UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_____________________________
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ending June 30, 2006
OR
[ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______ to _______
COMMISSION FILE NUMBER: 000-23601
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PATHFINDER BANCORP, INC.
------------------------
(Exact Name of Registrant as Specified in its Charter)
FEDERAL 16-1540137
------- ----------
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification Number)
214 West First Street, Oswego, NY 13126
---------------------------------------
(Address of Principal Executive Office) (Zip Code)
(315) 343-0057
--------------
(Registrant's Telephone Number including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ].
Indicate by check mark whether the Registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act. (Check one):
Large Accelerated Filer [ ] Accelerated Filer [] Non-Accelerated Filer [X]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of August 11, 2006 there were 2,950,419 shares issued and 2,463,132
shares outstanding of the Registrant's Common Stock.
PATHFINDER BANCORP, INC.
INDEX
PART 1 FINANCIAL INFORMATION PAGE NO.
Item 1. Consolidated Financial Statements
Consolidated Statements of Condition 1
Consolidated Statements of Income 2-3
Consolidated Statements of Shareholders' Equity 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6-10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11-20
Item 3. Quantitative and Qualitative Disclosure about Market 21-22
Risk
Item 4. Controls and Procedures 23
PART II OTHER INFORMATION 24-25
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits
SIGNATURES
PART I - FINANCIAL INFORMATION
ITEM 1-CONSOLIDATED FINANCIAL STATEMENTS
------ ---------------------------------
PATHFINDER BANCORP, INC.
CONSOLIDATED STATEMENTS OF CONDITION
JUNE 30, 2006 (UNAUDITED) AND DECEMBER 31, 2005
June 30, December 31,
ASSETS 2006 2005
-------------------------------------------------------------------------------------------------------------
(Dollars in thousands except per share data)
Cash and due from banks $ 7,386 $ 7,309
Interest earning deposits 317 586
-------------------------------------------------------------------------------------------------------------
Total cash and cash equivalents 7,703 7,895
Investment securities, at fair value 72,329 74,239
Federal Home Loan Bank stock, at cost 2,024 1,805
Loans 192,850 189,568
Less: Allowance for loan losses 1,664 1,679
-------------------------------------------------------------------------------------------------------------
Loans receivable, net 191,186 187,889
Premises and equipment, net 7,721 8,020
Accrued interest receivable 1,650 1,678
Foreclosed real estate 887 743
Goodwill 3,840 3,840
Intangible asset, net 293 404
Bank owned life insurance 6,087 5,987
Other assets 3,233 4,448
-------------------------------------------------------------------------------------------------------------
Total assets $ 296,953 $ 296,948
=============================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
-------------------------------------------------------------------------------------------------------------
Deposits:
Interest-bearing $ 212,574 $ 216,136
Noninterest-bearing 19,497 20,241
-------------------------------------------------------------------------------------------------------------
Total deposits 232,071 236,377
Short-term borrowings 7,900 2,000
Long-term borrowings 28,360 29,360
Junior subordinated debentures 5,155 5,155
Other liabilities 2,888 3,128
-------------------------------------------------------------------------------------------------------------
Total liabilities 276,374 276,020
Shareholders' equity:
Preferred stock, authorized shares 1,000,000; no shares issued or outstanding
Common stock, par value $.01; authorized 10,000,000 shares;
2,950,419 shares issued; and 2,463,132 shares outstanding, respectively 29 29
Additional paid in capital 7,721 7,721
Retained earnings 21,166 20,965
Accumulated other comprehensive loss (1,835) (1,285)
Treasury stock, at cost; 487,287 shares (6,502) (6,502)
-------------------------------------------------------------------------------------------------------------
Total shareholders' equity 20,579 20,928
-------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 296,953 $ 296,948
=============================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
-1
PATHFINDER BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
For the three For the three
months ended months ended
June 30, 2006 June 30, 2005
------------------------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
INTEREST INCOME:
Loans, including fees $ 3,137 $ 2,929
Debt securities:
Taxable 626 659
Tax-exempt 98 135
Dividends 67 56
Other 4 8
------------------------------------------------------------------------------------------------
Total interest income 3,932 3,787
------------------------------------------------------------------------------------------------
INTEREST EXPENSE:
Interest on deposits 1,279 1,031
Interest on short-term borrowings 116 39
Interest on long-term borrowings 458 456
------------------------------------------------------------------------------------------------
Total interest expense 1,853 1,526
------------------------------------------------------------------------------------------------
Net interest income 2,079 2,261
Provision for loan losses 1 66
------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 2,078 2,195
------------------------------------------------------------------------------------------------
OTHER INCOME:
Service charges on deposit accounts 350 319
Loan servicing fees 58 44
Earnings on bank owned life insurance 51 45
Net losses on sales of investment securities (7) -
Net gains on sales of loans and foreclosed real estate 2 -
Other charges, commissions and fees 152 138
-------------------------------------------------------------------------------------------------
Total other income 606 546
------------------------------------------------------------------------------------------------
OTHER EXPENSES:
Salaries and employee benefits 1,183 1,253
Building occupancy 306 287
Data processing expenses 306 319
Professional and other services 116 222
Amortization of intangible asset 55 55
Other expenses 344 374
------------------------------------------------------------------------------------------------
Total other expenses 2,310 2,510
------------------------------------------------------------------------------------------------
Income before income taxes 374 231
Provision for income taxes 71 (3)
------------------------------------------------------------------------------------------------
NET INCOME $ 303 $ 234
================================================================================================
NET INCOME PER SHARE - BASIC $ 0.12 $ 0.10
================================================================================================
NET INCOME PER SHARE - DILUTED $ 0.12 $ 0.09
================================================================================================
DIVIDENDS PER SHARE $ 0.1025 $ 0.1025
================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
-2
PATHFINDER BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
For the six For the six
months ended months ended
June 30, 2006 June 30, 2005
-----------------------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
INTEREST INCOME:
Loans, including fees $ 6,194 $ 5,818
Debt securities:
Taxable 1,267 1,263
Tax-exempt 196 238
Dividends 128 107
Other 12 59
-----------------------------------------------------------------------------------------------
Total interest income 7,797 7,485
INTEREST EXPENSE:
Interest on deposits 2,528 2,061
Interest on short-term borrowings 177 49
Interest on long-term borrowings 896 915
-----------------------------------------------------------------------------------------------
Total interest expense 3,601 3,025
-----------------------------------------------------------------------------------------------
Net interest income 4,196 4,460
Provision for loan losses 23 138
-----------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 4,173 4,322
-----------------------------------------------------------------------------------------------
OTHER INCOME:
Service charges on deposit accounts 721 593
Loan servicing fees 105 85
Earnings on bank owned life insurance 100 89
Net losses on sales of securities (9) -
Net losses on sales of loans/real estate (5) (12)
Other charges, commissions & fees 287 280
-----------------------------------------------------------------------------------------------
Total other income 1,199 1,035
-----------------------------------------------------------------------------------------------
OTHER EXPENSES:
Salaries and employee benefits 2,458 2,517
Building occupancy 622 562
Data processing expenses 630 639
Professional and other services 231 400
Amortization of intangible asset 111 111
Other expenses 669 701
-----------------------------------------------------------------------------------------------
Total other expenses 4,721 4,930
-----------------------------------------------------------------------------------------------
Income before income taxes 651 427
Provision for income taxes 108 44
-----------------------------------------------------------------------------------------------
NET INCOME $ 543 $ 383
===============================================================================================
NET INCOME PER SHARE - BASIC $ 0.22 $ 0.16
===============================================================================================
NET INCOME PER SHARE - DILUTED $ 0.22 $ 0.15
===============================================================================================
DIVIDENDS PER SHARE $ 0.205 $ 0.205
===============================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
-3
PATHFINDER BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
SIX MONTHS ENDED JUNE 30, 2006 AND JUNE 30, 2005
(unaudited)
Accumulated
Additional Other Com- Unearned
Common Stock Paid in Retained prehensive ESOP
Shares Amount Capital Earnings Income (Loss) Shares
------------ ------- ----------- ---------- -------------- ----------
(Dollars in thousands, except per share data)
BALANCE, DECEMBER 31, 2005 2,950,419 $ 29 $ 7,721 $ 20,965 $ (1,285) $ -
Comprehensive income (loss)
Net income 543
Other comprehensive loss, net of tax
Unrealized net losses on securities (550)
Total Comprehensive Loss
Dividends declared ($.2050 per share) (342)
-------------------------------------------------------------------------
BALANCE, JUNE 30, 2006 2,950,419 $ 29 $ 7,721 $ 21,166 $ (1,835) $ -
============ ======= =========== ========== ============== ==========
Treasury
Stock Total
---------- --------
(Dollars in thousands, except per share data)
BALANCE, DECEMBER 31, 2005 $ (6,502) $20,928
Comprehensive income (loss)
Net income 543
Other comprehensive loss, net of tax
Unrealized net losses on securities (550)
--------
Total Comprehensive Loss (7)
Dividends declared ($.2050 per share) (342)
--------------------
BALANCE, JUNE 30, 2006 $ (6,502) $20,579
========== ========
Accumulated
Additional Other Com- Unearned
Common Stock Paid in Retained prehensive ESOP
Shares Amount Capital Earnings Income (Loss) Shares
------------ ------- ----------- ---------- -------------- ----------
BALANCE, DECEMBER 31, 2004 2,937,419 $ 29 $ 7,453 $ 21,186 $ (307) $ (33)
Comprehensive income (loss)
Net income 383
Other comprehensive loss, net of tax
Unrealized net losses on securities (338)
Total Comprehensive Income
ESOP shares earned 40 22
Stock option exercised 13,000 - 86
Dividends declared ($.2050 per share) (341)
----------
BALANCE, JUNE 30, 2005 2,950,419 $ 29 $ 7,579 $ 21,228 $ (645) $ (11)
============ ======= =========== ========== ============== ==========
Treasury
Stock Total
---------- --------
BALANCE, DECEMBER 31, 2004 $ (6,502) $21,826
Comprehensive income (loss)
Net income 383
Other comprehensive loss, net of tax
Unrealized net losses on securities (338)
--------
Total Comprehensive Income 45
ESOP shares earned 62
Stock option exercised 86
Dividends declared ($.2050 per share) (341)
--------------- ----
BALANCE, JUNE 30, 2005 $ (6,502) $21,678
========== ========
The accompanying notes are an integral part of the consolidated financial
statements.
-4
PATHFINDER BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the six For the six
months ended months ends
June 30, June 30,
2006 2005
-------------- -------------
(Dollars in thousands)
OPERATING ACTIVITIES
Net income $ 543 $ 383
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 23 138
ESOP shares earned - 62
Proceeds from sale of loans - 2,443
Realized (gains) losses on sale of:
Real estate through foreclosure 5 19
Loans - (7)
Available-for-sale investment securities 9 -
Premises and equipment (8) -
Depreciation 377 332
Amortization of intangible asset 111 111
Amortization of deferred financing costs 15 15
Amortization of mortgage servicing rights 55 65
Earnings on bank owned life insurance (100) (89)
Net amortization of premiums on investment securities 65 182
Decrease (increase) in interest receivable 28 (178)
Net change in other assets and liabilities 1,267 24
-------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 2,390 3,500
-------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Purchase of investment securities available-for-sale (10,943) (19,615)
Purchase of FHLB stock (2,597) (1,009)
Proceeds from maturities and principal reductions of
investment securities available-for-sale 9,930 6,491
Proceeds from the redemption of FHLB stock 2,378 614
Proceeds from sale:
Real estate acquired through foreclosure 50 169
Available-for-sale investment securities 1,941 -
Premises and equipment 145
Net increase in loans (3,523) (1,622)
Purchase of premises and equipment (215) (777)
-------------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (2,834) (15,749)
-------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Net decrease in demand deposits, NOW accounts
savings accounts, money market deposit accounts
and escrow deposits (10,435) (6,717)
Net increase in time deposits 6,129 7,284
Increase in short-term borrowings 5,900 9,900
Payments on long-term borrowings (1,000) (2,000)
Proceeds from exercise of stock options - 86
Cash dividends paid (342) (340)
-------------------------------------------------------------------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 252 8,213
-------------------------------------------------------------------------------------
DECREASE IN CASH AND CASH EQUIVALENTS (192) (4,036)
Cash and cash equivalents at beginning of period 7,895 14,325
-------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 7,703 $ 10,289
=====================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
-5
PATHFINDER BANCORP, INC.
Notes to Financial Statements
(1) BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Pathfinder
Bancorp, Inc. and its wholly owned subsidiaries (the "Company") have been
prepared in accordance with U.S. generally accepted accounting principles for
interim financial information and the instructions for Form 10-Q and Article 10
of Regulation S-X. Accordingly, they do not include all of the information and
footnotes necessary for a complete presentation of consolidated financial
position, results of operations, and cash flows in conformity with U.S.
generally accepted accounting principles. Certain amounts in the 2005
consolidated financial statements have been reclassified to conform to the
current period presentation. These reclassifications had no effect on net
income as previously reported. In the opinion of management, all adjustments,
consisting of normal recurring accruals, considered necessary for a fair
presentation have been included.
The following material under the heading "Management's Discussion and Analysis
of Financial Condition and Results of Operations" was written with the
presumption that the users of the interim financial statements have read, or
have access to, the Company's latest audited financial statements and notes
thereto, together with Management's Discussion and Analysis of Financial
Condition and Results of Operations as of December 31, 2005 and for the three
year period then ended. Therefore, only material changes in financial condition
and results of operations are discussed in the remainder of Part 1.
Operating results for the three and six months ended June 30, 2006 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2006.
(2) EARNINGS PER SHARE
Basic earnings per share have been computed by dividing net income by the
weighted average number of common shares outstanding throughout the three months
and six months ended June 30, 2006 and 2005, using 2,463,132 and 2,452,357
weighted average common shares outstanding for the three months ended, and
2,463,132 and 2,449,889 for the six months ended, respectively. Diluted
earnings per share for the three months and six months ended June 30, 2006 and
2005 have been computed using 2,480,947 and 2,487,229 for the three months ended
and 2,481,360 and 2,486,999 for the six months ended, respectively. Diluted
earnings per share gives effect to weighted average shares that would be
outstanding assuming the exercise of issued stock options using the treasury
stock method.
-6
(3) PENSION BENEFITS
The composition of net periodic benefit plan cost for the three months and six
months ended June 30, 2006 and 2005 is as follows:
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
----------------------------------------------------------------------------------
2006 2005 2006 2005
--------- -------------- --------- ------------
(In thousands)
Service cost $ 48 $ 38 $ 96 $ 76
Interest cost 63 57 126 114
Expected return on plan assets (92) (71) (184) (142)
Amortization of net losses 28 24 56 48
----------------------------------------------------------------------------------
Net periodic benefit cost $ 47 $ 48 $ 94 $ 96
==================================================================================
The Company previously disclosed in its financial statements for the year ended
December 31, 2005, that it expected to contribute $192,000 to its pension plan
in 2006. As of June 30, 2006, $90,000 had been contributed to the pension plan.
(4) DIVIDEND RESTRICTIONS
The Company maintains a restricted capital account with a $1.7 million balance,
representing Pathfinder Bancorp, MHC's portion of dividends waived as of June
30, 2006.
(5) COMPREHENSIVE LOSS
The components of other comprehensive loss and related tax effects for the three
and six month periods ended June 30, 2006 and 2005 are as follows:
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
2006 2005 2006 2005
--------- -------------- --------- ------------
(In thousands)
Gross change in unrealized gains (losses)
on securities available for sale $ (829) $ 807 $ (917) $ (565)
Reclassification adjustment for (gains)
losses included in net income 7 - 9 -
---------------------------------------------------------------------------------------------
(822) 807 (908) (565)
Tax effect 329 (322) 358 227
---------------------------------------------------------------------------------------------
Net of tax amount $ (493) $ 485 $ (550) $ (338)
=============================================================================================
-7
(6) GUARANTEES
The Company does not issue any guarantees that would require liability
recognition or disclosure, other than its standby letters of credit. Standby
letters of credit written are conditional commitments issued by the Company to
guarantee the performance of a customer to a third party. Generally, all
letters of credit, when issued have expiration dates within one year. The
credit risk involved in issuing letters of credit is essentially the same as
those that are involved in extending loan facilities to customers. The Company,
generally, holds collateral and/or personal guarantees supporting these
commitments. The Company had $123,000 of standby letters of credit as of June
30, 2006. Management believes that the proceeds obtained through a liquidation
of collateral and the enforcement of guarantees would be sufficient to cover the
potential amount of future payments required under the corresponding guarantees.
The current amount of the liability as of June 30, 2006 for guarantees under
standby letters of credit issued is not material.
(7) STOCK BASED COMPENSATION
Prior to 2006, the Company accounted for stock-based compensation issued to
directors and employees using the intrinsic value method in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" (APB 25). This method required that compensation expense be
recognized to the extent that the fair value of the stock exceeds the exercise
price of the stock award at the grant date. The Company generally did not
recognize compensation expense related to stock option awards because the stock
options generally had fixed terms and exercise prices that were equal to or
greater than the fair value of the Company's common stock at the grant date.
Effective January 1, 2006, the Company adopted Financial Accounting Standards
Board (FASB) Statement No. 123(R), Share-Based Payment, ("SFAS 123(R)"). SFAS
123(R) requires compensation costs related to share-based payment transactions
to be recognized in the income statement (with limited exceptions) using the
modified prospective method based on the grant-date fair value of the
stock-based compensation issued. Compensation costs are recognized over the
period that an employee provides service in exchange for the award. As of the
date of adoption of SFAS 123(R), the Company's options were fully granted and
vested, there was no impact to the Company's consolidated financial position or
results of operations.
In conjunction with SFAS 123 (R), the Company also adopted FASB Staff Position
("FSP") SFAS 123(R)-2, "Practical Accommodation to the Application of Grant Date
as Defined in SFAS 123(R)" effective January 1, 2006. FSP 123(R)-2 provides
guidance on the application of grant date as defined in SFAS 123(R). In
accordance with this standard a grant date of an award exists if (a) the award
is a unilateral grant, and (b) the key terms and conditions of the award are
expected to be communicated to an individual recipient within a relatively short
time period from the date of approval. The adoption of this standard did not
impact our consolidated financial position, results of operations or cash flows
for the three or six-month period ended June 30, 2006.
In November 2005, the FASB issued final FSP No. 123(R)-3, "Transition Election
Related to Accounting for the Tax Effects of Share-Based Payment Awards." The
FSP provides an alternative method of calculating excess tax benefits (the
Additional Paid-in Capital "APIC" pool) from the method defined in SFAS 123(R)
for share-based payments. A one-time election to adopt the transition method in
this FSP is available to those entities adopting SFAS 123(R) using either the
modified retrospective or modified prospective method. Up to one year from the
initial adoption of SFAS 123(R) or effective date of the FSP is provided to make
this one-time election. However, until an entity makes its election, it must
follow the guidance in SFAS 123(R). We are currently evaluating the potential
impact of calculating the APIC pool with this alternative method and have not
yet determined which method we will adopt, or the expected impact on our
financial position or results of operations.
-8
In February 2006, the FASB issued FSP No. 123(R)-4, "Classifications of Options
and Similar Instruments Issued as Employee Compensation That Allow for Cash
Settlement upon the Occurrence of a Contingent Event." The position amends SFAS
123(R) to incorporate that a cash settlement feature that can be exercised only
upon the occurrence of a contingent event that is outside the employee's control
does not meet certain conditions in SFAS 123(R) until it becomes probable that
the event will occur. The guidance in this FSP was required to be applied upon
initial adoption of SFAS 123(R). The Company does not have any option grants
that allow for cash settlement.
(8) NEW ACCOUNTING PRONOUNCEMENTS
In January 2006, the Company adopted Financial Accounting Standard Board Staff
Position SFAS No. 115-1 and FAS 124-1, "The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments." The FSP addresses when
an investment is considered impaired, whether the impairment is
other-than-temporary and the measurement of an impairment loss. The FSP also
includes accounting considerations subsequent to the recognition of an
other-than-temporary impairment and requires certain disclosures about
unrealized losses that have not been recognized as other-than-temporary. The FSP
did not have a significant impact on the Company's consolidated financial
position or results of operations.
In January 2006, the Company adopted FASB Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations - an interpretation of SFAS No. 143,"
("FIN 47"). This Interpretation provides clarification with respect to the
timing of liability recognition for legal obligations associated with the
retirement of tangible long-lived assets when the timing and/or method of
settlement of the obligation are conditional on a future event. The adoption of
FIN 47 did not impact the Company's consolidated financial statements.
In January 2006, the Company adopted SFAS No. 154, Accounting Changes and Error
Corrections ("SFAS 154"). SFAS No. 154 requires retroactive application of a
voluntary change in accounting principle to prior period financial statements
unless it is impracticable. SFAS 154 also requires that a change in method of
depreciation, amortization, or depletion for long-lived, non-financial assets be
accounted for as a change in accounting estimate that is affected by a change in
accounting principle. The adoption of the provisions of SFAS 154 did not have a
material impact on the Company's consolidated financial statements.
In January 2006, the Company adopted FASB Staff Position FAS 13-1 ("FSP 13-1"),
which requires companies to expense rental costs associated with ground or
building operating leases that are incurred during a construction period, versus
capitalizing these rental costs. The adoption of FSP 13-1 did not have a
material impact on the Company's consolidated financial condition or results of
operations.
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid
Financial Instruments ("SFAS 155"). SFAS 155 amends FASB Statement No. 133 and
FASB Statement No. 140, and improves the financial reporting of certain hybrid
financial instruments by requiring more consistent accounting that eliminates
exemptions and provides a means to simplify the accounting for these
instruments. Specifically, SFAS 155 allows financial instruments that have
embedded derivatives to be accounted for as a whole (eliminating the need to
bifurcate the derivative from its host) if the holder elects to account for the
whole instrument on a fair value basis. The Company is required to adopt the
provisions of SFAS 155, as applicable, beginning in 2007. Management does not
believe the adoption of SFAS 155 will have a material impact on the Company's
consolidated financial position and results of operations.
In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of
Financial Assets -An Amendment of FASB Statement No. 140 ("SFAS 156"). SFAS 156
requires that all separately recognized servicing assets and servicing
liabilities be initially measured at fair value, if practicable. The statement
permits, but does not require, the subsequent measurement of servicing assets
and servicing liabilities at fair value. SFAS 156 is effective for the Company
-9
beginning in 2007. The Company does not believe that the adoption of SFAS 156
will have a significant effect on its consolidated financial statements.
In July 2006, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes-an
interpretation of FASB Statement No. 109" (FIN 48), which clarifies the
accounting for uncertainty in tax positions. This Interpretation requires that
companies recognize in their financial statements the impact of a tax position,
if that position is more likely than not of being sustained on audit, based on
the technical merits of the position. The provisions of FIN 48 are effective for
fiscal years beginning after December 15, 2006, with the cumulative effect of
the change in accounting principle recorded as an adjustment to opening retained
earnings. The Company is evaluating the impact of this new pronouncement on its
consolidated financial statements.
-10
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Throughout the Management's Discussion and Analysis ("MD&A") the term, "the
Company", refers to the consolidated entity of Pathfinder Bancorp, Inc.
Pathfinder Bank and Pathfinder Statutory Trust I are wholly owned subsidiaries
of Pathfinder Bancorp, Inc. Pathfinder Commercial Bank, Pathfinder REIT, Inc.
and Whispering Oaks Development, Inc. are the wholly owned subsidiaries of
Pathfinder Bank. At June 30, 2006, Pathfinder Bancorp, MHC, the Company's
mutual holding company parent, whose activities are not included in the MD&A,
held 64.3% of the Company's common stock while the public held 35.7% of the
Company's common stock.
The following discussion reviews the Company's financial condition at June 30,
2006 and the results of operations for the three and six months ended June 30,
2006 and June 30, 2005.
This Quarterly Report contains certain "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. Such
statements are subject to certain risks and uncertainties, including, among
other things, changes in economic conditions in the Company's market area,
changes in policies by regulatory agencies, fluctuations in interest rates,
demand for loans in the Company's market areas and competition, that could cause
actual results to differ materially from historical earnings and those presently
anticipated or projected. The Company wishes to caution readers not to place
undue reliance on any such forward-looking statements, which speak only as of
the date made. The Company wishes to advise readers that the factors listed
above could affect the Company's financial performance and could cause the
Company's actual results for future periods to differ materially from any
opinions or statements expressed with respect to future periods in any current
statements.
The Company does not undertake, and specifically declines any obligation, to
publicly release the result of any revisions that may be made to any
forward-looking statements to reflect events or circumstances after the date of
such statements or to reflect the occurrence of anticipated or unanticipated
events.
The Company's net income is primarily dependent on its net interest income,
which is the difference between interest income earned on its investments in
mortgage loans, investment securities and other loans, and its cost of funds
consisting of interest paid on deposits and borrowed funds. The Company's net
income is also affected by its provision for loan losses, as well as by the
amount of other income, including income from fees and service charges on
deposit accounts, net gains and losses on sales of securities, loans and
foreclosed real estate, and other expenses such as salaries and employee
benefits, building occupancy and equipment costs, data processing and income
taxes. Earnings of the Company also are affected significantly by general
economic and competitive conditions, particularly changes in market interest
rates, government policies and actions of regulatory authorities, which events
are beyond the control of the Company. In particular, the general level of
market rates tends to be highly cyclical.
-11
APPLICATION OF CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America and
follow practices within the banking industry. Application of these principles
requires management to make estimates, assumptions and judgments that affect the
amounts reported in the consolidated financial statements and accompanying
notes. These estimates, assumptions and judgments are based on information
available as of the date of the financial statements; accordingly, as this
information changes, the financial statements could reflect different estimates,
assumptions and judgments. Certain policies inherently have a greater reliance
on the use of estimates, assumptions and judgments and as such have a greater
possibility of producing results that could be materially different than
originally reported. Estimates, assumptions and judgments are necessary when
assets and liabilities are required to be recorded at fair value or when an
asset or liability needs to be recorded contingent upon a future event.
Carrying assets and liabilities at fair value inherently results in more
financial statement volatility. The fair values and information used to record
valuation adjustments for certain assets and liabilities are based on quoted
market prices or are provided by other third-party sources, when available.
When third party information is not available, valuation adjustments are
estimated in good faith by management.
The most significant accounting policies followed by the Company are presented
in Note 1 to the consolidated financial statements included in the 2005 Annual
Report on Form 10-K ("the Consolidated Financial Statements"). These policies,
along with the disclosures presented in the other financial statement notes and
in this discussion, provide information on how significant assets and
liabilities are valued in the consolidated financial statements and how those
values are determined. Based on the valuation techniques used and the
sensitivity of financial statement amounts to the methods, assumptions and
estimates underlying those amounts, management has identified the determination
of the allowance for loan losses to be the accounting area that requires the
most subjective and complex judgments, and as such could be the most subject to
revision as new information becomes available.
The allowance for loan losses represents management's estimate of probable loan
losses inherent in the loan portfolio. Determining the amount of the allowance
for loan losses is considered a critical accounting estimate because it requires
significant judgment and the use of estimates related to the amount and timing
of expected future cash flows on impaired loans, estimated losses on pools of
homogeneous loans based on historical loss experience, and consideration of
current economic trends and conditions, all of which may be susceptible to
significant change. The loan portfolio also represents the largest asset type
on the consolidated balance sheet. Note 1 to the Consolidated Financial
Statements describes the methodology used to determine the allowance for loan
losses, and a discussion of the factors driving changes in the amount of the
allowance for loan losses is included in this report.
The Company carries all of its investments at fair value with any unrealized
gains or losses reported net of tax as an adjustment to shareholders' equity.
Based on management's assessment, at June 30, 2006, the Company did not hold any
security that had a fair value decline that is currently expected to be other
than temporary. Consequently, any declines in a specific security's fair value
below amortized cost have not been provided for in the consolidated income
statement. The Company's ability to fully realize the value of its investment
in various securities, including corporate debt securities, is dependent on the
underlying creditworthiness of the issuing organization.
-12
EXECUTIVE SUMMARY
Net income was $303,000, or $0.12 per diluted share, for the three months ended
June 30, 2006 as compared to $234,000, or $0.09 per diluted share, for the same
period in 2005. For the six months ended June 30, 2006, the Company reported
net income of $543,000, or $0.22 per diluted share as compared to $383,000, or
$0.15 per diluted share, for the same period in 2005. The Company continued its
efforts toward transforming its traditional thrift balance sheet with mostly
residential loans as interest earning assets toward that of a community bank
with a more diverse mix of residential, consumer and commercial loans. On an
average balance basis, commercial loans comprise 25.9% of the total gross loan
portfolio at June 30, 2006, as compared to 25.0% of the portfolio at December
31, 2005. Asset quality continues to improve during 2006 as reflected by the
improvement in the non-performing loan ratios.
Short-term borrowings increased $5.9 million during the first half of 2006. The
short-term borrowings were entered into as a replacement for outflow of
municipal deposits from two large rate-sensitive customers toward the end of the
first quarter.
On April 23, 2006, Alliance Bank N.A. announced it had reached a definitive
agreement to merge with the parent company of Oswego County National Bank
(OCNB). OCNB, formerly, Oswego County Savings Bank has been domiciled in the
city of Oswego since its founding in 1870 and has been the primary local
competitor for Pathfinder Bank. In management's view, the absorption of OCNB
into Alliance Bank, a $900 million bank headquartered in Syracuse, NY, will
provide both challenges and opportunities for Pathfinder Bank. The challenge
will be the ability of a larger competitor to more actively and aggressively
market within the primary business area of Pathfinder Bank. Opportunities
exist, as management believes that it's unique competencies and differentiators
are more closely matched by a locally domiciled bank, than one headquartered
outside our primary market area. Opportunities may exist to garner additional
business opportunities with the traditional customer base of OCNB which is more
apt to conduct its business with a local bank.
RESULTS OF OPERATIONS
The return on average assets and return on shareholders' equity were 0.40% and
5.85%, respectively, for the three months ended June 30, 2006, compared with
0.30% and 4.38%, respectively, for the three months ended June 30, 2005. During
the second quarter of 2006, when compared to the second quarter of 2005, net
interest income decreased $182,000, offset by a $200,000 reduction in other
expenses, a decrease in the provision for loan losses of $65,000 and an increase
in other income, exclusive of net gains on sales of securities and loans/real
estate, by $65,000, or 12%.
For the six months ended June 30, 2006, net interest income decreased $264,000,
or 6%, when compared to the six months ended June 30, 2005. This decrease was
offset by a reduction in other expenses of $209,000, or 4%, an increase in other
income, exclusive of net gains on sales of securities and loans/real estate, of
$166,000, or 16%, and an 83%, or $115,000, reduction in provision for loan
losses.
NET INTEREST INCOME
Net interest income is the Company's primary source of operating income for
payment of operating expenses and providing for loan losses. It is the amount
by which interest earned on interest-earning deposits, loans and investment
securities, exceeds the interest paid on deposits and other interest-bearing
liabilities. Changes in net interest income and net interest margin ratio
-13
result from the interaction between the volume and composition of interest
earning assets, interest-bearing liabilities, related yields and associated
funding costs.
For the three months ended June 30, 2006, net interest income, on a
tax-equivalent basis, decreased to $2.1 million from $2.3 million, when compared
to the same quarter of 2005. The Company's net interest margin ratio for the
second quarter of 2006 decreased to 3.11% from 3.30% when compared to the same
quarter in 2005. Management expects continued margin compression to adversely
impact earnings, as we perceive the yield curve will continue to be flat over
the near term. The decline in net interest income was attributable to the higher
rates paid on both deposits and borrowings, offset by an increase of 34 basis
points in average interest-earning asset yields. Average interest-earning
assets decreased 3% to $273.5 million at June 30, 2006 as compared to $281.2
million at June 30, 2005. The decrease in average interest-earning assets was
primarily attributable to an $11.1 million decrease in investment securities and
a $1.1 million decrease in interest-earning deposits, offset by a $4.5 million
increase in loans receivable. Average interest-bearing liabilities decreased
$8.8 million, and the cost of funds increased 59 basis points to 2.88% for the
quarter ended June 30, 2006, from 2.29% for the same period in 2005. The
decrease in the average balance of interest-bearing liabilities resulted
primarily from a $10.0 million reduction in average deposits, partially offset
by a $1.2 million increase in borrowed funds. The reduction in deposits
principally occurred in the municipal money management accounts due to the
cyclical nature of the tax collections and expenditures of local municipal
entities. The sharp increase in cost of funds can be attributed to the 200
basis point increase in short-term interest rates over the past 12 months,
combined with a $7.8 million deposit migration from lower earning savings
accounts to higher yielding certificates of deposit.
For the six months ended June 30, 2006, net interest income, on a tax-equivalent
basis, decreased $271,000, to $4.3 million, from $4.6 million at June 30, 2005.
Net interest margin decreased 13 basis points, to 3.12% at June 30, 2006 from
3.25% at June 30, 2005. Average interest-earning assets decreased 6% to $274.8
million at June 30, 2006 as compared to $280.7 million at June 30, 2005, while
the yield on interest-earning assets increased 34 basis points to 5.74% from
5.40% for the comparable periods. The decrease in average interest-earning
assets was primarily attributable to a $5.2 million decrease in investment
securities and a $4.7 million decrease in interest-earning deposits, partially
offset by a $4.0 million increase in loans receivable. Average
interest-bearing liabilities decreased $5.9 million and the cost of funds
increased 50 basis points to 2.78% for the six months ended June 30, 2006, from
2.28% for the same period in 2005. The decrease in the average balance
of interest-bearing liabilities resulted primarily from a $6.4 million
reduction in average deposits, partially offset by a $487,000 increase in
borrowed funds.
INTEREST INCOME
Total interest income, on a tax-equivalent basis, for the quarter ended June 30,
2006 increased $133,000, or 4%, to $4.0 million from $3.9 million for the
quarter ended June 30, 2005. The average balance of loans increased $4.5
million to $192.0 million, with yields increasing 28 basis points to 6.55% for
the second quarter of 2006. Average commercial real estate loans increased $5.4
million, and the yield on those loans increased to 7.69% from 7.62% in 2005.
Average commercial loans increased $2.9 million, and experienced an increase in
the average tax-equivalent yield of 124 basis points, to 8.18% from 6.94%, in
2005. Average consumer loans increased $523,000, or 3%, and experienced an
increase in yield of 80 basis points. The increase in the yield on commercial
and consumer loans was primarily the result of new commercial loan originations
occurring at market rates significantly higher than the weighted average
existing portfolio rate as well as the adjustable rate portions of the
portfolios repricing upward in connection with upward adjustments in the prime
rate. Increases in the average balance of consumer and commercial loan
portfolios were offset by decreases in the average balance of residential real
estate loan portfolios and municipal loans. The average balance of the
residential real estate portfolio decreased $3.3 million, or 3%, combined with a
-14
slight decrease in yield to 5.77% from 5.80% for the same period in 2005. The
Company's municipal loan portfolio decreased $965,000, or 26%, when comparing
the second quarter of 2006 to the same period in 2005. The average yield on the
municipal loan portfolio increased to 5.56% in 2006 from 3.25% for the same
period in 2005.
Average investment securities (taxable and tax-exempt) for the quarter ended
June 30, 2006 decreased by $11.1 million when compared to the same period a year
ago, with a decrease in tax-equivalent interest income from investments of
$68,000, or 8%, compared to the second quarter of 2005. The average
tax-equivalent yield of the portfolio increased 19 basis points, to 4.07% from
3.88%. The decrease in average investment securities was primarily due to the
December 2005 sale of agency and municipal securities which had been purchased
as collateral for the additional municipal deposit relationships acquired during
2004 and 2005. Additional securities were sold during the first and second
quarters of 2006 as a result of the outflow of municipal deposits.
Total interest income, on a tax-equivalent basis, for the six months ended June
30, 2006 increased $302,000, or 4%, when compared to the six months ended June
30, 2005. Average loans increased $4.0 million, with yields increasing 27 basis
points to 6.49% from 6.22%. The average balance of commercial real estate
increased $4.4 million, with yields increasing to 7.63% from 7.43%, average
commercial loans increased $2.8 million, with yields increasing to 8.09% from
6.73% and average consumer loans increased $685,000 with yields increasing to
7.87% from 7.09% at June 30, 2005. These increases were offset by decreases in
the average balance of residential real estate and municipal loans of $3.3
million and $591,000, respectively.
For the six months ended June 30, 2006, tax-equivalent interest income from
investment securities decreased $31,000, or 2%, compared to the same period in
2005. The average tax-equivalent yield of the portfolio increased 16 basis
points, to 4.02% from 3.86%, offset by a $5.1 million decrease in the average
balance of investment securities.
INTEREST EXPENSE
Total interest expense increased $327,000 for the three months ended June 30,
2006, when compared to the same quarter in 2005. Deposit expense for the
comparable periods increased $248,000, or 24%, as the average rate paid on
higher yielding money management accounts increased 58 basis points to 2.51% in
2006 from 1.93% in 2005. The cost of time deposits increased 73 basis points as
existing time deposits matured and repriced into higher rates and new higher
priced promotional products were offered, combined with a 9% increase in the
average balance of time deposit accounts to $99.7 million in 2006 from $91.8
million in 2005. The cost of other interest-bearing deposits increased 5 basis
points, to 0.46% from 0.41% combined with an 8%, or $6.8 million, decrease in
the average balance of these deposits. Interest expense on borrowings increased
by $79,000, or 16%, from the prior period, resulting from an increase in the
cost of borrowed funds to 5.26% from 4.66%, combined with an increase in the
average balance of borrowed funds of $1.2 million. The increase in the cost of
borrowings primarily resulted from an increase in the cost of the $5.0 million
LIBOR (London Interbank Offered Rate) based junior subordinated debentures to
8.58% from 6.36%.
For the six months ended June 30, 2006, interest expense increased $576,000, or
19%, to $3.6 million from $3.0 million for the same period in 2005. The average
deposit balance decreased $6.4 million, offset by a 48 basis point increase in
the cost of deposits to 2.32% from 1.84%. The cost of borrowed funds increased
47 basis points to 5.16% from 4.69%, partially offset by a decrease in the
average balance of borrowed funds by $487,000, or 1%.
PROVISION FOR LOAN LOSSES
Provision for loan losses for the quarter ended June 30, 2006 decreased to
$1,000 from $66,000 for the same period in 2005, primarily as a result of
improved asset quality and stable loan balances. The Company's ratio of
-15
allowance for loan losses to period end loans has decreased to 0.86% at June 30,
2006 from 1.00% at June 30, 2005. Nonperforming loans to period end loans
decreased to 0.73% at June 30, 2006 from 1.08% at June 30, 2005.
For the six months ended June 30, 2006, the provision for loan losses was
$23,000 as compared to $138,000 for the same period in 2005 primarily resulting
from a decrease in the level of charge-offs to $49,000 for the six months ended
June 30, 2006 compared to $86,000 in 2005 and continued improvement in overall
asset quality.
OTHER INCOME
The Company's other income is primarily comprised of fees charged on deposit
account balances and transactions, loan servicing, commissions, and net gains on
securities, loans and foreclosed real estate.
The following table sets forth certain information on other income for the
periods indicated:
Three Months Ended June 30, Six Months Ended June 30,
2006 2005 $Change % Change 2006 2005 $Change % Change
------- ------- -------- --------- ------- -------- -------- ---------
(Dollars in thousands)
Service charges on deposit accounts $ 350 $ 319 $ 31 9.7% $ 721 $ 593 $ 128 21.6%
Loan servicing fees 58 44 14 31.8% 105 85 20 23.5%
Earnings on bank owned life insurance 51 45 6 13.3% 100 89 11 12.4%
Net gains/(losses) on sale of loans/ 2 - 2 - (5) (12) 7 -58.3%
foreclosed real estate
Other operating income 152 138 14 10.1% 287 280 7 2.5%
---------------------------------------------------------------------------------------------------------------------
Core noninterest income 613 546 67 12.3% 1,208 1,035 173 16.7%
Net losses on sales of securities (7) - (7) - (9) - (9) -
---------------------------------------------------------------------------------------------------------------------
Total other income $ 606 $ 546 $ 60 11.0% $1,199 $ 1,035 $ 164 15.8%
=====================================================================================================================
For the three months ended June 30, 2006, core other income reflected an
increase of $67,000, or 12%, when compared with the three months ended June 30,
2005. Income from service charges on deposit accounts increased because of the
number of deposit accounts increased primarily attributable to the opening of a
new branch, combined with an increase in fees associated with deposit accounts.
The increase in loan servicing fees was primarily due to an increase in
commercial loan volume, offset by a reduction in internal mortgage closing legal
fees as the Company switched to an outside legal service for all closings. The
increase in other operating income primarily resulted from fees associated with
Pathfinder Bank debit card usage and fees generated by investment services.
For the six months ended June 30, 2006, core other income increased $173,000 or
17%, when compared with the six months ended June 30, 2005. The increase in
core income for the six months ended June 30 2006, was primarily due to a fee
enhancement program on deposit accounts which began in the second quarter of
2005 and an increase in loan servicing fees from commercial loan volume.
The increase in the net losses on sales of investment securities for the three
and six month period was the result of the sale of corporate bonds in 2006.
There were no investment security sale transactions during the first two
quarters of 2005.
-16
OTHER EXPENSES
The following table sets forth certain information on other expense for the
periods indicated:
Three Months Ended June 30, Six Months Ended June 30,
2006 2005 $Change % Change 2006 2005 $Change % Change
------ ------- -------- --------- ------ ------- -------- ---------
(Dollars in thousands)
Salaries and employee benefits $1,183 $ 1,253 $ (70) -5.6% $2,458 $ 2,517 $ (59) -2.3%
Building occupancy 306 287 19 6.6% 622 562 60 10.7%
Data processing 306 319 (13) -4.1% 630 639 (9) -1.4%
Professional and other services 116 222 (106) -47.7% 231 400 (169) -42.3%
Amortization of intangible assets 55 55 - 0.0% 111 111 - 0.0%
Other operating 344 374 (30) -8.0% 669 701 (32) -4.6%
--------------------------------------------------------------------------------------------------------------
Total noninterest expense $2,310 $ 2,510 $ (200) -8.0% $4,721 $ 4,930 $ (209) -4.2%
==============================================================================================================
For the three months and six months ended June 30, 2006, salaries and employee
benefits decreased as a result of personnel realignment, a reduction in
commissions paid and a reduction in stock based compensation expense, as
compared with the three and six months ended June 30, 2005. These reductions
were offset by an increase in personnel expenses associated with the opening of
a new branch in June 2005. The Company had 103 full time equivalent employees
at June 30, 2006 compared to 113 at June 30, 2005. The increase in building
occupancy expense for the three and six months ended June 30, 2006, was
primarily the result of the operation of the new Central Square branch,
including maintenance, property taxes, utilities and telephone expenses,
combined with the recording of additional depreciation expense on the building
and equipment. The decrease in data processing charges for the three and six
months ended June 30, 2006 was due to a reduction in internet banking expenses
and ATM processing fees as the number of ATM machines in operation declined,
offset by increased depreciation expense and maintenance expense resulting from
system hardware and software acquisitions. The decrease in professional and
other services was primarily due to consulting expenses associated with a fee
enhancement program, a leadership training program, strategic planning and a
capital market analysis which occurred in 2005 with no similar expense in 2006.
The reduction in other operating expenses for the three and six month periods
was primarily due to lower ORE expenses due to the reduction in properties held,
a lower FDIC assessment for the first quarter of 2006, a gain recorded on the
sale of premises and equipment, lower ATM courier expenses (as the amount of ATM
machines in operation has decreased) and a reduction in mortgage recording tax
expense attributable to lower volume of residential mortgage originations.
These decreases were partially offset by increases in New York State Banking
Department exam expenses and increased travel and training expenses.
INCOME TAX EXPENSE
Income taxes increased $74,000 for the quarter ended June 30, 2006 as compared
to the same period in 2005, which was attributable to an increase in the
Company's pre-tax income and a decrease in tax-exempt interest income. The
effective tax rate was 16.6% for the six months ended June 30, 2006. The Company
continues to strive to reduce its tax rate from the statutory rate primarily
through the ownership of tax-exempt investment securities, bank owned life
insurance and other tax savings strategies. The enactment of proposed state tax
legislation, which would limit the benefit derived from Real Estate Investment
Trusts, would result in a higher effective state tax rate for the Company.
-17
CHANGES IN FINANCIAL CONDITION
ASSETS
Total assets remained constant at $296.9 million at June 30, 2006 when compared
to December 31, 2005. Loans receivable increased $3.3 million, or 2%, offset by
a decrease in investment securities of $1.9 million and a $1.2 million reduction
in other assets. The increase in loans receivable was primarily the result of a
$5.2 million, $1.0 million and $500,000 increase in the commercial adjustable
real estate, commercial loan and adjustable residential real estate portfolios,
respectively. These increases were offset by reductions of $1.7 million, $1.3
million and $500,000 in commercial fixed real estate loans, residential fixed
real estate and municipal loan portfolios, respectively. The decrease in
investment securities was primarily the result of a $1.0 million increase in
portfolio unrealized losses and amortization and prepayments within the
mortgage-backed security portfolio.
At June 30, 2006, the securities balance included a net unrealized loss on
available for sale securities of $3.1 million, compared with a net unrealized
loss of $2.1 million at December 31, 2005. These unrealized losses relate
principally to changes in interest rates subsequent to the acquisition of
specific securities. None of the securities in this category had an unrealized
loss that exceeded 8% of the book value of the Company. The Company has the
intent and ability to hold the individual securities to maturity or market price
recovery.
LIABILITIES
Total liabilities increased slightly to $276.4 million at June 30, 2006 from
$276.0 million at December 31, 2005. The slight increase in liabilities was
due to a $5.9 million increase in short-term borrowings, offset by a $4.3
million decrease in deposits and a $1.0 million reduction in long-term
borrowings. The increase in short-term borrowings was a result of the deposit
outflows of municipal customers that caused the Company to rely on short-term
wholesale borrowings for liquidity needs. The decrease in deposits was primarily
attributable to the cyclical declines in the deposit balances of certain large
municipal customers.
LOAN AND ASSET QUALITY AND ALLOWANCE FOR LOAN LOSSES
The following table represents information concerning the aggregate amount of
nonperforming assets:
For the Period Ending
(Dollars in thousands) June 30, December 31, June 30,
2006 2005 2005
-----------------------------------------------------------------------------------------
Nonaccrual loans:
Commercial $ 376 $ 757 $ 633
Consumer 78 89 106
Real estate - Construction 0 0 0
Mortgage 964 834 1,290
-----------------------------------------------------------------------------------------
Total nonaccrual loans 1,418 1,680 2,029
Loans past due 90 days or more and still accruing 0 0 0
-----------------------------------------------------------------------------------------
Total non-performing loans 1,418 1,680 2,029
Foreclosed real estate 887 743 878
-----------------------------------------------------------------------------------------
Total non-performing assets 2,305 2,423 2,907
-----------------------------------------------------------------------------------------
Non-performing loans to total loans 0.73% 0.89% 1.08%
Non-performing assets to total assets 0.78% 0.82% 0.94%
-----------------------------------------------------------------------------------------
-18
Total nonperforming loans and foreclosed real estate at June 30, 2006 decreased
4.9% when compared to December 31, 2005. Nonperforming loans continued to be
addressed primarily through increased collection efforts and foreclosure
proceedings. Management believes that adequate reserves exist for any potential
losses that may occur from the remediation process.
The allowance for loan losses at June 30, 2006 was $1.7 million, or 0.86% of
period end loans, compared to $1.7 million, or 0.89% of period end loans, at
December 31, 2005.
CAPITAL
Shareholders' equity decreased $349,000, or 2%, to $20.6 million at June 30,
2006. The decrease in shareholders' equity primarily resulted from a $550,000
increase in accumulated other comprehensive loss offset by a $201,000 increase
in retained earnings. The Company added $543,000 to retained earnings through
net income and returned $342,000 to its shareholders in the form of cash
dividends. The Company's mutual holding company parent, Pathfinder Bancorp, MHC
waived the dividend for the quarter ended June 30, 2006. (See Footnote 4).
Risk-based capital provides the basis for which all banks are evaluated in terms
of capital adequacy. Capital adequacy is evaluated primarily by the use of
ratios which measure capital against total assets, as well as against total
assets that are weighted based on defined risk characteristics. The Company's
goal is to maintain a strong capital position, consistent with the risk profile
of its subsidiary banks that supports growth and expansion activities while at
the same time exceeding regulatory standards. At June 30, 2006, Pathfinder Bank
exceeded all regulatory required minimum capital ratios and met the regulatory
definition of a "well-capitalized" institution, i.e. a leverage capital ratio
exceeding 5%, a Tier 1 risk-based capital ratio exceeding 6% and a total
risk-based capital ratio exceeding 10%.
LIQUIDITY
Liquidity management involves the Company's ability to generate cash or
otherwise obtain funds at reasonable rates to support asset growth and reduce
assets to meet deposit withdrawals, to maintain reserve requirements, and to
otherwise operate the Company on an ongoing basis. The Company's primary
sources of funds are deposits, borrowed funds, amortization and prepayment of
loans and mortgage backed securities and maturities of investment securities and
other short-term investments, and earnings and funds provided from operations.
While scheduled principal repayments on loans are a relatively predictable
source of funds, deposit flows and loan prepayments are greatly influenced by
general interest rates, economic conditions and competition. The Company
manages the pricing of deposits to maintain a desired deposit balance. In
addition, the Company invests excess funds in short-term, interest-earning and
other assets, which provide liquidity to meet lending requirements, and utilizes
short-term borrowings as a source of liquidity when necessary.
The Company's liquidity has been enhanced by its membership in the Federal Home
Loan Bank of New York, whose competitive advance programs and lines of credit
provide the Company with a safe, reliable and convenient source of funds. A
significant decrease in deposits in the future could result in the Company
having to seek other sources of funds for liquidity purposes. Such sources
could include, but are not limited to, additional borrowings, trust preferred
security offerings, brokered deposits, negotiated time deposits, the sale of
"available-for-sale" investment securities, the sale of securitized loans, or
the sale of whole loans. Such actions could result in higher interest expense
costs and/or losses on the sale of securities or loans.
-19
The Asset Liability Management Committees of the Company are responsible for
implementing the policies and guidelines for the maintenance of prudent levels
of liquidity. As of June 30, 2006, management reported to the Board of
Directors that the Company is in compliance with its liquidity policy
guidelines.
-20
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company continues to aggressively pursue delinquent loan relationships.
While this aggressive pursuit, combined with conservative provisioning, has
improved the overall quality of the loan portfolio, it has resulted in a
temporary increase in other real estate. The Company's risk of loss arising
from adverse changes in the fair value of financial instruments, or market risk,
is composed primarily of interest rate risk. The management of interest rate
sensitivity seeks to avoid fluctuating net interest margins and to provide
consistent net interest income through periods of changing interest rates. The
primary objective of the Company's asset-liability management activities is to
maximize net interest income while maintaining acceptable levels of interest
rate risk. The Company has Asset-Liability Management Committees which are
responsible for establishing policies to limit exposure to interest rate risk,
and to ensure procedures are established to monitor compliance with those
policies. Those procedures include reviewing the Company's assets and liability
policies, setting prices and terms on rate-sensitive products, and monitoring
and measuring the impact of interest rate changes on the Company's earnings and
capital. The Company's Board of Directors reviews the guidelines established by
these committees.
From 2001 until June 2004, the Federal Reserve lowered interest rates thirteen
times by a total of 550 basis points. These interest rate reductions have
caused significant repricing of Pathfinder Bank's interest-earning assets and
interest-bearing liabilities. Efforts have been made to shorten the repricing
duration of its rate sensitive assets by purchasing investment securities with
maturities within the next 3 to 5 years and promoting portfolio ARM (adjustable
rate mortgage) and hybrid ARM products. In addition, the Company has extended
the duration of its rate sensitive liabilities by lengthening the maturities of
its existing borrowings and offering certificates of deposit with three and four
year terms which allow depositors to make a one-time election, at any time
during the term of the certificate of deposit, to adjust the rate of the
instrument to the then prevailing rate for the certificate of deposit with the
same term.
Since June of 2004, the Federal Reserve has raised its key short-term interest
rate 250 basis points. Net interest margin compression has resulted as the yield
curve flattened from sharp increases in short-term interest rates while
longer-term rates have remained relatively stable. Management will continue to
seek to minimize any reduction in net interest income in a period of rising
short-term interest rates to the extent that it can resist raising its cost of
funds during this period. The Company is continuing to explore transactions and
strategies to both increase its net interest income and minimize its interest
rate risk.
GAP ANALYSIS. At June 30, 2006, the total interest-bearing liabilities maturing
or repricing within one year exceeded total interest-earning assets maturing or
repricing in the same period by $35.5 million, representing a cumulative
one-year gap ratio of a negative 11.94%.
EARNINGS AT RISK AND VALUE AT RISK. Management believes the simulation of net
interest income (Earnings at Risk) and net portfolio value (Value at Risk) in
different interest rate environments provides a more meaningful measure of
interest rate risk. Income simulation analysis captures both the potential of
all assets and liabilities to mature or reprice and the probability that they
will do so. Income simulation also attends to the relative interest rate
sensitivities of these items, and projects their behavior over an extended
period of time. Finally, income simulation permits management to assess the
probable effects on the balance sheet not only of changes in interest rates, but
also of proposed strategies for responding to them. Net portfolio value
represents the fair value of net assets (determined as the market value of
assets minus the market value of liabilities using a discounted cash flow
technique).
-21
The following table measures the Company's interest rate risk exposure in terms
of the percentage change in its net interest income and net portfolio value as a
result of hypothetical changes in 100 basis point increments in market interest
rates. The table quantifies the changes in net interest income and net
portfolio value to parallel shifts in the yield curve. The column "Percentage
Change in Net Interest Income" measures the change to the next twelve month's
projected net interest income, due to parallel shifts in the yield curve. The
column "Percentage Change in Net Portfolio Value" measures changes in the
current fair value of assets and liabilities to parallel shifts in the yield
curve. The column "NPV Capital Ratio" measures the ratio of the fair value of
net assets to the fair value of total assets at the base case and in 100 basis
point incremental interest rate shocks. The Company uses these percentage
changes as a means to measure interest rate risk exposure and quantifies those
changes against guidelines set by the Board of Directors as part of the
Company's Interest Rate Risk policy.
Percentage Percentage
Change in NPV Change in Change in
Interest Capital Net Interest Net Portfolio
Rates Ratio Income Value
--------- -------- ------------- --------------
300 8.34% -13.07% -26.25%
200 9.10% -8.31% -17.83%
100 9.86% -4.24% -8.96%
0 ---- ---- ----
-100 10.88% 1.36% 5.10%
-200 10.65% -0.22% 4.57%
-300 10.13% -3.84% 1.03%
-22
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.
-23
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
--------------------------
None
ITEM 1A - RISK FACTORS
----------------------
There have been no significant changes in the risk factors affecting Pathfinder
Bancorp, Inc. that were identified in Item 1A of Part 1 of the Company's Form
10-K for the year ended December 31, 2005.
ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
--------------------------------------------------------------------
None
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
----------------------------------------
None
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
------------------------------------------------------------
The Company's Annual Meeting of Shareholders was held on April 26, 2006. The
following are the items voted on and the results of the shareholder voting:
1. The election of Bruce E. Manwaring, L. William Nelson, George P. Joyce
and Lloyd "Buddy" Stemple to serve as directors of the Company, each for a term
of three years or until his successor has been elected and qualified.
Name For Withheld
Bruce E. Manwaring 2,427,820 9,282
L. William Nelson 2,427,820 9,282
George P. Joyce 2,421,816 15,286
Lloyd "Buddy" Stemple 2,420,316 16,786
Set forth below are the names of the other directors of the Company and
their terms of office.
Name Term Expires
Steven W. Thomas 2007
Corte J. Spencer 2007
Janette Resnick 2007
Chris C. Gagas 2008
Thomas W. Schneider 2008
Chris R. Burritt 2008
2. The ratification of the appointment of Beard Miller Company LLP as
auditors for the Company for the year ending December 31, 2006.
For Against Abstain
Number of Votes 2,433,639 3,313 150
-24
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
-25
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)
August 14, 2006 /s/ Thomas W. Schneider
-----------------------
Date: Thomas W. Schneider
President, Chief Executive Officer
August 14, 2006 /s/ James A. Dowd
----------------
Date: James A. Dowd
Senior Vice President, Chief Financial Officer