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PBHC > SEC Filings for PBHC > Form 10-Q on 13-Aug-2013All Recent SEC Filings

Show all filings for PATHFINDER BANCORP INC

Form 10-Q for PATHFINDER BANCORP INC


13-Aug-2013

Quarterly Report


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

General

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 June 30, 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 June 30, 2013 and the results of operations for the three and six months ended June 30, 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 commercial loans in excess of the total related credit threshold of $100,000 and single borrower residential mortgage loans in excess of the total related credit threshold of $300,000 identified as being impaired which are on nonaccrual and have been risk rated under the Company's risk rating system as substandard, doubtful, or loss. In addition, an accruing substandard loan could be identified as being impaired. The measurement of impaired loans is generally based upon the present value of future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral, less costs to sell. The majority of the Company's impaired loans are collateral-dependent. For all other loans and leases, the Company uses the general allocation methodology that establishes an allowance to estimate the probable incurred loss for each risk-rating category. The loan portfolio also represents the largest asset type on the consolidated statement of condition. Note 1 to the consolidated financial statements describes the methodology used to determine the allowance for loan losses and a discussion of the factors driving changes in the amount of the allowance for loan losses 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 $462,000 was maintained at June 30, 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 second quarter of 2013, net income was $823,000 as compared to $721,000 for the second quarter of 2012 due principally to an increase in net interest income and noninterest income, the latter stemming from the gain on the portfolio sale of approximately $8.8 million in longer term and lower yielding residential loans. Partially offsetting these increases in net income was an increase in the provision for loan losses and an increase in noninterest expense.

For the first half of 2013, net income was $1.3 million as compared to $1.2 million for the comparable prior year period. The improvement was due to an increase in net interest income and the above mentioned residential loan sale, partially offset by an increase in the provision for loan losses and an increase in noninterest expense between the comparable six month periods.

The Company's return on average assets and return on average equity for the second quarter of 2013 were 0.66% and 7.93%, respectively, as compared to 0.62% and 7.49% for the same prior year period. Return on average assets and return on average equity for the first half of 2013 were 0.53% and 6.43%, respectively, as compared to 0.54% and 6.50% for the same prior year period.

Average assets for the second quarter of 2013 were $502.3 million, or 7.3% greater than the comparable prior year period. The increase was attributable to increases in residential real estate loans, commercial loans, commercial real estate loans, and to a lesser extent, tax-exempt securities. Average balances of commercial real estate loans increased $13.7 million or 18.6% and commercial loans increased $13.4 million or 33.8% between these same periods in direct support of the Company's initiative to diversify its portfolio and increase its penetration within the commercial segments. Additionally, average balances of real estate residential loans increased $8.2 million, or 4.9%, between these same two time periods.

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 June 30,
                                         2013                                       2012
                                                       Average                                    Average
                          Average                      Yield /       Average                      Yield /
(Dollars in
thousands)                Balance       Interest          Cost       Balance       Interest          Cost
Interest-earning
assets:
Real estate loans
residential             $ 174,625     $    1,978          4.53 %   $ 166,447     $    2,046          4.92 %
Real estate loans
commercial                 87,475          1,169          5.35 %      73,769          1,094          5.93 %
Commercial loans           53,148            622          4.68 %      39,725            458          4.61 %
Consumer loans             25,244            359          5.69 %      27,474            390          5.68 %
Taxable investment
securities                 97,518            423          1.74 %     102,395            514          2.01 %
Tax-exempt investment
securities                 25,653            284          4.43 %      23,273            275          4.73 %
Interest-earning time
deposit                     1,821              5          1.10 %       2,000              6          1.20 %
Interest-earning
deposits                    5,571              2          0.14 %         951              1          0.42 %
Total
interest-earning
assets                    471,055          4,842          4.11 %     436,034          4,784          4.39 %
Noninterest-earning
assets:
Other assets               33,811                                     34,086
Allowance for loan
losses                     (4,756 )                                   (4,160 )
Net unrealized gains
on available for sale
securities                  2,235                                      2,279
Total assets            $ 502,345                                  $ 468,239
Interest-bearing
liabilities:
NOW accounts            $  40,441             20          0.20 %   $  30,672             19          0.25 %
Money management
accounts                   14,374              7          0.19 %      14,958             12          0.32 %
MMDA accounts              81,106             87          0.43 %      81,257            109          0.54 %
Savings and club
accounts                   69,595             13          0.07 %      64,179             13          0.08 %
Time deposits             165,688            502          1.21 %     158,316            583          1.47 %
Junior subordinated
debentures                  5,155             41          3.18 %       5,155             44          3.41 %
Borrowings                 31,344            163          2.08 %      30,780            217          2.81 %
Total
interest-bearing
liabilities               407,703            833          0.82 %     385,317            997          1.03 %
Noninterest-bearing
liabilities:
Demand deposits            48,821                                     40,079
Other liabilities           4,286                                      4,338
Total liabilities         460,810                                    429,734
Shareholders' equity       41,535                                     38,505
Total liabilities &
shareholders' equity    $ 502,345                                  $ 468,239
Net interest income                   $    4,009                                 $    3,787
Net interest rate
spread                                                    3.29 %                                     3.36 %
Net interest margin                                       3.40 %                                     3.47 %
Ratio of average
interest-earning
assets
to average
interest-bearing
liabilities                                             115.54 %                                   113.16 %

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                                                For the six months Ended June 30,
                                         2013                                       2012
                                                       Average                                    Average
                          Average                      Yield /       Average                      Yield /
(Dollars in
thousands)                Balance       Interest          Cost       Balance       Interest          Cost
Interest-earning
assets:
Real estate loans
residential             $ 176,270     $    4,037          4.58 %   $ 164,765     $    4,117          5.00 %
Real estate loans
commercial                 84,728          2,278          5.38 %      73,253          2,133          5.82 %
Commercial loans           52,151          1,230          4.72 %      39,780            969          4.87 %
Consumer loans             25,291            718          5.68 %      27,713            788          5.69 %
Taxable investment
securities                 95,681            842          1.76 %      98,095          1,005          2.05 %
Tax-exempt investment
securities                 25,815            573          4.44 %      21,807            521          4.78 %
Interest-earning time
deposit                     1,910             11          1.15 %       2,000             12          1.20 %
Interest-earning
deposits                    6,340              3          0.09 %       1,122              2          0.36 %
Total
interest-earning
assets                    468,186          9,692          4.14 %     428,535          9,547          4.46 %
Noninterest-earning
assets:
Other assets               33,329                                     34,297
Allowance for loan
losses                     (4,654 )                                   (4,101 )
Net unrealized gains
on available for sale
securities                  2,379                                      2,220
Total assets            $ 499,240                                  $ 460,951
Interest-bearing
liabilities:
NOW accounts            $  39,901             38          0.19 %   $  30,972             38          0.25 %
Money management
accounts                   14,409             16          0.22 %      14,668             26          0.35 %
MMDA accounts              81,156            183          0.45 %      79,233            223          0.56 %
Savings and club
accounts                   68,737             27          0.08 %      63,228             28          0.09 %
Time deposits             164,923          1,024          1.24 %     156,631          1,182          1.51 %
Junior subordinated
debentures                  5,155             81          3.14 %       5,155             86          3.34 %
Borrowings                 31,887            361          2.26 %      29,178            429          2.94 %
Total
interest-bearing
liabilities               406,168          1,730          0.85 %     379,065          2,012          1.06 %
Noninterest-bearing
liabilities:
Demand deposits            47,799                                     39,520
Other liabilities           3,960                                      3,956
Total liabilities         457,927                                    422,541
Shareholders' equity       41,313                                     38,410
Total liabilities &
shareholders' equity    $ 499,240                                  $ 460,951
Net interest income                   $    7,962                                 $    7,535
Net interest rate
spread                                                    3.29 %                                     3.40 %
Net interest margin                                       3.40 %                                     3.52 %
Ratio of average
interest-earning
assets
to average
interest-bearing
liabilities                                             115.27 %                                   113.05 %

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Net interest income, on a tax-equivalent basis, increased to $4.0 million for the three months ended June 30, 2013, from $3.8 million for the three months ended June 30, 2012. This was principally due to a decrease in interest expense and, to a lesser extent, an increase in interest income reflecting increases in average balances of the loan portfolio. The largest increases in earning assets were within real estate residential loans and commercial loans as the Company continued to experience strong loan demand within its marketplace. Net interest margin, however, contracted to 3.40% from 3.47% reflecting the lower yields obtained from our interest earning assets which recorded a greater decline than the rates paid on interest-bearing liabilities.

As indicated in the three month table above and in the rate/volume analysis below, total interest income on a tax-equivalent basis increased $59,000 due principally to an increase in average balances of both commercial loan products, partially offset by reductions in the yield for the real estate commercial and residential loan products. The yield on most classes of interest earning asset products decreased, with the most significant yield decrease reported in commercial real estate loans and residential real estate loans. For both of these products, yields decreased due to maturing loans and payoffs being replaced with those of lower rates reflecting current market conditions. Average balances of commercial loans reported the largest relative increase while also reporting a nominal increase in yield. The average yield on tax-exempt investment securities continues to be significantly greater than taxable investment securities during the second quarter of 2013, but significantly declined in second quarter year over year yields as management elected to reduce the duration of securities within this portfolio.

Interest expense decreased $164,000 between year over year second 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 to increased average balances of brokered deposits at shorter maturities which command lower market rates. Secondly, 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. Customers are largely opting to replace their higher rate maturing certificates of deposit with either one year certificates of deposit at the current lower market rate or money market deposit accounts at the current low market rate to preserve their liquidity in anticipation of potentially rising future market rates. Lastly, interest expense on borrowings, largely composed of FHLBNY long term advances, declined as higher rate maturing advances were replaced with borrowings at current lower market rates.

Referencing the above six month table and the rate/volume analysis below for the six month period ended June 30, 2013 as compared to the same prior year period, net interest income improved $427,000 driven primarily by the reduction in reduced interest expense from lower rates paid on certificates of deposit, reduced borrowing costs on replaced FHLBNY long term advances, and lower rates paid on money market deposit accounts. In addition, interest income increased due principally to an increase in average balances of commercial real estate and commercial loan products, despite lower yields recorded within each of these loan products. The Company continues to expand its commercial portfolio in our effort to improve diversification within our earning assets.

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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 . . .

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