Patriot National Bancorp Inc., in recently sizing up two suitors, ultimately chose a creative option that will reward shareholders based on future results rather than a rival deal providing a higher up-front share price.

The $937 million-asset company in Stamford, Conn., announced last week that it is selling a controlling stake to a group led by New York investor Michael Carrazza for $50 million. It accepted Carrazza's deal over another $50 million offer it received in October from an unsolicited, unidentified investor.

Carrazza entered into a letter of intent with Patriot in July, with the investment expected to close Oct. 1, but Patriot delayed the closing after receiving a last-minute bid from the unsolicited group.

"It was our responsibility to consider the other offer," said Charles Powell, Patriot's president and vice chairman. "But after a total analysis of both deals, the contingency designed by Michael Carrazza is rather unique and will be a greater benefit to our shareholders."

Investment bankers and bank consultants said the so-called recovery dividend speaks to the need for buyers and sellers to be creative in structuring deals in an uncertain economy.

Powell said the unsolicited offer was solid enough to cause it to hit the brakes on Carrazza's earlier offer — prompting Carrazza to file suit against Patriot. Yet a clause that provides existing shareholders with additional shares based on the company's ability to recover assets that have been charged off was too good to pass up, and Patriot grabbed it last week.

"Credit quality is driving this type of thing," said Robert Kafafian, the president and chief executive of Kafafian Group Inc., a community bank consulting group in Parsippany, N.J. "It is a way for the buyer to reward the company for performing better than anticipated and it makes the deal attractive to shareholders to approve the influx of capital."

Kafafian said he is working on some deals that include a benefit for better future performance and he expects to see more of these kinds of offers.

A handful of other deals announced this year have contained creative elements that address future loan performance.

For instance, First Niagara Financial Group Inc. is capping its overall cost for the troubled $5.6 billion-asset Harleysville National Corp. at roughly $400 million. As announced in July, each Harleysville share would be exchanged for 0.474 First Niagara share, placing the deal's value at $237 million. First Niagara also would plug a $150 million capital hole at Harleysville. However, if the capital hole gets larger by the time the deal closes, the amount paid to Harleysville shareholders would shrink.

In August, the $107 million-asset First Business Bank in San Diego announced a deal to buy 1st Pacific Bancorp, also of San Diego, for about $7 million as well as recoveries from charged-off loans and a lawsuit.

In the Patriot deal, the $50 million infusion will be sufficient to boost the company's Patriot National Bank unit from adequately capitalized at the end of the third quarter to above the baseline for well-capitalized institutions. Powell said based on third-quarter figures its Tier 1 leverage ratio would rise from 4.88% to more than 9% and its total risk-based capital ratio would increase from 8.75% to more than 12%.

Although Patriot National is operating under a formal agreement with the Office of the Comptroller of the Currency, it is not subject to the common elevated capital levels in such orders. Still, Powell said regulators have urged the bank to increase capital because of the company's high level of nonperforming assets.

At the end of the third quarter, Patriot's nonaccrual loans totaled $142.5 million, or 20.29% of the company's total portfolio. The problem assets are concentrated in residential construction loans as well as commercial real estate loans.

Those figures are high, Powell said, but deceiving. The company has managed to minimize losses because of its low loan-to-value ratio and the underlying value of the properties. Patriot financed construction of high-end homes in Connecticut's toniest areas, instead of large-scale tract developments.

"It looks bad from the outside," Carrazza acknowledged in an interview. "But we believe the portfolio is actually in relatively good shape. Patriot sidestepped many of the critical errors that others did with high loan-to-value ratios and weak underwriting. We don't see that trend at Patriot."

Carrazza came to that conclusion only after an exhaustive due diligence period that began in March, in which he and his team, as well as two outside consultants, analyzed more than 75% of Patriot's portfolio. The process was aggressive, with part of the analysis examining how many borrowers' livelihoods were connected to the large Wall Street investment banks that collapsed in 2008.

"We needed to see what was in there," Carrazza said. "We needed a clear understanding of what we were buying."

Going forward, Carrazza said Patriot will focus on aggressively working through problem assets and will look for ways to grow by building on the company's existing franchise.

"We believe the platform has a tremendous amount of opportunity on an organic basis," he said.

Carrazza said the company is possibly interested in striking deals with the Federal Deposit Insurance Corp. on bank failures, and is looking at distressed banks as well. Yet he noted there are fewer struggling banks in the Northeast compared with areas like Southern California or the Southeast.

Although this is his first foray into banking, Carrazza is a longtime private-equity manager across various sectors. His recent endeavors include sponsoring the $320 million buyout of the large crane rental business AmQuip Corp. He has also assembled a management team made up of community bankers and former regulators, but he would not identify them, adding that the group is still deciding if Patriot executives such as Powell will be a part of the company going forward.

The deal will give Carrazza's group, known as PNBK Holdings LLC, an 88% stake in Patriot. Carrazza said he recognizes that this opportunity comes with the dilution of existing shareholders. He is buying 33.3 million shares, increasing the number of existing shares eightfold.

The recovery dividend will be paid in stock at 100% for the first $1 million recovered before June 30, 2011, on chargeoffs made as of June 30, 2009, and 50% thereafter. Carrazza said that is his way of giving a nod to the existing shareholders and was part of the initial agreement. He also needs their approval to make his investment.

"This structure allows the existing shareholders to recoup some value that they would have been stripped of otherwise," Carrazza said. "This way, we both win."

W. Gray Medlin, co-founder and managing director in the Raleigh office of the investment banking firm Carson Medlin Co., said Carrazza's experience in other sectors is likely what drove the structure.

"This kind of structure has been used in previous banking cycles and is used often in other sectors frequently," Medlin said. "It is high time that we see these kinds of deals this go-round."

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