UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 For the Fiscal Year Ended December 31, 2005
[ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d.) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transaction period from _______ to _______
OR
COMMISSION FILE NUMBER: 23601
PATHFINDER BANCORP, INC.
(Exact Name of Registrant as Specified in its Charter)
FEDERAL 16-1540137
------------------------------ -------------------------------
State or Other Jurisdiction of (I.R.S.
Incorporation or Organization) Employer 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)
Securities Registered Pursuant to Section 12(b) of the Act:
None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act.
Yes [ ] No [X].
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act.
Yes [ ] No [X].
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 requirements for the past 90 days. Yes [X] No [ ].
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form
10-K or any amendments to this Form 10-K. [ ]
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 March 15, 2006 there were 2,950,419 shares issued and 2,463,132 shares outstanding of the Registrant's Common Stock.
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant, computed by reference to the
last sale price on March 15, 2006, as reported by the Nasdaq National Market was approximately $10,602,711.
(1) Proxy Statement for the 2005 Annual Meeting of Stockholders (Part III).
DOCUMENTS INCORPORATED BY REFERENCE:
TABLE OF CONTENTS
FORM 10-K ANNUAL REPORT
FOR THE YEAR ENDED
DECEMBER 31, 2005
PATHFINDER BANCORP, INC.
Page
PART I
Item 1. Description of the Business 1
Item 1A. Risk Factors 9
Item 1B. Unresolved Staff Comments 11
Item 2. Properties 12
Item 3. Legal Proceedings 12
Item 4. Submission of Matters to a Vote of Security Holders 12
PART II
Item 5. Market for the Registrant's Common Equity, Related Stockholder 13
Matters and Issuer Purchases of Equity Securities
Item 6. Selected Financial Data 14
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 15
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 33
Item 8. Financial Statements and Supplementary Data 36
Item 9. Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure 68
Item 9A. Controls and Procedures 68
Item 9B. Other Information 68
PART III
Item 10. Directors and Executive Officers of the Registrant 68
Item 11. Executive Compensation 69
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters 69
Item 13. Certain Relationships and Related Transactions 69
Item 14. Principal Accountant Fees and Services 69
PART IV
Item 15. Exhibits and Financial Statement Schedules 70
PART I
ITEM 1: BUSINESS
GENERAL
PATHFINDER BANCORP, INC.
Pathfinder Bancorp, Inc. (the "Company") is a Federally chartered mid-tier holding company headquartered in Oswego, New York. The
primary business of the Company is its investment in Pathfinder Bank (the "Bank") and Pathfinder Statutory Trust I. The Company is majority
owned by Pathfinder Bancorp, M.H.C., a federally-chartered mutual holding company (the "Mutual Holding Company"). At December 31,
2005, the Mutual Holding Company held 1,583,239 shares of Common Stock and the public held 879,893 shares of Common Stock (the
"Minority Shareholders"). At December 31, 2005, Pathfinder Bancorp, Inc. had total assets of $296.9 million, total deposits of $236.4 million
and shareholders' equity of $20.9 million.
The Company's executive office is located at 214 West First Street, Oswego, New York and the telephone number at that address is (315) 343-
0057.
PATHFINDER BANK
The Bank is a New York-chartered savings bank headquartered in Oswego, New York. The Bank operates from its main office as well as six
full-service offices located in its market area consisting of Oswego County and the contiguous counties. The Bank's deposits are insured by the
Federal Deposit Insurance Corporation ("FDIC"). The Bank was chartered as a New York savings bank in 1859 as Oswego City Savings Bank.
The Bank is a consumer-oriented institution dedicated to providing mortgage loans and other traditional financial services to its customers. The
Bank is committed to meeting the financial needs of its customers in Oswego County, New York, the county in which it operates.
The Bank is primarily engaged in the business of attracting deposits from the general public in the Bank's market area, and investing such
deposits, together with other sources of funds, in loans secured by one- to four-family residential real estate and commercial real estate. At
December 31, 2005, $150.9 million, or 80% of the Bank's total loan portfolio consisted of loans secured by real estate, of which $119.1 million,
or 64%, were loans secured by one- to four-family residences and $31.8 million, or 17%, were secured by commercial real estate. Additionally,
$16.3 million, or 11%, of total real estate loans, were secured by second liens on residential properties that are classified as consumer loans.
The Bank also originates commercial and consumer loans that totaled $18.3 and $3.4 million, respectively, or 12%, of the Bank's total loan
portfolio. The Bank invests a portion of its assets in securities issued by the United States Government agencies and sponsored enterprises,
state and municipal obligations, corporate debt securities, mutual funds, and equity securities. The Bank also invests in mortgage-backed
securities primarily issued or guaranteed by United States Government sponsored enterprises. The Bank's principal sources of funds are
deposits, principal and interest payments on loans and borrowings from correspondent financial institutions. The principal source of income is
interest on loans and investment securities. The Bank's principal expenses are interest paid on deposits, and employee compensation and
benefits.
The Bank's executive office is located at 214 West First Street, Oswego, New York, and its telephone number at that address is (315) 343-0057.
Pathfinder Bank formed a limited purpose commercial bank subsidiary, Pathfinder Commercial Bank, in October of 2002. Pathfinder
Commercial Bank was established to serve the depository needs of public entities in its market area.
Page 1
In April 1999, the Bank established Pathfinder REIT, Inc. as the Bank's wholly-owned real estate investment trust subsidiary. At December 31,
2005, Pathfinder REIT, Inc. held $23.7 million in mortgages and mortgage related assets. Recent legislation proposed by the New York State
legislature would eliminate the tax treatment accorded REITs. Enactment of this legislation would increase the state tax rate for the Company.
All disclosures in the Form 10-K relating to the Bank's loans and investments include loans and investments that are held by Pathfinder REIT,
Inc.
The Bank also has 100% ownership in Whispering Oaks Development Corp., which was originally formed to develop the Whispering Oaks
real estate subdivision in Baldwinsville, New York. The Bank gained titled to the Whispering Oaks real estate subdivision through foreclosure.
The Whispering Oaks real estate subdivision has been fully developed. The subsidiary is retained, however, in case the need to operate or
develop other foreclosed real estate emerges.
MARKET AREA AND COMPETITION
The economy in the Bank's market area is manufacturing-oriented and is also significantly dependent upon the State University of New York
College at Oswego. The major manufacturing employers in the Bank's market area are Entergy Nuclear Northeast, Novelis, Constellation,
NRG and Huhtamaki. The Bank is the second largest financial institution headquartered in Oswego County. However, the Bank encounters
competition from a variety of sources. The Bank's business and operating results are significantly affected by the general economic conditions
prevalent in its market areas.
The Bank encounters strong competition both in attracting deposits and in originating real estate and other loans. Its most direct competition for
deposits has historically come from commercial and savings banks, savings associations and credit unions in its market area. Competition for
loans comes from such financial institutions as well as mortgage banking companies. The Bank expects continued strong competition in the
foreseeable future, including increased competition from "super-regional" banks entering the market by purchasing large commercial banks and
savings banks. Many such institutions have greater financial and marketing resources available to them than does the Bank. The Bank
competes for savings deposits by offering depositors a high level of personal service and a wide range of competitively priced financial
services. The Bank competes for real estate loans primarily through the interest rates and loan fees it charges and advertising, as well as by
originating and holding in its portfolio mortgage loans which do not necessarily conform to secondary market underwriting standards.
REGULATION AND SUPERVISION
GENERAL
The Bank is a New York-chartered stock savings bank and its deposit accounts are insured up to applicable limits by the FDIC through the
Bank Insurance Fund ("BIF"). The Bank is subject to extensive regulation by the New York State Banking Department (the "Department"), as
its chartering agency, and by the FDIC, as its deposit insurer and primary federal regulator. The Bank is required to file reports with, and is
periodically examined by, the FDIC and the Superintendent of the Department concerning its activities and financial condition and must obtain
regulatory approvals prior to entering into certain transactions, including, but not limited to, mergers with or acquisitions of other banking
institutions. The Bank is a member of the Federal Home Loan Bank of New York ("FHLBNY") and is subject to certain regulations by the
Federal Home Loan Bank System. On July 19, 2001 the Company and the Mutual Holding Company completed their conversion to federal
charters. Consequently, they are subject to regulations of the Office of Thrift Supervision ("OTS") as savings and loan holding companies. Any
change in such regulations, whether by the Department, the FDIC, or the OTS could have a material adverse impact on the Bank, the Company
or the Mutual Holding Company.
Regulatory requirements applicable to the Bank, the Company and the Mutual Holding Company are referred to below or elsewhere herein.
Page 2
NEW YORK BANK REGULATION
The exercise by an FDIC-insured savings bank of the lending and investment powers under the New York State Banking Law is limited by
FDIC regulations and other federal law and regulations. In particular, the applicable provisions of New York State Banking Law and
regulations governing the investment authority and activities of an FDIC insured state-chartered savings bank have been substantially limited
by the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") and the FDIC regulations issued pursuant thereto.
The Bank derives its lending, investment and other authority primarily from the applicable provisions of New York State Banking Law and the
regulations of the Department, as limited by FDIC regulations. Under these laws and regulations, savings banks, including the Bank, may
invest in real estate mortgages, consumer and commercial loans, certain types of debt securities, including certain corporate debt securities and
obligations of federal, state and local governments and agencies, certain types of corporate equity securities and certain other assets. New York
State chartered savings banks may also invest in subsidiaries under their service corporation investment authority. A savings bank may use this
power to invest in corporations that engage in various activities authorized for savings banks, plus any additional activities, which may be
authorized by the Banking Board. Under FDICIA and the FDIC's implementing regulations, the Bank's investment and service corporation
activities are limited to activities permissible for a national bank unless the FDIC otherwise permits it.
The FDIC and the Superintendent have broad enforcement authority over the Bank. Under this authority, the FDIC and the Superintendent
have the ability to issue formal or informal orders to correct violations of law or unsafe or unsound banking practices.
INSURANCE OF ACCOUNTS AND REGULATION BY THE FDIC
The Bank is a member of the BIF, which is administered by the FDIC. Deposits are insured up to applicable limits by the FDIC and such
insurance is backed by the full faith and credit of the U.S. Government.
On February 15, 2006, federal legislation to reform federal deposit insurance was signed into law. This law requires, among other things, the
merger of the Savings Association Insurance Fund and the Bank Insurance Fund into a unified insurance deposit fund, an increase in the
amount of federal deposit insurance coverage from $100,000 to $130,000 (with a cost of living adjustment to become effective in five years),
and the reserve ratio to be modified to provide for a range between 1.15% and 1.50% of estimated insured deposits. The law requires the FDIC
to issue implementing regulations and the changes required by the law will not become effective until final regulations have been issued, which
must be no later than 270 days from February 15, 2006.
REGULATORY CAPITAL REQUIREMENTS
The FDIC has adopted risk-based capital guidelines to which the Bank is subject. The guidelines establish a systematic analytical framework
that makes regulatory capital requirements more sensitive to differences in risk profiles among banking organizations. The Bank is required to
maintain certain levels of regulatory capital in relation to regulatory risk-weighted assets. The ratio of such regulatory capital to regulatory risk-
weighted assets is referred to as the Bank's "risk-based capital ratio." Risk-based capital ratios are determined by allocating assets and specified
off-balance sheet items to four risk-weighted categories ranging from 0% to 100%, with higher levels of capital being required for the
categories perceived as representing greater risk.
These guidelines divide a savings bank's capital into two tiers. The first tier ("Tier I") includes common equity, retained earnings, certain non-
cumulative perpetual preferred stock (excluding auction rate issues) and minority interests in equity accounts of consolidated subsidiaries, less
goodwill and other intangible assets (except mortgage servicing rights and purchased credit card relationships subject to certain limitations).
Supplementary ("Tier II") capital
Page 3
includes, among other items, cumulative perpetual and long-term limited-life preferred stock, mandatory convertible securities, certain hybrid
capital instruments, term subordinated debt and the allowance for loan and lease losses, subject to certain limitations, less required deductions.
Savings banks are required to maintain a total risk-based capital ratio of at least 8%, of which at least 4% must be Tier I capital.
In addition, the FDIC has established regulations prescribing a minimum Tier I leverage ratio (Tier I capital to adjusted total assets as specified
in the regulations). These regulations provide for a minimum Tier I leverage ratio of 3% for banks that meet certain specified criteria, including
that they have the highest examination rating and are not experiencing or anticipating significant growth. All other banks are required to
maintain a Tier I leverage ratio of 3% plus an additional cushion of at least 100 to 200 basis points. The FDIC and the other federal banking
regulators have proposed amendments to their minimum capital regulations to provide that the minimum leverage capital ratio for a depository
institution that has been assigned the highest composite rating of 1 under the Uniform Financial Institutions Rating System will be 3% and that
the minimum leverage capital ratio for any other depository institution will be 4% unless a higher leverage capital ratio is warranted by the
particular circumstances or risk profile of the depository institution. The FDIC may, however, set higher leverage and risk-based capital
requirements on individual institutions when particular circumstances warrant. Savings banks experiencing or anticipating significant growth
are expected to maintain capital ratios, including tangible capital positions, well above the minimum levels.
LIMITATIONS ON DIVIDENDS AND OTHER CAPITAL DISTRIBUTIONS
The FDIC has the authority to use its enforcement powers to prohibit a savings bank from paying dividends if, in its opinion, the payment of
dividends would constitute an unsafe or unsound practice. Federal law also prohibits the payment of dividends by a bank that will result in the
bank failing to meet its applicable capital requirements on a pro forma basis. New York law also restricts the Bank from declaring a dividend
which would reduce its capital below (i) the amount required to be maintained by state law and regulation, or
(ii) the amount of the Bank's liquidation account established in connection with the reorganization undertook in 1997.
PROMPT CORRECTIVE ACTION
The federal banking agencies have promulgated regulations to implement the system of prompt corrective action required by federal law.
Under the regulations, a bank shall be deemed to be (i) "well capitalized" if it has total risk-based capital of 10.0% or more, has a Tier I risk-
based capital ratio of 6.0% or more, has a Tier I leverage capital ratio of 5.0% or more and is not subject to any written capital order or
directive; (ii) "adequately capitalized" if it has a total risk-based capital ratio of 8.0% or more, a Tier I risk-based capital ratio of 4.0% or more
and a Tier I leverage capital ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the definition of "well capitalized";
(iii) "undercapitalized" if it has a total risk-based capital ratio that is lessthan 8.0%, a Tier I risk-based capital ratio that is less than 4.0% or a
Tier I leverage capital ratio that is less than 4.0% (3.0% under certain circumstances); (iv) "significantly undercapitalized" if it has a total risk-
based capital ratio that is less than 6.0%, a Tier I risk-based capital ratio that is less than 3.0% or a Tier I leverage capital ratio that is less than
3.0%; and (v) "critically undercapitalized" if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%. Federal law and
regulations also specify circumstances under which a federal banking agency may reclassify a well capitalized institution as adequately
capitalized and may require an adequately capitalized institution to comply with supervisory actions as if it were in the next lower category
(except that the FDIC may not reclassify a significantly undercapitalized institution as critically undercapitalized).
Based on the foregoing, the Bank currently meets the criteria to be classified as a "well capitalized" savings institution.
TRANSACTIONS WITH AFFILIATES AND INSIDERS
Under current federal law, transactions between depository institutions and their affiliates are governed by Sections 23A and 23B of the Federal
Reserve Act and its implementing regulations. An affiliate of a savings bank is any company
Page 4
or entity that controls, is controlled by, or is under common control with the savings bank, other than a subsidiary of the savings bank. In a
holding company context, at a minimum, the parent holding company of a savings bank and any companies which are controlled by such
parent holding company are affiliates of the savings bank. Generally, Section 23A limits the extent to which the savings bank or its subsidiaries
may engage in "covered transactions" with any one affiliate to an amount equal to 10% of such savings bank's capital stock and surplus and
contains an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital stock and surplus. The term
"covered transaction" includes the making of loans or other extensions of credit to an affiliate; the purchase of assets from an affiliate, the
purchase of, or an investment in, the securities of an affiliate; the acceptance of securities of an affiliate as collateral for a loan or extension of
credit to any person; or issuance of a guarantee, acceptance, or letter of credit on behalf of an affiliate. Section 23A also establishes specific
collateral requirements for loans or extensions of credit to, or guarantees, acceptances on letters of credit issued on behalf of an affiliate.
Section 23B requires that covered transactions and a broad list of other specified transactions be on terms substantially the same, or no less
favorable, to the savings bank or its subsidiary as similar transactions with nonaffiliates.
Further, Section 22(h) of the Federal Reserve Act and its implementing regulations restrict a savings bank with respect to loans to directors,
executive officers, and principal stockholders. Under Section 22(h), loans to directors, executive officers and stockholders who control, directly
or indirectly, 10% or more of voting securities of a savings bank and certain related interests of any of the foregoing, may not exceed, together
with all other outstanding loans to such persons and affiliated entities, the savings bank's total capital and surplus. Section 22(h) also prohibits
loans above amounts prescribed by the appropriate federal banking agency to directors, executive officers, and stockholders who control 10%
or more of voting securities of a stock savings bank, and their respective related interests, unless such loan is approved in advance by a
majority of the board of directors of the savings bank. Any "interested" director may not participate in the voting. The loan amount (which
includes all other outstanding loans to such person) as to which such prior board of director approval is required, is the greater of $25,000 or
5% of capital and surplus or any loans over $500,000. Further, pursuant to Section 22(h), loans to directors, executive officers and principal
stockholders must generally be made on terms substantially the same as offered in comparable transactions to other persons. Section 22(g) of
the Federal Reserve Act places additional limitations on loans to executive officers.
FEDERAL HOLDING COMPANY REGULATION
GENERAL. The Company and the Mutual Holding Company are nondiversified mutual savings and loan holding companies within the
meaning of the Home Owners' Loan Act. The Company and the Mutual Holding Company are registered with the OTS and are subject to OTS
regulations, examinations, supervision and reporting requirements. As such, the OTS has enforcement authority over the Company and the
Mutual Holding Company, and their non-savings institution subsidiaries. Among other things, this authority permits the OTS to restrict or
prohibit activities that are determined to be a serious risk to the subsidiary savings institution.
PERMITTED ACTIVITIES. Under OTS regulation and policy, a mutual holding company and a federally chartered mid-tier holding company,
such as the Company, may engage in the following activities: (i) investing in the stock of a savings association; (ii) acquiring a mutual
association through the merger of such association into a savings association subsidiary of such holding company or an interim savings
association subsidiary of such holding company; (iii) merging with or acquiring another holding company, one of whose subsidiaries is a
savings association; (iv) investing in a corporation, the capital stock of which is available for purchase by a savings association under federal
law or under the law of any state where the subsidiary savings association or associations share their home offices; (v) furnishing or performing
management services for a savings association subsidiary of such company; (vi) holding, managing or liquidating assets owned or acquired
from a savings subsidiary of such company;
(vii) holding or managing properties used or occupied by a savings association subsidiary of such company; (viii) acting as trustee under deeds
of trust; (ix) any other activity (A) that the Federal Reserve Board, by regulation, has determined to be permissible for bank holding companies
under Section 4(c) of the Bank Holding Company Act of 1956, unless the Director of the OTS, by regulation, prohibits or limits any such
activity for savings and loan holding companies; or (B) in which multiple savings and loan holding companies were authorized (by regulation)
to directly engage on March 5, 1987; (x) any activity permissible for financial holding companies under Section 4(k) of the Bank
Page 5
Holding Company Act, including securities and insurance underwriting; and (xi) purchasing, holding, or disposing of stock acquired in
connection with a qualified stock issuance if the purchase of such stock by such savings and loan holding company is approved by the Director.
If a mutual holding company acquires or merges with another holding company, the holding company acquired or the holding company
resulting from such merger or acquisition may only invest in assets and engage in activities listed in (i) through (xi) above, and has a period of
two years to cease any nonconforming activities and divest of any nonconforming investments.
The Home Owners' Loan Act prohibits a savings and loan holding company, directly or indirectly, or through one or more subsidiaries, from
acquiring another savings association or holding company thereof, without prior written approval of the OTS. It also prohibits the acquisition
or retention of, with certain exceptions, more than 5% of a nonsubsidiary savings association, a nonsubsidiary holding company, or a
nonsubsidiary company engaged in activities other than those permitted by the Home Owners' Loan Act; or acquiring or retaining control of an
institution that is not federally insured. In evaluating applications by holding companies to acquire savings associations, the OTS must consider
the financial and managerial resources, future prospects of the company and association involved, the effect of the acquisition on the risk to the
insurance fund, the convenience and needs of the community and competitive factors.
The Office of Thrift Supervision is prohibited from approving any acquisition that would result in a multiple savings and loan holding company
controlling savings associations in more than one state, subject to two exceptions: (i) the approval of interstate supervisory acquisitions by
savings and loan holding companies, and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings
institution specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company
acquisitions.
WAIVERS OF DIVIDENDS BY MUTUAL HOLDING COMPANY. Office of Thrift Supervision regulations require the Mutual Holding
Company to notify the OTS of any proposed waiver of its receipt of dividends from the Company
CONVERSION OF THE MUTUAL HOLDING COMPANY TO STOCK FORM. OTS regulations permit the Mutual Holding Company to
convert from the mutual form of organization to the capital stock form of organization (a "Conversion Transaction"). There can be no assurance
when, if ever, a Conversion Transaction will occur, and the Board of Directors has no current intention or plan to undertake a Conversion
Transaction. In a Conversion Transaction a new holding company would be formed as the successor to the Company (the "New Holding
Company"), the Mutual Holding Company's corporate existence would end, and certain depositors of the Bank would receive the right to
subscribe for additional shares of the New Holding Company. In a Conversion Transaction, each share of common stock held by stockholders
other than the Mutual Holding Company ("Minority Stockholders") would be automatically converted into a number of shares of common
stock of the New Holding Company determined pursuant an exchange ratio that ensures that Minority Stockholders own the same percentage
of common stock in the New Holding Company as they owned in the Company immediately prior to the Conversion Transaction. Under OTS
regulations, Minority Stockholders would not be diluted because of any dividends waived by the Mutual Holding Company (and waived
dividends would not be considered in determining an appropriate exchange ratio), in the event the Mutual Holding Company converts to stock
form. The total number of shares held by Minority Stockholders after a Conversion Transaction also would be increased by any purchases by
Minority Stockholders in the stock offering conducted as part of the Conversion Transaction.
NEW YORK STATE BANK HOLDING COMPANY REGULATION
In addition to the federal regulation, a holding company controlling a state chartered savings bank organized or doing business in New York
State also may be subject to regulation under the New York State Banking Law. The term "bank holding company," for the purposes of the
New York State Banking Law, is defined generally to include any person, company or trust that directly or indirectly either controls the
election of a majority of the directors or owns, controls or holds with power to vote more than 10% of the voting stock of a bank holding
company or, if the Company is a banking institution, another banking institution, or 10% or more of the voting stock of each of two or more
banking
Page 6
institutions. In general, a bank holding company controlling, directly or indirectly, only one banking institution will not be deemed to be a bank
holding company for the purposes of the New York State Banking Law. As such, neither the Company nor the Mutual Holding Company is
subject to supervision by the Department.
FEDERAL SECURITIES LAW
The common stock of the Company is registered with the SEC under the Exchange Act. The Company is subject to the information, proxy
solicitation, insider trading restrictions and other requirements of the SEC under the Exchange Act.
The Company Common Stock held by persons who are affiliates (generally officers, directors and principal stockholders) of the Company may
not be resold without registration or unless sold in accordance with certain resale restrictions. If the Company meets specified current public
information requirements, each affiliate of the Company is able to sell in the public market, without registration, a limited number of shares in
any three-month period.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board requires all depository institutions to maintain noninterest-bearing reserves at specified levels against their
transaction accounts (primarily checking, money management and NOW checking accounts). At December 31, 2005, the Bank was in
compliance with these reserve requirements.
FEDERAL COMMUNITY REINVESTMENT REGULATION
Under the Community Reinvestment Act, as amended (the "CRA"), as implemented by FDIC regulations, a savings bank has a continuing and
affirmative obligation, consistent with its safe and sound operation, to help meet the credit needs of its entire community, including low and
moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it
limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community,
consistent with the CRA. The CRA requires the FDIC, in connection with its examination of a savings institution, to assess the institution's
record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such
institution. The CRA requires the FDIC to provide a written evaluation of an institution's CRA performance utilizing a four-tiered descriptive
rating system. The Bank's latest CRA rating was "outstanding."
NEW YORK STATE COMMUNITY REINVESTMENT REGULATION
The Bank is also subject to provisions of the New York State Banking Law which impose continuing and affirmative obligations upon banking
institutions organized in New York State to serve the credit needs of its local community ("NYCRA") which are substantially similar to those
imposed by the CRA. Pursuant to the NYCRA, a bank must file an annual NYCRA report and copies of all federal CRA reports with the
Department. The NYCRA requires the Department to make a biennial written assessment of a bank's compliance with the NYCRA, utilizing a
four-tiered rating system and make such assessment available to the public. The NYCRA also requires the Superintendent to consider a bank's
NYCRA rating when reviewing a bank's application to engage in certain transactions, including mergers, asset purchases and the establishment
of branch offices or automated teller machines, and provides that such assessment may serve as a basis for the denial of any such application.
The Bank's NYCRA rating as of its latest examination was "satisfactory."
THE USA PATRIOT ACT
The USA PATRIOT Act was signed into law on October 26, 2001. The USA PATRIOT Act gives the federal government new powers to
address terrorist threats through
Page 7
enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money laundering
requirements. The USA PATRIOT Act also requires the federal banking agencies to take into consideration the effectiveness of controls
designed to combat money laundering activities in determining whether to approve a merger or other acquisition application of a member
institution. Accordingly, if the Company were to engage in a merger or other acquisitions, its controls designed to combat money laundering
would be considered as part of the application process. The Company and the Bank have established policies, procedures and systems designed
to comply with these regulations.
SARBANES-OXLEY ACT OF 2002
The Sarbanes-Oxley Act of 2002 was signed into law on July 30, 2002. The Sarbanes-Oxley Act of 2002 is a law that addresses, among other
issues, corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information.
As directed by Section 302(a) of Sarbanes-Oxley Act of 2002, the Company Chief Executive Officers and Chief Financial Officer are each
required to certify that the company's quarterly and annual reports do not contain any untrue statement of a material fact. The rules have several
requirements, including having these officers certify that: they are responsible for establishing, maintaining and regularly evaluating the
effectiveness of our internal controls; they have made certain disclosures to our auditors and the audit committee of the Board of Directors
about our internal controls; and they have included information in our quarterly and annual reports about their evaluation and whether there
have been significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to the
evaluation. We will be subject to further reporting and audit requirements with the year ending December 31, 2007 under the requirements of
Sarbanes-Oxley. We have existing policies, procedures and systems designed to comply with these regulations, and are further enhancing and
documenting such policies, procedures and systems to ensure continued compliance with these regulations.
The company maintains an Internet website located at WWW.PATHFINDERBANK.COM on which, among other things, the Company makes
available, free of charge, various reports that it files with or furnishes to the Securities and Exchange Commission, including its Annual Report
on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K. The Company has also made available on its website its
Audit Committee Charter, Governance Guidelines and Code of Ethics. These reports are made available as soon as reasonably practicable after
these reports are filed with or furnished to the Securities and Exchange Commission.
FEDERAL AND STATE TAXATION
FEDERAL TAXATION
The following discussion of federal taxation is intended only to summarize certain pertinent federal income tax matters and is not a
comprehensive description of the tax rules applicable to the Company or the Bank.
BAD DEBT RESERVES. Prior to the 1996 Act, the Bank was permitted to establish a reserve for bad debts and to make annual additions to
the reserve. These additions could, within specified formula limits, be deducted in arriving at the Bank's taxable income. As a result of the 1996
Act, the Bank must use the small bank experience method in computing its bad debt deduction beginning with its 1996 Federal tax return.
TAXABLE DISTRIBUTIONS AND RECAPTURE. Prior to the 1996 Act, bad debt reserves created prior to January 1, 1988 were subject to
recapture into taxable income should the Bank fail to meet certain thrift asset and definitionaltests. New federal legislation eliminated these
thrift related recapture rules. However, under current law, pre-1988 reserves remain subject to recapture should the Bank cease to retain a bank
or thrift charter or make certain non-dividend distributions.
MINIMUM TAX. The Internal Revenue Code imposes an alternative minimum tax ("AMT") at a rate of 20% on a base of regular taxable
income plus certain tax preferences ("alternative minimum taxable income" or "AMTI"). The AMT is
Page 8
payable to the extent such AMTI is in excess of an exemption amount. Net operating losses can offset no more than 90% of AMTI. Certain
payments of alternative minimum tax may be used as credits against regular tax liabilities in future years.
NET OPERATING LOSS CARRYOVERS. A financial institution may carry back net operating losses to the preceding two taxable years and
forward to the succeeding 20 taxable years. This provision applies to losses incurred in taxable years beginning after August 5, 1997.
The Internal Revenue Service has examined the federal income tax return for the fiscal year ended 1992; the New York State fiscal year-end
tax returns for 1998 through 1999 are currently under examination by the New York State Department of Taxation and Finance. See Note 13 to
the Financial Statements.
STATE TAXATION
NEW YORK TAXATION. The Bank is subject to the New York State Franchise Tax on Banking Corporations in an annual amount equal to
the greater of (i) 8.0% of the Bank's "entire net income" allocable to New York State during the taxable year, or (ii) the applicable alternative
minimum tax. The alternative minimum tax is generally the greater of (a) 0.01% of the value of the Bank's assets allocable to New York State
with certain modifications, (b) 3% of the Bank's "alternative entire net income" allocable to New York State, or (c) $250. Entire net income is
similar to federal taxable income, subject to certain modifications and alternative entire net income is equal to entire net income without certain
modifications. Net operating losses arising in the current period can be carried forward to the succeeding 20 taxable years.
The Company's Annual Report on Form 10-K may be accessed on the Company's website at WWW.PATHFINDERBANK.COM.
ITEM 1A: RISK FACTORS
The material risks and uncertainties that management believes affect the Company are described below. The risks and uncertainties described
below are not the only ones facing the Company. Additional risks and uncertainties that management is not aware of or that management
currently deems immaterial may also impair the Company's business operations. This report is qualified in its entirety by these risk factors. If
any of the following risks actually occur, the Company's financial condition and results of operations could be materially and adversely
affected.
CHANGES IN INTEREST RATES CAN HAVE AN ADVERSE EFFECT ON PROFITABILITY
The Company's earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference between
interest income earned on interest earning assets such as loans and investment securities and interest expense paid on interest bearing liabilities
such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond the Company's control, including
general economic conditions, competition, and policies of various governmental and regulatory agencies and, in particular, the Board of
Governors of the Federal Reserve System. Changes in monetary policy, including changes in interest rates, could influence not only the interest
the Company receives on loans and investment securities and the amount of interest it pays on deposits and borrowings, but such changes could
also affect (i) the Company's ability to originate loans and obtain deposits,
(ii) the fair value of the Company's financial assets and liabilities, and (iii) the average duration of the Company's assets and liabilities. If the
interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, the
Company's net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest
rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.
Although management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes
in interest rates on the Company's results of operations, any substantial,
Page 9
unexpected, prolonged change in market interest rates could have a material adverse effect on the Company's financial condition and results of
operations. See Item 7A, "Quantitative and Qualitative Disclosures About Market Risk" located elsewhere in this report for further discussion
related to the Company's management of interest rate risk.
ALLOWANCE FOR LOAN LOSSES MAY BE INSUFFICIENT
The Company's loan customers may not repay their loans according to their terms and the collateral securing the payment of these loans may be
insufficient to assure repayment. The Company may experience significant loan losses, which would have a material adverse effect on
earnings. Management makes various assumptions and judgments about the collectibility of the loan portfolio, including the creditworthiness
of borrowers and the value of the real estate and other assets serving as collateral for the repayment of loans.
The Company maintains an allowance for loan losses in an attempt to cover any loan losses inherent in the portfolio. In determining the size of
the allowance, management relies on an analysis of the loan portfolio based on historical loss experience, volume and types of loans, trends in
classification, volume and trends in delinquencies and non-accruals, national and local economic conditions and other pertinent information. If
those assumptions are incorrect, the allowance may not be sufficient to cover future loan losses and adjustments may be necessary to allow for
different economic conditions or adverse developments in the loan portfolio. In addition, regulatory agencies review the Company's allowance
for loan losses and may require additions to the allowance based on their judgment about information available to them at the time of their
examination. An increase in the Company's allowance for loan losses could reduce its earnings.
EXTENSIVE REGULATION AND SUPERVISION
The Company, primarily through its principal subsidiaries Pathfinder Bank and Pathfinder Commercial Bank and certain non-bank
subsidiaries, is subject to extensive federal and state regulation and supervision. Banking regulations are primarily intended to protect
depositors' funds, federal deposit insurance funds and the banking system as a whole, not shareholders. These regulations affect the Company's
lending practices, capital structure, investment practices, dividend policy and growth, among other things. The Company is also subject to a
number of federal laws, which, among other things, require it to lend to various sectors of the economy and population, and establish and
maintain comprehensive programs relating to anti-money laundering and customer identification. Congress and federal regulatory agencies
continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies,
including changes in interpretation or implementation of statutes, regulations or policies, could affect the Company in substantial and
unpredictable ways. Such changes could subject the Company to additional costs, limit the types of financial services and products it may offer
and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws,
regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a
material adverse effect on the Company's business, financial condition and results of operations. The Company's compliance with certain of
these laws will be considered by banking regulators when reviewing bank merger and bank holding company acquisitions. While the Company
has policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur. See the
"Regulation and Supervision" section in Item 1, "Business" and Note 17 to consolidated financial statements included in Item 8, "Financial
Statements and Supplementary Data", which are located elsewhere in this report.
LOCAL MARKET ECONOMIES
The Company's business is concentrated in Oswego and parts of Onondaga counties of New York State. The economy in the Company's
market area is manufacturing-oriented and dependent on the State University of New York College at Oswego. As a result, its financial
condition, results of operations and cash flows are subject to changes if there are changes in the economic conditions in these areas. A
prolonged period of economic recession or other adverse economic conditions in one or both of these areas could have a negative impact on the
Company. The Company can provide no assurance that conditions in its market area economies will not deteriorate in the future and that such
deterioration would not have a material adverse effect on the Company.
Page 10
COMPETITION IN THE FINANCIAL SERVICES INDUSTRY
The Company faces substantial competition in all areas of its operations from a variety of different competitors, many of which are larger and
may have more financial resources. The Company competes with other providers of financial services such as other bank holding companies,
commercial and savings banks, savings and loan associations, credit unions, money market and mutual funds, mortgage companies, title
agencies, asset managers, insurance companies and a growing list of other local, regional and national institutions which offer financial
services. If the Company is unable to compete effectively, it will lose market share and income generated from loans, deposits, and other
financial products will decline.
ITEM 1B: UNRESOLVED STAFF COMMENTS
None
Page 11
ITEM 2: PROPERTIES
The Bank conducts its business through its main office located in Oswego, New York, and six full service branch offices located in Oswego
County. The following table sets forth certain information concerning the main office and each branch office of the Bank at December 31,
2005. The aggregate net book value of the Bank's premises and equipment was $8.0 million at December 31, 2005. For additional information
regarding the Bank's properties, see Note 7 to Notes to Financial Statements
LOCATION OPENING DATE OWNED/LEASED
--------------------------------------------------------------------------------
Main Office 1874 Owned
214 West First Street
Oswego, New York 13126
Plaza Branch 1989 Owned (1)
Route 104, Ames Plaza
Oswego, New York 13126
Mexico Branch 1978 Owned
Norman & Main Streets
Mexico, New York 13114
Oswego East Branch 1994 Owned
34 East Bridge Street
Oswego, New York 13126
Lacona Branch 2002 Owned
1897 Harwood Drive
Lacona, New York 13083
Fulton Branch 2003 Owned (2)
5 West First Street South
Fulton, New York 13069
Central Square Branch 2005 Owned
3025 East Ave
Central Square, New York 13036
(1) The building is owned; the underlying land is leased with an annual rent of $19,000
(2) The building is owned; the underlying land is leased with an annual rent of $23,000
ITEM 3: LEGAL PROCEEDINGS
There are various claims and lawsuits to which the Company is periodically involved incident to the Company's business. In the opinion of
management such claims and lawsuits in the aggregate are not expected to have a material adverse impact on the Company's consolidated
financial condition and results of operations.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of fiscal 2005 to a vote of the Company's shareholders.
Page 12
PART II
ITEM 5: MARKET FOR REGISTRANT'S COMMON STOCK, RELATED SECURITY HOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
Pathfinder Bancorp, Inc.'s common stock currently trades on the Nasdaq SmallCap market under the symbol "PBHC". There were 415
shareholders of record as of March 3, 2006. The following table sets forth the high and low closing bid prices and dividends paid per share of
common stock for the periods indicated:
DIVIDEND
QUARTER ENDED: HIGH LOW PAID
-----------------------------------------------
December 31, 2005 $15.050 $12.360 $ 0.1025
September 30, 2005 15.250 13.050 0.1025
June 30, 2005 18.000 14.250 0.1025
March 31, 2005 17.950 16.250 0.1025
-----------------------------------------------
December 31, 2004 $18.500 $16.250 $ 0.1025
September 30, 2004 16.630 14.770 0.1025
June 30, 2004 19.070 15.050 0.100
March 31, 2004 20.999 17.010 0.100
-----------------------------------------------
DIVIDENDS AND DIVIDEND HISTORY
The Company has historically paid regular quarterly cash dividends on its common stock, and the Board of Directors presently intends to
continue the payment of regular quarterly cash dividends, subject to the need for those funds for debt service and other purposes. Payment of
dividends on the common stock is subject to determination and declaration by the Board of Directors and will depend upon a number of
factors, including capital requirements, regulatory limitations on the payment of dividends, Pathfinder Bank and its subsidiaries results of
operations and financial condition, tax considerations, and general economic conditions. The Company's mutual holding company, Pathfinder
Bancorp, M.H.C., may elect to waive or receive dividends each time the Company declares a dividend. The election to waive the dividend
receipt requires prior non-objection of the Office of Thrift Supervision. Pathfinder Bancorp, M.H.C. elected to waive its dividend for the
quarters ended March 31, 2005 and September 30, 2005. During 2006, Pathfinder Bancorp, M.H.C. expects to waive two quarterly dividends.
Page 13
ITEM 6: SELECTED FINANCIAL DATA
Pathfinder Bancorp, Inc. ("the Company") is the parent company of Pathfinder Bank and Pathfinder Statutory Trust I. Pathfinder Bank has
three operating subsidiaries - Pathfinder Commercial Bank, Pathfinder REIT Inc., and Whispering Oaks Development, Inc.
The following selected consolidated financial data sets forth certain financial highlights of the Company and should be read in conjunction with
the consolidated financial statements and related notes, and the "Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this annual report on Form 10-K.
2005 2004 2003 2002 2001
-----------------------------------------------------------------------------------------------------
YEAR END (In thousands)
Total assets $296,948 $302,037 $277,940 $279,056 $244,514
Loans receivable, net 187,889 185,125 187,002 179,001 162,588
Deposits 236,377 236,672 206,894 204,522 169,589
Equity 20,928 21,826 21,785 23,230 22,185
FOR THE YEAR (In thousands)
Net interest income $ 8,742 $ 8,905 $ 9,337 $ 8,789 $ 7,853
Noninterest income 2,040 3,047 2,608 2,094 1,864
Core noninterest income (a) 2,333 1,996 1,740 1,511 1,355
Noninterest expense 10,060 9,307 9,094 7,964 6,863
Net income 462 1,405 1,652 1,156 1,602
PER SHARE
Net income (basic) $ 0.19 $ 0.58 $ 0.68 $ 0.45 $ 0.62
Book value 8.50 8.91 8.96 8.90 8.64
Tangible book value (b) 6.77 7.04 7.03 7.02 7.63
Cash dividends declared 0.410 0.405 0.40 0.30 0.26
RATIOS
Return on average assets 0.15% 0.47% 0.59% 0.45% 0.68%
Return on average equity 2.16 6.45 7.61 5.01 7.34
Return on average tangible equity (b) 2.72 8.17 9.77 7.03 8.29
Average equity to average assets 6.95 7.29 7.77 8.94 9.22
Dividend payout ratio (c) 147.84 47.54 39.41 36.76 28.37
Allowance for loan losses to loans receivable 0.89 0.98 0.91 0.82 1.03
Net interest rate spread 3.07 3.22 3.53 3.47 3.35
Noninterest income to average assets 0.66 1.02 0.93 0.81 0.79
Core noninterest income to average assets (a) 0.76 0.67 0.62 0.59 0.57
Noninterest expense to average assets 3.28 3.12 3.26 3.09 2.90
Efficiency ratio (d) 93.30 77.87 76.13 73.18 70.61
(a) Core noninterest income excludes net (losses) gains on sales and impairment of investment securities and net (losses) gains on sales of loans
and foreclosed real estate.
(b) Tangible equity excludes intangible assets.
(c) The dividend payout ratio is calculated using dividends declared and not waived by the Company's mutual holding company parent,
Pathfinder Bancorp, M.H.C., divided by net income.
(d) The efficiency ratio is calculated as noninterest expense divided by the sum of net interest income and noninterest income.
Page 14
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
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., however, Pathfinder
Statutory Trust I is deconsolidated for reporting purposes (see Note 10). Pathfinder Commercial Bank, Pathfinder REIT, Inc. and Whispering
Oaks Development, Inc. represent wholly owned subsidiaries of Pathfinder Bank. At December 31, 2005, Pathfinder Bancorp, M.H.C, the
Company's mutual holding company parent, whose activities are not included in the MD&A, held 64.3% of the Company's outstanding
common stock and the public held 35.7%.
When used in this Annual Report the words or phrases "will likely result", "are expected to", "will continue", "is anticipated", "estimate",
"project" or similar expression are intended to identify "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 results of any revisions, which 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 business strategy is to operate as a well-capitalized, profitable and independent community bank dedicated to providing value-
added products and services to our customers. Generally, the Company has sought to implement this strategy by emphasizing retail deposits as
its primary source of funds and maintaining a substantial part of its assets in locally-originated residential first mortgage loans, loans to
business enterprises operating in its markets, and in investment securities. Specifically, the Company's business strategy incorporates the
following elements: (i) operating as an independent community-oriented financial institution; (ii) maintaining capital in excess of regulatory
requirements; (iii) emphasizing investment in one-to-four family residential mortgage loans, loans to small businesses and investment
securities; and (iv) maintaining a strong retail deposit base.
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 and other loans, investment securities and other assets, and its cost of funds consisting of interest paid on deposits and
other borrowings. The Company's net income also is affected by its provision for loan losses, as well as by the amount of noninterest income,
including income from fees, service charges and servicing rights, net gains and losses on sales of securities, loans and foreclosed real estate,
and noninterest expense such as employee compensation and benefits, occupancy and equipment costs, data processing costs 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.
Page 15
APPLICATION OF CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States
and follow practices within the banking industry. Application of these principles requires management to make estimates, assumptions and
judgments that affect the amounts reported in the 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. 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 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 security 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 December 31, 2005, 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 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
During 2005, the Company focused on expanding its branch network in Oswego County by opening a full service branch in Central Square,
New York in June of 2005. Total deposits for the new branch at December 31, 2005 were $6.3 million. Total deposits for the Company
remained relatively consistent at $236.4 million at December 31, 2005 while the average balance of deposits increased $8.1 million to $220.5
million at 2005. The Company will continue to focus on building its market share in Central Square and developing more core deposit
relationships in its existing markets during 2006.
Total assets decreased 2%, primarily in the investment securities portfolio and interest-earning deposits. The loan portfolio increased 1% as net
growth in the commercial real estate, commercial and consumer loan portfolios were partially offset by a decrease in the residential real estate
portfolio. Asset quality
Page 16
continued to improve during 2006. Nonperforming assets to total assets was 0.81% at December 31, 2005 compared to 0.88% in the prior year.
The improvement in asset quality is attributable to the enhancement of collection procedures and the resolution through foreclosure and charge-
off of two commercial lending relationships. The Company expects to concentrate on continued commercial mortgage and commercial loan
growth during 2006.
Net income for 2005 was $462,000, or $0.19 per share, as compared to $1.4 million, or $0.58 per share, in 2004. Net interest margin
compression; an impairment charge and strategic losses taken in the investment securities portfolio; the additional costs of operating a new
branch; and personnel restructuring charges impacted earnings negatively during 2005. An improvement in asset quality and an increase in
service charges on deposit accounts partially offset these charges to income.
The Company experienced net interest margin compression to 3.21% in 2005 from 3.35% in 2004. Net interest income decreased 2% to $8.7
million for the year ended December 31, 2005. The Company expects continued pressure on core earnings as short-term rates are anticipated to
continue to rise and long-term rates are expected to remain relatively unchanged. This interest rate environment impacts the Company's liability
sensitive balance sheet negatively as deposits and borrowings reprice more rapidly than loans and investment securities. The Company has
implemented an asset/liability management strategy to combat the current interest rate environment including the growth of more rate sensitive
commercial real estate and commercial loan portfolio, increasing core deposit relationships and strategies to mitigate the rising cost of deposits.
The Company's efforts to enhance other interest income during 2005 by increasing the customer deposit base and increasing overdraft, returned
check and non-sufficient fund charges to be more reflective with local competition resulted in a 36% increase in service charges on deposit
accounts during 2005. The Company opened a new branch in Central Square, New York in June of 2005. The branch successfully gathered
$6.3 million in deposits in the first seven months. The Company will continue to focus on growing our market share in Central Square. Salaries
and employee benefits and building occupancy costs increased primarily from the addition of the new branch combined with fourth quarter
personnel realignment costs. The Company expects salaries and benefits and building occupancy to increase, as a full year of Central Square
operations will be reflected in 2006. The Company continues to explore cost saving strategies to minimize the growth of other operating
expenses.
RESULTS OF OPERATIONS
Net income for 2005 was $462,000, a decrease of $943,000, or 67%, compared to net income of $1.4 million for 2004. Basic earnings per share
decreased to $0.19 per share for the year ended December 31, 2005 from $0.58 per share for the year ended December 31, 2004. Return on
average equity decreased 67% to 2.16% in 2005 from 6.45% in 2004.
Net interest income, on a tax equivalent basis, decreased $106,000, or 1%, primarily resulting from interest rate spread compression as shorter
term cost of funds are repricing at higher rates faster than longer term assets. Provision for loan losses at December 31, 2005 decreased 58%
reflecting improved asset quality during 2005, combined with slower loan growth. The Company experienced a 16% increase in other income,
net of securities gains and losses, primarily attributable to increased deposit levels and the related service charges associated with checking
accounts, combined with an increase in the value of bank owned life insurance. Operating expenses increased 8% due to the hiring of additional
staff and related operating costs at the new Central Square branch, which opened in June of 2005, along with increased data processing
expenses and an increase in professional and other services.
NET INTEREST INCOME
Net interest income is the Company's primary source of operating income for payment of operating expenses and providing for possible 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 borrowed money. Changes in net interest income and the net interest margin ratio result from the interaction between the
volume and composition of earning assets and interest-bearing liabilities, and their respective yields and funding costs.
Page 17
Net interest income, on a tax-equivalent basis, decreased $106,000, or 1%, to $9.0 million for the year ended December 31, 2005, as compared
to the year ended December 31, 2004. The Company's net interest margin for 2005 decreased to 3.21% from 3.35% in 2004. The decrease in
net interest income is attributable to increased costs of interest-bearing liabilities and was partially offset by an increase in the yields on interest
earning assets. The average balance of interest-earning assets grew $8.2 million, or 3%, during 2005 and the average balance of interest-bearing
deposits increased by $8.1 million, or 4%. The increase in the average balance of interest-bearing liabilities primarily resulted from an increase
in the average balance of retail and municipal deposits. As a result, interest income, on a tax-equivalent basis, increased $677,000 during 2005.
Interest expense on deposits increased $680,000, or 19%, as the cost of deposits rose to 1.96% in 2005 from 1.71% in 2004. In addition to the
increase in the cost of deposits, interest expense on borrowings also increased by $103,000, or 5%, from the prior year.
In comparison, net interest income decreased $375,000, or 4%, on a tax-equivalent basis, from 2003 to 2004. The decrease in net interest
income was comprised of a decrease in interest income of $751,000, or 5%, partially offset by a decrease in interest expense of $375,000, or
6%. The average balance of interest-earning assets grew $14.6 million during 2004 and the average balance of interest-bearing deposits
increased by $20.7 million. The increase in the average balance of interest-bearing liabilities primarily resulted from attracting new municipal
deposit customers. The decrease in the average yield on interest-earning assets by 60 basis points resulted from the downward repricing of
loans from refinancing and originations in the lower interest rate environment and the purchase of $35.6 million in investment securities at
lower yields than the existing portfolio.
Page 18
AVERAGE BALANCES AND RATES
The following table sets forth information concerning average interest-earning assets and interest-bearing liabilities and the yields and rates
thereon. Interest income and resultant yield information in the table is on a fully tax-equivalent basis using marginal federal income tax rates of
34%. Averages are computed on the daily average balance for each month in the period divided by the number of days in the period. Yields and
amounts earned include loan fees. Non-accrual loans have been included in interest-earning assets for purposes of these calculations.
2005 2004
--------------------------------------------------------------------------------------------------------
Average Average
Average Yield / Average Yield/
(Dollars in thousands) Balance Interest Cost Balance Interest Cost
--------------------------------------------------------------------------------------------------------
Interest-earning assets:
Real estate loans residential $121,875 $ 7,092 5.82% $124,734 $ 7,491 6.01%
Real estate loans commercial 29,385 2,181 7.42% 30,958 2,254 7.28%
Commercial loans 17,563 1,135 6.46% 16,060 901 5.61%
Consumer loans 19,257 1,418 7.36% 17,427 1,194 6.85%
Taxable investment securities 74,496 2,728 3.66% 65,480 2,220 3.39%
Tax-exempt investment securities 13,202 681 5.16% 8,603 488 5.67%
Interest-earning deposits 3,041 71 2.33% 7,338 81 1.10%
--------------------------------------------------------------------------------------------------------
Total interest-earning assets $278,819 $ 15,306 5.49% $270,600 $ 14,629 5.41%
Noninterest-earning assets:
Other assets 31,455 30,236
Allowance for loan losses (1,835) (1,792)
Net unrealized gains
on available for sale securities (1,307) (515)
--------------------------------------------------------------------------------------------------------
Total Assets $307,132 $298,529
=========================================================================================================
Interest-bearing liabilities:
NOW accounts $ 19,877 $ 107 0.54% $ 20,808 $ 135 0.65%
Money management accounts 41,380 835 2.02% 40,775 567 1.39%
Savings and club accounts 65,558 291 0.44% 68,046 453 0.67%
Time deposits 93,732 3,086 3.29% 82,769 2,484 3.00%
Junior subordinated debentures 5,155 351 6.72% 5,155 251 4.80%
Borrowings 37,348 1,686 4.51% 37,674 1,683 4.47%
--------------------------------------------------------------------------------------------------------
Total Interest-bearing liabilities $263,050 $ 6,356 2.42% $255,227 $ 5,573 2.18%
--------------------------------------------------------------------------------------------------------
Noninterest-bearing liabilities:
Demand deposits 19,324 17,974
Other liabilities 3,416 3,556
------------------------------------------------------------------------------------
Total liabilities 285,790 276,757
------------------------------------------------------------------------------------
Shareholders' equity 21,342 21,772
------------------------------------------------------------------------------------
Total liabilities & shareholders' equity $307,132 $298,529
====================================================================================
Net interest income $ 8,950 $ 9,056
Net interest rate spread 3.07% 3.22%
Net interest margin 3.21% 3.35%
---------------------------------------------------------------------------------------------------------
Ratio of average interest-earning assets
to average interest-bearing liabilities 105.99% 106.02%
---------------------------------------------------------------------------------------------------------
2003
------------------------------------------------------------------------
Average
Average Yield/
(Dollars in thousands) Balance Interest Cost
------------------------------------------------------------------------
Interest-earning assets:
Real estate loans residential $129,687 $ 8,346 6.44%
Real estate loans commercial 31,122 2,480 7.97%
Commercial loans 14,181 798 6.37%
Consumer loans 15,787 1,225 7.76%
Taxable investment securities 54,115 2,193 4.05%
Tax-exempt investment securities 7,869 305 3.87%
Interest-earning deposits 3,252 33 0.99%
------------------------------------------------------------------------
Total interest-earning assets $256,013 $ 15,380 6.01%
Noninterest-earning assets:
Other assets 24,859
Allowance for loan losses (1,591)
Net unrealized gains
on available for sale securities 52
------------------------------------------------------------------------
Total Assets $279,333
=========================================================================
Interest-bearing liabilities:
NOW accounts $ 17,663 $ 140 0.79%
Money management accounts 21,788 248 1.14%
Savings and club accounts 66,481 511 0.77%
Time deposits 85,751 2,852 3.33%
Junior subordinated debentures 5,000 236 4.66%
Borrowings 43,490 1,961 4.51%
-------------------------------------------------------------------------
Total Interest-bearing liabilities $240,173 $ 5,948 2.48%
-------------------------------------------------------------------------
Noninterest-bearing liabilities:
Demand deposits 16,345
Other liabilities 1,098
------------------------------------------------------------------------
Total liabilities 257,616
------------------------------------------------------------------------
Shareholders' equity 21,717
------------------------------------------------------------------------
Total liabilities & shareholders' equity $279,333
=========================================================================
Net interest income $ 9,432
Net interest rate spread 3.53%
Net interest margin 3.68%
-------------------------------------------------------------------------
Ratio of average interest-earning assets
to average interest-bearing liabilities 106.60%
=========================================================================
INTEREST INCOME
Changes in interest income are derived as a result of the volume of loans and securities, as measured by changes in the respective average
balance and by the related yields on those balances. Interest income on a tax-equivalent basis increased $67,000, or 5%. Average loans
decreased 1% in 2005, with yields increasing 3 basis points to 6.29% The Company's average residential mortgage loan portfolio decreased
$2.9 million, or 2%, when comparing the year 2005 to
Page 19
2004. The average yield on the residential mortgage loan portfolio decreased 19 basis points to 5.82% in 2005 from 6.01% in 2004. The $20.2
million in residential mortgage originations were made at lower rates than the weighted average yield of the existing portfolio. An increase in
the average balance of consumer loans of $1.8 million, or 11%, resulted from an increase in home equity loans. The average yield increased 51
basis points, to 7.36% from 6.85% in 2004, primarily- resulting from the increase in home equity loans, which are based on the Bank's prime
rate. Average commercial loans increased 9% while the tax-equivalent yield increased 85 basis points to 6.46% in 2005 compared to 5.61%, in
2004. Increases in the average balance of residential real estate, consumer and commercial loan portfolios were partially offset by a decrease in
the average balance of commercial real estate portfolio of $1.6 million, or 5%.
Average loans decreased $1.6 million in 2004, with average yields declining 48 basis points to 6.26%. The interest income on loans decreased
$1.0 million, or 8%, in 2004 compared to 2003. For the comparable periods, average residential mortgage loans decreased $5.0 million, or 4%,
average consumer loans increased $1.6 million, or 10%, partially offset by a decrease in average commercial loans by $1.9 million, or 13%,
and a decrease in average commercial mortgage loans by $164,000, or 1%. Loans were originated at lower rates than in the prior period and a
large volume of existing mortgages had their rates modified downward or were refinanced at lower rates.
Interest income on investment securities increased 26% from 2005, resulting from an increase in the average balance of investment securities
(taxable and tax-exempt) by $13.6 million, or 18%, to $87.7 million in 2005 from $74.1 million in 2004. The tax-equivalent yield increased 23
basis points to 3.89% in 2005 from 3.66% in 2004 resulting primarily from the purchase of $23.4 million in investment securities during 2005
at higher yields than the existing investment portfolio combined with the sale of $4.3 million in lower yielding investment securities from the
portfolio in the fourth quarter of 2005.
Average investment securities (taxable and tax-exempt) in 2004 increased by $12.1 million, with an increase in tax-equivalent interest income
from investments of $210,000, or 8%, compared to 2003. The average tax-equivalent yield of the portfolio declined 37 basis points, to 3.66%
from 4.03%. The increase in the average balance of investment securities and the decrease in the tax-equivalent yield resulted from the
significant investment purchases at lower yields than the existing investment portfolio.
INTEREST EXPENSE
Changes in interest expense are derived as a result of the volume of deposits and borrowings as measured by changes in the respective average
balances and by the related interest costs on those balances. Interest expense increased $783,000, or 14%, in 2005, when compared to 2004.
The increase in the cost of funds resulted from an increase in the average cost of interest-bearing liabilities of 24 basis points, to 2.42% in 2005
from 2.18% at 2004, combined with a $7.8 million increase in the average balance of interest-bearing liabilities during 2005. The average cost
of deposits increased 25 basis points to 1.96% during 2005 from 1.71% for 2004. The increase in the cost of average deposits resulted from
rising short-term interest rates. The average cost of money management accounts increased 63 basis points and the cost of time deposits
increased 29 basis points. The average balance of deposits increased $8.1 million to $220.5 million at 2005 from $212.4 million at 2004. The
increase in the average balance of deposits primarily resulted from a $2.9 million, or 11%, increase in average balance of municipal deposits as
the Company continues to garner new relationships and an increase in the average balance of retail deposits resulting primarily from the new
branch in Central Square. The cost of junior subordinated debentures increased 192 basis points, increasing interest expense by $100,000.
Interest expense decreased $375,000, or 6%, in 2004 compared to 2003. The average cost of interest bearing liabilities declined 30 basis points
during the 12 months ended December 31, 2004.
Page 20
RATE/VOLUME ANALYSIS
Net interest income can also be analyzed in terms of the impact of changing interest rates on interest-earning assets and interest-bearing
liabilities and changing the volume or amount of these assets and liabilities. The following table represents the extent to which changes in
interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Company's interest income
and interest expense during the periods indicated. Information is provided in each category with respect to: (i) changes attributable to changes
in volume (change in volume multiplied by prior rate);
(ii) changes attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) total increase or decrease. Changes attributable
to both rate and volume have been allocated ratably.
YEARS ENDED DECEMBER 31,
------------------------------------------------------------------------------------
2005 VS. 2004 2004 VS. 2003
------------------------------------------------------------------------------------
INCREASE/(DECREASE) DUE TO INCREASE/(DECREASE) DUE TO
------------------------------------------------------------------------------------
TOTAL TOTAL
INCREASE INCREASE
In thousands) VOLUME RATE (DECREASE) VOLUME RATE (DECREASE)
------------------------------------------------------------------------------------
INTEREST INCOME:
Real estate loans residential $(168) $(231) $(399) $(311) $ (544) $(855)
Real estate loans commercial (116) 43 (73) (13) (213) (226)
Commercial loans 89 145 234 81 22 103
Consumer loans 131 93 224 120 (151) (31)
Taxable investment securities 322 186 508 417 (390) 27
Tax-exempt investment securities 240 (47) 193 31 152 183
Interest-earning deposits (65) 55 (10) 45 3 48
------------------------------------------------------------------------------------
Total interest income 433 244 677 370 (1,121) (751)
------------------------------------------------------------------------------------
INTEREST EXPENSE:
NOW accounts (6) (22) (28) 22 (27) (5)
Money management accounts 8 260 268 255 64 319
Savings and club accounts (16) (146) (162) 12 (70) (58)
Time deposits 348 254 602 (96) (272) (368)
Junior subordinated debentures - 100 100 8 7 15
Borrowings (13) 16 3 (262) (16) (278)
------------------------------------------------------------------------------------
Total interest expense 321 462 783 (61) (314) (375)
-----------------------------------------------------------------------------------
Net change in net interest income $ 112 $(218) $(106) $ 431 $ (807) $(376)
===================================================================================
Page 21
NONINTEREST INCOME
The Company's noninterest income is primarily comprised of fees 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 years indicated.
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------
(In thousands) 2005 2004 2003
---------------------------------------------------------------------------------------------
Service charges on deposit accounts $1,318 $ 967 $ 818
---------------------------------------------------------------------------------------------
Loan servicing fees 215 256 282
Increase in the value of bank owned life insurance 218 175 171
Other charges, commissions and fees 582 598 469
Core noninterest income $2,333 $1,996 $1,740
---------------------------------------------------------------------------------------------
Net (losses) gains on sales and impairment of investment securities (205) 772 542
Net (losses) gains on sales of loans and foreclosed real estate (88) 279 326
---------------------------------------------------------------------------------------------
Total noninterest income $2,040 $3,047 $2,608
=============================================================================================
Noninterest income in 2005 decreased 33%, when compared to 2004, as a result of a 17% increase in core noninterest income and a 128%
decrease in the non-core items, net (losses) gains on sales and impairment of investment securities and net (losses) gains on sales of loans and
foreclosed real estate. Service charges on deposit accounts increased 36% as the number of deposit accounts increased, a full year's effect of a
fee enhancement program, increased ATM usage fees and increased internet banking usage. The value of bank owned life insurance increased
25%. These reductions in core noninterest income were offset by a decrease in loan servicing fees of 16%, primarily due to a reduction in fees
associated with mortgage and commercial loan late charges, and internal mortgage legal fees. Investment security losses increased $977,000,
when compared to the 2004 period resulting primarily from net gains recognized in prior years combined with a $193,000 impairment loss
recognized on an equity security and fourth quarter investment portfolio restructurings. Net losses on the sale of loans/foreclosed real estate
increased $367,000 when compared to the prior year, as a result of a $215,000 reduction in the gain recognized on the sale of loans to the
secondary market as the volume of loans sold decreased by 25%, combined with adjustments made to the Fannie Mae custodial accounts to
cover additional interest due caused by early pay offs of sold and serviced loans. Additionally, a $74,000 gain was recognized in 2004 on the
remaining building lots held by Whispering Oaks Development, Inc.
Noninterest income in 2004 increased 17%, compared to 2003, as a result of a 10% increase in core noninterest income and a 42% increase in
the non-core items, net gains on sales and impairment of investment securities. The increase in the number of deposit accounts and the
introduction of new services to customers primarily accounted for the $149,000 increase in service charges on deposit accounts when compared
to 2003. A $129,000 increase in other charges, commissions and fees primarily resulted from recording $54,000 in New York State grant
income associated with a company wide Leadership Training initiative program, along with increased foreign ATM usage fees and fees
associated with the company's Visa debit card. Net gains on the sale of loans/foreclosed real estate decreased $47,000, or 14%, resulting
primarily from a $40,000 reduction in the gain recognized on the sale of loans to the secondary market as the volume of loans sold decreased
47%. Investment security gains increased $230,000, or 42%, when compared to the 2003 period. Investment security net gains were recorded
on the sale of equity and corporate debt securities.
Page 22
NONINTEREST EXPENSE
The following table sets forth certain information on noninterest expense for the years indicated.
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
(In thousands) 2005 2004 2003
------------------------------------------------------------------
Salaries and employee benefits $ 5,123 $4,798 $4,455
Building occupancy 1,178 1,169 1,159
Data processing expenses 1,226 981 868
Professional and other services 818 682 770
Amortization of intangible asset 223 223 223
Other expenses 1,492 1,454 1,619
------------------------------------------------------------------
Total noninterest expense $10,060 $9,307 $9,094
==================================================================
Noninterest expenses increased $753,000, or 8%, for the 12 months ended December 31, 2005 when compared to 2004. Salaries and employee
benefits increased 7% in 2005 primarily resulting from incremental salary raises, the staffing of a new Central Square branch and fourth quarter
personnel realignment costs. The 1% increase in building occupancy is primarily due to the operation of the new Central Square branch for 7
months of 2005. The 25% increase in data processing expenses during 2005 related to increased depreciation expense, an increase in internet
banking expense due to increased volume of users, increased check processing charges due to an increase in deposit accounts, and the increased
annual maintenance expense on our core processing system. Professional and other services increased 20% due to outside consulting charges
for performance management, a process improvement program, and strategic planning projects, along with increased advertising fees for the
new Central Square branch. The 3% increase in other operating expenses during 2005 resulted primarily from the charge off of losses on ATM
transactions and bad checks, additional ORE expenses associated with taxes and maintenance of properties, the write off of property and
equipment at our former Fulton Branch, as well as an increase in audits and exams. These expenses were offset by decreases in postage
expense, office supply expense and lower mortgage recording taxes due to decreased loan volume.
Noninterest expenses increased $213,000, or 2%, for the 12 months ended December 31, 2004 when compared to 2003. Salaries and employee
benefits increased 8% in 2004 primarily resulting from incremental salary raises and promotions, the hiring of a Human Resource Manager and
increased pension and health insurance costs. The 13% increase in data processing expenses during 2004 related to additional depreciation
costs associated with a full year's operation of the new Fulton branch, combined with a 15% increase in internet banking usage, additional
check processing charges due to a 5% increase in customer volume from a checking account acquisition program, and additional ATM
processing charges related to the installation of a new ATM machine and products and supplies resulting from the increase in customer volume.
Professional and other services decreased 11% due to a reduction in legal fees relating to a foreclosed property in 2003 not recurring in 2004,
and a reduction in mortgage consulting fees as in-house personnel were used to perform work that was originally contracted. These reductions
were offset by an increase in consulting fees associated with the checking account acquisition program and expenses associated with a
leadership training program. Corresponding grant income recorded in other income offset the leadership training program expenses. The 10%
decrease in other operating expenses during 2004 resulted primarily from a $164,000 expense relating to personnel realignment in 2003.
INCOME TAX EXPENSE
In 2005, the Company reported an income tax benefit of $51,000 compared to income tax expense of $502,000 in 2004. The income tax benefit
in 2005 resulted from the reduction in pretax income while income earned on tax-exempt investment securities and bank-owned life insurance
increased. The effective tax rate decreased to (12)% in 2005 compared to 26% in 2004. The decrease in the effective tax rate resulted primarily
from an increase in tax-exempt interest income in proportion to total taxable income. The Company has reduced its tax
Page 23
rate from the statutory rate primarily through the ownership of tax-exempt investment securities, bank owned life insurance and other tax
saving strategies. Enactment of proposed state tax legislation regarding Real Estate Investment Trusts would increase the state tax rate for the
Company.
Income tax expense decreased $99,000 to $502,000 for the year ended December 31, 2004 as compared to $601,000 in the prior year. The
decrease in income tax expense reflected lower pre-tax income during the year. The Company's effective tax rate remained at 26% in 2004 and
27% in 2003.
CHANGES IN FINANCIAL CONDITION
INVESTMENT SECURITIES
The investment portfolio represents 29% of the Company's earning assets and is designed to generate a favorable rate of return consistent with
safety of principal while assisting the Company in meeting the liquidity needs of the loan and deposit operations and managing the Company's
interest rate risk strategies. All of the Company's investments are classified as available for sale. The Company invests in investment securities
consisting primarily of mortgage-backed securities, securities issued by United States Government agencies and sponsored enterprises, state
and municipal obligations, mutual funds, equity securities, investment grade corporate debt instruments, and common stock issued by the
Federal Home Loan Bank of New York (FHLBNY). By investing in these types of assets, the Company reduces the credit risk of its asset base,
but must accept lower yields than would typically be available on commercial real estate loans and multi-family real estate loans.
Investment securities decreased $793,000, to $76.0 million at December 31, 2005 from $76.8 million at December 31, 2004. The decrease in
investment securities was primarily attributable to the sale of lower yielding investment securities in the fourth quarter of 2005. This decrease
was offset by acquisitions of investment securities to collateralize municipal deposits. In comparison, investment securities increased $17.2
million, or 29%, from 2003 to 2004. The increase in investment securities was primarily attributable to the acquisition of investment securities
to collateralize municipal deposit accounts.
The following table sets forth the carrying value of the Company's investment portfolio at the dates indicated.
AT DECEMBER 31,
---------------------------
(In thousands) 2005 2004 2003
--------------------------------------------------------------------------------------------
INVESTMENT SECURITIES:
US Treasury and agencies $ 20,713 $21,609 $ 6,354
State and political subdivisions 11,177 8,881 7,359
Corporate 5,936 5,919 6,421
Mortgage-backed 31,565 32,213 29,734
Equity securities and FHLB stock 2,626 2,800 2,932
Mutual funds 6,177 5,935 5,712
---------------------------------------------------------------------------------------------
78,194 77,357 58,512
Unrealized (loss) gain on available for sale portfolio (2,150) (520) 1,095
---------------------------------------------------------------------------------------------
Total investments in securities $ 76,044 $76,837 $59,607
=============================================================================================
Page 24
The following table sets forth the scheduled maturities, amortized cost, fair values and average yields for the Company's investment securities
at December 31, 2005. Yield is calculated on the amortized cost to maturity and adjusted to a fully tax-equivalent basis.
ONE YEAR OR LESS ONE TO FIVE YEARS FIVE TO TEN YEARS
----------------------------------------------------------------------------------------------------
ANNUALIZED ANNUALIZED ANNUALIZED
AMORTIZED WEIGHTED AMORTIZED WEIGHTED AMORTIZED WEIGHTED
(Dollars in thousands) COST AVG YIELD COST AVG YIELD COST AVG YIELD
----------------------------------------------------------------------------------------------------
DEBT INVESTMENT SECURITIES:
US Treasury and agencies $ 2,649 1.82% $10,966 3.31% $ 7,098 4.18%
State and political subdivisions 40 3.89% 2,763 3.04% 3,770 3.50%
Corporate 350 6.85% 2,450 4.50% 988 4.93%
----------------------------------------------------------------------------------------------------
Total $ 3,039 2.43% $16,179 3.44% $11,856 4.03%
----------------------------------------------------------------------------------------------------
EQUITY AND MORTGAGE-BACKED SECURITIES:
Mutual funds $ 6,177 1.94% $ - - $ - -
Mortgage-backed - - 3,915 3.87% 8,434 4.00%
Equity securities and FHLB stock 2,627 4.49% - - - -
----------------------------------------------------------------------------------------------------
Total 8,804 2.70% 3,915 3.87% $ 8,434 4.00%
----------------------------------------------------------------------------------------------------
Total investment securities $ 11,843 2.63% $20,094 3.53% $20,290 4.02%
===================================================================================================
MORE THAN TEN YEARS TOTAL INVESTMENT SECURITIES
--------------------------------------------------------------------------------------------
ANNUALIZED ANNUALIZED
AMORTIZED WEIGHTED AMORTIZED FAIR WEIGHTED
(Dollars in thousands) COST AVG YIELD COST VALUE AVG YIELD
--------------------------------------------------------------------------------------------
DEBT INVESTMENT SECURITIES:
US Treasury and agencies $ - - $ 20,713 $19,967 3.42%
State and political subdivisions 4,604 3.97% 11,177 10,980 3.58%
Corporate 2,148 5.31% 5,936 5,854 5.00%
--------------------------------------------------------------------------------------------
Total $ 6,752 4.37% 37,826 $36,801 3.71%
-------------------------------------------------------------------------------------------
EQUITY AND MORTGAGE-BACKED SECURITIES:
Mutual funds - - 6,177 $ 5,895 1.94%
Mortgage-backed 19,216 4.52% 31,565 30,718 4.30%
Equity securities and FHLB stock - - 2,626 2,630 5.08%
--------------------------------------------------------------------------------------------
Total 19,216 4.52% 40,368 39,243 3.99%
--------------------------------------------------------------------------------------------
Total investment securities 25,968 4.49% 78,194 $76,044 3.86%
============================================================================================
Page 25
LOANS RECEIVABLE
Loans receivable represent 71% of the Company's earning assets and account for the greatest portion of total interest income. The Company
emphasizes residential real estate financing and anticipates a continued commitment to financing the purchase or improvement of residential
real estate in its market area. The Company also extends credit to businesses within its marketplace secured by commercial real estate,
equipment, inventories and accounts receivable. It is anticipated that small business lending in the form of mortgages, term loans, leases, and
lines of credit will provide the most opportunity for balance sheet and revenue growth over the near term. Commercial loans comprise 10% of
the total loan portfolio. At December 31, 2005, 89% of the Company's total loan portfolio consisted of loans secured by real estate, of which
17% consisted of commercial real estate loans.
December 31,
-----------------------------------------------------------------------------
(In thousands) 2005 2004 2003 2002 2001
-----------------------------------------------------------------------------
Residential real estate (1) $119,707 $123,898 $128,989 $123,178 $112,110
Commercial real estate 31,845 29,874 31,278 32,657 30,455
Commercial loans 18,334 16,834 15,090 13,196 14,358
Consumer loans 19,682 18,505 16,880 15,068 12,615
-----------------------------------------------------------------------------
$189,568 $189,111 $192,237 $184,099 $169,538
=============================================================================
(1) Includes loans held for sale.
The following table shows the amount of loans outstanding as of December 31, 2005 which, based on remaining scheduled repayments of
principal, are due in the periods indicated. Demand loans having no stated schedule of repayments and no stated maturity, and overdrafts are
reported as one year or less. Adjustable and floating rate loans are included in the period on which interest rates are next scheduled to adjust
rather than the period in which they contractually mature, and fixed rate loans are included in the period in which the final contractual
repayment is due.
Due Under Due 1-5 Due Over
(In thousands) One Year Years Five Years Total
---------------------------------------------------------------------
Real estate:
Commercial real estate $ 8,691 $15,067 $ 8,087 $ 31,845
Construction 40 185 2,382 2,607
Residential real estate $39,319 48,640 29,141 117,100
---------------------------------------------------------------------
$48,050 $63,892 $39,610 $151,552
---------------------------------------------------------------------
Commercial 10,576 7,701 57 18,334
Consumer 10,148 4,900 4,634 19,682
---------------------------------------------------------------------
Total loans $68,774 $76,493 $44,301 $189,568
=====================================================================
Interest rates:
Fixed 18,024 49,993 37,279 105,296
Variable 50,750 26,500 7,022 84,272
---------------------------------------------------------------------
Total Loans $68,774 $76,493 $44,301 $189,568
=====================================================================
Total loans receivable remained relatively consistent when compared to the prior year. The commercial real estate, commercial loan and
consumer loan portfolios increased $2.0 million, $1.5 million and $1.2 million, respectively. The increases in these portfolios were partially
offset by a decrease in the residential real estate loans of $4.2 million. By comparison, loans receivable decreased $3.1 million, or 2%, in 2004
from 2003. The decrease of the loan portfolio from 2003 to 2004 is primarily attributable to the decrease in residential and commercial
mortgages as amortization, prepayments and sales outpaced loan originations of $29.3 million during 2004. Decreases in the mortgage
portfolios when comparing 2004 to 2003, were partially offset by an increase in municipal loans and consumer loans. The growth in the
consumer loan portfolio is primarily home equity loan originations.
Page 26
Residential real estate loans decreased $4.2 million, or 3%, during 2005. The residential real estate portfolio consists of 58% in fixed-rate
mortgages and 42% in adjustable-rate mortgages. The decrease in the residential real estate portfolio is principally due to a net decrease in 15-
year fixed rate mortgages of $5.1 million and a $2.1 million decrease in 30-year fixed rate loans held for sale, partially offset by an increase in
the adjustable rate mortgage portfolio. The increase in the adjustable rate mortgage portfolio primarily resulted from an increase in customer
demand for the Company's hybrid adjustable rate mortgages ("ARM"s). Hybrid ARMs have rates that are fixed for an initial period (principally
3, 5, 7 or 10 years) and then convert to one-year adjustable rate mortgages.
Commercial real estate loans increased $2.0 million, or 7%, from the prior year as new loan products were added to the portfolio. Commercial
real estate loans decreased $1.4 million, or 4%, during 2004.
Commercial loans, including loans to municipalities, increased 9% over the prior year to $18.3 million at December 31, 2005. The increase in
commercial loans resulted primarily from a $1.8 million net increase in small business loans. In comparison, commercial loans, including
municipal loans, increased 12% during 2004 primarily due to the origination of municipal loans.
Consumer loans, which include second mortgage loans, home equity lines of credit, direct installment and revolving credit loans, increased 6%
to $19.7 million at December 31, 2005. The increase resulted from an increase in home equity lines of credit and second mortgage loans. The
Company has promoted its home equity products by offering the customer loans with no closing costs and competitive market rates.
Management feels these loans are an attractive use of funds and will continue to promote home equity products in 2006. During 2004,
consumer loans increased $1.6 million, or 10%, resulting primarily from an increase in home equity products.
NONPERFORMING LOANS AND ASSETS
The following table represents information concerning the aggregate amount of nonperforming assets:
DECEMBER 31,
----------------------------------------------------------------------------------------------
(Dollars in thousands) 2005 2004 2003 2002 2001
----------------------------------------------------------------------------------------------
Nonaccrual loans:
Commercial real estate and commercial $ 757 $ 776 $1,677 $ 603 $ 488
Consumer 89 122 172 166 56
Real estate - construction - - 270 - -
Mortgage 834 953 873 942 1,576
----------------------------------------------------------------------------------------------
Total nonaccrual loans $1,680 $1,851 $2,992 $1,711 $2,120
Loans past due 90 days or more and still accruing - - - - -
----------------------------------------------------------------------------------------------
Total non-performing loans $1,680 $1,851 $2,992 $1,711 $2,120
Foreclosed real estate 743 798 202 1,396 632
----------------------------------------------------------------------------------------------
Total non-performing assets $2,423 $2,649 $3,194 $3,107 $2,752
----------------------------------------------------------------------------------------------
Non-performing loans to total loans 0.89% 0.98% 1.59% 0.95% 1.30%
Non-performing assets to total assets 0.82% 0.88% 1.15% 1.11% 1.13%
----------------------------------------------------------------------------------------------
Interest income received on nonaccrual loans - - - - -
----------------------------------------------------------------------------------------------
Interest income that would have been recorded
under the original terms of the loans $ 34 $ 64 $ 75 $ 141 $ 118
----------------------------------------------------------------------------------------------
Page 27
The asset quality of the Company's loan portfolio has improved during 2005. Residential and consumer delinquencies continue to decline by
14% during 2005 and 18% during 2004, resulting from the institution of a more stringent collection policy. Total nonperforming assets
(nonperforming loans and foreclosed real estate) at December 31, 2005 were 0.81% of total assets as compared to 0.88% of total assets at
December 31, 2004. Total nonperforming loans (past due 90 days or more) decreased $196,000, or 11%, during 2005 and decreased 38%
during 2004. Total delinquent loans (those 30 days or more delinquent) as a percentage of total loans were 2.03% at December 31, 2005
compared to 1.93% at December 31, 2004. Approximately 43% of the Company's nonperforming loans at December 31, 2005 are secured by
residential real estate with loss potential expected to be manageable within the allocated reserves.
The Company generally places a loan on nonaccrual status and ceases accruing interest when loan payment performance is deemed
unsatisfactory and the loan is past due 90 days or more. The Company considers a loan impaired when, based on current information and
events, it is probable that the Company will be unable to collect the scheduled payments of principal and interest when due according to the
contractual terms of the loan.
The measurement of impaired loans is generally based upon the present value of future cash flows discounted at the historical effective interest
rate, except that all collateral-dependent loans are measured for impairment based on fair value of the collateral. The Company used the fair
value of collateral to measure impairment on commercial and commercial real estate loans in 2005. At December 31, 2005, the Company had
$2.5 million in loans which were deemed to be impaired having a valuation allowance of $90,000. Of the impaired loan balance, $2.3 million
represents one commercial credit relationship that was restructured during 2004. A $63,000 impairment reserve is recorded on this relationship.
The customer has been making payments according to the restructured terms and its financial position has improved significantly.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is a reserve established through charges to expense in the form of a provision for loan losses and reduced by loan
charge-offs net of recoveries. Allowance for loan losses represents the amount available for probable credit losses in the Company's loan
portfolio as estimated by management. The Company maintains an allowance for loan losses based upon a monthly evaluation of known and
inherent risks in the loan portfolio, which includes a review of the balances and composition of the loan portfolio as well as analyzing the level
of delinquencies in each segment of the loan portfolio. The Company uses a general allocation method for the residential real estate and the
consumer loan pools based upon a methodology that uses loss factors applied to loan balances and reflects actual loss experience, delinquency
trends and current economic conditions. The Company reviews individually, commercial real estate and commercial loans greater than
$150,000, that are not accruing interest and risk rated under the Company's risk rating system, as special mention, substandard, doubtful or loss
to determine if the loans are impaired. If loans are determined to be impaired, the Company establishes a specific reserve allocation. The
specific allocation is determined based on the most recent valuation of the loan's collateral and the customer's ability to pay. For all other
commercial real estate and commercial loans, the Company uses the general allocation method that establishes a reserve for each risk rating
category. The general allocation method for commercial real estate and commercial loans considers the same factors that are considered when
evaluating residential real estate and consumer loan pools. The allowance for loan losses reflects management's best estimate of probable loan
losses at December 31, 2005.
The allowance for loans losses was $1.7 million at December 31, 2005, an 8% decrease from December 31, 2004. The allowance for loans
losses as a percentage of total loans decreased to 0.89% at December 31, 2005 from 0.98% in the prior year. Net loan charge-offs were
$459,000 during 2005 compared to $626,000 in 2004. The Company experienced a higher level of charge-offs during 2004 resulting from the
charge-off of portions of three commercial lending relationships.
Page 28
The following table sets forth the analysis of the allowance for loan losses at or for the periods indicated.
2005 2004 2003 2002 2001
----------------------------------------------------------------------------------------------------------------
% GROSS % GROSS % GROSS % GROSS % GROSS
Dollars in thousands) AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS
----------------------------------------------------------------------------------------------------------------
Commercial real estate and loans $1,282 26.5% $1,483 24.7% $1,218 24.1% $1,042 24.9% $1,083 26.5%
Consumer loans 289 10.4% 270 9.8% 120 8.8% 136 8.2% 100 7.4%
Residential real estate 108 63.1% 74 65.5% 377 67.1% 303 66.9% 496 66.1%
----------------------------------------------------------------------------------------------------------------
Total $1,679 100.0% $1,827 100.0% $1,715 100.0% $1,481 100.0% $1,679 100.0%
================================================================================================================
The following table sets forth the allocation of allowance for loan losses by loan category for the periods indicated. The allocation of the
allowance by category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses in any
category.
(Dollars in thousands) 2005 2004 2003 2002 2001
-------------------------------------------------------------------------------------------
BALANCE AT BEGINNING OF YEAR $1,827 $1,715 $1,481 $ 1,679 $1,274
Allowance acquired in branch purchase - - - 57 -
Provisions charged to operating expenses 311 738 598 1,375 708
-------------------------------------------------------------------------------------------
RECOVERIES OF LOANS PREVIOUSLY CHARGED-OFF:
Commercial real estate and loans 25 41 3 26 53
Consumer 14 20 17 6 9
Residential real estate 10 - 17 - -
-------------------------------------------------------------------------------------------
Total recoveries 49 61 37 32 62
-------------------------------------------------------------------------------------------
LOANS CHARGED OFF:
Commercial real estate and loans (284) (439) (128) (1,285) (72)
Consumer (137) (126) (189) (291) (184)
Residential real estate (87) (122) (84) (86) (109)
-------------------------------------------------------------------------------------------
Total charged-off (508) (687) (401) (1,662) (365)
-------------------------------------------------------------------------------------------
Net charge-offs (459) (626) (364) (1,630) (303)
-------------------------------------------------------------------------------------------
Balance at end of year $1,679 $1,827 $1,715 $ 1,481 $1,679
===========================================================================================
Net charge-offs to average loans outstanding 0.24% 0.33% 0.19% 0.92% 0.19%
Allowance for loan losses to year-end loans 0.89% 0.98% 0.91% 0.82% 1.03%
===========================================================================================
DEPOSITS
The Company's deposit base is drawn from seven full-service offices in its market area. The deposit base consists of demand deposits, money
management accounts, savings and time deposits. During 2005, 61% of the Company's average deposit base of $239.9 million consisted of core
deposits. Core deposits are considered to be more stable and provide the Company with a lower cost source of funds. The Company will
continue to emphasize retail deposits by maintaining its network of full service offices and providing depositors with a full range of deposit
product offerings. Pathfinder Commercial Bank will seek business growth by focusing on its local identification and service excellence. The
Commercial Bank had an average balance of $31.0 million in municipal deposits in 2005, primarily concentrated in money market demand
accounts.
Average deposits increased $9.5 million, or 4%, when compared to 2004. The increase in average deposits primarily related to a $2.9 million
increase in the average balance of municipal deposits combined with an increase in retail deposits. The new branch in Central Square added
$3.1 million to the average balance of retail deposits since its opening June of 2005. In comparison, average deposits from 2003 to 2004
increased $22.3 million, or 11%. Deposit growth in 2004 resulted from the growth both in retail and in municipal deposits. The Commercial
Bank increased the number of municipal customers to 20
Page 29
in 2004 from 11 in 2003. The new municipal customers account balances represented $20.2 million of the $30.0 million in municipal deposits
outstanding at December 31, 2004.
The Company's average deposit mix in 2005, as compared to 2004, reflected a slight shift from savings and club deposits to time deposits. The
Company's average demand deposits, interest and noninterest bearing, represented 16% of total average deposits, which was comparable with
2004. The Company's money management accounts represented 17% of total deposits, down 1 percentage point for the same period in 2004.
The Company promotes its money management account by offering competitive rates to retain existing and attract new customers.
The average amount of deposits, average rate paid and percentage of deposits are summarized below for the years indicated.
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------------------------------------------
2005 2004 2003
-------------------------------------------------------------------------------------------------------
AVG PERCENT AVG PERCENT AVG PERCENT
AVG RATE OF AVG RATE OF AVG RATE OF
(Dollars in thousands) BALANCE PAID DEPOSITS BALANCE PAID DEPOSITS BALANCE PAID DEPOSITS
-------------------------------------------------------------------------------------------------------
Noninterest bearing
demand accounts $ 19,324 - 8.06% $ 17,974 - 7.80% $ 16,345 - 7.86%
NOW accounts 19,877 0.54% 8.29% 20,808 0.65% 9.03% 17,663 0.79% 8.49%
Money management accounts 41,380 2.02% 17.25% 40,775 1.39% 17.70% 21,788 1.14% 10.47%
Savings and club accounts 65,558 0.44% 27.33% 68,046 0.67% 29.54% 66,481 0.77% 31.96%
Time deposits 93,732 3.29% 39.07% 82,769 3.00% 35.93% 85,751 3.33% 41.22%
-------------------------------------------------------------------------------------------------------
Total average deposits $239,871 1.96% 100.00% $230,372 1.71% 100.00% $208,028 1.96% 100.00%
=======================================================================================================
At December 31, 2005, time deposits in excess of $100,000 totaled $24.0 million, or 26%, of time deposits and 10% of total deposits. At
December 31, 2004, these deposits totaled $18.3 million, or 22% of time deposits and 8% of total deposits.
The following table indicates the amount of the Bank's certificates of deposit of $100,000 or more time remaining until maturity as of
December 31, 2005:
CERTIFICATES OF
DEPOSIT OF
In thousands) $100,000 OR MORE
---------------------------------------
REMAINING MATURITY:
Three Months or less $ 6,868
Three through Six months 2,765
Six through twelve months 3,886
Over twelve months 10,515
--------------------------------------
Total $24,034
======================================
Page 30
BORROWINGS
Short-term borrowings are comprised primarily of advances and overnight borrowing at the FHLBNY. There were $2.0 million in short-term
borrowings outstanding at December 31, 2005 as compared to $1.0 million in 2004.
Information regarding short-term borrowings during 2005, 2004 and 2003 is as follows:
(Dollars in thousands) 2005 2004 2003
------------------------------------------------------------------------
Maximum outstanding at any month end $15,000 $3,100 $12,000
Average amount outstanding during the year 5,692 1,400 2,660
Average interest rate during the year 3.57% 1.31% 1.17%
------------------------------------------------------------------------
Long-term borrowed funds consist of advances and repurchase agreements from the FHLBNY and junior subordinated debentures. Long-term
borrowed funds totaled $34.5 million at December 31, 2005 as compared to $39.5 million at December 31, 2004.
CAPITAL
Shareholders' equity decreased $898,000 to $20.9 million at December 31, 2005. The Company added $462,000 to retained earnings through
net income, which was more than offset by cash dividends returned to its shareholders of $686,000. Other comprehensive loss increased
$978,000 to $1.3 million at December 31, 2005. Additional paid in capital increased $268,000 due to the exercise of stock options and the
allocation of employee stock ownership plan shares.
The Company's mutual holding company parent, Pathfinder Bancorp, M.H.C., waived its right to receive the dividend for the quarters ended
June 30, 2005 and December 31, 2005.
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 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 December 31, 2005, 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%. See Note 17 in the accompanying financial
statements for the Company's and the Bank's ratios.
LIQUIDITY
Liquidity management involves the Company's ability to generate cash or otherwise obtain funds at reasonable rates to support asset growth,
meet deposit withdrawals, maintain reserve requirements, and 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 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.
The Company's liquidity has been enhanced by its membership in the FHLBNY, whose competitive advance programs and lines of credit
provide the Company with a
Page 31
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 Committee (ALCO) of the Company is responsible for implementing the policies and guidelines for the
maintenance of prudent levels of liquidity. As of December 31, 2005, the Company is in compliance with its policy guidelines with regard to
liquidity.
AGGREGATE CONTRACTUAL OBLIGATIONS
The following table represents the Company's on and off-balance sheet aggregate contractual obligations to make future payments as of
December 31, 2005:
OVER 1 OVER 3
1 YEAR TO TO OVER 5
(In thousands) OR LESS 3 YEARS 5 YEARS YEARS TOTAL
--------------------------------------------------------------------------------
Time deposits $ 51,724 $ 30,173 $ 7,690 $ 6,568 $ 96,155
Junior subordinated debentures - - - 5,155 5,155
Borrowings 5,000 17,960 8,400 - 31,360
Operating leases 47 98 102 115 362
Payments under benefit plans 305 697 752 9,181 10,935
--------------------------------------------------------------------------------
Total $ 57,075 $ 48,928 $ 16,944 $21,020 $143,967
================================================================================
In addition, the Company, in the conduct of ordinary business operations, routinely enters into contracts for services. These contracts may
require payment for services to be provided in the future and may also contain penalty clauses for the early termination of the contract.
Management is not aware of any additional commitments or contingent liabilities, which may have a material adverse impact on the liquidity or
capital resources of the Company.
OFF-BALANCE SHEET ARRANGEMENTS
The Company is also party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of
its customers. These financial instruments include commitments to extend credit and standby letters of credit. At December 31, 2005, the
Company had $19.5 million in outstanding commitments to extend credit and standby letters of credit. See Note 15 in the accompanying
financial statements.
Page 32
ITEM 7A: 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 Company has an Asset-Liability Management Committee (ALCO) which is
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 asset 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 the ALCO.
Since December of 2004, the Federal Reserve has increased short-term target rates 8 times, 25 basis points each time to 4.50% from 2.50%.
During this time frame longer-term interest rates have remained relatively unchanged resulting in a flattening and inversion of the yield curve.
The short-term interest rate increases have caused continued net interest margin compression as short-term deposits and borrowings on the
Company's liability sensitive balance sheet reprice into the current rate environment while security purchases and loan originations and
refinances were being done at the stable longer-term rates. During the past 24-month period of rising short-term interest rates, the Company has
continued to practice conservative balance sheet management strategies by attempting to extend the maturities of its rate sensitive liabilities and
shorten the maturity or repricing term of its rate sensitive assets. This conservative balance sheet management strategy has resulted in
additional margin pressure and reduction in net interest income during the prior two years. Management believes this balance sheet strategy
best positions the Company and lessens its risk against future interest rate fluctuations.
The primary objective of the Company's asset/liability management process is to maximize earnings and return on capital within acceptable
levels of risk. The Company does not believe it is possible to reliably predict future interest rate movements, and it seeks to maintain an
appropriate process and set of measurement tools that enable it to identify and quantify sources of interest rate risk ("IRR") in varying rate
environments. The primary tools used by the Company in managing rate risk are income simulation and net portfolio value modeling
techniques.
Interest rate risk can result from timing differences in the maturity/repricing of an institution's assets, liabilities and off balance sheet contracts;
the effect of embedded options, such as loan prepayments, interest rate caps/floors, and deposit withdrawals; and the difference in the behavior
of the various lending and funding rates, sometimes referred to as basis risk.
Given the potential types and differing related characteristics of IRR, it is important that the company maintain an appropriate process and set
of measurement tools that enable it to identify and quantify its primary sources of IRR. The Company also recognizes that effective
management of IRR includes an understanding of when potential adverse changes in interest rates will flow through its income statements.
Accordingly, the Company not only looks at a 12 month horizon when managing its exposure to IRR, it also considers a longer-term strategic
horizon.
It is the Company's objective to manage its exposure to interest rate risk, understanding that it is in the business of taking on rate risk and the
elimination of such risk is not possible. It is also understood that as exposure to interest rate risk is reduced, it may also result in net interest
margin being reduced.
Management believes the modeling and analysis of net interest income (Earnings at Risk) and net portfolio value (Value at Risk) in different
interest rate environments provides the most meaningful measure of interest rate risk. Net interest income simulation analysis captures both the
potential of all assets and liabilities to mature or reprice and the probability that they will do so. Net interest income simulation also attends to
the relative interest rate sensitivities of these items, and projects their behavior over an extended period of time. Finally, net interest 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
Page 33
assets minus the market value of liabilities using a discounted cash flow technique).
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. The Company's current
interest rate risk exposure is within those guidelines set forth.
PERCENTAGE PERCENTAGE
CHANGE IN NPV CHANGE IN CHANGE IN
INTEREST CAPITAL NET INTEREST NET PORTFOLIO
RATES RATIO INCOME VALUE
--------------------------------------------------
300 8.77% -12.75% -27.56%
200 9.63% -8.36% -18.54%
100 10.48% -4.10% -9.21%
0 11.26% --- ----
-100 11.55% 1.18% 4.91%
-200 11.20% -3.26% 3.60%
-300 10.60% -8.72% -0.30%
Page 34
An interest rate sensitive asset or liability is one that, within a defined time period, either matures or experiences an interest rate change in line
with general market interest rates. Historically, the most common method of estimating interest rate risk was to measure the maturity and
repricing relationships between interest-earning assets and interest-bearing liabilities at a specific point in time ("GAP"), typically one year.
Under this method, a company is considered liability sensitive when the amount of its interest-bearing liabilities exceeds the amount of its
interest-earning assets within the one-year horizon. However, assets and liabilities with similar repricing characteristics may not reprice at the
same time or to the same degree. As a result, the Company's GAP does not necessarily predict the impact of changes in general levels of
interest rates on net interest income.
The following table shows the GAP position for the Company as of December 31, 2005.
MORE
WITHIN 3 TO 12 1 TO 3 3 TO 5 5 TO 10 THAN
(Dollars in thousands) 3 MONTHS MONTHS YEARS YEARS YEARS 10 YEARS
------------------------------------------------------------------------------------------------------------------------
INTEREST-EARNING ASSETS:
Interest earning deposits $ 586 $ - $ - $ - $ - $ -
Investment securities and FHLB stock 12,744 6,675 18,017 15,071 17,732 5,805
Loans receivable 33,355 35,348 46,886 29,098 34,821 10,060
------------------------------------------------------------------------------------------------------------------------
Total interest-earning assets $ 46,685 $ 42,023 $ 64,903 $ 44,169 $ 52,553 $ 15,865
------------------------------------------------------------------------------------------------------------------------
INTEREST-BEARING LIABILITIES:
Transaction deposit accounts (1) $ 9,450 $ 28,347 $ 19,471 $ - $ - $ -
Savings deposits (1) 274 6,075 13,513 10,097 14,926 15,284
Certificates of deposit 19,333 32,130 30,265 7,858 6,550 19
Borrowings 2,000 3,000 17,960 8,400 - -
Junior subordinated debentures 5,155 - - - - -
------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities $ 36,212 $ 69,552 $ 81,209 $ 26,355 $ 21,476 $ 15,303
------------------------------------------------------------------------------------------------------------------------
Interest-earning assets less interest-
bearing liabilities ("interest rate sensitivity gap") $ 10,473 $(27,529) $(16,306) $ 17,814 $ 31,077 $ 562
------------------------------------------------------------------------------------------------------------------------
Cumulative excess (deficiency) of interest-
sensitive assets over interest-sensitive liabilities $ 10,473 $(17,056) $(33,362) $(15,548) $ 15,529 $ 16,091
------------------------------------------------------------------------------------------------------------------------
Interest sensitivity gap to total assets 3.53% -9.27% -5.49% 6.00% 10.47% 0.19%
------------------------------------------------------------------------------------------------------------------------
Cumulative interest sensitivity gap to total assets 3.53% -5.74% -11.23% -5.24% 5.23% 5.42%
------------------------------------------------------------------------------------------------------------------------
Ratio of interest-earning assets to interest-
bearing liabilities 128.92% 60.42% 79.92% 167.59% 244.71% 103.67%
------------------------------------------------------------------------------------------------------------------------
Cumulative ratio of interest-earning assets to
interest-bearing liabilities 128.92% 83.87% 82.16% 92.71% 106.61% 106.43%
------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands) TOTAL
--------------------------------------------------------------
INTEREST-EARNING ASSETS:
Interest earning deposits $ 586
Investment securities and FHLB stock 76,044
Loans receivable 189,568
---------------------------------------------------------------
Total interest-earning assets $266,198
---------------------------------------------------------------
INTEREST-BEARING LIABILITIES:
Transaction deposit accounts (1) $ 57,268
Savings deposits (1) 60,169
Certificates of deposit 96,155
Borrowings 31,360
Junior subordinated debentures 5,155
---------------------------------------------------------------
Total interest-bearing liabilities $250,107
---------------------------------------------------------------
Interest-earning assets less interest-
bearing liabilities ("interest rate sensitivity gap")
---------------------------------------------------------------
Cumulative excess (deficiency) of interest-
sensitive assets over interest-sensitive liabilities
---------------------------------------------------------------
Interest sensitivity gap to total assets
---------------------------------------------------------------
Cumulative interest sensitivity gap to total assets
---------------------------------------------------------------
Ratio of interest-earning assets to interest-
bearing liabilities
---------------------------------------------------------------
Cumulative ratio of interest-earning assets to
interest-bearing liabilities
(1) The following assumptions have been used when analyzing non-maturity deposits for GAP Table purposes: 14% of savings deposits are
assumed to reprice or mature within one year, 22% within 1 to 3 years, 16% within 3 to 5 years, and 24% within each of the remaining time
periods. Transaction deposits - 66% of the NOW account balances are assumed to reprice or mature within one year, and the remaining 34% is
assumed to reprice or mature within the 1 to 3 year time frame. 100% of the money management accounts are assumed to reprice within the
first three months
Page 35
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PATHFINDER BANCORP, INC Page
Report of Independent Registered Public Accounting Firm..............37
Consolidated Statements of Condition.................................38
Consolidated Statements of Income....................................39
Consolidated Statements of Changes in Shareholders' Equity...........40
Consolidated Statements of Cash Flows................................41
Notes to Consolidated Financial Statements...........................42
Page 36
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
[GRAPHIC OMITED]
To the Board of Directors and Shareholders Pathfinder Bancorp, Inc.
Oswego, New York
We have audited the accompanying consolidated statements of condition of Pathfinder Bancorp, Inc. and subsidiaries as of December 31, 2005
and 2004, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the three years in the
period ended December 31, 2005. These consolidated financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free
of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial
reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over
financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the
amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Pathfinder
Bancorp, Inc. and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America.
/s/ BEARD MILLER COMPANY LLP
Beard Miller Company LLP
Harrisburg, Pennsylvania
February 3, 2006
Page 37
CONSOLIDATED STATEMENTS OF CONDITION
DECEMBER 31,
------------------------
(In thousands, except share data) 2005 2004
--------------------------------------------------------------------------------------------------------
ASSETS:
Cash and due from banks $ 7,309 $ 6,741
Interest earning deposits 586 7,584
--------------------------------------------------------------------------------------------------------
Total cash and cash equivalents 7,895 14,325
--------------------------------------------------------------------------------------------------------
Investment securities, at fair value 74,239 75,069
Federal Home Loan Bank stock, at cost 1,805 1,768
Mortgage loans held-for-sale 0 2,159
Loans 189,568 186,952
Less: Allowance for loan losses 1,679 1,827
--------------------------------------------------------------------------------------------------------
Loans receivable, net 187,889 185,125
Premises and equipment, net 8,020 7,580
Accrued interest receivable 1,678 1,505
Foreclosed real estate 743 798
Goodwill 3,840 3,840
Intangible asset, net 404 627
Bank owned life insurance 5,987 5,768
Other assets 4,448 3,473
--------------------------------------------------------------------------------------------------------
Total assets $ 296,948 $302,037
========================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY:
Deposits:
Interest-bearing $ 216,136 $217,513
Noninterest-bearing 20,241 19,159
--------------------------------------------------------------------------------------------------------
Total deposits 236,377 236,672
--------------------------------------------------------------------------------------------------------
Short-term borrowings 2,000 1,000
Long-term borrowings 29,360 34,360
Junior subordinated debentures 5,155 5,155
Other liabilities 3,128 3,024
--------------------------------------------------------------------------------------------------------
Total liabilities 276,020 280,211
Shareholders' equity:
Preferred stock, authorized shares 1,000,000; no shares issued or outstanding
Common stock, par value $.01; authorized 10,000,000 shares;
2,950,419 and 2,937,419 shares issued; and 2,463,132 and
2,450,132 shares outstanding, respectively. 29 29
Additional paid-in-capital 7,721 7,453
Retained earnings 20,965 21,186
Accumulated other comprehensive loss (1,285) (307)
Unearned ESOP shares - (33)
Treasury Stock, at cost; 487,287 shares (6,502) (6,502)
--------------------------------------------------------------------------------------------------------
Total shareholders' equity 20,928 21,826
--------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 296,948 $302,037
=======================================================================================================
The accompanying notes are an integral part of the consolidated financial statements.
Page 38
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
--------------------------
(In thousands, except per share data) 2005 2004 2003
-------------------------------------------------------------------------------------------------
INTEREST AND DIVIDEND INCOME:
Loans, including fees $ 11,794 $11,815 $12,833
Debt securities:
Taxable 2,481 2,075 2,034
Tax-exempt 505 362 226
Dividends 247 145 159
Other 71 81 33
--------------------------------------------------------------------------------------------------
Total interest income 15,098 14,478 15,285
--------------------------------------------------------------------------------------------------
INTEREST EXPENSE:
Interest on deposits 4,319 3,639 3,751
Interest on short-term borrowings 204 17 31
Interest on long-term borrowings 1,833 1,917 2,166
--------------------------------------------------------------------------------------------------
Total interest expense 6,356 5,573 5,948
--------------------------------------------------------------------------------------------------
Net interest income 8,742 8,905 9,337
PROVISION FOR LOAN LOSSES 311 738 598
--------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 8,431 8,167 8,739
--------------------------------------------------------------------------------------------------
NONINTEREST INCOME:
Service charges on deposit accounts 1,318 967 818
Increase in value of bank owned life insurance 218 175 171
Loan servicing fees 215 256 282
Net (losses) gains on sales and impairment of investment securities (205) 772 542
Net (losses) gains on sales of loans and foreclosed real estate (88) 279 326
Other charges, commissions & fees 582 598 469
--------------------------------------------------------------------------------------------------
Total other income 2,040 3,047 2,608
--------------------------------------------------------------------------------------------------
NONINTEREST EXPENSE:
Salaries and employee benefits 5,123 4,798 4,455
Building occupancy 1,178 1,169 1,159
Data processing expenses 1,226 981 868
Professional and other services 818 682 770
Amortization of intangible asset 223 223 223
Other expenses 2,492 1,454 1,619
--------------------------------------------------------------------------------------------------
Total other expenses 10,060 9,307 9,094
--------------------------------------------------------------------------------------------------
Income before income taxes 411 1,907 2,253
(Benefit)/Provision for income taxes (51) 502 601
--------------------------------------------------------------------------------------------------
Net income 462 $ 1,405 $ 1,652
==================================================================================================
Net income per share - basic $ 0.19 $ 0.58 $ 0.68
==================================================================================================
Net income per share - diluted $ 0.19 $ 0.57 $ 0.67
==================================================================================================
Dividends per share $ 0.41 $ 0.405 $ 0.40
==================================================================================================
The accompanying notes are an integral part of the consolidated financial statements.
Page 39
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
ACCUMULATED
ADDITIONAL OTHER UNEARNED
COMMON STOCK ISSUED PAID-IN RETAINED COMPREHENSIVE ESOP
(In thousands, except per share data) SHARES AMOUNT CAPITAL EARNINGS INCOME (LOSS) SHARES
BALANCE, DECEMBER 31, 2002 2,914,669 $ 29 $ 7,114 $ 19,448 $ 579 $ (124)
--------------------------------------- ------------------- -------- ----------- --------------- -------------- ----------
Comprehensive income:
Net income 1,652
Other comprehensive income, net of tax
Unrealized net gains on securities 83
TOTAL COMPREHENSIVE INCOME:
ESOP shares earned 76 46
Stock option exercised 4,717 - 35
Treasury stock purchased
Dividends declared ($.40 per share) (651)
--------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2003 2,919,386 $ 29 $ 7,225 $ 20,449 $ 662 $ (78)
--------------------------------------- ------------------- -------- ----------- --------------- -------------- ----------
Comprehensive income:
---------------------------------------
Net income 1,405
Other comprehensive loss, net of tax
Unrealized net losses on securities (969)
TOTAL COMPREHENSIVE INCOME:
ESOP shares earned 88 45
Stock option exercised 18,033 - 140
Dividends declared ($.405 per share) (668)
BALANCE, DECEMBER 31, 2004 2,937,419 $ 29 $ 7,453 $ 21,186 $ (307) $ (33)
--------------------------------------- ------------------- -------- ----------- --------------- -------------- ----------
Comprehensive loss:
---------------------------------------
Net income 462
Other comprehensive income, net of tax
Unrealized net gains on securities (978)
TOTAL COMPREHENSIVE LOSS:
ESOP shares earned 55 33
Stock option exercised 13,000 - 213
Dividends declared ($.41 per share) (683)
BALANCE, DECEMBER 31, 2005 2,950,419 $ 29 $ 7,721 $ 20,965 $ (1,285) $ -
--------------------------------------- ------------------- -------- ----------- --------------- -------------- ----------
TREASURY
(In thousands, except per share data) STOCK TOTAL
--------
BALANCE, DECEMBER 31, 2002 $(3,815) $23,231
--------------------------------------- -------- --------
Comprehensive income:
Net income 1,652
Other comprehensive income, net of tax
Unrealized net gains on securities 83
TOTAL COMPREHENSIVE INCOME: 1,735
--------
ESOP shares earned 122
Stock option exercised 35
Treasury stock purchased (2,687) (2,687)
Dividends declared ($.40 per share) (651)
BALANCE, DECEMBER 31, 2003 $(6,502) $21,785
--------------------------------------- -------- --------
Comprehensive income:
---------------------------------------
Net income 1,405
Other comprehensive loss, net of tax
Unrealized net losses on securities (969)
TOTAL COMPREHENSIVE INCOME: 436
--------
ESOP shares earned 133
Stock option exercised 140
Dividends declared ($.405 per share) (668)
BALANCE, DECEMBER 31, 2004 $(6,502) $21,826
--------------------------------------- -------- --------
Comprehensive loss:
---------------------------------------
Net income 462
Other comprehensive income, net of tax
Unrealized net gains on securities (978)
TOTAL COMPREHENSIVE LOSS: (516)
--------
ESOP shares earned 88
Stock option exercised 213
Dividends declared ($.41 per share) (683)
BALANCE, DECEMBER 31, 2005 $(6,502) $20,928
--------------------------------------- -------- --------
The accompanying notes are an integral part of the consolidated financial statements.
Page 40
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
-----------------------------
(In thousands) 2005 2004 2003
----------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES:
Net Income $ 462 $ 1,405 $ 1,652
Adjustments to reconcile net income to net cash provided by (used in) operating
activities:
Provision for loan losses 311 738 598
ESOP shares earned 88 133 122
Deferred income tax expense 107 502 307
Proceeds from sale of loans 8,795 12,440 23,380
Originations of loans held-for-sale - (10,884) (23,049)
Realized losses (gains) on sales of:
Foreclosed real estate 23 (84) (91)
Loans 65 (195) (235)
Available-for-sale investment securities 205 (772) (542)
Depreciation 697 590 542
Amortization of intangible asset 223 223 223
Amortization of deferred financing costs 30 30 30
Amortization of mortgage servicing rights 123 158 122
Increase in value of bank owned life insurance (218) (175) (171)
Net amortization of premiums and discounts on investment securities 364 358 288
(Increase) decrease in interest receivable (173) (231) 61
Net change in other assets and liabilities (480) (1,855) 159
-----------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 10,622 2,381 3,396
-----------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Purchase of investment securities available-for-sale and
Federal Home Loan Bank Stock (23,361) (35,610) (25,780)
Proceeds from maturities and principal reductions of
investment securities available-for-sale 15,361 9,897 19,898
Proceeds from sale:
Available-for-sale investment securities 6,593 7,282 9,175
Real estate acquired through foreclosure 770 382 1,890
Purchase of bank owned life insurance - (1,100) -
Net (increase) decrease in loans (10,514) 245 (9,203)
Purchase of premises and equipment (1,137) (1,520) (1,571)
-----------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (12,288) (20,424) (5,591)
-----------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Net (decrease) increase in demand deposits, NOW accounts, savings accounts,
money management deposit accounts and escrow deposits (12,067) 28,441 5,429
Net increase (decrease) in time deposits 11,772 1,337 (3,057)
Net proceeds from (repayments on) short-term borrowings 1,000 (1,100) 1,400
Payments on long-term borrowings (10,000) (4,500) (9,000)
Proceeds from long-term borrowings 5,000 - 5,700
Proceeds from exercise of stock options 213 140 35
Cash dividends (682) (664) (651)
Treasury stock purchased - - (2,687)
-----------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by financing activities (4,764) 23,654 (2,831)
-----------------------------------------------------------------------------------------------------------------
(Decrease) increase in cash and cash equivalents (6,430) 5,611 (5,026)
Cash and cash equivalents at beginning of period 14,325 8,714 13,740
-----------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 7,895 $ 14,325 $ 8,714
=================================================================================================================
CASH PAID DURING THE PERIOD FOR:
Interest $ 6,338 $ 5,639 $ 5,991
Income taxes paid 95 312 250
NON-CASH INVESTING ACTIVITY:
Transfer of loans to foreclosed real estate 738 894 605
Transfer of loans to loans held-for-sale 6,701 - -
The accompanying notes are an integral part of the consolidated financial statements
Page 41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
The accompanying 2005 and 2004 consolidated financial statements include the accounts of Pathfinder Bancorp, Inc. (the "Company") and its
wholly owned subsidiary, Pathfinder Bank (the "Bank"). The 2003 consolidated financial statements also include the Company's other
subsidiary, Pathfinder Statutory Trust I (the "Trust"). The Trust was formed in 2002 for the purpose of issuing mandatorily redeemable
convertible securities, which are considered Tier I capital under regulatory capital adequacy requirements. The Trust was deconsolidated upon
adoption of Financial Accounting Standards Board Interpretation No. 46, "Consolidation of Variable Interest Entities," and Interpretation of
ARB No 51 (FIN 46), which was revised in December 2003 (See Note 10). The Bank has three wholly owned operating subsidiaries,
Pathfinder Commercial Bank, Whispering Oaks Development Inc. and Pathfinder REIT, Inc. All inter-company accounts and activity have
been eliminated in consolidation. The Company has seven full service offices located in Oswego County. The Company is primarily engaged
in the business of attracting deposits from the general public in the Company's market area, and investing such deposits, together with other
sources of funds, in loans secured by one-to-four family residential real estate, commercial real estate, business assets and investment
securities.
Pathfinder Bancorp, M.H.C., (the "Holding Company") a mutual holding company whose activity is not included in the accompanying
financial statements, owns approximately 64.3% of the outstanding common stock of the Company. Salaries, employee benefits and rent
approximating $135,000, $130,000 and $124,000, were allocated from the Company to Pathfinder Bancorp, M.H.C. during 2005, 2004 and
2003, respectively.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates. Management has identified the allowance for loan losses and the evaluation of securities for other than
temporary impairment to be the accounting areas that require the most subjective and complex judgments, and as such, could be the most
subject to revision as new information becomes available.
The Company is subject to the regulations of various governmental agencies. The Company also undergoes periodic examinations by the
regulatory agencies which may subject it to further changes with respect to asset valuations, amounts of required loss allowances, and operating
restrictions resulting from the regulators' judgments based on information available to them at the time of their examinations.
SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK
Most of the Company's activities are with customers located primarily in Oswego and parts of Onondaga counties of New York State. Note 3
discusses the types of securities that the Company invests in. Note 4 discusses the types of lending that the Company engages in. The Company
does not have any significant concentrations to any one industry or customer.
Page 42
ADVERTISING
The Company follows the policy of charging the costs of advertising to expense as incurred. Advertising costs included in other operating
expenses were $249,000, $224,000 and $245,000 for the year ended December 31, 2005, 2004 and 2003, respectively.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand, amounts due from banks and interest-bearing deposits (with original maturity of three months
or less).
INVESTMENT SECURITIES
The Company classifies investment securities as available-for-sale. Available-for-sale securities are reported at fair value, with net unrealized
gains and losses reflected as a separate component of shareholders' equity, net of the applicable income tax effect. None of the Company's
investment securities have been classified as trading or held-to-maturity securities.
Gains or losses on investment security transactions are based on the amortized cost of the specific securities sold. Premiums and discounts on
securities are amortized and accreted into income using the interest method over the period to first call or maturity.
The Company monitors investment securities for impairment on a quarterly basis. Declines in the fair value of investment securities below cost
that are deemed to be other-than-temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses,
management considers (1) the length of time and the extent to which the fair value has been less than cost,
(2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the
issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
FEDERAL HOME LOAN BANK STOCK
Federal law requires a member institution of the Federal Home Loan Bank ("FHLB") system to hold stock of its district FHLB according to a
predetermined formula. The stock is carried at cost.
MORTGAGE LOANS HELD-FOR-SALE
Mortgage loans held-for-sale are carried at the lower of cost or fair value. Fair value is determined in the aggregate. As of December 31, 2005,
there were no forward commitments outstanding. As of December 31, 2004, the Company had approximately $1,000,000 of mortgage loan
forward commitments outstanding to hedge interest rate risk on certain committed and originated loans. The differences between the settlement
value of the forward commitments and the fair value of these commitments were not significant at December 31, 2004.
TRANSFERS OF FINANCIAL ASSETS
Transfers of financial assets, including sales of loans and loan participations, are accounted for as sales, when control over the assets has been
surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the
transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets,
and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their
maturity.
Page 43
LOANS
The Company grants mortgage, commercial and consumer loans to customers. Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or pay-off, generally are stated at unpaid principal balances, less the allowance for loan losses and net
deferred loan origination fees and costs. The ability of the Company's debtors to honor their contracts is dependent upon the real estate and
general economic conditions in the market area. Interest income is generally recognized when income is earned using the interest method.
Nonrefundable loan fees received and related direct origination costs incurred are deferred and amortized over the life of the loan using the
interest method, resulting in a constant effective yield over the loan term. Deferred fees are recognized into income and deferred costs are
charged to income immediately upon prepayment of the related loan.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings.
Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent
recoveries, if any, are credited to the allowance. The Company periodically evaluates the adequacy of the allowance for loan losses in order to
maintain the allowance at a level that is sufficient to absorb probable credit losses. Management's evaluation of the adequacy of the allowance
is based on a review of the Company's historical loss experience, known and inherent risks in the loan portfolio and an analysis of the levels
and trends of delinquencies and charge-offs. This evaluation is inherently subjective as it requires estimates that are susceptible to significant
revision as more information becomes available.
The allowance consists of specific and general and unallocated components. The specific component relates to loans that are classified as
impaired. For impaired loans, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the
impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss
experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management's
estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying
assumptions used in the methodologies for estimating specific and general losses in the portfolio.
A loan is considered impaired, based on current information and events, if it is probable the Company will be unable to collect the scheduled
payments of principal or interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is
generally based upon the present value of future cash flows discounted at the historical effective rate, except that all collateral-dependent loans
are measured for impairment based on fair values of collateral.
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately
identify individual consumer and residential loans for impairment disclosures, unless such loans are the subject of a restructuring agreement.
INCOME RECOGNITION ON IMPAIRED AND NON-ACCRUAL LOANS
Loans, including impaired loans, are generally classified as non-accrual if they are past due as to maturity or payment of principal or interest
for a period of more than 90 days. When a loan is classified as non-accrual and the future collectibility of the recorded loan balance is doubtful,
collections of interest and principal are generally applied as a reduction to principal outstanding.
Page 44
When future collectibility of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a non-
accrual loan had been partially charged off, recognition of interest on a cash basis is limited to that which would have been recognized on the
recorded loan balance at the contractual interest rate. Cash interest receipts in excess of that amount are recorded as recoveries to the allowance
for loan losses until prior charge-offs have been fully recovered.
OFF-BALANCE SHEET CREDIT RELATED FINANCIAL INSTRUMENTS
In the ordinary course of business, the Company has entered into commitments to extend credit, including commitments under standby letters
of credit. Such financial instruments are recorded when they are funded.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost, less accumulated depreciation. Depreciation is computed on a straight-line basis over the estimated
useful lives of the related assets, ranging up to 39 years for premises and 10 years for equipment. Maintenance and repairs are charged to
operating expenses as incurred. The asset cost and accumulated depreciation are removed from the accounts for assets sold or retired and any
resulting gain or loss is included in the determination of income.
FORECLOSED REAL ESTATE
Properties acquired through foreclosure, or by deed in lieu of foreclosure, are carried at their fair value less estimated disposal costs. Write
downs of, and expenses related to, foreclosed real estate holdings included in noninterest expense were $155,000, $85,000 and $124,000 in
2005, 2004 and 2003, respectively.
INTANGIBLE ASSETS
Intangible assets represent core deposit intangibles and goodwill arising from acquisitions. Core deposit intangibles represent the premium the
Company has paid for deposits acquired in excess of the cost incurred had the funds been purchased in the capital markets. Core deposit
intangibles are amortized on a straight-line basis over a period of five years. Goodwill represents the excess cost of an acquisition over the fair
value of the net assets acquired. Goodwill is not amortized but is evaluated annually for impairment.
MORTGAGE SERVICING RIGHTS
Originated mortgage servicing rights are recorded at their fair value at the time of transfer and are amortized in proportion to and over the
period of estimated net servicing income or loss. The carrying value of the originated mortgage servicing rights is periodically evaluated for
impairment.
Page 45
STOCK-BASED COMPENSATION
The Company accounts for stock awards issued to directors, officers and key employees using the intrinsic value method in accordance with
Accounting Principles Board Opinion No. 25. This method requires 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 does not recognize compensation expense
related to stock awards because the stock awards generally have fixed terms and exercise prices that are equal to or greater than the fair value
of the Company's common stock at the grant date.
There is no pro forma expense reported for 2005 as stock options were fully vested during 2003. Pro forma amounts of net income and earnings
per share under Statement of Financial Accounting Standards No. 123 are as follows:
(Dollars in thousands) 2003
---------------------------------------------------------------------------------
NET INCOME:
As reported $ 1,652
Total stock-based compensation cost, net of tax, that would
have been included in the determination of net income if the
fair value based method had been applied to all awards 28
---------------------------------------------------------------------------------
Pro forma $ 1,624
=================================================================================
EARNINGS PER SHARE: BASIC DILUTED
---------------------------------------------------------------------------------
As reported $ 0.68 $ 0.67
Pro forma $ 0.67 $ 0.66
=================================================================================
The fair value of these options was estimated at the date of grant in July 2001 using the Black-Scholes options pricing model with the
following assumptions:
risk free interest rate - 5.0%; dividend yield - 2.0%; market price volatility - 52.4%. An assumed weighted average option life of 6 years has
been utilized. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting
period. No options were granted during 2005, 2004 and 2003.
RETIREMENT BENEFITS
The Company has established tax qualified retirement plans covering substantially all full-time employees and certain part-time employees.
Pension expense under these plans is charged to current operations and consists of several components of net pension cost based on various
actuarial assumptions regarding future experience under the plans. In addition, the Company has unfunded deferred compensation and
supplemental executive retirement plans for selected current and former employees and officers that provide benefits that cannot be paid from a
qualified retirement plan due to Internal Revenue Code restrictions. These plans are nonqualified under the Internal Revenue Code, and assets
used to fund benefit payments are not segregated from other assets of the Company, therefore, in general, a participant's or beneficiary's claim
to benefits under these plans is as a general creditor.
TREASURY STOCK
Treasury stock purchases are recorded at cost. There were no treasury stock purchases in 2005 and 2004. In 2003, the Company purchased
183,114 shares of treasury stock at an average cost of $14.67 per share, respectively. 160,114 of the shares purchased by the Company in 2003
related to a privately negotiated stock repurchase from Jewelcor Management Inc. The shares were purchased at $14.60 per share and
represented approximately 6.1% of the Company's outstanding common stock as of December 31, 2002. The privately negotiated transaction
was not part of the share repurchase program in effect for that period. The Company believes repurchase programs to be in the best interest of
its shareholders as a method to enhance long-term shareholder value.
Page 46
INCOME TAXES
Provisions for income taxes are based on taxes currently payable or refundable and deferred income taxes on temporary differences between
the tax basis of assets and liabilities and their reported amounts in the financial statements. Deferred tax assets and liabilities are reported in the
financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets and liabilities are expected to
be realized or settled.
EARNINGS PER SHARE
Basic earnings per share are computed by dividing net income by the weighted average number of common shares outstanding throughout each
year. 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.
COMPREHENSIVE INCOME (LOSS)
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain
changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the
equity section of the statement of condition, such items, along with net income, are components of comprehensive income.
The components of other comprehensive income (loss) and related tax effects for the years ended:
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
(In thousands) 2005 2004 2003
-------------------------------------------------------------------------------
Gross change in unrealized gains on
securities available for sale $ (1,835) $ (843) $ 681
Reclassification adjustment for (gains) losses
included in net income 205 (772) (542)
----------------------------------------------------------------------------
(1,630) (1,615) 139
Tax effect 652 646 (56)
----------------------------------------------------------------------------
Net of tax amount $ (978) $ (969) $ 83
============================================================================
RECLASSIFICATIONS
Certain amounts in the 2004 and 2003 consolidated financial statements have been reclassified to conform to the current year presentation.
These reclassifications had no effect on net income as previously reported.
NOTE 2: NEW ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board (FASB) issued Statement No. 123(R), "Share-Based Payment." Statement No.
123(R) revised Statement No. 123, "Accounting for Stock-Based Compensation," and supersedes APB Opinion No. 25, "Accounting for Stock
Issued to Employees," and its related implementation guidance. Statement No. 123(R) will require compensation costs related to share-based
payment transactions to be recognized in the financial statements (with limited exceptions). The amount of compensation cost will be measured
based on the grant-date fair value of the equity or liability instruments issued. Compensation cost will be recognized over the period that an
employee provides service in exchange for the award.
On April 14, 2005, the Securities and Exchange Commission ("SEC") adopted a rule that amends the compliance dates for Financial
Accounting Standards Board's Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment" ("SFAS No.
123R"). Under the rule, the Company is required to adopt SFAS No. 123R in the first annual period beginning after June 15, 2005. Since
Page 47
the Company's options are fully granted and vested, the Company does not anticipate the adoption will have any impact on the consolidated
financial statements.
In March 2005, the SEC issued Staff Accounting Bulletin No. 107 ("SAB No. 107"), "Share-Based Payment", providing guidance on option
valuation methods, the accounting for income tax effects of share-based payment arrangements upon adoption of SFAS No. 123(R), and the
disclosures in MD&A subsequent to the adoption. The Company will provide SAB No. 107 required disclosures upon adoption of SFAS No.
123(R).
In January 2003, the FASB's Emerging Issues Task Force (EITF) issued EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investors" ("EITF 03-1"), and in March 2004, the EITF issued an update. EITF 03-1 addresses the
meaning of other-than-temporary impairment and its application to certain debt and equity securities. EITF 03-1 aids in the determination of
impairment of an investment and gives guidance as to the measurement of impairment loss and the recognition and disclosures of other-than-
temporary investments. EITF 03-1 also provides a model to determine other-than-temporary impairment using evidence-based judgment about
the recovery of the fair value up to the cost of the investment by considering the severity and duration of the impairment in relation to the
forecasted recovery of the fair value. In July 2005, FASB adopted the recommendation of its staff to nullify key parts of EITF 03-1. The staff's
recommendations were to nullify the guidance on the determination of whether an investment is impaired as set forth in paragraphs 10-18 of
Issue 03-1 and not to provide additional guidance on the meaning of other-than-temporary impairment. Instead, the staff recommends entities
recognize other-than-temporary impairments by applying existing accounting literature such as paragraph 16 of SFAS 115.
In July 2005, the FASB issued a proposed interpretation of FAS 109, "Accounting for Income Taxes", to clarify certain aspects of accounting
for uncertain tax positions, including issues related to the recognition and measurement of those tax positions. If adopted as proposed, any
adjustments required to be recorded as a result of adopting the interpretation would be reflected as a cumulative effect from a change in
accounting principle. We are currently in the process of determining the impact of adoption of the interpretation as proposed on our financial
position and results of operations.
Page 48
NOTE 3: INVESTMENT SECURITIES - AVAILABLE-FOR-SALE
The amortized cost and estimated fair value of investment securities are summarized as follows:
DECEMBER 31, 2005
-------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
(In thousands) COST GAINS LOSSES VALUE
------------------------------------------------------------------------------
Bond investment securities:
US Treasury and agencies $ 20,713 $ - $ (746) $ 19,967
State and political subdivisions 11,177 2 (199) 10,980
Corporate 5,936 24 (106) 5,854
Mortgage-backed 31,565 67 (914) 30,718
------------------------------------------------------------------------------
Total 69,391 93 (1,965) 67,519
Equity investments 6,998 14 (292) 6,720
------------------------------------------------------------------------------
Total investment securities $ 76,389 $ 107 $(2,257) $ 74,239
==============================================================================
DECEMBER 31, 2004
-------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
(In thousands) COST GAINS LOSSES VALUE
------------------------------------------------------------------------------
Bond investment securities:
US Treasury and agencies $ 21,609 $ 4 $ (401) $ 21,212
State and political subdivisions 8,881 162 (31) 9,012
Corporate 5,919 92 (52) 5,959
Mortgage-backed 32,213 92 (278) 32,027
------------------------------------------------------------------------------
Total 68,622 350 (762) 68,210
Equity investments 6,967 5 (113) 6,859
------------------------------------------------------------------------------
Total investment securities $ 75,589 $ 355 $ (875) $ 75,069
==============================================================================
Gross gains of $190,000, $828,000 and $581,000 for 2005, 2004 and 2003, respectively and gross losses of $395,000, $56,000 and $38,000 for
2005, 2004 and 2003, respectively were realized on sales and calls of securities. The tax benefit related to net losses on investment securities
was $80,000 for 2005. Tax expense related to net gains on investment securities was $301,000 and $211,000 for 2004 and 2003, respectively.
The $395,000 loss in 2005 represented impairment losses recognized on equity investments and the loss recognized from the sale of
commercial bank portfolio securities.
Investment securities with a carrying value of approximately $38,899,000 at December 31, 2005 were pledged to collateralize certain deposit
and borrowing arrangements.
Page 49
The amortized cost and estimated fair value of debt investments at December 31, 2005 by contractual maturity are shown below. Expected
maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.
AMORTIZED ESTIMATED
(In thousands) COST FAIR VALUE
----------------------------------------------------------------
Due in one year or less $ 3,039 $ 3,008
Due after one year through five years 16,179 15,699
Due after five years through ten years 11,856 11,432
Due after ten years 6,752 6,662
Mortgage-backed securities 31,565 30,718
----------------------------------------------------------------
Totals $ 69,391 $ 67,519
================================================================
The Company's investment securities' gross unrealized losses and fair value, aggregated by investment category and length of time that
individual securities have been in a continuous unrealized loss position is as follows:
DECEMBER 31, 2005
------------------------------------------------------------------
LESS THAN TWELVE MONTHS TWELVE MONTHS OR MORE TOTAL
------------------------------------------------------------------------------------------------------------
UNREALIZED FAIR UNREALIZED FAIR UNREALIZED FAIR
(In thousands) LOSSES VALUE LOSSES VALUE LOSSES VALUE
------------------------------------------------------------------------------------------------------------
US Treasury and agency securities $ (106) $ 4,130 $ (639) $15,837 $ (746) $19,967
State and political subdivision securities (152) 8,872 (47) 1,491 (199) 10,363
Corporate securities (35) 1,965 (71) 1,896 (106) 3,861
Mortgage-backed securities (322) 13,814 (593) 15,073 (914) 28,887
Equity investment securities - - (292) 6,135 (292) 6,135
------------------------------------------------------------------------------------------------------------
$ (615) $28,781 $ (1,642) $40,432 $(2,257) $69,213
============================================================================================================
DECEMBER 31, 2004
------------------------------------------------------------------
LESS THAN TWELVE MONTHS TWELVE MONTHS OR MORE TOTAL
------------------------------------------------------------------------------------------------------------
UNREALIZED FAIR UNREALIZED FAIR UNREALIZED FAIR
(In thousands) LOSSES VALUE LOSSES VALUE LOSSES VALUE
------------------------------------------------------------------------------------------------------------
US Treasury and agency securities $ (370) $18,903 $ (31) $ 981 $ (401) $19,884
State and political subdivision securities (31) 2,411 - 56 (31) 2,467
Corporate securities (11) 976 (41) 936 (52) 1,912
Mortgage-backed securities (215) 19,949 (63) 3,301 (278) 23,250
Equity investment securities (10) 240 (103) 3,547 (113) 3,787
------------------------------------------------------------------------------------------------------------
$ (637) $42,479 $ (238) $ 8,821 $ (875) $51,300
============================================================================================================
The Company reviews its securities for impairment at least quarterly, and as a result of this review, impairment charges of $196,000 were
recorded during December 31, 2005. No impairment losses were recognized in 2004 and 2003.
At December 31, 2005 59 mortgage-backed and 33 US treasury and agency securities have unrealized losses. 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 6% of book value and a majority had unrealized losses totaling less than 3% of book value. The Company has the
intent and ability to hold the individual securities to maturity or market price recovery.
Page 50
At December 31, 2005, 32 state and political subdivision securities and 4 corporate securities have unrealized losses. In analyzing the issuer's
financial condition, management considers the industry analyst's reports, financial performance and projected target prices of investment
analysts within a one-year time frame. None of the securities in this category had an unrealized loss that exceeded 5% of book value and a
majority had unrealized losses totaling less than 2% of book value. The Company has the intent and ability to hold the individual securities to
maturity or market price recovery.
At December 31, 2005, 3 equity securities had unrealized losses. One of these securities is a mutual fund backed by adjustable rate mortgage-
backed securities and has an unrealized loss of 3% of book value. The unrealized loss relates principally to changes in interest rates subsequent
to the acquisition of the mutual fund. A second equity security is a mutual fund consisting primarily of investment grade dividend-paying
common stocks of large capitalization companies, i.e., companies with market capitalization in excess of $5 billion. A review of the underlying
securities indicates no individually impaired holdings and there is no indication that the profitability of these corporations is impaired beyond
the economic cycle. As such, the decline in market value is not considered to be other-than-temporarily impaired. The third equity security has
unrealized losses totaling $10,000, which is deemed to be immaterial to the consolidated financial statements.
NOTE 4: LOANS
Major classifications of loans at December 31, are as follows:
(In thousands) 2005 2004
----------------------------------------------------
REAL ESTATE MORTGAGES:
Conventional $116,423 $117,608
Construction 2,607 3,497
Commercial 31,845 29,874
----------------------------------------------------
150,875 150,979
----------------------------------------------------
OTHER LOANS:
Consumer 3,363 3,484
Home Equity/2nd Mortgage 16,319 15,021
Lease financing 334 715
Commercial 14,741 12,605
Municipal loans 3,259 3,514
38,016 35,339
----------------------------------------------------
Total loans 188,891 186,318
----------------------------------------------------
Net deferred loan costs 677 634
Less allowance for loan losses (1,679) (1,827)
----------------------------------------------------
Loans receivable, net $187,889 $185,125
====================================================
The Company grants mortgage and consumer loans to customers throughout Oswego and parts of Onondaga counties. Although the Company
has a diversified loan portfolio, a substantial portion of its debtor's ability to honor their contracts is dependent upon the counties' employment
and economic conditions.
Page 51
The following represents the approximate activity associated with loans to officers and directors during the fiscal year ending December 31,
2005:
(In thousands)
---------------------------------------
Balance at beginning of year $ 4,910
Originations 3,065
Principal payments (2,394)
---------------------------------------
Balance at end of year $ 5,581
=======================================
NOTE 5: ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses for the year ended December 31, are summarized as follows:
(In thousands) 2005 2004 2003
--------------------------------------------------------
Balance at beginning of year $1,827 $1,715 $1,481
Recoveries credited 49 61 37
Provision for loan losses 311 738 598
Loans charged-off (508) (687) (401)
--------------------------------------------------------
Balance at end of year $1,679 $1,827 $1,715
========================================================
The following is a summary of information pertaining to impaired loans for the years ending December 31,:
(In thousands) 2005 2004 2003
----------------------------------------------------------------------
Impaired loans without a valuation allowance $ - $ - $ -
Impaired loans with a valuation allowance 2,452 3,110 3,804
----------------------------------------------------------------------
Total impaired loans $2,452 $3,110 $3,804
----------------------------------------------------------------------
Valuation allowance related to impaired loans $ 90 $ 760 $ 527
----------------------------------------------------------------------
Average investment in impaired loans $2,856 $3,611 $3,446
----------------------------------------------------------------------
Interest income recognized on impaired loans $ 175 $ 153 $ 139
----------------------------------------------------------------------
Interest income recognized on a cash basis on
impaired loans $ - $ - $ 93
----------------------------------------------------------------------
As of December 31, 2005, no additional funds are committed to be advanced in connection with impaired loans.
The amount of loans on which the Company has ceased accruing interest aggregated approximately $1,655,000 and $1,851,000 at December
31, 2005 and 2004, respectively. There were no loans past due ninety days or more and still accruing interest at December 31, 2005 or 2004.
NOTE 6: SERVICING
Loans serviced for others are not included in the accompanying consolidated statements of condition. The unpaid principal balances of
mortgage and other loans serviced for others were $56,300,000, 53,000,000 and $47,600,000 at December 31, 2005, 2004 and 2003,
respectively.
The balance of capitalized servicing rights included in other assets at December 31, 2005 and 2004, was $146,000 and $198,000, respectively.
Page 52
The following summarizes mortgage-servicing rights capitalized and amortized:
(In thousands) 2005 2004 2003
-----------------------------------------------------------
Mortgage servicing rights capitalized $ 70 $ 99 $ 179
Mortgage servicing rights amortized $ 123 $ 158 $ 122
===========================================================
NOTE 7: PREMISES AND EQUIPMENT
A summary of premises and equipment at December 31, is as follows:
(In thousands) 2005 2004
---------------------------------------------------
Land $ 1,150 $ 1,150
Buildings 6,590 5,587
Furniture, fixture and equipment 6,120 5,597
Construction in progress 119 508
---------------------------------------------------
$13,979 $12,842
Less: Accumulated depreciation 5,959 5,262
---------------------------------------------------
$ 8,020 $ 7,580
===================================================
NOTE 8: GOODWILL AND INTANGIBLE ASSETS
A summary of intangible assets is as follows:
2005 2004
---------------------------------------------------------------------------------
GROSS GROSS
CARRYING ACCUMULATED CARRYING ACCUMULATED
(In thousands) AMOUNT AMORTIZATION AMOUNT AMORTIZATION
---------------------------------------------------------------------------------
Core deposit intangible $ 1,111 $ (707) $ 1,111 $ (484)
Amortization expense related to core deposit intangibles is estimated to total $223,000 and $181,000 for the years ending December 31, 2006
and 2007, respectively. Amortization of goodwill and the core deposit intangible is deductible for tax purposes.
NOTE 9: DEPOSITS
A summary of deposits at December 31, is as follows:
(In thousands) 2005 2004
-------------------------------------------------------
Savings accounts $ 60,176 $ 66,265
Time accounts 72,121 66,133
Time accounts over $100,000 24,034 18,250
Money management accounts 39,009 44,189
Demand deposit interest-bearing 18,259 20,339
Demand deposit noninterest-bearing 20,241 19,159
Mortgage escrow funds 2,537 2,337
-------------------------------------------------------
$236,377 $236,672
=======================================================
Page 53
At December 31, 2005, the scheduled maturities of time deposits are as follows:
(In thousands)
----------------------------
YEAR OF MATURITY:
----------------------------
2006 $51,724
2007 21,221
2008 8,952
2009 5,780
2010 1,910
Thereafter 6,568
---------------------------
$96,155
===========================
NOTE 10: BORROWED FUNDS
The composition of borrowings at December 31 is as follows:
(In thousands) 2005 2004
----------------------------------------------
SHORT-TERM FHLB ADVANCES:
FHLB Advances $ 2,000 $ 1,000
----------------------------------------------
Total short-term borrowings $ 2,000 $ 1,000
==============================================
LONG-TERM:
FHLB Repurchase agreements $ 3,400 $ 3,400
FHLB advances 25,960 30,960
----------------------------------------------
Total long-term borrowings $29,360 $34,360
==============================================
The principal balance, interest rate and maturity of the above borrowings at December 31, 2005 is as follows:
TERM PRINCIPAL RATES
----------------------------------------------------------------------
(Dollars in thousands)
Short-term advances with FHLB $ 2,000 3.97%-4.13%
Long-term:
----------------------------------------------------------------------
Repurchase agreements (due in 2006 and 2009) 3,400 5.56% -5.85%
Advances with FHLB
----------------------------------------------------------------------
due within 1 year 2,000 4.72%-5.32%
due within 2 years 11,350 3.00%-5.04%
due within 3 years 6,610 2.67%-5.98%
due within 4 years 1,000 6.00%
due within 5 years 5,000 4.39%
----------------------------------------------------------------------
Total advances with FHLB $ 25,960
----------------------------------------------------------------------
Total long-term borrowings $ 29,360
======================================================================
The repurchase agreements with the Federal Home Loan Bank ("FHLB") are collateralized by certain investment securities having a carrying
value of $3,689,000 at December 31, 2005. The collateral is under the Company's control. The line of credit agreement with the FHLB is used
for liquidity purposes. Interest on this line is determined at the time of borrowing. The average rate paid on the overnight line during 2005
approximated 3.57%. At December 31, 2005, $28,725,000 was available under the line of credit. In addition to the overnight line of credit
program, the Company also has access to the FHLB's Term Advance Program under which it can borrow at various terms and interest rates.
Residential mortgage loans with a carrying value of $84,899,000 and FHLB stock with a carrying value of $1,805,000 have been pledged by
the Company under a blanket collateral agreement to secure the Company's line of credit and term
Page 54
borrowings. The Company also maintains a $5,000,000 line of credit with a correspondent bank. Interest on the line is determined at the time of
borrowing. The Company did not draw on the line during 2005. Investment securities with a carrying value of $6,384,000 at December 31,
2005 collateralize the line of credit.
The Company has a non-consolidated subsidiary trust, Pathfinder Statutory Trust I, of which 100% of the common equity is owned by the
Company. The Trust issued $5,000,000 of 30 year floating rate Company-obligated pooled capital securities of Pathfinder Statutory Trust I.
The Company borrowed the proceeds of the capital securities from its subsidiary by issuing floating rate junior subordinated deferrable interest
debentures having substantially similar terms. The capital securities mature in 2032 and are treated as Tier 1 capital by the Federal Deposit
Insurance Company and the Office of Thrift Supervision. The capital securities of the trust are a pooled trust preferred fund of Preferred Term
Securities VI, Ltd. and are tied to the 3-month LIBOR plus 3.45% (7.97% at December 31, 2005 and 6.00% at December 31, 2004) with a five-
year call provision. The Company guarantees all of these securities. The Company capitalized $151,000 of deferred financing costs associated
with the debt issuance, which are being amortized on a straight-line basis over the 5-year period to call date.
The Company's equity interest in the trust subsidiary of $155,000 is reported in "Other assets". For regulatory reporting purposes, the Federal
Reserve Board has indicated that the preferred securities will continue to qualify as Tier 1 Capital subject to previously specified limitations,
until further notice. If regulators make a determination that Trust Preferred Securities can no longer be considered in regulatory capital, the
securities become callable and the Company may redeem them.
NOTE 11: EMPLOYEE BENEFITS AND DEFERRED COMPENSATION AND SUPPLEMENTAL RETIREMENT PLANS
The Company has a noncontributory defined benefit pension plan covering substantially all employees. The plan provides defined benefits
based on years of service and final average salary. In addition, the Company provides certain health and life insurance benefits for eligible
retired employees. The healthcare plan is contributory with participants' contributions adjusted annually; the life insurance plan is
noncontributory. Employees with less than 14 years of service as of January 1, 1995, are not eligible for the health and life insurance retirement
benefits.
The Company uses an October 1 measurement date for the defined benefit plan and postretirement benefit plan.
Page 55
The following tables set forth the changes in the plan's benefit obligation, fair value of plan assets and prepaid (accrued) benefit (cost) as of
December 31:
PENSION BENEFITS POSTRETIREMENT BENEFITS
-------------------------------------------------------------------------------------------
(In thousands) 2005 2004 2005 2004
-------------------------------------------------------------------------------------------
CHANGE IN BENEFIT OBLIGATIONS:
Benefit obligation at beginning of year $ 3,745 $ 3,382 $ 309 $ 367
Service cost 151 155 2 2
Interest cost 229 207 18 19
Actuarial gain (loss) 378 153 46 (58)
Plan participants' contributions - - 6 12
Benefit paid (142) (152) (27) (33)
-------------------------------------------------------------------------------------------
Benefit obligation at end of year $ 4,361 $ 3,745 $ 354 $ 309
-------------------------------------------------------------------------------------------
CHANGE IN PLAN ASSETS:
Fair value of plan assets at beginning of year $ 3,154 $ 2,792 $ - $ -
Actual return on plan assets 388 236 - -
Plan participants' contributions - - 6 12
Benefits paid (142) (152) (27) (33)
Employer contributions 670 278 21 21
-------------------------------------------------------------------------------------------
Fair value of plan assets at end of year $ 4,070 $ 3,154 $ - $ -
-------------------------------------------------------------------------------------------
COMPONENTS OF PREPAID/ACCRUED BENEFIT COST:
Unfunded status $ (291) $ (591) $(354) $(309)
Unrecognized transition obligation - - 115 134
Unrecognized actuarial net loss/(gain) 1,656 1,478 34 (13)
-------------------------------------------------------------------------------------------
Prepaid/(accrued) benefit/(cost) $ 1,365 $ 887 $(205) $(188)
===========================================================================================
The accumulated benefit obligation for the defined benefit plan was $3,602,000 and $3,042,000 at December 31, 2005 and 2004, respectively.
The significant assumptions used in determining the benefit obligation as of December 31, 2005, 2004 and 2003 are as follows:
PENSION BENEFITS POSTRETIREMENT BENEFITS
----------------------------------------------
2005 2004 2003 2005 2004 2003
------------------------------------------------------------------------------------------------
Weighted average discount rate 5.88% 6.25% 6.50% 5.88% 6.25% 6.00%
Expected long term rate of return on plan assets 9.00% 9.00% 9.00% - - -
Rate of increase in future compensation levels 3.00% 3.50% 4.00% - - -
================================================================================================
Assumed health care cost trend rates have a significant effect on the amounts reported for the postretirement health care plans. The annual rates
of increase in the per capita cost of covered medical and prescription drug benefits for year-end calculations were assumed to be 9.5% and
10.0%, respectively. The rates were assumed to decrease gradually to 3.75% in 2011 and remain at that level thereafter. A one-percentage point
change in the health care cost trend rates would have the following effects:
1 PERCENTAGE 1 PERCENTAGE
POINT POINT
(In thousands) INCREASE DECREASE
----------------------------------------------------------------------------
Effect on total of service and interest
cost components $ 21 $ (20)
Effect on post retirement benefit obligation 15 (11)
============================================================================
Page 56
The composition of the net periodic benefit plan cost for the years ended December 31, 2005, 2004 and 2003 is as follows:
PENSION BENEFITS POSTRETIREMENT BENEFITS
-------------------------------------------
(In thousands) 2005 2004 2003 2005 2004 2003
------------------------------------------------------------------------------------
Service cost $ 151 $ 155 $ 154 $ 2 $ 2 $ 2
Interest cost 229 207 200 18 19 21
Amortization of transition obligation - - - 19 18 18
Amortization of gains and losses 96 94 106 - - 1
Expected return on plan assets (285) (254) (227) - - -
------------------------------------------------------------------------------------
Net periodic benefit plan cost $ 191 $ 202 $ 233 $ 39 $ 39 $ 42
====================================================================================
The significant assumptions used in determining the net periodic benefit plan cost for years ended December 31:
PENSION BENEFITS POSTRETIREMENT BENEFITS
------------------------------------------
2005 2004 2003 2005 2004 2003
----------------------------------------------------------------------------------------------
Weighted average discount rate 5.88% 6.25% 6.50% 5.88% 6.25% 6.00%
Expected long term rate of return on plan assets 9.00% 9.00% 9.00% - - -
Rate of increase in future compensation levels 3.00% 3.50% 4.00% - - -
==============================================================================================
The long-term rate-of-return-on-assets assumption was set based on historical returns earned by equities and fixed income securities, adjusted
to reflect expectations of future returns as applied to the plan's target allocation of asset classes. Equities and fixed income securities were
assumed to earn real rates of return in the ranges of 5-9.0% and 2-6.0%, respectively. The long-term inflation rate was estimated to be 3.0%.
When these overall return expectations are applied to the plan's target allocation, the expected rate of return is determined to be 9.0%, which is
roughly the midpoint of the range of expected return.
The Company's pension plan weighted-average asset allocations at October 1, the measurement date, by asset category
ASSET CATEGORY 2005 2004
-------------------------------
Equity securities 72% 69%
Debt securities 28% 31%
-------------------------------
Total 100% 100%
===============================
Plan assets are invested in six diversified investment funds of the RSI Retirement Trust (the "Trust"), a no load series open-ended mutual fund.
The investment funds include four equity mutual funds and two bond mutual funds, each with its own investment objectives, investment
strategies and risks, as detailed in the Trust's prospectus. The Trust has been given discretion by the Plan Sponsor to determine the appropriate
strategic asset allocation versus plan liabilities, as governed by the Trust's Statement of Investment Objectives and Guidelines (the
"Guidelines").
The long-term investment objective is to be invested 65% in equity securities (equity mutual funds) and 35% in debt securities (bond mutual
funds). If the plan is underfunded under the Guidelines, the bond fund portion will be temporarily increased to 50% in order to lessen asset
value volatility. When the plan is no longer underfunded, the bond fund portion will be decreased back to 35%. Asset rebalancing is performed
at least annually, with interim adjustments made when the investment mix varies more than 5% from the target (i.e., a 10% target range).
The investment goal is to achieve investment results that will contribute to the proper funding of the pension plan by exceeding the rate of
inflation over the long-term. In addition, investment managers for the Trust are expected to
Page 57
provide above average performance when compared to their peer managers. Performance volatility is also monitored. Risk/volatility is further
managed by the distinct investment objectives of each of the Trust funds and the diversification within each fund.
For the fiscal year ending December 31, 2006, the Bank expects to contribute approximately $192,000 to the Plan.
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid.
YEARS ENDING DECEMBER 31:
--------------------------------
(In thousands)
--------------------------------
2006 $148
2007 148
2008 145
2009 148
2010 152
Years 2011 - 2015 981
================================
The Company also offers a 401(k) plan to its employees. Contributions to this plan by the Company were $145,000, $92,000 and $84,000 for
2005, 2004 and 2003, respectively.
The Company maintains optional deferred compensation plans for its directors whereby fees normally received are deferred and paid by the
Company based upon a payment schedule commencing at age 65 and continue monthly for 10 years. Directors must serve on the board for a
minimum of 5 years to be eligible for the Plan. At December 31, 2005 and 2004, other liabilities include approximately $1,412,0000 and
$1,276,000, respectively, relating to deferred compensation. Deferred compensation expense for the years ended December 31, 2005, 2004 and
2003 amounted to approximately $211,000, $185,000 and $116,000, respectively.
The Company has a supplemental executive retirement plan for the benefit of certain executive officers. At December 31, 2005 and 2004, other
liabilities include approximately $424,000 and $449,000 accrued under these plans. Compensation expense includes approximately $56,000,
$53,000 and $68,000 relating to the supplemental executive retirement plan for 2005, 2004 and 2003, respectively.
To fund the benefits under these plans, the Company is the owner of single premium life insurance policies on participants in the non-qualified
retirement plans. At December 31, 2005 and 2004, the cash value of these policies was $5,987,000 and $5,768,000, respectively.
NOTE 12: STOCK BASED COMPENSATION PLANS
In February 1997, the Board of Directors approved an option plan and granted options there under with an exercise price equal to the market
value of the Company's shares at the date of grant. Under the Stock Option Plan, up to 132,249 options have been authorized for grant of
incentive stock options and nonqualified stock options.
In July 2001, the Board approved the issuance of 38,499 stock options remaining in the 1997 Stock Option Plan. The exercise price is equal to
the market value of the Company's shares at the date of grant ($8.34). The options granted under the issuance have a 10-year term with one-
third vesting upon grant date and the remaining vesting and becoming exercisable ratably over a 2-year period.
Page 58
Activity in the Stock Option Plan is as follows:
WEIGHTED
OPTIONS AVERAGE SHARES
(Shares in thousands) OUTSTANDING EXERCISE PRICE EXERCISABLE
--------------------------------------------------------------------------------
Outstanding at December 31, 2002 93 $ 7.27 80
--------------------------------------------------------------------------------
Exercised (5) 7.49
Outstanding at December 31, 2003 88 $ 7.25 88
--------------------------------------------------------------------------------
Exercised (18) 7.75
Outstanding at December 31, 2004 70 $ 7.12 70
--------------------------------------------------------------------------------
Exercised (13) 6.58
Expired (11) 6.58
Outstanding at December 31, 2005 46 $ 7.41 46
--------------------------------------------------------------------------------
The Bank sponsors an Employee Stock Ownership Plan (ESOP) for employees who have attained the age of 21 and who have completed a 12
month period of employment with the Bank during which they worked at least 1,000 hours. The Bank purchased 92,574 shares of common
stock on behalf of the ESOP. The purchase of the shares was funded by a loan from the Company and the unearned shares are pledged as
collateral for the borrowing. As the loan was repaid, earned shares were released from collateral and allocated to the participants. As shares
were earned, the Bank records compensation expense at the average market price of the shares during the period. Cash dividends received on
unearned shares were allocated among the participants and were reported as compensation expense. ESOP compensation expense, including
cash dividends received on unearned shares, approximated $88,000, $136,000 and $129,000 for the years ended December 31, 2005, 2004 and
2003, respectively. Total earned shares at December 31, 2005, 2004 and 2003 were 92,574, 86,998 and 79,367, respectively. Unearned ESOP
shares are not considered outstanding for purposes of computing earnings per share. All shares were earned at December 31, 2005.
NOTE 13: INCOME TAXES
The provision for income taxes for the years ended December 31, is as follows:
(In thousands) 2005 2004 2003
-------------------------------------
Current $(160) $ - $ 294
Deferred 109 502 307
-------------------------------------
$ (51) $ 502 $ 601
=====================================
The provision for income taxes includes the following:
(In thousands) 2005 2004 2003
-----------------------------------------------------
Federal Income Tax $ (29) $ 520 $ 631
New York State Franchise Tax (22) (18) (30)
-----------------------------------------------------
$ (51) $ 502 $ 601
=====================================================
Page 59
The components of net deferred tax asset, included in other assets for the years ended December 31, are as follows:
(In thousands) 2005 2004
---------------------------------------------------------------
ASSETS:
Deferred compensation $ 715 $ 672
Allowance for loan losses 654 712
Postretirement benefits 82 74
Mortgage recording tax credit carryforward 361 304
Investment securities 865 213
Other 121 49
---------------------------------------------------------------
$ 2,798 $ 2,024
===============================================================
LIABILITIES:
Prepaid pension (532) (345)
Depreciation (647) (671)
Accretion (37) (47)
Loan origination fees (250) (236)
Intangible assets (432) (328)
Prepaid expenses (79) (119)
---------------------------------------------------------------
$(1,977) $(1,746)
---------------------------------------------------------------
Net deferred tax asset $ 821 $ 278
===============================================================
The Company has a New York State mortgage recording tax credit that has no carry forward limitations. The Company has determined that no
valuation allowance is necessary as it is more likely than not deferred tax assets will be realized through carryback to taxable income in prior
years, future reversals of existing temporary differences and through future taxable income. A reconciliation of the federal statutory income tax
rate to the effective income tax rate for the years ended December 31, is as follows:
2005 2004 2003
---------------------------------------------------------------
Federal statutory income tax rate 34.0% 34.0% 34.0%
State tax (3.0) (0.9) (0.6)
Tax-exempt interest income, net of TEFRA (44.8) (6.0) (5.1)
Increase in value of life insurance (18.1) (3.1) (2.6)
Other 19.5 2.3 1.0
---------------------------------------------------------------
Effective income tax rate (12.4)% 26.3% 26.7%
===============================================================
Page 60
The following is a reconciliation of basic to diluted earnings per share for the years ended December 31:
(Dollars in thousands, except per share data) EARNINGS SHARES EPS
-----------------------------------------------------------------------
2005 Net Income $ 462
Basic EPS 462 2,456 $0.19
-----------------------------------------------------------------------
Effect of dilutive securities
Stock options - 25
-----------------------------------------------------------------------
Diluted EPS $ 462 2,481 $0.19
-----------------------------------------------------------------------
2004 Net Income $ 1,405
Basic EPS 1,405 2,435 $0.58
-----------------------------------------------------------------------
Effect of dilutive securities
Stock options - 44
-----------------------------------------------------------------------
Diluted EPS $ 1,405 2,479 $0.57
-----------------------------------------------------------------------
2003 Net Income $ 1,652
Basic EPS 1,652 2,424 $0.68
-----------------------------------------------------------------------
Effect of dilutive securities
Stock options - 48
-----------------------------------------------------------------------
Diluted EPS $ 1,652 2,472 $0.67
=======================================================================
NOTE 15: COMMITMENTS AND CONTINGENCIES
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to extend credit and standby letters of credit. Such commitments involve, to
varying degrees, elements of credit risk in excess of the amount recognized in the consolidated statement of condition. The contractual amount
of those commitments to extend credit reflects the extent of involvement the commitment has in this particular class of financial instrument.
The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend
credit is represented by the contractual amount of the instrument.
The Company's exposure to credit loss is represented by the contractual amount of these commitments. The Company uses the same credit
policies in making commitments as it does for on-balance sheet instruments.
Page 61
At December 31, 2005 and 2004, the following financial instruments were outstanding whose contract amounts represent credit risk:
CONTRACT AMOUNT
-----------------------------------------------------------------------
(In thousands) 2005 2004
-----------------------------------------------------------------------
Commitments to grant loans $ 6,371 $ 5,120
Unfunded commitments under lines of credit 12,361 12,021
Standby letters of credit 798 1,106
=======================================================================
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the
commitment amounts are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash
requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed
necessary by the Company upon extension of credit, is based on management's credit evaluation of the counter party. Collateral held varies but
may include residential real estate and income-producing commercial properties.
Unfunded commitments under standby letters of credit, revolving credit lines and overdraft protection agreements are commitments for
possible future extensions of credit to existing customers. These lines of credit usually do not contain a specified maturity date and may not be
drawn upon to the total extent to which the Company is committed.
Outstanding letters of credit written are conditional commitments issued by the Bank to guarantee the performance of a customer to a third
party. The majority of these standby letters of credit expire within the next twelve months. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending other loan commitments. The Bank requires collateral supporting these letters of credit as
deemed necessary. Management believes that the proceeds obtained through a liquidation of such collateral would be sufficient to cover the
maximum potential amount of future payments required under the corresponding guarantees. The amount of the liability as of December 31,
2005 and 2004 or guarantees under standby letters of credit issued is not material.
The Company leases land and leasehold improvements under agreements that expire in various years with renewal options over the next 30
years. Rental expense, included in operating expenses, amounted to $42,000, $41,000 and $41,000 in 2005, 2004 and 2003, respectively. In
October 2002, the Company entered into a land lease with one of its directors on an arms-length basis. The rent expense paid to the related
party during 2005, 2004 and 2003 was $23,000, $21,000 and $21,000, respectively. Approximate minimum rental commitments for the
noncancelable operating leases are as follows:
YEARS ENDING DECEMBER 31:
------------------------------------
(In thousands)
2006 $ 47
2007 47
2008 51
2009 51
2010 51
Thereafter 115
-----------------------------------
Total minimum lease payments $362
===================================
NOTE 16: DIVIDENDS AND RESTRICTIONS
The board of directors of Pathfinder Bancorp, M.H.C., determines whether the Holding Company will waive or receive dividends declared by
the Company each time the Company declares a dividend, which is expected to be on a quarterly basis. The Holding Company may elect to
receive dividends and utilize such funds
Page 62
to pay expenses or for other allowable purposes. The Office of Thrift Supervision ("OTS") has indicated that (i) the Holding Company shall
provide the OTS annually with written notice of its intent to waive its dividends prior to the proposed date of the dividend, and the OTS shall
have the authority to approve or deny any dividend waiver request; (ii) if a waiver is granted, dividends waived by the Holding Company will
be excluded from the Company's capital accounts for purposes of calculating dividend payments to minority shareholders; (iii) the Company
shall establish a restricted capital account in the amount of any dividends waived by the Holding Company, and the amount of any dividend
waived by the Holding Company shall be available for declaration as a dividend solely to the Holding Company. During 2005, the Company
paid cash dividends totaling $325,000 to the Holding Company. For the second and fourth quarters ending June 30, 2005 and December 31,
2005, respectively, the Holding Company waived the right to receive its portion of the cash dividends declared on June 28, 2005 and December
27, 2005, respectively, which totaled $325,000. The Company maintains a restricted capital account with a $1,532,000 balance, representing
the Holding Company's portion of dividends waived as of December 31, 2005. During 2004 and 2003, the Holding Company waived dividends
totaling $320,000 and $317,000, respectively.
The Company's ability to pay dividends to its shareholders is largely dependent on the Bank's ability to pay dividends to the Company. In
addition to state law requirements and the capital requirements discussed in Note 17 the circumstances under which the Bank may pay
dividends are limited by federal statutes, regulations and policies. The amount of retained earnings legally available under these regulations
approximated $1,670,000 as of December 31, 2005. Dividends paid by the Bank to the Company would be prohibited if the effect thereof
would cause the Bank's capital to be reduced below applicable minimum capital requirements.
NOTE 17: REGULATORY MATTERS
The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking
agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative
measures of the their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital
amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain amounts and ratios (set forth in the
table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to
average assets (as defined). Management believes, as of December 31, 2005, that the Bank meets all capital adequacy requirements to which it
is subject.
Page 63
As of December 31, 2005, the Bank's most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as "well-
capitalized", under the regulatory framework for prompt corrective action. To be categorized as "well-capitalized", the Bank must maintain
total risk based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the tables below. There are no conditions or events since that
notification that management believes have changed the Bank's category. The Company's and the Bank's actual capital amounts and ratios as of
December 31, 2005and 2004 are also presented in the following table.
"To Be Well
Capitalized"
For Capital Under Prompt
Actual Adequacy Purposes Corrective Provisions
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
-----------------------------------------------------------------------------------------------
COMPANY
As of December 31, 2005:
Total Core Capital (to Risk-Weighted Assets) $24,802 13.5% $14,706 8.0% N/A N/A
Tier 1 Capital (to Risk-Weighted Assets) $23,123 12.6% $ 7,353 4.0% N/A N/A
Tier 1 Capital (to Average Assets) $23,123 7.6% $12,167 4.0% N/A N/A
---------------------------------------------------------------------------------------------
BANK
As of December 31, 2005:
Total Core Capital (to Risk-Weighted Assets) $22,957 12.6% $14,615 8.0% $18,269 10.0%
Tier 1 Capital (to Risk-Weighted Assets) $21,278 11.7% $ 7,307 4.0% $10,961 6.0%
Tier 1 Capital (to Average Assets) $21,278 7.1% $11,927 4.0% $14,909 5.0%
-----------------------------------------------------------------------------------------------
COMPANY
As of December 31, 2004:
Total Core Capital (to Risk-Weighted Assets) $24,493 13.5% $14,472 8.0% N/A N/A
Tier 1 Capital (to Risk-Weighted Assets) $22,666 12.5% $ 7,236 4.0% N/A N/A
Tier 1 Capital (to Average Assets) $22,666 7.7% $11,775 4.0% N/A N/A
------------------------------------------------------------------------------------------------
BANK
As of December 31, 2004:
Total Core Capital (to Risk-Weighted Assets) $22,974 12.8% $14,416 8.0% $18,020 10.0%
Tier 1 Capital (to Risk-Weighted Assets) $21,147 11.7% $ 7,208 4.0% $10,812 6.0%
Tier 1 Capital (to Average Assets) $21,147 7.1% $11,947 4.0% $14,934 5.0%
-----------------------------------------------------------------------------------------------
The Bank is required to maintain average balances on hand or with the Federal Reserve Bank. At December 31, 2005 and 2004, these reserve
balances amounted to $1,608,000 and $2,419,000, respectively.
NOTE 18: FAIR VALUES OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosure About Fair Value of Financial Instruments," requires disclosure of fair value information of financial instruments,
whether or not recognized in the consolidated statement of condition, for which it is practicable to estimate that value. In cases where quoted
market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are
significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair
value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate
settlement of the instrument.
Management uses its best judgment in estimating the fair value of the Company's financial instruments; however, there are inherent weaknesses
in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative
of the amounts the Company could have realized in a sales transaction on the dates indicated. The
Page 64
estimated fair value amounts have been measured as of their respective year-ends, and have not been re-evaluated or updated for purposes of
these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to
the respective reporting dates may be different than the amounts reported at each year-end.
The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only
provided for a limited portion of the Company's assets and liabilities. Due to a wide range of valuation techniques and the degree of
subjectivity used in making the estimates, comparisons between the Company's disclosures and those of other companies may not be
meaningful. The company, in estimating its fair value disclosures for financial instruments, used the following methods and assumptions:
CASH AND CASH EQUIVALENTS - the carrying amounts approximate fair value.
INVESTMENT SECURITIES - fair values of securities are based on quoted market prices, where available. If quoted market prices are not
available, fair values are based on quoted market prices of comparable instruments.
LOANS AND MORTGAGE LOANS HELD-FOR-SALE - for variable rate loans that reprice frequently and with no significant credit risk,
fair values approximate carrying values. Fair values for fixed rate loans are estimated using discounted cash flow analysis, using interest rates
currently being offered for loans with similar terms to borrowers of similar credit quality.
FEDERAL HOME LOAN BANK STOCK - the carrying amounts reported approximate fair value.
MORTGAGE SERVICING RIGHTS - the carrying amount approximates fair value.
ACCRUED INTEREST RECEIVABLE AND PAYABLE - the carrying amounts of accrued interest receivable and payable approximate their
fair values.
DEPOSIT LIABILITIES - The fair values disclosed for demand deposits (e.g., interest-bearing and noninterest-bearing checking, passbook
savings and certain types of money management accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e.,
their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies
interest rates currently being offered on certificates of deposits to a schedule of aggregated expected monthly maturities on time deposits.
BORROWINGS - the fair values for short-term borrowings and junior subordinated debentures approximate the carrying amounts. The fair
values for long-term borrowings were estimated using discounted cash flow analysis based on the Company's current incremental borrowing
rates for similar types of borrowing arrangements.
OFF-BALANCE SHEET INSTRUMENTS - Fair values for the Company's off-balance sheet instruments are based on fees currently charged
to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing.
Page 65
The carrying amounts and fair values of the Company's financial instruments as of December 31 are presented in the following table:
2005 2004
---------------------------------------------------------------------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
(Dollars in thousands) AMOUNTS FAIR VALUES AMOUNTS FAIR VALUES
---------------------------------------------------------------------------------------
FINANCIAL ASSETS:
Cash and cash equivalents $ 7,895 $ 7,895 $ 14,325 $ 14,325
Investment securities 74,239 74,239 75,069 75,069
Mortgage loans held-for-sale - - 2,159 2,329
Net Loans 187,889 189,598 185,125 190,034
Federal Home Loan Bank Stock 1,805 1,805 1,768 1,768
Accrued interest receivable 1,678 1,678 1,505 1,505
Mortgage servicing rights 146 146 198 198
---------------------------------------------------------------------------------------
FINANCIAL LIABILITIES:
Deposits $ 236,377 $ 236,552 $ 236,672 $ 237,410
Borrowed funds 31,360 33,883 35,360 36,360
Junior subordinated debentures 5,155 5,155 5,155 5,155
Accrued interest payable 161 161 143 143
---------------------------------------------------------------------------------------
OFF-BALANCE SHEET INSTRUMENTS:
Standby letter of credit $ - $ - $ - $ -
Commitments to extend credit - - - -
Forward rate lock commitments - - - -
=======================================================================================
NOTE 19: PARENT COMPANY - FINANCIAL INFORMATION
The following represents the condensed financial information of Pathfinder Bancorp, Inc. for years ended December 31:
STATEMENTS OF CONDITION 2005 2004
-----------------------------------------------------------------------------
(In thousands)
ASSETS
Cash $ 245 $ 982
Investments 19 -
Receivable from bank subsidiary - 41
Investment in subsidiaries 24,602 25,698
Due from subsidiaries 1,125 240
Other assets 207 243
---------------------------------------------------------------------------
Total assets $26,198 $27,204
===========================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Accrued liabilities 115 223
Junior subordinated debentures 5,155 5,155
Shareholders' equity 20,928 21,826
---------------------------------------------------------------------------
Total liabilities and shareholders' equity $26,198 $27,204
===========================================================================
--------------------------------------------------------------------------------
Page 66
STATEMENTS OF INCOME 2005 2004 2003
----------------------------------------------------------------------------------
(In thousands)
Interest income $ 14 $ 9 $ 16
Interest expense 352 259 243
----------------------------------------------------------------------------------
Net interest expense (338) (250) (227)
Operating expense (92) (130) (106)
Realized gain on sale of investment security - 330 104
Amortization of deferred financing costs (30) (30) (30)
----------------------------------------------------------------------------------
Loss before tax benefit and equity in
undistributed net income of subsidiaries (460) (80) (259)
----------------------------------------------------------------------------------
Tax benefit 128 20 73
----------------------------------------------------------------------------------
Loss before equity in undistributed net
income of subsidiaries (332) (60) (186)
Equity in undistributed net income of subsidiaries 794 1,465 1,837
----------------------------------------------------------------------------------
Net income $ 462 $ 1,405 $ 1,652
==================================================================================
STATEMENTS OF CASH FLOWS 2005 2004 2003
----------------------------------------------------------------------------------
(In thousands)
OPERATING ACTIVITIES
Net Income $ 462 $ 1,405 $ 1,652
Equity in undistributed earnings of subsidiaries (794) (1,465) (1,837)
Realized gain on sale of investment security - (330) (104)
ESOP shares earned 88 133 122
Amortization of deferred financing costs 30 30 30
Other operating activities (987) (304) 81
----------------------------------------------------------------------------------
Net cash used in operating activities (1,201) (531) (56)
----------------------------------------------------------------------------------
INVESTING ACTIVITIES
Proceeds from loan to subsidiary 41 56 56
Dividends receivable 911 8 7
Purchase of investments (18) - -
Proceeds from sale of investments - 430 154
----------------------------------------------------------------------------------
Net cash provided by investing activities 934 494 217
----------------------------------------------------------------------------------
FINANCING ACTIVITIES
Proceeds from exercise of stock options 213 140 35
Dividend received from subsidiary - - 1,500
Cash dividends (683) (664) (651)
Treasury stock purchased - - (2,687)
----------------------------------------------------------------------------------
Net used in financing activities (470) (524) (1,803)
----------------------------------------------------------------------------------
Decrease in cash and cash equivalents (737) (561) (1,643)
Cash and cash equivalents at beginning of year 982 1,543 3,186
----------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 245 $ 982 $ 1,543
==================================================================================
Page 67
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A: 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 annual 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.
ITEM 9B: OTHER INFORMATION
None
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
PART III
(a) Information concerning the directors of the Company is incorporated by reference hereunder in the Company's Proxy Materials for the
Annual Meeting of Stockholders.
(b) Set forth below is information concerning the Executive Officers of the Company at December 31, 2005
NAME AGE POSITIONS HELD WITH THE COMPANY
Thomas W. Schneider 44 President and Chief Executive Officer
James A. Dowd, CPA 38 Vice President, Chief Financial Officer
Edward A. Mervine 49 Vice President, General Counsel
John F. Devlin 41 Vice President, Senior Commercial Lender
Melissa A. Miller 48 Vice President, Chief Operating Officer
Rhonda Hutchis 47 Vice President, Retail Lending
Page 68
ITEM 11: EXECUTIVE COMPENSATION
Information with respect to management compensation and transactions required under this item is incorporated by reference hereunder in the
Company's Proxy Materials for the Annual Meeting of Stockholders under the caption "Compensation".
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
The information contained under the sections captioned "Stock Ownership of Management" is incorporated by reference to the Company's
Proxy Materials for its Annual Meeting of Stockholders.
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is set forth under the caption "Certain Transactions" in the Definitive Proxy Materials for the Annual
Meeting of Stockholders and is incorporated herein by reference.
ITEM 14: PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is set forth under the caption "Audit and Related Fees" in the Definitive Proxy Materials for the Annual
Meeting of Stockholders and is incorporated herein by reference.
Page 69
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements - The Company's consolidated financial statements, for the years ended December 31, 2005, 2004 and 2003,
together with the Report of Independent Registered Public Accounting Firm are filed as part of this Form 10-K report. See "Item 8: Financial
Statements and Supplementary Data." The supplemental financial information listed and appearing hereafter should be read in conjunction with
the financial statements included in this report.
(a)(2) Financial Statement Schedules - All financial statement schedules have been omitted as the required information is inapplicable or has
been included in "Item 7: Management Discussion and Analysis."
(b) Exhibits
3.1 Certificate of Incorporation of Pathfinder Bancorp, Inc. (Incorporated herein by reference to the Company's Current Report on Form 8-K
dated June 25, 2001)
3.2 Bylaws of Pathfinder Bancorp, Inc. (Incorporated herein by reference to the Company's Quarterly Report on Form 10Q dated August 15,
2005)
4 Form of Stock Certificate of Pathfinder Bancorp, Inc. (Incorporated herein by reference to the Company's Current Report on Form 8-K dated
June 25, 2001)
10.1 Form of Pathfinder Bank 1997 Stock Option Plan (Incorporated herein by reference to the Company's S-8 file no. 333-53027)
10.2 Form of Pathfinder Bank 1997 Recognition and Retention Plan
(Incorporated by reference to the Company's S-8 file no. 333-53027)
10.3 2003 Executive Deferred Compensation Plan (Incorporated by herein by reference to the Company's Quarterly Report on Form 10-Q for
the quarter ended March 31, 2004 file no. 000-23601)
10.4 2003 Trustee Deferred Fee Plan (Incorporated by herein by reference to the Company's Quarterly Report on Form 10-Q for the quarter
ended March 31, 2004 file no. 000-23601)
10.5 Employment Agreement between the Bank and Thomas W. Schneider, President and Chief Executive Officer (Incorporated by reference
to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2004 file no. 000-23601)
10.6 Employment Agreement between the Bank and Edward A. Mervine, Corporate Counsel (Incorporated by reference to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2004 file no. 000-23601)
21 Subsidiaries of Company
23 Consent of Beard Miller Company LLP
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 and Chief Financial Officer
Page 70
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Pathfinder Bancorp, Inc.
Date: March 30, 2006 By: /s/ Thomas W. Schneider
Thomas W. Schneider
President and Chief Executive Officer
Pursuant to the requirement of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
By: /s/ Janette Resnick
Janette Resnick, Chairman of the Board
Date: March 30, 2006
By: /s/ Thomas W. Schneider By:/s/ Chris R. Burritt
Thomas W. Schneider, President Chris R. Burritt, Director
and Chief Executive Officer
Date: March 30, 2006 Date: March 30, 2006
By: /s/ James A. Dowd By:/s/ George P. Joyce
James A. Dowd, Vice President, George P. Joyce, Director
Chief Financial Officer and
Trust Officer
Date: March 30, 2006 Date: March 30, 2006
By: /s/ Bruce E. Manwaring By:/s/ Corte J. Spencer
Bruce E. Manwaring, Director Corte J. Spencer, Director
Date: March 30, 2006 Date: March 30, 2006
By: /s/ L. William Nelson, Jr. By:/s/ Chris C. Gagas
L. William Nelson, Jr. Director Chris C. Gagas, Director
Date: March 30, 2006 Date: March 30, 2006
By: /s/ Steven W. Thomas By:/s/ Lloyd Stemple
Steven W. Thomas, Director Lloyd Stemple, Director
Date: March 30, 2006 Date: March 30, 2006
Page 71
EXHIBIT 21: SUBSIDIARIES OF THE COMPANY
Company Percent Owned
Pathfinder Bank (1) 100% Pathfinder Statutory Trust 100%
(1) Pathfinder Commercial Bank, Pathfinder REIT, Inc. and Whispering Oaks Development Corporation, 100% owned by Pathfinder Bank
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Pathfinder Bancorp, Inc.
Oswego, New York
We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 33-53027) of Pathfinder Bancorp, Inc. of
our report dated February 3, 2006, relating to the consolidated financial statements which appear in this Annual Report on Form 10-K.
/s/ BEARD MILLER COMPANY LLP
Beard Miller Company LLP
Harrisburg, Pennsylvania
March 24, 2006
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, President and Chief Executive Officer, certify that:
1. I have reviewed this annual report on Form 10-K 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 officers 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.
March 30, 2006 /s/ Thomas W. Schneider
Thomas W. Schneider
President and Chief Executive Officer
EXHIBIT 31.2RULE 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, Vice President and Chief Financial Officer, certify that:
1. I have reviewed this annual report on Form 10-K 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 officers 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.
March 30, 2006 /s/ James A. Dowd
James A. Dowd
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 Annual Report of the
Company on Form 10-K for the year ended December 31, 2005 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.
March 30, 2006 /s/ Thomas W. Schneider
Thomas W. Schneider
President and Chief Executive Officer
March 30, 2006 /s/ James A. Dowd
James A. Dowd
Vice President and Chief Financial Officer