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Pathfinder Bancorp, Inc. - Quarter Report: 2014 September (Form 10-Q)

UNITED STATES
 SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
_____________________________

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
       EXCHANGE ACT OF 1934

       For the quarterly period ended September 30, 2014

OR
[  ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
       EXCHANGE ACT OF 1934
     For the transition period from _______ to _______


PATHFINDER BANCORP, INC.
(Exact Name of Company as Specified in its Charter)

Maryland
(State of Other Jurisdiction of Incorporation)
001-36695
(Commission File No.)
38-3941859
(I.R.S. Employer Identification No.)
 

214 West First Street, Oswego, NY 13126
(Address of Principal Executive Office) (Zip Code)

(315) 343-0057
(Issuer's Telephone Number including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES T        NO *                                        

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this Chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
YES T        NO *

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer*                                        Accelerated filer*                                    Non-accelerated filer*                               Smaller reporting company  T
                      (Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   YES *    NO T

As of November 7, 2014, there were 4,352,203 shares issued and outstanding of the registrant's common stock.


 
PATHFINDER BANCORP, INC.
INDEX



PART I - FINANCIAL INFORMATION
 
PAGE NO.
 
 
 
 
Item 1.
Consolidated Financial Statements (Unaudited)
 
 
 
 
3
 
 
4
 
 
5
 
 
6
 
 
7
 
 
8
 
 
 
 
Item 2.
 
32
 
and Results of Operations (Unaudited)
 
 
 
 
 
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
48
 
 
 
 
Item 4.
 
48
 
 
 
 
PART II - OTHER INFORMATION
 
49
 
 
 
 
Item 1.
Legal Proceedings
 
 
Item 1A.
Risk Factors
 
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
 
Item 3.
Defaults upon Senior Securities
 
 
Item 4.
Mine Safety Disclosures
 
 
Item 5.
Other information
 
 
Item 6.
Exhibits
 
 
 
 
 
 
SIGNATURES
 
51
 
 
 
 
 
 
 
 
 


PART I -  FINANCIAL INFORMATION
Item 1 – Consolidated Financial Statements
Pathfinder Bancorp, Inc.
Consolidated Statements of Condition
(Unaudited)
 
 
September 30,
   
December 31,
 
(In thousands, except share and per share data)
 
2014
   
2013
 
ASSETS:
 
   
 
Cash and due from banks
 
$
7,432
   
$
6,535
 
Interest earning deposits
   
17,550
     
10,040
 
Total cash and cash equivalents
   
24,982
     
16,575
 
Interest earning time deposits
   
500
     
500
 
Available-for-sale securities, at fair value
   
94,135
     
80,959
 
Held-to-maturity securities, at amortized cost (fair value of $43,629 and $34,222, respectively)
   
42,477
     
34,412
 
Federal Home Loan Bank stock, at cost
   
1,829
     
2,440
 
Loans
   
374,257
     
341,633
 
Less: Allowance for loan losses
   
5,171
     
5,041
 
Loans receivable, net
   
369,086
     
336,592
 
Premises and equipment, net
   
12,945
     
11,644
 
Accrued interest receivable
   
1,865
     
1,715
 
Foreclosed real estate
   
440
     
619
 
Intangible assets, net
   
178
     
187
 
Goodwill
   
4,367
     
4,367
 
Bank owned life insurance
   
10,238
     
8,268
 
Other assets
   
6,992
     
5,515
 
Total assets
 
$
570,034
   
$
503,793
 
 
               
LIABILITIES AND SHAREHOLDERS' EQUITY:
               
Deposits:
               
Interest-bearing
 
$
390,928
   
$
361,969
 
Noninterest-bearing
   
92,101
     
48,171
 
Total deposits
   
483,029
     
410,140
 
Short-term borrowings
   
14,000
     
24,000
 
Long-term borrowings
   
17,021
     
16,853
 
Junior subordinated debentures
   
5,155
     
5,155
 
Accrued interest payable
   
73
     
86
 
Other liabilities
   
5,387
     
4,489
 
Total liabilities
   
524,665
     
460,723
 
Shareholders' equity:
               
Preferred stock - SBLF, par value $0.01 per share; $1,000 liquidation preference;
               
13,000 shares authorized; 13,000 shares issued and outstanding
   
13,000
     
13,000
 
Common stock, par value $0.01; authorized 10,000,000 shares;
               
2,979,969 and 2,979,969 shares issued and 2,625,182 and 2,623,182 shares outstanding
   
30
     
30
 
Additional paid in capital
   
8,334
     
8,226
 
Retained earnings
   
30,407
     
28,788
 
Accumulated other comprehensive loss
   
(1,330
)
   
(1,745
)
Unearned ESOP
   
(743
)
   
(826
)
Treasury stock, at cost; 354,787 and 356,787 shares,  respectively
   
(4,735
)
   
(4,761
)
Total Pathfinder Bancorp, Inc. shareholders' equity
   
44,963
     
42,712
 
Noncontrolling interest
   
406
     
358
 
Total equity
   
45,369
     
43,070
 
Total liabilities and shareholders' equity
 
$
570,034
   
$
503,793
 
 
The accompanying notes are an integral part of the consolidated financial statements.
               


 



Pathfinder Bancorp, Inc.
Consolidated Statements of Income
(Unaudited)
 
 
   
   
   
 
 
 
For the three
   
For the three
   
For the nine
   
For the nine
 
 
 
months ended
   
months ended
   
months ended
   
months ended
 
(In thousands, except per share data)
 
September 30, 2014
   
September 30, 2013
   
September 30, 2014
   
September 30, 2013
 
Interest and dividend income:
 
   
   
   
 
Loans, including fees
 
$
4,344
   
$
4,057
   
$
12,512
   
$
12,298
 
Debt securities:
                               
Taxable
   
473
     
399
     
1,360
     
1,181
 
Tax-exempt
   
196
     
189
     
585
     
569
 
Dividends
   
35
     
29
     
85
     
89
 
Interest earning time deposits
   
2
     
5
     
6
     
16
 
Federal funds sold and interest earning deposits
   
2
     
2
     
4
     
5
 
       Total interest income
   
5,052
     
4,681
     
14,552
     
14,158
 
Interest expense:
                               
Interest on deposits
   
479
     
605
     
1,505
     
1,894
 
Interest on short-term borrowings
   
28
     
23
     
68
     
40
 
Interest on long-term borrowings
   
149
     
151
     
443
     
575
 
       Total interest expense
   
656
     
779
     
2,016
     
2,509
 
          Net interest income
   
4,396
     
3,902
     
12,536
     
11,649
 
Provision for loan losses
   
410
     
216
     
930
     
816
 
          Net interest income after provision for loan losses
   
3,986
     
3,686
     
11,606
     
10,833
 
Noninterest income:
                               
Service charges on deposit accounts
   
311
     
313
     
894
     
856
 
Earnings and gain on bank owned life insurance
   
64
     
60
     
190
     
172
 
Loan servicing fees
   
81
     
30
     
202
     
112
 
Net gains on sales and redemptions of investment securities
   
3
     
17
     
29
     
116
 
Net gains on sales of loans and foreclosed real estate
   
10
     
36
     
39
     
487
 
Debit card interchange fees
   
127
     
114
     
369
     
341
 
Other charges, commissions & fees
   
304
     
134
     
880
     
400
 
          Total noninterest income
   
900
     
704
     
2,603
     
2,484
 
Noninterest expense:
                               
Salaries and employee benefits
   
2,141
     
2,033
     
6,526
     
5,884
 
Building occupancy
   
421
     
382
     
1,193
     
1,109
 
Data processing
   
367
     
356
     
1,131
     
1,067
 
Professional and other services
   
160
     
178
     
508
     
502
 
Advertising
   
141
     
146
     
372
     
393
 
FDIC assessments
   
99
     
123
     
294
     
291
 
Audits and exams
   
61
     
61
     
186
     
184
 
Other expenses
   
422
     
388
     
1,273
     
1,343
 
          Total noninterest expenses
   
3,812
     
3,667
     
11,483
     
10,773
 
Income before income taxes
   
1,074
     
723
     
2,726
     
2,544
 
Provision for income taxes
   
317
     
195
     
767
     
688
 
Net income attributable to noncontrolling interest and Pathfinder Bancorp, Inc .
   
757
     
528
     
1,959
     
1,856
 
Net income attributable to noncontrolling interest
   
11
     
-
     
48
     
-
 
Net income attributable to Pathfinder Bancorp Inc.
 
$
746
   
$
528
   
$
1,911
   
$
1,856
 
Preferred stock dividends
   
33
     
-
     
63
     
-
 
Net income available to common shareholders
 
$
713
   
$
528
   
$
1,848
   
$
1,856
 
 
                               
Earnings per common share - basic
 
$
0.28
   
$
0.21
   
$
0.73
   
$
0.74
 
Earnings per common share - diluted
 
$
0.28
   
$
0.20
   
$
0.72
   
$
0.73
 
Dividends per common share
 
$
0.03
   
$
0.03
   
$
0.09
   
$
0.09
 

The accompanying notes are an integral part of the consolidated financial statements.


 

Pathfinder Bancorp, Inc.
Consolidated Statements of Comprehensive Income (Loss)
(Unaudited)
 
 
   
   
   
 
 
 
For the three months ended
   
For the nine months ended
 
(In thousands)
 
September 30, 2014
   
September 30, 2013
   
September 30, 2014
   
September 30, 2013
 
Net Income
 
$
757
   
$
528
   
$
1,959
   
$
1,856
 
 
                               
Other Comprehensive Income (Loss)
                               
Retirement Plans:
                               
Net unrealized gains on retirement plans
   
11
     
95
     
33
     
286
 
 
                               
Unrealized holding gains on financial derivative:
                               
Change in unrealized holding gains (losses) on financial derivative
   
2
     
(10
)
   
(6
)
   
2
 
Reclassification adjustment for interest expense included in net income
   
16
     
15
     
47
     
46
 
Net unrealized gain on financial derivative
   
18
     
5
     
41
     
48
 
 
                               
Unrealized holding (losses) gains on available-for-sale securities:
                               
Unrealized holding (losses) gains arising during the period
   
(69
)
   
1,401
     
561
     
(1,888
)
Reclassification adjustment for net gains included in net income
   
(3
)
   
(17
)
   
(29
)
   
(116
)
Net unrealized (losses) gains on securities available-for-sale
   
(72
)
   
1,384
     
532
     
(2,004
)
 
                               
Accretion of net unrealized loss on securities transferred to held-to-maturity(1)
   
30
     
(1,332
)
   
90
     
(1,332
)
 
                               
Other comprehensive (loss) income,  before tax
   
(13
)
   
152
     
696
     
(3,002
)
Tax effect
   
3
     
(56
)
   
(281
)
   
1,201
 
Other comprehensive (loss) income, net of tax
   
(10
)
   
96
     
415
     
(1,801
)
Comprehensive income
   
747
     
624
     
2,374
     
55
 
Comprehensive income attributable to noncontrolling interest
   
11
     
-
     
48
     
-
 
Comprehensive income attributable to Pathfinder Bancorp, Inc.
 
$
736
   
$
624
   
$
2,326
   
$
55
 
 
                               
 
                               
Tax Effect Allocated to Each Component of Other Comprehensive Income (Loss)
                               
Retirement plan net losses recognized in plan expenses
 
$
(4
)
 
$
(38
)
 
$
(13
)
 
$
(115
)
Change in unrealized holding  losses on financial derivative
   
(1
)
   
5
     
2
     
-
 
Reclassification adjustment for interest expense included in net income
   
(6
)
   
(6
)
   
(19
)
   
(18
)
Unrealized holding gains (losses) arising during the period
   
27
     
(557
)
   
(226
)
   
755
 
Reclassification adjustment for net gains included in net income
   
1
     
7
     
12
     
46
 
Accretion of net unrealized loss on securities transferred to held-to-maturity(1)
   
(14
)
   
533
     
(37
)
   
533
 
Income tax effect related to other comprehensive income
 
$
3
   
$
(56
)
 
$
(281
)
 
$
1,201
 
 
                               
(1) The accretion of the unrealized holding losses in accumulated other comprehensive loss at the date of transfer partially offsets the amortization of the difference between the par value and the fair value of the investment securities at the date of transfer, and is an adjustment of yield.
                               
 
                               
The accompanying notes are an integral part of the consolidated financial statements.
                               
 
                               



 


PATHFINDER BANCORP, INC.
 
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
 
Nine months ended September 30, 2014 and September 30, 2013
'(Unaudited)
 
 
 
   
   
   
   
Accumulated
   
   
   
   
 
 
 
   
   
Additional
   
   
Other Com-
   
   
   
Non-
   
 
 
 
Preferred
   
Common
   
Paid in
   
Retained
   
prehensive
   
Unearned
   
Treasury
   
controlling
   
 
 (In thousands, except share and per share data)
 
Stock
   
Stock
   
Capital
   
Earnings
   
Loss
   
ESOP
   
Stock
   
Interest
   
Total
 
 
 
   
   
   
   
   
   
   
   
 
 Balance, January 1, 2014
 
$
13,000
   
$
30
   
$
8,226
   
$
28,788
   
$
(1,745
)
 
$
(826
)
 
$
(4,761
)
 
$
358
   
$
43,070
 
 
                                                                       
 Net income
   
-
     
-
     
-
     
1,911
     
-
     
-
     
-
     
48
     
1,959
 
 
                                                                       
 Other comprehensive income, net of tax
   
-
     
-
     
-
     
-
     
415
     
-
     
-
     
-
     
415
 
 
                                                                       
 Preferred stock dividends - SBLF
   
-
     
-
     
-
     
(63
)
   
-
     
-
     
-
     
-
     
(63
)
 
                                                                       
 ESOP shares earned (9,375 shares)
   
-
     
-
     
53
     
-
     
-
     
83
     
-
     
-
     
136
 
 
                                                                       
 Stock based compensation
   
-
     
-
     
63
     
-
     
-
     
-
     
-
     
-
     
63
 
 
                                                                       
 Stock options exercised
   
-
     
-
     
(8
)
   
-
     
-
     
-
     
26
     
-
     
18
 
 
                                                                       
 Common stock dividends declared
 ($0.09 per share)
   
-
     
-
     
-
     
(229
)
   
-
     
-
     
-
     
-
     
(229
)
 Balance, September 30, 2014
 
$
13,000
   
$
30
   
$
8,334
   
$
30,407
   
$
(1,330
)
 
$
(743
)
 
$
(4,735
)
 
$
406
   
$
45,369
 
 
                                                                       
 Balance, January 1, 2013
 
$
13,000
   
$
30
   
$
8,120
   
$
26,685
   
$
(1,318
)
 
$
(936
)
 
$
(4,834
)
 
$
-
   
$
40,747
 
 
                                                                       
 Net income
   
-
     
-
     
-
     
1,856
     
-
     
-
     
-
     
-
     
1,856
 
 
                                                                       
 Other comprehensive loss, net of tax
   
-
     
-
     
-
     
-
     
(1,801
)
   
-
     
-
     
-
     
(1,801
)
 
                                                                       
 ESOP shares earned (9,375 shares)
   
-
     
-
     
38
     
-
     
-
     
83
     
-
     
-
     
121
 
 
                                                                       
 Stock based compensation
   
-
     
-
     
59
     
-
     
-
     
-
     
-
     
-
     
59
 
 
                                                                       
 Stock options exercised
   
-
     
-
     
(6
)
   
-
     
-
     
-
     
6
     
-
     
-
 
 
                                                                       
 Common stock dividends declared
 ($0.09 per share)
   
-
     
-
     
-
     
(227
)
   
-
     
-
     
-
     
-
     
(227
)
 Balance, September 30, 2013
 
$
13,000
   
$
30
   
$
8,211
   
$
28,314
   
$
(3,119
)
 
$
(853
)
 
$
(4,828
)
 
$
-
   
$
40,755
 


The accompanying notes are an integral part of the consolidated financial statements.


 
PATHFINDER BANCORP, INC.
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
(Unaudited)
 
 
 
For the nine months ended September 30,
 
(In thousands)
 
2014
   
2013
 
OPERATING ACTIVITIES
 
   
 
Net income attributable to Pathfinder Bancorp, Inc.
 
$
1,911
   
$
1,856
 
Adjustments to reconcile net income to net cash flows from operating activities:
               
Provision for loan losses
   
930
     
816
 
Proceeds from sales of loans
   
-
     
11,456
 
Originations of loans held-for-sale
   
-
     
(11,016
)
Realized gains on sales and redemptions of:
               
Real estate acquired through foreclosure
   
(39
)
   
(47
)
Loans
   
-
     
(440
)
Available-for-sale investment securities
   
(29
)
   
(116
)
Depreciation
   
596
     
532
 
Amortization of mortgage servicing rights
   
11
     
(82
)
Amortization of deferred loan costs
   
91
     
83
 
Earnings on bank owned life insurance
   
(190
)
   
(170
)
Realized gain on proceeds from bank owned life insurance
   
-
     
(2
)
Net amortization of premiums and discounts on investment securities
   
530
     
567
 
Amortization of intangible assets
   
9
     
-
 
Stock based compensation and ESOP expense
   
199
     
180
 
Net change in accrued interest receivable
   
(150
)
   
(89
)
Net change in other assets and liabilities
   
(811
)
   
927
 
Net cash flows from operating activities
   
3,058
     
4,455
 
INVESTING ACTIVITIES
               
Purchase of investment securities available-for-sale
   
(27,099
)
   
(34,861
)
Purchase of investment securities held-to-maturity
   
(8,767
)
   
-
 
Proceeds from maturities of interest earning time deposits
   
-
     
500
 
Net proceeds from (purchases of) Federal Home Loan Bank stock
   
611
     
(984
)
Proceeds from maturities and principal reductions of
               
investment securities available-for-sale
   
13,545
     
18,353
 
Proceeds from maturities and principal reductions of
               
investment securities held-to-maturity
   
692
     
68
 
Proceeds from sales and redemptions of:
               
Available-for-sale investment securities
   
510
     
5,589
 
Real estate acquired through foreclosure
   
667
     
324
 
Purchase of bank owned life insurance
   
(1,780
)
   
-
 
Proceeds from bank owned life insurance
   
-
     
2
 
Net change in loans
   
(33,989
)
   
(4,811
)
Purchase of premises and equipment
   
(1,897
)
   
(607
)
Net cash flows from investing activities
   
(57,507
)
   
(16,427
)
FINANCING ACTIVITIES
               
Net change in demand deposits, NOW accounts, savings accounts,
               
money management deposit accounts, MMDA accounts and escrow deposits
   
52,925
     
21,953
 
Net change in time deposits and brokered deposits
   
19,964
     
(12,459
)
Net change in short-term borrowings
   
(10,000
)
   
15,000
 
Proceeds from long-term borrowings
   
250
     
-
 
Payments on long-term borrowings
   
(82
)
   
(9,083
)
Proceeds from exercise of stock options
   
18
     
-
 
Cash dividends paid to preferred shareholder - SBLF
   
(31
)
   
-
 
Cash dividends paid to common shareholders
   
(236
)
   
(83
)
Change in noncontrolling interest, net
   
48
     
(227
)
Net cash flows from financing activities
   
62,856
     
15,101
 
Change in cash and cash equivalents
   
8,407
     
3,129
 
Cash and cash equivalents at beginning of period
   
16,575
     
8,665
 
Cash and cash equivalents at end of period
 
$
24,982
   
$
11,794
 
CASH PAID DURING THE PERIOD FOR:
               
Interest
 
$
2,029
   
$
2,577
 
Income taxes
   
331
     
668
 
NON-CASH INVESTING ACTIVITY
               
Real estate acquired in exchange for loans
   
474
     
170
 
Transfer of available-for-sale securities to held-to-maturity
   
-
     
32,495
 
 
The accompanying notes are an integral part of the consolidated financial statements.
               


 

Pathfinder Bancorp, Inc.
Consolidated Statements of Cash Flows
 (Unaudited)



Notes to Consolidated Financial Statements (Unaudited)

(1)  Basis of Presentation

The accompanying unaudited consolidated financial statements of Pathfinder Bancorp, Inc., a federal corporation (the "Company"), Pathfinder Bank (the "Bank") and its other wholly owned subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information, the instructions for Form 10-Q and Article 8 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes necessary for a complete presentation of consolidated financial condition, results of operations and cash flows in conformity with generally accepted accounting principles.  In the opinion of management, all adjustments, consisting of normal recurring accruals considered necessary for a fair presentation, have been included.  Certain amounts in the 2013 consolidated financial statements may have been reclassified to conform to the current period presentation.  These reclassifications had no effect on net income or comprehensive income as previously reported.
 
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 consolidated financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices or are provided by other third-party sources, when available. When third party information is not available, valuation adjustments are estimated in good faith by management.
 
Although the Company owns, through its subsidiary Pathfinder Risk Management Company, Inc., 51% of the membership interest in FitzGibbons Agency, LLC ("Agency"), the Company is required to consolidate 100% of the Agency within the consolidated financial statements.  The 49% of which the Company does not own is accounted for separately as noncontrolling interests within the consolidated financial statements.

On April 8, 2014, the Boards of Directors of the Company, Pathfinder Bancorp, MHC, Pathfinder Bancorp, Inc., a Maryland corporation ("New Pathfinder"), and the Bank unanimously adopted a Plan of Conversion of Pathfinder Bancorp, MHC pursuant to which Pathfinder Bancorp, MHC undertook a "second-step" conversion and now ceases to exist. The Bank reorganized from a two-tier mutual holding company structure to a fully public stock holding company structure effective October 16, 2014, and, as a result is now the wholly-owned subsidiary of New Pathfinder. Because the conversion occurred after September 30, 2014, the information included in this quarterly report is that of the Company.  For further information on the plan of conversion and offering, see Note 25 of the Notes to the financial statements of the Company included in the New Pathfinder's registration statement, filed with the Securities and Exchange Commission on June 11, 2014.
 
(2)  New Accounting Pronouncements

In August 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") ASU 2014-14 – Receivables-Troubled Debt Restructurings by Creditors (Subtopic 310-40).  This ASU addressed the classification of certain government-guaranteed mortgage loans upon foreclosure.  Under certain government-sponsored loan guarantee programs, qualifying creditors can extend mortgage loans to borrowers with a guarantee that entitles the creditor to recover all or a portion of the unpaid principal balance from the government if the borrower defaults.  Currently, there is diversity in practice related to how creditors classify government-guaranteed mortgage loans, including FHA or VA guaranteed loans, upon foreclosure. Some creditors reclassify those loans to real estate consistent with other foreclosed loans that do not have guarantees; others reclassify the loans to other receivables. The objective of this Update is to reduce that diversity by addressing the classification of certain foreclosed mortgage loans held by creditors that are either fully or partially guaranteed under government programs. Greater consistency in classification of such mortgage loans upon foreclosure is expected to provide more decision-useful information about a creditor's foreclosed mortgage loans that are expected to be recovered, at least in part, through government guarantees. The amendments in this Update are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014.  The Company does not expect a material impact on its consolidated statements of condition, results of operations, or cash flows.

 (3)  Earnings per Common Share

Basic earnings per share are calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period.  Net income available to common shareholders is net income less the total of preferred dividends declared.  Diluted earnings per share include the potential dilutive effect that could occur upon the assumed exercise of issued stock options that are not anti-dilutive using the treasury stock method.  Anti-dilutive stock options, not included in the computation below, were 10,000 in the three and nine month periods ended September 30, 2014 and - and 35,000 in the three and nine month periods ended September 30, 2013, respectively.  Unallocated common shares held by the ESOP are not included in the weighted-average number of common shares outstanding for purposes of calculating earnings per common share until they are committed to be released to plan participants.

The following table sets forth the calculation of basic and diluted earnings per share:


 
 
Three months ended
   
Nine months ended
 
 
 
September 30,
   
September 30,
 
(In thousands, except per share data)
 
2014
   
2013
   
2014
   
2013
 
Basic Earnings Per Common Share
 
   
   
   
 
Net income available to common shareholders
 
$
713
   
$
528
   
$
1,848
   
$
1,856
 
Weighted average common shares outstanding
   
2,537
     
2,518
     
2,533
     
2,515
 
Basic earnings per common share
 
$
0.28
   
$
0.21
   
$
0.73
   
$
0.74
 
 
                               
Diluted Earnings Per Common Share
                               
Net income available to common shareholders
 
$
713
   
$
528
   
$
1,848
   
$
1,856
 
Weighted average common shares outstanding
   
2,537
     
2,518
     
2,533
     
2,515
 
Effect of assumed exercise of stock options
   
26
     
21
     
25
     
13
 
Diluted weighted average common shares outstanding
   
2,563
     
2,539
     
2,558
     
2,528
 
Diluted earnings per common share
 
$
0.28
   
$
0.20
   
$
0.72
   
$
0.73
 






 


(4) Investment Securities

The amortized cost and estimated fair value of investment securities are summarized as follows:

 
 
September 30, 2014
 
 
 
   
Gross
   
Gross
   
Estimated
 
 
 
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
(In thousands)
 
Cost
   
Gains
   
Losses
   
Value
 
Available-for-Sale Portfolio
 
   
   
   
 
Debt investment securities:
 
   
   
   
 
US Treasury, agencies and GSEs
 
$
18,900
   
$
3
   
$
(184
)
 
$
18,719
 
State and political subdivisions
   
7,838
     
131
     
(3
)
   
7,966
 
Corporate
   
13,801
     
153
     
(25
)
   
13,929
 
Residential mortgage-backed - US agency
   
33,283
     
388
     
(233
)
   
33,438
 
Collateralized mortgage obligations - US agency
   
18,062
     
217
     
(179
)
   
18,100
 
Total
   
91,884
     
892
     
(624
)
   
92,152
 
Equity investment securities:
                               
Mutual funds:
                               
Ultra short mortgage fund
   
643
     
4
     
-
     
647
 
Large cap equity fund
   
456
     
216
     
-
     
672
 
Other mutual funds
   
183
     
194
     
-
     
377
 
Common stock - financial services industry
   
271
     
16
     
-
     
287
 
Total
   
1,553
     
430
     
-
     
1,983
 
Total available-for-sale
 
$
93,437
   
$
1,322
   
$
(624
)
 
$
94,135
 
 
                               
Held-to-Maturity Portfolio
                               
Debt investment securities:
                               
US Treasury, agencies and GSEs
 
$
4,827
   
$
17
   
$
(4
)
 
$
4,840
 
State and political subdivisions
   
22,807
     
780
     
(2
)
   
23,585
 
Corporate
   
3,671
     
170
     
-
     
3,841
 
Residential mortgage-backed - US agency
   
8,275
     
112
     
-
     
8,387
 
Collateralized mortgage obligations - US agency
   
2,897
     
79
     
-
     
2,976
 
Total held-to-maturity
 
$
42,477
   
$
1,158
   
$
(6
)
 
$
43,629
 



 

 
 
December 31, 2013
 
 
 
   
Gross
   
Gross
   
Estimated
 
 
 
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
(In thousands)
 
Cost
   
Gains
   
Losses
   
Value
 
Available-for-Sale Portfolio
 
   
   
   
 
Debt investment securities:
 
   
   
   
 
US Treasury, agencies and GSEs
 
$
16,935
   
$
2
   
$
(340
)
 
$
16,597
 
State and political subdivisions
   
6,429
     
164
     
(6
)
   
6,587
 
Corporate
   
13,498
     
198
     
-
     
13,696
 
Residential mortgage-backed - US agency
   
22,231
     
332
     
(424
)
   
22,139
 
Collateralized mortgage obligations - agency
   
20,147
     
164
     
(308
)
   
20,003
 
Total
   
79,240
     
860
     
(1,078
)
   
79,022
 
Equity investment securities:
                               
Mutual funds:
                               
Ultra short mortgage fund
   
643
     
5
     
-
     
648
 
Large cap equity fund
   
456
     
195
     
-
     
651
 
Other mutual funds
   
183
     
162
     
-
     
345
 
Common stock - financial services industry
   
271
     
22
     
-
     
293
 
Total
   
1,553
     
384
     
-
     
1,937
 
Total available-for-sale
 
$
80,793
   
$
1,244
   
$
(1,078
)
 
$
80,959
 
 
                               
Held-to-Maturity Portfolio
                               
Debt investment securities:
                               
US Treasury, agencies and GSEs
 
$
1,872
   
$
-
   
$
(25
)
 
$
1,847
 
State and political subdivisions
   
21,371
     
11
     
(118
)
   
21,264
 
Corporate
   
3,746
     
16
     
(44
)
   
3,718
 
Residential mortgage-backed - US agency
   
5,556
     
-
     
(30
)
   
5,526
 
Collateralized mortgage obligations - agency
   
1,867
     
-
     
-
     
1,867
 
Total held-to-maturity
 
$
34,412
   
$
27
   
$
(217
)
 
$
34,222
 
 
The amortized cost and estimated fair value of debt investments at September 30, 2014 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.

 
 
Available-for-Sale
   
Held-to-Maturity
 
 
 
Amortized
   
Estimated
   
Amortized
   
Estimated
 
 
 
Cost
   
Fair Value
   
Cost
   
Fair Value
 
(In thousands)
 
   
   
   
 
Due in one year or less
 
$
4,891
   
$
4,925
   
$
185
   
$
185
 
Due after one year through five years
   
30,645
     
30,763
     
4,908
     
4,910
 
Due after five years through ten years
   
5,003
     
4,926
     
16,635
     
17,037
 
Due after ten years
   
-
     
-
     
9,577
     
10,134
 
Sub-total
   
40,539
     
40,614
     
31,305
     
32,266
 
Residential mortgage-backed - US agency
   
33,283
     
33,438
     
8,275
     
8,387
 
Collateralized mortgage obligations - US agency
   
18,062
     
18,100
     
2,897
     
2,976
 
Totals
 
$
91,884
   
$
92,152
   
$
42,477
   
$
43,629
 


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, are as follows:

 
 
September 30, 2014
 
 
 
Less than Twelve Months
   
Twelve Months or More
   
Total
 
 
 
Number of
   
   
   
Number of
   
   
   
Number of
   
   
 
 
 
Individual
   
Unrealized
   
Fair
   
Individual
   
Unrealized
   
Fair
   
Individual
   
Unrealized
   
Fair
 
 
 
Securities
   
Losses
   
Value
   
Securities
   
Losses
   
Value
   
Securities
   
Losses
   
Value
 
(Dollars in thousands)
 
   
   
   
   
   
   
   
   
 
Available-for-Sale
 
   
   
   
   
   
   
   
   
 
US Treasury, agencies and GSE's
   
3
   
$
(5
)
 
$
4,006
     
11
   
$
(179
)
 
$
11,810
     
14
   
$
(184
)
 
$
15,816
 
State and political subdivisions
   
3
     
(3
)
   
1,045
     
1
     
-
     
91
     
4
     
(3
)
   
1,136
 
Corporate
   
8
     
(25
)
   
4,999
     
-
     
-
     
-
     
8
     
(25
)
   
4,999
 
Residential mortgage-backed - US agency
   
6
     
(14
)
   
7,428
     
7
     
(219
)
   
8,177
     
13
     
(233
)
   
15,605
 
Collateralized mortgage obligations - US agency
   
3
     
(39
)
   
2,795
     
5
     
(140
)
   
4,104
     
8
     
(179
)
   
6,899
 
Totals
   
23
   
$
(86
)
 
$
20,273
     
24
   
$
(538
)
 
$
24,182
     
47
   
$
(624
)
 
$
44,455
 
Held-to-Maturity
                                                                       
US Treasury, agencies and GSE's
   
2
   
$
(4
)
 
$
1,976
     
-
   
$
-
   
$
-
     
2
   
$
(4
)
 
$
1,976
 
State and political subdivisions
   
1
     
(2
)
   
1,470
     
-
     
-
     
-
     
1
     
(2
)
   
1,470
 
Corporate
   
1
     
-
     
311
     
-
     
-
     
-
     
1
     
-
     
311
 
Residential mortgage-backed - US agency
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Collateralized mortgage obligations - US agency
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Totals
   
4
   
$
(6
)
 
$
3,757
     
-
   
$
-
   
$
-
     
4
   
$
(6
)
 
$
3,757
 

The Company conducts a formal review of investment securities on a quarterly basis for the presence of other-than-temporary impairment ("OTTI").  The Company assesses whether OTTI is present when the fair value of a debt security is less than its amortized cost basis at the statement of condition date.  Under these circumstances, OTTI is considered to have occurred (1) if we intend to sell the security; (2) if it is "more likely than not" we will be required to sell the security before recovery of its amortized cost basis; or (3) the present value of expected cash flows is not anticipated to be sufficient to recover the entire amortized cost basis.  The guidance requires that credit-related OTTI is recognized in earnings while non-credit-related OTTI on securities not expected to be sold is recognized in other comprehensive income ("OCI").  Non-credit-related OTTI is based on other factors, including illiquidity and changes in the general interest rate environment.  Presentation of OTTI is made in the consolidated statement of income on a gross basis, including both the portion recognized in earnings as well as the portion recorded in OCI.  The gross OTTI would then be offset by the amount of non-credit-related OTTI, showing the net as the impact on earnings.

Management does not believe any individual unrealized loss in the securities portfolio as of September 30, 2014 represents OTTI.  All securities are rated A3 or better by Moody's or S&P, with the exception of two corporate securities. The agency and municipal securities have relatively insignificant unrealized loss positions ranging from 4.3% to 0.1% of their current book values.  The unrealized losses reflected in the mortgage-backed security holdings and collateralized mortgage obligations are primarily attributable to changes in interest rates since the securities were acquired.  The Company does not intend to sell these securities, nor is it more likely than not that the Company will be required to sell these securities prior to the recovery of the amortized cost.

In determining whether OTTI has occurred for equity securities, the Company considers the applicable factors described above and the length of time the equity security's fair value has been below the carrying amount. Management has determined that we have the intent and ability to retain the equity securities for a sufficient period of time to allow for recovery. All of the Company's equity securities had a fair value greater than the book value at September 30, 2014.






Gross realized gains (losses) on sales of securities for the indicated periods are detailed below:

 
For the three months
 
For the nine months
 
 
ended September 30,
 
ended September 30,
 
(In thousands)
2014
 
2013
 
2014
 
2013
 
Realized gains
 
$
3
   
$
17
   
$
29
   
$
121
 
Realized losses
   
-
     
-
     
-
     
(5
)
 
 
$
3
   
$
17
   
$
29
   
$
116
 

As of September 30, 2014 and December 31, 2013, securities with a fair value of $62.2 million and $58.6 million, respectively, were pledged to collateralize certain municipal deposit relationships.  As of the same dates, securities with a fair value of $19.9 million and $21.6 million were pledged against certain borrowing arrangements.

Management has reviewed its loan and mortgage-backed securities portfolios and determined that, to the best of its knowledge, little or no exposure exists to sub-prime or other high-risk residential mortgages.  The Company is not in the practice of investing in, or originating, these types of investments or loans.

(5)  Pension and Postretirement Benefits

The Company had a non-contributory defined benefit pension plan that covered substantially all employees. On May 14, 2012, the Company informed its employees of its decision to freeze participation and benefit accruals under the plan, primarily to reduce some of the volatility in earnings that can accompany the maintenance of a defined benefit plan.  The freeze became effective June 30, 2012.  Compensation earned by employees up to June 30, 2012 is used for purposes of calculating benefits under the plan but there will be no future benefit accruals after this date.  Participants as of June 30, 2012, who continue to be employed by the Bank continue to earn vesting credit with respect to their frozen accrued benefits.

Prior to being frozen, the plan provided defined benefits based on years of service and final average salary. Although the plan was frozen, the Company maintains the responsibility for funding the plan, and its funding practice is to contribute at least the minimum amount annually to meet minimum funding requirements.  The funded status of the plan has and will continue to be affected by market conditions.  The Company expects to continue to fund this plan on an as needed basis and does not foresee any issues or conditions that could negatively impact the payment of benefit obligations to plan participants.  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 composition of net periodic pension plan and postretirement plan costs for the indicated periods is as follows:

 
Pension Benefits
 
Postretirement Benefits
 
Pension Benefits
 
Postretirement Benefits
 
 
For the three months ended September 30,
 
For the nine months ended September 30,
 
(In thousands)
2014
 
2013
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
 
 
Service cost
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 
Interest cost
   
102
     
95
     
5
     
4
     
305
     
284
     
14
     
13
 
Expected return on plan assets
   
(236
)
   
(214
)
   
-
     
-
     
(707
)
   
(640
)
   
-
     
-
 
Amortization of net losses
   
8
     
90
     
3
     
5
     
23
     
270
     
10
     
15
 
Net periodic benefit plan (benefit) cost
 
$
(126
)
 
$
(29
)
 
$
8
   
$
9
   
$
(379
)
 
$
(86
)
 
$
24
   
$
28
 

The Company will evaluate the need for further contributions to the defined benefit pension plan during 2014.  The prepaid pension asset is recorded in other assets on the statement of condition as of September 30, 2014.
 

 
(6)  Loans

Major classifications of loans at the indicated dates are as follows:

 
 
September 30,
   
December 31,
 
(In thousands)
 
2014
   
2013
 
Residential mortgage loans:
 
   
 
1-4 family first-lien residential mortgages
 
$
170,424
   
$
166,298
 
Construction
   
1,896
     
1,982
 
Total residential mortgage loans
   
172,320
     
168,280
 
 
               
Commercial loans:
               
Real estate
   
119,453
     
95,536
 
Lines of credit
   
16,568
     
14,444
 
Other commercial and industrial
   
36,994
     
32,675
 
Municipal
   
2,922
     
5,122
 
Total commercial loans
   
175,937
     
147,777
 
 
               
Consumer loans:
               
Home equity and junior liens
   
21,724
     
21,110
 
Other consumer
   
4,061
     
4,166
 
Total consumer loans
   
25,785
     
25,276
 
 
               
Total loans
   
374,042
     
341,333
 
Net deferred loan costs
   
215
     
300
 
Less allowance for loan losses
   
(5,171
)
   
(5,041
)
Loans receivable, net
 
$
369,086
   
$
336,592
 

The Company originates residential mortgage, commercial, and consumer loans largely to customers throughout Oswego and Onondaga counties. Although the Company has a diversified loan portfolio, a substantial portion of its borrowers' abilities to honor their loan contracts is dependent upon the counties' employment and economic conditions.

As of September 30, 2014 and December 31, 2013, residential mortgage loans with a carrying value of $120.2 million and $114.8 million, respectively, have been pledged by the Company to the Federal Home Loan Bank of New York ("FHLBNY") under a blanket collateral agreement to secure the Company's line of credit and term borrowings.

Loan Origination / Risk Management

The Company's lending policies and procedures are presented in Note 5 to the consolidated financial statements included in the 2013 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 17, 2014 as amended March 25, 2014 and have not changed.

To develop and document a systematic methodology for determining the allowance for loan losses, the Company has divided the loan portfolio into three portfolio segments, each with different risk characteristics but with similar methodologies for assessing risk.  Each portfolio segment is broken down into loan classes where appropriate.  Loan classes contain unique measurement attributes, risk characteristics, and methods for monitoring and assessing risk that are necessary to develop the allowance for loan losses.  Unique characteristics such as borrower type, loan type, collateral type, and risk characteristics define each class.  



 

The following table illustrates the portfolio segments and classes for the Company's loan portfolio:


Portfolio Segment
Class
 
 
Residential Mortgage Loans
1-4 family first-lien residential mortgages
 
Construction
 
 
Commercial Loans
Real estate
 
Lines of credit
 
Other commercial and industrial
 
Municipal
 
 
Consumer Loans
Home equity and junior liens
 
Other consumer

The following tables present the classes of the loan portfolio, not including net deferred loan costs, summarized by the aggregate pass rating and the classified ratings of special mention, substandard and doubtful within the Company's internal risk rating system as of the dates indicated:

 
 
As of September 30, 2014
 
 
 
   
Special
   
   
   
 
(In thousands)
 
Pass
   
Mention
   
Substandard
   
Doubtful
   
Total
 
Residential mortgage loans:
 
   
   
   
   
 
1-4 family first-lien residential mortgages
 
$
164,786
   
$
907
   
$
3,561
   
$
1,170
   
$
170,424
 
Construction
   
1,896
     
-
     
-
     
-
     
1,896
 
Total residential mortgage loans
   
166,682
     
907
     
3,561
     
1,170
     
172,320
 
Commercial loans:
                                       
Real estate
   
112,788
     
1,180
     
5,273
     
212
     
119,453
 
Lines of credit
   
15,295
     
403
     
864
     
6
     
16,568
 
Other commercial and industrial
   
35,598
     
447
     
919
     
30
     
36,994
 
Municipal
   
2,922
     
-
     
-
     
-
     
2,922
 
Total commercial loans
   
166,603
     
2,030
     
7,056
     
248
     
175,937
 
Consumer loans:
                                       
Home equity and junior liens
   
20,712
     
342
     
564
     
106
     
21,724
 
Other consumer
   
4,004
     
10
     
47
     
-
     
4,061
 
Total consumer loans
   
24,716
     
352
     
611
     
106
     
25,785
 
Total loans
 
$
358,001
   
$
3,289
   
$
11,228
   
$
1,524
   
$
374,042
 
 
                                       




 
 
   
   
   
   
 
 
 
As of December 31, 2013
 
 
 
   
Special
   
   
   
 
(In thousands)
 
Pass
   
Mention
   
Substandard
   
Doubtful
   
Total
 
Residential mortgage loans:
 
   
   
   
   
 
1-4 family first-lien residential mortgages
 
$
160,013
   
$
1,649
   
$
4,622
   
$
14
   
$
166,298
 
Construction
   
1,982
     
-
     
-
     
-
     
1,982
 
Total residential mortgage loans
   
161,995
     
1,649
     
4,622
     
14
     
168,280
 
Commercial loans:
                                       
Real estate
   
90,162
     
918
     
4,456
     
-
     
95,536
 
Lines of credit
   
12,941
     
560
     
943
     
-
     
14,444
 
Other commercial and industrial
   
31,159
     
468
     
899
     
149
     
32,675
 
Municipal
   
5,122
     
-
     
-
     
-
     
5,122
 
Total commercial loans
   
139,384
     
1,946
     
6,298
     
149
     
147,777
 
Consumer loans:
                                       
Home equity and junior liens
   
19,567
     
487
     
976
     
80
     
21,110
 
Other consumer
   
4,040
     
30
     
74
     
22
     
4,166
 
Total consumer loans
   
23,607
     
517
     
1,050
     
102
     
25,276
 
Total loans
 
$
324,986
   
$
4,112
   
$
11,970
   
$
265
   
$
341,333
 

Management has reviewed its loan portfolio and determined that, to the best of its knowledge, no exposure exists to sub-prime or other high-risk residential mortgages.  The Company is not in the practice of originating these types of loans.

Nonaccrual and Past Due Loans

Loans are placed on nonaccrual when the contractual payment of principal and interest has become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan may be currently performing.

Loans are considered past due if the required principal and interest payments have not been received within thirty days of the payment due date.




An age analysis of past due loans, segregated by portfolio segment and class of loans, as of September 30, 2014 and December 31, 2013, are detailed in the following tables:

 
As of September 30, 2014
 
 
30-59 Days
 
60-89 Days
 
90 Days
 
 
 
 
 
Past Due
 
Past Due
 
and Over
 
Total
 
 
Total Loans
 
(In thousands)
And Accruing
 
And Accruing
 
 
Past Due
 
Current
 
Receivable
 
Residential mortgage loans:
 
 
 
 
 
 
1-4 family first-lien residential mortgages
 
$
2,018
   
$
591
   
$
2,028
   
$
4,637
   
$
165,787
   
$
170,424
 
Construction
   
-
     
-
     
-
     
-
     
1,896
     
1,896
 
Total residential mortgage loans
   
2,018
     
591
     
2,028
     
4,637
     
167,683
     
172,320
 
Commercial loans:
                                               
Real estate
   
533
     
321
     
3,729
     
4,583
     
114,870
     
119,453
 
Lines of credit
   
20
     
801
     
298
     
1,119
     
15,449
     
16,568
 
Other commercial and industrial
   
664
     
571
     
1,132
     
2,367
     
34,627
     
36,994
 
Municipal
   
-
     
-
     
-
     
-
     
2,922
     
2,922
 
Total commercial loans
   
1,217
     
1,693
     
5,159
     
8,069
     
167,868
     
175,937
 
Consumer loans:
                                               
Home equity and junior liens
   
289
     
52
     
243
     
584
     
21,140
     
21,724
 
Other consumer
   
11
     
-
     
12
     
23
     
4,038
     
4,061
 
Total consumer loans
   
300
     
52
     
255
     
607
     
25,178
     
25,785
 
Total loans
 
$
3,535
   
$
2,336
   
$
7,442
   
$
13,313
   
$
360,729
   
$
374,042
 
 
                                               
 
                                               
 
As of December 31, 2013
 
 
30-59 Days
 
60-89 Days
 
90 Days
                         
 
Past Due
 
Past Due
 
and Over
 
Total
         
Total Loans
 
(In thousands)
And Accruing
 
And Accruing
         
Past Due
 
Current
 
Receivable
 
Residential mortgage loans:
                                               
1-4 family first-lien residential mortgages
 
$
2,213
   
$
1,472
   
$
2,194
   
$
5,879
   
$
160,419
   
$
166,298
 
Construction
   
-
     
-
     
-
     
-
     
1,982
     
1,982
 
Total residential mortgage loans
   
2,213
     
1,472
     
2,194
     
5,879
     
162,401
     
168,280
 
Commercial loans:
                                               
Real estate
   
1,407
     
1,901
     
1,934
     
5,242
     
90,294
     
95,536
 
Lines of credit
   
341
     
113
     
381
     
835
     
13,609
     
14,444
 
Other commercial and industrial
   
2,045
     
1,289
     
394
     
3,728
     
28,947
     
32,675
 
Municipal
   
-
     
-
     
-
     
-
     
5,122
     
5,122
 
Total commercial loans
   
3,793
     
3,303
     
2,709
     
9,805
     
137,972
     
147,777
 
Consumer loans:
                                               
Home equity and junior liens
   
954
     
281
     
402
     
1,637
     
19,473
     
21,110
 
Other consumer
   
46
     
51
     
45
     
142
     
4,024
     
4,166
 
Total consumer loans
   
1,000
     
332
     
447
     
1,779
     
23,497
     
25,276
 
Total loans
 
$
7,006
   
$
5,107
   
$
5,350
   
$
17,463
   
$
323,870
   
$
341,333
 



Nonaccrual loans, segregated by class of loan, were as follows:

 
 
September 30,
   
December 31,
 
(In thousands)
 
2014
   
2013
 
Residential mortgage loans:
 
   
 
1-4 family first-lien residential mortgages
 
$
2,028
   
$
2,194
 
 
   
2,028
     
2,194
 
Commercial loans:
               
Real estate
   
3,729
     
1,934
 
Lines of credit
   
298
     
381
 
Other commercial and industrial
   
1,132
     
394
 
 
   
5,159
     
2,709
 
Consumer loans:
               
Home equity and junior liens
   
243
     
402
 
Other consumer
   
12
     
45
 
 
   
255
     
447
 
Total nonaccrual loans
 
$
7,442
   
$
5,350
 

There were no loans past due ninety days or more and still accruing interest at September 30, 2014 or December 31, 2013.

The Company is required to disclose certain activities related to Troubled Debt Restructurings ("TDRs") in accordance with accounting guidance.  Certain loans have been modified in a TDR where economic concessions have been granted to a borrower who is experiencing, or expected to experience, financial difficulties.  These economic concessions could include a reduction in the loan interest rate, extension of payment terms, reduction of principal amortization, or other actions that it would not otherwise consider for a new loan with similar risk characteristics.

The Company is required to disclose new TDRs for each reporting period for which an income statement is being presented.  The Company has determined that there was a new TDR with a recorded investment of $96,000 in the third quarter of 2014.  The recorded investment is determined by the loan balance less the reserve associated with the loan.

The modification made within the commercial real estate loan class resulted in a pre-modification and post-modification recorded investment of $74,000 and $96,000, respectively.  The post-modification recorded investment included the funding of escrow and closing costs as a result of the restructuring.  Economic concessions granted included extended interest only payment terms and an additional $100,000 for working capital without an associated increase in collateral.  The TDR resulted in a loan balance of $565,000 with a specific reserve of $469,000, resulting in a recorded investment of $96,000.  The Company was required to increase the specific reserve against this loan by an additional $108,000 which was a component of the provision for loan losses in the third quarter of 2014.

The Company has determined that there were no payment defaults on this only TDR that occurred within the prior twelve months.

When the Company modifies a loan within a portfolio segment, a potential impairment is analyzed either based on the present value of the expected future cash flows discounted at the interest rate of the original loan terms or the fair value of the collateral less costs to sell.  If it is determined that the value of the loan is less than its recorded investment, then impairment is recognized as a component of the provision for loan losses, an associated increase to the allowance for loan losses or as a charge-off to the allowance for loan losses in the current period.




 


Impaired Loans

The following tables summarize impaired loan information by portfolio class at the indicated dates:

 
 
September 30, 2014
   
December 31, 2013
 
 
 
   
Unpaid
   
   
   
Unpaid
   
 
 
 
Recorded
   
Principal
   
Related
   
Recorded
   
Principal
   
Related
 
(In thousands)
 
Investment
   
Balance
   
Allowance
   
Investment
   
Balance
   
Allowance
 
With no related allowance recorded:
 
   
   
   
   
   
 
1-4 family first-lien residential mortgages
 
$
1,266
   
$
1,285
   
$
-
   
$
550
   
$
550
   
$
-
 
Commercial real estate
   
1,726
     
1,733
     
-
     
1,496
     
1,499
     
-
 
Commercial lines of credit
   
193
     
217
     
-
     
196
     
196
     
-
 
Other commercial and industrial
   
355
     
369
     
-
     
266
     
266
     
-
 
Home equity and junior liens
   
2
     
2
     
-
     
294
     
294
     
-
 
Other consumer
   
-
     
-
     
-
     
-
     
-
     
-
 
With an allowance recorded:
                                               
1-4 family first-lien residential mortgages
   
-
     
-
     
-
     
402
     
402
     
59
 
Commercial real estate
   
3,492
     
3,525
     
643
     
2,045
     
2,054
     
649
 
Commercial lines of credit
   
95
     
95
     
95
     
185
     
200
     
135
 
Other commercial and industrial
   
174
     
174
     
116
     
139
     
139
     
107
 
Home equity and junior liens
   
363
     
363
     
33
     
165
     
165
     
84
 
Other consumer
   
14
     
14
     
5
     
2
     
2
     
2
 
Total:
                                               
1-4 family first-lien residential mortgages
   
1,266
     
1,285
     
-
     
952
     
952
     
59
 
Commercial real estate
   
5,218
     
5,258
     
643
     
3,541
     
3,553
     
649
 
Commercial lines of credit
   
288
     
312
     
95
     
381
     
396
     
135
 
Other commercial and industrial
   
529
     
543
     
116
     
405
     
405
     
107
 
Home equity and junior liens
   
365
     
365
     
33
     
459
     
459
     
84
 
Other consumer
   
14
     
14
     
5
     
2
     
2
     
2
 
Totals
 
$
7,680
   
$
7,777
   
$
892
   
$
5,740
   
$
5,767
   
$
1,036
 

The following table presents the average recorded investment in impaired loans for the periods indicated:

 
 
For the three months ended
   
For the nine months ended
 
 
 
September 30,
   
September 30,
 
(In thousands)
 
2014
   
2013
   
2014
   
2013
 
1-4 family first-lien residential mortgages
 
$
1,289
   
$
781
   
$
1,221
   
$
1,521
 
Commercial real estate
   
5,239
     
3,949
     
4,855
     
3,621
 
Commercial lines of credit
   
378
     
418
     
403
     
412
 
Other commercial and industrial
   
517
     
674
     
511
     
767
 
Home equity and junior liens
   
369
     
467
     
412
     
525
 
Other consumer
   
15
     
2
     
8
     
3
 
Total
 
$
7,807
   
$
6,291
   
$
7,410
   
$
6,849
 





The following table presents the cash basis interest income recognized on impaired loans for the periods indicated:

 
 
For the three months ended
   
For the nine months ended
 
 
 
September 30,
   
September 30,
 
(In thousands)
 
2014
   
2013
   
2014
   
2013
 
1-4 family first-lien residential mortgages
 
$
4
   
$
10
   
$
13
   
$
23
 
Commercial real estate
   
59
     
79
     
114
     
151
 
Commercial lines of credit
   
4
     
2
     
5
     
13
 
Other commercial and industrial
   
13
     
8
     
33
     
20
 
Home equity and junior liens
   
4
     
6
     
10
     
24
 
Other consumer
   
-
     
-
     
-
     
-
 
Total
 
$
84
   
$
105
   
$
175
   
$
231
 

(7)   Allowance for Loan Losses

Summarized in the tables below are changes in the allowance for loan losses for the indicated periods and information pertaining to the allocation of the allowance for loan losses, balances of the allowance for loan losses, loans receivable based on individual, and collective impairment evaluation by loan portfolio class.  An allocation of a portion of the allowance to a given portfolio class does not limit the Company's ability to absorb losses in another portfolio class.


 
For the three months ended September 30, 2014
 
 
1-4 family
 
 
 
 
 
 
first-lien
 
Residential
 
 
 
Other
 
 
residential
 
construction
 
Commercial
 
Commercial
 
commercial
 
(In thousands)
mortgage
 
mortgage
 
real estate
 
lines of credit
 
and industrial
 
Allowance for loan losses:
 
 
 
 
 
Beginning Balance
 
$
491
   
$
-
   
$
2,624
   
$
554
   
$
851
 
   Charge-offs
   
(26
)
   
-
     
(256
)
   
(79
)
   
-
 
   Recoveries
   
-
     
-
     
-
     
-
     
3
 
   Provisions
   
48
     
-
     
345
     
(28
)
   
46
 
Ending balance
 
$
513
   
$
-
   
$
2,713
   
$
447
   
$
900
 
Ending balance: related to loans
                                       
individually evaluated for impairment
   
-
     
-
     
643
     
95
     
116
 
Ending balance: related to loans
                                       
collectively evaluated for impairment
 
$
513
   
$
-
   
$
2,070
   
$
352
   
$
784
 
 
                                       
Loans receivables:
                                       
Ending balance
 
$
170,424
   
$
1,896
   
$
119,453
   
$
16,568
   
$
36,994
 
Ending balance: individually
                                       
evaluated for impairment
   
1,266
     
-
     
5,218
     
288
     
529
 
Ending balance: collectively
                                       
evaluated for impairment
 
$
169,158
   
$
1,896
   
$
114,235
   
$
16,280
   
$
36,465
 
 
                                       
 
                                       
 
       
Home equity
 
Other
                 
 
Municipal
 
and junior liens
 
Consumer
 
Unallocated
 
Total
 
Allowance for loan losses:
                                       
Beginning Balance
 
$
1
   
$
422
   
$
109
   
$
114
   
$
5,166
 
   Charge-offs
   
-
     
(31
)
   
(24
)
   
-
     
(416
)
   Recoveries
   
-
     
1
     
7
     
-
     
11
 
   Provisions
   
-
     
(17
)
   
7
     
9
     
410
 
Ending balance
 
$
1
   
$
375
   
$
99
   
$
123
   
$
5,171
 
Ending balance: related to loans
                                       
individually evaluated for impairment
   
-
     
33
     
5
     
-
     
892
 
Ending balance: related to loans
                                       
collectively evaluated for impairment
 
$
1
   
$
342
   
$
94
   
$
123
   
$
4,279
 
 
                                       
Loans receivables:
                                       
Ending balance
 
$
2,922
   
$
21,724
   
$
4,061
           
$
374,042
 
Ending balance: individually
                                       
evaluated for impairment
   
-
     
365
     
14
             
7,680
 
Ending balance: collectively
                                       
evaluated for impairment
 
$
2,922
   
$
21,359
   
$
4,047
           
$
366,362
 


 
For the nine months ended September 30, 2014
 
 
1-4 family
 
 
 
 
 
 
first-lien
 
Residential
 
 
 
Other
 
 
residential
 
construction
 
Commercial
 
Commercial
 
commercial
 
(In thousands)
mortgage
 
mortgage
 
real estate
 
lines of credit
 
and industrial
 
Allowance for loan losses:
 
 
 
 
 
Beginning Balance
 
$
649
   
$
-
   
$
2,302
   
$
397
   
$
834
 
   Charge-offs
   
(68
)
   
-
     
(303
)
   
(164
)
   
(153
)
   Recoveries
   
1
     
-
     
-
     
3
     
6
 
   Provisions
   
(69
)
   
-
     
714
     
211
     
213
 
Ending balance
 
$
513
   
$
-
   
$
2,713
   
$
447
   
$
900
 
 
                                       
 
       
Home equity
 
Other
                 
 
Municipal
 
and junior liens
 
consumer
 
Unallocated
 
Total
 
Allowance for loan losses:
                                       
Beginning Balance
 
$
2
   
$
433
   
$
136
   
$
288
   
$
5,041
 
   Charge-offs
   
-
     
(81
)
   
(84
)
   
-
     
(853
)
   Recoveries
   
-
     
1
     
42
     
-
     
53
 
   Provisions
   
(1
)
   
22
     
5
     
(165
)
   
930
 
Ending balance
 
$
1
   
$
375
   
$
99
   
$
123
   
$
5,171
 



 



 
For the three months ended September 30, 2013
 
 
1-4 family
 
 
 
 
 
 
first-lien
 
Residential
 
 
 
Other
 
 
residential
 
construction
 
Commercial
 
Commercial
 
commercial
 
(In thousands)
mortgage
 
mortgage
 
real estate
 
lines of credit
 
and industrial
 
Allowance for loan losses:
 
 
 
 
 
Beginning Balance
 
$
585
   
$
-
   
$
2,055
   
$
418
   
$
1,045
 
   Charge-offs
   
-
     
-
     
-
     
-
     
(14
)
   Recoveries
   
24
     
-
     
-
     
21
     
-
 
   Provisions
   
25
     
-
     
295
     
(73
)
   
(43
)
Ending balance
 
$
634
   
$
-
   
$
2,350
   
$
366
   
$
988
 
Ending balance: related to loans
                                       
individually evaluated for impairment
   
61
     
-
     
679
     
100
     
232
 
Ending balance: related to loans
                                       
collectively evaluated for impairment
 
$
573
   
$
-
   
$
1,671
   
$
266
   
$
756
 
 
                                       
Loans receivables:
                                       
Ending balance
 
$
165,363
   
$
1,694
   
$
94,078
   
$
13,701
   
$
33,037
 
Ending balance: individually
                                       
evaluated for impairment
   
982
     
-
     
4,056
     
382
     
537
 
Ending balance: collectively
                                       
evaluated for impairment
 
$
164,381
   
$
1,694
   
$
90,022
   
$
13,319
   
$
32,500
 
 
                                       
 
                                       
 
       
Home equity
 
Other
                 
 
Municipal
 
and junior liens
 
Consumer
 
Unallocated
 
Total
 
Allowance for loan losses:
                                       
Beginning Balance
 
$
3
   
$
454
   
$
135
   
$
169
   
$
4,864
 
   Charge-offs
   
-
     
-
     
(36
)
   
-
     
(50
)
   Recoveries
   
-
     
-
     
10
     
-
     
55
 
   Provisions
   
(1
)
   
(9
)
   
23
     
(1
)
   
216
 
Ending balance
 
$
2
   
$
445
   
$
132
   
$
168
   
$
5,085
 
Ending balance: related to loans
                                       
individually evaluated for impairment
   
-
     
85
     
2
     
-
     
1,159
 
Ending balance: related to loans
                                       
collectively evaluated for impairment
 
$
2
   
$
360
   
$
130
   
$
168
   
$
3,926
 
 
                                       
Loans receivables:
                                       
Ending balance
 
$
4,968
   
$
20,917
   
$
4,009
           
$
337,767
 
Ending balance: individually
                                       
evaluated for impairment
   
-
     
464
     
2
             
6,423
 
Ending balance: collectively
                                       
evaluated for impairment
 
$
4,968
   
$
20,453
   
$
4,007
           
$
331,344
 

 
For the nine months ended September 30, 2013
 
 
1-4 family
 
 
 
 
 
 
first-lien
 
Residential
 
 
 
Other
 
 
residential
 
construction
 
Commercial
 
Commercial
 
commercial
 
(In thousands)
mortgage
 
mortgage
 
real estate
 
lines of credit
 
and industrial
 
Allowance for loan losses:
 
 
 
 
 
Beginning Balance
 
$
811
   
$
-
   
$
1,748
   
$
440
   
$
750
 
   Charge-offs
   
(104
)
   
-
     
-
     
(49
)
   
(29
)
   Recoveries
   
37
     
-
     
-
     
21
     
-
 
   Provisions
   
(110
)
   
-
     
602
     
(46
)
   
267
 
Ending balance
 
$
634
   
$
-
   
$
2,350
   
$
366
   
$
988
 
 
                                       
 
       
Home equity
 
Other
                 
 
Municipal
 
and junior liens
 
consumer
 
Unallocated
 
Total
 
Allowance for loan losses:
                                       
Beginning Balance
 
$
2
   
$
494
   
$
168
   
$
88
   
$
4,501
 
   Charge-offs
   
-
     
(81
)
   
(75
)
   
-
     
(338
)
   Recoveries
   
-
     
13
     
35
     
-
     
106
 
   Provisions
   
-
     
19
     
4
     
80
     
816
 
Ending balance
 
$
2
   
$
445
   
$
132
   
$
168
   
$
5,085
 

 (8)  Guarantees

The Company does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit.  Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party.  Generally, all letters of credit when issued have expiration dates within one year of issuance.  The credit risk involved in issuing letters of credit is essentially the same as those that are involved in extending loan facilities to customers.  The Company generally holds collateral and/or personal guarantees supporting these commitments.  The Company had $4.6 million of standby letters of credit outstanding as of September 30, 2014.  Management believes that the proceeds obtained through a liquidation of collateral and the enforcement of guarantees would be sufficient to cover the potential amount of future payments required under the corresponding guarantees.   The fair value of standby letters of credit was not significant to the Company's consolidated financial statements.

(9)  Fair Value Measurements

Accounting guidance related to fair value measurements and disclosures specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company's market assumptions. These two types of inputs have created the following fair value hierarchy:

Level 1 – Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2 – Quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.

Level 3 – Model-derived valuations in which one or more significant inputs or significant value drivers are unobservable.

 
An asset's or liability's level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs, minimize the use of unobservable inputs, to the extent possible, and considers counterparty credit risk in its assessment of fair value.

The Company used the following methods and significant assumptions to estimate fair value:

Investment securities:  The fair values of securities available-for-sale are obtained from an independent third party and are based on quoted prices on nationally recognized securities exchanges where available (Level 1).  If quoted prices are not available, fair values are measured by utilizing matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for specific securities but rather by relying on the securities' relationship to other benchmark quoted securities (Level 2).  Management made no adjustment to the fair value quotes that were received from the independent third party pricing service.

Interest rate swap derivative:  The fair value of the interest rate swap derivative is calculated based on a discounted cash flow model. All future floating cash flows are projected and both floating and fixed cash flows are discounted to the valuation date.  The curve utilized for discounting and projecting is built by obtaining publicly available third party market quotes for various swap maturity terms.

Impaired loans: Impaired loans are those loans in which the Company has measured impairment based on the fair value of the loan's collateral or the discounted value of expected future cash flows.  Fair value is generally determined based upon market value evaluations by third parties of the properties and/or estimates by management of working capital collateral or discounted cash flows based upon expected proceeds.  These appraisals may include up to three approaches to value: the sales comparison approach, the income approach (for income-producing property), and the cost approach.  Management modifies the appraised values, if needed, to take into account recent developments in the market or other factors, such as, changes in absorption rates or market conditions from the time of valuation and anticipated sales values considering management's plans for disposition.  Such modifications to the appraised values could result in lower valuations of such collateral. Estimated costs to sell are based on current amounts of disposal costs for similar assets.  These measurements are classified as Level 3 within the valuation hierarchy. Impaired loans are subject to nonrecurring fair value adjustment upon initial recognition or subsequent impairment.  A portion of the allowance for loan losses is allocated to impaired loans if the value of such loans is deemed to be less than the unpaid balance.

Foreclosed real estate:  Fair values for foreclosed real estate are initially recorded based on market value evaluations by third parties, less costs to sell ("initial cost basis").  Any write-downs required when the related loan receivable is exchanged for the underlying real estate collateral at the time of transfer to foreclosed real estate are charged to the allowance for loan losses.  Values are derived from appraisals, similar to impaired loans, of underlying collateral or discounted cash flow analysis.  Subsequent to foreclosure, valuations are updated periodically and assets are marked to current fair value, not to exceed the initial cost basis.  In the determination of fair value subsequent to foreclosure, management also considers other factors or recent developments, such as, changes in absorption rates and market conditions from the time of valuation and anticipated sales values considering management's plans for disposition.  Either change could result in adjustment to lower the property value estimates indicated in the appraisals.  These measurements are classified as Level 3 within the fair value hierarchy.



 

The following tables summarize assets measured at fair value on a recurring basis as of the indicated dates, segregated by the level of valuation inputs within the hierarchy utilized to measure fair value:

 
 
September 30, 2014
 
 
 
   
   
   
Total Fair
 
(In thousands)
 
Level 1
   
Level 2
   
Level 3
   
Value
 
Available-for-sale portfolio
 
   
   
   
 
Debt investment securities:
 
   
   
   
 
US Treasury, agencies and GSEs
 
$
-
   
$
18,719
   
$
-
   
$
18,719
 
State and political subdivisions
   
-
     
7,966
     
-
     
7,966
 
Corporate
   
-
     
13,929
     
-
     
13,929
 
Residential mortgage-backed - US agency
   
-
     
33,438
     
-
     
33,438
 
Collateralized mortgage obligations - US agency
   
-
     
18,100
     
-
     
18,100
 
Equity investment securities:
                               
Mutual funds:
                               
Ultra short mortgage fund
   
647
     
-
     
-
     
647
 
Large cap equity fund
   
672
     
-
     
-
     
672
 
Other mutual funds
   
-
     
377
     
-
     
377
 
Common stock - financial services industry
   
37
     
250
     
-
     
287
 
Total available-for-sale securities
 
$
1,356
   
$
92,779
   
$
-
   
$
94,135
 
 
                               
Interest rate swap derivative
 
$
-
   
$
(94
)
 
$
-
   
$
(94
)

 
 
December 31, 2013
 
 
 
   
   
   
Total Fair
 
(In thousands)
 
Level 1
   
Level 2
   
Level 3
   
Value
 
Available-for-sale portfolio
 
   
   
   
 
Debt investment securities:
 
   
   
   
 
US Treasury, agencies and GSEs
 
$
-
   
$
16,597
   
$
-
   
$
16,597
 
State and political subdivisions
   
-
     
6,587
     
-
     
6,587
 
Corporate
   
-
     
13,696
     
-
     
13,696
 
Residential mortgage-backed - US agency
   
-
     
22,139
     
-
     
22,139
 
Collateralized mortgage obligations - US agency
   
-
     
20,003
     
-
     
20,003
 
Equity investment securities:
                               
Mutual funds:
                               
Ultra short mortgage fund
   
648
     
-
     
-
     
648
 
Large cap equity fund
   
651
     
-
     
-
     
651
 
Other mutual funds
   
-
     
345
     
-
     
345
 
Common stock - financial services industry
   
42
     
251
     
-
     
293
 
Total available-for-sale securities
 
$
1,341
   
$
79,618
   
$
-
   
$
80,959
 
 
                               
Interest rate swap derivative
 
$
-
   
$
(135
)
 
$
-
   
$
(135
)
 
                               

Pathfinder Bank had the following assets measured at fair value on a nonrecurring basis as of September 30, 2014 and December 31, 2013:

 
September 30, 2014
 
 
 
 
 
Total Fair
 
(In thousands)
Level 1
 
Level 2
 
Level 3
 
Value
 
 Impaired loans
 
$
-
   
$
-
   
$
1,752
   
$
1,752
 
 Foreclosed real estate
 
$
-
   
$
-
   
$
99
   
$
99
 

 
December 31, 2013
 
 
 
 
 
Total Fair
 
(In thousands)
Level 1
 
Level 2
 
Level 3
 
Value
 
 Impaired loans
 
$
-
   
$
-
   
$
258
   
$
258
 
 Foreclosed real estate
 
$
-
   
$
-
   
$
69
   
$
69
 

The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis and for which Level 3 inputs were used to determine fair value at the indicated dates.

 
 
Quantitative Information about Level 3 Fair Value Measurements
 
 
 
 
 
 
Valuation
Unobservable
Range
 
Techniques
Input
(Weighted Avg.)
At September 30, 2014 (Unaudited)
 
 
Impaired loans
Appraisal of collateral
Appraisal Adjustments
5% - 30% (14%)
 
(Sales Approach)
Costs to Sell
4% - 50% (13%)
 
(Discounted Cash Flow)
 
 
 
 
 
 
Foreclosed real estate
Appraisal of collateral
Appraisal Adjustments
 15% - 15% (15%)
 
(Sales Approach)
Costs to Sell
 6% -   8%  (7%)
 
 
 
 


 
 
Quantitative Information about Level 3 Fair Value Measurements
 
 
 
 
 
 
Valuation
Unobservable
Range
 
Techniques
Input
(Weighted Avg.)
At December 31, 2013
 
 
 
Impaired loans
Appraisal of collateral
Appraisal Adjustments
5% - 30% (14%)
 
(Sales Approach)
Costs to Sell
6% - 50% (12%)
 
 
 
 
Foreclosed real estate
Appraisal of collateral
Appraisal Adjustments
 15% - 15% (15%)
 
(Sales Approach)
Costs to Sell
 6% -   7%  (6%)
 
 
 
 

There have been no transfers of assets into or out of any fair value measurement level during the quarter ended September 30, 2014.  Required disclosures include 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.
 

The Company has various processes and controls in place to ensure that fair value is reasonably estimated. The Company performs due diligence procedures over third-party pricing service providers in order to support their use in the valuation process. 

While the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

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 estimated fair value amounts have been measured as of their respective period-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 period-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 of these assets approximate their fair value and are classified as Level 1.

Interest earning time deposits – The carrying amounts of these assets approximate their fair value and are classified as    Level 1.

Investment securities – The fair values of securities available-for-sale and held-to-maturity are obtained from an independent third party and are based on quoted prices on nationally recognized exchange where available (Level 1).  If quoted prices are not available, fair values are measured by utilizing matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for specific securities, but rather by relying on the securities' relationship to other benchmark quoted securities (Level 2).  Management made no adjustment to the fair value quotes that were received from the independent third party pricing service.

Federal Home Loan Bank stock – The carrying amount of these assets approximates their fair value and are classified as Level 2.

Net loans – For variable-rate loans that re-price frequently, fair value is based on carrying amounts.  The fair value of other loans (for example, fixed-rate commercial real estate loans, mortgage loans, and commercial and industrial loans) is estimated using discounted cash flow analysis, based on interest rates currently being offered in the market for loans with similar terms to borrowers of similar credit quality.  Loan value estimates include judgments based on expected prepayment rates.  The measurement of the fair value of loans, including impaired loans, is classified within Level 3 of the fair value hierarchy.

Accrued interest receivable and payable – The carrying amount of these assets approximates their fair value and are classified as Level 1.

Deposits – 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) and are classified within Level 1 of the fair value hierarchy.  Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates of deposits to a schedule of aggregated expected monthly maturities on time deposits.  Measurements of the fair value of time deposits are classified within Level 2 of the fair value hierarchy.
 

 
Borrowings – Fixed/variable term "bullet" structures are valued using a replacement cost of funds approach.  These borrowings are discounted to the FHLBNY advance curve.  Option structured borrowings' fair values are determined by the FHLB for borrowings that include a call or conversion option.  If market pricing is not available from this source, current market indications from the FHLBNY are obtained and the borrowings are discounted to the FHLBNY advance curve less an appropriate spread to adjust for the option. These measurements are classified as Level 2 within the fair value hierarchy.

Junior subordinated debentures – The Company secures a quote from its pricing service based on a discounted cash flow methodology which results in a Level 2 classification for this borrowing.

Interest rate swap derivative – The fair value of the interest rate swap derivative is obtained from a third party pricing agent and is calculated based on a discounted cash flow model. All future floating cash flows are projected and both floating and fixed cash flows are discounted to the valuation date.  The curve utilized for discounting and projecting is built by obtaining publicly available third party market quotes for various swap maturity terms, and therefore is classified within Level 2 of the fair value hierarchy.

The carrying amounts and fair values of the Company's financial instruments as of the indicated dates are presented in the following table:

 
 
   
September 30, 2014
   
December 31, 2013
 
 
 
Fair Value
   
Carrying
   
Estimated
   
Carrying
   
Estimated
 
(Dollars In thousands)
 
Hierarchy
   
Amounts
   
Fair Values
   
Amounts
   
Fair Values
 
Financial assets:
 
   
   
   
   
 
Cash and cash equivalents
   
1
   
$
24,982
   
$
24,982
   
$
16,575
   
$
16,575
 
Interest earning time deposits
   
1
     
500
     
500
     
500
     
500
 
Investment securities - available-for-sale
   
1
     
1,356
     
1,356
     
1,341
     
1,341
 
Investment securities - available-for-sale
   
2
     
92,779
     
92,779
     
79,618
     
79,618
 
Investment securities - held-to-maturity
   
2
     
42,477
     
43,629
     
34,412
     
34,222
 
Federal Home Loan Bank stock
   
2
     
1,829
     
1,829
     
2,440
     
2,440
 
Net loans
   
3
     
369,086
     
375,006
     
336,592
     
343,660
 
Accrued interest receivable
   
1
     
1,865
     
1,865
     
1,715
     
1,715
 
 
                                       
Financial liabilities:
                                       
Demand Deposits, Savings, NOW and MMDA
   
1
   
$
311,491
   
$
311,491
   
$
250,248
   
$
250,248
 
Time Deposits
   
2
     
171,538
     
171,326
     
159,892
     
160,201
 
Borrowings
   
2
     
31,021
     
31,264
     
40,853
     
41,255
 
Junior subordinated debentures
   
2
     
5,155
     
4,983
     
5,155
     
4,825
 
Accrued interest payable
   
1
     
73
     
73
     
86
     
86
 
Interest rate swap derivative
   
2
     
94
     
94
     
135
     
135
 

(10)  Interest Rate Derivatives

Derivative instruments are entered into primarily as a risk management tool of the Company.  Financial derivatives are recorded at fair value as other liabilities.  The accounting for changes in the fair value of a derivative depends on whether it has been designated and qualifies as part of a hedging relationship. For a fair value hedge, changes in the fair value of the derivative instrument and changes in the fair value of the hedged asset or liability are recognized currently in earnings.  For a cash flow hedge, changes in the fair value of the derivative instrument, to the extent that it is effective, are recorded in other comprehensive income and subsequently reclassified to earnings as the hedged transaction impacts net income.  Any ineffective portion of a cash flow hedge is recognized currently in earnings.  See Note 9 for further discussion of the fair value of the interest rate derivative.
 

 
The Company has $5.0 million of floating rate trust preferred debt indexed to 3-month LIBOR.  As a result, it is exposed to variability in cash flows related to changes in projected interest payments caused by changes in the benchmark interest rate.  During the fourth quarter of fiscal 2009, the Company entered into an interest rate swap agreement, with a $2.0 million notional amount, to convert a portion of the variable-rate junior subordinated debentures to a fixed rate for a term of approximately 7 years at a rate of 4.96%.  The derivative is designated as a cash flow hedge.  The hedging strategy ensures that changes in cash flows from the derivative will be highly effective at offsetting changes in interest expense from the hedged exposure.

The following table summarizes the fair value of the outstanding derivative and its presentation on the statements of condition:

 
September 30,
 
December 31,
 
 (In thousands)
2014
 
2013
 
 Cash flow hedge:
 
 
 Other liabilities
 
$
94
   
$
135
 

The change in accumulated other comprehensive loss on a pretax basis and the impact on earnings from the interest rate swap that qualifies as a cash flow hedge for the periods indicated below were as follows:

 
Three Months Ended September 30,
 
(In thousands)
2014
   
2013
 
Balance as of June 30:
 
$
(112
)
 
$
(152
)
Amount of losses (gains) recognized in other comprehensive income
   
2
     
(10
)
Amount of loss reclassified from other comprehensive income
               
     and recognized as interest expense
   
16
     
15
 
Balance as of September 30:
 
$
(94
)
 
$
(147
)
 
               
 
               
 
Nine Months Ended September 30,
 
(In thousands)
   
2014
     
2013
 
Balance as of December 31:
 
$
(135
)
 
$
(195
)
Amount of (gains) losses recognized in other comprehensive income
   
(6
)
   
2
 
Amount of loss reclassified from other comprehensive income
               
     and recognized as interest expense
   
47
     
46
 
Balance as of September 30:
 
$
(94
)
 
$
(147
)

No amount of ineffectiveness has been included in earnings and the changes in fair value have been recorded in other comprehensive (loss) income.  Some, or all, of the amount included in accumulated other comprehensive (loss) income would be reclassified into current earnings should a portion of, or the entire hedge no longer be considered effective, but at this time, management expects the hedge to remain fully effective during the remaining term of the swap.

The Company posted cash of $200,000 under arrangements to satisfy collateral requirements associated with the interest rate swap contract.




 
(11)  Accumulated Other Comprehensive Income (Loss)

Changes in the components of accumulated other comprehensive income (loss) ("AOCI"), net of tax, for the periods indicated are summarized in the table below.

 
For the three months ended September 30, 2014
 
(In thousands)
Retirement Plans
 
Unrealized Gains and Losses on Financial Derivative
 
Unrealized Gains and Losses on Available-for-Sale Securities
 
Securities reclassified from AFS to HTM
 
Total
 
Beginning balance
 
$
(969
)
 
$
(67
)
 
$
461
   
$
(745
)
 
$
(1,320
)
Other comprehensive (loss)  income before reclassifications
   
-
     
-
     
(42
)
   
17
     
(25
)
Amounts reclassified from AOCI
   
7
     
10
     
(2
)
   
-
     
15
 
Ending balance
 
$
(962
)
 
$
(57
)
 
$
417
   
$
(728
)
 
$
(1,330
)
 
                                       
 
                                       
 
For the nine months ended September 30, 2014
 
 
Retirement Plans
 
Unrealized Gains and Losses on Financial derivative
 
Unrealized Gains and Losses on Available-for-Sale Securities
 
Unrealized Loss on Securities Transferred to Held-to-Maturity
 
Total
 
Beginning balance
 
$
(982
)
 
$
(81
)
 
$
99
   
$
(781
)
 
$
(1,745
)
Other comprehensive (loss) income before reclassifications
   
-
     
(4
)
   
335
     
53
     
384
 
Amounts reclassified from AOCI
   
20
     
28
     
(17
)
   
-
     
31
 
Ending balance
 
$
(962
)
 
$
(57
)
 
$
417
   
$
(728
)
 
$
(1,330
)


 
For the three months ended September 30, 2013
 
(In thousands)
Retirement Plans
 
Unrealized Gains and Losses on Financial derivative
 
Unrealized Gains and Losses on Available-for-Sale Securities
 
Securities reclassified from AFS to HTM
 
Total
 
Beginning balance
 
$
(2,651
)
 
$
(91
)
 
$
(473
)
 
$
-
   
$
(3,215
)
Other comprehensive (loss) income before reclassifications
   
-
     
(5
)
   
844
     
(799
)
   
40
 
Amounts reclassified from AOCI
   
57
     
9
     
(10
)
   
-
     
56
 
Ending balance
 
$
(2,594
)
 
$
(87
)
 
$
361
   
$
(799
)
 
$
(3,119
)
 
                                       
 
                                       
 
For the nine months ended September 30, 2013
 
 
Retirement Plans
 
Unrealized Gains and Losses on Financial derivative
 
Unrealized Gains and Losses on Available-for-Sale Securities
 
Unrealized Loss on Securities Transferred to Held-to-Maturity
 
Total
 
Beginning balance
 
$
(2,765
)
 
$
(117
)
 
$
1,564
   
$
-
   
$
(1,318
)
Other comprehensive income (loss) before reclassifications
   
-
     
2
     
(1,133
)
   
(799
)
   
(1,930
)
Amounts reclassified from AOCI
   
171
     
28
     
(70
)
   
-
     
129
 
Ending balance
 
$
(2,594
)
 
$
(87
)
 
$
361
   
$
(799
)
 
$
(3,119
)



 The following table presents the amounts reclassified out of each component of AOCI for the indicated period:

 
 
Amount Reclassified
 
 
 
Amount Reclassified
 
 
 
from AOCI1
 
 
 
from AOCI1
 
 
 
(Unaudited)
 
 
 
(Unaudited)
 
(In thousands)
 
For the three months ended
 
 
 
For the nine months ended
 
Details about AOCI1 components
 
September 30, 2014
   
September 30, 2013
 
Affected Line Item in the Statement  of Income
 
September 30, 2014
   
September 30, 2013
 
 
 
   
 
 
 
   
 
Unrealized holding gain on financial derivative:
 
   
 
 
 
   
 
 Reclassification adjustment for
   interest expense included in net income
 
$
(16
)
 
$
(15
)
 Interest on long term borrowings
 
$
(47
)
 
$
(46
)
 
   
6
     
6
 
 Provision for income taxes
   
19
     
18
 
 
 
$
(10
)
 
$
(9
)
 Net Income
 
$
(28
)
 
$
(28
)
Retirement plan items
               
 
               
Retirement plan net losses
               
 
               
   recognized in plan expenses2
 
$
(11
)
 
$
(95
)
 Salaries and employee benefits
 
$
(33
)
 
$
(286
)
 
   
4
     
38
 
 Provision for income taxes
   
13
     
115
 
 
 
$
(7
)
 
$
(57
)
 Net Income
 
$
(20
)
 
$
(171
)
 
               
 
               
Available-for-sale securities
               
 
               
Realized gain on sale of securities
 
$
3
   
$
17
 
Net gains on sales and redemptions of investment securities
 
$
29
   
$
116
 
 
   
(1
)
   
(7
)
 Provision for income taxes
   
(12
)
   
(46
)
 
 
$
2
   
$
10
 
 Net Income
 
$
17
   
$
70
 
 
               
 
               
1 Amounts in parentheses indicates debits in net income.
         
 
               
2 These items are included in net periodic pension cost.
         
 
               
   See Note 5 for additional information.
               
 
               

(12)  Stock Offering and Conversion

On October 16, 2014, the Company completed the conversion and reorganization pursuant to which Pathfinder Bancorp, MHC converted to the stock holding company form of organization.   New Pathfinder, the new stock holding company for Pathfinder Bank, sold 2,636,053 shares of common stock at $10.00 per share, for gross offering proceeds of $26.4 million in its stock offering.

Concurrent with the completion of the offering, shares of common stock of the Company owned by the public were exchanged for shares of New Pathfinder's common stock so that the shareholders now own approximately the same percentage of New Pathfinder's common stock as they owned of the Company's common stock immediately prior to the conversion, subject to adjustment as disclosed in the prospectus.  Shareholders of the Company received 1.6472 shares of New Pathfinder's common stock for each share of the Company's common stock they owned immediately prior to completion of the transaction.  Cash in lieu of fractional shares was paid based on the offering price of $10.00 per share. As a result of the offering and the exchange of shares, New Pathfinder has 4,352,203 shares outstanding.

The shares of common stock sold in the offering and issued began trading on the Nasdaq Capital Market on October 17, 2014 under the trading symbol "PBHC."


 


Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations (Unaudited)

Recent Developments

On October 16, 2014, the conversion of Pathfinder Bancorp, MHC from the mutual holding company form of organization to the stock holding company form of organization was completed. New Pathfinder became the new stock holding company for the Bank and sold 2,636,053 shares of common stock at $10.00 per share, for gross offering proceeds of $26.4 million in its stock offering.
 
Concurrent with the completion of the offering, shares of common stock of the Company owned by the public were exchanged for shares of New Pathfinder's common stock so that the Company's stockholders own approximately the same percentage of New Pathfinder's common stock as they owned of the Company's common stock immediately prior to the conversion.  Stockholders of the Company received 1.6472 shares of New Pathfinder's common stock for each share of the Company's common stock they owned immediately prior to completion of the transaction.  Cash in lieu of fractional shares was paid based on the offering price of $10.00 per share. As a result of the offering and the exchange of shares, New Pathfinder has 4,352,203 shares outstanding.

General

The Company was a federally chartered mid-tier holding company headquartered in Oswego, New York.  The primary business of the Company was its investment in Pathfinder Bank.  At September 30, 2014, the Company was majority owned by Pathfinder Bancorp, MHC, a federally-chartered mutual holding company (the "Mutual Holding Company").  At this same date, the Mutual Holding Company held 60.4% of the Company's common stock and the public and the Employee Stock Ownership Plan ("ESOP"), collectively, held the remaining 39.6% of the outstanding common stock.  At September 30, 2014, the Company and subsidiaries had total assets of $570.0 million, total liabilities of $524.7 million and shareholders' equity of $45.0 million plus noncontrolling interest of $406,000, which represented the 49% not owned by the Company as a result of the acquisition detailed in Note 23 within the 2013 audited consolidated financial statements filed on Form 10-K on March 17, 2014.

The following discussion reviews the Company's financial condition at September 30, 2014 and the results of operations for the three and nine-month periods ended September 30, 2014 and 2013.  Operating results for the three and nine months ended September 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014.
 
The following material under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" is written with the presumption that the users of the interim financial statements have read, or have access to, the Company's latest audited financial statements and notes thereto, together with Management's Discussion and Analysis of Financial Condition and Results of Operations as of December 31, 2013 and 2012 and for the two years then ended. Therefore, only material changes in financial condition and results of operations are discussed in the remainder of Part I.
Statement Regarding Forward-Looking Statements

This report contains forward-looking statements that are based on assumptions and may describe future plans, strategies and expectations of the Company. These forward-looking statements are generally identified by use of the words "believe," "expect," "intend," "anticipate," "estimate," "project" or similar expressions. The Company's ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations of the Company and its subsidiaries include, but are not limited to:

·
general economic conditions, either nationally or in our market area, that are worse than expected;

·
inflation and changes in the interest rate environment that reduce our interest margins or reduce the fair value of financial instruments;

·
increased competitive pressures among financial services companies;

·
changes in consumer spending, borrowing and savings habits;

·
our ability to enter new markets successfully and take advantage of growth opportunities, and the possible dilutive effect of potential acquisitions or de novo branches, if any;

·
legislative or regulatory changes that adversely affect our business;

·
adverse changes in the securities markets;

·
changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board or the Securities and Exchange Commission;

·
inability of third-party providers to perform their obligations to us; and

·
changes in our organization, compensation and benefit plans.
 

 
Management's ability to predict results or the effect of future plans or strategies is inherently uncertain. These factors include, but are not limited to, general economic conditions, changes in the interest rate environment, legislative or regulatory changes that may adversely affect our business, changes in accounting policies and practices, changes in competition and demand for financial services, adverse changes in the securities markets and changes in the quality or composition of the Company's loan or investment portfolios. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Except as required by applicable law or regulation, the Company does not undertake, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events.

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 consolidated financial statements and accompanying notes.  These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments.  Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported.  Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value or when an asset or liability needs to be recorded contingent upon a future event.  Carrying assets and liabilities at fair value inherently results in more financial statement volatility.  The fair values and information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices or are provided by other third-party sources, when available.  When third party information is not available, valuation adjustments are estimated in good faith by management.

The most significant accounting policies followed by the Company are presented in Note 1 to the annual audited consolidated financial statements included in the 2013 Annual Report filed with the Securities and Exchange Commission on Form 10-K on March 17, 2014, as amended March 25, 2014, ("the consolidated financial statements").  These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how significant assets and liabilities are valued in the consolidated financial statements and how those values are determined.  Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the allowance for loan losses, deferred income taxes, pension obligations, the evaluation of investment securities for other than temporary impairment, the evaluation of goodwill for impairment, and the estimation of fair values for accounting and disclosure purposes to be the accounting areas that require the most subjective and complex judgments.  These areas 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 on 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 Company establishes a specific allowance for all commercial loans in excess of the total related credit threshold of $100,000 and single borrower residential mortgage loans in excess of the total related credit threshold of $300,000 identified as being impaired which are on nonaccrual and have been risk rated under the Company's risk rating system as substandard, doubtful, or loss. In addition, an accruing substandard loan could be identified as being impaired.  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 the fair value of the collateral, less costs to sell.  The majority of the Company's impaired loans are collateral-dependent.  For all other loans and leases, the Company uses the general allocation methodology that establishes an allowance to estimate the probable incurred loss for each risk-rating category.  The loan portfolio also represents the largest asset type on the consolidated statement of condition.  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.

 
Deferred income tax assets and liabilities are determined using the liability method.  Under this method, the net deferred tax asset or liability is recognized for the future tax consequences.  This is attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases as well as net operating and capital loss carry forwards.  Deferred tax assets and liabilities are measured using enacted tax rates applied to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The affect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period that includes the enactment date.  If current available evidence about the future raises doubt about the likelihood of a deferred tax asset being realized, a valuation allowance is established.  The judgment about the level of future taxable income, including that which is considered capital, is inherently subjective and is reviewed on a continual basis as regulatory and business factors change.  A valuation allowance of $458,000 was maintained at September 30, 2014, as management believes it may not generate sufficient capital gains to offset its capital loss carry forward.  The Company's effective tax rate differs from the statutory rate due primarily to non-taxable income from investment securities and bank owned life insurance.

We maintain a noncontributory defined benefit pension plan covering substantially all employees. The plan provides defined benefits based on years of service and final average salary. On May 14, 2012, we informed our employees of our decision to freeze participation and benefit accruals under the plan, primarily to reduce some of the volatility in earnings that can accompany the maintenance of a defined benefit plan.  Pension and post-retirement benefit plan liabilities and expenses are based upon actuarial assumptions of future events; including fair value of plan assets, interest rates, and the length of time the Company will have to provide those benefits.  The assumptions used by management are discussed in Note 12 to the consolidated annual financial statements.

Management performs an annual evaluation of our goodwill for possible impairment. Based on the results of the December 31, 2013 evaluation, management has determined that the carrying value of goodwill was not impaired as of that date. The evaluation approach is described in Note 9 of the audited consolidated financial statements. Further information on the estimation of fair values can be found in Note 20 to the audited consolidated financial statements.

The Company carries all of its available-for-sale investments at fair value with any unrealized gains or losses reported net of tax as an adjustment to shareholders' equity and included in accumulated other comprehensive income (loss), except for the credit-related portion of debt security impairment losses and other-than-temporary impairment ("OTTI") of equity securities which are charged to earnings.  The Company's ability to fully realize the value of its investments in various securities, including corporate debt securities, is dependent on the underlying creditworthiness of the issuing organization.  In evaluating the debt security (both available-for-sale and held-to-maturity) portfolio for other-than-temporary impairment losses, management considers (1) if we intend to sell the security; (2) if it is "more likely than not" we will be required to sell the security before recovery of its amortized cost basis; or (3) if the present value of expected cash flows is not sufficient to recover the entire amortized cost basis. When the fair value of a held-to-maturity or available-for-sale security is less than its amortized cost basis, an assessment is made as to whether OTTI is present.  The Company considers numerous factors when determining whether a potential OTTI exists and the period over which the debt security is expected to recover.  The principal factors considered are (1) the length of time and the extent to which the fair value has been less than the amortized cost basis, (2) the financial condition of the issue and (guarantor, if any) and adverse conditions specifically related to the security, industry or geographic area, (3) failure of the issuer of the security to make scheduled interest or principal payments, (4) any changes to the rating of the security by a rating agency, and (5) the presence of credit enhancements, if any, including the guarantee of the federal government or any of its agencies.
 
 

 
The estimation of fair value is significant to several of our assets; including investment securities available-for-sale, the interest rate derivative, intangible assets, foreclosed real estate, and the value of loan collateral when valuing loans.  These are all recorded at either fair value, or the lower of cost or fair value. Fair values are determined based on third party sources, when available.  Furthermore, accounting principles generally accepted in the United States require disclosure of the fair value of financial instruments as a part of the notes to the consolidated financial statements.  Fair values on our available-for-sale securities may be influenced by a number of factors; including market interest rates, prepayment speeds, discount rates, and the shape of yield curves.

Fair values for securities available-for-sale are obtained from an independent third party pricing service.  Where available, fair values are based on quoted prices on a nationally recognized securities exchange.  If quoted prices are not available, fair values are measured using quoted market prices for similar benchmark securities.  Management made no adjustments to the fair value quotes that were provided by the pricing source.  The fair values of foreclosed real estate and the underlying collateral value of impaired loans are typically determined based on evaluations by third parties, less estimated costs to sell.  When necessary, appraisals are updated to reflect changes in market conditions.

Recent Events

On September 25, 2014, the Company announced that its Board of Directors declared a quarterly dividend of $.03 per common share.  The dividend is payable on November 4, 2014 to shareholders of record on October 15, 2014.

Overview and Results of Operations

We had net income of $746,000 for the three months ended September 30, 2014 compared to net income of $528,000 for the three months ended September 30, 2013.  The increase in the net income of $218,000, or 41.3%, was due primarily to an increase in net interest income as a result of the increase of average interest-earning asset balances and the decrease in the average cost of interest-bearing liabilities between the third quarter of 2014 and the third quarter of 2013, offset by a $194,000 increase in the provision for loan losses.  We had net income of $1.9 million for the nine months ended September 30, 2014 which was unchanged from the comparable prior year period.

Return on average assets was 0.52% for the three-month period ended September 30, 2014 compared to 0.43% for the corresponding period in 2013.  The increase was due principally to the increase in net income for the three months ended September 30, 2014 as compared to the prior year period.  Return on average assets was 0.47% for the nine-month period in 2014 as compared to 0.50% for the comparable prior year period.  This decrease was principally due to the increase in average assets of $30.8 million for the nine-month period ended September 30, 2014 as compared to the same prior year period.

Net interest margin, on a tax-equivalent basis, increased 9 basis points to 3.54% during the third quarter of 2014 as compared to the same prior year period.  For the nine month period ended September 30, 2014, net interest margin increased by 7 basis points to 3.49% as compared to the same prior year period.



 

Net Interest Income

Net interest income is the Company's primary source of operating income for payment of operating expenses and providing for loan losses.  It is the amount by which interest earned on loans, interest-earning deposits, and investment securities, exceeds the interest paid on deposits and other interest-bearing liabilities.  Changes in net interest income and net interest margin result from the interaction between the volume and composition of interest-earning assets, interest-bearing liabilities, related yields, and associated funding costs.

The following table sets forth information concerning average interest-earning assets and interest-bearing liabilities and the average yields and rates thereon for the periods indicated. 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. Nonaccrual loans have been included in interest-earning assets for purposes of these calculations.


 
 
For the three months Ended September 30,
 
 
 
2014
   
2013
 
 
 
   
   
Average
   
   
   
Average
 
 
 
Average
   
   
Yield /
   
Average
   
   
Yield /
 
(Dollars in thousands)
 
Balance
   
Interest
   
Cost
   
Balance
   
Interest
   
Cost
 
Interest-earning assets:
 
   
   
   
   
   
 
Real estate loans residential
 
$
171,652
   
$
1,934
     
4.51
%
 
$
168,660
   
$
1,889
     
4.48
%
Real estate loans commercial
   
112,158
     
1,425
     
5.08
%
   
92,923
     
1,245
     
5.36
%
Commercial loans
   
53,827
     
654
     
4.86
%
   
51,643
     
592
     
4.59
%
Consumer loans
   
25,716
     
339
     
5.27
%
   
24,921
     
346
     
5.55
%
Taxable investment securities
   
109,882
     
508
     
1.85
%
   
95,072
     
428
     
1.80
%
Tax-exempt investment securities
   
28,400
     
298
     
4.20
%
   
25,650
     
287
     
4.48
%
Interest-earning time deposit
   
500
     
2
     
1.60
%
   
1,500
     
5
     
1.33
%
Interest-earning deposits
   
7,434
     
2
     
0.11
%
   
5,410
     
2
     
0.15
%
Total interest-earning assets
   
509,569
     
5,162
     
4.06
%
   
465,779
     
4,794
     
4.12
%
Noninterest-earning assets:
                                               
Other assets
   
41,895
                     
34,068
                 
Allowance for loan losses
   
(5,191
)
                   
(4,979
)
               
Net unrealized gains
                                               
on available-for sale-securities
   
802
                     
(1,188
)
               
Total assets
 
$
547,075
                   
$
493,680
                 
Interest-bearing liabilities:
                                               
NOW accounts
 
$
39,779
   
$
23
     
0.23
%
 
$
36,066
   
$
20
     
0.22
%
Money management accounts
   
13,247
     
6
     
0.18
%
   
13,830
     
5
     
0.14
%
MMDA accounts
   
92,742
     
104
     
0.45
%
   
76,374
     
86
     
0.45
%
Savings and club accounts
   
74,163
     
16
     
0.09
%
   
69,435
     
13
     
0.07
%
Time deposits
   
167,415
     
330
     
0.79
%
   
158,309
     
481
     
1.22
%
Junior subordinated debentures
   
5,155
     
39
     
3.03
%
   
5,155
     
40
     
3.10
%
Borrowings
   
44,516
     
138
     
1.24
%
   
40,452
     
134
     
1.33
%
Total interest-bearing liabilities
   
437,017
     
656
     
0.60
%
   
399,621
     
779
     
0.78
%
Noninterest-bearing liabilities:
                                               
Demand deposits
   
58,548
                     
49,355
                 
Other liabilities
   
6,153
                     
4,480
                 
Total liabilities
   
501,718
                     
453,456
                 
Shareholders' equity
   
45,357
                     
40,224
                 
Total liabilities & shareholders' equity
 
$
547,075
                   
$
493,680
                 
Net interest income
         
$
4,506
                   
$
4,015
         
Net interest rate spread
                   
3.46
%
                   
3.34
%
Net interest margin
                   
3.54
%
                   
3.45
%
Ratio of average interest-earning assets
                                               
to average interest-bearing liabilities
                   
116.60
%
                   
116.56
%

 
 
Net interest income, on a tax-equivalent basis, increased $491,000, or 12.2%, to $4.5 million for the three months ended September 30, 2014 as compared to $4.0 million for the three months ended September 30, 2013. The increase in net interest income was due principally to the increase in interest income on our interest-earning assets due principally to our commercial real estate and commercial loan portfolios and our taxable investment securities.  Additionally, the increase in net interest income was also due to the decrease in average rates paid on time deposits.  As a result, our interest rate spread for the three months ended September 30, 2014 increased to 3.46% from 3.34% during the three months ended September 30, 2013.

Interest income on a tax-equivalent basis increased $368,000, or 7.7%, to $5.2 million for the three months ended September 30, 2014 compared to the three months ended September 30, 2013.  The increase in interest income was due principally to the increase in average balances of commercial real estate loans and increases in both average balances and yields on commercial loans and taxable investment securities, offset in part by a decrease in the average yield of commercial real estate loans. Additionally, interest expense decreased $123,000 between the year over year third quarter periods as the average cost of time deposits decreased due principally to the decrease in rates paid of 43 basis points on this interest-bearing liability product.  The decrease in average rates paid on time deposits was the result of maturing certificates of deposits reinvested in shorter duration certificate of deposit as consumers opted to improve their liquidity given the current uncertain low rate environment.  As a result, our interest spread for the three months ended September 30, 2014 increased to 3.46% from 3.34% during the three months ended September 30, 2013.

Interest income on loans, on a tax-equivalent basis, was $4.4 million for the three months ended September 30, 2014 as compared to $4.1 million for the three months ended September 30, 2013.  The year over year third quarter improvement was due primarily to the $19.2 million, or 20.7% increase in the average balance of commercial real estate loans and the 27 basis point improvement in yield on commercial loans.  The significant increase in the average balance of commercial real estate loans is due to the increased penetration and the Bank's acceptance into the greater Syracuse marketplace which results in somewhat larger loan sizes placed under our consideration. In addition, the average balance of our residential mortgage loan portfolio increased by 1.8% to $171.7 million and the average yield of this portfolio increased by 3 basis points to 4.51% for the three months ended September 30, 2014.  The slower growth in this portfolio reflects general market considerations.  The consumer loan portfolio, which includes home equity loans and lines of credit, recorded growth of 3.2% to $25.7 million and a decrease in yield of 28 basis points, both between the third quarter of 2013 and the third quarter of 2014.

Interest income, on a tax-equivalent basis, on taxable investment securities increased $80,000 for the three months ended September 30, 2014 as compared to the same prior year period due principally to an increase of 15.6% to $109.9 million, in the average balance of taxable investment securities and, to a lesser extent, a 5 basis point increase in average yield to 1.85%.

Interest income on tax-exempt securities increased $11,000 to $298,000 for the three months ended September 30, 2014 when compared to the three months ended September 30, 2013 due to the increase of average balances of this portfolio of 10.7% to $28.4 million.

Interest expense for the three months ended September 30, 2014 decreased $123,000, or 15.8%, to $656,000 from $779,000 for the three months ended September 30, 2013.  The decrease in our interest expense was primarily due to our interest expense on deposits decreasing $126,000, or 20.8%, to $479,000 during the three months ended September 30, 2014.  The average rate paid on interest-bearing liabilities decreased 18 basis points to 0.60% during the three months ended September 30, 2014, compared to 0.78% during the three months ended September 30, 2013 as market interest rates remained low.

Interest expense on deposits decreased $126,000 to $479,000 primarily due to the decrease in the average rate paid on time deposits of 43 basis points to 0.79% as maturing certificates of deposit were either replaced at lower current market rates or invested in lower costing core deposits during the three months ended September 30, 2014.  The average balance of lower cost core deposits, which include demand deposits, NOW, money management, money market, and savings and club accounts, increased $33.4 million to $278.5 million for the three months ended September 30, 2014 as a result of the increase in the average balance of money market deposit accounts whose average balance increased $16.4 million, or 21.4%, during the three months ended September 30, 2014 as compared to the three months ended September 30, 2013.
 

Interest expense on long-term borrowings increased nominally as the increase in average balances of $4.1 million to $44.5 million was nearly offset by the decrease in average rates paid FHLBNY borrowings as higher rate maturing FHLBNY advances were replaced with advances of a shorter duration and a lower average rate. The average rate of our borrowings decreased 9 basis points to 1.24% for the three months ended September 30, 2014 as compared to the three months ended September 30, 2013.
 

 

 
 
For the nine months Ended September 30,
 
 
 
2014
   
2013
 
 
 
   
   
Average
   
   
   
Average
 
 
 
Average
   
   
Yield /
   
Average
   
   
Yield /
 
(Dollars in thousands)
 
Balance
   
Interest
   
Cost
   
Balance
   
Interest
   
Cost
 
Interest-earning assets:
 
   
   
   
   
   
 
Real estate loans residential
 
$
169,862
   
$
5,663
     
4.45
%
 
$
173,705
   
$
5,925
     
4.55
%
Real estate loans commercial
   
105,741
     
3,929
     
4.95
%
   
87,489
     
3,523
     
5.37
%
Commercial loans
   
52,716
     
1,919
     
4.85
%
   
51,980
     
1,822
     
4.67
%
Consumer loans
   
25,520
     
1,029
     
5.38
%
   
25,167
     
1,064
     
5.64
%
Taxable investment securities
   
103,735
     
1,444
     
1.86
%
   
95,473
     
1,270
     
1.77
%
Tax-exempt investment securities
   
27,445
     
886
     
4.30
%
   
25,761
     
860
     
4.45
%
Interest-earning time deposit
   
500
     
6
     
1.60
%
   
1,772
     
16
     
1.20
%
Interest-earning deposits
   
5,700
     
4
     
0.09
%
   
6,026
     
5
     
0.11
%
Total interest-earning assets
   
491,219
     
14,880
     
4.03
%
   
467,373
     
14,485
     
4.13
%
Noninterest-earning assets:
                                               
Other assets
   
41,402
                     
33,580
                 
Allowance for loan losses
   
(5,118
)
                   
(4,764
)
               
Net unrealized gains
                                               
on available for sale securities
   
661
                     
1,177
                 
Total assets
 
$
528,164
                   
$
497,366
                 
Interest-bearing liabilities:
                                               
NOW accounts
 
$
39,319
   
$
55
     
0.19
%
 
$
38,609
   
$
60
     
0.21
%
Money management accounts
   
13,300
     
16
     
0.16
%
   
14,214
     
21
     
0.20
%
MMDA accounts
   
93,927
     
294
     
0.42
%
   
79,544
     
269
     
0.45
%
Savings and club accounts
   
74,628
     
47
     
0.08
%
   
68,973
     
40
     
0.08
%
Time deposits
   
159,810
     
1,092
     
0.91
%
   
162,694
     
1,504
     
1.23
%
Junior subordinated debentures
   
5,155
     
120
     
3.10
%
   
5,155
     
121
     
3.13
%
Borrowings
   
38,243
     
392
     
1.37
%
   
34,774
     
494
     
1.89
%
Total interest-bearing liabilities
   
424,382
     
2,016
     
0.63
%
   
403,963
     
2,509
     
0.83
%
Noninterest-bearing liabilities:
                                               
Demand deposits
   
54,980
                     
48,323
                 
Other liabilities
   
4,437
                     
4,134
                 
Total liabilities
   
483,799
                     
456,420
                 
Shareholders' equity
   
44,365
                     
40,946
                 
Total liabilities & shareholders' equity
 
$
528,164
                   
$
497,366
                 
Net interest income
         
$
12,864
                   
$
11,976
         
Net interest rate spread
                   
3.40
%
                   
3.30
%
Net interest margin
                   
3.49
%
                   
3.42
%
Ratio of average interest-earning assets
                                               
to average interest-bearing liabilities
                   
115.75
%
                   
115.70
%

Net interest income, on a tax-equivalent basis, increased $888,000, or 7.4%, to $12.9 million for the nine months ended September 30, 2014 as compared to $12.0 million for the nine months ended September 30, 2013.  The increase in net interest income was due primarily to the decrease in average rates paid on time deposits and Federal Home Loan Bank of New York borrowings between the year over year nine month periods.  Significant reductions were also recorded in average rates paid on time deposits and borrowings of 32 basis points and 52 basis points, respectively, between these same two periods.  As a result, our interest rate spread for the nine months ended September 30, 2014 increased to 3.40% from 3.30% for the nine months ended September 30, 2013.
 
 

 
Interest income on a tax-equivalent basis increased $395,000, or 2.7%, to $14.9 million for the nine months ended September 30, 2014 as compared to the same prior year period.  The increase in our interest income was due primarily to an increase in interest income on commercial real estate loans and taxable investment securities of $406,000, or 11.5%, and $174,000 or 13.7%, respectively, between the nine-month period ended September 30, 2014 and the nine-month period ended September 30, 2013.  The increase in our commercial real estate portfolio reflects the Company's continued penetration into the greater Syracuse market.  The increase in our taxable investment securities reflects the first half of the year needed to collateralize the increase in municipal deposits and the success in gathering deposits through organic growth and new customer relationships within the greater Syracuse market.  The average balance of interest-earning assets increased 5.1% to $491.2 million while yields earned decreased 10 basis points to 4.03% for the nine-month period ended September 30, 2014 as compared to the same prior year period.

Interest income on loans increased $206,000 to $12.5 million for the nine months ended September 30, 2014 from $12.3 million for the nine months ended September 30, 2013 primarily as a result of an increase in interest income from commercial real estate loans and partially offset by a decrease in interest income from residential real estate loans and the reduced interest we are able to accrue from the increase in nonaccrual loans.  Interest income from commercial real estate loans increased $406,000, or 11.5%, to $3.9 million for the nine months ended September 30, 2014. The average balance of commercial real estate loans increased $18.3 million, or 20.9%, to $105.7 million for the nine months ended September 30, 2014 from $87.5 million for the nine months ended September 30, 2013 due to our continued emphasis in our business strategy to expand into the Syracuse market.  Interest income on residential real estate loans decreased $262,000 for the nine months ended September 30, 2014 as compared to the same prior year period. The decrease in interest income on residential real estate loans was due to the decrease in the average balance of such loans of $3.8 million, or 2.2%, to $169.9 million for the nine months ended September 30, 2014 as compared to the same prior year period.  The decrease in the average balance of residential real estate loans was due principally to the $8.8 million residential loan sale that occurred in the second quarter of 2013, and, to a lesser extent, the slowdown in growth in residential mortgage loan originations during the first nine months of 2014 as compared to the same prior year period.  Additionally, the average yield on the residential loan portfolio decreased by 10 basis points to 4.45% for the nine months ended September 30, 2014 as maturing higher yielding residential mortgage loans were replaced by loans at the current lower interest rates.

Interest income on taxable investment securities increased $174,000 for the nine months ended September 30, 2014 due principally to an increase of $8.3 million in the average balance of taxable investment securities for the nine months ended September 30, 2014.   The increase in our average balance of taxable investment securities was the result of the need for additional collateral in support of our increasing balances of municipal deposits in the first half of 2014.  In addition, the average yield on such securities increased 9 basis points to 1.86% for the nine months ended September 30, 2014.  Interest income on tax-exempt securities increased $26,000 to $886,000 for the nine months ended September 30, 2014 when compared to the nine months ended September 30, 2013.  This increase was generally due to the average balance of tax-exempt securities increasing $1.7 million to $27.4 million for the nine months ended September 30, 2014, partially offset by the decrease in the average yield earned on the tax-exempt securities, which decreased 15 basis points to 4.30% for the nine months ended September 30, 2014. The increase in the average balance of tax-exempt securities was the result of the purchase of several in-market municipal securities offerings.  The majority of the municipal securities were issued by current municipal deposit customers of the Bank.  The related reduction in average yield was the result of the newly purchased municipal securities carrying yields that are slightly lower than the previously existing average tax-exempt portfolio yield.

Interest expense for the nine months ended September 30, 2014 decreased $493,000, or 19.7%, to $2.0 million from $2.5 million for the nine months ended September 30, 2013.  The decrease in interest expense was primarily due to decreases in interest expense on time deposits and FHLBNY borrowings during the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013.  The average rate paid on interest bearing liabilities decreased 20 basis points to 0.63% for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013 as market interest rates remained low.
 
 

 
Interest expense on deposits decreased primarily due to the decrease of 32 basis points in the average rate paid on time deposits as maturing certificates of deposit were either replaced at lower current market rates or invested in lower costing core deposits.  Consumers are opting to keep their investments in products of shorter duration and improve their liquidity given the current uncertain rate environment.  Accordingly, the average balance of core deposits increased $26.5 million to $276.2 million for the nine months ended September 30, 2014 as compared to the same prior year period.

Interest expense on borrowings decreased largely due to our higher rate FHLBNY maturing advances having been replaced by advances of a shorter duration and a lower average rate. The average rate of our borrowings decreased 52 basis points to 1.37% for the first nine months of 2014 as compared to the same prior year period.

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 changes in 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.


 
 
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
 
 
2014 vs. 2013
   
2014 vs. 2013
 
 
 
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
 
$
34
   
$
11
   
$
45
   
$
(130
)
 
$
(132
)
 
$
(262
)
Real estate loans commercial
   
558
     
(378
)
   
180
     
829
     
(423
)
   
406
 
Commercial loans
   
26
     
36
     
62
     
26
     
71
     
97
 
Consumer loans
   
51
     
(58
)
   
(7
)
   
22
     
(57
)
   
(35
)
Taxable investment securities
   
69
     
11
     
80
     
113
     
61
     
174
 
Tax-exempt investment securities
   
97
     
(86
)
   
11
     
67
     
(41
)
   
26
 
Interest-earning time deposits
   
(8
)
   
5
     
(3
)
   
(16
)
   
6
     
(10
)
Interest-earning deposits
   
3
     
(3
)
   
-
     
-
     
(1
)
   
(1
)
Total interest income
   
830
     
(462
)
   
368
     
911
     
(516
)
   
395
 
Interest Expense:
                                               
NOW accounts
   
2
     
1
     
3
     
2
     
(7
)
   
(5
)
Money management accounts
   
(1
)
   
2
     
1
     
(1
)
   
(4
)
   
(5
)
MMDA accounts
   
20
     
(2
)
   
18
     
55
     
(30
)
   
25
 
Savings and club accounts
   
1
     
2
     
3
     
3
     
4
     
7
 
Time deposits
   
169
     
(320
)
   
(151
)
   
(26
)
   
(386
)
   
(412
)
Junior subordinated debentures
   
-
     
(1
)
   
(1
)
   
-
     
(1
)
   
(1
)
Borrowings
   
44
     
(40
)
   
4
     
70
     
(172
)
   
(102
)
Total interest expense
   
235
     
(358
)
   
(123
)
   
103
     
(596
)
   
(493
)
Net change in net interest income
 
$
595
   
$
(104
)
 
$
491
   
$
808
   
$
80
   
$
888
 

Provision for Loan Losses

We establish a provision for loan losses, which is charged to operations, at a level management believes is appropriate to absorb probable incurred credit losses in the loan portfolio.  In evaluating the level of the allowance for loan losses, management considers historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral, and prevailing economic conditions.  This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as future events change. The provision for loan losses represents management's estimate of the amount necessary to maintain the allowance for loan losses at an adequate level.
 
 

 
We recorded $410,000 in provision for loan losses for the three month period ended September 30, 2014, as compared to $216,000 for the three month period ended September 30, 2013.  One large commercial relationship with two loan facilities was charged off in the amount of $336,000 in the third quarter of 2014, with a specific reserve allocated through the provision for loan losses in prior periods of $243,000.  The $177,000 decrease in specific reserves between June 30, 2014 and September 30, 2014 was largely due to the charge-offs associated with this commercial relationship.  The increase in the provision for loan losses was a direct result of the $405,000 in net charge-offs in the third quarter of 2014 and the $15.5 million growth in gross loans between the second quarter and the third quarter of 2014.  Management deems the amount of the provision recorded during the third quarter of 2014 to be adequate in support of the current level of allowance for loan losses.

We recorded a $930,000 provision for loan losses through the first nine months of 2014 as compared to $816,000 for the same prior year period.  Net charge-offs for the nine months ended September 30, 2014 were $800,000 as compared to $232,000 for the prior year period, an increase of $568,000.  The year over year increase in net charge-offs was due to certain first quarter 2014 non-recurring portfolio charge-offs recorded in order to conform more closely to FDIC guidance and the previously mentioned $336,000 charge-off recorded in the third quarter of 2014.  Management deems the amount of the provision recorded during the first nine months of 2014 to be adequate in support of the current level of allowance for loan losses.

We measure delinquency based on the amount of past due loans as a percentage of total loans.  Delinquency trends improved to 3.6% at September 30, 2014 as compared to 5.1% at December 31, 2013.  The improvement was seen in all of our loan portfolio segments with a significant percentage reduction seen in the consumer loan segment and the commercial loan segment.  Within the commercial loans portfolio segment past due categories, the increase in past due loans 90 days and over was more than offset by the decrease in past due loans in all other categories.  Delinquencies within the residential mortgage portfolio segment decreased to 2.7% of total residential mortgage loans from 3.5% as of December 31, 2013.  The ratio of the allowance for loan losses to period end loans decreased modestly from 1.48% at December 31, 2013 to 1.38% at September 30, 2014.  Management reviews trends in historical loss rates and environmental factors on a quarterly basis, in addition to assessing the specific allowance needs on impaired loans, and judges the current level of allowance for loan losses to be adequate to absorb the estimable and probable losses inherent in the loan portfolio.




 
Noninterest Income

The Company's noninterest income is primarily comprised of fees on deposit account balances and transactions, loan servicing, commissions, including insurance agency commissions, and net gains on securities, loans, and foreclosed real estate.

The following table sets forth certain information on noninterest income for the periods indicated:

 
 
 
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
(Dollars in thousands)
 
2014
   
2013
   
Change
   
2014
   
2013
   
Change
 
Service charges on deposit accounts
 
$
311
   
$
313
   
$
(2
)
   
-0.6
%
 
$
894
   
$
856
   
$
38
     
4.4
%
Earnings and gain on bank owned life insurance
   
64
     
60
     
4
     
6.7
%
   
190
     
172
     
18
     
10.5
%
Loan servicing fees
   
81
     
30
     
51
     
170.0
%
   
202
     
112
     
90
     
80.4
%
Debit card interchange fees
   
127
     
114
     
13
     
11.4
%
   
369
     
341
     
28
     
8.2
%
Other charges, commissions and fees
   
304
     
134
     
170
     
126.9
%
   
880
     
400
     
480
     
120.0
%
Noninterest income before gains
   
887
     
651
     
236
     
36.3
%
   
2,535
     
1,881
     
654
     
34.8
%
Net gains on sales and redemptions of investment securities
   
3
     
17
     
(14
)
   
-82.4
%
   
29
     
116
     
(87
)
   
-75.0
%
Net gains on sales of loans and foreclosed real estate
   
10
     
36
     
(26
)
   
-72.2
%
   
39
     
487
     
(448
)
   
-92.0
%
Total noninterest income
 
$
900
   
$
704
   
$
196
     
27.8
%
 
$
2,603
   
$
2,484
   
$
119
     
4.8
%

Total noninterest income for the three months ended September 30, 2014 increased to $900,000 from $704,000 for the three months ended September 30, 2013.  This increase of $196,000 between these two periods was due primarily to an increase of $170,000 in other charges, commissions and fees, the majority of which were from the commissions earned from Pathfinder Risk Management Company, Inc., which owns a 51% membership interest in FitzGibbons Agency, LLC ("Insurance Agency") which we acquired in the fourth quarter of 2013.  Accounting guidance requires the Company to consolidate 100% of the Insurance Agency within the consolidated financial statements.  The 49% of which the Company does not own is accounted for separately as a noncontrolling interest within the consolidated financial statements.  Additionally, loan servicing fees increased $51,000 due to the recognition of income from guarantee fees of the Federal National Mortgage Association ("FNMA").

Total noninterest income for the nine months ended September 30, 2014 increased $119,000, to $2.6 million as compared to $2.5 million for the same prior year period.  This increase was driven by the increase in other charges, commissions and fees of $480,000 during the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013.  The commissions of the Insurance Agency were responsible for $430,000 of this increase.  Additionally, loan servicing fees increased $90,000 and service charges on deposit accounts increased $38,000, during the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013. Loan servicing fees increased due to the previously mentioned FNMA guarantee fees.  Service charges on deposit accounts increased primarily due to the increase in the service charges associated with deposit accounts. These increases in noninterest income were offset by a $448,000 decrease in net gains on sales of loans and foreclosed real estate due principally to the $395,000 loan sale that occurred in the second quarter of 2013.  Additionally, we recorded a decrease of $87,000 in net gains on sales and redemptions of investment securities between the nine months ended September 30, 2014 and the nine months ended September 30, 2013.  A limited investment portfolio restructuring resulted in modest gains being recognized during the nine months ended September 30, 2013 that was not repeated during the nine months ended September 30, 2014.



 

Noninterest Expense

The following table sets forth certain information on noninterest expense for the periods indicated:

 
 
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
(Dollars in thousands)
 
2014
   
2013
   
Change
   
2014
   
2013
   
Change
 
Salaries and employee benefits
 
$
2,141
   
$
2,033
   
$
108
     
5.3
%
 
$
6,526
   
$
5,884
   
$
642
     
10.9
%
Building occupancy
   
421
     
382
     
39
     
10.2
%
   
1,193
     
1,109
     
84
     
7.6
%
Data processing
   
367
     
356
     
11
     
3.1
%
   
1,131
     
1,067
     
64
     
6.0
%
Professional and other services
   
160
     
178
     
(18
)
   
-10.1
%
   
508
     
502
     
6
     
1.2
%
Advertising
   
141
     
146
     
(5
)
   
-3.4
%
   
372
     
393
     
(21
)
   
-5.3
%
FDIC assessments
   
99
     
123
     
(24
)
   
-19.5
%
   
294
     
291
     
3
     
1.0
%
Audits and exams
   
61
     
61
     
-
     
0.0
%
   
186
     
184
     
2
     
1.1
%
Other expenses
   
422
     
388
     
34
     
8.8
%
   
1,273
     
1,343
     
(70
)
   
-5.2
%
Total noninterest expenses
 
$
3,812
   
$
3,667
   
$
145
     
4.0
%
 
$
11,483
   
$
10,773
   
$
710
     
6.6
%

Total noninterest expense for the three months ended September 30, 2014 increased $145,000, or 4.0%, to $3.8 million from $3.7 million for the three months ended September 30, 2013.

The increase in noninterest expense was due principally to increases in personnel expenses of $108,000 and building occupancy expenses of $39,000 for the three month period ended September 30, 2014.  Salaries and employee benefits expenses increased due in part to wage increases, increased deferred compensation expenses of $67,000, and the inclusion of $81,000 in personnel expenses of the Insurance Agency.  Offsetting the other components within personnel expenses was a $97,000 improvement in the pension benefit which offset other increases in employee benefits such as payroll taxes and 401(k) contributions.

Total noninterest expense for the nine months ended September 30, 2014 increased $710,000, or 6.6%, to $11.5 million from $10.8 million for the same prior year period due largely to the $642,000 increase in salaries and employee benefits expenses and $84,000 in building occupancy expenses.

The increase in salaries and employee benefits expenses reflected wage increases, $197,000 related to increased deferred compensation costs, and $111,000 related to commissions and accrued expenses for corporate bonus and incentive program.  Additionally, $234,000 of the increase in salaries and employee benefits expenses related to those of the Insurance Agency, which was not acquired until the fourth quarter of 2013.  Offsetting the other components within salaries and employee benefits expenses was a $293,000 improvement in the pension benefit which offset other increases in employee benefits such as payroll taxes and 401(k) contributions.  Partially offsetting the increase in the total noninterest expenses was a reduction in other operating expenses of $70,000 due principally to the $65,000 write-off of a repossessed asset which occurred in the second quarter of 2013.

Income Tax Expense

Income tax expense increased by $122,000 for the quarter ended September 30, 2014 as compared to the same period in 2013 primarily due to an increase in pretax income and an increase in the effective tax rate for the quarter to accommodate the year to date effective tax rate estimate of 28.5%, exclusive of the net income attributable to our controlling interest in the Insurance Agency.  For the three-month period ended September 30, 2013, the effective tax rate was 27.0%.  The increase in the effective tax rate between the year over year third quarter periods reflected a smaller proportion of tax-exempt items as a proportion of our taxable income in the third quarter of 2014.

Income tax expense for the nine months ended September 30, 2014 increased $79,000 to $767,000 as compared to $688,000 for the nine months ended September 30, 2013.  The increase in income tax expense was due to the increase in pretax income and an increase in the effective tax rate to 28.5%, exclusive of the net income attributable to our controlling interest in the Insurance Agency, from 27.0% for the nine months ended September 30, 2013.  The increase in the effective tax rate between the nine months ended September 30, 2014 and 2013 reflected a smaller proportion of tax-exempt items as a proportion of our taxable income in the first half of 2014.  We have reduced our effective tax rate from the combined federal and state statutory rate of 38.7% primarily through the ownership of tax-exempt investment securities, bank owned life insurance, and other tax saving strategies.

 
 
 
Earnings per Share

Basic and diluted earnings per share were $0.28 for the third quarter of 2014, as compared to basic and diluted earnings per share of $0.21 and $0.20, respectively, for the third quarter of 2013.  The increase in basic and diluted earnings per share between these two periods was due principally to the increase in net income available to common shareholders.  Basic and diluted earnings per share for the nine month period ended September 30, 2014 were $0.73 and $0.72, respectively, as compared to basic and diluted earnings per share of $0.74 and $0.73, respectively, for the nine month period ended September 30, 2013.

Changes in Financial Condition

Assets

Total assets increased $66.2 million, or 13.1%, to $570.0 million at September 30, 2014 as compared to $503.8 million at December 31, 2013.  This increase was due primarily to an increase in investment securities, loans, bank-owned life insurance, and total cash and cash equivalents.

Investment securities increased to $136.6 million at September 30, 2014 from $115.4 million at December 31, 2013 due principally to the need to collateralize the increase in municipal deposits between these same two time periods. Of the total increase of $21.2 million in investment securities, 62.0% was classified within the available-for-sale portfolio, centered largely in residential mortgage backed securities.  The remaining 38.0% increase was recorded in the held-to-maturity investment securities portfolio.  When new investment securities are acquired, management reviews certain security characteristics and determines the company's intent and ability to hold the security to maturity.  Based on the security characteristics and management's intentions, the security is classified as either available-for-sale or held-to-maturity.

Total loans receivable increased $32.7 million, or 9.6%, to $374.3 million at September 30, 2014 from $341.6 million at December 31, 2013 primarily due to a $23.9 million, or 25.0%, increase in commercial real estate loans. This increase was a direct result of our growth in the greater Syracuse marketplace. Additionally, commercial and industrial loans and lines of credit increased $6.4 million, or 13.7%, to $53.6 million at September 30, 2014..  Residential mortgage loans increased $4.0 million, or 2.4%, to $170.4 million at September 30, 2014.  During the third quarter of 2014, the Company achieved modest residential loan portfolio growth as we gained market share in the greater Syracuse marketplace. As a result of our effort to diversify our loan portfolio with an increased emphasis on our commercial loan and commercial real estate products, the percent of our portfolio from these loan products grew from 43.3% to 47.0% between December 31, 2013 and September 30, 2014.

Bank owned life insurance increased $2.0 million during the first nine months of 2014 to $10.2 million at September 30, 2014 due principally to additional purchases of single premium life insurance policies on selected participants.  These purchases will provide income that will assist in the funding of optional deferred compensation and supplemental executive retirement plans.

Liabilities

Total liabilities increased to $524.7 million at September 30, 2014 from $460.7 million at December 31, 2013.  Deposits increased $72.9 million, or 17.8%, to $483.0 million at September 30, 2014 from $410.1 million at December 31, 2013.  The increase was due largely to a $37.6 million increase in retail demand deposits as a result of subscription orders received from our second-step conversion that closed on October 16, 2014.  Additionally, municipal deposit accounts increased $24.2 million and business deposit accounts increased $13.1 million between these two time periods as a direct result of the Company's strategy to gather deposits across all markets.  The increase in retail deposits allowed us to pay down borrowings at FHLBNY by $10.0 million between December 31, 2013 and September 30, 2014.
 

 
Stockholders' Equity

The Company's shareholders' equity, exclusive of the noncontrolling interest, increased $2.3 million, or 5.4%, to $45.0 million at September 30, 2014 from $42.7 million at December 31, 2013.  This increase was principally due to a $1.6 million increase in retained earnings, resulting from $1.9 million in net income through the nine months ended September 30, 2014 offset by dividends declared on our common stock totaling $229,000, preferred stock dividends declared of $63,000, and a reduction of $415,000 in accumulated other comprehensive loss due principally to an increase in the market value of our available-for-sale investment portfolio.

We were not required to pay dividends on our SBLF preferred stock during the first quarter of 2014 reflecting an existing credit with the U.S. Treasury. This credit expired in the third quarter of 2014 in which we paid a dividend of $31,000.  We expect to be obligated to pay the full 1% dividend totaling approximately $32,500 per quarter beginning in the fourth quarter of 2014 and continuing through March 2016.

Capital

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 September 30, 2014, 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%.

Pathfinder Bank's capital amounts and ratios as of the indicated dates are presented in the following table.

 
 
 
 
 
To Be "Well-
 
 
 
 
Minimum
 
Capitalized"
 
 
 
 
For Capital
 
Under Prompt
 
 
 
Adequacy Purposes
 
Corrective Provisions
 
(Dollars in thousands)
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
As of September 30, 2014:
 
 
 
 
 
 
Total Core Capital (to Risk-Weighted Assets)
 
$
50,480
     
13.33
%
 
$
30,292
     
8.00
%
 
$
37,865
     
10.00
%
Tier 1 Capital (to Risk-Weighted Assets)
 
$
45,554
     
12.03
%
 
$
15,146
     
4.00
%
 
$
22,719
     
6.00
%
Tier 1 Capital (to Assets)
 
$
45,554
     
8.41
%
 
$
21,657
     
4.00
%
 
$
27,071
     
5.00
%
As of December 31, 2013:
                                               
Total Core Capital (to Risk-Weighted Assets)
 
$
47,862
     
14.13
%
 
$
27,106
     
8.00
%
 
$
33,883
     
10.00
%
Tier 1 Capital (to Risk-Weighted Assets)
 
$
43,454
     
12.82
%
 
$
13,553
     
4.00
%
 
$
20,330
     
6.00
%
Tier 1 Capital (to Assets)
 
$
43,454
     
8.72
%
 
$
19,928
     
4.00
%
 
$
24,910
     
5.00
%






 

Loan and Asset Quality and Allowance for Loan Losses

The following table represents information concerning the aggregate amount of non-performing assets at the indicated dates:

 
 
September 30,
   
December 31,
   
September 30,
 
(Dollars In thousands)
 
2014
   
2013
   
2013
 
Nonaccrual loans:
 
   
   
 
Commercial real estate and commercial loans
 
$
5,159
   
$
2,709
   
$
3,060
 
Consumer
   
255
     
447
     
425
 
Residential real estate
   
2,028
     
2,194
     
2,401
 
Total nonaccrual loans
   
7,442
     
5,350
     
5,886
 
Total nonperforming loans
   
7,442
     
5,350
     
5,886
 
Foreclosed real estate
   
440
     
619
     
301
 
Total nonperforming assets
 
$
7,882
   
$
5,969
   
$
6,187
 
 
                       
Troubled debt restructurings not included above
 
$
1,931
   
$
2,459
   
$
2,049
 
 
                       
Nonperforming loans to total loans
   
1.99
%
   
1.57
%
   
1.74
%
Nonperforming assets to total assets
   
1.38
%
   
1.18
%
   
1.26
%

Nonperforming assets include nonaccrual loans, nonaccrual troubled debt restructurings ("TDR"), and foreclosed real estate. Loans are considered modified in a TDR when, due to a borrower's financial difficulties, the Company makes a concession(s) to the borrower that it would not otherwise consider. These modifications may include, among others, an extension of the term of the loan, and granting a period when interest-only payments can be made, with the principal payments made over the remaining term of the loan or at maturity.  TDRs are included in the above table within the following categories of nonaccrual loans or TDRs not included above (the latter also known as accruing TDRs).

Nonperforming assets at September 30, 2014 were $7.9 million, or 1.38% of total assets, as compared to $6.0 million, or 1.18% of total assets, at December 31, 2013.  The $1.9 million increase in non-performing assets between December 31, 2013 and September 30, 2014 was due principally to two large commercial relationships.  The first commercial relationship, with a present aggregate loan balance of $970,000, became nonperforming during the second quarter of 2014 including related commercial business and personal residential loans extended to this relationship. The borrower brought all loans current within this relationship as of June 30, 2014 and continued with on time payment performance through September 30, 2014. We will maintain this relationship on non-performing status, however, while monitoring the borrower's payment performance.  Once management has concluded that payment of contractual principal and interest is no longer in doubt, the relationship may be reclassified as performing.  The second commercial relationship, with a present aggregate loan balance of $1.5 million across six loans at September 30, 2014, became nonperforming during the third quarter of 2014.  All six loans remain past due as of September 30, 2014.  These increases to nonperforming assets were partially offset by the previously mentioned $336,000 charge-off in the third quarter of 2014 and payments on nonperforming assets.




 
As indicated in the non-performing asset table above and the detailed table below, foreclosed real estate ("FRE") balances decreased at September 30, 2014 from December 31, 2013.

 
 
   
September 30,
   
   
December 31,
   
   
September 30,
 
(Dollars in thousands)
   
#
     
2014
     
#
     
2013
     
#
     
2013
 
Foreclosed real estate
                                               
Foreclosed residential mortgage loans
   
4
   
$
281
     
5
   
$
341
     
3
   
$
134
 
Foreclosed commercial real estate
   
1
     
159
     
3
     
278
     
2
     
167
 
Total
   
5
   
$
440
     
8
   
$
619
     
5
   
$
301
 

Fair values for FRE are initially recorded based on market value evaluations by third parties, less costs to sell ("initial cost basis").  Any write-downs required when the related loan receivable is exchanged for the underlying real estate collateral at the time of transfer to foreclosed real estate are charged to the allowance for loan losses.  Values are derived from appraisals, similar to impaired loans, of underlying collateral or discounted cash flow analysis.  Subsequent to foreclosure, valuations are updated periodically and assets are marked to current fair value, not to exceed the initial cost basis.

The allowance for loan losses represents management's estimate of the probable losses inherent in the loan portfolio as of the date of the statement of condition.  The allowance for loan losses was $5.2 million and $5.0 million at September 30, 2014 and December 31, 2013, respectively.  The ratio of the allowance for loan losses to gross loans was 1.38% at September 30, 2014 as compared to 1.48% at December 31, 2013.  Management performs a quarterly evaluation of the allowance for loan losses based on quantitative and qualitative factors and has determined that the current level of the allowance for loan losses of $5.2 million is adequate to absorb the losses in the loan portfolio as of September 30, 2014.

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.  There are no loans that are past due 90 days or more and still accruing interest.  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 fair value of the collateral, with a portion of the impaired loans measured based upon the present value of future cash flows discounted at the historical effective interest rate.  A specific reserve is established for an impaired loan if its carrying value exceeds its estimated fair value.  The estimated fair values of the majority of the Company's impaired loans are measured based on the estimated fair value of the loan's collateral.  For loans secured by real estate, estimated fair values are determined primarily through third-party appraisals or broker price opinions.  When a loan is determined to be impaired Pathfinder Bank will reevaluate the collateral which secures the loan. For real estate, the Company will obtain a new appraisal or broker's opinion whichever is considered to provide the most accurate value in the event of sale. An evaluation of equipment held as collateral will be obtained from a firm able to provide such an evaluation. Collateral will be inspected not less than annually for all impaired loans and will be reevaluated not less than every two years. Appraised values are discounted due to the market's perception of a reduced price Bank-owned property and the Bank's desire to sell the property quicker to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value.  The discounts also include estimated costs to sell the property.

At September 30, 2014 and December 31, 2013, the Company had $7.7 million and $5.7 million in loans, respectively, which were deemed to be impaired, having established specific reserves of $892,000 and $1.0 million, respectively, on these loans.  The increase between these two time periods was due to the previously mentioned addition of two newly impaired commercial relationships with a smaller portion of the increase within the one to four family residential mortgages.

Management has identified potential problem loans totaling $8.4 million as of September 30, 2014 as compared to $10.6 million as of December 31, 2013.  These loans have been internally classified as special mention, substandard, or doubtful, yet are not currently considered impaired.  This definition has been changed from that utilized at December 31, 2013 and December 31, 2012 and included in the 2013 audited consolidated financial statements filed on Form 10-K on March 17, 2014 as amended March 25, 2014.  Management has identified potential credit problems which may result in the borrowers not being able to comply with the current loan repayment terms and which may result in it being included in future impaired loan reporting.  The reduction in potential problem loans between these two time periods resulted from the conversion of loans from potential problem loans to impaired loans.  Within the risk rating levels of potential problem loans, 11 residential mortgages loans with an aggregate recorded investment of $1.2 million are rated as doubtful at September 30, 2014 as compared to one residential mortgage loan with a recorded investment of $14,000 at December 31, 2013.  The change in the risk rating of the additional 11 residential mortgage loans from substandard to doubtful was made to more accurately reflect the inherent risk of the credits. This change does not reflect a change of the risk profile of these loans or the estimated potential loss.  Management judges the current level of allowance for loan losses to be adequate to cover probable credit losses in the current loan portfolio.  The ratio of the allowance to loan and lease losses to period-end loans at September 30, 2014 was 1.38% as compared to 1.48% at December 31, 2013.

Appraisals are obtained at the time a real estate secured loan is originated.   For commercial real estate held as collateral, the property is inspected every two years.

In the normal course of business, Pathfinder Bank has infrequently sold residential mortgage loans and participation interests in commercial loans. As is typical in the industry, Pathfinder Bank makes certain representations and warranties to the buyer. Pathfinder Bank maintains a quality control program for closed loans and considers the risks and uncertainties associated with potential repurchase requirements to be minimal.

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 composition and 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 ability to borrow from the Federal Home Loan Bank of New York, whose competitive advance programs and lines of credit provide the Company with a safe, reliable, and convenient source of funds.  A significant decrease in deposits in the future could result in the Company having to seek other sources of funds for liquidity purposes.  Such sources could include, but are not limited to, additional borrowings, 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.

Through the first nine months of 2014, as indicated in the Consolidated Statement of Cash Flows, the Company reported net cash flows from financing activities of $62.8 million generated by increased balances of demand, savings and money market deposit accounts.  Included in this increase was the $37.6 million increase in retail demand deposits as a result of the subscription orders received from our second-step conversion which closed on October 16, 2014.  This was invested in purchases of investment securities of $21.1 million, net of proceeds from maturities, sales and redemptions of $14.8 million.  In addition, $34.0 million was invested in new loan generation.  Net cash flows from operating activities provided an additional $3.1 million through the first nine months of 2014 resulting in an increase in cash and equivalents of $8.4 million through this time period.  As a recurring source of liquidity, the Company's investment securities provided $14.2 million in proceeds from maturities and principal reductions through the first nine months of 2014.

The Company has a number of existing credit facilities available to it.  At September 30, 2014, total credit available to the Company under the existing lines of credit was approximately $153.5 million at FHLBNY, the Federal Reserve Bank, and three other correspondent banks.  At September 30, 2014, the Company had $30.0 million outstanding on its existing lines of credit with $123.5 million available.
 
 
 

The Asset Liability Management Committee of the Company is responsible for implementing the policies and guidelines for the maintenance of prudent levels of liquidity.  As of September 30, 2014, management reported to the Board of Directors that the Company is in compliance with its liquidity policy guidelines.

Item 3 – Quantitative and Qualitative Disclosures About Market Risk

A smaller reporting company is not required to provide the information relating to this item.

Item 4 – Controls and Procedures

Under the supervision and with the participation of the Company's management, including our Chief Executive Officer and Chief Financial Officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this quarterly report.  Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms.  There has been no change in the Company's internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonable likely to materially affect, the Company's internal control over financial reporting.



PART II – OTHER INFORMATION

Item 1 – Legal Proceedings

The Company is not currently a named party in a legal proceeding, the outcome of which would have a material and adverse effect on the financial condition or results of operations of the Company.

Item 1A – Risk Factors

A smaller reporting company is not required to provide the information relating to this item.

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

On June 11, 2014, New Pathfinder filed a Registration Statement on Form S-1 with the Securities and Exchange Commission in connection with the second-step conversion of Pathfinder Bancorp, MHC and the related offering of common stock by New Pathfinder.  The Registration Statement (File No. 333-196676) was declared effective by the Securities and Exchange Commission on August 12, 2014.  New Pathfinder registered 4,352,306 shares of common stock, par value $0.01 per share, pursuant to the Registration Statement for an aggregate offering value of $43.5 million.  The stock offering commenced on August 22, 2014, and ended on October 16, 2014.

Keefe, Bruyette & Woods, Inc., a Stifel Company ("KBW") was engaged to assist in the marketing of the common stock.   For its services, KBW received a fee of $250,000.  KBW was also reimbursed $121,000 for its reasonable out-of-pocket expenses, inclusive of its legal fees and expenses.

The stock offering resulted in gross proceeds of $26.4 million, through the sale of 2,636,053 shares of common stock at a price of $10.00 per share.  Expenses related to the offering were approximately $1.6 million, including $371,000 paid to KBW.  Net proceeds of the offering were approximately $24.8 million.

New Pathfinder contributed $12.4 million of the net proceeds of the offering to the Bank.  In addition, $1.1 million of the net proceeds were used to fund the loan to the employee stock ownership plan, and $11.3 million of the net proceeds were retained by New Pathfinder.  The net proceeds contributed to the Bank have been invested in short term instruments used to make loans.  The net proceeds retained by New Pathfinder have been deposited with the Bank.

Item 3 – Defaults Upon Senior Securities

None

Item 4 – Mine Safety Disclosures

Not applicable

Item 5 – Other Information

None

Item 6 – Exhibits

Exhibit No.                                                                           Description

31.1                          Rule 13a-14(a) / 15d-14(a) Certification of the Chief Executive Officer
31.2                          Rule 13a-14(a) / 15d-14(a) Certification of the Chief Financial Officer
32.1                      Section 1350 Certification of the Chief Executive Officer and Chief Financial
                             Officer


101
The following materials from Pathfinder Bancorp, Inc. Form 10-Q for the quarter ended September 30, 2014, formatted in Extensible Business Reporting Language (XBRL):
 (i) the Consolidated Statements of Income, (ii) the Consolidated Statements of Financial Condition, (iii) Consolidated Statements of Cash Flows, and (iv) related notes, tagged as blocks of text

















SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

PATHFINDER BANCORP, INC.
(registrant)

November 12, 2014                                              /s/ Thomas W. Schneider
Thomas W. Schneider
President and Chief Executive Officer

November 12, 2014                                              /s/ James A. Dowd
James A. Dowd
Senior Vice President and Chief Financial Officer