10-Q 1 form10-q.htm 2015 3RD QUARTER 10-Q
 
 
UNITED STATES
 SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
_____________________________

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
       EXCHANGE ACT OF 1934

       For the quarterly period ended September 30, 2015

OR
[  ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
       EXCHANGE ACT OF 1934
     For the transition period from _______ to _______

PATHFINDER BANCORP, INC.
(Exact Name of Company as Specified in its Charter)

Maryland
(State of Other Jurisdiction of Incorporation)
001-36695
(Commission File No.)
38-3941859
(I.R.S. Employer Identification No.)
 

214 West First Street, Oswego, NY 13126
(Address of Principal Executive Office) (Zip Code)

(315) 343-0057
(Issuer's Telephone Number including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES T        NO *                                        

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this Chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
YES T        NO *

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer*    Accelerated filer*         Non-accelerated filer*         Smaller reporting company  T
                                                                                 (Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   YES *    NO T

As of November 9, 2015, there were 4,352,203 shares issued and outstanding of the registrant's common stock.

 

 
PATHFINDER BANCORP, INC.
INDEX



PART I - FINANCIAL INFORMATION
 
PAGE NO.
       
Item 1.
Consolidated Financial Statements (Unaudited)
   
   
3
   
4
   
5
   
6
   
7
   
8
       
Item 2.
 
32
 
and Results of Operations (Unaudited)
   
       
Item 3.
 
48
       
Item 4.
 
48
       
 
49
       
Item 1.
Legal Proceedings
   
Item 1A.
Risk Factors
   
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
   
Item 3.
Defaults upon Senior Securities
   
Item 4.
Mine Safety Disclosures
   
Item 5.
Other information
   
Item 6.
Exhibits
   
       
 
50
       
       
 
 
PART I - FINANCIAL INFORMATION
Item 1 – Consolidated Financial Statements

Pathfinder Bancorp, Inc.
Consolidated Statements of Condition
(Unaudited)
   
September 30,
   
December 31,
 
(In thousands, except share and per share data)
 
2015
   
2014
 
ASSETS:
       
Cash and due from banks
 
$
9,564
   
$
6,822
 
Interest earning deposits
   
7,810
     
4,534
 
Total cash and cash equivalents
   
17,374
     
11,356
 
Available-for-sale securities, at fair value
   
98,007
     
88,073
 
Held-to-maturity securities, at amortized cost (fair value of $44,952 and $42,139, respectively)
   
43,534
     
40,875
 
Federal Home Loan Bank stock, at cost
   
1,881
     
3,454
 
Loans
   
414,795
     
387,538
 
Less: Allowance for loan losses
   
5,732
     
5,349
 
Loans receivable, net
   
409,063
     
382,189
 
Premises and equipment, net
   
14,091
     
13,200
 
Accrued interest receivable
   
2,082
     
1,849
 
Foreclosed real estate
   
472
     
261
 
Intangible assets, net
   
218
     
175
 
Goodwill
   
4,536
     
4,367
 
Bank owned life insurance
   
10,621
     
10,356
 
Other assets
   
5,319
     
4,869
 
Total assets
 
$
607,198
   
$
561,024
 
                 
LIABILITIES AND SHAREHOLDERS' EQUITY:
               
Deposits:
               
Interest-bearing
 
$
430,456
   
$
360,906
 
Noninterest-bearing
   
65,886
     
54,662
 
Total deposits
   
496,342
     
415,568
 
Short-term borrowings
   
15,225
     
55,100
 
Long-term borrowings
   
14,000
     
11,000
 
Junior subordinated debentures
   
5,155
     
5,155
 
Accrued interest payable
   
50
     
63
 
Other liabilities
   
5,246
     
4,934
 
Total liabilities
   
536,018
     
491,820
 
Shareholders' equity:
               
Preferred stock - SBLF, par value $0.01 per share; $1,000 liquidation preference;
               
13,000 shares authorized; 13,000 shares issued and outstanding
   
13,000
     
13,000
 
Common stock, par value $0.01; 25,000,000 authorized  shares;
               
4,352,203 shares issued and shares outstanding
   
44
     
44
 
Additional paid in capital
   
28,659
     
28,534
 
Retained earnings
   
32,642
     
31,085
 
Accumulated other comprehensive loss
   
(1,960
)
   
(2,119
)
Unearned ESOP
   
(1,619
)
   
(1,754
)
Total Pathfinder Bancorp, Inc. shareholders' equity
   
70,766
     
68,790
 
Noncontrolling interest
   
414
     
414
 
Total equity
   
71,180
     
69,204
 
Total liabilities and shareholders' equity
 
$
607,198
   
$
561,024
 

The accompanying notes are an integral part of the consolidated financial statements.
 
 
Pathfinder Bancorp, Inc.
Consolidated Statements of Income
(Unaudited)

   
For the three
   
For the three
   
For the nine
   
For the nine
 
   
months ended
   
months ended
   
months ended
   
months ended
 
(In thousands, except per share data)
 
September 30, 2015
   
September 30, 2014
   
September 30, 2015
   
September 30, 2014
 
Interest and dividend income:
               
Loans, including fees
 
$
4,699
   
$
4,344
   
$
13,649
   
$
12,512
 
Debt securities:
                               
Taxable
   
519
     
473
     
1,494
     
1,360
 
Tax-exempt
   
186
     
196
     
573
     
585
 
Dividends
   
40
     
35
     
109
     
85
 
Interest earning time deposits
   
-
     
2
     
-
     
6
 
Federal funds sold and interest earning deposits
   
5
     
2
     
12
     
4
 
       Total interest income
   
5,449
     
5,052
     
15,837
     
14,552
 
Interest expense:
                               
Interest on deposits
   
508
     
479
     
1,435
     
1,505
 
Interest on short-term borrowings
   
41
     
28
     
113
     
68
 
Interest on long-term borrowings
   
103
     
149
     
310
     
443
 
       Total interest expense
   
652
     
656
     
1,858
     
2,016
 
          Net interest income
   
4,797
     
4,396
     
13,979
     
12,536
 
Provision for loan losses
   
220
     
410
     
1,004
     
930
 
          Net interest income after provision for loan losses
   
4,577
     
3,986
     
12,975
     
11,606
 
Noninterest income:
                               
Service charges on deposit accounts
   
299
     
311
     
853
     
894
 
Earnings and gain on bank owned life insurance
   
250
     
64
     
400
     
190
 
Loan servicing fees
   
55
     
81
     
148
     
202
 
Net gains on sales and redemptions of investment securities
   
88
     
3
     
188
     
29
 
Net gains on sales of loans and foreclosed real estate
   
17
     
10
     
13
     
39
 
Debit card interchange fees
   
131
     
127
     
390
     
369
 
Other charges, commissions & fees
   
352
     
304
     
1,017
     
880
 
          Total noninterest income
   
1,192
     
900
     
3,009
     
2,603
 
Noninterest expense:
                               
Salaries and employee benefits
   
2,478
     
2,141
     
7,216
     
6,526
 
Building occupancy
   
535
     
421
     
1,479
     
1,193
 
Data processing
   
462
     
367
     
1,204
     
1,131
 
Professional and other services
   
206
     
160
     
654
     
508
 
Advertising
   
116
     
141
     
352
     
372
 
FDIC assessments
   
105
     
99
     
302
     
294
 
Audits and exams
   
58
     
61
     
179
     
186
 
Other expenses
   
598
     
422
     
1,628
     
1,273
 
          Total noninterest expenses
   
4,558
     
3,812
     
13,014
     
11,483
 
Income before income taxes
   
1,211
     
1,074
     
2,970
     
2,726
 
Provision for income taxes
   
316
     
317
     
829
     
767
 
Net income attributable to noncontrolling interest and Pathfinder Bancorp, Inc.
   
895
     
757
     
2,141
     
1,959
 
Net income attributable to noncontrolling interest
   
10
     
11
     
33
     
48
 
Net income attributable to Pathfinder Bancorp, Inc.
   
885
     
746
     
2,108
     
1,911
 
Preferred stock dividends
   
33
     
33
     
97
     
63
 
Net income available to common shareholders
 
$
852
   
$
713
   
$
2,011
   
$
1,848
 
                                 
Earnings per common share - basic
 
$
0.21
   
$
0.17
   
$
0.49
   
$
0.44
 
Earnings per common share - diluted
 
$
0.20
   
$
0.17
   
$
0.48
   
$
0.44
 
Dividends per common share
 
$
0.05
   
$
0.03
   
$
0.11
   
$
0.09
 

The accompanying notes are an integral part of the consolidated financial statements.
 
 
Pathfinder Bancorp, Inc.
 
Consolidated Statements of Comprehensive Income
 
(Unaudited)
 
                 
   
For the three months ended
   
For the nine months ended
 
(In thousands)
 
September 30, 2015
   
September 30, 2014
   
September 30, 2015
   
September 30, 2014
 
                 
Net Income
 
$
895
   
$
757
   
$
2,141
   
$
1,959
 
                                 
Other Comprehensive Income (Loss)
                               
                                 
Retirement Plans:
                               
Net unrealized gain on retirement plans
   
45
     
11
     
135
     
33
 
                                 
Unrealized holding gains on financial derivative:
                               
Change in unrealized holding gains/(losses) on financial derivative
   
(2
)
   
2
     
(8
)
   
(6
)
Reclassification adjustment for interest expense included in net income
   
15
     
16
     
46
     
47
 
Net unrealized gain on financial derivative
   
13
     
18
     
38
     
41
 
                                 
Unrealized holding (losses) gains on available for sale securities
                               
Unrealized holding gains (losses) arising during the period
   
594
     
(69
)
   
181
     
561
 
Reclassification adjustment for net (losses)  included in net income
   
(88
)
   
(3
)
   
(188
)
   
(29
)
Net unrealized gain (loss) on available for sale securities
   
506
     
(72
)
   
(7
)
   
532
 
                                 
Accretion of net unrealized loss on securities transferred to held-to-maturity(1)
   
34
     
30
     
99
     
90
 
                                 
Other comprehensive income (loss),  before tax
   
598
     
(13
)
   
265
     
696
 
Tax effect
   
(239
)
   
3
     
(106
)
   
(281
)
Other comprehensive income (loss), net of tax
   
359
     
(10
)
   
159
     
415
 
Comprehensive income
 
$
1,254
   
$
747
   
$
2,300
   
$
2,374
 
Comprehensive income attributable to noncontrolling interest
 
$
10
   
$
11
   
$
33
   
$
48
 
Comprehensive income attributable to Pathfinder Bancorp, Inc.
 
$
1,244
   
$
736
   
$
2,267
   
$
2,326
 
                                 
                                 
Tax Effect Allocated to Each Component of Other Comprehensive Loss
                               
Retirement plan net losses recognized in plan expenses
 
$
(18
)
 
$
(4
)
 
$
(54
)
 
$
(13
)
Change in unrealized holding gains/(losses) on financial derivative
   
1
     
(1
)
   
3
     
2
 
Reclassification adjustment for interest expense included in net income
   
(6
)
   
(6
)
   
(18
)
   
(19
)
Unrealized holding (losses) gains arising during the period
   
(238
)
   
27
     
(72
)
   
(226
)
Reclassification adjustment for net losses included in net income
   
36
     
1
     
75
     
12
 
Accretion of net unrealized loss on securities transferred to held-to-maturity(1)
   
(14
)
   
(14
)
   
(40
)
   
(37
)
Income tax effect related to other comprehensive income
 
$
(239
)
 
$
3
   
$
(106
)
 
$
(281
)
                                 
(1)
The accretion of the unrealized holding losses in accumulated other comprehensive loss at the date of transfer at September 30, 2013 partially offsets the amortization of the difference between the par value and the fair value of the investment securities at the date of transfer, and is an adjustment of yield.

The accompanying notes are an integral part of the consolidated financial statements.

 

Pathfinder Bancorp, Inc.
 
Consolidated Statements of Changes in Shareholders' Equity
 
Nine months ended September 30, 2015 and September 30, 2014
 
                                     
                   
Accumulated
                 
           
Additional
       
Other Com-
           
Non-
     
(In thousands, except share and per share data)
 
Preferred Stock
   
Common Stock
   
Paid in Capital
   
Retained Earnings
   
prehensive Loss
   
Unearned ESOP
   
Treasury Stock
   
Controlling Interest
   
Total
 
                                     
 Balance, January 1, 2015
 
$
13,000
   
$
44
   
$
28,534
   
$
31,085
   
$
(2,119
)
 
$
(1,754
)
 
$
-
   
$
414
   
$
69,204
 
                                                                         
 Net income
   
-
     
-
     
-
     
2,108
     
-
     
-
     
-
     
33
     
2,141
 
                                                                         
 Other comprehensive income, net of tax
   
-
     
-
     
-
     
-
     
159
     
-
     
-
     
-
     
159
 
 
                                                                       
 Preferred stock dividends - SBLF
   
-
     
-
     
-
     
(97
)
   
-
     
-
     
-
     
-
     
(97
)
                                                                         
 ESOP shares earned (18,332 shares)
   
-
     
-
     
62
     
-
     
-
     
135
     
-
     
-
     
197
 
                                                                         
 Stock based compensation
   
-
     
-
     
63
     
-
     
-
     
-
     
-
     
-
     
63
 
                                                                         
 Common stock dividends declared
($0.11 per share)
   
-
     
-
     
-
     
(454
)
   
-
     
-
     
-
     
-
     
(454
)
                                                                         
 Distributions from affiliates
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
(33
)
   
(33
)
 Balance, September 30, 2015
 
$
13,000
   
$
44
   
$
28,659
   
$
32,642
   
$
(1,960
)
 
$
(1,619
)
 
$
-
   
$
414
   
$
71,180
 
                                                                         
 Balance, January 1, 2014
 
$
13,000
   
$
30
   
$
8,226
   
$
28,788
   
$
(1,745
)
 
$
(826
)
 
$
(4,761
)
 
$
358
   
$
43,070
 
                                                                         
 Net income
   
-
     
-
     
-
     
1,911
     
-
     
-
     
-
     
48
     
1,959
 
                                                                         
 Other comprehensive income, net of tax
   
-
     
-
     
-
     
-
     
415
     
-
     
-
     
-
     
415
 
                                                                         
 Preferred stock dividends - SBLF
   
-
     
-
     
-
     
(63
)
   
-
     
-
     
-
     
-
     
(63
)
                                                                         
 ESOP shares earned (9,375 shares)
   
-
     
-
     
53
     
-
     
-
     
83
     
-
     
-
     
136
 
                                                                         
 Stock based compensation
   
-
     
-
     
63
     
-
     
-
     
-
     
-
     
-
     
63
 
                                                                         
 Stock options exercised
   
-
     
-
     
(8
)
   
-
     
-
     
-
     
26
     
-
     
18
 
                                                                         
 Common stock dividends declared
 ($0.09 per share)
   
-
     
-
     
-
     
(229
)
   
-
     
-
     
-
     
-
     
(229
)
 Balance, September 30, 2014
 
$
13,000
   
$
30
   
$
8,334
   
$
30,407
   
$
(1,330
)
 
$
(743
)
 
$
(4,735
)
 
$
406
   
$
45,369
 
                                                                         
The accompanying notes are an integral part of the consolidated financial statements.
                                                 




Pathfinder Bancorp, Inc.
 
Consolidated Statements of Cash Flows
 
(Unaudited)
 
   
For the nine months ended September 30,
 
(In thousands)
 
2015
   
2014
 
OPERATING ACTIVITIES
       
Net income attributable to Pathfinder Bancorp, Inc.
 
$
2,108
   
$
1,911
 
Adjustments to reconcile net income to net cash flows from operating activities:
               
Provision for loan losses
   
1,004
     
930
 
Proceeds from sales of loans
   
69
     
-
 
Originations of loans held-for-sale
   
(68
)
   
-
 
Realized gains on sales, redemptions and calls of:
               
Real estate acquired through foreclosure
   
(11
)
   
(39
)
Loans
   
(2
)
   
-
 
Available-for-sale investment securities
   
(188
)
   
(29
)
Depreciation
   
760
     
596
 
Amortization of mortgage servicing rights
   
10
     
11
 
Amortization of deferred loan costs
   
125
     
91
 
Earnings on bank owned life insurance
   
(265
)
   
(190
)
Net amortization of premiums and discounts on investment securities
   
673
     
530
 
Amortization of intangible assets
   
13
     
9
 
Stock based compensation and ESOP expense
   
260
     
199
 
Net change in accrued interest receivable
   
(233
)
   
(150
)
Net change in other assets and liabilities
   
15
     
(811
)
Net cash flows from operating activities
   
4,270
     
3,058
 
INVESTING ACTIVITIES
               
Purchase of investment securities available-for-sale
   
(49,220
)
   
(27,099
)
Purchase of investment securities held-to-maturity
   
(5,034
)
   
(8,767
)
Net proceeds from Federal Home Loan Bank stock
   
1,573
     
611
 
Proceeds from maturities and principal reductions of
               
investment securities available-for-sale
   
20,088
     
13,545
 
Proceeds from maturities and principal reductions of
               
investment securities held-to-maturity
   
2,378
     
692
 
Proceeds from sales, redemptions and calls of:
               
Available-for-sale investment securities
   
18,802
     
510
 
Real estate acquired through foreclosure
   
284
     
667
 
Acquisition of insurance agency
   
(225
)
   
-
 
Purchase of bank owned life insurance
   
-
     
(1,780
)
Proceeds from bank owned life insurance
   
(135
)
       
Net change in loans
   
(28,522
)
   
(33,989
)
Purchase of premises and equipment
   
(1,651
)
   
(1,897
)
Net cash flows from investing activities
   
(41,662
)
   
(57,507
)
FINANCING ACTIVITIES
               
Net change in demand deposits, NOW accounts, savings accounts,
               
money management deposit accounts, MMDA accounts and escrow deposits
   
61,382
     
52,925
 
Net change in time deposits and brokered deposits
   
19,392
     
19,964
 
Net change in short-term borrowings
   
(39,875
)
   
(10,000
)
Proceeds from long-term borrowings
   
3,000
     
168
 
Proceeds from exercise of stock options
   
-
     
18
 
Cash dividends paid to preferred shareholder - SBLF
   
(97
)
   
(31
)
Cash dividends paid to common shareholders
   
(392
)
   
(236
)
Change in noncontrolling interest, net
   
-
     
48
 
Net cash flows from financing activities
   
43,410
     
62,856
 
Change in cash and cash equivalents
   
6,018
     
8,407
 
Cash and cash equivalents at beginning of period
   
11,356
     
16,575
 
Cash and cash equivalents at end of period
 
$
17,374
   
$
24,982
 
CASH PAID DURING THE PERIOD FOR:
               
Interest
 
$
1,871
   
$
2,029
 
Income taxes
   
842
     
331
 
NON-CASH INVESTING ACTIVITY
               
Real estate acquired in exchange for loans
   
519
     
474
 
                 
The accompanying notes are an integral part of the consolidated financial statements.
               
 

 
Notes to Consolidated Financial Statements (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.  The results are not necessarily indicative of the results to be expected for the year ended December 31, 2015 or for any future period. Certain amounts in the 2014 consolidated financial statements may have been reclassified to conform to the current period presentation.  These reclassifications impacted share and per share data as a result of the Conversion and Offering that occurred on October 16, 2014 and reported by the Company in its Annual Report on Form 10-K filed on March 18, 2015, and are further detailed in Note 3 to these unaudited consolidated financial statements located elsewhere on this form.  These reclassifications had no effect on net income or comprehensive income as previously reported.

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 Agency's financial statements include the acquisition of the Huntington Agency, which occurred in the first quarter of 2015.  The 49% of which the Company does not own is accounted for separately as noncontrolling interests within the consolidated financial statements.

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 transaction is expected to be completed in the fourth quarter of 2015 and 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

In April 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") ASU 2015-03 – Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.  This ASU addresses accounting for debt issuance costs and states that debt issuance costs related to a note shall be reported in the balance sheet as a direct deduction from the face amount of that note. The discount, premium, or debt issuance costs associated with that note shall not be classified as a deferred charge or credit.  Amortization of discount or premium shall be reported as interest expense in the case of liabilities or as interest income in the case of assets. Amortization of debt issuance costs also shall be reported as interest expense. The amendment is effective for public business entities for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years.  Early adoption of the amendments is permitted and a reporting entity must apply the new guidance retrospectively to all periods presented. The Company does not expect a material impact on its consolidated statements of condition, results of operations, or cash flows as a result of adopting this pronouncement.
 

 
In July 2015, the FASB issued ASU 2015-12 – Plan Accounting: Defined Benefit Pension Plans (Topic 960), Defined Contribution Pension Plans (Topic 962), Health and Welfare Benefit Plans (Topic 965): (Part I) Fully Benefit-Responsive Investment Contracts, (Part II) Plan Investment Disclosures, (Part III) Measurement Date Practical Expedient (consensuses of the FASB Emerging Issues Task Force). The amendments in this ASU cover a range of topics related to accounting for, and disclosures related to, specific employee pension, retirement and welfare plans; The topics included in this ASU are: (1) accounting for fully benefit-responsive investment contracts, (2) new plan investment disclosures and (3) an expedient for entities that do not end their fiscal years on a calendar month end.  The amendments are effective for all entities for fiscal years beginning after December 15, 2015, with earlier application permitted. These changes are not expected to have a significant effect on the Company's current accounting practices or create a significant administrative cost to most entities, including the Company.  Therefore, the Company does not expect a material impact on its consolidated statements of condition, results of operations, or cash flows as a result of adopting this pronouncement.

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 stock options, not included in the computation below, were -0- for the three months ended September 30, 2015 and 5,491 for the nine months ended September 30, 2015 and 10,000 in the three and nine month periods ended September 30, 2014.  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.  Historical share and per share data have been adjusted by the exchange ratio of 1.6472 used in the Conversion and Offering.

   
Three months ended
   
Nine months ended
 
   
September 30,
   
September 30,
 
(In thousands, except per share data)
 
2015
   
2014
   
2015
   
2014
 
Basic Earnings Per Common Share
               
Net income available to common shareholders
 
$
852
   
$
713
   
$
2,011
   
$
1,848
 
Weighted average common shares outstanding
   
4,126
     
4,179
     
4,120
     
4,172
 
Basic earnings per common share
 
$
0.21
   
$
0.17
   
$
0.49
   
$
0.44
 
                                 
Diluted Earnings Per Common Share
                               
Net income available to common shareholders
 
$
852
   
$
713
   
$
2,011
   
$
1,848
 
Weighted average common shares outstanding
   
4,126
     
4,179
     
4,120
     
4,172
 
Effect of assumed exercise of stock options
   
71
     
42
     
65
     
40
 
Diluted weighted average common shares outstanding
   
4,197
     
4,221
     
4,185
     
4,212
 
Diluted earnings per common share
 
$
0.20
   
$
0.17
   
$
0.48
   
$
0.44
 


Note 4:   Investment Securities

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

 
 
September 30, 2015
 
       
Gross
   
Gross
   
Estimated
 
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
(In thousands)
 
Cost
   
Gains
   
Losses
   
Value
 
Available-for-Sale Portfolio
               
Debt investment securities:
               
US Treasury, agencies and GSEs
 
$
27,887
   
$
58
   
$
(23
)
 
$
27,922
 
State and political subdivisions
   
8,275
     
105
     
(6
)
   
8,374
 
Corporate
   
18,257
     
97
     
(85
)
   
18,269
 
Residential mortgage-backed - US agency
   
26,148
     
248
     
(129
)
   
26,267
 
Collateralized mortgage obligations - US agency
   
14,819
     
152
     
(54
)
   
14,917
 
Total
   
95,386
     
660
     
(297
)
   
95,749
 
Equity investment securities:
                               
Mutual funds:
                               
Ultra short mortgage fund
   
643
     
1
     
-
     
644
 
Large cap equity fund
   
456
     
126
     
-
     
582
 
Other mutual funds
   
183
     
242
     
-
     
425
 
Common stock - financial services industry
   
583
     
24
     
-
     
607
 
Total
   
1,865
     
393
     
-
     
2,258
 
Total available-for-sale
 
$
97,251
   
$
1,053
   
$
(297
)
 
$
98,007
 
                                 
Held-to-Maturity Portfolio
                               
Debt investment securities:
                               
US Treasury, agencies and GSEs
 
$
7,853
   
$
129
   
$
(14
)
 
$
7,968
 
State and political subdivisions
   
21,253
     
802
     
-
     
22,055
 
Corporate
   
3,421
     
158
     
(1
)
   
3,578
 
Residential mortgage-backed - US agency
   
8,096
     
197
     
-
     
8,293
 
Collateralized mortgage obligations - US agency
   
2,911
     
147
     
-
     
3,058
 
Total held-to-maturity
 
$
43,534
   
$
1,433
   
$
(15
)
 
$
44,952
 



 
 
December 31, 2014
 
       
Gross
   
Gross
   
Estimated
 
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
(In thousands)
 
Cost
   
Gains
   
Losses
   
Value
 
Available-for-Sale Portfolio
               
Debt investment securities:
               
US Treasury, agencies and GSEs
 
$
17,896
   
$
3
   
$
(149
)
 
$
17,750
 
State and political subdivisions
   
8,346
     
110
     
(13
)
   
8,443
 
Corporate
   
13,763
     
116
     
(19
)
   
13,860
 
Residential mortgage-backed - US agency
   
30,321
     
403
     
(149
)
   
30,575
 
Collateralized mortgage obligations - US agency
   
15,432
     
168
     
(124
)
   
15,476
 
Total
   
85,758
     
800
     
(454
)
   
86,104
 
Equity investment securities:
                               
Mutual funds:
                               
Ultra short mortgage fund
   
643
     
5
     
-
     
648
 
Large cap equity fund
   
456
     
193
     
-
     
649
 
Other mutual funds
   
183
     
196
     
-
     
379
 
Common stock - financial services industry
   
270
     
23
     
-
     
293
 
Total
   
1,552
     
417
     
-
     
1,969
 
Total available-for-sale
 
$
87,310
   
$
1,217
   
$
(454
)
 
$
88,073
 
                                 
Held-to-Maturity Portfolio
                               
Debt investment securities:
                               
US Treasury, agencies and GSEs
 
$
4,834
   
$
58
   
$
-
   
$
4,892
 
State and political subdivisions
   
22,610
     
824
     
(9
)
   
23,425
 
Corporate
   
2,487
     
33
     
(17
)
   
2,503
 
Residential mortgage-backed - US agency
   
8,043
     
242
     
-
     
8,285
 
Collateralized mortgage obligations - US agency
   
2,901
     
133
     
-
     
3,034
 
Total held-to-maturity
 
$
40,875
   
$
1,290
   
$
(26
)
 
$
42,139
 

The amortized cost and estimated fair value of debt investments at September 30, 2015 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.

   
Available-for-Sale
   
Held-to-Maturity
 
   
Amortized
   
Estimated
   
Amortized
   
Estimated
 
(In thousands)
 
Cost
   
Fair Value
   
Cost
   
Fair Value
 
Due in one year or less
 
$
6,527
   
$
6,564
   
$
195
   
$
195
 
Due after one year through five years
   
38,699
     
38,803
     
8,674
     
8,787
 
Due after five years through ten years
   
8,213
     
8,204
     
17,010
     
17,535
 
Due after ten years
   
980
     
994
     
6,648
     
7,084
 
Sub-total
   
54,419
     
54,565
     
32,527
     
33,601
 
Residential mortgage-backed - US agency
   
26,148
     
26,267
     
8,096
     
8,293
 
Collateralized mortgage obligations - US agency
   
14,819
     
14,917
     
2,911
     
3,058
 
Totals
 
$
95,386
   
$
95,749
   
$
43,534
   
$
44,952
 




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:

   
September 30, 2015
 
   
Less than twelve months
   
Twelve months or more
   
Total
 
   
Number of
       
Number of
       
Number of
     
   
Individual
 
Unrealized
 
Fair
   
Individual
 
Unrealized
 
Fair
   
Individual
 
Unrealized
 
Fair
 
(Dollars in thousands)
 
Securities
 
Losses
 
Value
   
Securities
 
Losses
 
Value
   
Securities
 
Losses
 
Value
 
Available-for-Sale
                       
US Treasury, agencies and GSE's
   
3
   
$
(7
)
 
$
2,996
     
3
   
$
(16
)
 
$
2,982
     
6
     
(23
)
 
$
5,978
 
State and political subdivisions
   
9
     
(4
)
   
858
     
3
     
(2
)
   
616
     
12
     
(6
)
   
1,474
 
Corporate
   
7
     
(85
)
   
7,291
     
-
     
-
     
-
     
7
     
(85
)
   
7,291
 
Residential mortgage-backed - US agency
   
3
     
(32
)
   
5,894
     
5
     
(97
)
   
5,035
     
8
     
(129
)
   
10,929
 
Collateralized mortgage obligations - US agency
   
2
     
(5
)
   
1,209
     
3
     
(49
)
   
1,881
     
5
     
(54
)
   
3,090
 
Totals
   
24
   
$
(133
)
 
$
18,248
     
14
   
$
(164
)
 
$
10,514
     
38
   
$
(297
)
 
$
28,762
 
Held-to-Maturity
                                                                       
US Treasury, agencies and GSE's
   
1
   
$
(14
)
 
$
1,985
     
-
   
$
-
   
$
-
     
1
     
(14
)
 
$
1,985
 
State and political subdivisions
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Corporate
   
1
     
(1
)
   
228
     
-
     
-
     
-
     
1
     
(1
)
   
228
 
Residential mortgage-backed - US agency
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Collateralized mortgage obligations - US agency
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Totals
   
2
   
$
(15
)
 
$
2,213
     
-
   
$
-
   
$
-
     
2
   
$
(15
)
 
$
2,213
 
                                                                         
                                                                         
   
December 31, 2014
 
   
Less than twelve months
   
Twelve months or more
   
Total
 
   
Number of
                   
Number of
                   
Number of
                 
   
Individual
 
Unrealized
 
Fair
   
Individual
 
Unrealized
 
Fair
   
Individual
 
Unrealized
 
Fair
 
(Dollars in thousands)
 
Securities
 
Losses
 
Value
   
Securities
 
Losses
 
Value
   
Securities
 
Losses
 
Value
 
Available-for-Sale
                                                                       
US Treasury, agencies and GSE's
   
7
   
$
(18
)
 
$
7,991
     
7
   
$
(131
)
 
$
7,856
     
14
     
(149
)
 
$
15,847
 
State and political subdivisions
   
19
     
(13
)
   
3,047
     
1
     
-
     
90
     
20
     
(13
)
   
3,137
 
Corporate
   
7
     
(19
)
   
4,520
     
-
     
-
     
-
     
7
     
(19
)
   
4,520
 
Residential mortgage-backed - US agency
   
2
     
(8
)
   
1,424
     
6
     
(141
)
   
6,256
     
8
     
(149
)
   
7,680
 
Collateralized mortgage obligations - US agency
   
3
     
(22
)
   
2,692
     
5
     
(102
)
   
3,963
     
8
     
(124
)
   
6,655
 
Totals
   
38
   
$
(80
)
 
$
19,674
     
19
   
$
(374
)
 
$
18,165
     
57
   
$
(454
)
 
$
37,839
 
Held-to-Maturity
                                                                       
US Treasury, agencies and GSE's
   
-
   
$
-
   
$
-
     
-
   
$
-
   
$
-
     
-
     
-
   
$
-
 
State and political subdivisions
   
1
     
(9
)
   
1,463
     
-
     
-
     
-
     
1
     
(9
)
   
1,463
 
Corporate
   
2
     
(17
)
   
1,108
     
-
     
-
     
-
     
2
     
(17
)
   
1,108
 
Residential mortgage-backed - US agency
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Collateralized mortgage obligations - US agency
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Totals
   
3
   
$
(26
)
 
$
2,571
     
-
   
$
-
   
$
-
     
3
   
$
(26
)
 
$
2,571
 

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 40 securities in an unrealized loss position at September 30, 2015.  Management does not believe any individual unrealized loss in the securities portfolio as of September 30, 2015 represents OTTI.  Among these securities, 12 were issued by state and political subdivisions, primarily school districts. Each of these securities is an insured general obligation issue and have unrealized losses that do not exceed 1.26% of their current book value for any one security.

Among the 40 securities in an unrealized loss position at quarter end, there were 20 agency and mortgage-backed securities 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 eight corporate securities with market values less than their respective book values have all been in an unrealized loss position for nine months or less and represent declines in value of the original security carrying value of 2.78% or less as of September 30, 2015.  All corporate securities currently in an unrealized loss position are A- rated or better by Standard and Poors. 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 September 30, 2015 represents OTTI.

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 has determined that we have the intent and ability to retain the equity securities for a sufficient period of time to allow for recovery. All of the Company's equity securities had a fair value greater than the book value at September 30, 2015.

Gross realized gains (losses) on sales of securities for the indicated periods are detailed below:

 
For the three months
 
For the nine months
 
 
ended September 30,
 
ended September 30,
 
(In thousands)
2015
 
2014
 
2015
 
2014
 
Realized gains
 
$
88
   
$
3
   
$
198
   
$
29
 
Realized losses
   
-
     
-
     
(10
)
   
-
 
 
 
$
88
   
$
3
   
$
188
   
$
29
 

As of September 30, 2015 and December 31, 2014, securities with a fair value of $82.7 million and $66.7 million, respectively, were pledged to collateralize certain municipal deposit relationships.  As of the same dates, securities with a fair value of $17.8 million and $19.9 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.

Note 5:   Pension and Postretirement Benefits

The Company had a non-contributory defined benefit pension plan that covered substantially all employees. 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 freeze became effective June 30, 2012.  Compensation earned by employees up to June 30, 2012 is used for purposes of calculating benefits under the plan but there will be no future benefit accruals after this date.  Participants as of June 30, 2012, who continue to be employed by the Bank, continue to earn vesting credit with respect to their frozen accrued benefits.

Prior to being frozen, the plan provided defined benefits based on years of service and final average salary. Although the plan was frozen, the Company maintains the responsibility for funding the plan, and its funding practice is to contribute at least the minimum amount annually to meet minimum funding requirements.  The funded status of the plan has and will continue to be affected by market conditions.  The Company expects to continue to fund this plan on an as needed basis and does not foresee any issues or conditions that could negatively impact the payment of benefit obligations to plan participants.  In addition, the Company provides certain health and life insurance benefits for 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.
 

 
In October 2014, the Society of Actuaries released new mortality tables with future mortality improvement assumptions which are expected to become the required standard for purposes of year end pension liability disclosures.  As such, the Company has adopted the "White Collar" version of the new mortality tables which more closely approximates the Company's participants in the frozen defined benefit pension plan at December 31, 2014.

The composition of net periodic pension plan and postretirement plan costs for the indicated periods is as follows:
 
 
Pension Benefits
 
Postretirement Benefits
 
Pension Benefits
 
Postretirement Benefits
 
 
For the three months ended September 30,
 
For the nine months ended September 30,
 
(In thousands)
2015
 
2014
 
2015
 
2014
 
2015
 
2014
 
2015
 
2014
 
Service cost
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 
Interest cost
   
117
     
102
     
4
     
5
     
351
     
305
     
13
     
14
 
Expected return on plan assets
   
(244
)
   
(236
)
   
-
     
-
     
(731
)
   
(707
)
   
-
     
-
 
Amortization of net losses
   
45
     
8
     
-
     
3
     
135
     
23
     
-
     
10
 
Net periodic benefit plan (benefit) cost
 
$
(82
)
 
$
(126
)
 
$
4
   
$
8
   
$
(245
)
 
$
(379
)
 
$
13
   
$
24
 
 
The Company will evaluate the need for further contributions to the defined benefit pension plan during the fourth quarter of 2015.  The prepaid pension asset is recorded in other assets on the statement of condition as of September 30, 2015.

Note 6:   Loans

Major classifications of loans at the indicated dates are as follows:

   
September 30,
   
December 31,
 
(In thousands)
 
2015
   
2014
 
Residential mortgage loans:
       
1-4 family first-lien residential mortgages
 
$
179,146
   
$
172,159
 
Construction
   
6,804
     
3,209
 
Total residential mortgage loans
   
185,950
     
175,368
 
                 
Commercial loans:
               
Real estate
   
126,931
     
125,952
 
Lines of credit
   
18,327
     
17,407
 
Other commercial and industrial
   
46,901
     
34,660
 
Tax exempt loans
   
9,195
     
7,201
 
Total commercial loans
   
201,354
     
185,220
 
                 
Consumer loans:
               
Home equity and junior liens
   
22,850
     
22,713
 
Other consumer
   
4,807
     
4,160
 
Total consumer loans
   
27,657
     
26,873
 
 
               
Total loans
   
414,961
     
387,461
 
Net deferred loan (fees) costs
   
(166
)
   
77
 
Less allowance for loan losses
   
(5,732
)
   
(5,349
)
Loans receivable, net
 
$
409,063
   
$
382,189
 


The Company primarily originates residential mortgage, commercial, and consumer loans largely to customers throughout Oswego and Onondaga counties within New York State. Although the Company has a diversified loan portfolio, a substantial portion of its borrowers' abilities to honor their loan contracts is dependent upon the counties' employment and economic conditions.

As of September 30, 2015 and December 31, 2014, residential mortgage loans with a carrying value of $122.8 million and $121.1 million, respectively, have been pledged by the Company to the Federal Home Loan Bank of New York ("FHLBNY") under a blanket collateral agreement to secure the Company's line of credit and term borrowings.

Loan Origination / Risk Management

The Company's lending policies and procedures are presented in Note 5 to the audited consolidated financial statements included in the 2014 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 18, 2015 and have not changed.

To develop and document a systematic methodology for determining the allowance for loan losses, the Company has divided the loan portfolio into three portfolio segments, each with different risk characteristics but with similar methodologies for assessing risk.  Each portfolio segment is broken down into loan classes where appropriate.  Loan classes contain unique measurement attributes, risk characteristics, and methods for monitoring and assessing risk that are necessary to develop the allowance for loan losses.  Unique characteristics such as borrower type, loan type, collateral type, and risk characteristics define each class.  

The following table illustrates the portfolio segments and classes for the Company's loan portfolio:

Portfolio Segment
Class
    
Residential Mortgage Loans
1-4 family first-lien residential mortgages
 
Construction
    
Commercial Loans
Real estate
 
Lines of credit
 
Other commercial and industrial
 
Tax exempt loans
    
Consumer Loans
Home equity and junior liens
 
Other consumer


The following tables present the classes of the loan portfolio, not including net deferred loan costs, summarized by the aggregate pass rating and the classified ratings of special mention, substandard and doubtful within the Company's internal risk rating system as of the dates indicated:

 
 
As of September 30, 2015
 
       
Special
             
(In thousands)
 
Pass
   
Mention
   
Substandard
   
Doubtful
   
Total
 
Residential mortgage loans:
                   
1-4 family first-lien residential mortgages
 
$
174,096
   
$
1,761
   
$
2,580
   
$
709
   
$
179,146
 
Construction
   
6,804
     
-
     
-
     
-
     
6,804
 
Total residential mortgage loans
   
180,900
     
1,761
     
2,580
     
709
     
185,950
 
Commercial loans:
                                       
Real estate
   
119,075
     
3,097
     
4,472
     
287
     
126,931
 
Lines of credit
   
16,971
     
573
     
702
     
81
     
18,327
 
Other commercial and industrial
   
45,738
     
117
     
744
     
302
     
46,901
 
Tax exempt loans
   
9,195
     
-
     
-
     
-
     
9,195
 
Total commercial loans
   
190,979
     
3,787
     
5,918
     
670
     
201,354
 
Consumer loans:
                                       
Home equity and junior liens
   
22,132
     
171
     
320
     
227
     
22,850
 
Other consumer
   
4,759
     
17
     
31
     
-
     
4,807
 
Total consumer loans
   
26,891
     
188
     
351
     
227
     
27,657
 
Total loans
 
$
398,770
   
$
5,736
   
$
8,849
   
$
1,606
   
$
414,961
 




 
 
As of December 31, 2014
 
       
Special
             
(In thousands)
 
Pass
   
Mention
   
Substandard
   
Doubtful
   
Total
 
Residential mortgage loans:
                   
1-4 family first-lien residential mortgages
 
$
166,352
   
$
1,384
   
$
3,370
   
$
1,053
   
$
172,159
 
Construction
   
3,209
     
-
     
-
     
-
     
3,209
 
Total residential mortgage loans
   
169,561
     
1,384
     
3,370
     
1,053
     
175,368
 
Commercial loans:
                                       
Real estate
   
119,521
     
1,157
     
5,132
     
142
     
125,952
 
Lines of credit
   
16,310
     
451
     
646
     
-
     
17,407
 
Other commercial and industrial
   
33,258
     
434
     
941
     
27
     
34,660
 
Tax exempt loans
   
7,201
     
-
     
-
     
-
     
7,201
 
Total commercial loans
   
176,290
     
2,042
     
6,719
     
169
     
185,220
 
Consumer loans:
                                       
Home equity and junior liens
   
21,722
     
333
     
574
     
84
     
22,713
 
Other consumer
   
4,113
     
10
     
37
     
-
     
4,160
 
Total consumer loans
   
25,835
     
343
     
611
     
84
     
26,873
 
Total loans
 
$
371,686
   
$
3,769
   
$
10,700
   
$
1,306
   
$
387,461
 

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

Nonaccrual and Past Due Loans

Loans are placed on nonaccrual when the contractual payment of principal and interest has become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan may be currently performing.

Loans are considered past due if the required principal and interest payments have not been received within thirty days of the payment due date.

An age analysis of past due loans, not including net deferred loan costs, segregated by portfolio segment and class of loans, as of September 30, 2015 and December 31, 2014, are detailed in the following tables:
 

 
 
As of September 30, 2015
 
   
30-59 Days
   
60-89 Days
   
90 Days
             
   
Past Due
   
Past Due
   
and Over
   
Total
       
Total Loans
 
(In thousands)
 
And Accruing
   
And Accruing
   
   
Past Due
   
Current
   
Receivable
 
Residential mortgage loans:
                       
1-4 family first-lien residential mortgages
 
$
1,741
   
$
884
   
$
1,083
   
$
3,708
   
$
175,438
   
$
179,146
 
Construction
   
-
     
-
     
-
     
-
     
6,804
     
6,804
 
Total residential mortgage loans
   
1,741
     
884
     
1,083
     
3,708
     
182,242
     
185,950
 
Commercial loans:
                                               
Real estate
   
1,372
     
149
     
2,941
     
4,462
     
122,469
     
126,931
 
Lines of credit
   
754
     
-
     
257
     
1,011
     
17,316
     
18,327
 
Other commercial and industrial
   
305
     
717
     
634
     
1,656
     
45,245
     
46,901
 
Tax exempt loans
   
-
     
-
     
-
     
-
     
9,195
     
9,195
 
Total commercial loans
   
2,431
     
866
     
3,832
     
7,129
     
194,225
     
201,354
 
Consumer loans:
                                               
Home equity and junior liens
   
86
     
80
     
317
     
483
     
22,367
     
22,850
 
Other consumer
   
14
     
13
     
16
     
43
     
4,764
     
4,807
 
Total consumer loans
   
100
     
93
     
333
     
526
     
27,131
     
27,657
 
Total loans
 
$
4,272
   
$
1,843
   
$
5,248
   
$
11,363
   
$
403,598
   
$
414,961
 
                                                 
 
 

 
 
 
As of December 31, 2014
 
   
30-59 Days
   
60-89 Days
   
 
             
   
Past Due
   
Past Due
   
90 Days
   
Total
       
Total Loans
 
(In thousands)
 
And Accruing
   
And Accruing
   
And Over
   
Past Due
   
Current
   
Receivable
 
Residential mortgage loans:
                       
1-4 family first-lien residential mortgages
 
$
1,455
   
$
687
   
$
1,902
   
$
4,044
   
$
168,115
   
$
172,159
 
Construction
   
-
     
-
     
-
     
-
     
3,209
     
3,209
 
Total residential mortgage loans
   
1,455
     
687
     
1,902
     
4,044
     
171,324
     
175,368
 
Commercial loans:
                                               
Real estate
   
1,462
     
32
     
3,547
     
5,041
     
120,911
     
125,952
 
Lines of credit
   
10
     
-
     
278
     
288
     
17,119
     
17,407
 
Other commercial and industrial
   
445
     
982
     
205
     
1,632
     
33,028
     
34,660
 
Tax exempt loans
   
-
     
-
     
-
     
-
     
7,201
     
7,201
 
Total commercial loans
   
1,917
     
1,014
     
4,030
     
6,961
     
178,259
     
185,220
 
Consumer loans:
                                               
Home equity and junior liens
   
120
     
17
     
313
     
450
     
22,263
     
22,713
 
Other consumer
   
6
     
17
     
11
     
34
     
4,126
     
4,160
 
Total consumer loans
   
126
     
34
     
324
     
484
     
26,389
     
26,873
 
Total loans
 
$
3,498
   
$
1,735
   
$
6,256
   
$
11,489
   
$
375,972
   
$
387,461
 

Nonaccrual loans, segregated by class of loan, were as follows:

   
September 30,
   
December 31,
 
(In thousands)
 
2015
   
2014
 
Residential mortgage loans:
       
1-4 family first-lien residential mortgages
 
$
1,083
   
$
1,902
 
 
   
1,083
     
1,902
 
Commercial loans:
               
Real estate
   
2,941
     
3,547
 
Lines of credit
   
257
     
278
 
Other commercial and industrial
   
634
     
205
 
 
   
3,832
     
4,030
 
Consumer loans:
               
Home equity and junior liens
   
317
     
313
 
Other consumer
   
16
     
11
 
 
   
333
     
324
 
Total nonaccrual loans
 
$
5,248
   
$
6,256
 

There were no loans past due ninety days or more and still accruing interest at September 30, 2015 or December 31, 2014.

The Company is required to disclose certain activities related to Troubled Debt Restructurings ("TDR"s) in accordance with accounting guidance. Certain loans have been modified in a TDR where economic concessions have been granted to a borrower who is experiencing, or expected to experience, financial difficulties. These economic concessions could include a reduction in the loan interest rate, extension of payment terms, reduction of principal amortization, or other actions that it would not otherwise consider for a new loan with similar risk characteristics.

The Company is required to disclose new TDRs for each reporting period for which an income statement is being presented.
 

 
The Company has determined that there were no new TDRs for the three month period ended September 30, 2015 and one new TDR in the nine month period ended September 30, 2015.

·
The modification made within the commercial real estate loan class resulted in a pre-modification and post-modification recorded investment of $678,000 and $324,000, respectively.  Economic concessions granted included extended payment terms without an associated increase in collateral.  The Company was required to increase the specific reserve against this loan by an additional $354,000, which was a component of the provision of loan losses in the second quarter of 2015.

The Company has determined that there was one new TDR's for the nine month period ended September 30, 2014.

·
The modification made within the commercial real estate loan class resulted in a pre-modification and post-modification recorded investment of $74,000 and $96,000, respectively. The post-modification recorded investment included the funding of escrow and closing costs as a result of the restructuring. Economic concessions granted included extended interest only payment terms and an additional $100,000 for working capital without an associated increase in collateral. The TDR resulted in a loan balance of $565,000 with a specific reserve of $469,000, resulting in a recorded investment of $96,000. The Company was required to increase the specific reserve against this loan by an additional $108,000, which was a component of the provision for loan losses in the third quarter of 2014.
The table below details loans that have been modified as TDRs during the twelve months prior to September 30, 2015, which have subsequently defaulted during the year ended September 30, 2015.

(In thousands)
Number of Contracts
 
Recorded Investment
 
Allowance for Loan Loss
 
Other commercial and industrial
   
1
   
$
240
   
$
209
 

The Company had no loans that had been modified as TDRs during the twelve months prior to September 30, 2014, which had subsequently defaulted during the year ending September 30, 2014.

When the Company modifies a loan within a portfolio segment, a potential impairment is analyzed either based on the present value of the expected future cash flows discounted at the interest rate of the original loan terms or the fair value of the collateral less costs to sell. If it is determined that the value of the loan is less than its recorded investment, then impairment is recognized as a component of the provision for loan losses, an associated increase to the allowance for loan losses or as a charge-off to the allowance for loan losses in the current period.

Impaired Loans

The following tables summarize impaired loan information by portfolio class at the indicated dates:

   
September 30, 2015
   
December 31, 2014
 
       
Unpaid
           
Unpaid
     
   
Recorded
   
Principal
   
Related
   
Recorded
   
Principal
   
Related
 
(In thousands)
 
Investment
   
Balance
   
Allowance
   
Investment
   
Balance
   
Allowance
 
With no related allowance recorded:
                       
1-4 family first-lien residential mortgages
 
$
476
   
$
476
   
$
-
   
$
1,138
   
$
1,163
   
$
-
 
Commercial real estate
   
2,316
     
2,427
     
-
     
2,083
     
2,154
     
-
 
Commercial lines of credit
   
657
     
678
     
-
     
185
     
197
     
-
 
Other commercial and industrial
   
689
     
719
     
-
     
335
     
356
     
-
 
Home equity and junior liens
   
-
     
-
     
-
     
21
     
21
     
-
 
Other consumer
   
7
     
8
     
-
     
-
     
-
     
-
 
With an allowance recorded:
                                               
1-4 family first-lien residential mortgages
   
-
     
-
     
-
     
-
     
-
     
-
 
Commercial real estate
   
2,206
     
2,299
     
826
     
2,927
     
2,972
     
552
 
Commercial lines of credit
   
-
     
-
     
-
     
93
     
99
     
93
 
Other commercial and industrial
   
240
     
242
     
209
     
268
     
268
     
238
 
Home equity and junior liens
   
290
     
290
     
3
     
340
     
340
     
31
 
Other consumer
   
-
     
-
     
-
     
11
     
11
     
3
 
Total:
                                               
1-4 family first-lien residential mortgages
   
476
     
476
     
-
     
1,138
     
1,163
     
-
 
Commercial real estate
   
4,522
     
4,726
     
826
     
5,010
     
5,126
     
552
 
Commercial lines of credit
   
657
     
678
     
-
     
278
     
296
     
93
 
Other commercial and industrial
   
929
     
961
     
209
     
603
     
624
     
238
 
Home equity and junior liens
   
290
     
290
     
3
     
361
     
361
     
31
 
Other consumer
   
7
     
8
     
-
     
11
     
11
     
3
 
Totals
 
$
6,881
   
$
7,139
   
$
1,038
   
$
7,401
   
$
7,581
   
$
917
 


The following table presents the average recorded investment in impaired loans for the periods indicated:
 
             
 
For the three months ended
 
For the nine months ended
 
 
September 30,
 
September 30,
 
(In thousands)
2015
   
2014
 
2015
   
2014
 
1-4 family first-lien residential mortgages
 
$
477
   
$
1,289
   
$
720
   
$
1,221
 
Commercial real estate
   
4,669
     
5,239
     
4,820
     
4,855
 
Commercial lines of credit
   
635
     
378
     
505
     
403
 
Other commercial and industrial
   
941
     
517
     
813
     
511
 
Home equity and junior liens
   
292
     
369
     
310
     
412
 
Other consumer
   
7
     
15
     
9
     
8
 
Total
 
$
7,021
   
$
7,807
   
$
7,177
   
$
7,410
 
                                 
The following table presents the cash basis interest income recognized on impaired loans for the periods indicated:
 
                                 
 
For the three months ended
 
For the nine months ended
 
 
September 30,
 
September 30,
 
(In thousands)
   
2015
     
2014
     
2015
     
2014
 
1-4 family first-lien residential mortgages
 
$
4
   
$
4
   
$
13
   
$
13
 
Commercial real estate
   
21
     
59
     
71
     
114
 
Commercial lines of credit
   
(3
)
   
4
     
4
     
5
 
Other commercial and industrial
   
5
     
13
     
23
     
33
 
Home equity and junior liens
   
-
     
4
     
4
     
10
 
Other consumer
   
-
     
-
     
-
     
-
 
Total
 
$
27
   
$
84
   
$
115
   
$
175
 


Note 7:   Allowance for Loan Losses

Summarized in the tables below are changes in the allowance for loan losses for the indicated periods and information pertaining to the allocation of the allowance for loan losses, balances of the allowance for loan losses, loans receivable based on individual, and collective impairment evaluation by loan portfolio class.  An allocation of a portion of the allowance to a given portfolio class does not limit the Company's ability to absorb losses in another portfolio class.

 
For the three months ended September 30, 2015
 
 
1-4 family
         
 
first-lien
 
Residential
     
Other
 
 
residential
 
construction
 
Commercial
 
Commercial
 
commercial
 
(In thousands)
mortgage
 
mortgage
 
real estate
 
lines of credit
 
and industrial
 
Allowance for loan losses:
         
Beginning Balance
 
$
544
   
$
-
   
$
3,288
   
$
517
   
$
1,110
 
   Charge-offs
   
(21
)
   
-
     
(195
)
   
(150
)
   
-
 
   Recoveries
   
2
     
-
     
-
     
-
     
2
 
   Provisions
   
(13
)
   
-
     
(62
)
   
3
     
(55
)
Ending balance
 
$
512
   
$
-
   
$
3,031
   
$
370
   
$
1,057
 
Ending balance: related to loans
                                       
individually evaluated for impairment
   
-
     
-
     
826
     
-
     
209
 
Ending balance: related to loans
                                       
collectively evaluated for impairment
 
$
512
   
$
-
   
$
2,205
   
$
370
   
$
848
 
                                         
Loans receivables:
                                       
Ending balance
 
$
179,146
   
$
6,804
   
$
126,931
   
$
18,327
   
$
46,901
 
Ending balance: individually
                                       
evaluated for impairment
   
476
     
-
     
4,522
     
657
     
929
 
Ending balance: collectively
                                       
evaluated for impairment
 
$
178,670
   
$
6,804
   
$
122,409
   
$
17,670
   
$
45,972
 
                                         
                                         
         
Home equity
 
Other
                 
 
Municipal
 
and junior liens
 
Consumer
 
Unallocated
 
Total
 
Allowance for loan losses:
                                       
Beginning Balance
 
$
5
   
$
331
   
$
105
   
$
-
   
$
5,900
 
   Charge-offs
   
-
     
(11
)
   
(28
)
   
-
     
(405
)
   Recoveries
   
-
     
1
     
12
     
-
     
17
 
   Provisions
   
(1
)
   
7
     
18
     
323
     
220
 
Ending balance
 
$
4
   
$
328
   
$
107
   
$
323
   
$
5,732
 
Ending balance: related to loans
                                       
individually evaluated for impairment
   
-
     
3
     
-
     
-
     
1,038
 
Ending balance: related to loans
                                       
collectively evaluated for impairment
 
$
4
   
$
325
   
$
107
   
$
323
   
$
4,694
 
                                         
Loans receivables:
                                       
Ending balance
 
$
9,195
   
$
22,850
   
$
4,807
           
$
414,961
 
Ending balance: individually
                                       
evaluated for impairment
   
-
     
290
     
7
             
6,881
 
Ending balance: collectively
                                       
evaluated for impairment
 
$
9,195
   
$
22,560
   
$
4,800
           
$
408,080
 




 
 
For the nine months ended September 30, 2015
 
 
1-4 family
         
 
first-lien
 
Residential
     
Other
 
 
residential
 
construction
 
Commercial
 
Commercial
 
commercial
 
(In thousands)
mortgage
 
mortgage
 
real estate
 
lines of credit
 
and industrial
 
Allowance for loan losses:
         
Beginning Balance
 
$
509
   
$
-
   
$
2,801
   
$
460
   
$
1,034
 
   Charge-offs
   
(186
)
   
-
     
(224
)
   
(160
)
   
(108
)
   Recoveries
   
40
     
-
     
-
     
36
     
7
 
   Provisions
   
149
     
-
     
454
     
34
     
124
 
Ending balance
 
$
512
   
$
-
   
$
3,031
   
$
370
   
$
1,057
 
                                         
         
Home equity
 
Other
                 
 
Tax exempt
 
and junior liens
 
consumer
 
Unallocated
 
Total
 
Allowance for loan losses:
                                       
Beginning Balance
 
$
3
   
$
388
   
$
98
   
$
56
   
$
5,349
 
   Charge-offs
   
-
     
(11
)
   
(60
)
   
-
     
(749
)
   Recoveries
   
-
     
8
     
37
     
-
     
128
 
   Provisions
   
1
     
(57
)
   
32
     
267
     
1,004
 
Ending balance
 
$
4
   
$
328
   
$
107
   
$
323
   
$
5,732
 

 
For the three months ended September 30, 2014
 
 
1-4 family
         
 
first-lien
 
Residential
     
Other
 
 
residential
 
construction
 
Commercial
 
Commercial
 
commercial
 
(In thousands)
mortgage
 
mortgage
 
real estate
 
lines of credit
 
and industrial
 
Allowance for loan losses:
         
Beginning Balance
 
$
491
   
$
-
   
$
2,624
   
$
554
   
$
851
 
   Charge-offs
   
(26
)
   
-
     
(256
)
   
(79
)
   
-
 
   Recoveries
   
-
     
-
     
-
     
-
     
3
 
   Provisions
   
48
     
-
     
345
     
(28
)
   
46
 
Ending balance
 
$
513
   
$
-
   
$
2,713
   
$
447
   
$
900
 
Ending balance: related to loans
                                       
individually evaluated for impairment
   
-
     
-
     
643
     
95
     
116
 
Ending balance: related to loans
                                       
collectively evaluated for impairment
 
$
513
   
$
-
   
$
2,070
   
$
352
   
$
784
 
                                         
Loans receivables:
                                       
Ending balance
 
$
170,424
   
$
1,896
   
$
119,453
   
$
16,568
   
$
36,994
 
Ending balance: individually
                                       
evaluated for impairment
   
1,266
     
-
     
5,218
     
288
     
529
 
Ending balance: collectively
                                       
evaluated for impairment
 
$
169,158
   
$
1,896
   
$
114,235
   
$
16,280
   
$
36,465
 
                                         
         
Home equity
 
Other
                 
 
Municipal
 
and junior liens
 
Consumer
 
Unallocated
 
Total
 
Allowance for loan losses:
                                       
Beginning Balance
 
$
1
   
$
422
   
$
109
   
$
114
   
$
5,166
 
   Charge-offs
   
-
     
(31
)
   
(24
)
   
-
     
(416
)
   Recoveries
   
-
     
1
     
7
     
-
     
11
 
   Provisions
   
-
     
(17
)
   
7
     
9
     
410
 
Ending balance
 
$
1
   
$
375
   
$
99
   
$
123
   
$
5,171
 
Ending balance: related to loans
                                       
individually evaluated for impairment
   
-
     
33
     
5
     
-
     
892
 
Ending balance: related to loans
                                       
collectively evaluated for impairment
 
$
1
   
$
342
   
$
94
   
$
123
   
$
4,279
 
                                         
Loans receivables:
                                       
Ending balance
 
$
2,922
   
$
21,724
   
$
4,061
           
$
374,042
 
Ending balance: individually
                                       
evaluated for impairment
   
-
     
365
     
14
             
7,680
 
Ending balance: collectively
                                       
evaluated for impairment
 
$
2,922
   
$
21,359
   
$
4,047
           
$
366,362
 

 
For the nine months ended September 30, 2014
 
 
1-4 family
         
 
first-lien
 
Residential
     
Other
 
 
residential
 
construction
 
Commercial
 
Commercial
 
commercial
 
(In thousands)
mortgage
 
mortgage
 
real estate
 
lines of credit
 
and industrial
 
Allowance for loan losses:
         
Beginning Balance
 
$
649
   
$
-
   
$
2,302
   
$
397
   
$
834
 
   Charge-offs
   
(68
)
   
-
     
(303
)
   
(164
)
   
(153
)
   Recoveries
   
1
     
-
     
-
     
3
     
6
 
   Provisions
   
(69
)
   
-
     
714
     
211
     
213
 
Ending balance
 
$
513
   
$
-
   
$
2,713
   
$
447
   
$
900
 
                                         
         
Home equity
 
Other
                 
 
Municipal
 
and junior liens
 
consumer
 
Unallocated
 
Total
 
Allowance for loan losses:
                                       
Beginning Balance
 
$
2
   
$
433
   
$
136
   
$
288
   
$
5,041
 
   Charge-offs
   
-
     
(81
)
   
(84
)
   
-
     
(853
)
   Recoveries
   
-
     
1
     
42
     
-
     
53
 
   Provisions
   
(1
)
   
22
     
5
     
(165
)
   
930
 
Ending balance
 
$
1
   
$
375
   
$
99
   
$
123
   
$
5,171
 

Note 8:  Foreclosed Real Estate

The Company is required to disclose the carrying amount of foreclosed residential real estate properties held as a result of obtaining physical possession of the property at each reporting period.

         
(Dollars in thousands)
Number of properties
 
September 30, 2015
 
Number of properties
 
December 31, 2014
 
Foreclosed real estate
       
Foreclosed residential mortgage loans
   
6
   
$
341
     
4
   
$
261
 
Foreclosed commercial real estate
   
2
     
131
     
-
     
-
 
Total
   
8
   
$
472
     
4
   
$
261
 

At September 30, 2015, the Company reported $149,000 in residential real estate loans in the process of foreclosure.

Note 9:   Guarantees

The Company does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit.  Standby letters of credit written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party.  Generally, all letters of credit, when issued have expiration dates within one year.  The credit risk involved in issuing letters of credit is essentially the same as those that are involved in extending loan facilities to customers.  The Company generally holds collateral and/or personal guarantees supporting these commitments.  The Company had $1.6 million of standby letters of credit as of September 30, 2015.  Management believes that the proceeds obtained through a liquidation of collateral and the enforcement of guarantees would be sufficient to cover the potential amount of future payments required under the corresponding guarantees.   The fair value of standby letters of credit was not significant to the Company's consolidated financial statements.

Note 10:  Fair Value Measurements

Accounting guidance related to fair value measurements and disclosures specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company's market assumptions. These two types of inputs have created the following fair value hierarchy:

Level 1 – Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
 

 
Level 2 – Quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.

Level 3 – Model-derived valuations in which one or more significant inputs or significant value drivers are unobservable.

An asset's or liability's level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs, minimize the use of unobservable inputs, to the extent possible, and considers counterparty credit risk in its assessment of fair value.

The Company used the following methods and significant assumptions to estimate fair value:

Investment securities:  The fair values of securities available-for-sale are obtained from an independent third party and are based on quoted prices on nationally recognized securities exchanges where available (Level 1).  If quoted prices are not available, fair values are measured by utilizing matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for specific securities but rather by relying on the securities' relationship to other benchmark quoted securities (Level 2).  Management made no adjustment to the fair value quotes that were received from the independent third party pricing service.  During the third quarter of 2015, the Company purchased $313,000 in the common stock of a community-based financial institution that conducts its operations outside of the Company's primary market area.  The purchase was in conjunction with a capital raise by the financial institution that attracted multiple investors. The stock of this financial institution is not traded on any exchange and there are no quoted market prices available for this security (Level 3).  The security was purchased immediately before the measurement date at September 30, 2015.  Commensurate with the timing of the purchase, this investment was valued at its acquisition cost, which was considered to be its fair value as of the measurement date. The Company had no securities of this type at December 31, 2014.

Interest rate swap derivative:  The fair value of the interest rate swap derivative is calculated based on a discounted cash flow model. All future floating cash flows are projected and both floating and fixed cash flows are discounted to the valuation date.  The curve utilized for discounting and projecting is built by obtaining publicly available third party market quotes for various swap maturity terms.

Impaired loans: Impaired loans are those loans in which the Company has measured impairment based on the fair value of the loan's collateral or the discounted value of expected future cash flows.  Fair value is generally determined based upon market value evaluations by third parties of the properties and/or estimates by management of working capital collateral or discounted cash flows based upon expected proceeds.  These appraisals may include up to three approaches to value: the sales comparison approach, the income approach (for income-producing property), and the cost approach.  Management modifies the appraised values, if needed, to take into account recent developments in the market or other factors, such as, changes in absorption rates or market conditions from the time of valuation and anticipated sales values considering management's plans for disposition.  Such modifications to the appraised values could result in lower valuations of such collateral. Estimated costs to sell are based on current amounts of disposal costs for similar assets.  These measurements are classified as Level 3 within the valuation hierarchy. Impaired loans are subject to nonrecurring fair value adjustment upon initial recognition or subsequent impairment.  A portion of the allowance for loan losses is allocated to impaired loans if the value of such loans is deemed to be less than the unpaid balance.

Foreclosed real estate:  Fair values for foreclosed real estate are initially recorded based on market value evaluations by third parties, less costs to sell ("initial cost basis").  Any write-downs required when the related loan receivable is exchanged for the underlying real estate collateral at the time of transfer to foreclosed real estate are charged to the allowance for loan losses.  Values are derived from appraisals, similar to impaired loans, of underlying collateral or discounted cash flow analysis.  Subsequent to foreclosure, valuations are updated periodically and assets are marked to current fair value, not to exceed the initial cost basis.  In the determination of fair value subsequent to foreclosure, management also considers other factors or recent developments, such as, changes in absorption rates and market conditions from the time of valuation and anticipated sales values considering management's plans for disposition.  Either change could result in adjustment to lower the property value estimates indicated in the appraisals.  These measurements are classified as Level 3 within the fair value hierarchy.
 
 

 
The following tables summarize assets measured at fair value on a recurring basis as of the indicated dates, segregated by the level of valuation inputs within the hierarchy utilized to measure fair value:


 
September 30, 2015
 
       
Total Fair
 
(In thousands)
Level 1
 
Level 2
 
Level 3
 
Value
 
Available-for-sale portfolio
       
Debt investment securities:
       
US Treasury, agencies and GSEs
 
$
-
   
$
27,922
   
$
-
   
$
27,922
 
State and political subdivisions
   
-
     
8,374
     
-
     
8,374
 
Corporate
   
-
     
18,269
     
-
     
18,269
 
Residential mortgage-backed - US agency
   
-
     
26,267
     
-
     
26,267
 
Collateralized mortgage obligations - US agency
   
-
     
14,917
     
-
     
14,917
 
Equity investment securities:
                               
Mutual funds:
                               
Ultra short mortgage fund
   
644
     
-
     
-
     
644
 
Large cap equity fund
   
582
     
-
     
-
     
582
 
Other mutual funds
   
-
     
425
     
-
     
425
 
Common stock - financial services industry
   
44
     
250
     
313
     
607
 
Total available-for-sale securities
 
$
1,270
   
$
96,424
   
$
313
   
$
98,007
 
                                 
Interest rate swap derivative
 
$
-
   
$
(44
)
 
$
-
   
$
(44
)
                                 
                                 
 
December 31, 2014
 
                         
Total Fair
 
(In thousands)
Level 1
 
Level 2
 
Level 3
 
Value
 
Available-for-sale portfolio
                               
Debt investment securities:
                               
US Treasury, agencies and GSEs
 
$
-
   
$
17,750
   
$
-
   
$
17,750
 
State and political subdivisions
   
-
     
8,443
     
-
     
8,443
 
Corporate
   
-
     
13,860
     
-
     
13,860
 
Residential mortgage-backed - US agency
   
-
     
30,575
     
-
     
30,575
 
Collateralized mortgage obligations - US agency
   
-
     
15,476
     
-
     
15,476
 
Equity investment securities:
                               
Mutual funds:
                               
Ultra short mortgage fund
   
648
     
-
     
-
     
648
 
Large cap equity fund
   
649
     
-
     
-
     
649
 
Other mutual funds
   
-
     
379
     
-
     
379
 
Common stock - financial services industry
   
43
     
250
     
-
     
293
 
Total available-for-sale securities
 
$
1,340
   
$
86,733
   
$
-
   
$
88,073
 
                                 
Interest rate swap derivative
 
$
-
   
$
(82
)
 
$
-
   
$
(82
)


The changes in Level 3 assets and liabilities measured at estimated fair value on a recurring basis during the three months ended September 30, 2015 were as follows:

 (In thousands)  
Common Stock - Financial Services Industry
 
Balance - June 30, 2015
 
$
-
 
Total gains realized/unrealized:
       
Included in earnings
   
-
 
Included in other comprehensive income
   
-
 
Settlements
   
313
 
Sales
   
-
 
Balance - September 30, 2015
 
$
313
 
Changes in unrealized gains included in earnings related to assets still held at September 30, 2015
 
$
-
 

The changes in Level 3 assets and liabilities measured at estimated fair value on a recurring basis during the nine months ended September 30, 2015 were as follows:

 (In thousands)  
Common Stock - Financial Services Industry
 
Balance - December 31, 2014
 
$
-
 
Total gains realized/unrealized:
       
Included in earnings
   
-
 
Included in other comprehensive income
   
-
 
Settlements
   
313
 
Sales
   
-
 
Balance - September 30, 2015
 
$
313
 
Changes in unrealized gains included in earnings related to assets still held at September 30, 2015
 
$
-
 

The following table summarizes the valuation techniques and significant unobservable inputs used for the Company's investments that are categorized within Level 3 of the fair value hierarchy at the indicated dates.
 
At September 30, 2015
 
 Investment Type
 
Fair Value
 
 Valuation Techniques
 Unobservable Input
 
Weight
 
 (In thousands)
           
 Common Stock - financial services
 
$
313
 
 Inputs to comparables
 Weight ascribed to comparable companies
   
100
%
 
There were no investments held within Level 3 of the fair value hierarchy as of December 31, 2014.


 

Pathfinder Bank had the following assets measured at fair value on a nonrecurring basis as of September 30, 2015 and December 31, 2014:

 
September 30, 2015
 
       
Total Fair
 
(In thousands)
Level 1
 
Level 2
 
Level 3
 
Value
 
 Impaired loans
 
$
-
   
$
-
   
$
1,294
   
$
1,294
 
 Foreclosed real estate
 
$
-
   
$
-
   
$
435
   
$
435
 
                                 
                                 
 
December 31, 2014
 
                         
Total Fair
 
(In thousands)
Level 1
 
Level 2
 
Level 3
 
Value
 
 Impaired loans
 
$
-
   
$
-
   
$
1,277
   
$
1,277
 
 Foreclosed real estate
 
$
-
   
$
-
   
$
105
   
$
105
 


The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis and for which Level 3 inputs were used to determine fair value at the indicated dates.

 
 
Quantitative Information about Level 3 Fair Value Measurements
 
       
 
Valuation
Unobservable
Range
 
Techniques
Input
(Weighted Avg.)
At September 30, 2015
 
 
 
Impaired loans
Appraisal of collateral
Appraisal Adjustments
5% - 10% (8%)
 
(Sales Approach)
Costs to Sell
7% - 15% (13%)
 
Discounted Cash Flow
   
       
Foreclosed real estate
Appraisal of collateral
Appraisal Adjustments
 15% - 15% (15%)
 
(Sales Approach)
Costs to Sell
 6% -   8% (7%)
 
 
 
 
       
 
 
Quantitative Information about Level 3 Fair Value Measurements
 
       
 
Valuation
Unobservable
Range
 
Techniques
Input
(Weighted Avg.)
At December 31, 2014
 
 
 
Impaired loans
Appraisal of collateral
Appraisal Adjustments
5% - 25% (13%)
 
(Sales Approach)
Costs to Sell
6% - 50% (13%)
 
Discounted Cash Flow
   
       
Foreclosed real estate
Appraisal of collateral
Appraisal Adjustments
 15% - 15% (15%)
 
(Sales Approach)
Costs to Sell
 6% - 8% (7%)
 
 
 
 

There have been no transfers of assets into or out of any fair value measurement level during the quarter ended September 30, 2015.

Required disclosures include fair value information of financial instruments, whether or not recognized in the consolidated statement of condition, for which it is practicable to estimate that value.  In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques.  Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument.
 

 
The Company has various processes and controls in place to ensure that fair value is reasonably estimated. The Company performs due diligence procedures over third-party pricing service providers in order to support their use in the valuation process. 

While the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

Management uses its best judgment in estimating the fair value of the Company's financial instruments; however, there are inherent weaknesses in any estimation technique.  Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in sales transactions on the dates indicated.  The estimated fair value amounts have been measured as of their respective period-ends, and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates.  As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each period-end.

The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company's assets and liabilities.  Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company's disclosures and those of other companies may not be meaningful.  The Company, in estimating its fair value disclosures for financial instruments, used the following methods and assumptions:

Cash and cash equivalents – The carrying amounts of these assets approximate their fair value and are classified as Level 1.

Investment securities – The fair values of securities available-for-sale and held-to-maturity are obtained from an independent third party and are based on quoted prices on nationally recognized exchange where available (Level 1).  If quoted prices are not available, fair values are measured by utilizing matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for specific securities, but rather by relying on the securities' relationship to other benchmark quoted securities (Level 2).  Management made no adjustment to the fair value quotes that were received from the independent third party pricing service.  During the third quarter of 2015, the Company purchased $313,000 in the common stock of a community-based financial institution that conducts its operations outside of the Company's primary market area.  The purchase was in conjunction with a capital raise by the financial institution that attracted multiple investors. The stock of this financial institution is not traded on any exchange and there are no quoted market prices available for this security (Level 3).  The security was purchased immediately before the measurement date at September 30, 2015.  Commensurate with the timing of the purchase, this investment was valued at its acquisition cost, which was considered to be its fair value as of the measurement date. The Company had no securities of this type at December 31, 2014.


Federal Home Loan Bank stock – The carrying amount of these assets approximates their fair value and are classified as Level 2.

Net loans – For variable-rate loans that re-price frequently, fair value is based on carrying amounts.  The fair value of other loans (for example, fixed-rate commercial real estate loans, mortgage loans, and commercial and industrial loans) is estimated using discounted cash flow analysis, based on interest rates currently being offered in the market for loans with similar terms to borrowers of similar credit quality.  Loan value estimates include judgments based on expected prepayment rates.  The measurement of the fair value of loans, including impaired loans, is classified within Level 3 of the fair value hierarchy.

Accrued interest receivable and payable – The carrying amount of these assets approximates their fair value and are classified as Level 1.
 

 
Deposits – The fair values disclosed for demand deposits (e.g., interest-bearing and noninterest-bearing checking, passbook savings and certain types of money management accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts) and are classified within Level 1 of the fair value hierarchy.  Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates of deposits to a schedule of aggregated expected monthly maturities on time deposits.  Measurements of the fair value of time deposits are classified within Level 2 of the fair value hierarchy.

Borrowings – Fixed/variable term "bullet" structures are valued using a replacement cost of funds approach.  These borrowings are discounted to the FHLBNY advance curve.  Option structured borrowings' fair values are determined by the FHLB for borrowings that include a call or conversion option.  If market pricing is not available from this source, current market indications from the FHLBNY are obtained and the borrowings are discounted to the FHLBNY advance curve less an appropriate spread to adjust for the option. These measurements are classified as Level 2 within the fair value hierarchy.

Junior subordinated debentures – The Company secures a quote from its pricing service based on a discounted cash flow methodology which results in a Level 2 classification for this borrowing.

Interest rate swap derivative – The fair value of the interest rate swap derivative is obtained from a third party pricing agent and is calculated based on a discounted cash flow model. All future floating cash flows are projected and both floating and fixed cash flows are discounted to the valuation date.  The curve utilized for discounting and projecting is built by obtaining publicly available third party market quotes for various swap maturity terms, and therefore is classified within Level 2 of the fair value hierarchy.

The carrying amounts and fair values of the Company's financial instruments as of the indicated dates are presented in the following table:


       
September 30, 2015
   
December 31, 2014
 
   
Fair Value
   
Carrying
   
Estimated
   
Carrying
   
Estimated
 
(Dollars In thousands)
 
Hierarchy
   
Amounts
   
Fair Values
   
Amounts
   
Fair Values
 
Financial assets:
                   
Cash and cash equivalents
   
1
   
$
17,374
   
$
17,374
   
$
11,356
   
$
11,356
 
Investment securities - available-for-sale
   
1
     
1,270
     
1,270
     
1,340
     
1,340
 
Investment securities - available-for-sale
   
2
     
96,424
     
96,424
     
86,733
     
86,733
 
Investment securities - available-for-sale
   
3
     
313
     
313
     
-
     
-
 
Investment securities - held-to-maturity
   
2
     
43,534
     
44,952
     
40,875
     
42,139
 
Federal Home Loan Bank stock
   
2
     
1,881
     
1,881
     
3,454
     
3,454
 
Net loans
   
3
     
409,063
     
415,965
     
382,189
     
388,151
 
Accrued interest receivable
   
1
     
2,082
     
2,082
     
1,849
     
1,849
 
                                         
Financial liabilities:
                                       
Demand Deposits, Savings, NOW and MMDA
   
1
   
$
324,385
   
$
324,385
   
$
263,004
   
$
263,004
 
Time Deposits
   
2
     
171,957
     
172,183
     
152,564
     
152,457
 
Borrowings
   
2
     
29,225
     
29,359
     
66,100
     
66,282
 
Junior subordinated debentures
   
2
     
5,155
     
4,385
     
5,155
     
4,799
 
Accrued interest payable
   
1
     
50
     
50
     
63
     
63
 
Interest rate swap derivative
   
2
     
44
     
44
     
82
     
82
 


 

Note 11:   Interest Rate Derivatives

Derivative instruments are entered into primarily as a risk management tool of the Company.  Financial derivatives are recorded at fair value as other liabilities.  The accounting for changes in the fair value of a derivative depends on whether it has been designated and qualifies as part of a hedging relationship. For a fair value hedge, changes in the fair value of the derivative instrument and changes in the fair value of the hedged asset or liability are recognized currently in earnings.  For a cash flow hedge, changes in the fair value of the derivative instrument, to the extent that it is effective, are recorded in other comprehensive income and subsequently reclassified to earnings as the hedged transaction impacts net income.  Any ineffective portion of a cash flow hedge is recognized currently in earnings.  See Note 10 for further discussion of the fair value of the interest rate derivative.

The Company has $5.0 million of floating rate trust preferred debt indexed to 3-month LIBOR.  As a result, it is exposed to variability in cash flows related to changes in projected interest payments caused by changes in the benchmark interest rate.  During the fourth quarter of fiscal 2009, the Company entered into an interest rate swap agreement, with a $2.0 million notional amount, to convert a portion of the variable-rate junior subordinated debentures to a fixed rate for a term of approximately seven years at a rate of 4.96%.  The derivative is designated as a cash flow hedge.  The hedging strategy ensures that changes in cash flows from the derivative will be highly effective at offsetting changes in interest expense from the hedged exposure.

The following table summarizes the fair value of the outstanding derivative and its presentation on the statements of condition:

 
September 30,
 
December 31,
 
 (In thousands)
2015
 
2014
 
 Cash flow hedge:
   
 Other liabilities
 
$
44
   
$
82
 

The change in accumulated other comprehensive loss on a pretax basis and the impact on earnings from the interest rate swap that qualifies as a cash flow hedge for the periods indicated below were as follows:

 
Three months ended September 30,
 
(In thousands)
2015
   
2014
 
Balance as of June 30:
 
$
(57
)
 
$
(112
)
Amount of gains/(losses) recognized in other comprehensive income
   
(2
)
   
2
 
Amount of loss reclassified from other comprehensive income
               
     and recognized as interest expense
   
15
     
16
 
Balance as of September 30:
 
$
(44
)
 
$
(94
)
                 
                 
 
Nine months ended September 30,
 
(In thousands)
   
2015
     
2014
 
Balance as of December 31:
 
$
(82
)
 
$
(135
)
Amount of losses recognized in other comprehensive income
   
(8
)
   
(6
)
Amount of loss reclassified from other comprehensive income
               
     and recognized as interest expense
   
46
     
47
 
Balance as of September 30:
 
$
(44
)
 
$
(94
)

No amount of ineffectiveness has been included in earnings and the changes in fair value have been recorded in other comprehensive (loss) income.  Some, or all, of the amount included in accumulated other comprehensive (loss) income would be reclassified into current earnings should a portion of, or the entire hedge no longer be considered effective, but at this time, management expects the hedge to remain fully effective during the remaining term of the swap.

The Company posted cash of $201,000 under arrangements to satisfy collateral requirements associated with the interest rate swap contract.
 
 
Note 12:   Accumulated Other Comprehensive Income (Loss)

Changes in the components of accumulated other comprehensive income (loss) ("AOCI"), net of tax, for the periods indicated are summarized in the table below.

 
For the three months ended September 30, 2015
 
(In thousands)
Retirement Plans
 
Unrealized Gains and Losses on Financial Derivative
 
Unrealized Gains and Losses on Available-for-Sale Securities
 
Unrealized Loss on Securities Transferred to Held-to-Maturity
 
Total
 
Beginning balance
 
$
(1,740
)
 
$
(34
)
 
$
149
   
$
(694
)
 
$
(2,319
)
Other comprehensive (loss) income before reclassifications
   
-
     
(1
)
   
356
     
20
     
375
 
Amounts reclassified from AOCI
   
27
     
9
     
(52
)
   
-
     
(16
)
Ending balance
 
$
(1,713
)
 
$
(26
)
 
$
453
   
$
(674
)
 
$
(1,960
)
 
 
 
For the nine months ended September 30, 2015
 
(In thousands)
Retirement Plans
 
Unrealized Gains and Losses on Financial derivative
 
Unrealized Gains and Losses on Available-for-Sale Securities
 
Unrealized Loss on Securities Transferred to Held-to-Maturity
 
Total
 
Beginning balance
 
$
(1,794
)
 
$
(49
)
 
$
457
   
$
(733
)
 
$
(2,119
)
Other comprehensive (loss) income before reclassifications
   
-
     
(5
)
   
109
     
59
     
163
 
Amounts reclassified from AOCI
   
81
     
28
     
(113
)
   
-
     
(4
)
Ending balance
 
$
(1,713
)
 
$
(26
)
 
$
453
   
$
(674
)
 
$
(1,960
)


 
For the three months ended September 30, 2014
 
(In thousands)
Retirement Plans
 
Unrealized Gains and Losses on Financial derivative
 
Unrealized Gains and Losses on Available-for-Sale Securities
 
Unrealized Loss on Securities Transferred to Held-to-Maturity
 
Total
 
Beginning balance
 
$
(969
)
 
$
(67
)
 
$
461
   
$
(745
)
 
$
(1,320
)
Other comprehensive (loss) income before reclassifications
   
-
     
-
     
(42
)
   
17
     
(25
)
Amounts reclassified from AOCI
   
7
     
10
     
(2
)
   
-
     
15
 
Ending balance
 
$
(962
)
 
$
(57
)
 
$
417
   
$
(728
)
 
$
(1,330
)
 
 
 
For the nine months ended September 30, 2014
 
(In thousands)
Retirement Plans
 
Unrealized Gains and Losses on Financial derivative
 
Unrealized Gains and Losses on Available-for-Sale Securities
 
Securities reclassified from AFS to HTM
 
Total
 
Beginning balance
 
$
(982
)
 
$
(81
)
 
$
99
   
$
(781
)
   
(1,745
)
Other comprehensive (loss) income before reclassifications
   
-
     
(4
)
   
335
     
53
     
384
 
Amounts reclassified from AOCI
   
20
     
28
     
(17
)
   
-
     
31
 
Ending balance
 
$
(962
)
 
$
(57
)
 
$
417
   
$
(728
)
 
$
(1,330
)



 The following table presents the amounts reclassified out of each component of AOCI for the indicated period:

   
Amount Reclassified
     
Amount Reclassified
 
   
from AOCI1
     
from AOCI1
 
   
(Unaudited)
 
 
 
(Unaudited)
 
(In thousands)
 
For the three months ended
     
For the nine months ended
 
Details about AOCI1 components
 
September 30, 2015
   
September 30, 2014
 
Affected Line Item in the Statement  of Income
 
September 30, 2015
   
September 30, 2014
 
   
   
 
 
 
   
 
Unrealized holding gain on financial derivative:
                 
Reclassification adjustment for
                 
   interest expense included in net income
 
$
(15
)
 
$
(16
)
Interest on long term borrowings
 
$
(46
)
 
$
(47
)
     
6
     
6
 
 Provision for income taxes
   
18
     
19
 
   
$
(9
)
 
$
(10
)
 Net Income
 
$
(28
)
 
$
(28
)
Retirement plan items
                                 
Retirement plan net losses
                                 
   recognized in plan expenses2
 
$
(45
)
 
$
(11
)
 Salaries and employee benefits
 
$
(135
)
 
$
(33
)
     
18
     
4
 
 Provision for income taxes
   
54
     
13
 
   
$
(27
)
 
$
(7
)
 Net Income
 
$
(81
)
 
$
(20
)
                                   
Available-for-sale securities
                                 
Realized gain on sale of securities
 
$
88
   
$
3
 
Net gains on sales and redemptions of investment securities
 
$
188
   
$
29
 
     
(36
)
   
(1
)
 Provision for income taxes
   
(75
)
   
(12
)
   
$
52
   
$
2
 
 Net Income
 
$
113
   
$
17
 
                                   
1 Amounts in parentheses indicates debits in net income.
                           
2 These items are included in net periodic pension cost.
                           
   See Note 5 for additional information.
                                 


Note 13:  Subsequent Events

On October 15, 2015, the Company executed a $10.0 million non-amortizing subordinated loan agreement (the "Subordinated Loan") with an unrelated third party that is scheduled to mature on October 15, 2025. The Company has the right to prepay the Subordinated Note at any time after October 15, 2020 without penalty. The terms of the Subordinated Loan call for interest payments at an annual interest rate of 3.50% from October 15, 2015 to February 29, 2016. The annual interest rate charged the Company will increase to 6.25% on March 1, 2016.  The Subordinated Loan is senior in the Company's credit repayment hierarchy only to the Company's common equity and, as a result, qualifies as Tier 2 capital for all future periods when applicable.  The Company paid $161,000 in origination and legal fees as part of this transaction.  These fees will be amortized over the life of the Subordinated Loan through its first call date using the effective interest method.  The effective cost of funds related to this transaction is 6.46% calculated under this method.

The Company's management intends to use a portion of the proceeds from the Subordinated Loan for general corporate purposes and a portion of the proceeds to support the repayment of $13.0 million of the existing variable rate, non-cumulative perpetual senior preferred stock issued through the SBLF (the "preferred stock"). Due to certain restrictions imposed on the Company at the time that the preferred stock was issued, the timetable for repaying the SBLF and consequently retiring the preferred stock cannot be determined at this time.  The issuance of the Subordinated Note will increase interest expense by $646,000 per year but this increase in interest expense will likely be offset by a decrease in interest expense and/or preferred stock dividend distributions associated with reductions in other obligations of the Company including the preferred stock.  The timing and amount of those interest expense savings and preferred dividend distribution reductions cannot be definitively determined at this time.
 

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

General

The Company is a Maryland corporation headquartered in Oswego, New York.  The primary business of the Company is its investment in Pathfinder Bank (the "Bank"), a New York savings bank, which is 100% owned by the Company and the Company is 100% owned by public shareholders.  At September 30, 2015, the Company had 4,352,203 shares of common stock outstanding. The Bank has four wholly-owned operating subsidiaries, Pathfinder Commercial Bank, Pathfinder Risk Management Company, Inc. ("PRMC"), Pathfinder REIT, Inc. and Whispering Oaks Development Corp. All significant inter-company accounts and activity have been eliminated in consolidation.  Although the Company owns, through its subsidiary PRMC, 51% of the membership interest in FitzGibbons Agency, LLC ("FitzGibbons"), the Company is required to consolidate 100% of FitzGibbons 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.  At September 30, 2015, the Company and subsidiaries had total assets of $607.2 million, total liabilities of $536.0 million and shareholders' equity of $71.2 million including the noncontrolling interest of $414,000, which represents the 49% of FitzGibbons not owned by the Company. See "Recent Events," below for a description of the proposed merger between Pathfinder Bank and Pathfinder Commercial Bank.

The following discussion reviews the Company's financial condition at September 30, 2015 and the results of operations for the three and nine month periods ended September 30, 2015 and 2014. Operating results for the three and nine months ended September 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015.

The following material under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" is written with the presumption that the users of the interim financial statements have read, or have access to, the Company's latest audited financial statements and notes thereto, together with Management's Discussion and Analysis of Financial Condition and Results of Operations as of December 31, 2014 and 2013 and for the two years then ended.  Therefore, only material changes in financial condition and results of operations are discussed in the remainder of Item 2.

Statement Regarding Forward-Looking Statements

This report contains forward-looking statements that are based on assumptions and may describe future plans, strategies and expectations of the Company. These forward-looking statements are generally identified by use of the words "believe," "expect," "intend," "anticipate," "estimate," "project" or similar expressions. The Company's ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations of the Company and its subsidiaries include, but are not limited to:

·
general economic conditions, either nationally or in our market area, that are worse than expected;

·
inflation and changes in the interest rate environment that reduce our interest margins or reduce the fair value of financial instruments;

·
increased competitive pressures among financial services companies;

·
changes in consumer spending, borrowing and savings habits;

·
our ability to enter new markets successfully and take advantage of growth opportunities, and the possible dilutive effect of potential acquisitions or de novo branches, if any;

·
legislative or regulatory changes that may adversely affect our business;

·
adverse changes in the securities markets;

·
changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board or the Securities and Exchange Commission;
 

 
·
inability of third-party providers to perform their obligations to us; and

·
changes in our organization, compensation and benefit plans.

Management's ability to predict results or the effect of future plans or strategies is inherently uncertain. These factors include, but are not limited to, general economic conditions, changes in the interest rate environment, legislative or regulatory changes that may adversely affect our business, changes in accounting policies and practices, changes in competition and demand for financial services, adverse changes in the securities markets and changes in the quality or composition of the Company's loan or investment portfolios. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Except as required by applicable law or regulation, the Company does not undertake, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated 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 2014 Annual Report filed with the Securities and Exchange Commission on Form 10-K on March 18, 2015, ("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, the evaluation of goodwill for 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.

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.  Impairment is measured by either the present value of the expected future cash flows discounted at the loan's effective interest rate or the fair value of the underlying collateral if the loan is collateral dependent.  The majority of the Company's impaired loans utilize the fair value of the underlying collateral.

·
For all other loans, 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.

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 $319,000 was maintained at September 30, 2015, 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.

The Company maintains 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.  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 available-for-sale 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 (both available-for-sale and held-to-maturity) 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. When the fair value of a held-to-maturity or available-for-sale security is less than its amortized cost basis, an assessment is made as to whether OTTI is present.  The Company considers numerous factors when determining whether a potential OTTI exists and the period over which the debt security is expected to recover.  The principal factors considered are (1) the length of time and the extent to which the fair value has been less than the amortized cost basis, (2) the financial condition of the issue and (guarantor, if any) and adverse conditions specifically related to the security, industry or geographic area, (3) failure of the issuer of the security to make scheduled interest or principal payments, (4) any changes to the rating of the security by a rating agency, and (5) the presence of credit enhancements, if any, including the guarantee of the federal government or any of its agencies.

Management performs an annual evaluation of our goodwill for possible impairment at each of our reporting units. Based on the results of the December 31, 2014 evaluation, management has determined that the carrying value of goodwill was not impaired as of that date. The evaluation approach is described in Note 9 of the annual audited consolidated financial statements. Further information on the estimation of fair values can be found in Note 20 to the annual audited consolidated financial statements.
 

 
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 annual audited 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 such quotations are 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

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 combine with the Bank's wholly-owned subsidiary, Pathfinder Commercial Bank, a New York State-chartered commercial bank.  Prior to or simultaneously with the combination, 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, which it currently is, and its name will be changed to "Pathfinder Bank".  The transaction is expected to be completed in the fourth quarter of 2015 and will have little impact on 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.

On October 15, 2015, the Company executed a $10.0 million non-amortizing subordinated loan agreement (the "Subordinated Loan") with an unrelated third party that is scheduled to mature on October 15, 2025. The Company has the right to prepay the Subordinated Note at any time after October 15, 2020 without penalty. The terms of the Subordinated Loan call for interest payments at an annual interest rate of 3.50% from October 15, 2015 to February 29, 2016. The annual interest rate charged the Company will increase to 6.25% on March 1, 2016.  The Subordinated Loan is senior in the Company's credit repayment hierarchy only to the Company's common equity and, as a result, qualifies as Tier 2 capital for all future periods when applicable.  The Company paid $161,000 in origination and legal fees as part of this transaction.  These fees will be amortized over the life of the Subordinated Loan through its first call date using the effective interest method.  The effective cost of funds related to this transaction is 6.37% calculated under this method.

The Company's management intends to use a portion of the proceeds from the Subordinated Loan for general corporate purposes and a portion of the proceeds to support the repayment of $13.0 million of the existing variable rate, non-cumulative perpetual senior preferred stock issued through the SBLF (the "preferred stock"). Due to certain restrictions imposed on the Company at the time that the preferred stock was issued, the timetable for repaying the SBLF and consequently retiring the preferred stock cannot be determined at this time.  The issuance of the Subordinated Note will increase interest expense by $637,000 per year but this increase in interest expense will likely be offset by a decrease in interest expense and/or preferred stock dividend distributions associated with reductions in other obligations of the Company including the preferred stock.  The timing and amount of those interest expense savings and preferred dividend distribution reductions cannot be definitively determined at this time.

On September 24, 2015, the Company announced that its Board of Directors declared a quarterly dividend of $0.05 per common share.  The dividend is payable on November 3, 2015 to shareholders of record on October 14, 2015.
 

 
Overview and Results of Operations

The following represents the significant highlights of the Company's operating results between the third quarter of 2015 and the third quarter of 2014.

·
Net income available to common shareholders improved by 19.5% to $852,000.
·
Basic and diluted earnings per common share improved to $0.21 and $0.20 per share, respectively, due to the reported increase in earnings.  Return on average assets increased seven basis points to 0.59%.
·
Net interest income, after provision for loan losses, increased 14.8% to $4.6 million due to the Company's increase in asset size.  Net interest margin decreased by six basis points to 3.39%, due to a 19 basis point decline in loan yields in the quarter ended September 30, 2015 as compared with the same quarter in 2014.  This decline in loan yields was primarily due to the effects of the current interest rate environment whereby loans are being originated at lower yields than the loans that they are replacing that were originated in a previously higher interest rate environment.   The general decline in loan yields is commensurate with the current general interest rate environment and overall market competitive conditions.

The following represents significant highlights of the Company's operating results between the first nine months of 2015 and the first nine months of 2014.

·
Net income available to common shareholders improved by 8.8% to $2.0 million.
·
Basic and diluted earnings per common share improved to $0.49 and $0.48 per share, respectively, due to the reported increase in earnings.  Return on average assets remained constant at 0.47%.
·
Net interest income, after provision for loan losses, increased 11.8% to $13.0 million.  Net interest margin decreased by seven basis points to 3.33% as the decrease in average yield on interest earning assets declined for the reasons noted for the three months ended September 30, 2015, as discussed above.
·
Asset quality exhibited signs of improvement between December 31, 2014 and September 30, 2015. Delinquencies decreased, the ratio of annualized net loan charge-offs to average loans decreased by four basis points to 0.21%, and the ratio of nonperforming loans to period end loans decreased by 34 basis points to 1.27%.

The following reflects the changes in financial condition between December 31, 2014 and September 30, 2015.

·
Total assets increased 8.2% to $607.2 million.  Increases were recorded in investment securities, loans, and cash and equivalents.  This was funded largely by the increases in Money Market Deposit Accounts ("MMDA") and business and municipal demand deposits.

The Company reported net income available to common shareholders of $852,000 for the three months ended September 30, 2015 compared to net income available to common shareholders of $713,000 for the three months ended September 30, 2014.  The increase in net income available to common shareholders was due primarily to a $401,000 increase in net interest income, before provision for loan losses, as a result of the increase in average interest-earning asset balances and the decrease in the average cost of interest-bearing liabilities between year-over-year third quarter periods.  Net income for the quarter ended September 30, 2015 was further improved by a $292,000 increase in noninterest income and a reduction in the provision for loan losses of $190,000 as compared with the same three month period in 2014. Partially offsetting these increases to net income was a $746,000 increase in noninterest expenses for the quarter ended September 30, 2015 as compared to the quarter ended September 30, 2014.

Return on average assets increased seven basis points to 0.59% between the year-over-year third quarter periods as the increase in net income (the numerator in the ratio) was outpaced by the increase in average assets (the denominator in the ratio).  Average assets increased due to increased loan origination activity supported by the increase in average deposits seen in the third quarter of 2015 as compared to the third quarter of 2014.

Net income available to common shareholders for the nine months ended September 30, 2015 was $2.0 million, an increase of $163,000 or 8.8% over the comparable prior year period.  The increase in net income available to common shareholders was primarily due to the increase in net interest income, after provision for loan losses, of $1.4 million resulting from higher average balances of interest earning assets and a decrease in average rates paid on interest bearing liabilities. Noninterest income increased $406,000 or 15.6%, to $3.0 million for the nine months ended September 30, 2015 as compared to the same nine-month period in 2014.  This increase was due to a broad range of factors including increased interchange fee income, insurance and investment commission income and a general increase in fee generating activities commensurate with the growth of the Company.  Partially offsetting these positive factors was an increase in noninterest expenses of $1.5 million or 13.3%, to $13.0 million for the nine months ended September 30, 2015 as compared to the nine month period ended September 30, 2014.
 

 
Return on average assets remained unchanged at 0.47% in the year-over-year nine month periods.  This was due to an increase in net income in the nine months ended September 30, 2015 that was essentially matched by a similar rate of increase in the Company's average assets.

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.

The following tables set forth information concerning average interest-earning assets and interest-bearing liabilities and the average yields and rates thereon for the periods indicated.  Interest income and resultant yield information in the tables has not been adjusted for tax equivalency.  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. The prior year has been reclassified so as not to include adjustments for tax equivalency.  Additionally, the prior year has been reclassified to include Fed funds sold to be categorized with interest-earning deposits.
 

 

   
For the three months ended September 30,
 
   
2015
   
2014
 
           
Average
           
Average
 
   
Average
       
Yield /
   
Average
       
Yield /
 
(Dollars in thousands)
 
Balance
   
Interest
   
Cost
   
Balance
   
Interest
   
Cost
 
Interest-earning assets:
                       
Loans
 
$
409,217
   
$
4,699
     
4.59
%
 
$
363,353
   
$
4,344
     
4.78
%
Taxable investment securities
   
116,220
     
559
     
1.92
%
   
107,407
     
508
     
1.89
%
Tax-exempt investment securities
   
27,357
     
186
     
2.72
%
   
28,400
     
196
     
2.76
%
Interest-earning time deposit
   
-
     
-
     
0.00
%
   
500
     
2
     
1.60
%
Fed funds sold and interest-earning deposits
   
13,514
     
5
     
0.15
%
   
9,909
     
2
     
0.08
%
Total interest-earning assets
   
566,308
     
5,449
     
3.85
%
   
509,569
     
5,052
     
3.97
%
Noninterest-earning assets:
                                               
Other assets
   
40,270
                     
41,895
                 
Allowance for loan losses
   
(5,998
)
                   
(5,191
)
               
Net unrealized gains
                                               
on available-for sale-securities
   
538
                     
802
                 
Total assets
 
$
601,118
                   
$
547,075
                 
Interest-bearing liabilities:
                                               
NOW accounts
 
$
45,051
   
$
24
     
0.21
%
 
$
39,779
   
$
23
     
0.23
%
Money management accounts
   
12,740
     
5
     
0.16
%
   
13,247
     
6
     
0.18
%
MMDA accounts
   
121,494
     
170
     
0.56
%
   
92,742
     
104
     
0.45
%
Savings and club accounts
   
73,343
     
15
     
0.08
%
   
74,163
     
16
     
0.09
%
Time deposits
   
156,374
     
294
     
0.75
%
   
167,415
     
330
     
0.79
%
Junior subordinated debentures
   
5,155
     
41
     
3.18
%
   
5,155
     
39
     
3.03
%
Borrowings
   
50,003
     
103
     
0.83
%
   
44,516
     
138
     
1.24
%
Total interest-bearing liabilities
   
464,160
     
652
     
0.56
%
   
437,017
     
656
     
0.60
%
Noninterest-bearing liabilities:
                                               
Demand deposits
   
63,223
                     
58,548
                 
Other liabilities
   
2,709
                     
6,153
                 
Total liabilities
   
530,092
                     
501,718
                 
Shareholders' equity
   
71,026
                     
45,357
                 
Total liabilities & shareholders' equity
 
$
601,118
                   
$
547,075
                 
Net interest income
         
$
4,797
                   
$
4,396
         
Net interest rate spread
                   
3.29
%
                   
3.37
%
Net interest margin
                   
3.39
%
                   
3.45
%
Ratio of average interest-earning assets
                                               
to average interest-bearing liabilities
                   
122.01
%
                   
116.60
%



   
For the nine months ended September 30,
 
   
2015
   
2014
 
           
Average
           
Average
 
   
Average
       
Yield /
   
Average
       
Yield /
 
(Dollars in thousands)
 
Balance
   
Interest
   
Cost
   
Balance
   
Interest
   
Cost
 
Interest-earning assets:
                       
Loans
 
$
398,223
   
$
13,649
     
4.57
%
 
$
353,839
   
$
12,512
     
4.71
%
Taxable investment securities
   
119,627
     
1,603
     
1.79
%
   
101,449
     
1,445
     
1.90
%
Tax-exempt investment securities
   
28,027
     
573
     
2.73
%
   
27,445
     
585
     
2.84
%
Interest-earning time deposit
   
-
     
-
     
0.00
%
   
500
     
6
     
1.60
%
Fed funds sold and interest-earning deposits
   
13,332
     
12
     
0.12
%
   
7,986
     
4
     
0.07
%
Total interest-earning assets
   
559,209
     
15,837
     
3.78
%
   
491,219
     
14,552
     
3.95
%
Noninterest-earning assets:
                                               
Other assets
   
40,017
                     
41,402
                 
Allowance for loan losses
   
(5,661
)
                   
(5,118
)
               
Net unrealized gains
                                               
on available for sale securities
   
829
                     
661
                 
Total assets
 
$
594,394
                   
$
528,164
                 
Interest-bearing liabilities:
                                               
NOW accounts
 
$
46,160
   
$
63
     
0.18
%
 
$
39,319
   
$
55
     
0.19
%
Money management accounts
   
12,956
     
15
     
0.15
%
   
13,300
     
16
     
0.16
%
MMDA accounts
   
117,379
     
440
     
0.50
%
   
93,927
     
294
     
0.42
%
Savings and club accounts
   
74,674
     
46
     
0.08
%
   
74,628
     
47
     
0.08
%
Time deposits
   
156,158
     
871
     
0.74
%
   
159,810
     
1,093
     
0.91
%
Junior subordinated debentures
   
5,155
     
121
     
3.13
%
   
5,155
     
120
     
3.10
%
Borrowings
   
46,582
     
302
     
0.86
%
   
38,243
     
391
     
1.37
%
Total interest-bearing liabilities
   
459,064
     
1,858
     
0.54
%
   
424,382
     
2,016
     
0.63
%
Noninterest-bearing liabilities:
                                               
Demand deposits
   
61,790
                     
54,980
                 
Other liabilities
   
3,067
                     
4,437
                 
Total liabilities
   
523,921
                     
483,799
                 
Shareholders' equity
   
70,473
                     
44,365
                 
Total liabilities & shareholders' equity
 
$
594,394
                   
$
528,164
                 
Net interest income
         
$
13,979
                   
$
12,536
         
Net interest rate spread
                   
3.24
%
                   
3.32
%
Net interest margin
                   
3.33
%
                   
3.40
%
Ratio of average interest-earning assets
                                               
to average interest-bearing liabilities
                   
121.82
%
                   
115.75
%

As indicated in the above tables, net interest income increased $401,000, or 9.1%, to $4.8 million for the three months ended September 30, 2015 as compared to the same prior year period due principally to the increase in average balances of interest earning assets and the decrease in average rates paid on average time deposits and borrowings.  Net interest margin reported a nominal decrease of 7 basis points to 3.3% due largely to the decrease in average yields earned on the Company's loans and tax-exempt investment securities.   The following analysis should also be viewed in conjunction with the table below which reports the changes in net interest income attributable to rate and volume.

Interest income increased $397,000, or 7.9%, to $5.4 million for the three months ended September 30, 2015 compared to the three months ended September 30, 2014.  The increase in interest income was due principally to the increase in average balances of loans and taxable investment securities which increased 12.6% and 8.2%, respectively, in 2015 as compared with the same three month period in 2014. The increase in the average balances of loans reflected the Company's continued success in its expansion within the greater Syracuse market in conjunction with organic growth as a result of our new Syracuse business banking office which opened in the third quarter of 2014.  These increases offset the 19 basis point decrease in average yield on loans. The decrease in the yield on loans was the result of previously existing loans maturing at higher yields and being replaced by new loans at the lower current market yields.


Interest expense for the three months ended September 30, 2015 decreased $4,000, or 0.6%, to $652,000 when compared to the same prior year period. This decrease was primarily due to the decrease in average rates paid on time deposits as maturing certificates of deposit at higher rates were replaced with certificates of deposit at the current lower market rates.  This effect was partially offset by an increase in average interest-bearing liabilities of $27.1 million or 6.2%, to $464.2 million for the three months ended September 30, 2015 as compared to the same period in the prior year.

For the nine month period ended September 30, 2015, interest income increased $1.3 million, or 8.8%, to $15.8 million compared to the same prior year period.  The increase in interest income was due primarily to the increase in average balances of loans and taxable investment securities, which increased 12.5% and 17.9%, respectively.  The increase in the average balances of loans was the direct result of the Company's success in filling the borrowing needs of credit worthy customers within our established market areas and our successful entry into the greater Syracuse marketplace.  Partially offsetting the interest income generated by the increases in average balances of loans and taxable investment securities were decreases in average yields on these two product types of 14 basis points and 11 basis points, respectively, and for reasons similar to those cited previously for the decrease in average yields for the third quarter year-over-year comparisons.

Interest expense for the nine months ended September 30, 2015 decreased $158,000 or 7.8% to $1.9 million due principally to the 17 basis points reduction on average rates paid on time deposits.  Additionally, interest expense on borrowings decreased $88,000 due principally to the decrease of 51 basis points in the average rates paid on FHLBNY advances, partially offset by the $8.3 million increase in average balances of FHLBNY advances.

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 September 30,
   
Nine months ended September 30,
 
   
2015 vs. 2014
   
2015 vs. 2014
 
   
Increase/(Decrease) Due to
   
Increase/(Decrease) Due to
 
           
Total
           
Total
 
           
Increase
           
Increase
 
(In thousands)
 
Volume
   
Rate
   
(Decrease)
   
Volume
   
Rate
   
(Decrease)
 
Interest Income:
                       
Loans
 
$
1,316
   
$
(961
)
 
$
355
   
$
1,737
   
$
(600
)
 
$
1,137
 
Taxable investment securities
   
42
     
9
     
51
     
290
     
(132
)
   
158
 
Tax-exempt investment securities
   
(7
)
   
(3
)
   
(10
)
   
18
     
(30
)
   
(12
)
Interest-earning time deposits
   
(1
)
   
(1
)
   
(2
)
   
(3
)
   
(3
)
   
(6
)
Interest-earning deposits
   
1
     
2
     
3
     
4
     
4
     
8
 
Total interest income
   
1,351
     
(954
)
   
397
     
2,046
     
(761
)
   
1,285
 
Interest Expense:
                                               
NOW accounts
   
10
     
(9
)
   
1
     
10
     
(2
)
   
8
 
Money management accounts
   
-
     
(1
)
   
(1
)
   
-
     
(1
)
   
(1
)
MMDA accounts
   
37
     
29
     
66
     
82
     
64
     
146
 
Savings and club accounts
   
-
     
(1
)
   
(1
)
   
-
     
(1
)
   
(1
)
Time deposits
   
(21
)
   
(16
)
   
(37
)
   
(24
)
   
(197
)
   
(221
)
Junior subordinated debentures
   
-
     
2
     
2
     
-
     
1
     
1
 
Borrowings
   
90
     
(124
)
   
(34
)
   
110
     
(200
)
   
(90
)
Total interest expense
   
116
     
(120
)
   
(4
)
   
178
     
(336
)
   
(158
)
Net change in net interest income
 
$
1,235
   
$
(834
)
 
$
401
   
$
1,868
   
$
(425
)
 
$
1,443
 

Provision for Loan Losses

We established a provision for loan losses, which is charged to operations, at a level management believes is appropriate to absorb probable incurred credit losses in the loan portfolio.  In evaluating the level of the allowance for loan losses, management considers historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral, and prevailing economic conditions.  This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as future events change. 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 $220,000 in provision for loan losses for the three month period ended September 30, 2015, as compared to $410,000 for the three month period ended September 30, 2014.  The decrease in the provision for loan losses was due principally to a general improvement in the loan portfolio's credit quality resulting in a reduction in nonperforming loans to total loans from 1.61% at December 30, 2014 to 1.27% at September 30, 2015.  Partially offsetting this improvement in loan quality was a 12.6% increase in average loan balances over the nine month period ended September 30, 2015 and the corresponding increase in estimable and probable loan losses inherent in the performing loan portfolio.

For the first nine months of 2015 we recorded $1.0 million in provision for loan losses as compared to $930,000 in the same prior year period. This increase was due primarily to a 12.0% increase in average loan balances between the first nine months of 2015 and the first nine months of 2014.

Management extensively reviews trends in historical losses, environmental factors and specific reserve needs on loans individually evaluated for impairment in its determination of the adequacy of the allowance for loan losses.

The Company measures delinquency based on the amount of past due loans as a percentage of total loans.  This delinquency ratio improved to 2.7% at September 30, 2015 as compared to 3.0% at December 31, 2014.   This improvement was concentrated in the 60-89 day and 90 days and over past due categories and was primarily in the commercial loan and residential loan product segments.  Commercial lines of credit 30-59 days past due increased to $754,000 at September 30, 2015 from -0- at December 31, 2014.  This increase was primarily the result of three delinquent loans to one borrower totaling $671,000 that were brought current and therefore removed from the delinquency listing in October 2015. The consumer loan product segment, representing 6.7% of the total loan portfolio, reported a small increase in delinquencies between December 31, 2014 and September 30, 2015.
 

 
Noninterest Income

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

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

   
Three months ended September 30,
   
Nine months ended September 30,
 
(Dollars in thousands)
 
2015
   
2014
   
Change
   
2015
   
2014
   
Change
 
Service charges on deposit accounts
 
$
299
   
$
311
   
$
(12
)
   
-3.9
%
 
$
853
   
$
894
   
$
(41
)
   
-4.6
%
Earnings and gain on bank owned life insurance
   
250
     
64
     
186
     
290.6
%
   
400
     
190
     
210
     
110.5
%
Loan servicing fees
   
55
     
81
     
(26
)
   
-32.1
%
   
148
     
202
     
(54
)
   
-26.7
%
Debit card interchange fees
   
131
     
127
     
4
     
3.1
%
   
390
     
369
     
21
     
5.7
%
Other charges, commissions and fees
   
352
     
304
     
48
     
15.8
%
   
1,017
     
880
     
137
     
15.6
%
Noninterest income before gains
   
1,087
     
887
     
200
     
22.5
%
   
2,808
     
2,535
     
273
     
10.8
%
Net gains on sales and redemptions of investment securities
   
88
     
3
     
85
     
2833.3
%
   
188
     
29
     
159
     
548.3
%
Net gains on sales of loans and foreclosed real estate
   
17
     
10
     
7
     
70.0
%
   
13
     
39
     
(26
)
   
-66.7
%
Total noninterest income
 
$
1,192
   
$
900
   
$
292
     
32.4
%
 
$
3,009
   
$
2,603
   
$
406
     
15.6
%

The Company recorded a nonrecurring gain on the proceeds of a life insurance policy in the amount of $135,000 during the three months ended September 30, 2015. This accounted for a significant portion of the $292,000, or 32.4%, increase in total noninterest income in the three months ended September 30, 2015 as compared with the same three month period in 2014. In addition to this amount, the remainder of the increase in total noninterest income between year-over-year third quarter periods was due largely to the increase in commission income from the Agency of $41,000. The increase in net commission income from the Agency was largely the result of the first quarter acquisition of the Baldwinsville, New York based Huntington Agency that closed in the first quarter of 2015. Additionally, the Company recorded gains of $88,000 for the sales of eight investment securities. Partially offsetting the increases in noninterest income noted above was a decrease in loan servicing fees of $26,000 and service charges on deposit accounts of $12,000 as compared with the third quarter of 2014.  The decline in loan servicing fees during the third quarter of 2015 as compared with the same quarter of 2014 was due to the recognition of nonrecurring loan servicing fee income received in 2014 that represented amounts that had been due to the Company from prior periods. The decline in deposit loan servicing fees resulted from a change in the Company's practice of recording certain fees as other noninterest income in 2015 that had been previously recorded as deposit account service fees in prior years.

The Company recorded a nonrecurring gain on the proceeds of a life insurance policy in the amount of $135,000 during the nine months ended September 30, 2015. This accounted for a significant portion of the $406,000, or 15.6%, increase in total noninterest income in the nine months ended September 30, 2015 as compared with the same three month period in 2014. In addition to this amount, the increase in total noninterest income for the nine months ended September 30, 2015 as compared to the same prior year period was due to the increase in other charges, commission and fees due principally to the Agency and the investment services business unit.  An $87,000 increase in net commission income from the Agency was largely the result of the first quarter acquisition activity described above.  Net commission income from the investment services business unit recorded a year-over-year three quarter aggregate increase of $24,000.  Additionally, the Company recorded gains of $188,000 for the sales of 20 securities.  These securities sales were made to release collateral that was previously acquired for a large influx of municipal deposits that were deemed to be temporary, to raise liquidity to fund increased loan volume and to realign the portfolio to meet changes in the Company's overall balance sheet and future cash flow requirements.  Partially offsetting the increases in noninterest income noted above was the decrease in net gains on sales of loans and foreclosed real estate as the third quarter activity recorded a $13,000 gain as compared to the $39,000 in net gains on the sale of four foreclosed real estate properties in the third quarter of 2014.
 

 
Noninterest Expense

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

   
Three months ended September 30,
   
Nine months ended September 30,
 
(Dollars in thousands)
 
2015
   
2014
   
Change
   
2015
   
2014
   
Change
 
Salaries and employee benefits
 
$
2,478
   
$
2,141
   
$
337
     
15.7
%
 
$
7,216
   
$
6,526
   
$
690
     
10.6
%
Building occupancy
   
535
     
421
     
114
     
27.1
%
   
1,479
     
1,193
     
286
     
24.0
%
Data processing
   
462
     
367
     
95
     
25.9
%
   
1,204
     
1,131
     
73
     
6.5
%
Professional and other services
   
206
     
160
     
46
     
28.8
%
   
654
     
508
     
146
     
28.7
%
Advertising
   
116
     
141
     
(25
)
   
-17.7
%
   
352
     
372
     
(20
)
   
-5.4
%
FDIC assessments
   
105
     
99
     
6
     
6.1
%
   
302
     
294
     
8
     
2.7
%
Audits and exams
   
58
     
61
     
(3
)
   
-4.9
%
   
179
     
186
     
(7
)
   
-3.8
%
Other expenses
   
598
     
422
     
176
     
41.7
%
   
1,628
     
1,273
     
355
     
27.9
%
Total noninterest expenses
 
$
4,558
   
$
3,812
   
$
746
     
19.6
%
 
$
13,014
   
$
11,483
   
$
1,531
     
13.3
%

The increase in noninterest expenses between year-over-year third quarter periods was due principally to an increase in salaries and employee benefits, building occupancy, and other expenses.  The detail of these noninterest expenses in the third quarter follows:

The increase in salaries and employee benefits between the year-over-year third quarter periods was principally due to general increases in salary and headcount increases related to the new Syracuse business banking office which opened in the third quarter of 2014.

The increase in building occupancy expenses was principally due to $81,000 in additional depreciation related primarily to newly-acquired furniture and fixtures placed in service throughout 2015 and the addition of the new Syracuse business banking office discussed above.

The increase in data processing costs was primarily due to a combined increase of $68,000 in internet banking and check processing charges related to increased customer usage of the Company's business banking services and increased business banking transaction volume.

The increase in professional and other services expenses was due largely to an additional $33,000 in legal and consulting fees related to ongoing business initiatives related to the proposed merger of Pathfinder Bank with the Bank's wholly-owned subsidiary, Pathfinder Commercial Bank.  See "Recent Events," above.

Other expenses increased in the year-over-year third quarter periods due principally to community service donations that increased by $93,000 and $30,000 in reserves for potential recourse contingencies related to previous residential mortgage loan sales.  The remainder of the increases relate to a range of discretionary spending aimed at enhancing the future competitiveness of the Company in the marketplace.

The increase in noninterest expenses between the nine month period ended September 30, 2015 and the same prior year period was principally due to an increase in salaries and employee benefit expenses, building occupancy expenses, and other expenses.  The detail of these noninterest expenses in the nine month period follows:

The increase in salaries and employee benefits between these two time periods was due to wage and merit increases and personnel expenses related to the operation of the new Syracuse business banking office, ESOP compensation expenses driven by the increase in market value of our common stock shares, and employee benefits.

The increase in building occupancy expenses is primarily related to $104,000 in additional depreciation related primarily to newly-acquired furniture and fixtures placed in service throughout 2015, a $77,000 increase in property taxes, $51,000 related to the lease on the new Syracuse business banking office, and $38,000 related to the increase in building maintenance driven principally by the unusually harsh winter in early 2015.
 

 
The increase in professional and other services expenses was due largely to an additional $135,000 in legal and consulting fees related to ongoing business initiatives.

Other expenses increased in the nine months ended September 30, 2015, as compared to the previous nine-month period in 2014, due to an additional $142,000 in community service donations, an additional $80,000 in reserves for potential contingencies related to previous residential mortgage loan sales, and $36,000 in debit card related expenses.

Income Tax Expense

Income tax expense decreased by $1,000 for the quarter ended September 30, 2015 as compared to the same period in 2014 primarily due to an increase in pretax income and a decrease in the effective tax rate for the year-over-year third quarter periods.  This decrease in the effective income tax rate was substantially produced by the recognition of $135,000 in non-taxable life insurance proceeds. The effective tax rate for the third quarter of 2015 was 26.5%, exclusive of the net income attributable to our controlling interest in the Insurance Agency.  For the three-month period ended September 30, 2014, the effective tax rate was 30.1%.

Income tax expense increased by $62,000 for the nine month period ended September 30, 2015 as compared to the same prior year period due principally to the increase in pretax income between these two periods.  The effective tax rate was 28.6% for the first nine months of 2015 as compared to 29.2% for the same prior year period, exclusive of the net income attributable to our controlling interest in the Insurance Agency.

Significant changes to New York State's tax laws took effect January 1, 2015.  New York has eliminated Article 32, a bank-specific section of its tax law.  The Company will now be subject to Article 9-A, the same regime that covers most other corporations doing business within the state.  The effect of this change is expected to be favorable in its entirety for financial institutions, such as the Company, that do business almost exclusively within the state.  For the three and nine month period ended September 30, 2015, this change did not materially change the recorded New York State tax expense, as now computed, in comparison to the expense that would have been recorded under the previous regime.

Earnings per Share

Basic and diluted earnings per share increased $0.04 and $0.03, respectively in the three months ended September 30, 2015 as compared with the same three month period in 2014.  Basic and diluted earnings per share for the three months ended September 30, 2015 improved to $0.21 and $0.20 per share, respectively, due to the reported increase in net income.

For the nine months ended September 30, 2015, basic and diluted earnings per share increased $0.05 and $0.04, respectively, in 2015 as compared with the same nine month period in 2014.  Basic and diluted earnings per share improved in the 2015 nine month period to $0.49 and $0.48 per share, respectively. The increase in earnings per share between the two nine month periods was due to the reported increase in net income between these two time periods, offset partially by the increase in preferred stock dividends of $34,000.  Further information on earnings per share can be found in Note 3 to our unaudited consolidated financial statements.

Changes in Financial Condition

Assets

Total assets increased $46.1 million, or 8.2%, to $607.2 million at September 30, 2015 as compared to December 31, 2014.  This increase was due primarily to an increase in investment securities, loans, and total cash and cash equivalents.

Total loans receivable increased $27.3 million, or 7.0%, to $414.8 million at September 30, 2015 from December 31, 2014. All loan product segments recorded increases between these two dates led by increases in commercial and industrial loans and 1-4 family first-lien residential mortgages. Pathfinder Bank's disciplined customer contact efforts have allowed us to continue to grow in our targeted market areas while maintaining our credit standards.

Investment securities increased $12.6 million, or 9.8%, to $141.5 million at September 30, 2015 due principally to the need to collateralize the increase in municipal deposits between these two dates. Of the total increase in investment securities, $9.9 million was classified within the available-for-sale portfolio.  The remaining increase was recorded in the held-to-maturity investment securities portfolio.  When new investment securities are acquired, management reviews certain security characteristics and determines the Company's intent and ability to hold the security to maturity.  Based on the security characteristics and management's intentions, the security is classified as either available-for-sale or held-to-maturity.

Liabilities

Total liabilities increased $44.2 million, or 9.0%, to $536.0 million at September 30, 2015.  Deposits increased $80.8 million, or 19.4%, to $496.3 million at September 30, 2015. The increase was due largely to MMDA promotions in the second and third quarters of 2015 resulting in business and municipal deposit increases.  Additionally, demand deposit accounts increased in the business market segment and both demand deposit accounts and NOW accounts increased within the municipal market segment prompted by the seasonal property tax collections in the first three quarters of the year. These increases allowed the total of short term and long term borrowings from the FHLB to be paid down by $36.9 million during the nine months ended September 30, 2015.

Shareholders' Equity

The Company's shareholders' equity, exclusive of the non-controlling interest, increased $2.0 million to $70.8 million at September 30, 2015 from $68.8 million at December 31, 2014.  This increase was principally due to a $1.6 million increase in retained earnings, and a $159,000 decrease in accumulated comprehensive loss.  The increase in retained earnings resulted from $2.1 million in net income offset by $454,000 in dividends declared on our common stock and $97,000 in dividends declared on our SBLF preferred stock.  The decrease in accumulated comprehensive loss was the result of the increase in fair market value of our available for sale investment securities during the third quarter of 2015.

Capital

Capital adequacy is evaluated primarily by the use of ratios which measure capital against total assets, as well as against total assets that are weighted based on defined risk characteristics.  The Company's goal is to maintain a strong capital position, consistent with the risk profile of its subsidiary banks that supports growth and expansion activities while at the same time exceeding regulatory standards.  At September 30, 2015, Pathfinder Bank exceeded all regulatory required minimum capital ratios and met the regulatory definition of a "well-capitalized" institution, i.e. a leverage capital ratio exceeding 5%, a Tier 1 risk-based capital ratio exceeding 8%, Tier 1 common equity exceeding 6.5%, and a total risk-based capital ratio exceeding 10%.

Pathfinder Bank's capital amounts and ratios as of the indicated dates are presented in the following table.
         
 
         
 
        MinimumTo Be "Well-  
     
Minimum
 
Capitalized"
 
     
For Capital
 
Under Prompt
 
 
Actual
 
Adequacy Purposes
 
Corrective Provisions
 
(Dollars in thousands)
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
As of September 30, 2015
           
Total Core Capital (to Risk-Weighted Assets)
 
$
66,189
     
16.70
%
 
$
31,703
     
8.00
%
 
$
39,629
     
10.00
%
Tier 1 Capital (to Risk-Weighted Assets)
 
$
61,060
     
15.41
%
 
$
23,778
     
6.00
%
 
$
31,703
     
8.00
%
Tier 1 Common Equity (to Risk-Weighted Assets)
 
$
61,060
     
15.41
%
 
$
17,833
     
4.50
%
 
$
25,759
     
6.50
%
Tier 1 Capital (to Assets)
 
$
61,060
     
10.23
%
 
$
23,865
     
4.00
%
 
$
29,831
     
5.00
%
As of December 31, 2014:
                                               
Total Core Capital (to Risk-Weighted Assets)
 
$
63,831
     
16.60
%
 
$
30,754
     
8.00
%
 
$
38,443
     
10.00
%
Tier 1 Capital (to Risk-Weighted Assets)
 
$
58,842
     
15.31
%
 
$
15,377
     
4.00
%
 
$
23,066
     
6.00
%
Tier 1 Capital (to Assets)
 
$
58,842
     
10.55
%
 
$
22,302
     
4.00
%
 
$
27,878
     
5.00
%


Loan and Asset Quality and Allowance for Loan Losses

The following table represents information concerning the aggregate amount of non-performing assets at the indicated dates:

 
 
September 30,
   
December 31,
   
September 30,
 
(Dollars In thousands)
 
2015
   
2014
   
2014
 
Nonaccrual loans:
           
Commercial loans
 
$
3,832
   
$
4,030
   
$
5,159
 
Consumer
   
333
     
324
     
255
 
Residential mortgage loans
   
1,083
     
1,902
     
2,028
 
Total nonaccrual loans
   
5,248
     
6,256
     
7,442
 
Total nonperforming loans
   
5,248
     
6,256
     
7,442
 
Foreclosed real estate
   
472
     
261
     
440
 
Total nonperforming assets
 
$
5,720
   
$
6,517
   
$
7,882
 
                         
Troubled debt restructurings not included above
 
$
1,939
   
$
2,219
   
$
1,931
 
                         
Nonperforming loans to total loans
   
1.27
%
   
1.61
%
   
1.99
%
Nonperforming assets to total assets
   
0.94
%
   
1.16
%
   
1.38
%

Nonperforming assets include nonaccrual loans, nonaccrual troubled debt restructurings ("TDR"), and foreclosed real estate. The Company generally places a loan on nonaccrual status and ceases accruing interest when loan payment performance is deemed unsatisfactory and the loan is past due 90 days or more.  There are no loans that are past due 90 days or more and still accruing interest.  Loans are considered modified in a TDR when, due to a borrower's financial difficulties, the Company makes a concession(s) to the borrower that it would not otherwise consider. These modifications may include, among others, an extension of the term of the loan, and granting a period when interest-only payments can be made, with the principal payments made over the remaining term of the loan or at maturity.  TDRs are included in the above table within the following categories of nonaccrual loans or TDRs not included above (the latter also known as accruing TDRs).

As indicated in the table above, nonperforming assets at September 30, 2015 were $5.7 million, $797,000 lower than the $6.5 million at December 31, 2014.  The decrease in nonperforming loans was the result of a decrease of $819,000 in nonperforming residential mortgage loans and a decrease of $198,000 in commercial loans to a single borrower that were restored to accrual status. The decrease in nonperforming residential loans was comprised of two loans totaling $360,000 that were written down and charged off to their net realizable value and transfer to foreclosed assets and three loans totaling $430,000 that were restored to accrual status. This decrease in nonperforming residential and commercial loans was partially offset by a $211,000 increase in foreclosed real estate assets.

As indicated in the nonperforming asset table above, foreclosed real estate ("FRE") balances increased at September 30, 2015 from December 31, 2014 due to the addition of two residential mortgage and two commercial real estate properties.  There were no foreclosed commercial real estate properties at December 31, 2014 and four residential mortgage properties as of that date...  More information regarding foreclosed real estate can be found in Note 8 to our unaudited consolidated financial statements.

Fair values for commercial FRE are initially recorded based on market value evaluations by third parties, less costs to sell ("initial cost basis").  On a prospective basis, and in accordance with Accounting Standards Update 2014-04, residential FRE assets will be initially recorded at the lower of the net amount of loan receivable or the real estate's fair value less costs to sell.   Any write-downs required when the related loan receivable is exchanged for the underlying real estate collateral at the time of transfer to FRE are charged to the allowance for loan losses.  Values are derived from appraisals, similar to impaired loans, of underlying collateral or discounted cash flow analysis.  Subsequent to foreclosure, valuations are updated periodically and assets are marked to current fair value, not to exceed the initial cost basis for the FRE property.
 

 
The allowance for loan losses represents management's estimate of the probable losses inherent in the loan portfolio as of the date of the statement of condition.  The allowance for loan losses was $5.7 million and $5.3 million at September 30, 2015 and December 31, 2014, respectively.    The increase in the allowance for loan losses was due, in part, to the increase in the specific reserves on impaired loans between these two dates.  The Company reported the ratio of the allowance for loan losses to gross loans remained constant at 1.38% at September 30, 2015 and December 31, 2014. Management performs a quarterly evaluation of the allowance for loan losses based on quantitative and qualitative factors and has determined that the current level of the allowance for loan losses is adequate to absorb the losses in the loan portfolio as of September 30, 2015.

The Company considers a loan impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan.   The measurement of impaired loans is generally based upon the fair value of the collateral, with a portion of the impaired loans measured based upon the present value of future cash flows discounted at the historical effective interest rate.  A specific reserve is established for an impaired loan if its carrying value exceeds its estimated fair value.  The estimated fair values of the majority of the Company's impaired loans are measured based on the estimated fair value of the loan's collateral.  For loans secured by real estate, estimated fair values are determined primarily through third-party appraisals or broker price opinions.  When a loan is determined to be impaired Pathfinder Bank will reevaluate the collateral which secures the loan. For real estate, the Company will obtain a new appraisal or broker's opinion whichever is considered to provide the most accurate value in the event of sale. An evaluation of equipment held as collateral will be obtained from a firm able to provide such an evaluation. Collateral will be inspected not less than annually for all impaired loans and will be reevaluated not less than every two years. Appraised values are discounted due to the market's perception of a reduced price Bank-owned property and the Bank's desire to sell the property quicker to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value.  The discounts also include estimated costs to sell the property.

At September 30, 2015 and December 31, 2014, the Company had $6.9 million and $7.4 million in loans, respectively, which were deemed to be impaired, having established specific reserves of $1.0 million and $917,000, respectively, on these loans.  The decrease in impaired loans between these two dates was driven by the decrease in impaired 1-4 family first lien residential mortgages, and partially offset by an increase in impaired loans within the commercial lines of credit and other commercial and industrial loan classes.

Management has identified potential problem loans totaling $9.3 million as of September 30, 2015 which is $900,000 greater than the $8.4 million in potential problem loans reported at December 31, 2014.  These loans have been internally classified as special mention, substandard, or doubtful, yet are not currently considered impaired.  The increase was principally due to the addition of one large commercial relationship across two loans totaling $2.6 million rated as special mention, partially offset by the positive migration of a number of loans into classification categories above special mention. Management has identified potential credit problems which required heightened management attention and may result in the borrowers not being able to comply with the current loan repayment terms and which may result in it being included in future impaired loan reporting.

Appraisals are obtained at the time a real estate secured loan is originated.   For commercial real estate held as collateral, the property is inspected every two years.

In the normal course of business, Pathfinder Bank has infrequently sold residential mortgage loans and participation interests in commercial loans. As is typical in the industry, Pathfinder Bank makes certain representations and warranties to the buyer. Pathfinder Bank maintains a quality control program for closed loans and considers the risks and uncertainties associated with potential repurchase requirements to be minimal.

Liquidity

Liquidity management involves the Company's ability to generate cash or otherwise obtain funds at reasonable rates to support asset growth, meet deposit withdrawals, maintain reserve requirements, and otherwise operate the Company on an ongoing basis.  The Company's primary sources of funds are deposits, borrowed funds, amortization and prepayment of loans and maturities of investment securities and other short-term investments, and earnings and funds provided from operations.  While scheduled principal repayments on loans are a relatively predictable source of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition.  The Company manages the pricing of deposits to maintain a desired deposit composition and balance.  In addition, the Company invests excess funds in short-term interest-earning and other assets, which provide liquidity to meet lending requirements.
 

 
The Company's liquidity has been enhanced by its ability to borrow from the Federal Home Loan Bank of New York, whose competitive advance programs and lines of credit provide the Company with a safe, reliable, and convenient source of funds.  A significant decrease in deposits in the future could result in the Company having to seek other sources of funds for liquidity purposes.  Such sources could include, but are not limited to, additional borrowings, brokered deposits, negotiated time deposits, the sale of "available-for-sale" investment securities, the sale of securitized loans, or the sale of whole loans.  Such actions could result in higher interest expense costs and/or losses on the sale of securities or loans.

Through the first nine months of 2015, as indicated in the Consolidated Statement of Cash Flows, the Company reported net cash flows from financing activities of $43.4 million generated principally by $61.3 million in increased balances of demand, savings and money market deposit accounts, partially offset by a $39.9 million reduction in short-term borrowings.  This increase in the balances of demand, savings and money market deposit accounts was the result of organic growth and new customer relationships within our existing marketplace concentrated in the business and municipal customer segments coupled with targeted promotions for our MMDA product.  The financing proceeds were invested in purchases of investment securities of $13.0 million, net of proceeds from maturities, sales and redemptions.  In addition, $28.5 million was invested in net new loan generation.  Net cash flows from operating activities provided an additional $4.3 million through the first nine months of 2015 resulting in an increase in cash and equivalents of $6.0 million through this time period.  As a recurring source of liquidity, the Company's investment securities provided $22.5 million in proceeds from maturities and principal reductions through the first nine months of 2015.

The Company has a number of existing credit facilities available to it.  At September 30, 2015, total credit available to the Company under the existing lines of credit was approximately $155.0 million at FHLBNY, the Federal Reserve Bank, and three other correspondent banks.  At September 30, 2015, the Company had $29.2 million outstanding on its existing lines of credit with $125.8 million available.

The Asset Liability Management Committee of the Company is responsible for implementing the policies and guidelines for the maintenance of prudent levels of liquidity.  As of September 30, 2015, management reported to the Board of Directors that the Company is in compliance with its liquidity policy guidelines.


Item 3 – Quantitative and Qualitative Disclosures About Market Risk

A smaller reporting company is not required to provide the information relating to this item.


Item 4 – Controls and Procedures

Under the supervision and with the participation of the Company's management, including our Chief Executive Officer and Chief Financial Officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this quarterly report.  Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms.  There has been no change in the Company's internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonable likely to materially affect, the Company's internal control over financial reporting.
 

 
PART II – OTHER INFORMATION

Item 1 – Legal Proceedings

The Company is not currently a named party in a legal proceeding, the outcome of which would have a material and adverse effect on the financial condition or results of operations of the Company.

Item 1A – Risk Factors

A smaller reporting company is not required to provide the information relating to this item.

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3 – Defaults Upon Senior Securities

None

Item 4 – Mine Safety Disclosures

Not applicable

Item 5 – Other Information

None

Item 6 – Exhibits

Exhibit No.                                                                           Description

31.1                          Rule 13a-14(a)/15d-14(a) Certification of the Chief Executive Officer
31.2                          Rule 13a-14(a)/15d-14(a) Certification of the Chief Financial Officer
32.1                 Section 1350 Certification of the Chief Executive Officer and Chief Financial
                        Officer
101 The following materials from Pathfinder Bancorp, Inc. Form 10-Q for the quarter ended September 30, 2015, formatted in Extensible Business Reporting Language (XBRL): (i) the Consolidated Statements of Income, (ii) the Consolidated Statements of Financial Condition, (iii) Consolidated Statements of Cash Flows, and (iv) related notes


SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

PATHFINDER BANCORP, INC.
(registrant)

 November 13, 2015                     /s/ Thomas W. Schneider
Thomas W. Schneider
President and Chief Executive Officer

 November 13, 2015                    /s/ James A. Dowd
James A. Dowd
Senior Vice President and Chief Financial Officer
 
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