UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_____________________________
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ending September 30, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______ to _______
COMMISSION FILE NUMBER: 000-23601
---------
PATHFINDER BANCORP, INC.
------------------------
(Exact Name of Registrant as Specified in its Charter)
FEDERAL 16-1540137
-----------------------------------------------------------------
(State or Other Jurisdiction of Incorporation (I.R.S. Employer
or Organization Identification Number)
214 West First Street, Oswego, NY 13126
---------------------------------------
(Address of Principal Executive Office) (Zip Code)
(315) 343-0057
--------------
(Registrant's Telephone Number including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ].
Indicate by check mark whether the Registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act. (Check one):
Large Accelerated Filer [ ] Accelerated Filer [ ] Non-Accelerated Filer[X]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of November 13, 2006 there were 2,951,819 shares issued and 2,464,532
shares outstanding of the Registrant's Common Stock.
PATHFINDER BANCORP, INC.
INDEX
PART 1 FINANCIAL INFORMATION PAGE NO.
Item 1. CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Statements of Condition 1
Consolidated Statements of Income 2-3
Consolidated Statements of Shareholders' Equity 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6-10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11-19
Item 3. Quantitative and Qualitative Disclosure
about Market Risk 20-21
Item 4. Controls and Procedures 22
PART II OTHER INFORMATION 23
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and
Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits
SIGNATURES 24
PART I - FINANCIAL INFORMATION
ITEM 1- CONSOLIDATED FINANCIAL STATEMENTS
- -----------------------------------------
PATHFINDER BANCORP, INC.
CONSOLIDATED STATEMENTS OF CONDITION
SEPTEMBER 30, 2006 (UNAUDITED) AND DECEMBER 31, 2005
September 30, December 31,
ASSETS 2006 2005
- ------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Cash and due from banks $ 8,547 $ 7,309
Interest earning deposits 257 586
--------------- --------------
Total cash and cash equivalents 8,804 7,895
Investment securities, at fair value 69,058 74,239
Federal Home Loan Bank stock, at cost 1,772 1,805
Loans 197,463 189,568
Less: Allowance for loan losses 1,631 1,679
--------------- --------------
Loans receivable, net 195,832 187,889
Premises and equipment, net 7,602 8,020
Accrued interest receivable 1,636 1,678
Foreclosed real estate 497 743
Goodwill 3,840 3,840
Intangible asset, net 238 404
Bank owned life insurance 6,137 5,987
Other assets 2,587 4,448
--------------- --------------
Total assets $ 298,003 $ 296,948
=============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Deposits:
Interest-bearing $ 216,026 $ 216,136
Non interest-bearing 21,895 20,241
--------------- --------------
Total deposits 237,921 236,377
Short-term borrowings 3,300 2,000
Long-term borrowings 27,360 29,360
Junior subordinated debentures 5,155 5,155
Other liabilities 2,902 3,128
--------------- --------------
Total liabilities 276,638 276,020
Shareholders' equity:
Preferred stock, authorized shares 1,000,000; no shares issued or outstanding
Common stock, par value $.01; authorized 10,000,000 shares;
2,951,819 and 2,950,419 shares issued; and 2,464,532 and 2,463,132 shares
outstanding, respectively 29 29
Additional paid in capital 7,732 7,721
Retained earnings 21,083 20,965
Accumulated other comprehensive loss (977) (1,285)
Treasury stock, at cost; 487,287 shares (6,502) (6,502)
--------------- --------------
Total shareholders' equity 21,365 20,928
--------------- --------------
Total liabilities and shareholders' equity $ 298,003 $ 296,948
=============== ==============
The accompanying notes are an integral part of the consolidated financial
statements.
1
PATHFINDER BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
For the three For the three
months ended months ended
September 30, 2006 September 30, 2005
-------------------- --------------------
(Dollars in thousands, except per share data)
INTEREST INCOME:
Loans, including fees $ 3,222 $ 3,006
Debt securities:
Taxable 561 621
Tax-exempt 98 138
Dividends 82 61
Other 4 3
----------------- ------------------
Total interest income 3,967 3,829
----------------- ------------------
INTEREST EXPENSE:
Interest on deposits 1,376 1,061
Interest on short-term borrowings 78 107
Interest on long-term borrowings 456 459
Total interest expense 1,910 1,627
----------------- ------------------
Net interest income 2,057 2,202
Provision for loan losses - 91
----------------- ------------------
Net interest income after provision for loan losses 2,057 2,111
----------------- ------------------
OTHER INCOME:
Service charges on deposit accounts 338 356
Loan servicing fees 55 61
Earnings on bank owned life insurance 50 44
Net losses on sales of investment securities - (192)
Net (losses) gains on sales of loans and foreclosed real estate (29) 42
Other charges, commissions and fees 130 138
----------------- ------------------
Total other income 544 449
----------------- ------------------
OTHER EXPENSES:
Salaries and employee benefits 1,307 1,290
Building occupancy 291 318
Data processing expenses 328 325
Professional and other services 121 172
Amortization of intangible asset 55 55
Other expenses 289 333
----------------- ------------------
Total other expenses 2,391 2,493
----------------- ------------------
Income before income taxes 210 67
Provision for income tax expense (benefit) 40 (49)
----------------- ------------------
NET INCOME $ 170 $ 116
================ ==================
NET INCOME PER SHARE - BASIC $ 0.07 $ 0.05
================ ==================
NET INCOME PER SHARE - DILUTED $ 0.07 $ 0.05
================ ==================
DIVIDENDS PER SHARE $ 0.1025 $ 0.1025
================ ==================
The accompanying notes are an integral part of the consolidated financial
statements.
2
PATHFINDER BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
For the nine For the nine
months ended months ended
September 30, 2006 September 30, 2005
-------------------- --------------------
(Dollars in thousands, except per share data)
INTEREST INCOME:
Loans, including fees $ 9,416 $ 8,824
Debt securities:
Taxable 1,828 1,884
Tax-exempt 294 376
Dividends 210 168
Other 16 62
----------------- ------------------
Total interest income 11,764 11,314
----------------- ------------------
INTEREST EXPENSE:
Interest on deposits 3,904 3,122
Interest on short-term borrowings 263 156
Interest on long-term borrowings 1,344 1,374
----------------- ------------------
Total interest expense 5,511 4,652
----------------- ------------------
Net interest income 6,253 6,662
Provision for loan losses 23 229
----------------- ------------------
Net interest income after provision for loan losses 6,230 6,433
----------------- ------------------
OTHER INCOME:
Service charges on deposit accounts 1,059 949
Loan servicing fees 160 146
Earnings on bank owned life insurance 150 133
Net losses on sales of securities (9) (192)
Net (losses) gains on sales of loans/real estate (34) 30
Other charges, commissions & fees 417 418
----------------- ------------------
Total other income 1,743 1,484
----------------- ------------------
OTHER EXPENSES:
Salaries and employee benefits 3,765 3,807
Building occupancy 913 880
Data processing expenses 958 964
Professional and other services 352 572
Amortization of intangible asset 166 166
Other expenses 958 1,034
----------------- ------------------
Total other expenses 7,112 7,423
----------------- ------------------
Income before income taxes 861 494
Provision for income tax expense (benefit) 148 (5)
----------------- ------------------
NET INCOME $ 713 $ 499
==================== ==================
NET INCOME PER SHARE - BASIC $ 0.29 $ 0.20
==================== ==================
NET INCOME PER SHARE - DILUTED $ 0.29 $ 0.20
==================== ==================
DIVIDENDS PER SHARE $ 0.3075 $ 0.3075
==================== ==================
The accompanying notes are an integral part of the consolidated financial
statements.
3
PATHFINDER BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2006 AND SEPTEMBER 30, 2005
(unaudited)
Accumulated
Additional Other Com- Unearned
Common Stock Paid in Retained prehensive ESOP
Shares Amount Capital Earnings Income (Loss) Shares
------------ ------- ----------- ------------- -------------- ----------
(Dollars in thousands, except per share data)
BALANCE, DECEMBER 31, 2005 2,950,419 $ 29 $ 7,721 $ 20,965 $ (1,285) $ -
Comprehensive income
Net income 713
Other comprehensive income, net of tax
Unrealized net gains on securities 308
Total Comprehensive Income
Stock options exercised 1,400 - 11
Dividends declared ($.3075 per share) (595)
- -----------------------------------------------------------------------------------------------------------------------------
BALANCE, SEPTEMBER 30, 2006 2,951,819 $ 29 $ 7,732 $ 21,083 $ (977) $ -
=============================================================================================================================
BALANCE, DECEMBER 31, 2004 2,937,419 $ 29 $ 7,453 $ 21,186 $ (307) $ (33)
Comprehensive income
Net income 499
Other comprehensive income, net of tax
Unrealized net losses on securities (328)
Total Comprehensive Income
ESOP shares earned 55 33
Stock options exercised 13,000 - 86
Dividends declared ($.3075 per share) (593)
- -----------------------------------------------------------------------------------------------------------------------------
BALANCE, SEPTEMBER 30, 2005 2,950,419 $ 29 $ 7,594 $ 21,092 $ (635) $ -
=============================================================================================================================
Treasury
Stock Total
---------- --------
(Dollars in thousands, except per share data)
BALANCE, DECEMBER 31, 2005 $ (6,502) $20,928
Comprehensive income
Net income 713
Other comprehensive income, net of tax
Unrealized net gains on securities 308
--------
Total Comprehensive Income 1,021
Stock options exercised 11
Dividends declared ($.3075 per share) (595)
- -------------------------------------------------------------------
BALANCE, SEPTEMBER 30, 2006 $ (6,502) $21,365
===================================================================
BALANCE, DECEMBER 31, 2004 $ (6,502) $21,826
Comprehensive income
Net income 499
Other comprehensive income, net of tax
Unrealized net losses on securities (328)
--------
Total Comprehensive Income 171
ESOP shares earned 88
Stock options exercised 86
Dividends declared ($.3075 per share) (593)
- -------------------------------------------------------------------
BALANCE, SEPTEMBER 30, 2005 $ (6,502) $21,578
===================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
4
PATHFINDER BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the nine For the nine
months ended months ends
September 30, September 30,
2006 2005
--------------- ---------------
(Dollars in thousands)
OPERATING ACTIVITIES
Net income $ 713 $ 499
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 23 229
ESOP shares earned - 88
Deferred income tax expense 277 133
Realized losses (gains) on sale of:
Real estate through foreclosure 34 7
Loans - (37)
Available-for-sale investment securities 9 192
Premises and equipment (13) -
Depreciation 561 518
Amortization of intangible asset 166 166
Amortization of deferred financing costs 23 23
Amortization of mortgage servicing rights 77 22
Earnings on bank owned life insurance (150) (133)
Net amortization of premiums on investment securities 116 279
Decrease (increase) in interest receivable 42 (139)
Net change in other assets and liabilities (214) (259)
--------------- ---------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 1,664 1,588
--------------- ---------------
INVESTING ACTIVITIES
Purchase of investment securities available-for-sale (10,985) (19,642)
Net (purchase) redemption of FHLB stock 33 131
Proceeds from maturities and principal reductions of
investment securities available-for-sale 15,792 9,183
Proceeds from sale:
Portfolio loans - 8,897
Real estate acquired through foreclosure 456 414
Available-for-sale investment securities 771 -
Premises and equipment 145 -
Net increase in loans (7,114) (6,021)
Purchase of premises and equipment (275) (949)
--------------- ---------------
NET CASH USED IN INVESTING ACTIVITIES (1,177) (7,987)
--------------- ---------------
FINANCING ACTIVITIES
Net decrease in demand deposits, NOW accounts
savings accounts, money market deposit accounts
and escrow deposits (10,226) (4,641)
Net increase in time deposits 11,770 8,821
Increase in short-term borrowings 1,300 1,000
Payments on long-term borrowings (2,000) (4,000)
Proceeds from exercise of stock options 11 86
Cash dividends paid (433) (429)
--------------- ---------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 422 837
--------------- ---------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 909 (5,562)
Cash and cash equivalents at beginning of period 7,895 14,325
--------------- ---------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 8,804 $ 8,763
=============== ===============
NONCASH INVESTING ACTIVITY:
Conversion of Parent Company advances to loans receivable $ 1,101 $ -
Transfer of loans to foreclosed real estate 249 558
The accompanying notes are an integral part of the consolidated financial
statements.
5
PATHFINDER BANCORP, INC.
Notes to Financial Statements
(1) BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Pathfinder
Bancorp, Inc. and its wholly owned subsidiaries (the "Company") have been
prepared in accordance with U.S. generally accepted accounting principles for
interim financial information and the instructions for Form 10-Q and Article 10
of Regulation S-X. Accordingly, they do not include all of the information and
footnotes necessary for a complete presentation of consolidated financial
position, results of operations, and cash flows in conformity with U.S.
generally accepted accounting principles. Certain amounts in the 2005
consolidated financial statements have been reclassified to conform to the
current period presentation. These reclassifications had no effect on net
income as previously reported. In the opinion of management, all adjustments,
consisting of normal recurring accruals, considered necessary for a fair
presentation have been included.
The following material under the heading "Management's Discussion and Analysis
of Financial Condition and Results of Operations" was written with the
presumption that the users of the interim financial statements have read, or
have access to, the Company's latest audited financial statements and notes
thereto, together with Management's Discussion and Analysis of Financial
Condition and Results of Operations as of December 31, 2005 and for the three
year period then ended. Therefore, only material changes in financial condition
and results of operations are discussed in the remainder of Part 1.
Operating results for the three and nine months ended September 30, 2006 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2006.
(2) EARNINGS PER SHARE
Basic earnings per share have been computed by dividing net income by the
weighted average number of common shares outstanding throughout the three months
and nine months ended September 30, 2006 and 2005, using 2,463,482 and 2,461,328
weighted average common shares outstanding for the three months ended, and
2,463,250 and 2,453,744 for the nine months ended, respectively. Diluted
earnings per share for the three months and nine months ended September 30, 2006
and 2005 have been computed using 2,483,465 and 2,488,418 for the three months
ended and 2,482,069 and 2,487,478 for the nine months ended, respectively.
Diluted earnings per share gives effect to weighted average shares that would be
outstanding assuming the exercise of issued stock options using the treasury
stock method.
6
(3) PENSION BENEFITS
The composition of net periodic benefit plan cost for the three months and nine
months ended September 30, 2006 and 2005 is as follows:
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2006 2005 2006 2005
- ---------------------------------------------------------------------------------
(In thousands)
Service cost $ 48 $ 38 $ 144 $ 114
Interest cost 63 57 189 171
Expected return on plan assets (92) (71) (276) (213)
Amortization of net losses 28 24 84 72
- ---------------------------------------------------------------------------------
Net periodic benefit cost $ 47 $ 48 $ 141 $ 144
=================================================================================
The Company previously disclosed in its financial statements for the year ended
December 31, 2005, that it expected to contribute $192,000 to its pension plan
in 2006. As of September 30, 2006, $135,000 had been contributed to the pension
plan.
(4) COMPREHENSIVE INCOME (LOSS)
The components of other comprehensive income (loss) and related tax effects for
the three and nine month periods ended September 30, 2006 and 2005 are as
follows:
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2006 2005 2006 2005
- ------------------------------------------------------------------------------------------
(In thousands)
Gross change in unrealized gains (losses)
on securities available for sale $ 1,430 $ (175) $ 513 $ (739)
Reclassification adjustment for (gains)
losses included in net income - 192 9 192
- ------------------------------------------------------------------------------------------
1,430 17 522 (547)
Tax effect (572) (7) (214) 219
- ------------------------------------------------------------------------------------------
Net of tax amount $ 858 $ 10 $ 308 $ (328)
==========================================================================================
(5) GUARANTEES
The Company does not issue any guarantees that would require liability
recognition or disclosure, other than its standby letters of credit. Standby
letters of credit written are conditional commitments issued by the Company to
guarantee the performance of a customer to a third party. Generally, all letters
of credit, when issued have expiration dates within one year. The credit risk
involved in issuing letters of credit is essentially the same as those that are
involved in extending loan facilities to customers. The Company, generally,
holds collateral and/or personal guarantees supporting these commitments. The
Company had $216,000 of standby letters of credit as of September 30, 2006.
Management believes that the proceeds obtained through a liquidation of
collateral and the enforcement of guarantees would be sufficient to cover the
potential amount of future payments required under the corresponding guarantees.
The current amount of the liability as of September 30, 2006 for guarantees
under standby letters of credit issued is not material.
7
(6) STOCK BASED COMPENSATION
Prior to 2006, the Company accounted for stock-based compensation issued to
directors and employees using the intrinsic value method in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" (APB 25). This method required that compensation expense be
recognized to the extent that the fair value of the stock exceeds the exercise
price of the stock award at the grant date. The Company generally did not
recognize compensation expense related to stock option awards because the stock
options generally had fixed terms and exercise prices that were equal to or
greater than the fair value of the Company's common stock at the grant date.
Effective January 1, 2006, the Company adopted Financial Accounting Standards
Board (FASB) Statement No. 123(R), Share-Based Payment, ("SFAS 123(R)"). SFAS
123(R) requires compensation costs related to share-based payment transactions
to be recognized in the income statement (with limited exceptions) using the
modified prospective method based on the grant-date fair value of the
stock-based compensation issued. Compensation costs are recognized over the
period that an employee provides service in exchange for the award. As of the
date of adoption of SFAS 123(R), the Company's options were fully granted and
vested, and accordingly, there was no impact to the Company's consolidated
financial position or results of operations.
In conjunction with SFAS 123(R), the Company also adopted FASB Staff Position
("FSP") SFAS 123(R)-2, "Practical Accommodation to the Application of Grant Date
as Defined in SFAS 123(R)" effective January 1, 2006. FSP 123(R)-2 provides
guidance on the application of grant date as defined in SFAS 123(R). In
accordance with this standard a grant date of an award exists if (a) the award
is a unilateral grant, and (b) the key terms and conditions of the award are
expected to be communicated to an individual recipient within a relatively short
time period from the date of approval. The adoption of this standard did not
impact our consolidated financial position, results of operations or cash flows
for the three or nine-month periods ended September 30, 2006.
In November 2005, the FASB issued final FSP No. 123(R)-3, "Transition Election
Related to Accounting for the Tax Effects of Share-Based Payment Awards." The
FSP provides an alternative method of calculating excess tax benefits (the
Additional Paid-in Capital "APIC"pool) from the method defined in SFAS 123(R)
for share-based payments. A one-time election to adopt the transition method in
this FSP is available to those entities adopting SFAS 123(R) using either the
modified retrospective or modified prospective method. Up to one year from the
initial adoption of SFAS 123(R) or effective date of the FSP is provided to make
this one-time election. However, until an entity makes its election, it must
follow the guidance in SFAS 123(R). We are currently evaluating the potential
impact of calculating the APIC pool with this alternative method and have not
yet determined which method we will adopt, or the expected impact on our
consolidated financial position or results of operations.
In February 2006, the FASB issued FSP No. 123(R)-4, "Classifications of Options
and Similar Instruments Issued as Employee Compensation That Allow for Cash
Settlement upon the Occurrence of a Contingent Event." The position amends SFAS
123(R) to incorporate that a cash settlement feature that can be exercised only
upon the occurrence of a contingent event that is outside the employee's control
does not meet certain conditions in SFAS 123(R) until it becomes probable that
the event will occur. The guidance in this FSP was required to be applied upon
initial adoption of SFAS 123(R). The Company does not have any option grants
that allow for cash settlement.
8
(7) NEW ACCOUNTING PRONOUNCEMENTS
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid
Financial Instruments ("SFAS 155"). SFAS 155 amends FASB Statement No. 133 and
FASB Statement No. 140, and improves the financial reporting of certain hybrid
financial instruments by requiring more consistent accounting that eliminates
exemptions and provides a means to simplify the accounting for these
instruments. Specifically, SFAS 155 allows financial instruments that have
embedded derivatives to be accounted for as a whole (eliminating the need to
bifurcate the derivative from its host) if the holder elects to account for the
whole instrument on a fair value basis. The Company is required to adopt the
provisions of SFAS 155, as applicable, beginning in 2007. Management does not
believe the adoption of SFAS 155 will have a material impact on the Company's
consolidated financial position and results of operations.
In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of
Financial Assets -An Amendment of FASB Statement No. 140 ("SFAS 156"). SFAS 156
requires that all separately recognized servicing assets and servicing
liabilities be initially measured at fair value, if practicable. The statement
permits, but does not require, the subsequent measurement of servicing assets
and servicing liabilities at fair value. SFAS 156 is effective for the Company
beginning in 2007. The Company does not believe that the adoption of SFAS 156
will have a significant effect on its consolidated financial statements.
In July 2006, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes-an
interpretation of FASB Statement No. 109" (FIN 48), which clarifies the
accounting for uncertainty in tax positions. This Interpretation requires that
companies recognize in their financial statements the impact of a tax position,
if that position is more likely than not of being sustained on audit, based on
the technical merits of the position. The provisions of FIN 48 are effective for
fiscal years beginning after December 15, 2006, with the cumulative effect of
the change in accounting principle recorded as an adjustment to opening retained
earnings. The Company is evaluating the impact of this new pronouncement on its
consolidated financial statements.
In September 2006, the FASB issued FASB Statement No. 157, Fair Value
Measurements, which defines fair value, establishes a framework for measuring
fair value under GAAP, and expands disclosures about fair value measurements.
FASB Statement No. 157 applies to other accounting pronouncements that require
or permit fair value measurements. The new guidance is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and for
interim periods within those fiscal years. We are currently evaluating the
potential impact, if any, of the adoption of FASB Statement No. 157 on our
consolidated financial position, results of operations and cash flows.
On September 29, 2006, the Financial Accounting Standards Board "FASB" issued
SFAS No. 158, Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans ("SFAS 158"), which amends SFAS 87 and SFAS 106 to require
recognition of the overfunded or underfunded status of pension and other
postretirement benefit plans on the balance sheet. Under SFAS 158, gains and
losses, prior service costs and credits, and any remaining transition amounts
under SFAS 87 and SFAS 106 that have not yet been recognized through net
periodic benefit cost will be recognized in accumulated other comprehensive
income, net of tax effects, until they are amortized as a component of net
periodic cost. The measurement date - the date at which the benefit obligation
and plan assets are measured - is required to be the company's fiscal year end.
SFAS 158 is effective for publicly-held companies for fiscal years ending after
December 15, 2006, except for the measurement date provisions, which are
effective for fiscal years ending after December 15, 2008. The Company is
currently analyzing the effects of SFAS 158 but does not expect its
implementation will have a significant impact on the Company's financial
conditions or results of operations.
On September 13, 2006, the Securities and Exchange Commission "SEC" issued Staff
Accounting Bulletin No. 108 ("SAB 108"). SAB 108 provides interpretive guidance
on how the effects of the carryover or reversal of prior year misstatements
9
should be considered in quantifying a potential current year misstatement. Prior
to SAB 108, companies might evaluate the materiality of financial statement
misstatements using either the income statement or balance sheet approach, with
the income statement approach focusing on new misstatements added in the
current year, and the balance sheet approach focusing on the cumulative amount
of misstatement present in a company's balance sheet. Misstatements that would
be material under one approach could be viewed as immaterial under another
approach, and not be corrected. SAB 108 now requires that companies view
financial statement misstatements as material if they are material according to
either the income statement or balance sheet approach. The Company has analyzed
SAB 108 and determined that upon adoption it will have no impact on the reported
results of operations or financial conditions.
10
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Throughout the Management's Discussion and Analysis ("MD&A") the term, "the
Company", refers to the consolidated entity of Pathfinder Bancorp, Inc.
Pathfinder Bank and Pathfinder Statutory Trust I are wholly owned subsidiaries
of Pathfinder Bancorp, Inc. Pathfinder Commercial Bank, Pathfinder REIT, Inc.
and Whispering Oaks Development, Inc. are the wholly owned subsidiaries of
Pathfinder Bank. At September 30, 2006, Pathfinder Bancorp, MHC, the Company's
mutual holding company parent, whose activities are not included in the MD&A,
held 64.2% of the Company's common stock while the public held 35.8% of the
Company's common stock.
The following discussion reviews the Company's financial condition at September
30, 2006 and the results of operations for the three and nine months ended
September 30, 2006 and September 30, 2005.
This Quarterly Report contains certain "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. Such
statements are subject to certain risks and uncertainties, including, among
other things, changes in economic conditions in the Company's market area,
changes in policies by regulatory agencies, fluctuations in interest rates,
demand for loans in the Company's market areas and competition, that could cause
actual results to differ materially from historical earnings and those presently
anticipated or projected. The Company wishes to caution readers not to place
undue reliance on any such forward-looking statements, which speak only as of
the date made. The Company wishes to advise readers that the factors listed
above could affect the Company's financial performance and could cause the
Company's actual results for future periods to differ materially from any
opinions or statements expressed with respect to future periods in any current
statements.
The Company does not undertake, and specifically declines any obligation, to
publicly release the result of any revisions that may be made to any
forward-looking statements to reflect events or circumstances after the date of
such statements or to reflect the occurrence of anticipated or unanticipated
events.
The Company's net income is primarily dependent on its net interest income,
which is the difference between interest income earned on its investments in
mortgage loans, investment securities and other loans, and its cost of funds
consisting of interest paid on deposits and borrowed funds. The Company's net
income is also affected by its provision for loan losses, as well as by the
amount of other income, including income from fees and service charges on
deposit accounts, net gains and losses on sales of securities, loans and
foreclosed real estate, and other expenses such as salaries and employee
benefits, building occupancy and equipment costs, data processing and income
taxes. Earnings of the Company also are affected significantly by general
economic and competitive conditions, particularly changes in market interest
rates, government policies and actions of regulatory authorities, which events
are beyond the control of the Company. In particular, the general level of
market rates tends to be highly cyclical.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America and
follow practices within the banking industry. Application of these principles
requires management to make estimates, assumptions and judgments that affect the
11
amounts reported in the consolidated financial statements and accompanying
notes. These estimates, assumptions and judgments are based on information
available as of the date of the financial statements; accordingly, as this
information changes, the financial statements could reflect different estimates,
assumptions and judgments. Certain policies inherently have a greater reliance
on the use of estimates, assumptions and judgments and as such have a greater
possibility of producing results that could be materially different than
originally reported. Estimates, assumptions and judgments are necessary when
assets and liabilities are required to be recorded at fair value or when an
asset or liability needs to be recorded contingent upon a future event.
Carrying assets and liabilities at fair value inherently results in more
financial statement volatility. The fair values and information used to record
valuation adjustments for certain assets and liabilities are based on quoted
market prices or are provided by other third-party sources, when available.
When third party information is not available, valuation adjustments are
estimated in good faith by management.
The most significant accounting policies followed by the Company are presented
in Note 1 to the consolidated financial statements included in the 2005 Annual
Report on Form 10-K ("the Consolidated Financial Statements"). These policies,
along with the disclosures presented in the other financial statement notes and
in this discussion, provide information on how significant assets and
liabilities are valued in the consolidated financial statements and how those
values are determined. Based on the valuation techniques used and the
sensitivity of financial statement amounts to the methods, assumptions and
estimates underlying those amounts, management has identified the determination
of the allowance for loan losses to be the accounting area that requires the
most subjective and complex judgments, and as such could be the most subject to
revision as new information becomes available.
The allowance for loan losses represents management's estimate of probable loan
losses inherent in the loan portfolio. Determining the amount of the allowance
for loan losses is considered a critical accounting estimate because it requires
significant judgment and the use of estimates related to the amount and timing
of expected future cash flows on impaired loans, estimated losses on pools of
homogeneous loans based on historical loss experience, and consideration of
current economic trends and conditions, all of which may be susceptible to
significant change. The loan portfolio also represents the largest asset type
on the consolidated balance sheet. Note 1 to the Consolidated Financial
Statements describes the methodology used to determine the allowance for loan
losses, and a discussion of the factors driving changes in the amount of the
allowance for loan losses is included in this report.
The Company carries all of its investments at fair value with any unrealized
gains or losses reported net of tax as an adjustment to shareholders' equity.
Based on management's assessment, at September 30, 2006, the Company did not
hold any security that had a fair value decline that is currently expected to be
other than temporary. Consequently, any declines in a specific security's fair
value below amortized cost have not been provided for in the consolidated income
statement. The Company's ability to fully realize the value of its investment
in various securities, including corporate debt securities, is dependent on the
underlying creditworthiness of the issuing organization.
EXECUTIVE SUMMARY
Net income was $170,000, or $0.07 per diluted share, for the three months ended
September 30, 2006 as compared to $116,000, or $0.05 per diluted share, for the
same period in 2005. For the nine months ended September 30, 2006, the Company
reported net income of $713,000, or $0.29 per diluted share as compared to
$499,000, or $0.20 per diluted share, for the same period in 2005. The Company
continued its efforts toward transforming its traditional thrift balance sheet
with mostly residential loans as interest earning assets toward that of a
community bank with a more diverse mix of residential, consumer and commercial
loans. On an average balance basis, commercial loans comprise 26.2% of the
total gross loan portfolio for the nine months ended September 30, 2006, as
compared to 25.0% of the portfolio in 2005. Asset quality continues to improve
12
during 2006 as reflected by the improvement in the ratio of non-performing loans
to period end loans to 0.69% at September 30, 2006, from 0.88% at September 30,
2005.
On April 23, 2006, Alliance Bank N.A. announced it had reached a definitive
agreement to merge with the parent company of Oswego County National Bank
(OCNB). OCNB, formerly, Oswego County Savings Bank has been domiciled in the
city of Oswego since its founding in 1870 and has been the primary local
competitor for Pathfinder Bank. In management's view, the absorption of OCNB
into Alliance Bank, a $900 million bank headquartered in Syracuse, NY, will
provide both challenges and opportunities for Pathfinder Bank. The challenge
will be the ability of a larger competitor to more actively and aggressively
market within the primary business area of Pathfinder Bank. Opportunities
exist, as management believes that it's unique competencies and differentiators
are more closely matched by a locally domiciled bank, than one headquartered
outside our primary market area. Opportunities may exist to garner additional
business relationships with the traditional customer base of OCNB that is more
apt to conduct its business with a local bank.
RESULTS OF OPERATIONS
The return on average assets and return on shareholders' equity were 0.23% and
3.21%, respectively, for the three months ended September 30, 2006, compared
with 0.15% and 2.16%, respectively, for the three months ended September 30,
2005. During the third quarter of 2006, when compared to the third quarter of
2005, net interest income decreased $145,000, combined with a decrease in other
income, exclusive of net gains on sales of securities and loans/real estate, by
$26,000, or 4%, offset by a $102,000, or 4%, reduction in other expenses. No
provision for loan losses was made in the quarter.
The return on average assets and return on shareholders' equity were 0.32% and
4.53%, respectively, for the nine months ended September 30, 2006, compared with
0.22% and 3.10%, respectively, for the nine months ended September 30, 2005.
For the nine months ended September 30, 2006, net interest income decreased
$409,000, or 6%, when compared to the nine months ended September 30, 2005.
This decrease was offset by a reduction in other expenses of $311,000, or 4%, an
increase in other income, exclusive of net gains on sales of securities and
loans/real estate, of $140,000, or 9%, and a 90%, or $206,000, reduction in
provision for loan losses.
NET INTEREST INCOME
Net interest income is the Company's primary source of operating income for
payment of operating expenses and providing for loan losses. It is the amount
by which interest earned on interest-earning deposits, loans and investment
securities, exceeds the interest paid on deposits and other interest-bearing
liabilities. Changes in net interest income and net interest margin ratio
result from the interaction between the volume and composition of interest
earning assets, interest-bearing liabilities, related yields and associated
funding costs.
For the three months ended September 30, 2006, net interest income, on a
tax-equivalent basis, decreased to $2.1 million from $2.2 million, when compared
to the same quarter of 2005. The Company's net interest margin for the third
quarter of 2006 decreased to 3.11% from 3.21% when compared to the same quarter
in 2005. Management expects continued margin compression to adversely impact
earnings, as we anticipate the yield curve will continue to be flat or inverted
over the near term. The decline in net interest income was attributable to the
higher rates paid of 54 basis points on both deposits and borrowings, offset by
an increase of 40 basis points in average interest-earning asset yields.
Average interest-earning assets decreased 3% to $270.3 million for the three
months ended September 30, 2006 as compared to $279.6 million for the three
months ended September 30, 2005. The decrease in average interest-earning assets
was primarily attributable to a $14.4 million decrease in investment securities,
offset by a $5.0 million increase in loans receivable. Average interest-bearing
liabilities decreased $9.7 million, and the cost of funds increased 54 basis
13
points to 3.03% for the quarter ended September 30, 2006, from 2.49% for the
same period in 2005. The decrease in the average balance of interest- bearing
liabilities resulted primarily from an $8.3 million decrease in borrowed funds
and a $1.4 million decrease in average deposits. The decrease in deposits
principally occurred in the municipal money management accounts due to
fluctuating deposit activities of the local municipal entities. The increase in
cost of funds can be attributed to the 175 basis point increase in short-term
interest rates over the past 12 months, combined with a change in the
composition of deposits as $8.2 million in deposits shifted from lower cost
savings accounts to higher cost certificates of deposit.
For the nine months ended September 30, 2006, net interest income, on a
tax-equivalent basis, decreased $417,000, to $6.4 million, from $6.8 million for
the nine months ended September 30, 2005. Net interest margin decreased 12
basis points, to 3.12% for the nine months ended September 30, 2006 from 3.24%
for the nine months ended September 30, 2005. Average interest-earning assets
decreased 3% to $273.1 million for the nine months ended September 30, 2006 as
compared to $280.3 million for the nine months ended September 30, 2005, while
the yield on interest-earning assets increased 36 basis points to 5.81% from
5.45% for the comparable periods. The decrease in average interest-earning
assets was primarily attributable to an $8.3 million decrease in investment
securities and a $3.3 million decrease in interest-earning deposits, partially
offset by a $4.4 million increase in loans receivable. Average interest-bearing
liabilities decreased $7.6 million while the cost of funds increased 52 basis
points to 2.86% for the nine months ended September 30, 2006, from 2.34% for
the same period in 2005. The decrease in the average balance of
interest-bearing liabilities resulted from a $5.2 million decrease in average
deposits and a $2.4 million decrease in borrowed funds.
INTEREST INCOME
Total interest income, on a tax-equivalent basis, for the quarter ended
September 30, 2006 increased $137,000, or 4%, to $4.0 million from $3.9 million
for the quarter ended September 30, 2005. The average balance of loans
increased $5.0 million to $194.7 million, with yields increasing 29 basis points
to 6.64% for the third quarter of 2006. Average commercial real estate loans
increased $6.6 million, and the yield on those loans increased to 7.77% from
7.30% in 2005. Average commercial loans increased $2.5 million, and experienced
an increase in the average yield of 19 basis points, to 8.59% from 8.40%, in
2005. Average consumer loans increased $915,000, or 5%, and experienced an
increase in yield of 88 basis points. The increase in the yield on commercial
and consumer loans was primarily the result of new loan originations occurring
at market rates higher than the weighted average existing portfolio rate as well
as the adjustable rate portions of the portfolios repricing upward in connection
with Federal Reserve increases in the prime rate. Increases in the average
balance of consumer and commercial loan portfolios were offset by decreases in
the average balance of residential real estate loan portfolios and municipal
loans. The average balance of the residential real estate portfolio decreased
$4.1 million, or 3%, combined with a slight decrease in yield to 5.75% from
5.79% for the same period in 2005. The Company's municipal loan portfolio
decreased $951,000, or 5%, when comparing the third quarter of 2006 to the same
period in 2005. The average tax equivalent yield on the municipal loan
portfolio increased to 5.87% in the third quarter of 2006 from 4.32% for the
same period in 2005.
Average investment securities (taxable and tax-exempt) for the quarter ended
September 30, 2006 decreased by $14.4 million when compared to the same period a
year ago, with a decrease in tax-equivalent interest income from investments of
$79,000, or 9%, compared to the third quarter of 2005. The average
tax-equivalent yield of the portfolio increased 31 basis points, to 4.13% from
3.82%. The decrease in average investment securities was primarily due to the
December 2005 sale of agency and municipal securities which had been purchased
as collateral for the additional municipal deposit relationships acquired during
2004 and 2005. Additional securities were sold during the first and second
quarters of 2006 following the decrease in municipal deposits.
14
Total interest income, on a tax-equivalent basis, for the nine months ended
September 30, 2006 increased $442,000, or 4%, when compared to the nine months
ended September 30, 2005. Average loans increased $4.4 million, with average
yields increasing 27 basis points to 6.54% from 6.27%. The average balance of
commercial real estate increased $4.9 million, with average yields increasing to
7.72% from 7.39%, average commercial loans increased $2.9 million, with average
yields increasing to 8.16% from 7.31% and average consumer loans increased
$764,000 with average yields increasing to 8.06% from 7.24% for the nine moths
September 30, 2005. These increases were offset by decreases in the average
balance of residential real estate and municipal loans of $3.5 million and
$712,000, respectively.
For the nine months ended September 30, 2006, tax-equivalent interest income
from investment securities decreased $109,000, or 4%, compared to the same
period in 2005. The average tax-equivalent yield of the portfolio increased 22
basis points, to 4.06% from 3.84%, offset by an $8.3 million decrease in the
average balance of investment securities.
INTEREST EXPENSE
Total interest expense increased $283,000 for the three months ended September
30, 2006, when compared to the same quarter in 2005. Deposit expense for the
comparable periods increased $315,000, or 30%, as the average rate paid on
higher cost money management accounts increased 46 basis points to 2.52% in 2006
from 2.06% in 2005. The cost of time deposits also increased 86 basis points as
existing time deposits matured and rolled over into higher cost deposits. In
addition, the Bank introduced new higher cost promotional deposit products,
combined with a 14% increase in the average balance of time deposit accounts to
$104.7 million in 2006 from $92.2 million in 2005. The cost of other
interest-bearing deposits increased slightly to 0.47% from 0.45%, offset by a
6%, or $4.8 million, decrease in the average balance of these deposits.
Interest expense on borrowings decreased by $32,000, or 6%, from the prior
period, resulting from a decrease in the average balance of borrowed funds of
$8.3 million, or 17%, offset by an increase in the cost of borrowed funds to
5.42% from 4.75%. The increase in the cost of borrowings primarily resulted
from an increase in the cost of the $5.0 million LIBOR (London Interbank Offered
Rate) based junior subordinated debentures to 8.88% from 6.91%. The cost of the
junior subordinated debenture adjusts quarterly.
For the nine months ended September 30, 2006, interest expense increased
$859,000, or 19%, to $5.5 million from $4.7 million for the same period in 2005.
The average deposit balance decreased $5.2 million, offset by a 53 basis point
increase in the cost of deposits to 2.41% from 1.88%. The cost of borrowed funds
increased 53 basis points to 5.24% from 4.71%, partially offset by a decrease in
the average balance of borrowed funds by $2.4 million, or 6%.
PROVISION FOR LOAN LOSSES
No provision for loan losses was made for the quarter ended September 30, 2006
reflecting the Bank's improved asset quality. The Company's ratio of allowance
for loan losses to period end loans has decreased to 0.83% at September 30, 2006
from 0.97% at September 30, 2005. Nonperforming loans to period end loans
decreased to 0.68% at September 30, 2006 from 0.89% at September 30, 2005.
For the nine months ended September 30, 2006, the provision for loan losses was
$23,000 as compared to $229,000 for the same period in 2005 primarily resulting
from a decrease in the level of charge-offs to $86,000 for the nine months ended
September 30, 2006 compared to $255,000 in 2005 and continued improvement in
overall asset quality.
15
NONINTEREST INCOME
The Company's noninterest income is primarily comprised of fees charged on
deposit account balances and transactions, loan servicing, commissions, and net
gains on securities, loans and foreclosed real estate.
The following table sets forth certain information on noninterest income for the
periods indicated:
Three Months Ended September 30,
2006 2005 $Change % Change
- -----------------------------------------------------------------------------
(Dollars in thousands)
Service charges on deposit accounts $ 338 $ 356 $ (18) -5.1%
Loan servicing fees 55 61 (6) -9.8%
Earnings on bank owned life insurance 50 44 6 13.6%
Other operating income 130 138 (8) -5.8%
- -----------------------------------------------------------------------------
Core other income 573 599 (26) -4.3%
Net gains/(losses) on sale of loans/
foreclosed real estate (29) 42 (71) -169.0%
Net losses on sales of securities - (192) 192 -100.0%
- -----------------------------------------------------------------------------
Total other income $ 544 $ 449 $ 95 21.2%
=============================================================================
Nine Months Ended September 30,
2006 2005 $Change % Change
- -----------------------------------------------------------------------------
(Dollars in thousands)
Service charges on deposit accounts $ 1,059 $ 949 $ 110 11.6%
Loan servicing fees 160 146 14 9.6%
Earnings on bank owned life insurance 150 133 17 12.8%
Other operating income 417 418 (1) -0.2%
- -----------------------------------------------------------------------------
Core other income 1,786 1,646 140 8.5%
Net gains/(losses) on sale of loans/
foreclosed real estate (34) 30 (64) -213.3%
Net losses on sales of securities (9) (192) 183 -95.3%
- -----------------------------------------------------------------------------
Total other income $1,743 $1,484 $ 259 17.5%
=============================================================================
For the three months ended September 30, 2006, core other income reflected a
decrease of $26,000, or 4%, when compared with the three months ended September
30, 2005. Income from service charges on deposit accounts decreased primarily
due to lower net collected fees on checking account activity. The decrease in
other operating income primarily resulted from a decrease in fees associated
with foreign ATM usage, partially offset by an increase in Pathfinder Bank debit
card usage.
For the nine months ended September 30, 2006, core other income increased
$140,000 or 9%, when compared with the nine months ended September 30, 2005.
The increase was primarily due to a fee enhancement program on deposit accounts
which began in the second quarter of 2005.
The increase in the net losses on sales of loans/foreclosed real estate for the
three and nine month period was the result of the sale of four ORE properties in
the third quarter of 2006. Additionally, a gain on the sale of loans was
recorded in the third quarter of 2005. There were no loan sales during the
first nine months of 2006.
The decrease in the net losses on sales of investment securities for the three
and nine month period was primarily due to a $192,000 other than temporary
impairment charge recorded in the third quarter of 2005, with no similar charges
taken in 2006.
NONINTEREST EXPENSES
The following table sets forth certain information on noninterest expense for
the periods indicated:
Three Months Ended September 30,
2006 2005 $Change % Change
- --------------------------------------------------------------------------
(Dollars in thousands)
Salaries and employee benefits $ 1,307 $1,290 $ 17 1.3%
Building occupancy 291 318 (27) -8.5%
Data processing 328 325 3 0.9%
Professional and other services 121 172 (51) -29.7%
Amortization of intangible assets 55 55 - 0.0%
Other operating 289 333 (44) -13.2%
- -------------------------------------------------------------------------
Total noninterest expense $ 2,391 $2,493 $ (102) -4.1%
- -------------------------------------------------------------------------
Nine Months Ended September 30,
2006 2005 $Change % Change
- ------------------------------------------------------------------------
(Dollars in thousands)
Salaries and employee benefits $ 3,765 $3,807 $ (42) -1.1%
Building occupancy 913 880 33 3.8%
Data processing 958 964 (6) -0.6%
Professional and other services 352 572 (220) -38.5%
Amortization of intangible assets 166 166 - 0.0%
Other operating 958 1,034 (76) -7.4%
- -------------------------------------------------------------------------
Total noninterest expense $ 7,112 $7,423 $ (311) -4.2%
=========================================================================
16
Total noninterest expense decreased $102,000 for the three months ended
September 30, 2006, when compared to the same quarter of 2005. The decrease in
building occupancy expense for the three months ended September 30, 2006, was
primarily the result of a reduction of machine maintenance expenses and
nonrecurring expenses associated with branch facility improvements in 2005. The
decrease in professional and other expenses for the three-month period ending
September 30, 2006, was primarily due to costs associated with a company wide
leadership training program and process improvement initiatives that occurred in
2005. The decrease in other operating expenses was primarily attributable to
lower expenses associated with foreclosed real estate, a reduction in office
supplies and a reduction in costs associated with home equity loan originations.
Total noninterest expense decreased $311,000 for the nine months ended September
30, 2006 when compared to the same period of 2005. The reduction in salaries and
employee benefits was primarily due to a personnel realignment in December 2005
and a reduction of expenses recognized on the employee stock ownership plan.
These reductions were offset by an increase in staffing costs for the new branch
that opened in June of 2005. The decrease in professional and other services was
primarily due to the 2005 expenses associated with the leadership training
program and process improvement initiatives. The reduction in other operating
expenses was primarily due to a reduction in office supply expenses, lower
expenses associated with home equity loan origination costs and mortgage
recording tax expenses, a reduction in expenses on ORE property due to the
number of foreclosed properties held and the recording of gains recognized on
the sale of fixed assets. Building occupancy costs increased primarily due to
the full nine months of operation of the new Central Square branch which opened
in June 2005, combined with increased depreciation expenses.
INCOME TAX EXPENSE
Income taxes increased $89,000 and $153,000 for the quarter ended and nine
months ended September 30, 2006, respectively, as compared to the same period in
2005. These increases were attributable to an increase in the Company's pre-tax
income and a decrease in tax-exempt interest income. The effective tax rate
was 19.0% for the three months and 17.2% for the nine months ended September 30,
2006. The Company continues to strive to reduce its tax rate from the statutory
rate of 34% primarily through the ownership of tax-exempt investment securities,
bank owned life insurance and other tax savings strategies. The enactment of
proposed state tax legislation, which would limit the benefit derived from Real
Estate Investment Trusts, would result in a higher effective state tax rate for
the Company, if passed.
CHANGES IN FINANCIAL CONDITION
ASSETS
Total assets increased to $298.0 million at September 30, 2006 from $296.9
million at December 31, 2005. Loans receivable increased $7.9 million, or 4%,
offset by a decrease in investment securities of $5.2 million and a $1.9 million
reduction in other assets. The increase in loans receivable was primarily the
result of a $5.0 million increase in commercial real estate, a $1.9 million
increase in commercial loans and a $1.3 million increase in consumer loans. The
decrease in investment securities was primarily the result of amortization and
prepayments within the mortgage-backed securities and government and agencies
portfolio.
At September 30, 2006, the securities balance included a net unrealized loss on
available for sale securities of $1.6 million, as compared to a net unrealized
loss of $2.2 million at December 31, 2005. These unrealized losses relate
principally to changes in interest rates subsequent to the acquisition of
specific securities. None of the securities in this category had an unrealized
loss that exceeded 8% of the book value of the Company. The Company has the
intent and ability to hold the individual securities to maturity or market price
recovery.
17
The decrease in other assets is primarily due to the elimination of
inter-company balances between the Bank and the Company which were paid off by
the origination of two commercial loans in May of 2006.
LIABILITIES
Total liabilities increased slightly to $276.6 million at September 30, 2006
from $276.0 million at December 31, 2005. The slight increase in liabilities
was due to a $1.5 million increase in non-interest bearing deposits and a $1.3
million increase in short-term borrowings, offset by a $2.0 million decrease in
long-term borrowings. Short-term borrowings were increased to replace deposit
outflows from municipal customers. The increase in non-interest bearing deposits
was primarily attributable to new business account relationships and the opening
of the new Central Square branch in June of 2005.
LOAN AND ASSET QUALITY AND ALLOWANCE FOR LOAN LOSSES
The following table represents information concerning the aggregate amount of
nonperforming assets:
For the Period Ending
- ---------------------------------------------------------------------------------------------------
(Dollars in thousands) September 30, December 31, September 30,
2006 2005 2005
- ---------------------------------------------------------------------------------------------------
Nonaccrual loans:
Commercial $ 468 $ 757 $ 336
Consumer 130 89 126
Real estate - Construction 0 0 0
Mortgage 749 834 1,179
- ----------------------------------------------------------------------------------------------------
Total nonaccrual loans 1,347 1,680 1,641
Loans past due 90 days or more and still accruing 0 0 0
- ----------------------------------------------------------------------------------------------------
Total non-performing loans 1,347 1,680 1,641
Foreclosed real estate 497 743 935
- ----------------------------------------------------------------------------------------------------
Total non-performing assets $ 1,844 $ 2,423 $ 2,576
====================================================================================================
Non-performing loans to total loans 0.68% 0.89% 0.88%
Non-performing assets to total assets 0.62% 0.82% 0.85%
====================================================================================================
Total nonperforming loans and foreclosed real estate at September 30, 2006
decreased 19.8% when compared to December 31, 2005. The sharp decrease in
commercial nonaccrual loans is a result of the workout of one commercial loan
relationship and the foreclosure on the real estate of another relationship. No
loss of principle or interest was recognized from either situation.
Nonperforming loans continued to be addressed primarily through increased
collection efforts and foreclosure proceedings. The decrease in foreclosed real
estate is a result of a conscious effort on the bank's part to aggressively
market foreclosed properties and reduce the amount of time that they are being
carried. Management believes that adequate reserves exist for potential losses
that may occur.
The allowance for loan losses at September 30, 2006 was $1.6 million, or 0.83%
of period end loans, compared to $1.7 million, or 0.89% of period end loans, at
December 31, 2005.
CAPITAL
Shareholders' equity increased $437,000, or 2%, to $21.4 million at September
30, 2006. The increase in shareholders' equity primarily resulted from a
$308,000 reduction in accumulated other comprehensive loss and $118,000 in
retained earnings. The Company added $713,000 to retained earnings through net
income and returned $595,000 to its shareholders in the form of cash dividends.
The Company's mutual holding company parent, Pathfinder Bancorp, MHC accepted
the dividend for the quarter ended September 30, 2006.
Risk-based capital provides the basis for which all banks are evaluated in terms
of capital adequacy. Capital adequacy is evaluated primarily by the use of
ratios which measure capital against total assets, as well as against total
18
assets that are weighted based on defined risk characteristics. The Company's
goal is to maintain a strong capital position, consistent with the risk profile
of its subsidiary banks that supports growth and expansion activities while at
the same time exceeding regulatory standards. At September 30, 2006, Pathfinder
Bank exceeded all regulatory required minimum capital ratios and met the
regulatory definition of a "well-capitalized" institution, i.e. a leverage
capital ratio exceeding 5%, a Tier 1 risk-based capital ratio exceeding 6% and a
total risk-based capital ratio exceeding 10%.
LIQUIDITY
Liquidity management involves the Company's ability to generate cash or
otherwise obtain funds at reasonable rates to support asset growth and reduce
assets to meet deposit withdrawals, to maintain reserve requirements, and to
otherwise operate the Company on an ongoing basis. The Company's primary
sources of funds are deposits, borrowed funds, amortization and prepayment of
loans and mortgage backed securities and maturities of investment securities and
other short-term investments, and earnings and funds provided from operations.
While scheduled principal repayments on loans are a relatively predictable
source of funds, deposit flows and loan prepayments are greatly influenced by
general interest rates, economic conditions and competition. The Company
manages the pricing of deposits to maintain a desired deposit balance. In
addition, the Company invests excess funds in short-term, interest-earning and
other assets, which provide liquidity to meet lending requirements, and utilizes
short-term borrowings as a source of liquidity when necessary.
The Company's liquidity has been enhanced by its membership in the Federal Home
Loan Bank of New York, whose competitive advance programs and lines of credit
provide the Company with a safe, reliable and convenient source of funds. A
significant decrease in deposits in the future could result in the Company
having to seek other sources of funds for liquidity purposes. Such sources
could include, but are not limited to, additional borrowings, trust preferred
security offerings, brokered deposits, negotiated time deposits, the sale of
"available-for-sale" investment securities, the sale of securitized loans, or
the sale of whole loans. Such actions could result in higher interest expense
costs and/or losses on the sale of securities or loans.
The Asset Liability Management Committees of the Company are responsible for
implementing the policies and guidelines for the maintenance of prudent levels
of liquidity. As of September 30, 2006, management reported to the Board of
Directors that the Company is in compliance with its liquidity policy
guidelines.
19
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's risk of loss arising from adverse changes in the fair value of
financial instruments, or market risk, is composed primarily of interest rate
risk. The management of interest rate sensitivity seeks to avoid fluctuating net
interest margins and to provide consistent net interest income through periods
of changing interest rates. The primary objective of the Company's asset-
liability management activities is to maximize net interest income while
maintaining acceptable levels of interest rate risk. The Company has Asset-
Liability Management Committees which are responsible for establishing policies
to limit exposure to interest rate risk, and to ensure procedures are
established to monitor compliance with those policies. Those procedures include
reviewing the Company's assets and liability policies, setting prices and terms
on rate-sensitive products, and monitoring and measuring the impact of interest
rate changes on the Company's earnings and capital. The Company's Board of
Directors reviews the guidelines established by these committees.
From 2001 until June 2004, the Federal Reserve lowered interest rates thirteen
times by a total of 550 basis points. These interest rate reductions have
caused significant repricing of Pathfinder Bank's interest-earning assets and
interest-bearing liabilities. Efforts have been made to shorten the repricing
duration of its rate sensitive assets by purchasing investment securities with
maturities within the next 3 to 5 years and promoting portfolio ARM (adjustable
rate mortgage) and hybrid ARM products. In addition, the Company has extended
the duration of its rate sensitive liabilities by lengthening the maturities of
its existing borrowings and offering certificates of deposit with three and four
year terms which allow depositors to make a one-time election, at any time
during the term of the certificate of deposit, to adjust the rate of the
instrument to the then prevailing rate for the certificate of deposit with the
same term.
Since June of 2004, the Federal Reserve has raised its key short-term interest
rate 425 basis points. Net interest margin compression has resulted as the yield
curve flattened from sharp increases in short-term interest rates while
longer-term rates have remained relatively stable. Management will continue to
seek to minimize any reduction in net interest income in a period of rising
short-term interest rates to the extent that it can resist raising its cost of
funds during this period. The Company is continuing to explore transactions and
strategies to both increase its net interest income and minimize its interest
rate risk.
GAP ANALYSIS. At September 30, 2006, the total interest-bearing liabilities
maturing or repricing within one year exceeded total interest-earning assets
maturing or repricing in the same period by $31.4 million, representing a
cumulative one-year gap ratio of a negative 10.56%.
EARNINGS AT RISK AND VALUE AT RISK. Management believes the simulation of net
interest income (Earnings at Risk) and net portfolio value (Value at Risk) in
different interest rate environments provides a more meaningful measure of
interest rate risk. Income simulation analysis captures both the potential of
all assets and liabilities to mature or reprice and the probability that they
will do so. Income simulation also attends to the relative interest rate
sensitivities of these items, and projects their behavior over an extended
period of time. Finally, income simulation permits management to assess the
probable effects on the balance sheet not only of changes in interest rates, but
also of proposed strategies for responding to them. Net portfolio value
represents the fair value of net assets (determined as the market value of
assets minus the market value of liabilities using a discounted cash flow
technique).
20
The following table measures the Company's interest rate risk exposure in terms
of the percentage change in its net interest income and net portfolio value as a
result of hypothetical changes in 100 basis point increments in market interest
rates. The table quantifies the changes in net interest income and net
portfolio value to parallel shifts in the yield curve. The column "Percentage
Change in Net Interest Income" measures the change to the next twelve month's
projected net interest income, due to parallel shifts in the yield curve. The
column "Percentage Change in Net Portfolio Value" measures changes in the
current fair value of assets and liabilities to parallel shifts in the yield
curve. The column "NPV Capital Ratio" measures the ratio of the fair value of
net assets to the fair value of total assets at the base case and in 100 basis
point incremental interest rate shocks. The Company uses these percentage
changes as a means to measure interest rate risk exposure and quantifies those
changes against guidelines set by the Board of Directors as part of the
Company's Interest Rate Risk policy.
Percentage Percentage
Change in NPV Change in Change in
Interest Capital Net Interest Net Portfolio
Rates Ratio Income Value
- --------------------------------------------------
300 7.23% -17.64% -33.70%
200 8.23% -11.60% -22.82%
100 9.21% -5.72% -11.48%
0 ---- ---- ----
- -100 10.66% 2.71% 7.40%
- -200 10.58% 2.00% 8.44%
- -300 10.14% -0.65% 5.64%
21
ITEM 4 - CONTROLS AND PROCEDURES
Under the supervision and with the participation of the Company's management,
including our Chief Executive Officer and Chief Financial Officer, the Company
has evaluated the effectiveness of the design and operation of its disclosure
controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the
Exchange Act) as of the end of the period covered by this quarterly report.
Based upon that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that, as of the end of the period covered by this report, the
Company's disclosure controls and procedures are effective to ensure that
information required to be disclosed in the reports that the Company files or
submits under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported, within the time periods specified in the Securities and
Exchange Commission's rules and forms. There has been no change in the
Company's internal control over financial reporting during the most recent
fiscal quarter that has materially affected, or is reasonable likely to
materially affect, the Company's internal control over financial reporting.
22
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
- --------------------------
None
ITEM 1A - RISK FACTORS
- ----------------------
There have been no significant changes in the risk factors affecting Pathfinder
Bancorp, Inc. that were identified in Item 1A of Part 1 of the Company's Form
10-K for the year ended December 31, 2005.
ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
- --------------------------------------------------------------------
None
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
- ----------------------------------------
None
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
None
ITEM 5 - OTHER INFORMATION
- --------------------------
None
ITEM 6 - EXHIBITS
- -----------------
Exhibit No. Description
- ----------- -----------
31.1 Rule 13a-14(a) / 15d-14(a) Certification of the Chief
Executive Officer
31.2 Rule 13a-14(a) / 15d-14(a) Certification of the Chief
Financial Officer
32.1 Section 1350 Certification of the Chief Executive
Officer and Chief Financial Officer
23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PATHFINDER BANCORP, INC.
------------------------
(Registrant)
November 14, 2006 /s/ Thomas W. Schneider
- ----------------- -----------------------
Date: Thomas W. Schneider
President, Chief Executive Officer
November 14, 2006 /s/ James A. Dowd
- ----------------- ----------------
Date: James A. Dowd
Senior Vice President, Chief Financial Officer
24
EXHIBIT 31.1
Rule 13a-14(a) / 15d-14(a) Certification of the Chief Executive Officer
Certification of Chief Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Thomas W. Schneider certify that:
1. I have reviewed the September 30, 2006 quarterly report on Form 10-Q of
Pathfinder Bancorp, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our conclusions
about the effectiveness of the disclosure controls and procedures, as
of the end of the period covered by this report based on such
evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors:
a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting which
are reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
November 14, 2006 /s/ Thomas W. Schneider
- ----------------- -----------------------
Date Thomas W. Schneider
President and Chief Executive Officer
EXHIBIT 31.2
Rule 13a-14(a) / 15d-14(a) Certification of the Chief Financial Officer
Certification of Chief Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, James A. Dowd certify that:
1. I have reviewed the September 30, 2006 quarterly report on Form 10-Q of
Pathfinder Bancorp, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our conclusions
about the effectiveness of the disclosure controls and procedures, as
of the end of the period covered by this report based on such
evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors:
a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting which
are reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
November 14, 2006 /s/ James A. Dowd
- ----------------- -----------------
Date James A. Dowd
Senior Vice President and Chief Financial
Officer
EXHIBIT 32.1
Section 1350 Certification of the Chief Executive and Chief Financial Officer
Certification pursuant to
18 U.S.C. Section 1350,
as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
Thomas W. Schneider, President and Chief Executive Officer, and James A. Dowd,
Vice President and Chief Financial Officer of Pathfinder Bancorp, Inc. (the
"Company"), each certify in his capacity as an officer of the Company that he
has reviewed the Quarterly Report of the Company on Form 10-Q for the quarter
ended September 30, 2006 and that to the best of his knowledge:
1. the report fully complies with the requirements of Sections 13(a) of
the Securities Exchange Act of 1934; and
2. the information contained in the report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
The purpose of this statement is solely to comply with Title 18, Chapter 63,
Section 1350 of the United States Code, as amended by Section 906 of the
Sarbanes-Oxley Act of 2002.
November 14, 2006 /s/ Thomas W. Schneider
- ----------------- -----------------------
Date Thomas W. Schneider
President and Chief Executive Officer
November 14, 2006 /s/ James A. Dowd
- ----------------- -----------------
Date James A. Dowd
Senior Vice President and Chief Financial
Officer