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PBHC > SEC Filings for PBHC > Form 10-Q on 14-May-2013All Recent SEC Filings

Show all filings for PATHFINDER BANCORP INC | Request a Trial to NEW EDGAR Online Pro



Quarterly Report

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


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. Pathfinder Commercial Bank, Pathfinder REIT, Inc., Pathfinder Risk Management, Inc., and Whispering Oaks Development Corp. are wholly owned subsidiaries of Pathfinder Bank. At March 31, 2013, 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 60.5% of the Company's outstanding common stock and public shareholders, including shares held by the Employee Stock Ownership Plan ("ESOP"), held the remaining 39.5% of the outstanding common stock.

The following discussion reviews the Company's financial condition at March 31, 2013 and the results of operations for the three months ended March 31, 2013 and 2012.

Statement Regarding Forward-Looking Statements

When used in this quarterly report the words or phrases "will likely result", "are expected to", "will continue", "is anticipated", "estimate", "project", or similar expression are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties. By identifying these forward-looking statements for you in this manner, the Company is alerting you to the possibility that its actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in these forward-looking statements. 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 various factors 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. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.

Application of Critical Accounting Policies

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

The most significant accounting policies followed by the Company are presented in Note 1 to the annual audited consolidated financial statements included in the 2012 Annual Report filed on form 10-K on March 18, 2013 ("the consolidated financial statements"). These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how significant assets and liabilities are valued in the consolidated financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the allowance for loan losses, deferred income taxes, pension obligations, the evaluation of investment securities for other than temporary impairment, and the estimation of fair values for accounting and disclosure purposes to be the accounting areas that require the most subjective and complex judgments. These areas could be the most subject to revision as new information becomes available.

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The allowance for loan losses represents management's estimate of probable loan losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment on the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The Company establishes a specific allowance for all loans identified as being impaired with a balance in excess of $100,000 which are on nonaccrual and have been risk rated under the Company's risk rating system as substandard, doubtful, or loss. In addition, an accruing substandard loan could be identified as being impaired. The measurement of impaired loans is generally based upon the present value of future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral, less costs to sell. The majority of the Company's impaired loans are collateral-dependent. For all other loans and leases, the Company uses the general allocation methodology that establishes an allowance to estimate the probable incurred loss for each risk-rating category. The loan portfolio also represents the largest asset type on the consolidated statement of condition. Note 1 to the consolidated financial statements describes the methodology used to determine the allowance for loan losses and a discussion of the factors driving changes in the amount of the allowance for loan losses 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. This is attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases as well as net operating and capital loss carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates applied to taxable income in the years in which those temporary differences are expected to be recovered or settled. The affect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period that includes the enactment date. If current available evidence about the future raises doubt about the likelihood of a deferred tax asset being realized, a valuation allowance is established. The judgment about the level of future taxable income, including that which is considered capital, is inherently subjective and is reviewed on a continual basis as regulatory and business factors change. A valuation allowance of $458,000 was maintained at March 31, 2013, as management believes it may not generate sufficient capital gains to offset its capital loss carry forward. The Company's effective tax rate differs from the statutory rate due primarily to non-taxable income from investment securities and bank owned life insurance.

Pension and post-retirement benefit plan liabilities and expenses are based upon actuarial assumptions of future events; including fair value of plan assets, interest rates, and the length of time the Company will have to provide those benefits. The assumptions used by management are discussed in Note 12 to the consolidated annual financial statements.

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 and included in accumulated other comprehensive income (loss), except for the credit-related portion of debt security impairment losses and other-than-temporary impairment ("OTTI") of equity securities which are charged to earnings. The Company's ability to fully realize the value of its investments in various securities, including corporate debt securities, is dependent on the underlying creditworthiness of the issuing organization. In evaluating the debt security portfolio for other-than-temporary impairment losses, management considers (1) if we intend to sell the security; (2) if it is "more likely than not" we will be required to sell the security before recovery of its amortized cost basis; or (3) if the present value of expected cash flows is not sufficient to recover the entire amortized cost basis. In determining whether OTTI has occurred for equity securities the Company considers the applicable factors described above and the length of time the equity security's fair value has been below the carrying amount. Management 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.

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

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

Recent Events

As reported by the Company on its Form 10-K filed on March 29, 2012, the purchase of the 51% controlling interest in the Fitzgibbons Agency, pending the completion of the final stages of due diligence, was expected to close in the early part of the second quarter of 2012. The Company and the Fitzgibbons Agency are addressing the final elements of the transaction and are working to expedite a closing at the earliest possible time.

Overview and Results of Operations

For the first quarter of 2013, net income was $505,000 as compared to $529,000 for the first quarter of 2012 due to an increase in the provision for loan losses, a reduction in noninterest income, and an increase in noninterest expenses. Partially offsetting these reductions to net income was a $188,000 increase in net interest income between the year over year first quarter periods.

The Company's return on average assets and return on average equity for the first quarter of 2013 were 0.41% and 4.92%, respectively, as compared to 0.47% and 5.52% for the same prior year period.

Average assets for the first quarter of 2013 were $496.1 million, or 9.2% greater than the comparable prior year period. The increase was attributable to increases in residential real estate loans, commercial loans, commercial real estate, and to a lesser extent, tax-exempt securities. Commercial loans increased $11.6 million or 29.2% between these same periods in direct support of the Company's initiative to diversify its portfolio and increase its penetration within this segment.

Net Interest Income

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

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

                                              For the three months Ended March 31,
                                         2013                                       2012
                                                       Average                                    Average
                          Average                      Yield /       Average                      Yield /
(Dollars in
thousands)                Balance       Interest          Cost       Balance       Interest          Cost
Real estate loans
residential             $ 177,934     $    2,059          4.63 %   $ 162,741     $    2,071          5.09 %
Real estate loans
commercial                 81,951          1,109          5.41 %      72,990          1,039          5.69 %
Commercial loans           51,144            608          4.76 %      39,578            511          5.16 %
Consumer loans             25,339            359          5.67 %      27,968            398          5.69 %
Taxable investment
securities                 93,820            418          1.78 %      93,747            492          2.10 %
Tax-exempt investment
securities                 25,979            289          4.45 %      20,324            246          4.84 %
Interest-earning time
deposit                     2,000              6          1.20 %       2,000              7          1.40 %
deposits                    7,117              1          0.06 %       1,294              1          0.31 %
assets                    465,284          4,849          4.17 %     420,642          4,765          4.53 %
Other assets               32,845                                     35,512
Allowance for loan
losses                     (4,551 )                                   (4,042 )
Net unrealized gains
on available for sale
securities                  2,525                                      2,161
Total assets            $ 496,103                                  $ 454,273
NOW accounts            $  39,355             19          0.19 %   $  31,275             19          0.24 %
Money management
accounts                   14,444              9          0.25 %      14,374             14          0.39 %
MMDA accounts              81,206             96          0.47 %      77,186            114          0.59 %
Savings and club
accounts                   67,870             14          0.08 %      62,267             15          0.10 %
Time deposits             164,150            521          1.27 %     154,928            599          1.55 %
Junior subordinated
debentures                  5,155             40          3.10 %       5,155             42          3.26 %
Borrowings                 32,437            197          2.43 %      27,557            213          3.09 %
liabilities               404,617            896          0.89 %     372,742          1,016          1.09 %
Demand deposits            46,765                                     38,955
Other liabilities           3,632                                      4,258
Total liabilities         455,014                                    415,955
Shareholders' equity       41,089                                     38,318
Total liabilities &
shareholders' equity    $ 496,103                                  $ 454,273
Net interest income                   $    3,953                                 $    3,749
Net interest rate
spread                                                    3.28 %                                     3.44 %
Net interest margin                                       3.40 %                                     3.57 %
Ratio of average
to average
liabilities                                             114.99 %                                   112.85 %

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Net interest income, on a tax-equivalent basis, increased to $4.0 million for the three months ended March 31, 2013, from $3.7 million for the three months ended March 31, 2012. This was due to a greater increase in average earning assets between the year over year quarters, compared with interest bearing liabilities, partially offset by the decrease in net interest rate spread. This was reflected in a decrease in net interest margin during the comparative periods. The largest increases in earning assets were within the real estate loans residential and commercial loan product segments of the balance sheet as the Company continued to experience strong loan demand within its marketplace.

As indicated in the three month table above and in the rate/volume analysis below, total interest income on a tax-equivalent basis increased $84,000 due principally to an increase in average balances of commercial loans, commercial real estate loans, and tax-exempt investment securities, partially offset by reductions in the yield for each of these products. The yield on all classes of interest earning asset products decreased, with the most significant yield decrease of 46 basis points reported in residential real estate loans. Residential real estate loans yield decreased due to maturing loans and payoffs being replaced with those of lower rates reflecting current market conditions. The average yield on tax- exempt investment securities decreased by 39 basis points, however, the average yield was significantly greater than the average yield on taxable investment securities through the first quarter of 2013. In this same time period, management elected to invest in longer term securities to take advantage of the positive slope of the yield curve for this product. Consumer loans, generally comprised of home equity loans and lines of credit, auto loans, and personal loans, reported a 9.4% decline in average balances but only a nominal decline in average yield.

Interest expense decreased $120,000 between year over year first quarter periods, as indicated in the above three month table. The primary reason for the decline was lower rates paid on time deposits as higher cost maturing certificates of deposit were replaced with lower cost certificates of deposits at current market rates. In addition, interest expense on money market deposit accounts declined as the Company was able to gather an increase in average balances of these short term deposit accounts at lower rates and in support of consumers' desire to invest in short term products.

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Rate/Volume Analysis

Net interest income can also be analyzed in terms of the impact of changing interest rates on interest-earning assets and interest-bearing liabilities and changes in the volume or amount of these assets and liabilities. The following table represents the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Company's interest income and interest expense during the periods indicated. Information is provided in each category with respect to: (i) changes attributable to changes in volume (change in volume multiplied by prior rate);
(ii) changes attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) total increase or decrease. Changes attributable to both rate and volume have been allocated ratably.

                                           Three months ended March 31,
                                                  2013 vs. 2012
                                            Increase/(Decrease) Due to
(In thousands)                          Volume            Rate     (Decrease)
Interest Income:
Real estate loans residential       $      755       $    (767 )   $       (12 )
Real estate loans commercial               342            (272 )            70
Commercial loans                           327            (230 )            97
Consumer loans                             (38 )            (1 )           (39 )
Taxable investment securities                3             (77 )           (74 )
Tax-exempt investment securities           156            (113 )            43
Interest-earning time deposits               -              (1 )            (1 )
Interest-earning deposits                    5              (5 )             -
Total interest income                    1,550          (1,466 )            84
Interest Expense:
NOW accounts                                17             (17 )             -
Money management accounts                    -              (5 )            (5 )
MMDA accounts                               34             (52 )           (18 )
Savings and club accounts                    7              (8 )            (1 )
Time deposits                              196            (274 )           (78 )
Junior subordinated debentures               -              (2 )            (2 )
Borrowings                                 158            (174 )           (16 )
Total interest expense                     412            (532 )          (120 )
Net change in net interest income   $    1,138       $    (934 )   $       204

Provision for Loan Losses

The provision for loan losses represents management's estimate of the amount necessary to maintain the allowance for loan losses at an adequate level. The Company recorded $324,000 in provision for loan losses for the three-month period ended March 31, 2013, as compared to $225,000 for the three-month period ended March 31, 2012. This increase was due primarily to the specific reserve required from the addition of a large commercial relationship newly categorized as impaired in the first quarter of 2013. Net charge-offs for the first quarter of 2013 were $139,000 as compared to net charge-offs of $93,000 for the first quarter of 2012.

Delinquency trends of all of the Company's loan segments improved as of March 31, 2013 when compared to December 31, 2012, most notable in 1-4 family first lien residential mortgages and consumer loans, the latter including home equity loans and lines of credit. The most significant improvements seen in this product segment was seen in the 30-59 days past due category. Delinquencies of commercial and municipal loans improved modestly as the decrease in delinquencies within the 30-59 days category was partially offset by the increase in delinquencies in the over 90 days category.

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Noninterest Income

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

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

                                                       Three Months Ended March 31,
(Dollars in thousands)                           2013           2012             Change
Service charges on deposit accounts        $      255      $     273     $     (18 )        -6.6 %
Earnings and gain on bank owned life
insurance                                          61             93           (32 )       -34.4 %
Loan servicing fees                                44             41             3           7.3 %
Debit card interchange fees                       106             97             9           9.3 %
Other charges, commissions and fees               142            136             6           4.4 %
Noninterest income before gains (losses)          608            640           (32 )        -5.0 %
Net gains on sales and redemptions of
investment securities                              39            112           (73 )       -65.2 %
Net gains (losses) on sales of loans and
foreclosed real estate                             29            (24 )          53        -220.8 %
Total noninterest income                   $      676      $     728     $     (52 )        -7.1 %

As indicated above, noninterest income for the first quarter of 2013 decreased when compared to the same prior year period due principally to significant net gains from the sale of investment securities in 2012 due to portfolio restructuring and greater earnings on bank owned life insurance in 2012. These decreases were partially offset by net gains on the sales of loans and foreclosed real estate as the Company elected to take advantage of current market prices of residential real estate loans and concurrently improve the interest rate risk profile of the balance sheet.

Noninterest Expense

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

                                        Three Months Ended March 31,
(Dollars in thousands)                2013        2012          Change
Salaries and employee benefits    $  1,910     $ 1,974     $ (64 )     -3.2 %
. . .
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