UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004
OR
[ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSACTION PERIOD FROM ______________ TO ________________
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COMMISSION FILE NUMBER: 000-23601
PATHFINDER BANCORP, INC.
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(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
FEDERAL 16-1540137
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(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION
INCORPORATION OR ORGANIZATION) (NUMBER)
214 WEST FIRST STREET, OSWEGO, NY 13126
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) (ZIP CODE)
(315) 343-0057
(REGISTRANT'S TELEPHONE NUMBER INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE
(TITLE OF CLASS)
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 TWELVE MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE REPORTS) AND (2) HAS BEEN SUBJECT TO SUCH REQUIREMENTS FOR THE
PAST 90 DAYS.
YES X NO
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INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405
OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE
BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS
INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENTS TO
THIS FORM 10-K. [ X ]
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS
DEFINED IN RULE 12B-2 OF THE ACT).
YES NO X
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The aggregate value of the voting stock held by non-affiliates of the
Registrant, computed by reference to the average bid and asked prices of the
Common Stock as of June 30, 2004 ($15.175) was $8,689,175.
As of June 30, 2004 there were 2,935,419 shares issued and 2,448,132 shares
outstanding of the Registrant's Common Stock.
Documents Incorporated by Reference: Proxy Statement for the 2004 Annual Meeting
of Stockholders (Parts I and III).
PART I
ITEM 1: BUSINESS
GENERAL
PATHFINDER BANCORP, INC.
Pathfinder Bancorp, Inc. (the "Company") is a Federally chartered mid-tier
holding company headquartered in Oswego, New York. The primary business of the
Company is its investment in Pathfinder Bank (the "Bank") and Pathfinder
Statutory Trust I. The Company is majority owned by Pathfinder Bancorp, M.H.C.,
a Federally-chartered mutual holding company (the "Mutual Holding Company").
At December 31, 2004, the Mutual Holding Company held 1,583,239 shares of Common
Stock and the public held 866,893 shares of Common Stock (the "Minority
Shareholders"). At December 31, 2004, Pathfinder Bancorp, Inc. had total assets
of $302.0 million, total deposits of $236.7 million and shareholders' equity of
$21.8 million.
On June 26, 2002, the Company formed a wholly owned subsidiary, Pathfinder
Statutory Trust I, a Connecticut business trust. The trust issued $5,000,000 of
30-year floating rate Company-obligated pooled capital securities of Pathfinder
Statutory Trust I. The Company borrowed the proceeds of the capital securities
from its subsidiary by issuing floating rate junior subordinated deferrable
interest debentures having substantially similar terms. The capital securities
mature in 2032 and qualify as Tier 1 capital by the Federal Deposit Insurance
Company and the Office of Thrift Supervision. The capital securities of the
trust are a pooled trust preferred fund of Preferred Term Securities VI, Ltd.
and are tied to the 3-month LIBOR plus 3.45% with a five year call provision.
These securities are guaranteed by the Company.
The Company's executive office is located at 214 West First Street, Oswego, New
York and the telephone number at that address is (315) 343-0057.
PATHFINDER BANK
The Bank is a New York-chartered savings bank headquartered in Oswego, New York.
The Bank has six full-service offices located in its market area consisting of
Oswego County and the contiguous counties. The Bank's deposits are insured by
the Federal Deposit Insurance Corporation ("FDIC"). The Bank was chartered as a
New York savings bank in 1859 as Oswego City Savings Bank. The Bank is a
consumer-oriented institution dedicated to providing mortgage loans and other
traditional financial services to its customers. The Bank is committed to
meeting the financial needs of its customers in Oswego County, New York, the
county in which it operates.
The Bank is primarily engaged in the business of attracting deposits from the
general public in the Bank's market area, and investing such deposits, together
with other sources of funds, in loans secured by one- to four-family residential
real estate and commercial real estate. At December 31, 2004, $168.8 million,
or 89% of the Bank's total loan portfolio consisted of loans secured by real
estate, of which $123.9 million, or 66%, were loans secured by one- to
four-family residences and $29.9 million, or 16%, were secured by commercial
real estate. Additionally, $15.0 million, or 8%, of total real estate loans,
were secured by second liens on residential properties that are classified as
consumer loans. The Bank also originates commercial and consumer loans that
totaled $16.8 and $3.5 million, respectively, or 11%, of the Bank's total loan
portfolio. The Bank invests a portion of its assets in securities issued by the
United States Government agencies and sponsored enterprises, state and municipal
obligations, corporate debt securities, mutual funds, and equity securities.
The Bank also invests in mortgage-backed securities primarily issued or
guaranteed by the United States Government sponsored enterprises. The Bank's
principal sources of funds are deposits, principal and interest payments on
loans and borrowings from correspondent financial institutions. The principal
source of income is interest on loans and investment securities. The Bank's
principal expenses are interest paid on deposits, and employee compensation and
benefits.
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The Bank's executive office is located at 214 West First Street, Oswego, New
York, and its telephone number at that address is (315) 343-0057.
On October 25, 2002, Pathfinder Bank completed the purchase of assets and the
assumption of non-municipal deposits of the Lacona, New York branch of Cayuga
Bank ("Branch Acquisition"). In addition, Pathfinder Bank formed a limited
purpose commercial bank subsidiary, Pathfinder Commercial Bank. Pathfinder
Commercial Bank was established to serve the depository needs of public entities
in its market area and it assumed the municipal deposit liabilities acquired as
part of the Branch Acquisition. The transaction included approximately $26.4
million in deposits, $2.3 million in loans and $430,000 in vault cash and
facilities and equipment. The Branch Acquisition reflects a premium on deposit
liabilities assumed of approximately $2.4 million. As of December 31, 2004, no
impairment has been recognized.
In April 1999, the Bank established Pathfinder REIT, Inc. as the Bank's
wholly-owned real estate investment trust subsidiary. At December 31, 2004,
Pathfinder REIT, Inc. held $26.8 million in mortgages and mortgage related
assets. Recent legislation proposed by the New York State legislature would
eliminate the tax treatment accorded REITs. Enactment of this legislation would
increase the state tax rate for the Company. All disclosures in the Form 10-K
relating to the Bank's loans and investments include loans and investments that
are held by Pathfinder REIT, Inc.
MARKET AREA AND COMPETITION
The economy in the Bank's market area is manufacturing-oriented and is also
significantly dependent upon the State University of New York College at Oswego.
The major manufacturing employers in the Bank's market area are Entergy Nuclear
Northeast, Novelis, Constellation, NRG and Huhtamaki. The Bank is the second
largest financial institution headquartered in Oswego County. However, the Bank
encounters competition from a variety of sources. The Bank's business and
operating results are significantly affected by the general economic conditions
prevalent in its market areas.
The Bank encounters strong competition both in attracting deposits and in
originating real estate and other loans. Its most direct competition for
deposits has historically come from commercial and savings banks, savings
associations and credit unions in its market area. Competition for loans comes
from such financial institutions as well as mortgage banking companies. The
Bank expects continued strong competition in the foreseeable future, including
increased competition from "super-regional" banks entering the market by
purchasing large banks and savings banks. Many such institutions have greater
financial and marketing resources available to them than does the Bank. The
Bank competes for savings deposits by offering depositors a high level of
personal service and a wide range of competitively priced financial services.
The Bank competes for real estate loans primarily through the interest rates and
loan fees it charges and advertising, as well as by originating and holding in
its portfolio mortgage loans which do not necessarily conform to secondary
market underwriting standards.
REGULATION AND SUPERVISION
GENERAL
The Bank is a New York-chartered stock savings bank and its deposit accounts are
insured up to applicable limits by the FDIC through the Bank Insurance Fund
("BIF"). The Bank is subject to extensive regulation by the New York State
Banking Department (the "Department"), as its chartering agency, and by the
FDIC, as its deposit insurer and primary federal regulator. The Bank is
required to file reports with, and is periodically examined by, the FDIC and the
Superintendent of the Department concerning its activities and financial
condition and must obtain regulatory approvals prior to entering into certain
transactions, including, but not limited to, mergers with or acquisitions of
other banking institutions. The Bank is a member of the FHLB of New York and is
subject to certain regulations by the Federal Home Loan Bank System. On July
19, 2001 the Company and the Mutual Holding Company completed their conversion
to federal charters. Consequently, they are subject to regulations of the
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Office of Thrift Supervision ("OTS") as savings and loan holding companies. Any
change in such regulations, whether by the Department, the FDIC, or the OTS
could have a material adverse impact on the Bank, the Company or the Mutual
Holding Company.
Regulatory requirements applicable to the Bank, the Company and the Mutual
Holding Company are referred to below or elsewhere herein.
NEW YORK BANK REGULATION
The exercise by an FDIC-insured savings bank of the lending and investment
powers under the New York State Banking Law is limited by FDIC regulations and
other federal law and regulations. In particular, the applicable provisions of
New York State Banking Law and regulations governing the investment authority
and activities of an FDIC insured state-chartered savings bank have been
substantially limited by the Federal Deposit Insurance Corporation Improvement
Act of 1991 ("FDICIA") and the FDIC regulations issued pursuant thereto.
The Bank derives its lending, investment and other authority primarily from the
applicable provisions of New York State Banking Law and the regulations of the
Department, as limited by FDIC regulations. Under these laws and regulations,
savings banks, including the Bank, may invest in real estate mortgages, consumer
and commercial loans, certain types of debt securities, including certain
corporate debt securities and obligations of federal, state and local
governments and agencies, certain types of corporate equity securities and
certain other assets. New York State chartered savings banks may also invest in
subsidiaries under their service corporation investment authority. A savings
bank may use this power to invest in corporations that engage in various
activities authorized for savings banks, plus any additional activities, which
may be authorized by the Banking Board. Under FDICIA and the FDIC's
implementing regulations, the Bank's investment and service corporation
activities are limited to activities permissible for a national bank unless the
FDIC otherwise permits it.
The FDIC and the Superintendent have broad enforcement authority over the Bank.
Under this authority, the FDIC and the Superintendent have the ability to issue
formal or informal orders to correct violations of law or unsafe or unsound
banking practices.
INSURANCE OF ACCOUNTS AND REGULATION BY THE FDIC
The Bank is a member of the BIF, which is administered by the FDIC. Deposits
are insured up to applicable limits by the FDIC and such insurance is backed by
the full faith and credit of the U.S. Government.
The FDIC establishes deposit insurance premiums based upon the risks a
particular bank or savings association poses to its deposit insurance funds.
Under the risk-based deposit insurance assessment system, the FDIC assigns an
institution to one of three capital categories based on the institution's
financial information consisting of: (i) well capitalized; (ii) adequately
capitalized; or (iii) undercapitalized and one of three supervisory
subcategories within each capital group. With respect to the capital ratios,
institutions are classified as well capitalized or adequately capitalized using
ratios that are substantially similar to the prompt corrective action capital
ratios discussed above. Any institution that does not meet these two
definitions is deemed to be undercapitalized for this purpose. The supervisory
subgroup to which an institution is assigned is based on a supervisory
evaluation provided to the FDIC by theinstitution's primary federal regulator
and information that the FDIC determines to be relevant to the institution's
financial condition and the risk posed to the deposit insurance funds (which may
include, if applicable, information provided by the institution's state
supervisor). An institution's assessment rate depends on the capital category
and supervisory category to which it is assigned. Under the final risk-based
assessment system, there are nine assessment risk classifications (i.e.,
combinations of capital groups and supervisory subgroups) to which different
assessment rates are applied. Assessments rates for deposit insurance currently
range from 0 basis points to 27 basis points. The capital and supervisory
subgroup to which an institution is assigned by the FDIC is confidential and may
not be disclosed. The Bank's rate of deposit insurance assessments will depend
upon the category and subcategory to which the Bank is assigned by the FDIC.
Any increase in insurance assessments could have an adverse effect on the
earnings of the Bank.
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REGULATORY CAPITAL REQUIREMENTS
The FDIC has adopted risk-based capital guidelines to which the Bank is subject.
The guidelines establish a systematic analytical framework that makes regulatory
capital requirements more sensitive to differences in risk profiles among
banking organizations. The Bank is required to maintain certain levels of
regulatory capital in relation to regulatory risk-weighted assets. The ratio of
such regulatory capital to regulatory risk-weighted assets is referred to as the
Bank's "risk-based capital ratio." Risk-based capital ratios are determined by
allocating assets and specified off-balance sheet items to four risk-weighted
categories ranging from 0% to 100%, with higher levels of capital being required
for the categories perceived as representing greater risk.
These guidelines divide a savings bank's capital into two tiers. The first tier
("Tier I") includes common equity, retained earnings, certain non-cumulative
perpetual preferred stock (excluding auction rate issues) and minority interests
in equity accounts of consolidated subsidiaries, less goodwill and other
intangible assets (except mortgage servicing rights and purchased credit card
relationships subject to certain limitations). Supplementary ("Tier II") capital
includes, among other items, cumulative perpetual and long-term limited-life
preferred stock, mandatory convertible securities, certain hybrid capital
instruments, term subordinated debt and the allowance for loan and lease losses,
subject to certain limitations, less required deductions. Savings banks are
required to maintain a total risk-based capital ratio of at least 8%, of which
at least 4% must be Tier I capital.
In addition, the FDIC has established regulations prescribing a minimum Tier I
leverage ratio (Tier I capital to adjusted total assets as specified in the
regulations). These regulations provide for a minimum Tier I leverage ratio of
3% for banks that meet certain specified criteria, including that they have the
highest examination rating and are not experiencing or anticipating significant
growth. All other banks are required to maintain a Tier I leverage ratio of 3%
plus an additional cushion of at least 100 to 200 basis points. The FDIC and
the other federal banking regulators have proposed amendments to their minimum
capital regulations to provide that the minimum leverage capital ratio for a
depository institution that has been assigned the highest composite rating of 1
under the Uniform Financial Institutions Rating System will be 3% and that the
minimum leverage capital ratio for any other depository institution will be 4%
unless a higher leverage capital ratio is warranted by the particular
circumstances or risk profile of the depository institution. The FDIC may,
however, set higher leverage and risk-based capital requirements on individual
institutions when particular circumstances warrant. Savings banks experiencing
or anticipating significant growth are expected to maintain capital ratios,
including tangible capital positions, well above the minimum levels.
LIMITATIONS ON DIVIDENDS AND OTHER CAPITAL DISTRIBUTIONS
The FDIC has the authority to use its enforcement powers to prohibit a savings
bank from paying dividends if, in its opinion, the payment of dividends would
constitute an unsafe or unsound practice. Federal law also prohibits the
payment of dividends by a bank that will result in the bank failing to meet its
applicable capital requirements on a pro forma basis. New York law also
restricts the Bank from declaring a dividend which would reduce its capital
below (i) the amount required to be maintained by state law and regulation, or
(ii) the amount of the Bank's liquidation account established in connection with
the Reorganization.
PROMPT CORRECTIVE ACTION
The federal banking agencies have promulgated regulations to implement the
system of prompt corrective action required by federal law. Under the
regulations, a bank shall be deemed to be (i) "well capitalized" if it has total
risk-based capital of 10.0% or more, has a Tier I risk-based capital ratio of
6.0% or more, has a Tier I leverage capital ratio of 5.0% or more and is not
subject to any written capital order or directive; (ii) "adequately capitalized"
if it has a total risk-based capital ratio of 8.0% or more, a Tier I risk-based
capital ratio of 4.0% or more and a Tier I leverage capital ratio of 4.0% or
more (3.0% under certain circumstances) and does not meet the definition of
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"well capitalized"; (iii) "undercapitalized" if it has a total risk-based
capital ratio that is lessthan 8.0%, a Tier I risk-based capital ratio that is
less than 4.0% or a Tier I leverage capital ratio that is less than 4.0% (3.0%
under certain circumstances); (iv) "significantly undercapitalized" if it has a
total risk-based capital ratio that is less than 6.0%, a Tier I risk-based
capital ratio that is less than 3.0% or a Tier I leverage capital ratio that is
less than 3.0%; and (v) "critically undercapitalized" if it has a ratio of
tangible equity to total assets that is equal to or less than 2.0%. Federal law
and regulations also specify circumstances under which a federal banking agency
may reclassify a well capitalized institution as adequately capitalized and may
require an adequately capitalized institution to comply with supervisory actions
as if it were in the next lower category (except that the FDIC may not
reclassify a significantly undercapitalized institution as critically
undercapitalized).
Based on the foregoing, the Bank currently meets the criteria to be classified
as a "well capitalized" savings institution.
TRANSACTIONS WITH AFFILIATES AND INSIDERS
Under current federal law, transactions between depository institutions and
their affiliates are governed by Sections 23A and 23B of the Federal Reserve Act
and its implementing regulations. An affiliate of a savings bank is any company
or entity that controls, is controlled by, or is under common control with the
savings bank, other than a subsidiary of the savings bank. In a holding company
context, at a minimum, the parent holding company of a savings bank and any
companies which are controlled by such parent holding company are affiliates of
the savings bank. Generally, Section 23A limits the extent to which the savings
bank or its subsidiaries may engage in "covered transactions" with any one
affiliate to an amount equal to 10% of such savings bank's capital stock and
surplus and contains an aggregate limit on all such transactions with all
affiliates to an amount equal to 20% of such capital stock and surplus. The term
"covered transaction" includes the making of loans or other extensions of credit
to an affiliate; the purchase of assets from an affiliate, the purchase of, or
an investment in, the securities of an affiliate; the acceptance of securities
of an affiliate as collateral for a loan or extension of credit to any person;
or issuance of a guarantee, acceptance, or letter of credit on behalf of an
affiliate. Section 23A also establishes specific collateral requirements for
loans or extensions of credit to, or guarantees, acceptances on letters of
credit issued on behalf of an affiliate. Section 23B requires that covered
transactions and a broad list of other specified transactions be on terms
substantially the same, or no less favorable, to the savings bank or its
subsidiary as similar transactions with nonaffiliates.
Further, Section 22(h) of the Federal Reserve Act and its implementing
regulations restrict a savings bank with respect to loans to directors,
executive officers, and principal stockholders. Under Section 22(h), loans to
directors, executive officers and stockholders who control, directly or
indirectly, 10% or more of voting securities of a savings bank and certain
related interests of any of the foregoing, may not exceed, together with all
other outstanding loans to such persons and affiliated entities, the savings
bank's total capital and surplus. Section 22(h) also prohibits loans above
amounts prescribed by the appropriate federal banking agency to directors,
executive officers, and stockholders who control 10% or more of voting
securities of a stock savings bank, and their respective related interests,
unless such loan is approved in advance by a majority of the board of directors
of the savings bank. Any "interested" director may not participate in the
voting. The loan amount (which includes all other outstanding loans to such
person) as to which such prior board of director approval is required, is the
greater of $25,000 or 5% of capital and surplus or any loans over $500,000.
Further, pursuant to Section 22(h), loans to directors, executive officers and
principal stockholders must generally be made on terms substantially the same as
offered in comparable transactions to other persons. Section 22(g) of the
Federal Reserve Act places additional limitations on loans to executive
officers.
FEDERAL HOLDING COMPANY REGULATION
GENERAL. The Company and the Mutual Holding Company are nondiversified mutual
savings and loan holding companies within the meaning of the Home Owners' Loan
Act. The Company and the Mutual Holding Company are registered with the OTS and
are subject to OTS regulations, examinations, supervision and reporting
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requirements. As such, the OTS has enforcement authority over the Company and
the Mutual Holding Company, and their non-savings institution subsidiaries.
Among other things, this authority permits the OTS to restrict or prohibit
activities that are determined to be a serious risk to the subsidiary savings
institution.
PERMITTED ACTIVITIES. Under OTS regulation and policy, a mutual holding company
and a federally chartered mid-tier holding company, such as the Company, may
engage in the following activities: (i) investing in the stock of a savings
association; (ii) acquiring a mutual association through the merger of such
association into a savings association subsidiary of such holding company or an
interim savings association subsidiary of such holding company; (iii) merging
with or acquiring another holding company, one of whose subsidiaries is a
savings association; (iv) investing in a corporation, the capital stock of which
is available for purchase by a savings association under federal law or under
the law of any state where the subsidiary savings association or associations
share their home offices; (v) furnishing or performing management services for a
savings association subsidiary of such company; (vi) holding, managing or
liquidating assets owned or acquired from a savings subsidiary of such company;
(vii) holding or managing properties used or occupied by a savings association
subsidiary of such company; (viii) acting as trustee under deeds of trust; (ix)
any other activity (A) that the Federal Reserve Board, by regulation, has
determined to be permissible for bank holding companies under Section 4(c) of
the Bank Holding Company Act of 1956, unless the Director of the OTS, by
regulation, prohibits or limits any such activity for savings and loan holding
companies; or (B) in which multiple savings and loan holding companies were
authorized (by regulation) to directly engage on March 5, 1987; (x) any activity
permissible for financial holding companies under Section 4(k) of the Bank
Holding Company Act, including securities and insurance underwriting; and (xi)
purchasing, holding, or disposing of stock acquired in connection with a
qualified stock issuance if the purchase of such stock by such savings and loan
holding company is approved by the Director. If a mutual holding company
acquires or merges with another holding company, the holding company acquired or
the holding company resulting from such merger or acquisition may only invest in
assets and engage in activities listed in (i) through (xi) above, and has a
period of two years to cease any nonconforming activities and divest of any
nonconforming investments.
The Home Owners' Loan Act prohibits a savings and loan holding company, directly
or indirectly, or through one or more subsidiaries, from acquiring another
savings association or holding company thereof, without prior written approval
of the OTS. It also prohibits the acquisition or retention of, with certain
exceptions, more than 5% of a nonsubsidiary savings association, a nonsubsidiary
holding company, or a nonsubsidiary company engaged in activities other than
those permitted by the Home Owners' Loan Act; or acquiring or retaining control
of an institution that is not federally insured. In evaluating applications by
holding companies to acquire savings associations, the OTS must consider the
financial and managerial resources, future prospects of the company and
association involved, the effect of the acquisition on the risk to the insurance
fund, the convenience and needs of the community and competitive factors.
The Office of Thrift Supervision is prohibited from approving any acquisition
that would result in a multiple savings and loan holding company controlling
savings associations in more than one state, subject to two exceptions: (i) the
approval of interstate supervisory acquisitions by savings and loan holding
companies, and (ii) the acquisition of a savings institution in another state if
the laws of the state of the target savings institution specifically permit such
acquisitions. The states vary in the extent to which they permit interstate
savings and loan holding company acquisitions.
WAIVERS OF DIVIDENDS BY MUTUAL HOLDING COMPANY. Office of Thrift Supervision
regulations require the Mutual Holding Company to notify the OTS of any proposed
waiver of its receipt of dividends from the Company
CONVERSION OF THE MUTUAL HOLDING COMPANY TO STOCK FORM. OTS regulations permit
the Mutual Holding Company to convert from the mutual form of organization to
the capital stock form of organization (a "Conversion Transaction"). There can
be no assurance when, if ever, a Conversion Transaction will occur, and the
Board of Directors has no current intention or plan to undertake a Conversion
Transaction. In a Conversion Transaction a new holding company would be formed
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as the successor to the Company (the "New Holding Company"), the Mutual Holding
Company's corporate existence would end, and certain depositors of the Bank
would receive the right to subscribe for additional shares of the New Holding
Company. In a Conversion Transaction, each share of common stock held by
stockholders other than the Mutual Holding Company ("Minority Stockholders")
would be automatically converted into a number of shares of common stock of the
New Holding Company determined pursuant an exchange ratio that ensures that
Minority Stockholders own the same percentage of common stock in the New Holding
Company as they owned in the Company immediately prior to the Conversion
Transaction. Under OTS regulations, Minority Stockholders would not be diluted
because of any dividends waived by the Mutual Holding Company (and waived
dividends would not be considered in determining an appropriate exchange ratio),
in the event the Mutual Holding Company converts to stock form. The total
number of shares held by Minority Stockholders after a Conversion Transaction
also would be increased by any purchases by Minority Stockholders in the stock
offering conducted as part of the Conversion Transaction.
NEW YORK STATE BANK HOLDING COMPANY REGULATION
In addition to the federal regulation, a holding company controlling a state
chartered savings bank organized or doing business in New York State also may be
subject to regulation under the New York State Banking Law. The term "bank
holding company," for the purposes of the New York State Banking Law, is defined
generally to include any person, company or trust that directly or indirectly
either controls the election of a majority of the directors or owns, controls or
holds with power to vote more than 10% of the voting stock of a bank holding
company or, if the Company is a banking institution, another banking
institution, or 10% or more of the voting stock of each of two or more banking
institutions. In general, a bank holding company controlling, directly or
indirectly, only one banking institution will not be deemed to be a bank holding
company for the purposes of the New York State Banking Law. As such, neither
the Company nor the Mutual Holding Company is subject to supervision by the
Department.
FEDERAL SECURITIES LAW
The common stock of the Company is registered with the SEC under the Exchange
Act. The Company is subject to the information, proxy solicitation, insider
trading restrictions and other requirements of the SEC under the Exchange Act.
The Company Common Stock held by persons who are affiliates (generally officers,
directors and principal stockholders) of the Company may not be resold without
registration or unless sold in accordance with certain resale restrictions. If
the Company meets specified current public information requirements, each
affiliate of the Company is able to sell in the public market, without
registration, a limited number of shares in any three-month period.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board requires all depository institutions to maintain
noninterest-bearing reserves at specified levels against their transaction
accounts (primarily checking, money management and NOW checking accounts). At
December 31, 2004, the Bank was in compliance with these reserve requirements.
FEDERAL COMMUNITY REINVESTMENT REGULATION
Under the Community Reinvestment Act, as amended (the "CRA"), as implemented by
FDIC regulations, a savings bank has a continuing and affirmative obligation,
consistent with its safe and sound operation, to help meet the credit needs of
its entire community, including low and moderate income neighborhoods. The CRA
does not establish specific lending requirements or programs for financial
institutions nor does it limit an institution's discretion to develop the types
of products and services that it believes are best suited to its particular
community, consistent with the CRA. The CRA requires the FDIC, in connection
with its examination of a savings institution, to assess the institution's
record of meeting the credit needs of its community and to take such record into
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account in its evaluation of certain applications by such institution. The CRA
requires the FDIC to provide a written evaluation of an institution's CRA
performance utilizing a four-tiered descriptive rating system. The Bank's
latest CRA rating was "outstanding."
NEW YORK STATE COMMUNITY REINVESTMENT REGULATION
The Bank is also subject to provisions of the New York State Banking Law which
impose continuing and affirmative obligations upon banking institutions
organized in New York State to serve the credit needs of its local community
("NYCRA") which are substantially similar to those imposed by the CRA. Pursuant
to the NYCRA, a bank must file an annual NYCRA report and copies of all federal
CRA reports with the Department. The NYCRA requires the Department to make a
biennial written assessment of a bank's compliance with the NYCRA, utilizing a
four-tiered rating system and make such assessment available to the public. The
NYCRA also requires the Superintendent to consider a bank's NYCRA rating when
reviewing a bank's application to engage in certain transactions, including
mergers, asset purchases and the establishment of branch offices or automated
teller machines, and provides that such assessment may serve as a basis for the
denial of any such application.
The Bank's NYCRA rating as of its latest examination was "satisfactory."
THE USA PATRIOT ACT
The USA PATRIOT Act was signed into law on October 26, 2001. The USA PATRIOT
Act gives the federal government new powers to address terrorist threats through
enhanced domestic security measures, expanded surveillance powers, increased
information sharing and broadened anti-money laundering requirements. The USA
PATRIOT Act also requires the federal banking agencies to take into
consideration the effectiveness of controls designed to combat money laundering
activities in determining whether to approve a merger or other acquisition
application of a member institution. Accordingly, if we engage in a merger or
other acquisitions, our controls designed to combat money laundering would be
considered as part of the application process. We have established policies,
procedures and systems designed to comply with these regulations.
SARBANES-OXLEY ACT OF 2002
The Sarbanes-Oxley Act of 2002 was signed into law on July 30, 2002. The
Sarbanes-Oxley Act of 2002 is a law that addresses, among other issues,
corporate governance, auditing and accounting, executive compensation, and
enhanced and timely disclosure of corporate information. As directed by Section
302(a) of Sarbanes-Oxley Act of 2002, the Company Chief Executive Officers and
Chief Financial Officer are each required to certify that the company's
quarterly and annual reports do not contain any untrue statement of a material
fact. The rules have several requirements, including having these officers
certify that: they are responsible for establishing, maintaining and regularly
evaluating the effectiveness of our internal controls; they have made certain
disclosures to our auditors and the audit committee of the Board of Directors
about our internal controls; and they have included information in our quarterly
an annual reports about their evaluation and whether there have been significant
changes in our internal controls or in other factors that could significantly
affect internal controls subsequent to the evaluation. We will be subject to
further reporting and audit requirements with the year ending December 31, 2006
under the requirements of Sarbanes-Oxley. We have existing policies, procedures
and systems designed to comply with these regulations, and are further enhancing
and documenting such policies, procedures and systems to ensure continued
compliance with these regulations.
The company maintains an Internet website located at WWW.PATHFINDERBANK.COM on
which, among other things, the Company makes available, free of charge, various
reports that it files with or furnishes to the Securities and Exchange
Commission, including its Annual Report on Form 10-K, quarterly reports on Form
10-Q, and current reports on Form 8-K. The Company has also made available on
its website its Audit Committee Charter and corporate governance guidelines.
These reports are made available as soon as reasonably practicable after these
reports are filed with or furnished to the Securities and Exchange Commission.
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Page 8
FEDERAL AND STATE TAXATION
FEDERAL TAXATION
The following discussion of federal taxation is intended only to summarize
certain pertinent federal income tax matters and is not a comprehensive
description of the tax rules applicable to the Company or the Bank.
BAD DEBT RESERVES. Prior to the 1996 Act, the Bank was permitted to establish a
reserve for bad debts and to make annual additions to the reserve. These
additions could, within specified formula limits, be deducted in arriving at the
Bank's taxable income. As a result of the 1996 Act, the Bank must use the small
bank experience method in computing its bad debt deduction beginning with its
1996 Federal tax return.
TAXABLE DISTRIBUTIONS AND RECAPTURE. Prior to the 1996 Act, bad debt reserves
created prior to January 1, 1988 were subject to recapture into taxable income
should the Bank fail to meet certain thrift asset and definitional tests. New
federal legislation eliminated these thrift related recapture rules. However,
under current law, pre-1988 reserves remain subject to recapture should the Bank
cease to retain a bank or thrift charter or make certain non-dividend
distributions.
MINIMUM TAX. The Internal Revenue Code imposes an alternative minimum tax
("AMT") at a rate of 20% on a base of regular taxable income plus certain tax
preferences ("alternative minimum taxable income" or "AMTI"). The AMT is
payable to the extent such AMTI is in excess of an exemption amount. Net
operating losses can offset no more than 90% of AMTI. Certain payments of
alternative minimum tax may be used as credits against regular tax liabilities
in future years.
NET OPERATING LOSS CARRYOVERS. A financial institution may carry back net
operating losses to the preceding two taxable years and forward to the
succeeding 20 taxable years. This provision applies to losses incurred in
taxable years beginning after August 5, 1997.
The Internal Revenue Service has examined the federal income tax return for the
fiscal year ended 1992; the New York State fiscal year-end tax returns for 1998
through 1999 are currently under examination by the New York State Department of
Taxation and Finance. See Note 13 to the Financial Statements.
STATE TAXATION
NEW YORK TAXATION. The Bank is subject to the New York State Franchise Tax on
Banking Corporations in an annual amount equal to the greater of (i) 8.0% of the
Bank's "entire net income" allocable to New York State during the taxable year,
or (ii) the applicable alternative minimum tax. The alternative minimum tax is
generally the greater of (a) 0.01% of the value of the Bank's assets allocable
to New York State with certain modifications, (b) 3% of the Bank's "alternative
entire net income" allocable to New York State, or (c) $250. Entire net income
is similar to federal taxable income, subject to certain modifications and
alternative entire net income is equal to entire net income without certain
modifications. Net operating losses arising in can be carried forward to the
succeeding 20 taxable years.
The Company's Annual Report on Form 10-K may be accessed on the Company's
website at WWW.PATHFINDERBANK.COM.
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ITEM 2: PROPERTIES
The Bank conducts its business through its main office located in Oswego, New
York, and five full service branch offices located in Oswego County. The
following table sets forth certain information concerning the main office and
each branch office of the Bank at December 31, 2004. The aggregate net book
value of the Bank's premises and equipment was $7.6 million at December 31,
2004. For additional information regarding the Bank's properties, see Note 8 to
Notes to Financial Statements
LOCATION OPENING DATE OWNED/LEASED
- -----------------------------------------------------
Main Office . . . . . . . 1874 Owned
214 West First Street
Oswego, New York 13126
Plaza Branch. . . . . . . 1989 Owned (1)
Roue 104, Ames Plaza
Oswego, New York 13126
Mexico Branch . . . . . . 1978 Owned
Norman and Main Streets
Mexico, New York 13114
Oswego East Branch. . . . 1994 Owned
34 East Bridge Street
Oswego, New York 13126
Lacona Branch . . . . . . 2002 Owned
1897 Hardwood Drive
Lacona, New York 13083
Fulton Branch . . . . . . 2003 Owned (2)
5 West First Street South
Fulton, New York 13069
- --------------------------------------------------------------------------------
(1) The building is owned; the underlying land is leased with an annual rent of
$20,000
(2) The building is owned; the underlying land is leased with an annual rent of
$21,000
ITEM 3: LEGAL PROCEEDINGS
There are various claims and lawsuits to which the Company is periodically
involved incident to the Company's business. In the opinion of management such
claims and lawsuits in the aggregate are immaterial to the Company's
consolidated financial condition and results of operations.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of fiscal 2004 to a vote of
our shareholders.
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Page 10
PART II
ITEM 5: MARKET FOR COMPANY'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS
Pathfinder Bancorp, Inc.'s common stock currently trades on the Nasdaq SmallCap
market under the symbol "PBHC". There were 348 shareholders of record as of
February 21, 2005. The following table sets forth the high and low closing bid
prices and dividends paid per share of common stock for the periods indicated:
DIVIDEND
QUARTER ENDED: HIGH LOW PAID
- ---------------------------------------------------
December 31, 2004. $ 18.500 $16.250 $0.1025
September 30, 2004 16.630 14.770 0.1025
June 30, 2004. . . 19.070 15.050 0.100
March 31, 2004 . . 20.999 17.010 0.100
- ---------------------------------------------------
December 31, 2003. $ 18.459 $16.250 $0.100
September 30, 2003 17.000 14.000 0.100
June 30, 2003. . . 15.250 13.685 0.100
March 31, 2003 . . 14.890 13.200 0.100
- ---------------------------------------------------
DIVIDENDS AND DIVIDEND HISTORY
The Company has historically paid regular quarterly cash dividends on its common
stock, and the Board of Directors presently intends to continue the payment of
regular quarterly cash dividends, subject to the need for those funds for debt
service and other purposes. Payment of dividends on the common stock is subject
to determination and declaration by the Board of Directors and will depend upon
a number of factors, including capital requirements, regulatory limitations on
the payment of dividends, Pathfinder Bank and its subsidiaries results of
operations and financial condition, tax considerations, and general economic
conditions. The Company's mutual holding company, Pathfinder Bancorp, M.H.C.,
may elect to waive or receive dividends each time the Company declares a
dividend. The election to waive the dividend receipt requires prior
non-objection of the Office of Thrift Supervision.
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ITEM 6: SELECTED FINANCIAL DATA
Pathfinder Bancorp, Inc. ("the Company") is the parent company of Pathfinder
Bank and Pathfinder Statutory Trust I. Pathfinder Bank has three operating
subsidiaries - Pathfinder Commercial Bank, Pathfinder REIT Inc., and Whispering
Oaks Development, Inc.
The following selected consolidated financial data sets forth certain financial
highlights of the Company and should be read in conjunction with the
consolidated financial statements and related notes, and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included elsewhere in this annual report on Form 10-K.
2004 2003 2002 2001 2000
- -----------------------------------------------------------------------------------------------------
YEAR END (IN THOUSANDS)
Total assets . . . . . . . . . . . . . . . . . $302,037 $277,940 $279,056 $244,514 $232,355
Loans receivable, net. . . . . . . . . . . . . 185,125 187,002 179,001 162,588 148,362
Deposits . . . . . . . . . . . . . . . . . . . 236,672 206,894 204,522 169,589 161,459
Equity . . . . . . . . . . . . . . . . . . . . 21,826 21,785 23,230 22,185 20,962
FOR THE YEAR (IN THOUSANDS)
Net interest income. . . . . . . . . . . . . . $ 8,905 $ 9,337 $ 8,789 $ 7,853 $ 7,393
Net income . . . . . . . . . . . . . . . . . . 1,405 1,652 1,156 1,602 356
PER SHARE
Net income (basic) . . . . . . . . . . . . . . $ 0.58 $ 0.68 $ 0.45 $ 0.62 $ 0.14
Book value . . . . . . . . . . . . . . . . . . 8.91 8.96 8.90 8.64 8.06
Tangible book value (a). . . . . . . . . . . . 7.04 7.03 7.02 7.63 7.04
Cash dividends declared. . . . . . . . . . . . 0.405 0.40 0.30 0.26 0.24
RATIOS
Return on average assets . . . . . . . . . . . 0.47% 0.59% 0.45% 0.68% 0.16%
Return on average equity . . . . . . . . . . . 6.45% 7.61% 5.01% 7.34% 1.79%
Return on average tangible equity (a). . . . . 8.17% 9.77% 7.03% 8.29% 2.08%
Average equity to average assets . . . . . . . 7.29% 7.77% 8.94% 9.22% 8.91%
Dividend payout ratio (b). . . . . . . . . . . 47.54% 39.41% 36.76% 28.37% 173.62%
Allowance for loan losses to loans receivable. 0.98% 0.91% 0.82% 1.03% 0.86%
Net interest rate spread . . . . . . . . . . . 3.22% 3.53% 3.47% 3.35% 3.34%
Noninterest income to average assets . . . . . 1.02% 0.93% 0.81% 0.79% 0.49%
Noninterest expense to average assets. . . . . 3.12% 3.26% 3.09% 2.90% 3.45%
Efficiency ratio (c) . . . . . . . . . . . . . 77.87% 76.13% 73.18% 70.61% 90.64%
(a) Tangible equity excludes intangible assets.
(b) The dividend payout ratio is calculated using dividends declared and not
waived by the Company's mutual holding company parent, Pathfinder Bancorp,
M.H.C., divided by net income.
(c) The efficiency ratio is calculated as noninterest expense divided by net
interest income plus noninterest income.
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ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
Throughout the Management's Discussion and Analysis ("MD&A") the term, "the
Company", refers to the consolidated entity of Pathfinder Bancorp, Inc.
Pathfinder Bank and Pathfinder Statutory Trust I are wholly owned subsidiaries
of Pathfinder Bancorp, Inc., however, Pathfinder Statutory Trust I is
deconsolidated for reporting purposes (see Note 10). Pathfinder Commercial Bank,
Pathfinder REIT, Inc. and Whispering Oaks Development, Inc. represent wholly
owned subsidiaries of Pathfinder Bank. At December 31, 2004, Pathfinder Bancorp,
M.H.C, the Company's mutual holding company parent, whose activities are not
included in the MD&A, held 64.6% of the Company's outstanding common stock and
the public held 35.4%.
When used in this Annual Report the words or phrases "will likely result", "are
expected to", "will continue", "is anticipated", "estimate", "project" or
similar expression are intended to identify "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements are subject to certain risks and uncertainties, including, among
other things, changes in economic conditions in the Company's market area,
changes in policies by regulatory agencies, fluctuations in interest rates,
demand for loans in the Company's market areas and competition, that could cause
actual results to differ materially from historical earnings and those presently
anticipated or projected. The Company wishes to caution readers not to place
undue reliance on any such forward-looking statements, which speak only as of
the date made. The Company wishes to advise readers that the factors listed
above could affect the Company's financial performance and could cause the
Company's actual results for future periods to differ materially from any
opinions or statements expressed with respect to future periods in any current
statements.
The Company does not undertake, and specifically declines any obligation, to
publicly release the results of any revisions, which may be made to any
forward-looking statements to reflect events or circumstances after the date of
such statements or to reflect the occurrence of anticipated or unanticipated
events.
The Company's business strategy is to operate as a well-capitalized, profitable
and independent community bank dedicated to providing value-added products and
services to our customers. Generally, the Company has sought to implement this
strategy by emphasizing retail deposits as its primary source of funds and
maintaining a substantial part of its assets in locally-originated residential
first mortgage loans, loans to business enterprises operating in its markets,
and in investment securities. Specifically, the Company's business strategy
incorporates the following elements: (i) operating as an independent com-
munity-oriented financial institution; (ii) maintaining capital in excess of
regulatory requirements; (iii) emphasizing investment in one-to-four family
residential mortgage loans, loans to small businesses and investment securities;
and (iv) maintaining a strong retail deposit base.
The Company's net income is primarily dependent on its net interest income,
which is the difference between interest income earned on its investments in
mortgage and other loans, investment securities and other assets, and its cost
of funds consisting of interest paid on deposits and other borrowings. The
Company's net income also is affected by its provision for loan losses, as well
as by the amount of noninterest income, including income from fees, service
charges and servicing rights, net gains and losses on sales of securities, loans
and foreclosed real estate, and noninterest expense such as employee
compensation and benefits, occupancy and equipment costs, data processing costs
and income taxes. Earnings of the Company also are affected significantly by
general economic and competitive conditions, particularly changes in market
interest rates, government policies and actions of regulatory authorities, which
events are beyond the control of the Company. In particular, the general level
of market rates tends to be highly cyclical.
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Page 13
APPLICATION OF CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States and follow
practices within the banking industry. Application of these principles requires
management to make estimates, assumptions and judgments that affect the amounts
reported in the financial statements and accompanying notes. These estimates,
assumptions and judgments are based on information available as of the date of
the financial statements; accordingly, as this information changes, the
financial statements could reflect different estimates, assumptions and
judgments. Certain policies inherently have a greater reliance on the use of
estimates, assumptions and judgments and as such have a greater possibility of
producing results that could be materially different than originally reported.
Estimates, assumptions and judgments are necessary when assets and liabilities
are required to be recorded at fair value or when an asset or liability needs to
be recorded contingent upon a future event. Carrying assets and liabilities at
fair value inherently results in more financial statement volatility. The fair
values and information used to record valuation adjustments for certain assets
and liabilities are based on quoted market prices or are provided by other
third-party sources, when available. When third party information is not
available, valuation adjustments are estimated in good faith by management.
The most significant accounting policies followed by the Company are presented
in Note 1 to the consolidated financial statements. These policies, along with
the disclosures presented in the other financial statement notes and in this
discussion, provide information on how significant assets and liabilities are
valued in the 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 determination of the allowance for loan losses to
be the accounting area that requires the most subjective and complex judgments,
and as such could be the most subject to revision as new information becomes
available.
The allowance for loan losses represents management's estimate of probable loan
losses inherent in the loan portfolio. Determining the amount of the allowance
for loan losses is considered a critical accounting estimate because it requires
significant judgment and the use of estimates related to the amount and timing
of expected future cash flows on impaired loans, estimated losses on pools of
homogeneous loans based on historical loss experience, and consideration of
current economic trends and conditions, all of which may be susceptible to
significant change. The loan portfolio also represents the largest asset type
on the consolidated balance sheet. Note 1 to the consolidated financial
statements describes the methodology used to determine the allowance for loan
losses, and a discussion of the factors driving changes in the amount of the
allowance for loan losses is included in this report.
The Company carries all of its investments at fair value with any unrealized
gains or losses reported net of tax as an adjustment to shareholders' equity.
Based on management's assessment, at December 31, 2004, the Company did not hold
any security that had a fair value decline that is currently expected to be
other than temporary. Consequently, any declines in a specific security's fair
value below amortized cost have not been provided for in the income statement.
The Company's ability to fully realize the value of its investment in various
securities, including corporate debt securities, is dependent on the underlying
creditworthiness of the issuing organization.
EXECUTIVE SUMMARY
Total deposits increased by 14% during 2004, primarily driven by the growth of
municipal deposits. The Company entered the municipal deposit market at the end
of 2002 and has since increased the number of municipal customers by 180%. The
municipal deposit market will be a continued focus in 2005 as well as continued
expansion into new markets in Oswego County. The Company plans on opening a
branch in Central Square, New York in the second quarter of 2005.
Total assets increased 10%, primarily in the investment securities portfolio.
The loan portfolio decreased 1% as loans sales, amortization and pre-payments
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Page 14
outpaced loan originations during 2004. Although the Company experienced a
decline in the loan portfolio, asset quality of the existing loans improved
during 2004. Nonperforming assets to total assets was 0.88% at December 31,
2004 compared to 1.15% in the prior year. The improvement in asset quality is
attributable to the enhancement of collection procedures and the resolution
through foreclosure or charge-off of three significant commercial lending
relationships. The Company expects to concentrate on continued commercial
mortgage and commercial loan growth during 2005. In the first quarter of 2005,
the Company hired a Senior Commercial Lender, with over 22 year of experience in
small business lending. The increase in commercial lending staff and the
relocation of the Business Services Division to a prime retail location are
primary strategies for achieving growth in commercial lending during 2005.
Net income for 2004 was $1.4 million, or $0.58 per share, as compared to $1.7
million, or $0.68 per share, in 2003. Soft loan demand combined with a
flattening of the interest rate yield curve resulted in compression of net
interest margin and a reduction in earnings. Long-term interest rates remain at
historic lows while the Federal Reserve Bank has increased short-term rates 100
basis points over the past year. The Company expects continued margin
compression during 2005 as a result of monetary policy, general economic
conditions, and the Company's asset-liability management modeling.
The Company plans to enhance other interest income during 2005 by increasing the
customer deposit base and increasing overdraft, returned check and non-
sufficient fund charges to be in line with local competitors. The Company
continues to focus on the development of its employees, systems, branch
structure and product offerings to enhance customer service. During 2004 and
continuing in 2005, the Company received New York State grant money to conduct
comprehensive training programs for all employees in leadership skills,
performance management and business metrics.
RESULTS OF OPERATIONS
Net income for 2004 was $1.4 million, a decrease of $247,000, or 15%, compared
to net income of $1.6 million for 2003. Basic earnings per share decreased to
$0.58 per share for the year ended December 31, 2004 from $0.68 per share for
the year ended December 31, 2003. Return on average equity decreased 15% to
6.45% in 2004 from 7.61% in 2003.
Net interest income, on a tax equivalent basis, decreased $375,000, or 4%,
primarily resulting from interest rate spread compression as longer term assets
have repriced at lower rates while shorter term cost of funds are repricing at
higher rates. Provision for loans losses increased 23% due to the charge-off of
two commercial credit relationships during the fourth quarter of 2004. The
Company experienced a 10% increase in other income, net of securities gains and
losses, primarily attributable to increased deposit levels and the related
service charges associated with checking accounts and other charges, commissions
and fees. Operating expenses increased 2% due to the hiring of additional staff
and an increase in data processing expenses. The Company expects higher
operating costs when the Central Square branch opens in 2005.
NET INTEREST INCOME
Net interest income is the Company's primary source of operating income for
payment of operating expenses and providing for possible loan losses. It is the
amount by which interest earned on interest-earning deposits, loans and
investment securities, exceeds the interest paid on deposits and other
interest-bearing liabilities. Changes in net interest income and net interest
margin ratios result from the interaction between the volume and composition of
earning assets, interest-bearing liabilities, related yields and associated
funding costs.
Net interest income, on a tax-equivalent basis, decreased $376,000, or 4%, to
$9.1 million for the year ended December 31, 2004, as compared to the year ended
December 31, 2003. The Company's net interest margin for 2004 decreased to 3.35%
from 3.68% in 2003. The decrease in net interest income is attributable to
decreased yields in interest earning assets and was offset by a decrease in the
costs of interest bearing liabilities. The average balance of interest- earning
assets grew $14.6 million, or 6%, during 2004 and the average balance of
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Page 15
interest-bearing deposits increased by $20.7 million, or 11%. The increase in
the average balance of interest-bearing liabilities primarily resulted from
attracting new municipal deposit customers. The decrease in the average yield on
interest-earning assets by 60 basis points resulted from the downward repricing
of loans from refinancing and originations in the current low interest rate
environment and the purchase of $35.6 million in investment securities at lower
yields than the existing portfolio. The decrease in the yield on interest-
earning assets was partially offset by the increase in the average balance. As a
result, interest income, on a tax-equivalent basis, decreased $751,000 during
2004. Interest expense on deposits decreased $112,000, or 3%, resulting from a
decrease in the cost of deposits to 1.71% in 2004 from 1.96% in 2003. In
addition to the decrease in the cost of deposits, interest expense on borrowings
also decreased by $264,000, or 12%, from the prior year. The decrease in the
cost of funds was partially offset by a $20.7 million, or 11%, increase in the
average deposit balance.
In comparison, net interest income increased $530,000, or 6%, on a tax-
equivalent basis, from 2002 to 2003. The increase in net interest income was
comprised of a decrease in net interest expenses of $1.1 million, or 15%,
partially offset by a decrease in interest income of $544,000, or 3%. The
increase in net interest income is attributable to increased volumes in earning
asset and deposit balances and the maintenance of stable spreads.
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Page 16
AVERAGE BALANCES AND RATES
The following table sets forth information concerning average interest-earning
assets and interest-bearing liabilities and the yields and rates thereon.
Interest income and resultant yield information in the table is on a fully
tax-equivalent basis using marginal federal income tax rates of 34%. Averages
are computed on the daily average balance for each month in the period divided
by the number of days in the period. Yields and amounts earned include loan
fees. Non-accrual loans have been included in interest-earning assets for
purposes of these calculations.
2004 2003
- ------------------------------------------------------------------------------------------------------
Average Average
Average Yield / Average Yield/
(Dollars in thousands) Balance Interest Cost Balance Interest Cost
- ------------------------------------------------------------------------------------------------------
Interest-earning assets:
Real estate loans residential . . . . . . $124,734 $ 7,491 6.01% $129,687 $ 8,346 6.44%
Real estate loans commercial. . . . . . . 30,958 2,254 7.28% 31,122 2,480 7.97%
Commercial loans. . . . . . . . . . . . . 16,060 901 5.61% 14,181 798 5.62%
Consumer loans. . . . . . . . . . . . . . 17,427 1,194 6.85% 15,787 1,225 7.76%
Taxable investment securities . . . . . . 65,480 2,220 3.39% 54,115 2,193 4.05%
Tax-exempt investment securities. . . . . 8,603 488 5.67% 7,869 305 3.87%
Interest-earning deposits . . . . . . . . 7,338 81 1.10% 3,252 33 0.99%
- ------------------------------------------------------------------------------------------------------
Total interest-earning assets . . . . . . $270,600 $ 14,629 5.41% $256,013 $ 15,380 6.01%
Noninterest-earning assets:
Other assets. . . . . . . . . . . . . . . 30,236 24,859
Allowance for loan losses . . . . . . . . (1,792) (1,591)
Net unrealized gains
on available for sale securities. . . . (515) 52
- ------------------------------------------------------------------------------------------------------
Total Assets . . . . . . . . . . . . . . $298,529 $279,333
======================================================================================================
Interest-bearing liabilities:
NOW accounts. . . . . . . . . . . . . . . $ 20,808 $ 135 0.65% $ 17,663 $ 140 0.79%
Money management accounts . . . . . . . . 40,775 567 1.39% 21,788 248 1.14%
Savings and club accounts . . . . . . . . 68,046 453 0.67% 66,481 511 0.77%
Time deposits . . . . . . . . . . . . . . 82,769 2,484 3.00% 85,751 2,852 3.33%
Junior subordinated debentures. . . . . . 5,155 251 4.80% 5,000 236 4.66%
Borrowings. . . . . . . . . . . . . . . . 37,674 1,683 4.47% 43,490 1,961 4.51%
- ------------------------------------------------------------------------------------------------------
Total Interest-bearing liabilities. . . . $255,227 $ 5,573 2.19% $240,173 $ 5,948 2.48%
- ------------------------------------------------------------------------------------------------------
Noninterest-bearing liabilities:
Demand deposits . . . . . . . . . . . . . 17,974 16,345
Other liabilities . . . . . . . . . . . . 3,556 1,098
- ------------------------------------------------------------------------------------------------------
Total liabilities . . . . . . . . . . . . 276,757 257,616
- ------------------------------------------------------------------------------------------------------
Shareholders' equity. . . . . . . . . . . 21,772 21,717
Total liabilities & shareholders' equity. $298,529 $279,333
======================================================================================================
Net interest income . . . . . . . . . . . $ 9,056 $ 9,432
Net interest rate spread. . . . . . . . . 3.22% 3.53%
Net interest margin . . . . . . . . . . . 3.35% 3.68%
- ------------------------------------------------------------------------------------------------------
Ratio of average interest-earning assets
to average interest-bearing liabilities . 106.02% 106.60%
- ------------------------------------------------------------------------------------------------------
2002
- ---------------------------------------------------------------------------
Average
Average Yield/
Balance Interest Cost
- ---------------------------------------------------------------------------
Interest-Earning Assets:
Real estate loans residential. . . . . . . $117,688 $ 8,194 6.96%
Real estate loans commercial . . . . . . . 31,790 2,641 8.31%
Commercial loans . . . . . . . . . . . . . 14,774 984 6.66%
Consumer loans . . . . . . . . . . . . . . 12,795 1,117 8.73%
Taxable investment securities. . . . . . . 46,247 2,437 5.27%
Tax-exempt investment securities . . . . . 6,036 434 7.19%
Interest-earning deposits. . . . . . . . . 9,163 117 1.28%
- ---------------------------------------------------------------------------
Total interest-earning assets. . . . . . . $238,493 $ 15,924 6.68%
Noninterest-earning assets:
Other assets . . . . . . . . . . . . . . 20,987
Allowance for loan losses. . . . . . .. . (1,877)
Net unrealized gains
on available for sale securities . .. . 368
- ---------------------------------------------------------------------------
Total Assets. . . . . . . . . . . . .. . $257,971
===========================================================================
Interest-bearing liabilities:
NOW accounts . . . . . . . . . . . . . . $ 15,850 $ 168 1.06%
Money management accounts. . . . . . . . 11,571 242 2.09%
Savings and club accounts. . . . . . . . 62,494 948 1.52%
Time deposits. . . . . . . . . . . . . . . 77,701 3,299 4.25%
Junior subordinated debentures 2,635 138 5.24%
Borrowings. . . . . . . . . . . . . . . 48,626 2,228 4.58%
- ---------------------------------------------------------------------------
Total Interest-bearing liabilities . . . . $218,877 $ 7,023 3.21%
- ---------------------------------------------------------------------------
Noninterest-bearing liabilities:
Demand deposits. . . . . . . . . . . . . . 13,154
Other liabilities. . . . . . . . . . . . . 2,873
- ---------------------------------------------------------------------------
Total liabilities. . . . . . . . . . . . . 234,904
- ---------------------------------------------------------------------------
Shareholders' equity . . . . . . . . . . . 23,067
- ---------------------------------------------------------------------------
Total liabilities & shareholders' equity . $257,971
===========================================================================
Net interest income. . . . . . . . . . . . $ 8,901
Net interest rate spread . . . . . . . . . 3.47%
Net interest margin. . . . . . . . . . . . 3.73%
- ---------------------------------------------------------------------------
Ratio of average interest-earning assets
to average interest-bearing liabilities. . 108.96%
- ---------------------------------------------------------------------------
INTEREST INCOME
Average loans decreased 1% in 2004, with yields declining 48 basis points to
6.26%. The Company's average residential mortgage loan portfolio decreased $5.0
million, or 4%, when comparing the year 2004 to 2003. The average yield on the
residential mortgage loan portfolio decreased 43 basis points to 6.01% in 2004
from 6.44% in 2003. New loans were originated at lower rates than in the prior
- --------------------------------------------------------------------------------
Page 17
period and a large volume of existing mortgages had their rates modified
downward or were refinanced at lower rates. An increase in the average balance
of consumer loans of $1.6 million, or 10%, resulted from an increase in home
equity loans. The average yield declined 91 basis points, to 6.85% from 7.76% in
2003, primarily resulting from the increase in home equity loans, which are
based on the Bank's prime rate. Average commercial loans increased 13% while the
tax-equivalent yield remained consistent at 5.61% in 2004 compared to 5.62%, in
2003.
Average loans increased $13.7 million in 2003, with yields declining 57 basis
points to 6.74%. The interest income on loans decreased $87,000, or 0.7%, in
2003 compared to 2002. For the comparable periods, average residential mortgage
loans increased $12.0 million, or 10%, average consumer loans increased $3.0
million, or 23%, partially offset by a decrease in average commercial loans by
$593,000, or 4%, and a decrease in average commercial mortgage loans by
$668,000, or 2%.
Interest income on investment securities increased 8% from 2003 resulting from
an increase in the average balance of investment securities (taxable and
tax-exempt) by $12.1 million, or 20%, to $74.1 million in 2004 from $62.0
million in 2003. The tax-equivalent yield decreased 37 basis points to 3.66% in
2004 from 4.03% in 2003 resulting primarily from significant investment
purchases in the current year at lower yields than the existing investment
portfolio.
Average investment securities (taxable and tax-exempt) in 2003 increased by $9.7
million, with a decrease in tax-equivalent interest income from investments of
$373,000, or 13%, compared to 2002. The average tax-equivalent yield of the
portfolio declined 146 basis points, to 4.03% from 5.49%. The increase in the
average balance of investment securities resulted from the investment of the net
proceeds received in the purchase of assets and the assumption of the deposits
of the Lacona, New York branch of Cayuga Bank (the "Branch Acquisition") into
the investment and loan portfolios.
INTEREST EXPENSE
Interest expense decreased $375,000, or 6%, in 2004, when compared to 2003. The
decrease in the cost of funds resulted from a reduction in the average cost of
interest-bearing liabilities of 30 basis points, to 2.18% in 2004 from 2.48% at
2003. The decrease in the cost of funds was partially offset by a $15.1
million, or 6%, increase in the average balance of interest-bearing liabilities
during 2004. The cost of deposits decreased 25 basis points to 1.71% during
2004 from 1.96% for 2003. The decrease in the cost of deposits was partially
offset by a $20.7 million, or 11%, increase in the average balance of deposits.
The cost of junior subordinated debentures increased 14 basis points, increasing
interest expense by $15,000.
Interest expense decreased $1.1 million, or 15%, in 2003 compared to 2002. The
average cost of interest bearing liabilities declined 73 basis points during the
12 months ended December 31, 2003.
- --------------------------------------------------------------------------------
Page 18
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
changing 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.
Years Ended December 31,
- -------------------------------------------------------------------------------------------------------
2004 vs. 2003 2003 vs. 2002
Increase/(Decrease) Due to Increase/(Decrease) Due to
- -------------------------------------------------------------------------------------------------------
Total Total
Increase Increase
(In thousands) Volume Rate (Decrease) Volume Rate (Decrease)
- -------------------------------------------------------------------------------------------------------
Interest Income:
Real estate loans residential. . . $ (311) $ (544) $ (855) $ 794 $ (642) $ 152
Real estate loans commercial . . . (13) (213) (226) (55) (106) (161)
Commercial loans . . . . . . . . . 81 22 103 (38) (148) (186)
Consumer loans . . . . . . . . . . 120 (151) (31) 241 (133) 108
Taxable investment securities. . . 417 (390) 27 331 (575) (244)
Tax-exempt investment securities . 31 152 183 108 (237) (129)
Interest-earning deposits. . . . . 45 3 48 (62) (22) (84)
- -------------------------------------------------------------------------------------------------------
Total interest income. . . . . . . 370 (1,121) (751) 1,319 (1,863) (544)
Interest Expense:
NOW accounts. . . . . . . . . . . 22 (27) (5) 18 (46) (28)
Money management accounts. . . . . 255 64 319 149 (143) 6
Savings and club accounts. . . . . 12 (70) (58) 57 (494) (437)
Time deposits. . . . . . . . . . . (96) (272) (368) 318 (765) (447)
Junior subordinated debentures . . 8 7 15 114 (16) 98
Borrowings . . . . . . . . . . . . (262) (16) (278) (232) (34) (266)
- -------------------------------------------------------------------------------------------------------
Total interest expense . . . . . . (61) (314) (375) 424 (1,498) (1,074)
- -------------------------------------------------------------------------------------------------------
Net change in net interest income. $ 431 $ (807) $ (376) $ 895 $ (365) $ 530
========================================================================================================
- --------------------------------------------------------------------------------
Page 19
NONINTEREST INCOME
The Company's noninterest income is primarily comprised of fees on deposit
account balances and transactions, loan servicing, commissions, and net gains on
securities, loans and foreclosed real estate.
The following table sets forth certain information on noninterest income for the
years indicated.
For the Years Ended December 31,
- -----------------------------------------------------------------------------------
(In thousands) 2004 2003 2002
- -----------------------------------------------------------------------------------
Service charges on deposit accounts . . . . . . . . . . . . $ 967 $ 818 $ 629
Loan servicing fees . . . . . . . . . . . . . . . . . . . . 256 282 265
Increase in the value of bank owned life insurance. . . . . 175 171 179
Net gains on sales of loans/foreclosed real estate. . . . . 279 326 193
Other charges, commissions and fees . . . . . . . . . . . . 598 469 438
- -----------------------------------------------------------------------------------
Core noninterest income . . . . . . . . . . . . . . . . . . 2,275 2,066 1,704
Net gains on sales and impairment of investment securities. 772 542 390
- -----------------------------------------------------------------------------------
Total noninterest income. . . . . . . . . . . . . . . . . . $3,047 $2,608 $2,094
===================================================================================
Noninterest income in 2004 increased 17%, compared to 2003, as a result of a 10%
increase in core noninterest income and a 42% increase in the non-core item, net
gains on sales and impairment of investment securities. The increase in the
number of deposit accounts and the introduction of new services to customers
primarily accounted for the $149,000 increase in service charges on deposit
accounts when compared to 2003. A $129,000 increase in other charges,
commissions and fees primarily resulted from recording $54,000 in New York State
grant income associated with a company wide Leadership Training initiative
program, along with increased foreign ATM usage fees and fees associated with
the company's Visa debit card. Net gains on the sale of loans/foreclosed real
estate decreased $47,000, or 14%, resulting primarily from a $40,000 reduction
in the gain recognized on the sale of loans to the secondary market as the
volume of loans sold decreased 47%. Investment security gains increased
$230,000, or 42%, when compared to the 2003 period. Investment security net
gains consist of net gains associated with the sale of equity and corporate debt
securities.
Noninterest income increased $514,000, or 25%, in 2003 compared to 2002. The
increase was primarily attributable to a $362,000 increase in the core
noninterest income components: a $189,000 increase in service charges on deposit
accounts; a $17,000 increase in loan servicing fees due to the increase in our
servicing portfolio and a $133,000 increase in net gains on sale of
loans/foreclosed real estate and a $31,000 increase in other charges,
commissions and fees. These increases in core noninterest income were partially
offset by an $8,000 decrease in the value of bank owned life insurance. The
increase in the net gains on sale of loans/foreclosed real estate primarily
resulted from the Company recognizing an increase in the gain of $152,000 in
2003 related to the sale of loans to the secondary market. The $152,000 increase
in net gains on sales of security investments when compared to 2002 primarily
resulted from the Company recognizing a $275,000 impairment loss on a corporate
debt security in the fourth quarter of 2002.
- --------------------------------------------------------------------------------
Page 20
NONINTEREST EXPENSE
The following table sets forth certain information on noninterest expense for
the years indicated.
For the Years Ended December 31,
- -----------------------------------------------------------
(In thousands) 2004 2003 2002
- -----------------------------------------------------------
Salaries and employee benefits. . $4,798 $4,455 $3,757
Building occupancy. . . . . . . . 1,031 1,004 796
Data processing expenses. . . . . 981 868 920
Professional and other services . 682 770 858
Amortization of intangible asset. 223 223 39
Other expenses. . . . . . . . . . 1,592 1,774 1,594
- -----------------------------------------------------------
Total noninterest expense . . . . $9,307 $9,094 $7,964
===========================================================
Noninterest expenses increased $213,000, or 2%, for the 12 months ended December
31, 2004 when compared to 2003. Salaries and employee benefits increased 8%
in 2004 primarily resulting from incremental salary raises and promotions, the
hiring of a Human Resource Manager and increased pension and health insurance
costs. The 13% increase in data processing expenses during 2004 related to
additional depreciation costs associated with a full year's operation of the new
Fulton branch, combined with a 15% increase in internet banking usage,
additional check processing charges due to a 5% increase in customer volume from
a checking account acquisition program, and additional ATM processing charges
related to the installation of a new ATM machine and products and supplies
resulting from the increase in customer volume. Professional and other services
decreased 11% due to a reduction in legal fees relating to a foreclosed property
in 2003, not recurring in 2004 and a reduction in mortgage consulting fees as
in-house personnel were used to perform work that was originally contracted.
These reductions were offset by an increase in consulting fees associated with
the checking account acquisition program and expenses associated with a
leadership training program. Corresponding grant income recorded in other
income offset the leadership training program expenses. The 10% decrease in
other operating expenses during 2004 resulted primarily from a $164,000 expense
relating to personnel realignment in 2003.
Noninterest expenses increased 14% for the 12 months ended December 31, 2003
when compared to 2002. Salaries and employee benefits increased 19% in 2003
primarily resulting from the incremental salary and benefit costs associated
with the operation of an additional branch location and increased pension and
health insurance costs. The 26% increase in building occupancy expenses during
2003 also related to additional costs associated with a full year's operation of
the additional branch. Amortization expense for 2003 increased $184,000 due to
the amortization of branch acquisition intangibles. The 11% increase in other
operating expenses during 2003 resulted primarily from a $164,000 expense
relating to personnel realignment.
INCOME TAX EXPENSE
Income tax expense decreased $99,000 to $502,000 for the year ended December 31,
2004 as compared to $601,000 in the prior year. The decrease in income tax
expense reflected lower pre-tax income during the year. The Company's effective
tax rate remained at 27% in 2004. The Company has reduced its tax rate from
the statutory rate primarily through the ownership of tax-exempt investment
securities, bank owned life insurance and other tax saving strategies.
Enactment of proposed state tax legislation regarding Real Estate Investment
Trusts would increase the state tax rate for the Company.
Income tax expense increased $213,000 to $601,000 for the year ended December
31, 2003 as compared to $388,000 in the prior year. The increase in income tax
expense reflected higher pre-tax income during the year. The Company's
effective tax rate increased to 27% in 2003 compared to 25% in the prior year.
- --------------------------------------------------------------------------------
Page 21
CHANGES IN FINANCIAL CONDITION
INVESTMENT SECURITIES
The investment portfolio represents 28% of the Company's earning assets and is
designed to generate a favorable rate of return consistent with safety of
principal while assisting the Company in meeting the liquidity needs of the loan
and deposit operations and managing the Company's interest rate risk strategies.
All of the Company's investments are classified as available for sale. The
Company invests in investment securities consisting primarily of mortgage-backed
securities, securities issued by United States Government agencies and sponsored
enterprises, state and municipal obligations, mutual funds, equity securities,
investment grade corporate debt instruments, and common stock issued by the
Federal Home Loan Bank of New York (FHLB of NY). By investing in these types of
assets, the Company reduces the credit risk of its asset base, but must accept
lower yields than would typically be available on commercial real estate loans
and multi-family real estate loans.
Investment securities and Federal Home Loan Bank ("FHLB") stock increased $17.2
million, or 29%, to $76.8 million at December 31, 2004 from $59.6 million at
December 31, 2003. The increase in investment securities was primarily
attributable to the acquisition of investment securities to collateralize
municipal accounts. In comparison, investment securities decreased $2.9
million, or 5%, from 2002 to 2003. The decrease in investment securities was
primarily attributable to the acceleration of principal repayment on
mortgaged-backed securities, reflecting refinancing activity in the underlying
loans.
The following table sets forth the carrying value of the Company's investment
portfolio and Federal Home Loan Bank Stock at the dates indicated.
AT DECEMBER 31,
- --------------------------------------------------------------------------------------------
(In Thousands) 2004 2003 2002
- --------------------------------------------------------------------------------------------
Investment Securities:
US treasury and agencies. . . . . . . . . . . . . . . $ 21,609 $ 6,354 $ 4,378
State and political subdivisions. . . . . . . . . . . 8,881 7,359 8,549
Corporate . . . . . . . . . . . . . . . . . . . . . . 5,919 6,421 15,375
Mortgage-backed . . . . . . . . . . . . . . . . . . . 32,213 29,734 24,440
Equity securities and FHLB stock. . . . . . . . . . . 2,800 2,932 6,225
Mutual funds. . . . . . . . . . . . . . . . . . . . . 5,935 5,712 2,582
- --------------------------------------------------------------------------------------------
$ 77,357 $58,512 $61,549
Unrealized (loss) gain on available for sale portfolio. (520) 1,095 957
- --------------------------------------------------------------------------------------------
Total investments in securities and FHLB stock. . . $ 76,837 $59,607 $62,506
============================================================================================
- --------------------------------------------------------------------------------
Page 22
The following table sets forth the scheduled maturities, amortized cost, fair
values and average yields for the Company's investment securities and Federal
Home Loan Bank ("FHLB") Stock at December 31, 2004. Yield is calculated on the
amortized cost to maturity and adjusted to a fully tax-equivalent basis.
ONE YEAR OR LESS ONE TO FIVE YEARS FIVE TO TEN YEARS
- -------------------------------------------------------------------------------------------------------------------------
ANNUALIZED ANNUALIZED ANNUALIZED
AMORTIZED WEIGHTED AMORTIZED WEIGHTED AMORTIZED WEIGHTED
(Dollars in thousands) COST AVERAGE YIELD COST AVERAGE YIELD COST AVERAGE YIELD
- -------------------------------------------------------------------------------------------------------------------------
Debt investment securities:
US Treasury and agencies. . . . . . . . - - $ 14,679 2.64% $ 6,929 3.81%
State and political subdivisions. . . . $ 849 7.01% 3,582 5.52% 1,863 5.17%
Corporate . . . . . . . . . . . . . . . $ 1,998 1.52% 799 6.96% 986 4.93%
- -------------------------------------------------------------------------------------------------------------------------
Total . . . . . . . . . . . . . . . . . $ 2,847 3.16% $ 19,060 3.37% $ 9,778 4.18%
Equity and mortgage-backed securities:
Mutual funds. . . . . . . . . . . . . . $ 5,935 1.48% - - - -
Mortgage-backed . . . . . . . . . . . . - - $ 2,534 4.80% $ 10,883 3.88%
Equity securities and FHLB stock. . . . 2,800 1.73% - - - -
- -------------------------------------------------------------------------------------------------------------------------
Total . . . . . . . . . . . . . . . . . $ 8,735 1.56% $ 2,534 5.76% $ 10,883 3.83%
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT SECURITIES . . . . . . $ 11,582 1.95% $ 21,594 3.53% $ 20,661 4.02%
===========================================================================================================================
MORE THAN TEN YEARS TOTAL INVESTMENT SECURITIES
- -------------------------------------------------------------------------------------------------------
ANNUALIZED ANNUALIZED
AMORTIZED WEIGHTED AMORTIZED FAIR WEIGHTED
(Dollars in thousands) COST AVERAGE YIELD COST VALUE AVERAGE YIELD
- -------------------------------------------------------------------------------------------------------
Debt investment securities:
US Treasury and agencies. . . . . . . . $ - - $ 21,608 $21,212 3.02%
State and political subdivisions. . . . 2,588 6.22% 8,882 9,012 5.80%
Corporate . . . . . . . . . . . . . . . 2,136 3.10% 5,919 5,959 4.83%
- -------------------------------------------------------------------------------------------------------
Total . . . . . . . . . . . . . . . . . 4,724 4.88% 36,409 36,183 3.99%
Equity and mortgage-backed securities:
Mutual funds. . . . . . . . . . . . . . - - 5,935 5,902 1.47%
Mortgage-backed . . . . . . . . . . . . 18,796 4.03% 32,213 32,027 4.04%
Equity securities and FHLB stock. . . . - - 2,800 2,725 1.73%
- -------------------------------------------------------------------------------------------------------
Total . . . . . . . . . . . . . . . . . 18,796 0.00% 40,948 40,654 3.51%
- -------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT SECURITIES . . . . . . $ 23,520 4.18% $ 77,357 $76,837 3.74%
=======================================================================================================
- --------------------------------------------------------------------------------
Page 23
LOANS RECEIVABLE
Loans receivable represent 69% of the Company's earning assets and account for
the greatest portion of total interest income. The Company emphasizes
residential real estate financing and anticipates a continued commitment to
financing the purchase or improvement of residential real estate in its market
area. The Company also extends credit to businesses within its marketplace
secured by commercial real estate, equipment, inventories and accounts
receivable. It is anticipated that small business lending in the form of
mortgages, term loans, leases, and lines of credit will provide the most
opportunity for balance sheet and revenue growth over the near term. Commercial
loans comprise 9% of the total loan portfolio. At December 31, 2004, 89% of the
Company's total loan portfolio consisted of loans secured by real estate, of
which 16% consisted of commercial real estate loans.
December 31,
- -----------------------------------------------------------------------------
(In thousands) 2004 2003 2002 2001 2000
- -----------------------------------------------------------------------------
Residential real estate (1) $123,898 $128,989 $123,178 $112,110 $ 97,268
Commercial real estate. . . 29,874 31,278 32,657 30,455 27,367
Commercial loans. . . . . . 16,834 15,090 13,196 14,358 12,873
Consumer loans. . . . . . . 18,505 16,880 15,068 12,615 12,987
- -----------------------------------------------------------------------------
Total Loans Receivable $189,111 $192,237 $184,099 $169,538 $150,495
=============================================================================
(1) Includes loans held for sale.
The following table shows the amount of loans outstanding as of December 31,
2004 which, based on remaining scheduled repayments of principal, are due in the
periods indicated. Demand loans having no stated schedule of repayments and no
stated maturity, and overdrafts are reported as on year or less. Adjustable and
floating rate loans are included in the period on which interest rates are next
schedules to adjust rather than the period in which they contractually mature,
and fixed rate loans are included in the period in which the final contractual
repayment is due.
Due Under Due 1-5 Due Over
(In thousands) One Year Years Five Years Total
- ---------------------------------------------------------------------
Real estate:
Commercial real estate . $ 5,683 $ 19,939 $ 4,252 $ 29,874
Construction . . . . . . 419 332 4,179 4,930
Residential real estate. 39,755 59,365 19,848 118,968
- ---------------------------------------------------------------------
$ 45,857 $ 79,636 $ 28,279 $153,772
- ---------------------------------------------------------------------
Commercial . . . . . . . 12,726 3,673 435 16,834
Consumer . . . . . . . . 9,595 4,592 4,318 18,505
- ---------------------------------------------------------------------
Total loans. . . . . . . $ 68,178 $ 87,901 $ 33,032 $189,111
- ---------------------------------------------------------------------
Interest rates:
Fixed. . . . . . . . . . 33,793 61,482 25,139 120,414
Variable . . . . . . . . 34,385 26,419 7,893 68,697
- ---------------------------------------------------------------------
Total Loans. . . . . . . $ 68,178 $ 87,901 $ 33,032 $189,111
=====================================================================
Total loans receivable decreased $3.1 million, or 2%, over the prior year. By
comparison, loans receivable increased $8.1 million, or 4%, in 2003 from 2002.
The decrease of the loan portfolio is primarily attributable to the decrease in
residential and commercial mortgages as amortization, prepayments and sales
outpaced loan originations of $29.3 million during 2004. Decreases in the
mortgage portfolios were partially offset by an increase in municipal loans and
consumer loans. The growth in the consumer loan portfolio is primarily home
equity loan originations.
- --------------------------------------------------------------------------------
Page 24
Residential real estate loans decreased $5.1 million, or 4%, during 2004. The
residential real estate portfolio consists of 64% in fixed-rate mortgages and
36% in adjustable-rate mortgages. The decrease in the residential real estate
portfolio is principally due to a net decrease in 15-year fixed rate mortgages
of $7.5 million and a $1.3 million decrease in 30-year fixed rate loans held for
sale, partially offset by an increase in the adjustable rate mortgage portfolio.
The Company focused its mortgage marketing efforts on hybrid adjustable rate
mortgages ("ARM"s). Hybrid ARMs have rates that are fixed for an initial period
(principally 3, 5, 7 or 10 years) and then convert to one-year adjustable rate
mortgages. During 2003, the Company originated $23.0 million of 30-year fixed
rate mortgages and subsequently sold them into the secondary market as customers
continued to refinance their higher fixed rate and adjustable rate mortgages
into the fixed rate portfolio products, as compared to $17.1 million in
originations of 30-year fixed rate mortgages in 2002.
Commercial real estate loans decreased $1.4 million, or 4%, from the prior year
as amortization and pre-payments outpaced loan originations during 2004.
Commercial real estate loans decreased $1.4 million, or 4%, during 2003.
Consumer loans, which include second mortgage loans, home equity lines of
credit, direct installment and revolving credit loans, increased 10% to $18.5
million at December 31, 2004. The increase resulted from an increase in home
equity lines of credit and second mortgage loans. The Company has promoted its
home equity products by offering the customer loans with no closing costs and
competitive market rates. Management feels these loans are an attractive use of
funds and will continue to promote home equity products in 2005. During 2003,
consumer loans increased $1.8 million, or 12%, resulting primarily from an
increase in home equity products.
Commercial loans, including loans to municipalities, increased 12% over the
prior year to $16.8 million at December 31, 2004. The increase in commercial
loans resulted from a $900,000 increase in short-term loans to the Company's
municipal customers and an $800,000 net increase in small business loans. The
balance of municipal loans at December 31, 2003 was $2.6 million. In
comparison, commercial loans, including municipal loans, increased 14% during
2003 primarily due to the origination of municipal loans.
NONPERFORMING LOANS AND ASSETS
The following table represents information concerning the aggregate amount of
nonperforming assets:
DECEMBER 31,
- ------------------------------------------------------------------------------------------------------
(Dollars in thousands) 2004 2003 2002 2001 2000
- ------------------------------------------------------------------------------------------------------
Nonaccrual loans:
Commercial real estate and commercial. . . . . . . $ 776 $1,677 $ 603 $ 488 $ 169
Consumer . . . . . . . . . . . . . . . . . . . . . 122 172 166 56 65
Real estate - construction . . . . . . . . . . . . - 270 - - -
mortgage. . . . . . . . . . 953 873 942 1,576 1,594
- ------------------------------------------------------------------------------------------------------
Total nonaccrual loans . . . . . . . . . . . . . . $ 1,851 $2,992 $1,711 $2,120 $1,828
Loans past due 90 days or more and still accruing. - - - - -
- ------------------------------------------------------------------------------------------------------
Total non-performing loans . . . . . . . . . . . . $ 1,851 $2,992 $1,711 $2,120 $1,828
Foreclosed real estate . . . . . . . . . . . . . . 798 202 1,396 632 884
- ------------------------------------------------------------------------------------------------------
Total non-performing assets. . . . . . . . . . . . $ 2,649 $3,194 $3,107 $2,752 $2,712
======================================================================================================
Non-performing loans to total loans. . . . . . . . 0.98% 1.59% 0.95% 1.30% 1.23%
Non-performing assets to total assets. . . . . . . 0.88% 1.15% 1.11% 1.13% 1.17%
- ------------------------------------------------------------------------------------------------------
Interest income received on nonaccrual loans . . . - - - - -
- ------------------------------------------------------------------------------------------------------
Interest income that would have been recorded
under the original terms of the loans. . . . . . . $ 64 $ 75 $ 141 $ 118 $ 132
- ------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Page 25
Total nonperforming assets (nonperforming loans and foreclosed real estate) at
December 31, 2004 were 0.88% of total assets as compared to 1.15% of total
assets at December 31, 2003. Total nonperforming loans (past due 90 days or
more) decreased $1.1 million, or 38%, during 2004. The total delinquent loans
(those 30 days or more delinquent) as a percentage of total loans were 1.93% at
December 31, 2004 compared to 3.46% at December 31, 2003. Approximately 51% of
the Company's nonperforming loans at December 31, 2004 are secured by
residential real estate with loss potential expected to be manageable within the
allocated reserves. Nonperforming loans decreased 38% primarily due to the
resolution of certain commercial credit relationships through payment,
foreclosure and transfer into foreclosed real estate or the charge-off of
unrecoverable amounts. In addition, the Bank has instituted a more stringent
collection policy that has successfully reduced consumer and residential
mortgage delinquencies by 18%. Foreclosed real estate increased $596,000
primarily due to the foreclosure of three commercial properties during 2004 that
are presently being marketed and are carried at their expected realizable value.
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. 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 present value of
future cash flows discounted at the historical effective interest rate, except
that all collateral-dependent loans are measured for impairment based on fair
value of the collateral. The Company used the fair value of collateral to
measure impairment on commercial and commercial real estate loans in 2004. At
December 31, 2004 the Company had $3.1 million in loans which were deemed to be
impaired having a valuation allowance of $760,000. $2.6 million of the impaired
loan balance represents one commercial credit relationship that was restructured
during 2004. A $600,000 impairment reserve is recorded on this relationship.
The customer has been making payments according to the restructured terms.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is a reserve established through charges to
expense in the form of a provision for loan losses and reduced by loan
charge-offs net of recoveries. Allowance for loan losses represents the amount
available for probable credit losses in the Company's loan portfolio as
estimated by management. The Company maintains an allowance for loan losses
based upon a monthly evaluation of known and inherent risks in the loan
portfolio, which includes a review of the balances and composition of the loan
portfolio as well as analyzing the level of delinquencies in each segment of the
loan portfolio. The Company uses a general allocation method for the
residential real estate and the consumer loan pools based upon a methodology
that uses loss factors applied to loan balances and reflects actual loss
experience, delinquency trends and current economic conditions. The Company
reviews individually, commercial real estate and commercial loans greater than
$150,000, on nonaccrual and risk rated under the Company's risk rating system,
as special mention, substandard, doubtful or loss to determine if the loans are
impaired. If loans are determined to be impaired, the Company establishes a
specific reserve allocation. The specific allocation is determined based on the
most recent valuation of the loan's collateral and the customer's ability to
pay. For all other commercial real estate and commercial loans, the Company
uses the general allocation methodology that establishes a reserve for each risk
rating category. The general allocation methodology for commercial real estate
and commercial loans considers the same factors that are considered when
evaluating residential real estate and consumer loan pools. The allowance for
loan losses reflects management's best estimate of probable loan losses at
December 31, 2004.
The allowance for loans losses was $1.8 million at December 31, 2004, a 7%
increase from December 31, 2003. The allowance for loans losses as a percentage
of total loans increased to 0.98% at December 31, 2004 from 0.91% in the prior
year. Net loan charge-offs were $626,000 during 2004 compared to $364,000 in
2003. The Company experienced a higher level of charge-offs during 2004
resulting from the charge-off of portions of three commercial lending
relationships.
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The following table sets forth the analysis of the allowance for loan losses at
or for the periods indicated.
2004 2003 2002 2001 2000
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% GROSS % GROSS % GROSS % GROSS % GROSS
(Dollars in thousands) AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS
- -----------------------------------------------------------------------------------------------------------------
Commercial real estate and loans $1,483 9.0% $1,218 8.0% $1,042 7.3% $1,083 8.8% $ 455 8.6%
Consumer loans . . . . . . . . . 270 9.9% 120 8.9% 136 8.3% 100 7.7% 353 8.6%
Residential real estate. . . . . 74 81.1% 377 83.1% 303 84.4% 496 83.5% 466 82.8%
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Total. . . . . . . . . . . . . . $1,827 100.0% $1,715 100.0% $1,481 100.0% $1,679 100.0% $1,274 100.0%
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The following table sets forth the allocation of allowance for loan losses by
loan category for the periods indicated. The allocation of the allowance by
category is not necessarily indicative of future losses and does not restrict
the use of the allowance to absorb losses in any category.
(Dollars in thousands) 2004 2003 2002 2001 2000
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Balance at beginning of year. . . . . . . . . $1,715 $1,481 $ 1,679 $1,274 $1,150
Allowance acquired in branch purchase . . . . - - 57 - -
Provisions charged to operating expenses. . . 738 598 1,375 708 244
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Recoveries of loans previously charged-off
Commercial real estate and loans. . . . . . . 41 3 2