006		7,399,006		—		7,399,006
Substandard		—		—		—		1,505,350		1,505,350		719,509		2,224,859

Total Commercial	$	10,171	$	—	$	10,171	$	35,399,071	$	35,409,242	$	1,019,509	$	36,428,751

Commercial Real Estate
Pass	$	—	$	—	$	—	$	211,765,042	$	211,765,042	$	566,936	$	212,331,978
Special Mention		—		—		—		16,929,236		16,929,236		—		16,929,236
Substandard		—		—		—		7,636,269		7,636,269		10,597,838		18,234,107

Total Commercial Real Estate	$	—	$	—	$	—	$	236,330,547	$	236,330,547	$	11,164,774	$	247,495,321

Construction
Special Mention	$	—	$	—	$	—	$	3,135,953	$	3,135,953	$	—	$	3,135,953
Substandard		—		—		—		—		—		1,862,038		1,862,038

Total Construction	$	—	$	—	$	—	$	3,135,953	$	3,135,953	$	1,862,038	$	4,997,991

Construction to Permanent
Pass	$	—	$	—	$	—	$	3,593,058	$	3,593,058	$	—	$	3,593,058
Substandard		—		—		—		—		—		1,258,710		1,258,710

Total Construction to Permanent	$	—	$	—	$	—	$	3,593,058	$	3,593,058	$	1,258,710	$	4,851,768

Residential Real Estate
Pass	$	40,838	$	—	$	40,838	$	102,944,976	$	102,985,814	$	—	$	102,985,814
Special Mention		—		—		—		5,310,178		5,310,178		—		5,310,178
Substandard		—		—		—		—		—		10,737,033		10,737,033

Total Residential Real Estate	$	40,838	$	—	$	40,838	$	108,255,154	$	108,295,992	$	10,737,033	$	119,033,025

Consumer
Pass	$	—	$	12,443	$	12,443	$	50,608,110	$	50,620,553	$	—	$	50,620,553
Special Mention		—		—		—		662,705		662,705		—		662,705
Substandard		—		—		—		58,000		58,000		2,368		60,368

Total Consumer	$	—	$	12,443	$	12,443	$	51,328,815	$	51,341,258	$	2,368	$	51,343,626

Total	$	51,009	$	12,443	$	63,452	$	438,042,598	$	438,106,050	$	26,044,432	$	464,150,482

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

The following table summarizes impaired loans as of December 31, 2013:


	Recorded Investment		Unpaid Principal Balance		Related Allowance
2013
With no related allowance recorded:
Commercial	$	1,799	$	150,969	$	—
Commercial Real Estate		7,596,817		8,316,412		—
Construction		—		—		—
Construction to Permanent		1,197,474		1,425,000
Residential		5,098,392		7,631,751		—
Consumer		590,825		669,584		—

Total:	$	14,485,307	$	18,193,716	$	—
With an allowance recorded:
Commercial	$	6,150,000	$	6,150,000	$	1,500,000
Commercial Real Estate		170,406		215,219		31,097
Construction		260,000		486,625		260,000
Construction to Permanent		—		—		—
Residential		925,874		1,065,974		97,829
Consumer		1,811		2,062		1,811

Total:	$	7,508,091	$	7,919,880	$	1,890,737
Commercial	$	6,151,799	$	6,300,969	$	1,500,000
Commercial Real Estate		7,767,223		8,531,631		31,097
Construction		260,000		486,625		260,000
Construction to Permanent		1,197,474		1,425,000		—
Residential		6,024,266		8,697,725		97,829
Consumer		592,636		671,646		1,811

Total:	$	21,993,398	$	26,113,596	$	1,890,737

Impaired loans consist of non-accrual loans, TDRs and loans that were previously classified as TDRs that have been upgraded.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

The following table summarizes impaired loans as of December 31, 2012:


	Recorded Investment		Unpaid Principal Balance		Related Allowance
2012
With no related allowance recorded:
Commercial	$	46,301	$	131,195	$	—
Commercial Real Estate		12,328,103		13,369,985		—
Construction		—		—		—
Construction to Permanent		1,258,710		1,425,000
Residential		10,760,965		12,786,388		—
Consumer		564,175		564,175		—

Total:	$	24,958,254	$	28,276,743	$	—
With an allowance recorded:
Commercial	$	173,208	$	350,000	$	33,280
Commercial Real Estate		3,581,000		3,606,947		728,607
Construction		1,862,038		2,013,663		120,616
Construction to Permanent		—		—		—
Residential		2,806,210		2,806,766		83,543
Consumer		2,368		2,506		2,368

Total:	$	8,424,824	$	8,779,882	$	968,414
Commercial	$	219,509	$	481,195	$	33,280
Commercial Real Estate		15,909,103		16,976,932		728,607
Construction		1,862,038		2,013,663		120,616
Construction to Permanent		1,258,710		1,425,000		—
Residential		13,567,175		15,593,154		83,543
Consumer		566,543		566,681		2,368

Total:	$	33,383,078	$	37,056,625	$	968,414

At December 31, 2013 and 2012, the recorded investment of impaired loans was $22.0 million and $33.4 million, with related allowances of $1.9 million and $1.0 million, respectively.

Included in the tables above at December 31, 2013 and 2012, are loans with carrying balances of $14.5 million and $25.0 million respectively that required no specific reserves in our allowance for loan losses. Loans that did not require specific reserves have sufficient collateral values, less costs to sell, supporting the carrying balances of the loans. In some cases, there may be no specific reserves because the Company already charged-off the specific impairment. Once a borrower is in default, the Company is under no obligation to advance additional funds on unused commitments.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

On a case-by-case basis, the Company may agree to modify the contractual terms of a borrower’s loan to remain competitive and assist customers who may be experiencing financial difficulty, as well as preserve the Company’s position in the loan. If the borrower is experiencing financial difficulties and a concession has been made, the loan is classified as a troubled debt restructured loan.

The following table presents the total troubled debt restructured loans as of December 31, 2013 which are included in impaired loans:


	Accrual				Non-accrual				Total
	# of Loans		Amount		# of Loans		Amount		# of Loans		Amount
Construction to permanent		1	$	990,913		1	$	1,197,474		2	$	2,188,387

Total Troubled Debt Restructurings		1	$	990,913		1	$	1,197,474		2	$	2,188,387

The following table presents the total troubled debt restructured loans as of December 31, 2012:


	Accrual				Non-accrual				Total
	# of Loans		Amount		# of Loans		Amount		# of Loans		Amount
Commercial Real Estate		—	$	—		2	$	4,255,658		2	$	4,255,658
Residential Real Estate		—		—		3		5,519,232		3		5,519,232
Construction to permanent		—		—		1		1,258,710		1		1,258,710
Commercial		—		—		1		37,251		1		37,251
Consumer home equity		1		564,175		—		—		1		564,175

Total Troubled Debt Restructurings		1	$	564,175		7	$	11,070,851		8	$	11,635,026

107

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

The following table summarizes the two loans that were modified in a troubled debt restructuring during the year ended December 31, 2013 and are included in total impaired loans.


	Twelve months ended December 31, 2013
	Number of Relationships		Pre-Modification Outstanding Recorded Investment		Number of Relationships		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings
Construction to permanent		2	$	4,730,324		1	$	990,913

Total Troubled Debt Restructurings		2	$	4,730,324		1	$	990,913

The following table summarizes the six loans that were modified in a troubled debt restructuring during the year ended December 31, 2012.


	Twelve months ended December 31, 2012
	Number of Relationships		Pre-Modification Outstanding Recorded Investment		Number of Relationships		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings
Residential Real Estate		3	$	8,529,624		3	$	5,524,800
Construction to permanent		1		4,905,000		—		—
Commercial		1		37,251		1		37,251
Consumer home equity		1		564,175		1		564,175

Total Troubled Debt Restructurings		6	$	14,036,050		5	$	6,126,226

Substantially all of our troubled debt restructured loan modifications involve lowering the monthly payments on such loans through either a reduction in interest rate below market rate, an extension of the term of the loan, or a combination of these two methods. These modifications rarely result in the forgiveness of principal or accrued interest. In addition, we frequently obtain additional collateral or guarantor support when modifying commercial loans. If the borrower had demonstrated performance under the previous terms and our underwriting process shows the borrower has the capacity to continue to perform under the restructured terms, the loan will continue to accrue interest. Non-accruing restructured loans may be returned to accrual status when there has been a sustained period of repayment performance (generally six consecutive months of payments) and both principal and interest are deemed collectible.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

During the year ended December 31, 2013, two construction to permanent loans to one borrower in the amount of $3.7 million and $1.0 million were downgraded due to the financial hardship of the borrower. The loan for $3.7 million has since been upgraded as to risk rating. Four troubled debt restructured loans, a commercial loan for $37,000, a residential real estate loan for $4.4 million and two commercial real estate loans aggregating $3.9 million have since paid off. Two troubled debt restructured loans, a home equity installment loan for $563,000 and a residential real estate loan for $347,000 were upgraded due to the improvement in the borrower’s financial condition. One residential real estate loan for $500,000 was charged off, due to the uncertainty of the collectability of the loan.

During the year ended December 31, 2012, four of the troubled debt restructured loans were upgraded and are no longer classified as troubled debt restructurings as compared to December 31, 2011. The upgrades, due to performance, were a commercial construction loan for $1.2 million where the bank received additional collateral, a commercial real estate loan for $234,000 due to increased cash flow generated from the borrower’s business and a residential real estate loan for $2.8 million due to increased liquidity of the borrower. The fourth loan, a construction to permanent troubled debt restructured loan for $4.9 million was restructured into two loans, both of which have been upgraded. One loan was upgraded to pass, due to increased liquidity from additional tenants and is now classified as commercial real estate. The other loan for $1.1 million was upgraded to special mention, due to increased liquidity of the borrower. There was another troubled debt restructuring of a residential loan for $4.7 million that was upgraded to special mention due to increased liquidity of the borrower during the first quarter of 2012, which has since been downgraded to substandard, due to financial hardship of the borrower in the second quarter. Two troubled debt restructurings had a payment default, a commercial real estate loan which became an OREO in the second quarter and has since been sold, and a construction loan that is currently an OREO. There was one troubled debt restructuring of a residential loan for $364,000 due to the discharge from bankruptcy of the borrower. There were two troubled debt restructurings due to forbearance agreements of the borrowers, a commercial loan for $37,000 and a home equity installment loan for $564,000. There was an additional troubled debt restructuring for $500,000 due to foreclosure action of a residential real estate loan. The Bank obtained a judgment lien on another property of the borrower, resulting in additional collateral of $500,000.

109

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Note 5. Premises and Equipment

At December 31, 2013 and 2012, premises and equipment consisted of the following:


	2013			2012
Leasehold improvements	$	6,060,275		$	6,356,657
Furniture, equipment and software		6,981,177			6,591,500
Land		7,340,858			—
Buildings		4,956,407			964,745

		25,338,717			13,912,902
Less: accumulated depreciation and amortization		(10,277,279	)		(9,536,286	)

	$	15,061,438		$	4,376,616

For the years ended December 31, 2013, 2012 and 2011, depreciation and amortization expense related to premises and equipment totaled $1,230,917, $1,215,774 and $1,272,660 respectively. Included in the year ended December 31, 2012 of total premises and equipment above, approximately $88,000 was related to assets held for sale.

Note 6. Other Real Estate Operations

At December 31, 2013 and 2012, the Company had other real estate owned of $0 and $4,873,844 respectively. For the years ended December 31, 2013, 2012 and 2011, amounts charged to operations for other real estate owned totaled $211,687, $(58,044) and $877,969 respectively. A summary of other real estate operations for the years ended December 31, 2013, 2012 and 2011 is as follows:


	2013			2012			2011
Expenses of holding other real estate owned	$	325,650		$	127,099		$	918,291
Impairment write-downs on other real estate owned		—			—			165,764
(Gain) loss on sale of other real estate owned		(113,963	)		(185,143	)		(193,786	)
Rental income from other real estate owned		—			—			(12,300	)

Expense from other real estate operations	$	211,687		$	(58,044	)	$	877,969

110

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Note 7. Deposits

At December 31, 2013 and 2012, deposits consisted of the following:


	Weighted Average Interest Rate			2013		Weighted Average Interest Rate			2012
Non-interest bearing		—		$	55,358,161		—		$	65,176,125

Interest bearing:
Time certificates, less than $100,000		1.05	%		129,548,033		1.37	%		160,610,601
Time certificates, $100,000 or more		1.09	%		106,387,098		1.50	%		121,142,374
Money market		0.04	%		29,309,657		0.20	%		42,401,428
Savings		0.30	%		80,982,920		0.51	%		77,760,967
NOW		0.01	%		28,618,213		0.07	%		30,191,403

Total interest bearing					374,845,921					432,106,773

Total deposits				$	430,204,082				$	497,282,898

At December 31, 2013 and 2012, we did not have any certificates of deposit through the Certificate of Deposit Account Registry Service (CDARS) network included in time certificates. Included in total deposits above, approximately $24.7 million is related to deposits held for sale at December 31, 2012. There were no deposits held for sale at December 31, 2013.

Interest expense on deposits consists of the following:


	Year Ended December 31,
	2013		2012		2011
Time certificates, less than $100,000	$	1,821,591	$	2,706,666	$	3,380,456
Time certificates, $100,000 or more		1,600,519		2,225,726		2,567,071
Money market		40,481		71,808		88,813
Savings		349,998		330,842		235,628
NOW		8,718		16,435		11,610

	$	3,821,307	$	5,351,477	$	6,283,578

111

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Contractual maturities of time certificates of deposit as of December 31, 2013 are summarized below:


	Weighted Average Interest Rate			Balance of Time Certificates of Deposit
Due within:
1 year		0.96	%	$	200,555,373
1-2 years		1.99	%		16,514,915
2-3 years		1.59	%		5,661,154
3-4 years		1.58	%		8,018,162
4-5 years		0.85	%		5,185,527

		1.07	%	$	235,935,131

Note 8. Borrowings

Federal Home Loan Bank borrowings

The Bank is a member of the Federal Home Loan Bank of Boston (“FHLB”). At December 31, 2013, the Bank has the ability to borrow from the FHLB based on a certain percentage of the value of the Bank’s qualified collateral, as defined in the FHLB Statement of Products Policy, comprised mainly of mortgage-backed securities and loans segregated as collateral for the FHLB. The additional amount available under this agreement as of December 31, 2013 was $37,000,000. In accordance with an agreement with the FHLB, the qualified collateral must be free and clear of liens, pledges and encumbrances. In addition, the Company has a $2,000,000 available line of credit with the FHLB. At December 31, 2013 and 2012, there were no advances outstanding under this line of credit. During 2013, $50,000,000 of FHLB advances with interest rates ranging from 0.77% to 3.69%, were paid off and a $10,000,000 FHLB advance with an interest rate of 2.19% was restructured. The restructured advance allowed the Company to reduce the effective interest rates, from 2.19% to 0.77%, and to extend the maturity for one year, in accordance with ASC 470-50, “Debt Modifications and Extinguishments”. At December 31, 2013 and 2012, outstanding advances from the FHLB aggregated $57,000,000 and $50,000,000 respectively, with average interest rates ranging from 0.19% to 1.17%.

Repurchase agreements

At December 31, 2013 and 2012, the Company had $0 and $7,000,000 of securities sold under agreements to repurchase bearing interest at a fixed rate of 4.3475%. During 2013, the $7,000,000 of repurchase agreements with an interest rate of 4.41% was repaid.

112

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Junior subordinated debt owed to unconsolidated trust

During 2003, the Company formed the Trust of which 100% of the Trust’s common securities are owned by the Company. The Trust has no independent assets, and exists for the sole purpose of issuing trust securities and investing the proceeds thereof in an equivalent amount of junior subordinated debentures issued by the Company. The Trust issued $8,000,000 of trust preferred securities in 2003.

Trust preferred securities currently qualify for up to 25% of the Company’s Tier I Capital, with the excess qualifying as Tier 2 Capital. On March 1, 2005, the Federal Reserve Board of Governors, which is the banking regulator for the Holding Company, approved final rules that allowed for the continued inclusion of outstanding and prospective issuances of trust preferred securities in regulatory capital, subject to new, stricter limitations, which became effective March 31, 2009 and had no impact on the Company.

The subordinated debentures of $8,248,000 are unsecured obligations of the Company and are subordinate and junior in right of payment to all present and future senior indebtedness of the Company. The Company has entered into a guarantee, which together with its obligations under the subordinated debentures and the declaration of trust governing the Trust, including its obligations to pay costs, expenses, debts and liabilities, other than trust securities, provides a full and unconditional guarantee of amounts on the capital securities. The subordinated debentures, which bear interest at the three-month LIBOR plus 3.15% (3.39585% at December 31, 2013), mature on March 26, 2033. Beginning in the second quarter of 2009, the Company began deferring interest payments on the subordinated debentures as permitted under the terms of the debentures. Interest is still being accrued and charged to operations. The Company may only defer the payment of interest for 20 consecutive quarters, or thru March, 2014, and all accrued interest must be paid at the completion of the deferral period, June 2014. As of December 31, 2013, the accrued interest payable is approximately $1.4 million.

The duration of the Trust is 30 years, with an early redemption feature at the Company’s option on a quarterly basis which commenced March 26, 2008. The Trust securities also bear interest at the three month LIBOR plus 3.15%.

113

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Maturity of borrowings

The contractual maturities of the Company’s borrowings at December 31, 2013, by year, are as follows:


	Fixed Rate		Floating Rate		Total
2014	$	57,000,000	$	—	$	57,000,000
2015		—		—		—
2016		—		—		—
2017		—		—		—
2018		—		—		—
Thereafter		—		8,248,000		8,248,000

Total borrowings	$	57,000,000	$	8,248,000	$	65,248,000

Note 9. Commitments and Contingencies

Operating leases

The Company has non-cancelable operating leases for its eight branch banking offices and for administrative and operational activities, which expire on various dates through 2017. Most of the leases contain rent escalation provisions, as well as renewal options for one or more periods. Under these lease agreements, the Company is required to pay certain operating costs such as insurance and property taxes. The Company also leases certain equipment under cancelable and non-cancelable arrangements.

Included in the table below, $39,646 of operating lease commitments have already been accounted for and included in restructuring charges in the consolidated financial statements for one branch that was closed.

114

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Future minimum rental commitments under the terms of these leases by year and in the aggregate, are as follows:


Years Ending December 31,	Amount
2014	$	1,638,568
2015		1,271,057
2016		720,034
2017		182,978
2018		—
Thereafter		—

	$	3,812,637

Total rental expense, which is charged to operations on a straight line basis, for cancelable and non-cancelable operating leases was $2,142,995, $2,531,929 and $2,838,066 for the years ended December 31, 2013, 2012 and 2011, respectively. The Company subleased excess space at two locations. Income from subleases included in non-interest expense was $70,835, $54,846 and $33,326 for the years ended December 31, 2013, 2012 and 2011, respectively.

Employment Agreements

The Company has two change of control agreements that entitle executive officers to receive up to two and one-half times the greater of the officer’s base salary at the time or total compensation for the most recently completed fiscal year if a change of control occurs while such officers are full time employees of the Company or within six months following termination of employment other than for cause or by reason of death or disability.

Legal Matters

Neither the Company nor the Bank has any pending legal proceedings, other than ordinary routine litigation, incidental to its business, to which the Company or the Bank is a party or any of its property is subject. Management and its legal counsel are of the opinion that the ultimate disposition of these routine matters will not have a material adverse effect on the Company’s consolidated financial condition, results of operations or liquidity.

115

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Note 10. Income Taxes

The components of the income tax provision (benefit) for the years ended December 31, 2013, 2012 and 2011 are as follows:


	2013			2012		2011
Current
Federal	$	—		$	—	$	—
State		(21,080	)		—		—

Total		(21,080	)		—		—

Deferred
Federal		(317,704	)		—		—
State		—			—		—

Total		(317,704	)		—		—

Benefit for income taxes	$	(338,784	)	$	—	$	—

A reconciliation of the anticipated income tax benefit (computed by applying the statutory Federal income tax rate of 34% to loss before income taxes) to the income tax provision (benefit) as reported in the statements of operations for the years ended December 31, 2013, 2012 and 2011 is as follows:


	2013			2012			2011
Benefit for income taxes at statutory Federal rate	$	(2,593,428	)	$	(182,296	)	$	(5,256,200	)
State taxes, net of Federal benefit		(21,080	)		—			—
Dividends received deduction		—			—			(50,100	)
Nondeductible expenses		6,006			4,570			5,900
Write-off of DTA due to 382 Limitation		—			—			10,382,276
Change in cash surrender value of life insurance		(177,843	)		(175,814	)		(216,300	)
Increase (decrease) in valuation allowance		2,447,561			329,113			(4,853,660	)
Other		0			24,427			(11,916	)

Total benefit for income taxes	$	(338,784	)	$	—		$	—

116

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

At December 31, 2013 and 2012, the tax effects of temporary differences that give rise to the Company’s deferred tax assets and deferred tax liabilities are as follows:


	2013			2012			2011
Deferred tax assets:
Allowance for loan losses	$	2,212,628		$	2,343,090		$	3,655,330
Nonaccrual interest		1,474,105			1,324,824			774,233
Premises and equipment		1,276,365			1,073,884			1,090,095
Accrued expenses		375,881			224,523			405,108
Share-based Compensation		—			72,456			—
Capital loss carryover		572,301			572,301			572,301
State NOL carryforward benefit		3,612,623			3,237,434			3,081,579
Federal NOL carryforward benefit		18,427,179			15,850,218			14,755,699
NOL write-off for § 382 Limitation		(10,382,276	)		(10,382,276	)		(10,382,276	)
Federal AMT benefit estimate		—			317,704			317,704
Unrealized loss AFS		462,192			250,819			—
Other		36,791			153,959			144,809

Gross deferred tax assets		18,067,789			15,038,936			14,414,582
Valuation allowance		(18,067,789	)		(15,038,936	)		(14,414,582	)

Deferred tax assets, net of valuation allowance		—			—			—
Deferred tax liabilities
Investment securities		—			—			(82,337	)
Other		—			—			—

Gross deferred tax liabilities		—			—			(82,337	)

Deferred tax liability, net	$	—		$	—		$	(82,337	)

The net deferred tax liability at December 31, 2013 and 2012 is included in accrued expenses and other liabilities in the consolidated balance sheets.

117

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

The allocation of the deferred tax (benefit) provision items charged to operations and items charged directly to equity for the years ended December 31, 2013, 2012 and 2011 are as follows:


	2013		2012		2011
Deferred tax benefit allocated to equity	$	—	$	—	$	(712,832	)
Deferred tax provision allocated to operations		—		—		—

Total deferred tax benefit	$	—	$	—	$	(712,832	)

The determination of the amount of deferred income tax assets which are more likely than not to be realized is primarily dependent on projections of future earnings, which are subject to uncertainty and estimates that may change given economic conditions and other factors. A valuation allowance related to deferred tax assets is required when it is considered more likely than not that all or part of the benefit related to such assets will not be realized. Management has reviewed the deferred tax position of the Company at December 31, 2013. The deferred tax position has been affected by several significant transactions in prior years. These transactions include increased provision for loan losses, the levels of non-accrual loans and other-than-temporary impairment write-offs of certain investments, as well as a loss on the bulk sale of loans in 2011. As a result, the Company is in a cumulative net loss position at December 31, 2013, and under the applicable accounting guidance, has concluded that it is not more-likely-than-not that the Company will be able to realize its deferred tax assets and, accordingly, has established a full valuation allowance totaling $18.1 million against its deferred tax asset at December 31, 2013. The valuation allowance is analyzed quarterly for changes affecting the deferred tax asset. If, in the future, the Company generates taxable income on a sustained basis, management’s conclusion regarding the need for a deferred tax asset valuation allowance could change, resulting in the reversal of all or a portion of the deferred tax asset valuation allowance.

As measured under the rules of the Tax Reform Act of 1986, the Company has undergone a greater than 50% change of ownership in 2010. Consequently, use of the Company’s net operating loss carryforward and certain built in deductions available against future taxable income in any one year are limited. The maximum amount of carry forwards available in a given year is limited to the product of the Company’s fair market value on the date of ownership change and the federal long-term tax-exempt rate, plus any limited carry forward not utilized in prior years.

The Company has analyzed the impact of its recent ownership change and has calculated the annual limitation under IRC 382 to be $284,000. Based on the analysis, the Company has determined that the pre-change net operating losses and net unrealized built-in deductions were approximately $36.2 million. Based on a 20 year carry forward period, the Company could utilize approximately $5.6 million of the pre-change net operating losses and built-in deductions. Therefore, the Company wrote-off approximately $10.4 million of deferred tax assets in 2011. Accordingly, the write-off of the deferred tax asset did not affect the consolidated financial statements as there was a full valuation allowance against the deferred tax asset. At December 31, 2013, the Company had $19.1 million of U.S. federal pre-tax net operating loss carryforwards, which are not subject to the above mentioned IRC Section 382 limitation and do not begin to expire until 2020.

118

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Note 11. Other intangible assets

The changes in the carrying amount of core deposit intangibles for the years ended December 31, 2013 and 2012 are as follows:


	2013		2012
Core Deposit Intangible:
Balance as of January 1,	$	—	$	38,196
Amortization expense		—		6,962
Asset disposal		—		31,234

Balance as of December 31,		—		—

Total other intangible assets	$	—	$	—

Amortization expense for the years ended December 31, 2013, 2012 and 2011 was $0, $6,962 and $15,012, respectively. The asset disposal of $31,234 was part of the consolidation of branches and is included in restructuring charges and asset disposals on the consolidated financial statements.

Note 12. Cash Surrender Value of Life Insurance

The Bank has an investment in, and is the beneficiary of, life insurance policies. The purpose of these life insurance investments is to provide income through the appreciation in the cash surrender value of the policies on the lives of certain officers, directors and employees of the Bank. These policies have an aggregate cash surrender value of $22,024,770 and $21,501,703 at December 31, 2013 and 2012, respectively. These assets are unsecured and maintained in a separate account with one insurance carrier. Income earned on these life insurance policies aggregated $523,067, $517,099 and $636,272 for the years ended December 31, 2013, 2012 and 2011, respectively, and is included in non-interest income.

119

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Note 13. Share-Based Compensation

The Company maintains the Patriot National Bancorp, Inc. 2012 Stock Plan to provide an incentive to directors and employees of the Company by the grant of options, restricted stock awards or phantom stock units. The Plan provides for the issuance of up to 3,000,000 shares of the Company’s common stock subject to certain Plan limitations. 2,552,964 shares of stock remain available for issuance under the Plan as of December 31, 2013. The vesting of restricted stock awards and options may be accelerated in accordance with terms of the plan. The Compensation Committee shall make terms and conditions applicable to the vesting of restricted stock awards and stock options. Restricted stock grants are available to directors and employees and vest in quarterly or annual installments over a three, four or five year period from the date of grant. The Compensation Committee accelerated the vesting of the initial grant of restricted stock in 2012, whereby the first year of the tranche vested immediately. The initial grant, which was awarded to the directors of the Board and accelerated, was deemed as compensation for past services. Stock options were granted at an exercise price equal to $2.20 based on a price determined by the Compensation Committee and all had an expiration period of 10 years. The fair value of stock options granted on January 24, 2012, was estimated utilizing the Black-Scholes option pricing model using the following assumptions: an expected life of 6.28 years utilizing the simplified method, risk-free rate of return of 1.28%, volatility of 61.29% and no dividend yield. The Company was expensing the grant date fair value of all share-based compensation over the requisite vesting periods on a straight-line basis. As of December 31, 2013, there were no outstanding stock options.

For the years ended December 31, 2013, 2012 and 2011, the Company recorded $130,686, $306,421 and $0 of total stock-based compensation, respectively. During 2013, the Company awarded 294,861 shares of restricted stock to employees, there were no shares of restricted stock issued to directors and no options were granted or exercised. In 2012, there were no options exercised and 152,169 shares of restricted stock were issued to directors in payment of directors’ fees in the net amount of $120,397. There were no awards in 2011.

The following table is a summary of the Company’s non-vested stock options as of December 31, 2013, and changes therein during the year then ended:


	Number of Stock Options			Weighted Average Grant Date Fair Value		Weighted Average Exercise Price		Weighted Average Contractual Life (years)
Outstanding—December 31, 2011		—		$	—	$	—		—
Granted		850,000			0.90		2.20		10

Outstanding—December 31, 2012		850,000			0.90		2.20		10
Forfeited		(850,000	)		0.90		2.20		10

Outstanding—December 31, 2013		—		$	—	$	—		—

Exercisable—December 31, 2013		—		$	—	$	—		—

120

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

The following is a summary of the status of the Company’s restricted shares as of December 31, 2013, and changes therein during the period then ended.


	Number of Shares Awarded			Weighted Average Grant Date Fair Value
Non-vested at December 31, 2011		—		$	—
2012 Granted		152,169			1.69
Vested		(72,821	)		1.65
Forfeited		(34,782	)		1.73

Non-vested at December 31, 2012		44,566		$	1.73
2013 Granted		329,649			1.24
Vested		(92,380	)		1.41
Forfeited		—			—

Non-vested at December 31, 2013		281,835		$	1.26

Expected future stock award expense related to the non-vested restricted awards as of December 31, 2013, is $356,190 over an average period of 2.88 years.

Note 14. Shareholders’ Equity

Common Stock

On December 16, 2009, the Company entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) with the Bank and PNBK Holdings, LLC, a limited liability company controlled by Michael Carrazza (“Holdings”). Pursuant to the Securities Purchase Agreement, on October 15, 2010, the Company issued and sold to Holdings 33,600,000 shares of its common stock at a purchase price of $1.50 per share for an aggregate purchase price of $50,400,000. The shares sold to Holdings represent 87.6% of the Company’s current issued and outstanding common stock. Also in connection with that sale, certain directors and officers of both the Company and the Bank resigned and were replaced with nominees of Holdings and Michael Carrazza became Chairman of the Board of the Company.

In connection with that sale, the Company reduced the par value of its common stock to $0.01 per share and increased the number of its authorized common shares to 100,000,000. Also in connection with that sale, the Company entered into a Registration Rights Agreement with Holdings. The Registration Rights Agreement provides Holdings with customary demand, shelf and piggyback registration rights.

The Bank is currently party to an agreement with the Office of the Comptroller of the Currency (“OCC”), which restricts the Bank’s ability to pay dividends without the consent of the OCC. To date, the OCC has not consented to the Bank paying any dividends. In addition, the Company is party to an agreement with the Federal Reserve Bank of New York which also restricts the ability of the Company to pay dividends.

121

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Loss Per Share

The following tables represent information about the computation of basic and diluted loss per share for the years ended December 31, 2013, 2012 and 2011:

2013

Net

Weighted Average

Per Share

Loss

Common Shares O/S

Amount

Basic and Diluted Loss Per Share

Loss attributable to common shareholders

(7,288,946

)

38,423,533

(0.19

)


	2012
	Net			Weighted Average		Per Share
	Loss			Common Shares O/S		Amount
Basic and Diluted Loss Per Share
Loss attributable to common shareholders	$	(536,164	)		38,401,889	$	(0.01	)


	2011
	Net			Weighted Average		Per Share
	Loss			Common Shares O/S		Amount
Basic and Diluted Loss Per Share
Loss attributable to common shareholders	$	(15,459,486	)		38,362,727	$	(0.40	)

For the years ended December 31, 2013, 2012 and 2011, there were no dilutive securities.

Note 15. 401(k) Savings Plan

The Company offers employees participation in the Patriot National Bank 401(k) Savings Plan (the “401(k) Plan”) under Section 401(k) of the Internal Revenue Code. The 401(k) Plan covers substantially all employees who have completed six months of service, are 21 years of age and who elect to participate. Under the terms of the 401(k) Plan, participants can contribute up to the maximum amount allowed, subject to Federal limitations. The Company may make discretionary matching contributions of 50% of the first 6% of the participants’ salary to the 401(k) Plan. Participants are immediately vested in their contributions and the Company’s contributions. The Company contributed approximately $130,000, $160,000 and $201,000 to the 401(k) Plan in 2013, 2012 and 2011, respectively.

122

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Note 16. Financial Instruments with Off-Balance-Sheet Risk

In the normal course of business, the Company is a party to financial instruments with off-balance-sheet risk to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit and involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the balance sheets. The contractual amounts of these instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

The contractual amounts of commitments to extend credit and standby letters of credit represent the amounts of potential accounting loss should: the contract be fully drawn upon; the customer default; and the value of any existing collateral becomes worthless. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments and evaluates each customer’s creditworthiness on a case-by-case basis. Management believes that the Company controls the credit risk of these financial instruments through credit approval processes, credit limits, monitoring procedures and the receipt of collateral as deemed necessary.

Financial instruments whose contract amounts represent credit risk are as follows at December 31, 2013 and 2012:


	2013		2012
Commitments to extend credit:
Future loan commitments	$	7,102,437	$	16,601,019
Home equity lines of credit		28,707,608		30,044,312
Unused lines of credit		40,207,868		39,652,231
Undisbursed construction loans		2,187,752		3,233,322
Financial standby letters of credit		1,117,997		7,000

	$	79,323,662	$	89,537,884

Standby letters of credit are written commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Guarantees that are not derivative contracts have been recorded on the Company’s consolidated balance sheet at their fair value at inception.

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 to extend credit generally have fixed expiration dates or other termination clauses and may require payment of a fee by the borrower. Since these commitments could expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the customer. Collateral held varies, but may include residential and commercial property, deposits and securities. The bank has established a reserve of $12,000 and $5,000 as of December 31, 2013 and December 31, 2012, respectively.

123

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Note 17. Regulatory and Operational Matters

The Company and the 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 possibly additional discretionary—actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s and the Bank’s capital amounts and classification 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 the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). In addition, due to the Bank’s asset profile and current economic conditions in its markets, the Bank’s capital plan pursuant to the Agreement described below does target a minimum 9% Tier 1 leverage capital ratio.

In February 2009 the Bank entered into a formal written agreement (the “Agreement”) with the Office of the Comptroller of the Currency. Under the terms of the Agreement, the Bank has appointed a Compliance Committee of outside directors and the Chief Executive Officer. The Committee must report quarterly to the Board of Directors and to the OCC on the Bank’s progress in complying with the Agreement. The Agreement requires the Bank to review, adopt and implement a number of policies and programs related to credit and operational issues. The Agreement further provides for limitations on the acceptance of certain brokered deposits and the extension of credit to borrowers whose loans are criticized. The Bank may pay dividends during the term of the Agreement only with prior written permission from the OCC. The Agreement also requires that the Bank develop and implement a three-year capital plan. The Bank has taken or put into process all of the steps required by the Agreement, and does not anticipate that the restrictions included within the Agreement will impair its current business plan.

124

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

The Company’s and the Bank’s actual capital amounts and ratios at December 31, 2013 and 2012 were (dollars in thousands):

To Be Well

Capitalized Under

For Capital

Prompt Corrective

Actual

Adequacy Purposes

Action Provisions

2013

Amount

Ratio

Amount

Ratio

Amount

Ratio

The Company:

Total Capital (to Risk Weighted Assets)

56,060

13.95

43,300

8.00

N/A

Tier 1 Capital (to Risk Weighted Assets)

51,027

12.70

21,650

4.00

N/A

Tier 1 Capital (to Average Assets)

51,027

9.33

21,888

4.00

N/A

The Bank:

Total Capital (to Risk Weighted Assets)

55,758

13.86

43,270

8.00

54,087

10.00

Tier 1 Capital (to Risk Weighted Assets)

50,730

12.61

21,635

4.00

32,452

6.00

Tier 1 Capital (to Average Assets)

50,730

9.28

21,872

4.00

27,340

5.00

125

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011


											To Be Well
											Capitalized Under
						For Capital					Prompt Corrective
	Actual					Adequacy Purposes					Action Provisions
2012	Amount		Ratio			Amount		Ratio			Amount		Ratio
The Company:
Total Capital (to Risk Weighted Assets)	$	63,253		15.64	%	$	49,447		8.00	%	$	N/A		N/A
Tier 1 Capital (to Risk Weighted Assets)		58,186		14.39	%		24,724		4.00	%		N/A		N/A
Tier 1 Capital (to Average Assets)		58,186		9.33	%		24,948		4.00	%		N/A		N/A
The Bank:
Total Capital (to Risk Weighted Assets)	$	61,908		15.31	%	$	49,447		8.00	%	$	61,808		10.00	%
Tier 1 Capital (to Risk Weighted Assets)		56,840		14.05	%		24,723		4.00	%		37,085		6.00	%
Tier 1 Capital (to Average Assets)		56,840		9.11	%		24,952		4.00	%		31,190		5.00	%

Restrictions on dividends, loans and advances

The Company’s ability to pay dividends is dependent on the Bank’s ability to pay dividends to the Company. Pursuant to the February 9, 2009 Agreement between the Bank and the OCC, the Bank can pay dividends to the Company only pursuant to a dividend policy requiring compliance with the Bank’s OCC-approved capital program, in compliance with applicable law and with the prior written determination of no supervisory objection by the Assistant Deputy Comptroller. In addition to the Agreement, certain other restrictions exist regarding the ability of the Bank to transfer funds to the Company in the form of cash dividends, loans or advances. The approval of the OCC is required to pay dividends in excess of the Bank’s earnings retained in the current year plus retained net earnings for the preceding two years. As of December 31, 2013, the Bank had an accumulated deficit; therefore, dividends may not be paid to the Company. The Bank is also prohibited from paying dividends that would reduce its capital ratios below minimum regulatory requirements.

The Company’s ability to pay dividends and incur debt is also restricted by the Reserve Bank Agreement. Under the terms of the Reserve Bank Agreement, the Company has agreed that it shall not declare or pay any dividends or incur, increase or guarantee any debt without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation (the “Director”) of the Board of Governors.

Loans or advances to the Company from the Bank are limited to 10% of the Bank’s capital stock and surplus on a secured basis.

126

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Recent Legislative Developments

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Act”) was signed into law on July 21, 2010. The Act is a significant piece of legislation that will continue to have a major impact on the financial services industry, including the organization, financial condition and operations of banks and bank holding companies. Management continues to evaluate the impact of the Act; however, uncertainty remains as to its operational impact, which could have a material adverse impact on the Company’s business, results of operations and financial condition. Many of the provisions of the Act are aimed at financial institutions that are significantly larger than the Company and the Bank. Notwithstanding this, there are many other provisions that the Company and the Bank are subject to and will have to comply with, including any new rules applicable to the Company and the Bank promulgated by the Bureau of Consumer Financial Protection, a new regulatory body dedicated to consumer protection. As rules and regulations are promulgated by the agencies responsible for implementing and enforcing the Act, the Company and the Bank will have to address each to ensure compliance with applicable provisions of the Act and compliance costs are expected to increase.

On June 28, 2011, the Federal Reserve Board approved a final debit-card interchange rule. This primarily impacts larger banks and has not had a material impact on the Company.

Note 18. Related Party Transactions

In the normal course of business, the Company grants loans to executive officers, directors and members of their immediate families, as defined, and to entities in which these individuals have more than a 10% equity ownership. Such loans are transacted at terms, including interest rates, similar to those available to unrelated customers.

127

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Changes in loans outstanding to such related parties during 2013 and 2012 are as follows:


	2013			2012
Balance, beginning of year	$	122		$	2,068,939
Additional Loans		58			483
Repayments		(143	)		(2,069,300	)

Balance, end of year	$	37		$	122

Related party deposits aggregated approximately $3,063,909 and $3,224,946 as of December 31, 2013 and 2012, respectively.

The Company leased office space to a director of the Company during 2012 and 2011. Rental income under these leases for the years ended December 31, 2013, 2012 and 2011 was approximately $0, $15,266 and $25,601 respectively. During 2013, the Company did not lease office space to any director.

The Company paid legal fees of approximately $3,725 and $75 to an attorney who was a director of the Company during 2012 and 2011 respectively. During 2013, there were no legal fees paid to any director for legal services.

Receivables due from affiliates aggregated approximately $400 and $39,000 for rent paid on its behalf as of December 31, 2013 and 2012 respectively.

128

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Note 19. Other Comprehensive Income

Other comprehensive income, which is comprised solely of the change in unrealized gains and losses on available for sale securities, is as follows:


	2013
	Before Tax Amount			Tax Effect			Net of Tax Amount
Unrealized holding losses arising during the period	$	(568,850	)	$	—		$	(568,850	)

Unrealized holding losses on available for sale securities	$	(568,850	)	$	—		$	(568,850	)


	2012
	Before Tax Amount			Tax Effect			Net of Tax Amount
Unrealized holding gains arising during the period	$	76,135		$	(28,931	)	$	47,204
Less reclassification adjustment for gains recognized in income		(910,591	)		111,268			(799,323	)

Unrealized holding losses on available for sale securities	$	(834,456	)	$	82,337		$	(752,119	)


	2011
	Before Tax Amount			Tax Effect			Net of Tax Amount
Unrealized holding losses arising during the period	$	(766,569	)	$	291,296		$	(475,273	)
Less reclassification adjustment for gains recognized in income		(1,109,305	)		421,536			(687,769	)

Unrealized holding losses on available for sale securities	$	(1,875,874	)	$	712,832		$	(1,163,042	)

129

PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Note 20. Fair Value and Interest Rate Risk

As described in Note 1, the Company used fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. A description of the valuation methodologies used for assets and liabilities recorded at fair value, and for estimating fair value for financial and non-financial instruments not recorded at fair value, is set forth below.

Cash and due from banks, federal funds sold, short-term investments and accrued interest receivable and payable: The carrying amount is a reasonable estimate of fair value. These financial instruments are not recorded at fair value on a recurring basis.

Available-for-Sale Securities: These financial instruments are recorded at fair value in the financial statements. Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. If quoted prices are not available, then fair values are estimated by using pricing models (i.e., matrix pricing) or quoted prices of securities with similar characteristics and are classified within Level 2 of the valuation hierarchy. Examples of such instruments include U.S. government agency bonds and mortgage-backed securities, corporate bonds and money market preferred equity securities. The prices for these instruments are obtained through an independent pricing service or dealer market participants with whom the Company has historically transacted both purchases and sales of investment securities. Prices obtained from these sources include prices derived from market quotations and matrix pricings. The fair value measurements considered observable data may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. Management reviews the data and assumptions used in pricing the securities by its third party provider to ensure the highest level of significant inputs are derived from market observable data. Level 3 securities are instruments for which significant unobservable input are utilized. Available-for-sale securities are recorded at fair value on a recurring basis.

Loans: For variable rate loans, which reprice frequently and have no significant change in credit risk, carrying values are a reasonable estimate of fair values, adjusted for credit losses inherent in the portfolios. The fair value of fixed rate loans is estimated by discounting the future cash flows using the period end rates, estimated by using local market data, at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities, adjusted for credit losses inherent in the portfolios. The Company does not record loans at fair value on a recurring basis. However, from time to time, nonrecurring fair value adjustments to collateral-dependent impaired loans are recorded to reflect partial write-downs based on the observable market price or current appraised value of collateral. Fair values estimated in this manner do not fully incorporate an exit-price approach to fair value, but instead are based on a comparison to current market rates for comparable loans.

Other Real Estate Owned: The fair value of the Company’s OREO properties is based on the estimated current property valuations less estimated selling costs. When the fair value is based on current observable appraised values, OREO is classified within Level 2. The Company classifies the OREO within Level 3 when unobservable adjustments are made to appraised values. The Company does not record other real estate owned at fair value on a recurring basis.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Deposits: The fair value of demand deposits, regular savings and certain money market deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposit and other time deposits is estimated using a discounted cash flow calculation that applies interest rates currently being offered for deposits of similar remaining maturities, estimated using local market data, to a schedule of aggregated expected maturities on such deposits. The Company does not record deposits at fair value on a recurring basis.

Short-term borrowings: The carrying amounts of borrowings under short-term repurchase agreements and other short-term borrowings maturing within 90 days approximate their fair values. The Company does not record short-term borrowings at fair value on a recurring basis.

Junior Subordinated Debt: Junior subordinated debt reprices quarterly and as a result the carrying amount is considered a reasonable estimate of fair value. The Company does not record junior subordinated debt at fair value on a recurring basis.

Federal Home Loan Bank Borrowings: The fair value of the advances is estimated using a discounted cash flow calculation that applies current Federal Home Loan Bank interest rates for advances of similar maturity to a schedule of maturities of such advances. The Company does not record these borrowings at fair value on a recurring basis.

Other Borrowings: The fair values of longer term borrowings and fixed rate repurchase agreements are estimated using a discounted cash flow calculation that applies current interest rates for transactions of similar maturity to a schedule of maturities of such transactions. The Company does not record these borrowings at fair value on a recurring basis.

Off-balance sheet instruments: Fair values for the Company’s off-balance-sheet instruments (lending commitments) are based on interest rate changes and fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The Company does not record its off-balance-sheet instruments at fair value on a recurring basis.

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PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

The following table details the financial assets measured at fair value on a recurring basis as of December 31, 2013 and 2012, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine fair value:


	Quoted Prices in		Significant		Significant
	Active Markets		Observable		Unobservable		Balance
	for Identical Assets		Inputs		Inputs		as of
December 31, 2013	(Level 1)		(Level 2)		(Level 3)		December 31, 2013
Corporate bonds	$	—	$	8,869,794	$	—	$	8,869,794
U.S. Government agency mortgage-backed securities		—		21,752,212		—		21,752,212
U.S. Government agency bonds		—		7,079,350		—		7,079,350

Securities available for sale	$	—	$	37,701,356	$	—	$	37,701,356


	Quoted Prices in		Significant		Significant
	Active Markets		Observable		Unobservable		Balance
	for Identical Assets		Inputs		Inputs		as of
December 31, 2012	(Level 1)		(Level 2)		(Level 3)		December 31, 2012
Corporate bonds	$	—	$	8,486,259	$	—	$	8,486,259
U.S. Government agency mortgage-backed securities		—		25,706,891		—		25,706,891
U.S. Government bonds		—		7,526,170		—		7,526,170

Securities available for sale	$	—	$	41,719,320	$	—	$	41,719,320

Certain financial assets and financial liabilities are measured at fair value on a non-recurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

The following table reflects assets measured at fair value on a non-recurring basis as of December 31, 2013 and 2012, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:


	Quoted Prices in		Significant		Significant
	Active Markets		Observable		Unobservable
	for Identical Assets		Inputs		Inputs
	(Level 1)		(Level 2)		(Level 3)		Balance
December 31, 2013
Impaired Loans ⁽¹⁾	$	—	$	—	$	7,508,091	$	7,508,091

Other real estate owned (2)	$	—	$	—	$	—	$	—

December 31, 2012
Impaired Loans ⁽¹⁾	$	—	$	—	$	8,424,786	$	8,424,786

Other real estate owned (2)	$	—	$	—	$	4,873,844	$	4,873,844

⁽¹⁾	Represents carrying value for which adjustments are based on the appraised value of the collateral.

⁽²⁾	Represents carrying value for which adjustments are based on the appraised value of the property.

The Company discloses fair value information about financial instruments, whether or not recognized in the consolidated balance sheet, for which it is practicable to estimate that value. Certain financial instruments are excluded from disclosure requirements and, accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

The estimated fair value amounts have been measured as of December 31, 2013 and December 31, 2012 and have not been reevaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than amounts reported on those dates.

The information presented should not be interpreted as an estimate of the fair value of the Company since a fair value calculation is only required for a limited portion of the Company’s assets and liabilities. Due to the wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other bank holding companies may not be meaningful.

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PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

The following is a summary of the carrying amounts and estimated fair values of the Company’s financial instruments not measured and not reported at fair value on the consolidated balance sheets at December 31, 2013 and 2012 (in thousands):

2013

2012

Fair Value

Carrying

Estimated

Carrying

Estimated

Hierarchy

Amount

Fair Value

Amount

Fair Value

Financial Assets:

Cash and noninterest bearing deposits due from banks

Level 1

1,570

2,736

Interest-bearing deposits due from banks

Level 1

33,295

67,567

Short-term investments

Level 1

—

711

Other Investments

Level 2

4,450

3,500

Federal Reserve Bank stock

Level 1

1,444

1,730

Federal Home Loan Bank stock

Level 1

4,143

4,344

Loans receivable, net

Level 3

418,148

424,831

458,794

464,551

Accrued interest receivable

Level 1

1,566

1,894

Financial Liabilities:

Demand deposits

Level 1

55,358

65,176

Savings deposits

Level 1

80,983

77,761

Money market deposits

Level 1

29,310

42,401

NOW accounts

Level 1

28,618

30,191

Time deposits

Level 2

235,935

236,602

281,753

284,974

FHLB borrowings

Level 2

57,000

50,000

52,448

Securities sold under repurchase agreements

Level 2

—

7,000

7,683

Subordinated debt

Level 2

8,248

8,248

Accrued interest payable

Level 1

1,388

1,241

The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent possible to mitigate interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall interest rate risk.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Off-balance-sheet instruments

Loan commitments on which the committed interest rate is less than the current market rate were insignificant at December 31, 2013 and 2012. The estimated fair value of fee income on letters of credit at December 31, 2013 and 2012 was insignificant.

Note 21. Restructuring Charges and Asset Disposals

The Company recorded restructuring charges and asset disposals of $0.5 million and $0.9 million for the twelve months ended December 31, 2013 and 2012. These costs are included in restructuring charges and asset disposals expense in the Consolidated Statements of Operations.

During 2011, the Company announced that it would be undertaking a series of initiatives that are designed to transform and enhance its operations in order to strengthen the Company’s competitive position and return it to its goal of restored health and profitability.

On March 3, 2011, the Company announced that it would consolidate four branches, effective June 2011, to reduce operating expenses. All customer accounts in the affected branches were transferred to nearby Patriot branches to minimize any inconvenience to customers. The consolidation of these branches resulted in an earnings charge of $1.8 million, which is comprised of lease termination expenses of $1.2 million, lease liabilities charges of $400,000, and severance payments of $200,000 to affected employees. In addition, there was a $600,000 write-off of leasehold improvements and other fixed assets for these branches that were closed.

In order to further reduce operating expenses, the Company announced on May 16, 2011 that it would be executing a workforce reduction plan with employees in the back office operational areas. There were a total of eighteen employees affected by this reduction. This initiative resulted in an earnings charge of $600,000, which is comprised exclusively of severance payments to affected employees.

On September 23, 2011, the Company subleased vacant office space at 900 Bedford Street, Stamford, CT, effective October 1, 2011 for a term of two years.

On March 30, 2012 the Company announced that it would close the NYC branch, effective June 2012. During the first quarter, the Company executed a workforce reduction of back office personnel to further reduce operating expenses. There were twelve employees in total affected by this announcement. This initiative resulted in a restructuring charge of $495,207, which was comprised of $445,429 for severance expenses for the branch and back office personnel, asset disposals of $39,445 and $10,333 in lease liabilities.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

On June 29, 2012, the Company announced that it would be consolidating three more branches in its continued effort to reduce operating expenses. Restructuring charges for the consolidation of these branches of $444,285 were comprised of $247,163 for severance expenses, lease liability charges of $140,292 and $56,830 in asset disposals.

On May 29, 2013, the Company purchased a branch location where the cost of the lease exceeded the cost to own. This facility is intended to provide headquarter office space and replace our leased headquarter space by July 2015. This branch was part of a restructuring initiative in 2011, resulting in a reduction of $120,703 in lease liability costs.

On June 13, 2013, the Company executed a workforce reduction of the residential lending group and retail operations to further reduce operating expenses. There were nineteen employees in total affected by this announcement. Restructuring charges for this initiative resulted in $515,161 in severance expenses.

During July and October 2013, there were additional workforce reductions of back office personnel, resulting in restructuring charges of $53,510 and $73,935 in severance expenses, respectively.

Restructuring reserves at December 31, 2013 for the restructuring activities taken in accordance with these initiatives are comprised of the following:


	Balance at December 31, 2012		Expenses			Cash payments			Non-cash charges			Balance at December 31, 2013
Lease liability costs 2011	$	172,999		(120,703	)					(52,296	)	$	—
Lease liability costs 2012		80,220		—			(22,112	)		(34,865	)		23,243
Severance and benefit costs 2013		—		642,606			(576,047	)		—			66,559

Total	$	253,219	$	521,903		$	(598,159	)	$	(87,161	)	$	89,802

The restructuring reserves at December 31, 2013 are included in accrued expenses and other liabilities in the Consolidated Balance Sheet.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

Note 22. Condensed Parent Company Only Financial Statements

The following represent the condensed parent company only balance sheets as December 31, 2013 and 2012, and condensed statements of operations and cash flows for the years ended December 31, 2013, 2012, and 2011.

CONDENSED BALANCE SHEETS

December 31, 2013 and 2012


	2013		2012
ASSETS
Cash and due from banks	$	1,734,335	$	2,382,695
Investment in subsidiaries		49,931,446		56,601,461
Other assets		200,563		286,506

Total assets	$	51,866,344	$	59,270,662

LIABILITIES AND SHAREHOLDERS’ EQUITY
Borrowings		8,248,000		8,248,000
Accrued expenses and other liabilities		1,777,656		1,454,864
Shareholders’ equity		41,840,688		49,567,798

Total liabilities and shareholders’ equity	$	51,866,344	$	59,270,662

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PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

CONDENSED STATEMENTS OF OPERATIONS

Years Ended December 31, 2013, 2012 and 2011


	2013			2012			2011
Revenues
Dividends from subsidiary bank	$	—		$	—		$	—

Total revenue		—			—			—

Expenses
Interest on subordinated debt		292,725			308,797			294,631
Other expenses		395,056			699,646			319,070

Total expenses		687,781			1,008,443			613,701

Loss before equity in undistributed net loss of subsidiaries		(687,781	)		(1,008,443	)		(613,701	)

Equity in undistributed net (loss) income of subsidiaries		(6,601,165	)		472,279			(14,845,785	)

Net loss	$	(7,288,946	)	$	(536,164	)	$	(15,459,486	)

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PATRIOT NATIONAL BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

December 31, 2013, 2012 and 2011

CONDENSED STATEMENTS OF CASH FLOWS

Years Ended December 31, 2013, 2012 and 2001


	2013			2012			2011
Cash Flows from Operating Activities
Net loss	$	(7,288,946	)	$	(536,164	)	$	(15,459,486	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Equity in undistributed loss (income) of subsidiaries		6,601,165			(472,279	)		14,845,785
Share-based compensation expense		130,686			306,421			—
Change in assets and liabilities:
Decrease (increase) in other assets		85,943			(68,213	)		373,920
Increase in accrued expenses and other liabilities		322,792			187,422			341,801

Net cash (used in) provided by operating activities		(148,360	)		(582,813	)		102,020

Cash Flows from Investing Activities
Net investment in bank subsidiary		(500,000	)		—			—

Net cash used in investing activities		(500,000	)		—			—

Cash Flows from Financing Activities
Proceeds from issuance of common stock		—			—			—

Net cash provided by financing activities		—			—			—

Net (decrease) increase in cash and cash equivalents		(648,360	)		(582,813	)		102,020
Cash and cash equivalents
Beginning		2,382,695			2,965,508			2,863,488

Ending	$	1,734,335		$	2,382,695		$	2,965,508

Supplemental Disclosures of Cash Flow Information
Cash paid for interest	$	—		$	—		$	—

Accrued dividends declared on common stock	$	—		$	—		$	—

139