Pathfinder Bancorp - 10-Q quarterly report FY2016 Q1

PATHFINDER BANCORP, INC.

INDEX

Pathfinder Bancorp, Inc.

Consolidated Statements of Condition

(Unaudited)

Pathfinder Bancorp, Inc.

Consolidated Statements of Income

(Unaudited)

Note 1:  Basis of Presentation

The accompanying unaudited consolidated financial statements of Pathfinder Bancorp, Inc., (the "Company"), Pathfinder Bank (the "Bank") and its other wholly owned subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information, the instructions for Form 10-Q and Article 8 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes necessary for a complete presentation of consolidated financial condition, results of operations and cash flows in conformity with generally accepted accounting principles.  In the opinion of management, all adjustments, consisting of normal recurring accruals considered necessary for a fair presentation, have been included.  Certain amounts in the 2015 consolidated financial statements may have been reclassified to conform to the current period presentation.  These reclassifications had no effect on net income or comprehensive income as previously reported.  Operating results for the three months ended March 31, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016.

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

Although the Company owns, through its subsidiary Pathfinder Risk Management Company, Inc., 51% of the membership interest in FitzGibbons Agency, LLC ("Agency"), the Company is required to consolidate 100% of the Agency within the consolidated financial statements.  The 49% of which the Company does not own is accounted for separately as noncontrolling interests within the consolidated financial statements.

On February 16, 2016, the Company redeemed all 13,000 shares of the Series B Preferred Stock outstanding with the payment of $13.0 million to the Small Business Lending Facility ("SBLF").  This redemption was substantially financed by the issuance on October 15, 2015 of the $10 million Subordinated Loan with an effective annual interest rate of 6.44%.  The issuance of the Subordinated Loan will increase interest expense by $644,000 per year but prospectively reduce the amount payable to the SBLF in preferred stock dividends.  Effective April 1, 2016, the annual dividend rate for the preferred stock would have been 9.0%.  Therefore, the retirement of the $13.0 million of the SBLF Preferred Series B stock will result in an annual reduction of dividends payable to the preferred shareholder of $1.2 million. The Company paid preferred stock dividends totaling $130,000 in 2015.  These transactions had no effect on the regulatory capital position of the Bank.

On May 8, 2015, the Company announced that the Bank filed an application with the New York State Department of Financial Services ("NYSDFS") and the Federal Deposit Insurance Corporation ("FDIC") to merge with the Bank's wholly-owned subsidiary, Pathfinder Commercial Bank, a New York State-chartered limited purpose commercial bank.  Prior to or simultaneously with the merger, Pathfinder Commercial Bank's charter will be amended such that Pathfinder Commercial Bank will become a full-service commercial bank, rather than a limited purpose commercial bank, and its name will be changed to "Pathfinder Bank".  The NYSDFS and the FDIC have approved the application and the transaction is expected to be completed in the first six months of 2016. The transaction will not impact the current activities or investments of the Bank and Pathfinder Commercial Bank, although the Bank expects some annual cost savings as a result of the conversion.

Note 2:   New Accounting Pronouncements

Accounting for Income Taxes - Under current U.S. GAAP, if the deduction for a share-based payment award for income tax purposes exceeds the compensation cost for accounting purposes, then the additional tax benefit is recognized in additional paid-in capital and referred to as an excess tax benefit. Accumulated excess tax benefits are available to offset current and subsequent period tax deficiencies (i.e., when the deduction for tax purposes is less than the compensation cost for accounting purposes). If the accumulated amount is exhausted, then all subsequent tax deficiencies are recognized in the income statement. The foregoing income tax accounting requirements apply to share-based-payment transactions and to employee stock ownership plan transactions. As amended by ASU No. 2016-09, (1) all excess tax benefits and all tax deficiencies are to be recognized as income tax expense or benefit in the income statement, (2) such benefits and deficiencies are deemed to be discrete items in the reporting period in which they occur (i.e., they should not be considered in determining the annual estimated effective tax rate), and (3) because there is no longer any excess tax benefits recognized in additional paid-in capital, the assumed proceeds from applying the treasury stock method when computing earnings per share (EPS) will exclude the amount of excess tax benefits that would have been recognized in additional paid-in capital.

Classification of Excess Tax Benefits in the Cash Flow Statement - Under current U.S. GAAP, excess tax benefits are required to be separated from other income tax cash flows and classified as a financing activity in the cash flow statement. As amended by ASU No. 2016-09, the requirement to present excess tax benefits as cash inflows from financing activities and as cash outflows from operating activities has been eliminated, and, thus, amounts relating to excess tax benefits must be classified in the cash flow statement as an operating activity.

Forfeitures - Current U.S. GAAP requires compensation cost to be recognized for awards in which the requisite service period is rendered (i.e., for awards with performance or service conditions, compensation cost is recognized only for awards that vest). Also, under current U.S. GAAP, an estimate must be made of the number of awards for which the requisite service period is expected to be rendered, and accruals of compensation cost must be based on the estimated number of awards that will vest. As amended by ASU No. 2016-09, an entity-wide accounting policy election could be made either to (1) estimate the effect of forfeitures in the initial accrual of compensation cost each year, or (2) account for forfeitures in compensation cost when they actually occur.

Minimum Statutory Withholding Tax Requirements - Current U.S. GAAP requires an award to be classified as a liability if an amount in excess of the minimum statutory withholding requirements is withheld (or may be withheld) at the employee's discretion. As amended by ASU No. 2016-09, the requirement for classification as a liability has been modified so that a partial cash settlement of an award for tax withholding will not, of itself, automatically result in liability classification, provided that the amount withheld does not exceed the maximum individual statutory tax rate in the applicable jurisdictions.

Classification in the Cash Flow Statement of Employee Taxes Paid When an Employer Withholds Shares for Tax-Withholding Purposes - As amended by ASU No. 2016-09, cash paid by an employer to a taxing authority when directly withholding shares for tax withholding purposes is classified as a financing activity in the cash flow statement. Current U.S. GAAP does not directly address the cash flow statement classification of such transactions. The Practical Expedients for Non-Public Entities for the expected term of a share option and intrinsic value are not applicable to a public entity and therefore will not be discussed.

Elimination of Indefinitely Deferred Guidance -  FASB Staff Position FAS 123(R)-1, Classification and Measurement of Freestanding Financial Instruments Originally Issued in Exchange for Employee Services under FASB Statement No. 123(R), indefinitely deferred the guidance making a freestanding financial instrument subject to the recognition and measurement requirements of other U.S. GAAP when the rights conveyed by the instrument are no longer dependent on the holder being an employee. As amended by ASU No. 2016-09, such deferred guidance has been eliminated from the Codification (and, accordingly, there will be no change in the application of existing U.S. GAAP).

Note 3:   Earnings per Common Share

Basic earnings per share are calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period.  Net income available to common shareholders is net income to Pathfinder Bancorp, Inc. less the total of preferred dividends declared. Diluted earnings per share include the potential dilutive effect that could occur upon the assumed exercise of issued stock options using the Treasury Stock method.  Anti-dilutive shares are common stock equivalents with average exercise prices in excess of the weighted average market price for the period presented. Anti-dilutive stock options, not included in the computation below, were 16,472 for the three months ended March 31, 2016 and March 31, 2015, respectively.  Unallocated common shares held by the ESOP are not included in the weighted-average number of common shares outstanding for purposes of calculating earnings per common share until they are committed to be released to plan participants.

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

Note 4:   Investment Securities

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

The amortized cost and estimated fair value of debt investments at March 31, 2016 by contractual maturity are shown below.  Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.

The Company's investment securities' gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows:

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

There were 43 securities in an unrealized loss position at March 31, 2016, of which 11 have been in loss positions for a period greater than twelve months and 32 have been in loss positions for a period less than twelve months.  This compares to 71 securities in an unrealized loss position at December 31, 2015, of which 14 had been in loss positions for a period greater than twelve months and 57 had been in loss positions for a period less than twelve months.  Among the 11 securities in loss positions for a period greater than twelve months at March 31, 2016, seven were mortgage-backed pass-through securities or collateralized mortgage obligations issued by the following entities sponsored and guaranteed by the United States Government: FNMA, FHLMC, FHLB and FFCB. These issuing entities are currently rated Aaa by Moody's Investor Services and AA+ by Standard and Poors.  The remaining four securities that have been in loss positions for a period greater than twelve months are corporate issuances that have declines in their market values of 3.04% or less of their book values as of March 31, 2016 and are rated A- or better by Standard and Poors.

Among the 32 securities in an unrealized loss position at March 31, 2016 for less than twelve months, 19 were either direct issuances of, or mortgage-backed securities or collateralized mortgage obligations issued by, the following entities sponsored and guaranteed by the United States Government: FNMA, FHLMC, FHLB and FFCB.  Of the remaining 13 securities, nine were issued by state or political subdivisions, with declines in their market values of 1.67% or less of their book value.  Of the four remaining securities, three are corporate issuances and one is an equity security.  Two of the corporate issuances have aggregate book values of $1.7 million and have unrecognized losses estimated in the range of 6.56% to 9.63% and the one remaining corporate security has an insignificant unrecognized loss of 0.30%.  The unrealized losses reflected are primarily attributable to changes in interest rates since the securities were acquired.  The Company does not intend to sell these securities, nor is it more likely than not, that the company will be required to sell these securities prior to recovery of the amortized cost.  As such, management does not believe any individual unrealized loss as of March 31, 2016 represents OTTI.

In addition to the factors used in determining whether OTTI has occurred for debt securities, the Company considers specific additional factors related to the equity security's issuer and the length of time the equity security's fair value has been below the carrying amount. Management has determined that we have the intent and ability to retain the equity securities in our portfolio for a sufficient period of time to allow for recovery.  As noted above, one equity security has been in a loss position for less than twelve months.  This security has a loss of 1.11% at March 31, 2016.  Management believes that this loss is transitory and that the Company has the ability to hold this security indefinitely.  As a result, management does not believe that this unrealized loss as of March 31, 2016 represents OTTI.

Proceeds of $15.3 million and $6.5 million on sales and redemptions of securities for the three months ended March 31, 2016 and 2015, respectively, resulted in gross realized gains (losses) detailed below:

As of March 31, 2016 and December 31, 2015, securities with a fair value of $120.4 million and $89.7 million, respectively, were pledged to collateralize certain municipal deposit relationships.  As of the same dates, securities with a fair value of $15.5 million and $17.8 million were pledged against certain borrowing arrangements.

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

The Company has a noncontributory defined benefit pension plan covering substantially all employees. The plan provides defined benefits based on years of service and final average salary. On May 14, 2012, the Company informed its employees of its decision to freeze participation and benefit accruals under the plan, primarily to reduce some of the volatility in earnings that can accompany the maintenance of a defined benefit plan.  The plan was frozen on June 30, 2012.  Compensation earned by employees up to June 30, 2012 is used for purposes of calculating benefits under the plan but there are no future benefit accruals after this date.  Participants as of June 30, 2012 will continue to earn vesting credit with respect to their frozen accrued benefits as they continue to work. In addition, the Company provides certain health and life insurance benefits for a limited number of eligible retired employees.  The healthcare plan is contributory with participants' contributions adjusted annually; the life insurance plan is noncontributory.  Employees with less than 14 years of service as of January 1, 1995, are not eligible for the health and life insurance retirement benefits.