INTRODUCTION

Throughout 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 II are wholly owned subsidiaries of Pathfinder Bancorp, Inc., however, Pathfinder Statutory Trust II is not consolidated for reporting purposes (see Note 10 of the consolidated financial statements). Pathfinder Commercial Bank, Pathfinder REIT, Inc. and Whispering Oaks Development Corp. are wholly owned subsidiaries of Pathfinder Bank. At December 31, 2008, Pathfinder Bancorp, M.H.C, the Company's mutual holding company parent, whose activities are not included in the consolidated financial statements or the MD&A, held 63.7% of the Company's outstanding common stock and the public held 36.3%.

This Annual Report contains supplemental financial information determined by methods other than in accordance with Accounting Principles Generally Accepted in the United States of America ("GAAP"). The Company's management believes that such non-GAAP financial measures are useful to management and investors as it enhances their ability to evaluate and compare the Company's operating results from period to period in a meaningful manner, as operating results excluding other than temporary impairment charges on its investment security holdings are essential in understanding the financial performance of the Company, and is more representative of the basis that management utilizes to monitor financial performance. Readers are cautioned that non-GAAP measures should not be considered as an alternative to any measure of performance as promulgated under GAAP, and should consider the impairment charges recorded during 2008 in assessing the Company's performance. Non-GAAP measures have limitations as analytical tools, and investors should not consider them in isolation or as a substitute for analyzing the Company's performance under GAAP, nor are they necessarily comparable to non-GAAP measures presented by other companies.

The Company's business strategy is to operate as a well-capitalized, profitable and independent community bank dedicated to providing value-added products and services to our customers. Generally, the Company has sought to implement this strategy by emphasizing retail deposits as its primary source of funds and maintaining a substantial part of its assets in locally-originated residential first mortgage loans, loans to business enterprises operating in its markets, and in investment securities. Specifically, the Company's business strategy incorporates the following elements: (i) operating as an independent community-oriented financial institution; (ii) maintaining capital in excess of regulatory requirements; (iii) emphasizing investment in one-to-four family residential mortgage loans, loans to small businesses and investment securities; and (iv) maintaining a strong retail deposit base.

The Company's net income is primarily dependent on its net interest income, which is the difference between interest income earned on its investments in mortgage and other loans, investment securities and other assets, and its cost of funds consisting of interest paid on deposits and borrowings. The Company's net income also is affected by its provision for loan losses, as well as by the amount of noninterest income, including income from fees, service charges and servicing rights, net gains and losses on sales of securities, loans and foreclosed real estate, and noninterest expense such as employee compensation and benefits, occupancy and equipment costs, data processing costs and income taxes. Earnings of the Company also are affected significantly by general economic and competitive conditions, particularly changes in market interest rates, government policies and actions of regulatory authorities, of which these events are beyond the control of the Company. In particular, the general level of market rates tends to be highly cyclical.

APPLICATION OF CRITICAL ACCOUNTING POLICIES

The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States and follow practices within the banking industry. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the financial statements; accordingly, as this information

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

The most significant accounting policies followed by the Company are presented in Note 1 to the consolidated financial statements. These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how significant assets and liabilities are valued in the 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 goodwill for impairment, the evaluation of investment securities for other than temporary 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, 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 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 is included in this report.

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 attributable to 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 effect 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. To the extent that 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 $540,000 was established during the year ended December 31, 2008, 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 to non-taxable investment securities, and bank owned life insurance offset by the valuation allowance established on a portion of the capital loss carry forwards.

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, rate of future compensation increases and the length of time the Company will have to provide those benefits. The assumptions used by management are discussed in Note 11 to the consolidated financial statements.

As a result of deteriorating economic conditions in the financial markets, which impacted the trading value of the Company's common stock, management engaged an independent third party to test the Company's goodwill for impairment as of December 31, 2008. Testing was performed by utilizing a three-step valuation approach which is described in Note 8 to the consolidated financial statements.

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, except for security impairment losses, 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 security portfolio for other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Based on management's assessments during the year ended December 31, 2008, the Company recorded other than temporary impairment charges of $ 2,253,000, including an $875,000 charge on a $1,000,000 holding in a senior unsecured note issued by Lehman Brothers Holdings Inc., which filed a Chapter 11 Bankruptcy petition on September 15, 2008, the AMF Large Cap Equity Fund in the amount of $690,000, $269,000 in the AMF Ultra Short Mortgage Fund, $67,000 in the Financial Institutions Fund and $10,000 on a stock investment in The Phoenix Companies. In addition to the impairment charges, the Company's available for sale investment portfolio at December 31, 2008 includes unrealized losses of $2.4 million. See Note 3 to the consolidated financial statements for further discussion of the unrealized losses. Management continually analyzes the portfolio to determine if further impairment has occurred that may be deemed as other-than-temporary. Further charges are possible depending on future economic conditions.

The estimation of fair value is significant to several of our assets, including investment securities available for sale, intangible assets and foreclosed real estate, as well as 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 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. Note 18 in the consolidated financial statements provides additional information on how we determine fair values. The fair values of foreclosed real estate and the underlying collateral value of impaired loans are typically determined based on appraisals by third parties, less estimated costs to sell. If necessary, appraisals are updated to reflect changes in market conditions.

EXECUTIVE SUMMARY

Total deposits for the Company increased 7%, to $269.4 million at December 31, 2008, while the average balance of deposits increased $10.0 million to $265.8 million at December 31, 2008. The Company will continue to focus on building market share in the Central Square and Fulton markets where the existing Pathfinder Bank share of the market is 20% or less. In all other market areas, Pathfinder Bank currently has the majority of the current deposit market share. Pathfinder seeks to continue to develop core deposit relationships in all markets through the acquisition of demand deposit relationships. Efforts will also be focused on the expansion of commercial deposit relationships with the Bank's existing commercial lending relationships.

Total assets increased 10.0%, primarily in the loan and investment security portfolios. The loan portfolio increased 12% with net growth in all loan categories. The Company expects to concentrate on continued commercial mortgage and commercial loan portfolio growth during 2009. The ratio of non-performing assets to total assets was 0.75% at December 31, 2008 compared to 0.77% in the prior year. Although this ratio has remained relatively stable, there was a decrease in asset quality of the loan portfolio. Non-performing loans increased $732,000, primarily due to commercial loan relationships. This decrease in loan quality was offset by the reduction of foreclosed real estate of $530,000.

Net income for 2008 was $368,000, or $0.15 per share, as compared to $1.1 million, or $0.45 per share, in 2007. The decline in income was primarily the result of the Company recording impairment charges on investment security holdings totaling $1.6 million, net of the related tax benefits of $659,000. Core earnings, which represent earnings exclusive of investment portfolio other-than-temporary impairment losses, resulted in net income of $2 million or $0.79 per diluted share for the year ended December 31, 2008.

The following table reconciles the Company's 2008 net income to core earnings, including per share figures.

                                                                         For the year
                                                                                ended
                                                                         December 31,
                                                                                 2008
Net Income                                                                 $  368,000
Other than temporary impairment charge - investments                        2,253,000
Related tax benefit                                                          (659,000 ) *
Core earnings                                                              $1,962,000
Diluted earnings per share                                                      $0.15
Other than temporary impairment charge, net of tax, per share                    0.64
Core earnings, diluted earnings per share                                       $0.79

*Net of a deferred tax asset valuation reserve of $242,000 for the year ended December 31, 2008.

RESULTS OF OPERATIONS

Net income for 2008 was $368,000, a decrease of $754,000, or 67%, compared to net income of $1.1 million for 2007. Basic and diluted earnings per share decreased to $0.15 per share for the year ended December 31, 2008 from $0.45 per share, for the year ended December 31, 2007. Return on average equity decreased to 1.70% in 2008 from 5.27% in 2007. All of these declines in performance were primarily the result of the impairment charges described above.

Net interest income, on a tax equivalent basis, increased $2 million, or 22%, resulting from both volume increases in all loan categories and total investment securities and significant rate decreases applied to all interest-earning liabilities. The provision for loan losses for the year ended December 31, 2008 increased $455,000, reflecting the increased inherent risk within the expanding commercial lending activities, the overall growth in the total loan portfolio and general weakening of economic conditions. The Company experienced an 82% decrease in noninterest income. Noninterest income increased 6%, exclusive of securities gains and losses, primarily attributable to increased cash surrender values of bank-owned life insurance, an increase in issued Visa Debit cards and increased usage from the existing customer base and increased loan servicing fees related to collateral discharges and new rate lock fees on loans that did not close. Noninterest expense increased only 1% due to increases in personnel expense, building occupancy, and other operating expenses, partially offset by a reduction in amortization of intangibles.

Net Interest Income

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

Net interest income, on a tax-equivalent basis, increased $2 million, or 22%, to $10.8 million for the year ended December 31, 2008, as compared to $8.8 million for the year ended December 31, 2007. The Company's net interest margin for 2008 increased to 3.43% from 3.07% in 2007. The increase in net interest income is attributable to an increase in the average balance of interest earning assets, combined with increased yields on interest earning assets and a decrease in the cost of interest-bearing liabilities. The average balance of interest-earning assets increased $28.2 million, or 10%, during 2008 and the average balance of interest-bearing liabilities increased by $26.2 million, or 10%. The increase in the average balance of interest earning assets primarily resulted from a $22.7 million increase in the average balance of the loan portfolio and a $7.7 million increase in the average balance of the security investment portfolio, offset by a $2.2 million reduction in the average balance of interest earning deposits. The increase in the average balance of interest-bearing liabilities primarily resulted from a $7.3 million, or 3%, increase in the average balance of deposits, combined with a $18.9 million, or 60%, increase in the average balance of borrowed funds. Interest income, on a tax-equivalent basis, increased $1.0 million, or 6%, during 2008, as the decrease in yield on interest earning assets to 5.87% in 2008 from 6.08% in 2007 was offset by the 10% increase in volume. Interest expense on deposits decreased $1.2 million, or 18%, as the cost of deposits dropped 60 basis points to 2.36% in 2008 from 2.96% in 2007. Interest expense on borrowings increased $273,000, or 16%, during 2008 as the increase in the average balance of borrowed funds by 60% was partially offset by a decrease in the cost of borrowed funds to 4.00% in 2008 from 5.52% in 2007.

Average Balances and Rates

The following table sets forth information concerning average interest-earning assets and interest-bearing liabilities and the yields and rates thereon. Interest income and resultant yield information in the table is on a fully tax-equivalent basis using marginal federal income tax rates of 34%. Averages are computed on the daily average balance for each month in the period divided by the number of days in the period. Yields and amounts earned include loan fees. Non-accrual loans have been included in interest-earning assets for purposes of these calculations.

                                                                             For the Years Ended December 31,
                                                2008                                      2007                                       2006
                                                              Average                                   Average                                    Average
                                   Average                    Yield /        Average                    Yield /         Average                     Yield/
(Dollars in thousands)             Balance      Interest         Cost        Balance      Interest         Cost         Balance      Interest         Cost
Interest-earning assets:
Real estate loans residential     $130,702        $7,527         5.76 %     $120,079        $6,945         5.78 %      $119,417        $6,876         5.76 %
Real estate loans commercial        49,040         3,620         7.38 %       43,573         3,309         7.59 %        35,076         2,705         7.71 %
Commercial loans                    27,033         1,751         6.48 %       23,710         1,976         8.33 %        19,961         1,574         7.88 %
Consumer loans                      26,291         1,915         7.28 %       23,011         1,894         8.23 %        20,153         1,641         8.14 %
Taxable investment securities       74,105         3,365         4.54 %       66,230         2,881         4.35 %        66,788         2,658         3.97 %
Tax-exempt investment
securities                           5,252           255         4.86 %        5,446           258         4.74 %        10,240           481         4.70 %
Interest-earning deposits            2,851            61         2.14 %        5,050           211         4.18 %         1,779            91         5.12 %
Total interest-earning assets      315,274        18,494         5.87 %      287,099        17,474         6.08 %       273,414        16,026         5.86 %
Noninterest-earning assets:
Other assets                        30,274                                    27,774                                     31,600
Allowance for loan losses           (2,006 )                                  (1,583 )                                   (1,661 )
Net unrealized losses
on available for sale
securities                          (1,690 )                                  (1,372 )                                   (2,142 )
Total assets                      $341,852                                  $311,918                                   $301,211
Interest-bearing liabilities:
NOW accounts                       $23,762            95         0.40 %      $22,235           113         0.51 %       $21,094           102         0.48 %
Money management accounts           10,574            52         0.49 %       11,348            89         0.78 %        13,318           110         0.83 %
MMDA accounts                       29,181           570         1.95 %       23,682           937         3.96 %        20,608           786         3.81 %
Savings and club accounts           52,482           168         0.32 %       53,359           279         0.52 %        58,997           266         0.45 %
Time deposits                      124,267         4,777         3.84 %      122,333         5,483         4.48 %       103,596         4,203         4.06 %
Junior subordinated
debentures                           5,155           257         4.99 %        6,454           511         7.81 %         5,155           448         8.57 %
Borrowings                          45,239         1,756         3.88 %       25,063         1,230         4.91 %        33,589         1,608         4.79 %
Total interest-bearing
liabilities                        290,660         7,675         2.64 %      264,474         8,642         3.27 %       256,357         7,523         2.93 %
Noninterest-bearing
liabilities:
Demand deposits                     25,493                                    22,828                                     20,745
Other liabilities                    4,088                                     3,338                                      2,943
Total liabilities                  320,241                                   290,640                                    280,045
Shareholders' equity                21,611                                    21,278                                     21,166
Total liabilities &
shareholders' equity              $341,852                                  $311,918                                   $301,211
Net interest income                              $10,819                                    $8,832                                     $8,503
Net interest rate spread                                         3.22 %                                    2.81 %                                     2.93 %
Net interest margin                                              3.43 %                                    3.07 %                                     3.11 %
Ratio of average
interest-earning assets
to average interest-bearing
liabilities                                                    108.47 %                                  108.55 %                                   106.65 %

Interest Income

Changes in interest income result from changes in the average balances of loans and securities and the related yields on those balances. Interest income on a tax-equivalent basis increased $1.0 million, or 5.8%. Average loans increased 10.8% in 2008, with yields decreasing 35 basis points to 6.36%. The Company's average residential mortgage loan portfolio increased $10.6 million, or 8.8%, when comparing 2008 to 2007. The average yield on the residential mortgage loan portfolio decreased 2 basis points to 5.76% in 2008 from 5.78% in 2007. The average balance of commercial real estate loans increased $5.5 million, or 12.5%, while the yield decreased to 7.38% in 2008 from 7.59% in 2007. Average commercial loans increased 14.0% and the tax-equivalent yield decreased to 6.48% in 2008 compared to 8.33%, in 2007. The average balance of consumer loans increased $3.3 million, or 14.3% when compared to 2007. The average yield decreased 95 basis points, to 7.28% from 8.23% in 2007.

Interest income on investment securities increased 15.3% from 2007, resulting from an increase in the average balance of investment securities (taxable and tax-exempt) of $7.7 million, or 10.7%, to $79.4 million in 2008 from $71.7 million in 2007. The average yield increased 18 basis points to 4.56% in 2008 from 4.38% in 2007.

Interest Expense

Changes in interest expense result from changes in the average balances of deposits and borrowings and the related interest costs on those . . .