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Fair Value and Interest Rate Risk

3 Months Ended

Mar. 31, 2023

Patriot measures the carrying value of certain financial assets and liabilities at fair value, as required by its policies as a financial institution and by US GAAP. The carrying values of certain assets and liabilities are measured at fair value on a recurring basis, such as available-for-sale securities; while other assets and liabilities are measured at fair value on a non-recurring basis due to external factors requiring management’s judgment to estimate potential losses of value resulting in asset impairments or the establishment of valuation reserves. Measuring assets and liabilities at fair value may result in fluctuations to carrying value that have a significant impact on the results of operations or other comprehensive income for the period and period over period.

Following is a detailed summary of the guidance provided by US GAAP regarding the application of fair value measurements and Patriot’s application thereof. Additionally, the following information includes detailed summaries of the effects fair value measurements have on the carrying amounts of asset and liabilities presented in the consolidated financial statements.

The objective of fair value measurement is to value an asset that may be sold or a liability that may be transferred at the estimated value which might be obtained in a transaction between unrelated parties under current market conditions. US GAAP establishes a framework for measuring assets and liabilities at fair value, as well as certain financial instruments classified in equity. The framework provides a fair value hierarchy, which prioritizes quoted prices in active markets for identical assets and liabilities and minimizes unobservable inputs, which are inputs for which market data are not available and that are developed by management using the best information available to develop assumptions about the value market participants might place on the asset to be sold or liability to be transferred.

The three levels of the fair value hierarchy consist of:

Level 1 - Unadjusted quoted market prices for identical assets or liabilities in active markets that the entity has the ability to access at the measurement date (such as active exchange-traded equity securities and certain U.S. and government agency debt securities).

Level 2 - Observable inputs other than quoted prices included in Level 1, such as:

–Quoted prices for similar assets or liabilities in active markets (such as U.S. agency and government sponsored mortgage-backed securities)

–Quoted prices for identical or similar assets or liabilities in less active markets (such as certain U.S. and government agency debt securities, and corporate and municipal debt securities that trade infrequently)

–Other inputs that are observable for substantially the full term of the asset or liability (i.e. interest rates, yield curves, prepayment speeds, default rates, etc.).

Level 3 - Valuation techniques that require unobservable inputs that are supported by little or no market activity and are significant to the fair value measurement of the asset or liability (such as pricing and discounted cash flow models that typically reflect management’s estimates of the assumptions a market participant would use in pricing the asset or liability).

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 and accrued interest receivable and payable

The carrying amount is a reasonable estimate of fair value and accordingly these are classified as Level 1. These financial instruments are not recorded at fair value on a recurring basis.

Available-for-sale securities

The fair value of securities available for sale (carried at fair value) are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities, but rather by relying on the securities' relationship to other benchmark quoted prices, or using unobservable inputs employing various techniques and assumptions (Level 3).

Other Investments

The Bank’s investment portfolio includes the Solomon Hess SBA Loan Fund, which is utilized by the Bank to satisfy its Community Reinvestment Act (“CRA”) lending requirements. As this fund operates as a private fund, shares in the fund are not publicly traded but may be redeemed with 60 days’ notice at cost. For that reason, the carrying amount was considered comparable to fair value at both March 31, 2023 and December 31, 2022 due to its short-term nature.

Federal Reserve Bank Stock and Federal Home Loan Bank Stock

Shares in the FRB and Federal Home Loan Bank (“FHLB”) are purchased and redeemed based upon their $100 par value. The stocks are non-marketable equity securities, and as such, are considered restricted securities that are carried at cost.

Loans

The fair value of loan portfolio is estimated by discounting the future cash flows using the rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. We estimate the fair value of our loan portfolio using an exit price notion resulting in prior periods no longer being comparable. The exit price notion requires determination of the price at which willing market participants would transact at the measurement date under current market conditions depending on facts and circumstances, such as origination rates, credit risk, transaction costs, liquidity, national and regional market trends and other adjustments, utilizing publicly available rates and indices. The application of an exit price notion requires the use of significant judgment.

Loans Held for Sale

The fair value of loans held for sale is estimated by using a market approach that includes prices for loans sold awaiting settlement and other observable inputs. The Company has determined that the inputs used to value the loans held for sale fall within Level 2 of the fair value hierarchy.

SBA Servicing Asset

Servicing assets do not trade in an active, open market with readily observable prices. The Company estimates the fair value of servicing assets using discounted cash flow models incorporating numerous assumptions from the perspective of a market participant including market discount rates and prepayment speeds. Due to the significant unobservable input related to the servicing rights, the SBA servicing asset is classified within Level 3 of the valuation hierarchy.

Derivative asset (liability) - Interest Rate Swaps

The Company’s derivative assets and liabilities consist of transactions as part of management’s strategy to manage interest rate risk. The valuation of interest rate swap agreements does not contain any counterparty risk. The valuation of the Company’s interest rate swaps is obtained from a third-party pricing service and is determined using a discounted cash flow analysis on the expected cash flows of each derivative. The pricing analysis is based on observable inputs for the contractual terms of the derivatives, including the period to maturity and interest rate curves. The Company has determined that the inputs used to value its interest rate derivatives fall within Level 2 of the fair value hierarchy. See Note 8 for additional disclosures on derivatives.

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. Patriot does not record deposits at fair value on a recurring basis.

Senior Notes, Subordinated Notes, and Junior Subordinated Debt and Note Payable

Patriot does not record senior notes at fair value on a recurring basis. The fair value of the senior notes was estimated by discounting future cash flows at rates at which similar notes would be made. The carrying value is considered comparable to fair value.

Patriot does not record subordinated notes issued in September 2018 at fair value on a recurring basis. The fair value of the subordinated notes was estimated by discounting future cash flows at rates at which similar notes would be made. The carrying value is considered comparable to fair value.

Patriot does not record junior subordinated debt at fair value on a recurring basis. Junior subordinated debt reprices quarterly, as a result, the carrying amount is considered a reasonable estimate of fair value.

The Company considers its own credit worthiness in determining the fair value of its senior notes, subordinated notes, notes payable and junior subordinated debt.

Federal Home Loan Bank Borrowings

The fair value of FHLB advances is estimated using a discounted cash flow calculation that applies current FHLB interest rates for advances of similar maturity to a schedule of maturities of such advances. Patriot does not record FHLB advances at fair value on a recurring basis.

Off-balance sheet financial instruments

Off-balance sheet financial instruments 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 off-balance-sheet financial instruments (i.e., commitments to extend credit) are insignificant and are not recorded on a recurring basis.

The following table provides a comparison of the carrying amounts and estimated fair values of Patriot’s financial assets and liabilities as of March 31, 2023 and December 31, 2022:


(In thousands)		March 31, 2023				December 31, 2022
	Fair Value Hierarchy	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
Financial Assets:
Cash and noninterest bearing balances due from banks	Level 1	$	1,828	$	1,828	$	5,182	$	5,182
Interest-bearing deposits due from banks	Level 1	58,424		58,424		33,311		33,311
Available-for-sale securities	Level 2	81,531		81,531		75,093		75,093
Available-for-sale securities	Level 3	10,205		10,205		9,427		9,427
Other investments	Level 2	4,450		4,450		4,450		4,450
Federal Reserve Bank stock	Level 2	2,673		2,673		2,627		2,627
Federal Home Loan Bank stock	Level 2	6,374		6,374		3,874		3,874
Loans receivable, net	Level 3	860,968		846,185		838,006		818,960
Loans held for sale	Level 2	6,882		7,471		5,211		5,534
SBA servicing assets	Level 3	893		987		886		1,013

Accrued interest receivable	Level 2	7,308		7,308		7,267		7,267
Interest rate swap receivable	Level 2	106		106		203		203

Financial assets, total		$	1,041,642	$	1,027,542	$	985,537	$	966,941

Financial Liabilities:
Demand deposits	Level 2	$	152,773	$	152,773	$	269,636	$	269,636
Savings deposits	Level 2	56,418		56,418		71,002		71,002
Money market deposits	Level 2	306,474		306,474		211,000		211,000
Negotiable order of withdrawal accounts	Level 2	29,316		29,316		34,440		34,440
Time deposits	Level 2	206,398		203,531		225,670		221,353
Brokered deposits	Level 1	105,089		104,362		48,698		47,684
FHLB borrowings	Level 2	150,000		149,075		85,000		83,853
Senior notes	Level 2	11,619		11,162		11,640		11,103
Subordinated debt	Level 2	9,847		9,758		9,840		9,680
Junior subordinated debt owed to unconsolidated trust	Level 2	8,130		8,130		8,128		8,128
Note payable	Level 3	533		504		585		544
Accrued interest payable	Level 2	771		771		585		585
Interest rate swap liability	Level 2	106		106		203		203

Financial liabilities, total		$	1,037,474	$	1,032,380	$	976,427	$	969,211

The carrying amount of cash and noninterest bearing balances due from banks, interest-bearing deposits due from banks, and demand deposits approximates fair value, due to the short-term nature and high turnover of these balances. These amounts are included in the table above for informational purposes.

In the normal course of its operations, Patriot assumes interest rate risk (i.e., the risk that general interest rate levels will fluctuate). As a result, the fair value of Patriot’s financial assets and liabilities are affected when interest market rates change, which change may be either favorable or unfavorable. Management attempts to mitigate interest rate risk by matching the maturities of its financial assets and liabilities. However, borrowers with fixed rate obligations are less likely to prepay their obligations in a rising interest rate environment and more likely to prepay their obligations in a falling interest rate environment. Conversely, depositors receiving fixed rates are more likely to withdraw funds before maturity in a rising interest rate environment and less likely to do so in a falling interest rate environment. Management monitors market rates of interest and the maturities of its financial assets and financial liabilities, adjusting the terms of new loans and deposits in an attempt to minimize interest rate risk. Additionally, management mitigates its overall interest rate risk through its available funds investment strategy.

The following tables detail the financial assets measured at fair value on a recurring basis and the valuation techniques utilized relative to the fair value hierarchy, as of March 31, 2023 and December 31, 2022:


(In thousands)	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
March 31, 2023:
U. S. Government agency and mortgage-backed securities	$	—	$	67,537	$	—	$	67,537
Corporate bonds	—		3,457		10,205		13,662
Subordinated notes	—		4,521		—		4,521
SBA loan pools	—		5,505		—		5,505
Municipal bonds	—		511		—		511
Available-for-sale securities	$	—	$	81,531	$	10,205	$	91,736

Interest rate swap receivable	$	—	$	106	$	—	$	106

Interest rate swap liability	$	—	$	106	$	—	$	106

December 31, 2022:
U. S. Government agency and mortgage-backed securities	$	—	$	59,046	$	—	$	59,046
Corporate bonds	—		5,228		9,427		14,655
Subordinated notes	—		4,602		—		4,602
SBA loan pools	—		5,718		—		5,718
Municipal bonds	—		499		—		499
Available-for-sale securities	$	—	$	75,093	$	9,427	$	84,520

Interest rate swap receivable	$	—	$	203	$	—	$	203

Interest rate swap liability	$	—	$	203	$	—	$	203

Patriot measures certain financial assets and financial liabilities at fair value on a non-recurring basis. When circumstances dictate (e.g., impairment of long-lived assets, other than temporary impairment of collateral value), the carrying values of such financial assets and financial liabilities are adjusted to fair value or fair value less costs to sell, as may be appropriate.

As of March 31, 2023 and December 31, 2022, four corporate bonds were classified as Level 3 instruments. The fair values of these securities were determined using a present value approach. The discount rate assumed was determined based on unobservable inputs in a pricing model. During the three months ended March 31, 2023 and 2022, the Company had no transfers into or out of Levels 1, 2 or 3.

The reconciliation of the beginning and ending balances during 2023 for Level 3 available-for-sale securities is as follows:


(In thousands)	Three Months Ended March 31, 2023		Three Months Ended March 31, 2022
Level 3 fair value, beginning of year	$	9,427	$	13,180
Purchases	—		—
Realized gain (loss)	—		—
Unrealized gain (loss)	778		(1,943)
Transfers in and /or out of Level 3	—		—
Level 3 fair value, end of year	$	10,205	$	11,237

The table below presents the valuation methodology and unobservable inputs for level 3 assets measured at fair value on a non-recurring basis as of March 31, 2023 and December 31, 2022:


(In thousands)	Fair Value		Valuation Methodology	Unobservable Inputs	Range of Inputs
March 31, 2023:
Impaired loans, net	$	17,112	Real Estate Appraisals	Discount for appraisal type	5.8	%	-	20%

SBA servicing assets	987		Discounted Cash Flows	Market discount rates	14.73	%	-	14.90%

December 31, 2022:
Impaired loans, net	$	12,873	Real Estate Appraisals	Discount for appraisal type	5.8	%	-	20%

SBA servicing assets	1,013		Discounted Cash Flows	Market discount rates	14.73	%	-	14.90%

Patriot 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 necessarily represent the complete underlying value of financial instruments included in the consolidated financial statements.

The estimated fair value amounts have been measured as of March 31, 2023 and December 31, 2022, and have not been reevaluated or updated for purposes of these consolidated financial statements subsequent to those respective dates. As such, the estimated fair values of the financial instruments measured may be different than if they had been subsequently valued.

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

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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