-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, ArRGVZ36f1W1qOmG1SZQNXqfoQ5+4mDY58JlXDz4EeGqlKWuQ3FY7CPmA+J9SiV+ 4cvSvKHJZ4jQenPY0rNGQA== 0000950109-98-002280.txt : 19980331 0000950109-98-002280.hdr.sgml : 19980331 ACCESSION NUMBER: 0000950109-98-002280 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980330 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: PATHFINDER BANCORP INC CENTRAL INDEX KEY: 0001046188 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTIONS, NOT FEDERALLY CHARTERED [6036] IRS NUMBER: 161540137 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-23601 FILM NUMBER: 98578271 BUSINESS ADDRESS: STREET 1: 214 W FIRST ST CITY: OSWEGO STATE: DE ZIP: 13126 BUSINESS PHONE: 3153430057 MAIL ADDRESS: STREET 1: 214 W FIRST ST CITY: OSWEGO STATE: DE ZIP: 13126 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 OR [_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transaction period from ____________ to ___________ Commission File Number: 000-23601 PATHFINDER BANCORP, INC. ------------------------------------------------------------------- (Exact Name of Registrant as Specified in its Charter) DELAWARE 16-1540137 --------------------------------- ------------------------------- (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 $.10 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 ______ NO X ------ 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] As of February 28, 1998, there were issued and outstanding 2,874,999 shares of the Registrant's Common Stock. 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 February 28, 1998 ($20.875) was $22,579,820. DOCUMENTS INCORPORATED BY REFERENCE 1. Sections of Annual Report to Stockholders for the fiscal year ended December 31, 1997 (Parts II and IV). 2. Proxy Statement for the 1998 Annual Meeting of Stockholders (Parts I and III). PART I ------ ITEM 1. BUSINESS - ------- -------- GENERAL PATHFINDER BANCORP, INC. Pathfinder Bancorp, Inc. (the "Company") is a Delaware corporation which was organized in September 1997. The only significant asset of the Company is its investment in Oswego City Savings Bank (the "Bank"). The Company is majority owned by Pathfinder Bancorp, MHC, a New York-chartered mutual holding company (the "Mutual Holding Company"). On December 30, 1997 the Company acquired all of the issued and outstanding common stock of the Bank in connection with the Bank's reorganization into the two-tier form of mutual holding company ownership. At that time, each share of outstanding Bank common stock was automatically converted into one share of Company common stock, par value $.l0 per share (the "Common Stock"). At February 28, 1998 the Mutual Holding Company held 1,552,500 of Common Stock and the public held 1,322,499 of Common Stock (the "Minority Shareholders"). 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. OSWEGO CITY SAVINGS BANK The Bank is a New York-chartered savings bank headquartered in Oswego, New York. The Bank has five 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. At December 31, 1997, the Bank had total assets of $196.8 million, total deposits of $152.4 million, and shareholders' equity of $23.6 million. 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. At December 31, 1997, $112.0 million, or 92.1% of the Bank's total loan portfolio consisted of loans secured by real estate, of which $82.7 million, or 73.8%, were loans secured by one- to four-family residences, $17.5 million, or 15.6%, were secured by commercial real estate, $2.2 million, or 2.0%, were secured by multi-family properties and $9.6 million, or 8.6%, of total real estate loans, were secured by second liens on residential properties. The Bank also originates consumer and other loans which totaled $10.8 million, or 8.9%, of the Bank's total loan portfolio. The Bank invests a portion of its assets in securities issued by the United States Government, 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 or agencies thereof. 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. 1 On September 5, 1997, the Bank entered into an Agreement and Plan of Merger (the "Merger Agreement") with Oswego County Savings Bank ("County Savings") providing for the merger of County Savings with and into the Bank with the Bank as the surviving institution (the "Merger"). County Savings is a New York chartered mutual savings bank located in Oswego, New York. At December 31, 1997, County Savings had assets of $112.1 million, deposits of $97.9 million and net worth of $11.2 million. The Merger Agreement provides that additional shares of the Company's Common Stock equal to the fair value of County Savings will be issued in connection with the Merger. The issuance of additional shares of the Common Stock is intended to represent the value of the interest of the depositors of County Savings that is being transferred to the Bank. Current minority Shareholders' existing equity ownership interests will be diluted as a result of the Merger. At this time however, it is impossible to quantify the extent of the dilution Minority Shareholders will experience in their equity interest. Such dilution will depend upon the fair value of County Savings as determined by an independent appraisal, and the market price of the Common Stock preceding the completion of the Merger, as well as the percentage of Common Stock sold in a subscription and community offering if one is conducted. An independent appraisal firm will determine the fair value of County Savings as if County Savings were forming a mutual holding company and conducting a minority stock offering. The Merger is subject to various conditions, including receipt of regulatory approvals from the Federal Reserve Board, the Federal Deposit Insurance Corporation, and the New York Banking Department, as well as receipt of approval of the Company's shareholders and if necessary County Savings' depositors. As a result of regulatory review the terms of the Merger may be significantly modified. 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. 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 Niagara Mohawk, Alcan Aluminum, the New York Power Authority, Nestle and Sealright, a food container manufacturer. 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. 2 LENDING ACTIVITIES LOAN PORTFOLIO COMPOSITION. The Bank's loan portfolio primarily consists of one- to four-family mortgage loans secured by residential and investment properties, as well as mortgage loans secured by multi-family residences and commercial real estate. To a lesser extent the Bank's loan portfolio also includes consumer and business loans. The Bank generally originates loans for retention in its portfolio, although during 1997 the Bank began originating loans (primarily 15 year and 30 year fixed rate mortgages) for securitization and possible sale to government sponsored enterprises. At December 31, 1997, $1.5 million, or 1.8% of the Bank's total one- to four-family real estate portfolio consisted of loans held for sale. In recent years, the Bank has not purchased loans originated by other lenders. At December 31, 1997, 58.6% of the Bank's loan portfolio consisted of one- to four-family adjustable rate mortgage ("ARM") loans. 3 ANALYSIS OF LOAN PORTFOLIO. The following table sets forth the composition of the Bank's loan portfolio in dollar amounts and in percentages of the portfolio at the dates indicated.
YEARS ENDED DECEMBER 31, --------------------------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 ----------------- ----------------- ---------------- ----------------- ---------------- AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- (DOLLARS IN THOUSANDS) Real estate loans: First mortgage loans(1)(3).... $102,403 84.2% $ 90,761 83.5% $ 83,325 83.2% $76,275 85.1% $67,824 86.1% Second mortgage loans(2)..... 9,561 7.9 9,082 8.3 8,303 8.3 7,931 8.8 7,025 8.9 -------- ----- -------- ------ -------- ----- ------- ----- ------- ----- Total real estate loans........ 111,964 92.1 99,843 91.8 91,628 91.5 84,206 93.9 74,849 95.0 -------- ----- -------- ------ -------- ----- ------- ----- ------- ----- Consumer loans and other loans: Consumer...................... 4,278 3.5 3,481 3.2 3,286 3.1 3,258 3.6 2,563 3.2 Student....................... 13 -- 58 0.1 63 0.1 1,085 1.3 864 1.1 Lease financing............... 564 0.5 1,153 1.1 2,013 2.0 835 0.9 708 0.9 Commercial business loans..... 5,908 4.9 5,482 5.0 3,860 3.9 1,028 1.2 616 0.8 -------- ----- -------- ------ -------- ----- ------- ----- ------- ----- Total consumer and other loans....................... 10,763 8.9 10,174 9.4 9,222 9.2 6,206 7.0 4,751 6.0 -------- ----- -------- ------ -------- ----- ------- ----- ------- ----- Total loans receivable....... 122,727 101.0 110,017 101.2 100,850 100.7 90,412 100.9 79,600 101.0 Less: Unearned discount and origination fees............. (314) (0.3) (368) (0.4) (355) (0.4) (429) (0.5) (507) (0.6) Allowance for loan losses..... (828) (0.7) (907) (0.8) (346) (0.3) (315) (0.4) (280) (0.4) -------- ----- -------- ------ -------- ----- ------- ----- ------- ----- Total loans receivable, net......................... $121,585 100.0% $108,742 100.00% $100,149 100.0% $89,668 100.0% $78,813 100.0% ======== ===== ======== ====== ======== ===== ======= ===== ======= =====
_______________________ (1) Includes $82.7 million, $17.5 million and $2.2 million of one- to four- family residential loans, commercial real estate and multi-family loans, respectively, at December 31, 1997. (2) Includes $4.2 million and $5.3 million of home equity line of credit loans and home equity fixed rate, fixed term loans, respectively, at December 31, 1997. (3) Includes $1.5 million of mortgage loans held for sale at December 31, 1997. 4 LOAN MATURITY SCHEDULE. The following table sets forth certain information as of December 31, 1997, regarding the dollar amount of loans maturing in the Bank's portfolio based on their contractual terms to maturity. Demand loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less. Adjustable and floating rate loans are included in the period in which interest rates are next scheduled 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.
ONE THREE FIVE TEN BEYOND WITHIN THROUGH THROUGH THROUGH THROUGH TWENTY ONE YEAR THREE YEARS FIVE YEARS TEN YEARS TWENTY YEARS YEARS TOTAL -------- ----------- ---------- --------- ------------ ------ -------- (IN THOUSANDS) Real estate loans: First mortgage loans...... $44,173 $4,612 $14,561 $10,431 $24,165 $4,461 $102,403 Second mortgage loans..... 4,271 338 923 3,880 149 -- 9,561 Consumer and other loans.. 4,516 1,937 2,094 1,276 940 -- 10,763 ------- ------ ------- ------- ------- ------ -------- Total loans.............. $52,960 $6,887 $17,578 $15,587 $25,254 $4,461 $122,727 ======= ====== ======= ======= ======= ====== ========
The following table sets forth at December 31, 1997, the dollar amount of all fixed rate and adjustable rate loans due or repricing after December 31, 1998.
FIXED ADJUSTABLE TOTAL ------- ---------- ------- (IN THOUSANDS) Real estate loans: First mortgage loans...... $38,282 $19,948 $58,230 Second mortgage loans..... 5,290 -- 5,290 Consumer and other loans.. 5,451 796 6,247 ------- ------- ------- Total loans........... $49,023 $20,744 $69,767 ======= ======= =======
ONE- TO FOUR-FAMILY RESIDENTIAL MORTGAGE LOANS. The Bank's primary lending activity is the origination of first mortgage loans secured by one- to four- family residential properties. A portion of one-to four-family mortgage loans originated by the Bank are secured by non-owner occupied homes which are primarily used to furnish housing to students attending the SUNY College at Oswego. The Bank generally retains in its portfolio all ARM loans that it originates. However, the Bank generally underwrites its loans so as to be eligible for resale in the secondary mortgage market. At December 31, 1997, approximately 91.1% of the Bank's one- to four-family residential real estate loans were secured by owner-occupied properties. Fixed-rate one- to four-family residential mortgage loans originated by the Bank are generally for terms of up to 20 years (although loans originated for sale into the secondary market can have terms up to 30 years), amortize on a monthly basis, and have principal and interest due each month. Such real estate loans often remain outstanding for significantly shorter periods than their contractual terms to maturity, particularly in a declining interest rate environment. Borrowers may refinance or prepay loans at their option. One- to four-family residential mortgage loans originated by the Bank customarily contain "due-on-sale" clauses which permit the Bank to accelerate the indebtedness of the loan upon transfer of ownership of the mortgaged property. Due-on-sale clauses are an important means of increasing the interest rate on existing mortgage loans during periods of rising interest rates. An origination fee of up to 3% is charged on fixed-rate mortgage loans. As a result of the low interest rate environment that has existed in recent years, many of the Bank's borrowers have refinanced their mortgage loans with the Bank at 5 lower interest rates. During years ended December 31, 1997 and 1996, 38.2% and 49.2%, respectively, of the Bank's one- to four-family mortgage loan originations consisted of fixed-rate loans. The Bank also originates ARM loans which serve to reduce interest rate risk. The Bank currently originates one-year ARM loans which adjust each year at 275 basis points (100 basis points equal 1%) above the adjusted six month moving average of the six-month Treasury bill auction discount rate. The Bank also offers a loan product whereby the interest is fixed for the first five years and adjusts annually thereafter. This loan product typically is originated with terms up to 30 years. ARM loans are originated with terms ranging from 5 to 30 years. ARM loans originated by the Bank provide for maximum periodic interest rate adjustment of 2 percent per year and an overall maximum interest rate increase which is determined at the time the loan is originated. However, ARM loans may not adjust to a level below the initial rate. ARMs may be offered at an initial rate below the prevailing market rate. The Bank's one- to four-family ARM loan originations totaled $13.2 million, $8.7 million, and $8.2 million, during the fiscal years 1997, 1996, and 1995, respectively. The Bank requires that borrowers qualify for ARM loans based upon the loan's fully indexed rate. At December 31, 1997, $48.4 million, or 58.6%, of the Bank's one- to four- family loan portfolio consisted of ARM loans. ARM loans generally pose a credit risk in that as interest rates rise, the amount of a borrower's monthly loan payment also rises, thereby increasing the potential for delinquencies and loan losses. At the same time, the marketability of such loans may be adversely affected by higher rates. The Bank also originates loans to finance the construction of one- to four- family owner-occupied residences. Funds are disbursed as construction progresses. Loans to finance one- to four-family construction typically provide for a six-month construction phase during which interest accrues and which is deducted from the funds disbursed. Upon completion of the construction phase the loan automatically converts to permanent financing. At December 31, 1997, the Bank held $1.6 million of one- to four-family construction loans. The Bank's lending policies require private mortgage insurance for loan to value ratios in excess of 80%. COMMERCIAL REAL ESTATE LOANS. Loans secured by commercial real estate constituted approximately $17.5 million, or 14.3%, of the Bank's total loan portfolio at December 31, 1997. At December 31, 1997, substantially all of the Bank's commercial real estate loans were secured by properties located within the Bank's market area. At December 31, 1997, the Bank's commercial real estate loans had an average principal balance of $203,000. At that date, the largest commercial real estate loan had a principal balance of $1.2 million, and was secured by a health care facility. This loan is currently performing in accordance with the original terms. Commercial real estate loans are generally offered with adjustable interest rates tied to a market index which currently is the adjusted six month moving average of the six month Treasury bill auction discount rate, with an overall interest rate cap which is determined at the time the loan is originated. Commercial real estate loans may not adjust to a level below the initial rate. The Bank generally offers commercial real estate loans with from one to five year adjustment periods. The Bank generally makes commercial real estate loans up to 75% of the appraised value of the property securing the loan. An origination fee of up to 2% of the principal balance of the loan is typically charged on commercial real estate loans. Commercial real estate loans originated by the Bank generally are underwritten to mature between 5 and 20 years with an amortization schedule of between 10 and 30 years. The Bank has in the past sold loan participations to other financial institutions and expects to do so in the future as opportunities arise. 6 In underwriting commercial real estate loans the Bank reviews the expected net operating income generated by the real estate to support debt service, the age and condition of the collateral, the financial resources and income level of the borrower and the borrower's experience in owning or managing similar properties. The Bank generally obtains personal guarantees from all commercial borrowers. Loans secured by commercial real estate generally involve a greater degree of risk than one- to four-family residential mortgage loans and carry larger loan balances. This increased credit risk is a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties, and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by commercial real estate is typically dependent upon the successful operation of the related real estate. If the cash flow from the property is reduced, the borrower's ability to repay the loan may be impaired. MULTI-FAMILY REAL ESTATE LOANS. Loans secured by multi-family real estate (real estate containing five or more dwellings) constituted approximately $2.2 million, or 1.8%, of the Bank's total loan portfolio at December 31, 1997. At December 31, 1997, the Bank had a total of 14 loans secured by multi-family real estate properties. The Bank's multi-family real estate loans are secured by multi-family rental properties (primarily townhouses and walk-up apartments). At December 31, 1997, substantially all of the Bank's multi-family real estate loans were secured by properties located within the Bank's market area. At December 31, 1997, the Bank's multi-family real estate loans had an average principal balance of approximately $159,000 and the largest multi-family real estate loan had a principal balance of $367,000, and was performing in accordance with its terms. Multi-family real estate loans generally are offered with adjustable interest rates tied to the adjusted six month moving average of the six month Treasury Bill auction discount rate index with an overall interest rate cap which is determined at the time the loan is originated. Multi-family real estate loans may not adjust below the initial rate. Multi-family real estate loans are underwritten to mature between 5 and 20 years, and to amortize over 10 to 30 years. An origination fee of 1% is generally charged on multi- family real estate loans. In underwriting multi-family real estate loans, the Bank reviews the expected net operating income generated by the real estate to support the debt service, the age and condition of the collateral, the financial resources and income level of the borrower and the borrower's experience in owning or managing similar properties. The Bank generally requires a debt service coverage ratio of at least 120% (net of operating expenses) of the monthly loan payment. The Bank makes multi-family real estate loans up to 75% of the appraised value of the property securing the loan. The Bank generally obtains personal guarantees from all multi-family real estate borrowers. Loans secured by multi-family real estate generally involve a greater degree of credit risk than one-to four-family residential mortgage loans and carry larger loan balances. This increased credit risk is a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties, and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by multi-family real estate and commercial real estate is typically dependent upon the successful operation of the related real estate property. If the cash flow from the project is reduced, the borrower's ability to repay the loan may be impaired. 7 SECOND MORTGAGE LOANS. The Bank also offers home equity loans and equity lines of credit collateralized by a second mortgage on the borrower's principal residence. The Bank's home equity lines of credit are secured by the borrower's principal residence with a maximum loan-to-value ratio, including the principal balances of both the first and second mortgage loans of 80%, or up to 90% where the Bank has made the first mortgage loan. At December 31, 1997, the disbursed portion of home equity lines of credit totaled $4.2 million. Home equity lines of credit are offered on an adjustable rate basis with interest rates tied to the prime rate as published in The Wall Street Journal, plus up to 175 basis points and with terms of up to 15 years. Home equity loans are fixed rate loans with terms generally up to 10 years, although on occasion the Bank may originate a home equity loan with a term of up to 15 years. CONSUMER LOANS. As of December 31, 1997, consumer loans totaled $4.3 million, or 3.5%, of the Bank's total loan portfolio. The principal types of consumer loans offered by the Bank are unsecured personal loans, and loans secured by deposit accounts. Other consumer loans are offered on a fixed rate basis with maturities generally of less than five years. The underwriting standards employed by the Bank for consumer loans include a determination of the applicant's credit history and an assessment of ability to meet existing obligations and payments on the proposed loan. The stability of the applicant's monthly income may be determined by verification of gross monthly income from primary employment, and additionally from any verifiable secondary income. Creditworthiness and the employment history of the applicant are of primary consideration in originating consumer loans, and in the case of home equity lines of credit, the Bank obtains a title guarantee, title search, or an opinion as to the validity of title. COMMERCIAL BUSINESS LOANS. The Bank currently offers commercial business loans to businesses in its market area and to deposit account holders. At December 31, 1997, the Bank had commercial business loans outstanding with an aggregate balance of $6.5 million, of which $3.0 million consisted of commercial lines of credit and $564,000 were lease financing arrangements. The average commercial business loan balance was approximately $55,000. Commercial business loans generally have fixed rates of interest. The loans are generally of short duration with average terms of five years, but which may range up to 15 years. Lease financing arrangements are loans which are secured by pools of leases for medical or dental equipment or general business office equipment. Underwriting standards employed by the Bank for commercial business loans include a determination of the applicant's ability to meet existing obligations and payments on the proposed loan from normal cash flows generated by the applicant's business. The financial strength of each applicant also is assessed through a review of financial statements provided by the applicant. Commercial business loans generally bear higher interest rates than residential loans, but they also may involve a higher risk of default since their repayment is generally dependent on the successful operation of the borrower's business. The Bank generally obtains guarantees from the borrower, a third party, or the Small Business Administration, as a condition to originating its commercial business loans. LOAN ORIGINATIONS, SOLICITATION, PROCESSING, AND COMMITMENTS. Loan originations are derived from a number of sources such as existing customers, developers, walk-in customers, real estate broker referrals, and commissioned mortgage loan originators. Upon receiving a loan application, the Bank obtains a credit report and employment verification to verify specific information relating to the applicant's 8 employment, income, and credit standing. In the case of a real estate loan, an independent appraiser approved by the Bank appraises the real estate intended to secure the proposed loan. A loan processor in the Bank's loan department checks the loan application file for accuracy and completeness, and verifies the information provided. Mortgage loans of up to $150,000 may be approved by any designated loan officer; mortgage loans in excess of $150,000 must be approved by the Board of Directors. Commercial loans of up to $35,000 unsecured, or $50,000 (if secured by other than real estate) may be approved by the Bank's President or either of the two lending Vice Presidents. These individuals may join their limits to a total approval amount of $105,000 unsecured, and $150,000 secured. Loans in excess of these limits must be approved by either the entire Board of Directors, or a subcommittee of the Board of Directors. The Board of Directors, at their monthly meeting, will review and verify that management's approvals of loans are made within the scope of management's authority. Fire and casualty insurance is required at the time the loan is made and throughout the term of the loan, and upon request of the Bank, flood insurance may be required. After the loan is approved, a loan commitment letter is promptly issued to the borrower. At December 31, 1997, the Bank had commitments to originate $14.0 million of loans. If the loan is approved, the commitment letter specifies the terms and conditions of the proposed loan including the amount of the loan, interest rate, amortization term, a brief description of the required collateral, and required insurance coverage. The borrower must provide proof of fire and casualty insurance on the property (and, as required, flood insurance) serving as collateral, which insurance must be maintained during the full term of the loan. Title insurance, title search, or an opinion of counsel as to the validity of title are required on all loans secured by real property. In recent years, the Bank has not purchased loans originated by other lenders. ORIGINATION, PURCHASE AND SALE OF LOANS. The table below shows the Bank's loan origination, purchase and sales activity for the periods indicated.
YEAR ENDED DECEMBER 31, ------------------------------------- 1997 1996 1995 1994 -------- -------- -------- ------- (IN THOUSANDS) Loan receivable, beginning of period.................. $110,017 $100,850 $ 90,412 $79,600 Originations: Real estate: First mortgage (1)(3)................................ 26,281 $ 23,496 18,219 19,739 Second mortgage (2).................................. 2,178 1,912 643 2,014 Consumer and other loans: Consumer loans....................................... 2,306 3,442 2,747 3,510 Student.............................................. -- -- 438 954 Lease financing...................................... 300 -- 1,177 459 Commercial........................................... 3,525 1,850 2,756 716 -------- -------- -------- ------- Total originations.................................. 34,590 30,700 25,980 27,392 Transfer of mortgage loans to foreclosed real estate.. 374 445 645 120 Repayments............................................ 21,506 21,088 13,774 15,791 Loan sales............................................ -- -- 1,123 669 -------- -------- -------- ------- Net loan activity..................................... 12,710 9,167 10,438 10,812 Total loans receivable at end of period.............. $122,727 $110,017 $100,850 $90,412 ======== ======== ======== =======
______________ (1) Includes $21.3 million, and $5.0 million in one- to four-family residential loans and commercial real estate loans, respectively, for the year ended December 31, 1997. (2) Includes $2.1 million in home equity loans and a net change of $53,000 in home equity lines of credit for the year ended December 31, 1997. (3) Includes $1.5 million of mortgage loans held for sale originated during the year ended December 31, 1997. LOAN ORIGINATION FEES AND OTHER INCOME. In addition to interest earned on loans, the Bank generally receives loan origination fees. To the extent that loans are originated or acquired for the Bank's 9 portfolio, SFAS 91 requires that the Bank defer loan origination fees and costs and amortize such amounts as an adjustment of yield over the life of the loan by use of the level yield method. ARM loans originated below the fully indexed interest rate will have a substantial portion of the deferred amount recognized as income in the initial adjustment period. Fees deferred under SFAS 91 are recognized into income immediately upon prepayment or the sale of the related loan. At December 31, 1997, the Bank had $314,000 of net deferred loan origination fees. Loan origination fees vary with the volume and type of loans and commitments made and purchased, principal repayments, and competitive conditions in the mortgage markets, which in turn respond to the demand for and availability of money. In addition to loan origination fees, the Bank also receives other fees, service charges, and other income that consist primarily of deposit transaction account service charges, late charges and income from REO operations. The Bank recognized fees and service charges of $1.0 million, $873,000, and $771,000, for the fiscal years ended December 31, 1997, 1996, and 1995, respectively. LOANS-TO-ONE BORROWER. With certain limited exceptions, a New York chartered savings bank may not make unsecured loans or extend unsecured credit for commercial, corporate or business purposes (including lease financing) to a single borrower, which in the aggregate exceed 15% of the Bank's net worth. At December 31, 1997, the Bank's largest lending relationship totaled $1.6 million and consisted of loans secured by retail businesses and properties. The Bank's second largest lending relationship totaled $1.5 million and consisted of loans secured by commercial real estate and marketable securities. The Bank's third largest lending relationship totaled $1.5 million and consisted of loans secured by retail businesses and properties. The Bank's fourth largest lending relationship totaled $1.4 million and was secured by a retail office plaza, retail business property and residence. The Bank's fifth largest lending relationship totaled $1.4 million and consisted of loans secured by multi-family residential housing and residence. At December 31, 1997 all of the aforementioned loans were performing in accordance with their terms. DELINQUENCIES AND CLASSIFIED ASSETS DELINQUENCIES. The Bank's collection procedures provide that when a loan is 15 days past due, a computer-generated late notice is sent to the borrower requesting payment. If the delinquency continues, at 30 days a delinquent notice is sent and personal contact efforts are attempted, either in person or by telephone, to strengthen the collection process and obtain reasons for the delinquency. Also, plans to arrange a repayment plan are made. If a loan becomes 60 days past due, and no progress has been made in resolving the delinquency, the Bank will send a 10-day demand letter and personal contact is attempted, and the loan becomes subject to possible legal action if suitable arrangements to repay have not been made. When a loan continues in a delinquent status for 90 days or more, and a repayment schedule has not been made or kept by the borrower, generally a notice of intent to foreclose is sent to the borrower for mortgage loans, and a final demand letter is presented to the borrower of non-real estate loans, giving 30 days to repay all outstanding interest and principal. If not cured, foreclosure proceedings or other appropriate legal actions are initiated to minimize any potential loss. NON-PERFORMING ASSETS. Loans are reviewed on a regular basis and are placed on a non-accrual status when, in the opinion of management, the collection of additional interest is doubtful. Loans are placed on non-accrual status when either principal or interest is 90 days or more past due or less than 90 days, in the event the loan has been referred to the Bank's legal counsel for foreclosure. Interest accrued and unpaid at the time a loan is placed on non-accrual status is charged against interest income. At December 31, 1997, the Bank had non-performing assets of $2.3 million, and a ratio of non-performing 10 loans and real estate owned ("REO") of 1.2% total assets. Non-performing assets decreased $393,000, or 14.6%, to $2.3 million in 1997 from $2.7 million in 1996. Non-performing assets, however, have increased $800,000, or 53%, from $1.5 million in 1995. While the changes in non-performing assets tend to be cyclical, the increase over this two-year period is primarily due to higher delinquent payments on one- to four-family and multi-family residential loans and a $231,000 increase in commercial business loan delinquencies. The average loan- to-value collateral ratios of the mortgages is approximately 65%. Commercial business loans with payments due over 90 days represent two loans, one of which has a principal balance of $220,000. This loan is in foreclosure and is 75% guaranteed by the Small Business Administration. Real estate acquired by the Bank as a result of foreclosure or by the deed in lieu of foreclosure is classified as REO until such time as it is sold. These properties are carried at the lower of their recorded amount or estimated fair value less estimated costs to sell the property. REO totaled $767,000. $700,000,and $586,000 at December 31, 1997, 1996,and 1995, respectively. The largest component of REO consists of a real estate development project which had a net book value of $483,000 at December 31, 1997. The Bank originally entered into a $570,000 commercial real estate loan in 1988 for the development of 49 single family residences. This loan was made under the "leeway provision" of the New York State Banking Law. Under this provision of the Banking Law the lending relationship was originally structured so that the Bank held title to the property securing the loan subject to the fulfillment of the borrower's obligations under the loan. In 1990, the developer became insolvent, was unable to satisfy the terms of the loan and the Bank assumed control of the project. During 1997, the Bank invested an additional $276,000 to further the land for development. The Bank has developed and sold 25 lots through December 31, 1997. The proceeds from the sale of the lots are used to reduce the outstanding balance of REO. The Bank believes it will fully recover its investment in this property. 11 DELINQUENT LOANS AND NON-PERFORMING ASSETS The following table sets forth information regarding the Bank's loans delinquent 90 days or more, and real estate acquired or deemed acquired by foreclosure at the dates indicated. When a loan is delinquent 90 days or more, the Bank reverses all accrued interest thereon and ceases to accrue interest thereafter. For all the dates indicated, the Bank did not have any material restructured loans within the meaning of SFAS 15 and SFAS 114.
AT DECEMBER 31, ----------------------------------------------------- 1997 1996 1995 1994 1993 --------- --------- --------- --------- --------- (DOLLARS IN THOUSANDS) Loans delinquent 90 days or more: Real estate loans..................................... $ 1,255 $ 1,953 $ 849 $ 1,045 $ 745 Consumer loans........................................ 283 45 70 69 43 -------- -------- -------- -------- -------- Total delinquent loans............................... 1,538 1,998 919 1,114 788 Total REO............................................... 767 700 586 610 809 -------- -------- -------- -------- -------- Total nonperforming assets (1)..................... $ 2,305 $ 2,698 $ 1,505 $ 1,724 $ 1,597 ======== -------- ======== ======== ======== Total loans delinquent 90 days or more to total loans receivable (2).......................... 1.0% 1.8% 0.9% 1.2% 1.0% Total loans delinquent 90 days or more to total assets.. 0.8% 1.1% 0.5% 0.7% 0.6% Total nonperforming assets to total assets.............. 1.2% 1.4% 0.8% 1.0% 1.2% Net loans receivable(3)................................. 121,585 108,742 100,149 89,668 78,813 -------- -------- -------- -------- -------- Total assets............................................ $196,770 $189,937 $180,952 $170,715 $129,270 ======== ======== ======== ======== ========
_______________ (1) Net of specific valuation allowances. (2) Net of unearned discount, and the allowance for loan losses. (3) Includes $1.5 million of mortgage loans held for sale at December 31, 1997. During the year ended December 31, 1997, and year ended December 31, 1996, respectively, additional gross interest income of $117,000 and $81,000 would have been recorded on loans accounted for on a non-accrual basis if the loans had been current throughout the period. No interest income on non-accrual loans was included in income during the same periods. The following table sets forth information with respect to loans past due 30-89 days in the Bank's portfolio at the dates indicated.
AT DECEMBER 31, -------------------------------------- 1997 1996 1995 1994 1993 ------ ------ ------ ------ ------ (IN THOUSANDS) Loans past due 30-89 days: Real estate loans............ $2,232 $1,867 $2,465 $1,503 $1,537 Consumer and other loans..... 296 249 133 137 423 ------ ------ ------ ------ ------ Total past due 30-89 days... $2,528 $2,116 $2,598 $1,640 $1,960 ====== ====== ====== ====== ======
12 The following table sets forth information regarding the Bank's delinquent loans 60 days and greater and REO at December 31, 1997.
AT DECEMBER 31, 1997 -------------------- BALANCE NUMBER -------- ------ (IN THOUSANDS) Residential real estate: Loans 60 to 89 days delinquent.................................... $ 679 15 Loans more than 90 days delinquent................................ 1,255 30 Consumer and commercial business loans 60 days or more delinquent.. 404 31 Real estate owned.................................................. 767 7 ------ -- Total........................................................... $3,105 83 ====== ==
CLASSIFICATION OF ASSETS. Federal regulations provide for the classification of loans and other assets such as debt and equity securities considered to be of lesser quality as "substandard," "doubtful," or "loss" assets. An asset is considered "substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the "distinct possibility" that the savings institution will sustain "some loss" if the deficiencies are not corrected. Assets classified as "doubtful" have all of the weaknesses inherent in those classified "substandard," with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions, and values, "highly questionable and improbable." Assets classified as "loss" are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets that do not expose the savings institution to risk sufficient to warrant classification in one of the aforementioned categories, but which possess some weaknesses, are required to be designated "special mention" by management. When a savings institution classifies problem assets as either substandard or doubtful, it is required to establish general allowances for loan losses in an amount deemed prudent by management. General allowances represent loss allowances that have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When a savings institution classifies problem assets as "loss," it is required either to establish a specific allowance for losses equal to 100% of the amount of the assets so classified, or to charge off such amount. A savings institution's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by federal and state regulatory authorities, which can order the establishment of additional general or specific loss allowances. The Bank regularly reviews the problem loans in its portfolio to determine whether any loans require classification in accordance with applicable regulations. 13 The following table sets forth the aggregate amount of the Bank's internally classified assets at the dates indicated.
AT DECEMBER 31, ------------------------------ 1997 1996 1995 1994 ------ ------ ------ ------ (IN THOUSANDS) Substandard assets (1)...... $1,719 $1,980 $1,163 $1,534 Doubtful assets............. 55 59 34 11 Loss assets................. 16 6 5 2 ------ ------ ------ ------ Total classified assets.. $1,790 $2,045 $1,202 $1,547 ====== ====== ====== ======
___________ (1) Includes $483,000, $250,000, $292,000 and $421,000 for a real estate development project classified as REO at December 31, 1997, 1996, 1995 and 1994, respectively. ALLOWANCE FOR LOAN LOSSES. Management's policy is to provide for estimated losses on the Bank's loan portfolio based on management's evaluation of the potential losses that may be incurred. The Bank reviews on a quarterly basis the loans in its portfolio which have demonstrated delinquencies, including problem loans, to determine whether any loans require classification or the establishment of appropriate reserves or allowances for losses. Such evaluation, which includes a review of all loans of which full collectibility of interest and principal may not be reasonably assured, considers, among other matters, past loss experience, present economic conditions and other factors deemed relevant by management. Management calculates the general allowance for loan losses on past experience as well as current delinquencies and the composition of the Bank's loan portfolio. While both general and specific loss allowances are charged against earnings, general loan loss allowances are included, subject to certain limitations, as capital in computing risk-based capital under federal regulations. In accordance with SFAS 114, a loan is considered impaired when each of the following criteria are met: the loan is of a material size, the loan is considered to be non-performing, and a loss is probable. The measurement of impaired loans is generally based upon the present value of expected future cash flows discounted at the historic effective interest rate, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral. Management will continue to review the entire loan portfolio to determine the extent, if any, to which further additional loan loss provisions may be deemed necessary. Management believes that the Bank's current allowance for loan losses is adequate, however, there can be no assurance that the allowance for loan losses will be adequate to cover losses that may in fact be realized in the future or that additional provisions for loan losses will not be required. 14 ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES. The following table sets forth the analysis of the allowance for loan losses at or for the periods indicated.
AT OR FOR THE PERIOD ENDED DECEMBER 31, --------------------------------------------------- 1997 1996 1995 1994 1993 --------- --------- --------- -------- -------- (DOLLARS IN THOUSANDS) Total loans receivable, net................................ $121,585 $108,742 $100,149 $89,668 $78,813 Average loans outstanding.................................. 113,651 104,354 95,979 84,596 78,355 Allowance balance (at beginning of period)................. 906 346 315 280 296 Provision for losses: Real estate............................................... 121 90 53 30 10 Consumer and other loans.................................. 140 546 50 35 23 Charge-offs: Real estate............................................... -- -- 17 14 -- Consumer and other loans.................................. 358 93 64 80 146 Recoveries: Real estate............................................... -- -- -- 6 -- Consumer and other loans.................................. 18 17 9 58 97 -------- -------- -------- ------- ------- Allowance balance (at end of period)....................... $ 827 $ 906 $ 346 $ 315 $ 280 ======== ======== ======== ======= ======= Allowance for loan losses as a percent of net loans receivable at end of period............................... 0.7% 0.8% 0.3% 0.4% 0.4% Loans charged off as a percent of average loans outstanding............................................... 0.3% 0.1% 0.1% 0.1% 0.2% Ratio of allowance for loan losses to total nonperforming loans at end of period (1)................................ 53.8% 45.3% 37.6% 28.3% 35.5% Ratio of allowance for loan losses to total nonperforming assets at end of period (1)............................... 35.9% 33.6% 23.0% 18.3% 17.5%
_____________ (1) Net of specific reserves. 15 ALLOCATION OF ALLOWANCE FOR LOAN LOSSES. 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.
AT DECEMBER 31, -------------------------------------------------------------------------- 1997 1996 1995 ------------------------- ------------------------ -------------------- % OF LOANS % OF LOANS % OF LOANS IN EACH IN EACH IN EACH CATEGORY TO CATEGORY TO CATEGORY TO AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS ----------- ------------ ----------- ----------- -------- ----------- (DOLLARS IN THOUSANDS) Balance at end of period applicable to: Real estate loans....................... $461 91.23% $340 90.66% $ 250 90.86% Consumer and other loans................ 366 8.77 566 9.34 96 9.14 ---- ------ ---- ------ ------ ------ Total allowance for loan losses (1).... $827 100.00% $906 100.00% $ 346 100.00% ==== ====== ==== ====== ====== ======
_________________ (1) Percentages include unearned discount and origination fees. 16 INVESTMENT ACTIVITIES The investment policy of the Bank established by the Board of Directors attempts to provide and maintain liquidity, maintain a high quality diversified investment portfolio in order to obtain a favorable return on investment without incurring undue interest rate and credit risk, provide collateral for pledging requirements, and to complement the Bank's lending activities. At December 31, 1997, the Bank had investment securities with an aggregate amortized cost value of $55.6 million and a market value of $56.8 million. At December 31, 1997, the Bank's carrying value of investment securities consisted of $18.3 million of corporate debt issues and $11.9 million of securities issued or guaranteed by the United States Government or agencies thereof and state and municipal obligations. The corporate debt issues primarily consist of financial corporation debt and industrial debentures (the largest single issue was $1.0 million). These issues generally have maturities of between two and five years. All corporate debt investments have been rated as investment grade by either Moody's or Standard & Poor's. Typically, such investments yield 30-50 basis points more than Treasury securities with comparable maturities. To a lesser extent, the Bank also invests in mutual funds and equity securities. At December 31, 1997, the Bank held $1.1 in common stock and $1.8 million in an equity mutual fund. At December 31, 1997, the Bank had invested $23.2 million in mortgage-backed securities, net. Mortgage-backed securities, like mortgage loans, amortize over the life of the security as the underlying mortgages are paid down. The speed at which principal payments above normally scheduled amortization occurs, is generally unpredictable. Historically, the securities have paid down more rapidly in a falling interest rate environment, thereby shortening the life of the security. Likewise, in a rising interest rate environment, the life of the mortgage-backed security tends to extend. The result is that, generally, the Bank will receive more investable funds in lower interest rate environments and less investable funds during periods of higher interest rates. The embedded option on the part of the underlying mortgagee to prepay the loan, therefore, tends to impact the value of the security and can adversely impact the Bank's net interest margin. The Bank's investments are, generally, liquid, and therefore allow the Bank to respond more readily to changing market conditions. The investment portfolio is accounted for in accordance with FASB Statement 115. At December 31, 1997, the Bank's available- for-sale and held-to-maturity portfolios had carrying values of $51.7 million and $5.1 million, respectively. The Bank generally has maintained a portfolio of liquid assets that exceeds regulatory requirements. Liquidity levels may be increased or decreased depending upon the yields on investment alternatives and upon management's judgment as to the attractiveness of the yields then available in relation to other opportunities and its expectation of the yield that will be available in the future, as well as management's projections as to the short term demand for funds to be used in the Bank's loan origination and other activities. For further information regarding the Bank's investments see Note 2 to the Notes to Financial Statements. 17 INVESTMENT PORTFOLIO. The following table sets forth the carrying value of the Bank's investment portfolio at the dates indicated. At December 31, 1997, the market value of the Bank's investments was approximately $56.8 million. The market value of investments includes interest-earning deposits, and mortgage- backed securities.
AT DECEMBER 31, --------------------------------------- 1997 1996 1995 1994 ------- -------- -------- -------- (IN THOUSANDS) Investment securities: U.S. Government and agency obligations................. $ 4,856 $ 5,879 $ 8,171 $ 6,070 State and municipal obligations........................ 6,636 6,172 5,297 3,072 Corporate debt issues.................................. 18,121 22,060 28,533 33,192 Equity securities...................................... 1,139 557 69 87 Mutual funds........................................... 1,785 1,178 1,865 5,872 ------- ------- ------- ------- 32,537 35,846 43,935 48,293 Unrealized gain (loss) on available for sale portfolio.. 1,126 827 996 (158) ------- ------- ------- ------- Total investment securities........................... 33,663 36,673 $44,931 $48,135 ------- ------- ------- ------- Interest-earning deposits in other institutions......... -- -- -- 2,043 Federal funds sold...................................... -- 1,550 8,200 11,584 ------- ------- ------- ------- Total investments.................................... $33,663 $38,223 $53,131 $61,762 ======= ======= ======= ======= Mortgage-backed securities, net: Adjustable rate........................................ 3,823 4,787 2,812 247 Fixed rate............................................. 19,200 18,179 5,100 769 ------- ------- ------- ------- 23,023 22,966 7,912 1,016 Unrealized gain (loss) on available for sale portfolio.. 135 (137) 41 (24) ------- ------- ------- ------- Total mortgage-backed securities, net................ $23,158 $22,829 $ 7,953 $ 992 ======= ======= ======= =======
INVESTMENT PORTFOLIO MATURITIES. The following table sets forth the carrying value, market value, average life in years, and annualized weighted average yield of the Bank's investment portfolio at December 31, 1997.
ANNUALIZED AVERAGE WEIGHTED CARRYING MARKET LIFE AVERAGE VALUE VALUE YEARS YIELD -------- ------- ------- ----------- (DOLLARS IN THOUSANDS) Investment securities: U.S. Government treasury.............................. $ 220 $ 222 2.286 6.83% U.S. Government agency................................ 4,636 4,662 6.480 6.97 State and municipal obligations....................... 6,636 7,060 7.433 5.73 Corporate debt issues................................. 18,121 18,345 2.791 7.07 Marketable equity securities.......................... 2,924 3,400 -- 6.85 ------- ------- ----- ----- Total............................................. $32,537 $33,689 6.761 ------- ======= ===== Unrealized gain on available for sale portfolio..... 1,126 ----- Carrying value of investment securities................. $33,663 ======= Investment securities held to maturity: (1) Corporate debt obligations............................ $ 5,115 5,141 1.409 7.173 ======= ======= ===== =====
__________________ (1) The information is included above as a component of corporate debt issues. 18 SECURITIES PORTFOLIO MATURITIES. The following table sets forth the scheduled maturities, carrying values, market values and average yields for the Bank's investment securities at December 31, 1997. Yield is calculated on the amortized cost to maturity.
AT DECEMBER 31, 1997 ---------------------------------------------------------------------------------------- ONE YEAR OR LESS ONE TO FIVE YEARS FIVE TO TEN YEARS MORE THAN TEN YEARS -------------------- -------------------- --------------------- -------------------- ANNUALIZED ANNUALIZED ANNUALIZED ANNUALIZED WEIGHTED WEIGHTED WEIGHTED WEIGHTED CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE VALUE YIELD VALUE YIELD VALUE YIELD VALUE YIELD -------- ---------- -------- ---------- -------- ---------- -------- --------- (DOLLARS IN THOUSANDS) Debt investment securities: U.S. Agency securities................... -- -- $1,084 7.010% $ 3,514 6.919% $ 38 9.429% U.S. Government securities............... -- -- 201 6.420 -- -- 19 11.154 State and municipal obligations.......... 251 6.408 1,502 5.954 3,422 5.562 1,461 5.644 Corporate debt issues.................... 8,655 7.579 3,329 6.604 4,382 7.069 1,755 7.124 ------- ----- ------ ----- ------- ----- ------- ------ Total.............................. $ 8,906 7.546 $6,116 6.510 $11,318 6.567 $ 3,273 6.514 ======= ====== ======= ======= Equity and mortgage-backed securities: Mutual funds............................. $ 1,785 0.700% $ -- --% $ -- --% $ -- --% Mortgage-backed securities............... -- -- 1,249 6.789 4,236 7.048 17,538 6.957 Common stock............................. 1,139 6.153 -- -- -- -- -- -- ------- ----- ------ ----- ------- ----- ------- ------ Total.............................. $ 2,924 2.824 $1,249 6.789 $ 4,236 7.048 $17,538 6.957 ======= ====== ======= ======= Total investment securities........ $11,830 6.379 $7,365 6.558 $15,554 6.698 $20,811 6.887 ======= ====== ======= ======= Unrealized gain on available for sale portfolio Total carrying value............. Investment securities held to maturity: (1) Corporate debt obligations............... $ 4,271 7.328 -- -- $ 774 6.592 $ 70 4.131 ------- ------ ------- ------- Total securities..................... $ 4,271 7.328 $ 0 0.000% $ 774 6.592 $ 70 4.131 ======= ====== ======= ======= AT DECEMBER 31, 1997 -------------------------------- TOTAL INVESTMENT SECURITIES ANNUALIZED WEIGHTED CARRYING MARKET AVERAGE VALUE VALUE YIELD -------- ------- ----------- (DOLLARS IN THOUSANDS) Debt investment securities: U.S. Agency securities.............................. $ 4,636 $ 4,662 6.975% U.S. Government securities.......................... 220 222 6.816 State and municipal obligations..................... 6,636 7,060 5.730 Corporate debt issues............................... 18,121 18,345 7.070 ------- ------- ----- Total......................................... $29,613 $30,289 6.753 ======= ======= Equity and mortgage-backed securities: Mutual funds........................................ $ 1,785 $ 1,785 0.700% Mortgage-backed securities.......................... 23,023 23,158 6.964 Preferred stock..................................... -- -- -- Common stock........................................ 1,139 1,615 6.153 ------- ------- ----- Total......................................... $25,947 $26,558 6.497 ======= ======= Total investment securities................... $55,560 $56,847 6.634 ======= ======= Unrealized gain on available for sale portfolio....... 1,261 ------- Total carrying value.......................... $56,821 ======= Investment securities held to maturity: (1) Corporate debt obligations.......................... $ 5,115 $ 5,141 7.173 ------- ------- Total securities................................ $ 5,115 $ 5,141 7.173 ======= =======
____________________________________ (1) The information is included as a component of debt investment securities. 19 SOURCES OF FUNDS GENERAL. Deposits are the primary source of the Bank's funds for lending and other investment purposes. In addition to deposits, the Bank derives funds from the amortization and prepayment of loans and mortgage-backed securities, the maturity of investment securities and operations and from other borrowings. Scheduled loan principal repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are influenced significantly by general interest rates and market conditions. Borrowings may be used on a short-term basis to compensate for reductions in the availability of funds from other sources or on a longer term basis for general business purposes. DEPOSITS. Consumer and commercial deposits are attracted principally from within the Bank's market area through the offering of a broad selection of deposit instruments including noninterest-bearing demand accounts, NOW accounts, passbook and club accounts, money market deposit, term certificate accounts and individual retirement accounts. While the Bank accepts deposits of $100,000 or more, it generally does not currently offer premium rates for such deposits. Deposit account terms vary according to the minimum balance required, the period of time during which the funds must remain on deposit, and the interest rate, among other factors. The Bank has a committee which meets weekly to evaluate the Bank's internal cost of funds, surveys rates offered by competing institutions, reviews the Bank's cash flow requirements for lending and liquidity and the number of certificates of deposit maturing in the upcoming week. This committee executes rate changes when deemed appropriate. The Bank does not obtain funds through brokers, nor does it solicit funds outside its market area. DEPOSIT PORTFOLIO. The following table sets forth information regarding interest rates, terms, minimum amounts and balances of the Bank's savings and other deposits as of December 31, 1997:
WEIGHTED PERCENTAGE AVERAGE MINIMUM OF TOTAL INTEREST RATE MINIMUM TERM CHECKING AND SAVINGS DEPOSITS AMOUNT BALANCES DEPOSITS - ------------- ------------ ----------------------------- ------ -------- -------- (IN THOUSANDS) 0.000 None Non-interest demand account $ 50 $ 7,644 5.03% 2.560 None NOW accounts 500 13,306 8.75 3.010 None Passbook and club accounts 100 63,937 42.05 2.849 None Money market accounts 2,500 113 0.07 CERTIFICATES OF DEPOSIT ----------------------- 4.942 6 months Fixed term, fixed rate 2,500 5,247 3.45% 5.653 9 months Fixed term, fixed rate 1,000 100 0.07 5.608 12 months Fixed term, fixed rate 1,000 19,423 12.77 6.091 15 months Fixed term, fixed rate 1,000 10,025 6.59 4.969 18 months Fixed term, variable rate 1,000 1,856 1.22 5.557 18 months Fixed term, fixed rate 1,000 2,617 1.72 5.640 24 months Fixed term, fixed rate 1,000 3,445 2.27 5.820 30 months Fixed term, fixed rate 1,000 4,368 2.87 6.036 36 months Fixed term, fixed rate (1) 1,000 5,443 3.58 6.064 48 months Fixed term, fixed rate (1) 1,000 4,718 3.10 6.050 60 months Fixed term, fixed rate 1,000 1,627 1.07 6.779 84 months Fixed term, fixed rate 1,000 7,641 5.03 6.194 60 through 120 months Fixed term, fixed rate 1,000 549 0.36 -------- ------ TOTAL $152,059(2) 100.00 ======== ======
__________________ (1) This deposit product allows the depositor to elect to adjust the interest rate paid once during the initial term of the deposit to the then prevailing rate. (2) Table excludes escrow accounts totalling $340,000 at December 31, 1997. 20 The following table sets forth the change in dollar amount of savings deposits in the various types of savings accounts offered by the Bank between the dates indicated.
BALANCE PERCENT BALANCE PERCENT BALANCE PERCENT AT OF INCR. AT OF INCR. AT OF INCR. 12/31/97 DEPOSITS (DECR) 12/31/96 DEPOSITS (DECR) 12/31/95 DEPOSITS (DECR) -------- -------- -------- -------- -------- -------- -------- -------- -------- (IN THOUSANDS) Club accounts................... $ 792 0.52% $ 131 $ 661 0.42% $ 110 $ 551 0.3% $ (67) Noninterest accounts............ 7,644 5.03 303 7,341 4.63 129 7,212 4.6 1,124 NOW accounts.................... 13,306 8.75 224 13,082 8.24 917 12,165 7.7 (912) Passbooks....................... 63,145 41.53 (1,828) 64,973 40.94 (5,495) 70,468 44.6 (7,027) Money market deposit accounts... 113 0.07 (61) 174 0.11 (78) 252 0.2 (532) Time deposits which mature: Within 12 months............... 38,860 25.56 (14,075) 52,935 33.36 15,011 37,924 24.0 10,762 Within 12-36 months............ 22,611 14.87 7,679 14,933 9.41 (5,968) 20,901 13.2 (1,977) Beyond 36 months............... 5,588 3.67 990 4,598 2.90 (3,914) 8,512 5.4 850 -------- ------ -------- -------- ----- -------- -------- ----- -------- Total........................ $152,059 100.00% $ (6,637) $158,697 100.0% $ 712 $157,985 100.0% $ 2,221 ======== ====== ======== ======== ===== ======== ======== ===== ======== BALANCE PERCENT BALANCE AT OF INCR. AT 12/31/94 DEPOSITS (DECR) 12/31/93 -------- -------- -------- -------- Club accounts................... $ 618 0.4% $ 304 $ 314 Noninterest accounts............ 6,088 3.9 1,056 5,032 NOW accounts.................... 13,077 8.4 6,208 6,869 Passbooks....................... 77,495 49.8 8,911 68,584 Money market deposit accounts... 784 0.5 546 238 Time deposits which mature: Within 12 months............... 27,162 17.4 9,104 18,058 Within 12-36 months............ 22,878 14.7 15,718 7,160 Beyond 36 months............... 7,662 4.9 (1,427) 9,089 -------- ----- -------- -------- Total........................ $155,764(1) 100.0% $ 40,420 $115,344 ======== ===== ======== ========
- ------------------ (1) Table excludes escrow accounts totalling $340,000 at December 31, 1997. 21 The following table sets forth the certificates of deposit in the Bank classified by rates as of the dates indicated:
AT DECEMBER 31, ------------------------------------------ 1997 1996 1995 1994 ------- -------- ------- -------- (IN THOUSANDS) RATE - ---- 3.00% or less.......................... $ 139 $ 180 $ 274 $ 136 3.01 - 4.99%........................... 7,253 10,665 3,601 24,210 5.00 - 6.99%........................... 55,228 57,128 58,313 28,010 7.00 - 8.99%........................... 4,552 4,667 5,347 5,009 9.00 - 10.99%.......................... -- -- 53 337 -------- -------- -------- -------- $ 67,172 $ 72,640 $ 67,588 $ 57,702 ======== ======== ======== ========
The following table sets forth the amount and maturities of certificates of deposit at December 31, 1997.
--------------------------------------------------------------------- AMOUNT DUE LESS THAN 1-2 2-3 3-4 4-5 AFTER 5 ONE YEAR YEARS YEARS YEARS YEARS YEARS TOTAL ---------- --------- -------- -------- ------- -------- ------- (IN THOUSANDS) RATE 3.00% or less............................. $ 139 $ -- $ -- $ -- $ -- $ -- $ 139 3.01 - 3.99%.............................. 6 10 -- -- -- -- 16 4.00 - 4.99%.............................. 6,475 755 6 -- -- -- 7,237 5.00 - 5.99%.............................. 27,770 14,113 2,609 1,645 549 1,454 48,140 6.00 - 6.99%.............................. 1,927 1,412 2,498 289 732 230 7,088 7.00 - 7.99%.............................. -- 3,669 -- -- 764 4,433 8.00% and above........................... -- 119 -- -- -- -- 119 ------- ------- ------ ------ ------ ------ ------- $36,317 $20,078 $5,113 $1,934 $1,281 $2,448 $67,172 ======= ======= ====== ====== ====== ====== =======
The following table indicates the amount of the Bank's certificates of deposit of $100,000 or more by time remaining until maturity as of December 31, 1997.
CERTIFICATES OF DEPOSIT OF $100,000 REMAINING MATURITY OR MORE ------------------ --------------- (IN THOUSANDS) Three months or less................................................ $ 1,768 Three through six months............................................ 1,535 Six through twelve months........................................... 2,010 Over twelve months.................................................. 3,142 -------- Total............................................................ $ 8,455 ========
The following table sets forth the net changes in the deposit activities of the Bank for the periods indicated:
AT DECEMBER 31, ------------------------------------------ 1997 1996 1995 1994 -------- -------- -------- --------- (IN THOUSANDS) Balance at beginning of period................................................ $158,697 $157,985 $155,764 $115,344 Net deposits (withdrawals).................................................... (12,920) (5,611) (4,034) 35,727 Interest credited............................................................. 6,283 6,323 6,255 4,693 -------- -------- -------- -------- Ending balance................................................................ 152,060 158,697 157,985 155,764 -------- -------- -------- -------- Net increase (decrease) in deposits........................................... $ (6,637) $ 712 $ 2,251 $ 40,420 ======== ======== ======== ========
22 BORROWINGS Savings deposits are the primary source of funds of the Bank's lending and investment activities and for its general business purposes. At December 31, 1997, the Bank had $7.9 million in funds obtained from repurchase agreements outstanding, $5.8 million in an overnight line of credit, and $4.5 million in term advances. The Bank is a member of the Federal Home Loan Bank System. The following table summarizes the outstanding balance of short-term borrowing of the Bank for the years indicated.
AT DECEMBER 31, ------------------------ 1997 1996 1995 -------- ------- ----- (In thousands) Overnight Line of Credit $ 5,750 $ -- $ -- Term borrowings (original term) 90 days or less 7,942 7,610 -- 1 year 3,550 -- -- 2 year 1,000 -- -- ------- ------ ----- Balance at end of period $18,242 $7,610 $ -- ======= ====== ===== Daily average during the year 10,212 1,472 -- Maximum month-end balance 18,892 7,610 -- Weighted average rate during the year 5.92% 5.90% -- Year-end average rate 5.84% 5.47% --
PERSONNEL As of December 31, 1997, the Bank had 59 full-time and 18 part-time employees. None of the Bank's employees is represented by a collective bargaining group. The Bank believes its relationship with its employees to be good. REGULATION AND SUPERVISION GENERAL The Bank is a New York State chartered stock savings bank and its deposit accounts are insured up to applicable limits by the FDIC. The Bank is subject to extensive regulation by the State of New York Banking Department (the "Department") as its chartering agency, and by the FDIC, as the deposit insurer. The Bank must file reports with the Department and the FDIC concerning its activities and financial condition, in addition to obtaining regulatory approvals prior to entering into certain transactions such as establishing branches and mergers with, or acquisitions of, other depository institutions. There are periodic examinations by the Department and the FDIC to assess the Bank's compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which a savings bank may engage, and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. 23 Any change in such regulation, whether by the Department, the FDIC or through legislation, could have a material adverse impact on the Holding Company, the Bank, and their operations and stockholders. The Company is also required to file certain reports with, and otherwise comply with the rules and regulations of, the FRB and the Department and the FDIC which administers the provisions of the Securities Exchange Act of 1934. Certain of the regulatory requirements applicable to the Bank and to the Company are referred to below or elsewhere herein. The exercise by an FDIC-insured savings bank of the lending and investment powers of a savings bank 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 Banking 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. Under the statutory authority for investing in equity securities, a savings bank may invest up to 7.5% of its assets in corporate stock, with an overall limit of 5% of its assets invested in common stock. Investment in the stock of a single corporation is limited to the lesser of 2% of the outstanding stock of such corporation or 1% of the savings bank's assets, except as set forth below. Such equity securities must meet certain earnings ratios and other tests of financial performance. A savings bank's lending powers are not subject to percentage of assets limitations, although there are limits applicable to single borrowers. A savings bank may also, pursuant to the "leeway" power, make investments not otherwise permitted under the New York State Banking Law. This power permits investments in otherwise impermissible investments of up to 1% of assets in any single investment, subject to certain restrictions and to an aggregate limit for all such investments of up to 5% of assets. Additionally, in lieu of investing in such securities in accordance with and reliance upon the specific investment authority set forth in the New York State Banking Law, savings banks are authorized to elect to invest under a "prudent person" standard in a wider range of debt and equity securities as compared to the types of investments permissible under such specific investment authority. However, in the event a savings bank elects to utilize the "prudent person" standard, it will be unable to avail itself of the other provisions of the New York State Banking Law and regulations which set forth specific investment authority. The Bank has not elected to conduct its investment activities under the "prudent person" standard. A savings bank may also exercise trust powers upon approval of the Department. 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 Department. Investment by a savings bank in the stock, capital notes and debentures of its service corporations is limited to 3% of the bank's assets, and such investments, together with the bank's loans to its service corporations, may not exceed 10% of the savings bank's assets. Furthermore, New York banking regulations impose requirements on loans which a bank may make to its executive officers and directors and to certain corporations or partnerships in which such persons have equity interests. These requirements include, but are not limited to, requirements that (i) certain loans must be approved in advance by a majority of the entire board of directors and the interested party must abstain from 24 participating directly or indirectly in the voting on such loan, (ii) the loan must be on terms that are not more favorable than those offered to unaffiliated third parties, and (iii) the loan must not involve more than a normal risk of repayment or present other unfavorable features. Under the New York State Banking Law, the Superintendent of Banks (the "Superintendent") may issue an order to a New York State chartered banking institution to appear and explain an apparent violation of law, to discontinue unauthorized or unsafe practices and to keep prescribed books and accounts. Upon a finding by the Department that any director, trustee or officer of any banking organization has violated any law, or has continued unauthorized or unsafe practices in conducting the business of the banking organization after having been notified by the Superintendent to discontinue such practices, such director, trustee or officer may be removed from office after notice and an opportunity to be heard. The Bank does not know of any past or current practice, condition or violation that might lead to any proceeding by the Superintendent or the Department against the Bank or any of its directors or officers. STANDARDS FOR SAFETY AND SOUNDNESS. FDICIA requires the federal bank regulatory agencies to prescribe regulatory standards for all insured depository institutions and depository institution holding companies relating to: (i) internal controls, information systems and audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; (v) asset growth; and (vi) compensation, fees and benefits. The compensation standards would prohibit employment contracts, compensation or benefit arrangements, stock option plans, fee arrangements or other compensatory arrangements that provide excessive compensation, fees or benefits or could lead to material financial loss. In addition the federal banking regulatory agencies are required to prescribe by regulation standards specifying: (i) maximum classified assets to capital ratios; (ii) minimum earnings sufficient to absorb losses without impairing capital; and (iii) to the extent feasible, a minimum ratio of market value to book value for publicly traded shares of depository institutions and depository institution holding companies. In November 1993, the federal banking agencies, including the FDIC, proposed regulations regarding the implementation of these standards. OTHER DEPOSIT INSURANCE REFORMS. FDICIA amended the FDI Act to prohibit insured depository institutions that are not well-capitalized from accepting brokered deposits unless a waiver has been obtained from the FDIC. Deposit brokers are required to register with the FDIC. CONSUMER PROTECTION PROVISIONS. FDICIA enacted consumer oriented provisions including a requirement of notice to regulators and customers for any proposed branch closing and provisions intended to encourage the offering of "lifeline" banking accounts and lending in distressed communities. FDICIA also requires depository institutions to make additional disclosures to depositors with respect to the rate of interest and the terms of their deposit accounts. UNIFORM LENDING STANDARD. Under FDICIA, the federal banking agencies are required to adopt uniform regulations prescribing standards for extensions of credit that are secured by liens on interests in real estate or made for the purpose of financing the construction of a building or other improvements to real estate. Insured depository institutions must adopt and maintain written policies that establish appropriate limits and standards for extensions of credit that are secured by liens or interests in real estate or are made for the purpose of financing permanent improvements to real estate. These policies must establish loan portfolio diversification standards, prudent underwriting standards (including loan-to-value limits) that are clear and measurable, loan administration procedures, and documentation, approval and reporting requirements. The real estate lending policies must reflect consideration of the Interagency 25 Guidelines for Real Estate Lending Policies (the "Interagency Guidelines") that have been adopted by the federal banking regulators. The Interagency Guidelines, among other things, require depository institutions to establish internal loan-to-value limits for real estate loans that are not in excess of the following supervisory limits: (i) for loans secured by undeveloped land, the supervisory loan-to-value limit is 65% of the value of the collateral; (ii) for land development loans, the supervisory limit is 75%; (iii) for loans for the construction of commercial, multi-family or other nonresidential property, the supervisory limit is 80%; (iv) for loans for the construction of one- to four- family properties, the supervisory limit is 85%; and (v) for loans secured by other improved property (e.g. farmland, commercial property and other income-producing property including non-owner- occupied, one- to four- family property) the supervisory limit is 85%. The Interagency Guidelines indicate that on a case-by-case basis it may be appropriate to originate or purchase loans with loan-to-value ratios in excess of the supervisory loan-to-value limits, based on the support provided by other credit factors. The aggregate amount of loans in excess of the supervisory loan-to-value limits, however, should not exceed 100% of total capital and the total of such loans secured by commercial, agricultural, multi-family and other non-one- to four- family residential properties should not exceed 30% of total capital. The supervisory loan-to-value limits do not apply to certain categories of loans including loans insured or guaranteed by the United States Government and its agencies or by financially capable state, local or municipal governments or agencies, loans backed by the full faith and credit of state governments, loans that are to be sold promptly after origination without recourse to a financially responsible party, loans that are renewed, refinanced or restructured in connection with a workout, loans to facilitate sales of real estate acquired by the institution in the ordinary course of collecting a debt previously contracted and loans where the real estate is not the primary collateral. INSURANCE OF DEPOSIT ACCOUNTS The Bank is a member of the Bank Insurance Fund ("BIF"). The BIF has achieved the required reserve ratio of 1.25% of insured reserve deposits. At December 31, 1997 the Bank held $24.6 million in deposits which are insured by the Savings Association Insurance Fund. The Bank paid $33,000 in federal deposit insurance premiums for the fiscal year ended December 31, 1997, as compared to $236,000 in 1996. Under the FDI Act, insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance. At December 31, 1997, the Bank's capital exceeded the capital requirements imposed by the FDIC. CAPITAL MAINTENANCE The FDIC has issued regulations that require BIF-insured banks, such as the Bank, to maintain minimum levels of capital. The regulations establish a minimum leverage capital ratio requirement of not less than 3.0% for banks in the strongest financial and managerial condition, with a CAMEL Rating of 1 (the highest examination rating of the FDIC for banks). For all other banks, the minimum leverage capital 26 requirement is 3% plus additional capital of at least 100 to 200 basis points. Core capital (also referred to as "Tier 1 capital") is comprised of the sum of common stockholders' equity, non-cumulative perpetual preferred stock (including any related surplus) and minority interests in consolidated subsidiaries, minus all intangible assets (other than qualifying servicing rights). The FDIC also requires that savings banks meet a risk-based capital standard. The risk-based capital standard requires the maintenance of total capital (which is defined as core capital and supplementary capital) to risk- weighted assets of at least 8% and core capital to risk-weighted assets of at least 4%. In determining the amount of risk-weighted assets, all assets, plus certain off-balance sheet items, are multiplied by a risk-weight of 0% to 100%, based on the risks the FDIC believes are inherent in the type of asset or off- balance sheet item. The components of core capital are equivalent to those discussed above under the leverage capital ratio requirement. The components of supplementary capital currently include cumulative perpetual preferred stock, perpetual preferred stock, mandatory convertible securities, subordinated debt, intermediate preferred stock and allowance for possible loan and lease losses. Allowance for possible loan and lease losses includable in supplementary capital is limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of capital counted toward supplementary capital cannot exceed 100% of core capital. LOANS-TO-ONE-BORROWER LIMITATIONS With certain limited exceptions, a New York State chartered savings bank may not make unsecured loans or extend credit for commercial, corporate or business purposes (including lease financing) to a single borrower, the aggregate amount of which would be in excess of 15% of the bank's net worth. In addition, the Bank may make secured loans or extensions of credit to a single borrower which aggregate 25% of the Bank's net worth provided that the underlying collateral is valued in an amount equal to at least 10% of the Bank's net worth. The Bank currently complies with all applicable loans-to-one- borrower limitations. COMMUNITY REINVESTMENT ACT Federal Regulation. Under the Community Reinvestment Act ("CRA"), as implemented by FDIC regulations, a savings institution 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 account in its evaluation of certain applications by such institution. The Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") amended the CRA to require, effective July 1, 1990, public disclosure of an institution's CRA rating and require the FDIC to provide a written evaluation of an institution's CRA performance utilizing a four-tiered descriptive rating system which replaced the five-tiered numerical rating system. New York State 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 Banking Department. The NYCRA requires the Banking Department to make an annual written assessment of a bank's compliance with the NYCRA, utilizing a four-tiered rating 27 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. At December 31, 1997, the Bank complied with its NYCRA requirements. The Bank's CRA rating as of its latest examination was satisfactory. FEDERAL RESERVE SYSTEM Under Federal Reserve Board regulations, the Bank is required to maintain noninterest-earning reserves against its transaction accounts (primarily NOW and regular checking accounts). At December 31, 1997, the Bank complied with these requirements. HOLDING COMPANY REGULATION The Company is a registered bank holding company pursuant to the Bank Holding Company Act of 1956, as amended (the "BHCA"). The Company is subject to examination, regulation and periodic reporting under the BHCA, as administered by the FRB. The FRB has adopted capital adequacy guidelines for bank holding companies (on a consolidated basis) substantially similar to those of the FDIC for the Bank. The Company's consolidated capital exceeds these requirements. A bank holding company is generally prohibited from engaging in, or acquiring direct or indirect control of any company engaged in, non-banking activities. One of the principal exceptions to this prohibition is for activities found by the FRB to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Some of the principal activities that the FRB has determined by regulation to be so closely related to banking are: (i) making or servicing loans; (ii) performing certain data processing services: (iii) providing securities brokerage services; (iv) acting as fiduciary, investment or financial advisor; (v) leasing personal or real property; (vi) making investments in corporations or projects designed primarily to promote community welfare; and (vii) acquiring a savings and loan association. Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the FRA on any extension of credit to the bank holding company or its subsidiaries, and on the acceptance of stocks or securities of such holding company or its subsidiaries as collateral, and on the acceptance of such stocks or securities as collateral for loans. In addition, related provisions of the FRA and FRB regulations limit the amount of, and establish required procedures and credit standards with respect to, loans and other extensions of credit to officers, directors and principal stockholders of the Bank, the Company, any subsidiary of the Company and related interests of such persons. Moreover, subsidiaries of bank holding companies are prohibited from engaging in certain tie-in arrangements (with the Company or any of its subsidiaries) in connection with any extension of credit, lease or sale of property or furnishing of services. The Company and the Bank will be affected by the monetary and fiscal policies of various agencies of the United States Government, including the Federal Reserve System. In view of changing conditions in the national economy and in the money markets, it is impossible for management of the Company to accurately predict future changes in monetary policy or the effect of such changes on the business or financial condition of the Company. 28 NEW YORK STATE BANK HOLDING COMPANY REGULATION. In addition to the federal bank holding company regulations, a bank holding company 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. Under New York State Banking Law, the prior approval of the Banking Department is required before: (1) any action is taken that causes any company to become a bank holding company; (2) any action is taken that causes any banking institution to become or be merged or consolidated with a subsidiary of a bank holding company; (3) any bank holding company acquires direct or indirect ownership or control of more than 5% of the voting stock of a banking institution; (4) any bank holding company or subsidiary thereof acquires all or substantially all of the assets of a banking institution; or (5) any action is taken that causes any bank holding company to merge or consolidate with another bank holding company. Additionally, certain restrictions apply to New York State bank holding companies regarding the acquisition of banking institutions which have been chartered five years or less and are located in smaller communities. Officers, directors and employees of New York State bank holding companies are subject to limitations regarding their affiliation with securities underwriting or brokerage firms and other bank holding companies and limitations regarding loans obtained from its subsidiaries. Although the Company will not be a bank holding company for purposes of New York State law, any future acquisition of ownership, control, or the power to vote 10% or more of the voting stock of another bank or bank holding company would cause it to become such. 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 specific charge off method in computing its bad debt deduction beginning with its 1996 Federal tax return. In addition, the federal legislation requires the recapture (over a six year period) of the excess of tax bad debt reserves at December 31, 1995 over those established as of December 31, 1987. 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 make certain non-dividend distributions. MINIMUM TAX. The 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 29 be used as credits against regular tax liabilities in future years. The Bank has not been subject to the alternative minimum tax and has no such amounts available as credits for carryover. 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. At December 31, 1997, the Bank had no net operating loss carryforwards for federal income tax purposes. The Internal Revenue Service has examined the federal income tax return for the fiscal year ended 1992; the fiscal year-end tax returns for 1991, 1993, 1994 and 1995 remain open. See Note 12 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) 9% 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 (including the fact that net operating losses cannot be carried back or carried forward) and alternative entire net income is equal to entire net income without certain modifications. DELAWARE STATE TAXATION. As a Delaware holding company not earning income in Delaware, the Company is exempt from Delaware corporate income tax but is required to file an annual report with and pay an annual franchise tax to the State of Delaware. ITEM 2. PROPERTIES - -------------------- The Bank conducts its business through its main office located in Oswego, New York, and four 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, 1997. The aggregate net book value of the Bank's premises and equipment was $3.7 million at December 31, 1997. For additional information regarding the Bank's properties, see Note 5 to Notes to Financial Statements.
LOCATION OPENING DATE OWNED/LEASED ANNUAL RENT - -------- ------------ ------------- ----------- Main Office 1874 Owned -- - ----------- 214 West First Street Oswego, New York 13126 Plaza Branch 1989 Owned (1) -- - ------------ Route 104, Ames Plaza Oswego, New York 13126 Mexico Branch 1978 Owned -- - ------------- Norman & Main Streets Mexico, New York 13114 Oswego East Branch 1994 Owned -- - ------------------ 34 East Bridge Street Oswego, New York 13126
30 Fulton Branch 1994 Owned -- - ------------- 114 Oneida Street Fulton, New York 13068
_____________________________ (1) The property is owned; the underlying land is leased. 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 to a vote of stockholders during the fourth quarter of the year under report. PART II ITEM 5. MARKET FOR COMPANY'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS - ------------------------------------------------------------------------------- The "Market for Common Stock" section of the Company's Annual Report to Stockholders is incorporated herein by reference. ITEM 6. SELECTED FINANCIAL DATA - --------------------------------- The selected financial information for the year ended December 31, 1997 is filed as part of the Company's Annual Report to Stockholders and is incorporated by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ------------------------------------------------------------------------- RESULTS OF OPERATIONS --------------------- The "Management's Discussion and Analysis of Financial Condition and Results of Operations" section of the Company's Annual Report to Stockholders is incorporated herein by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK - -------------------------------------------------------------------- The information required by this item is set forth under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Annual Report to Stockholders which is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------- The financial statements are contained in the Company's Annual Report to Stockholders and are incorporated herein by reference. 31 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND - ------------------------------------------------------------------------- FINANCIAL DISCLOSURE -------------------- None. PART III -------- ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY - --------------------------------------------------------- (a) Information concerning the directors of the Company is incorporated by reference hereunder in the Company's Proxy Materials for the Annual Meeting of Stockholders. (b) Set forth below is information concerning the Principal Officers of the Company.
NAME AGE POSITIONS HELD WITH THE COMPANY - --------------------- --- ---------------------------------------- Chris C. Gagas 67 Chairman of the Board, President and Chief Executive Officer Anita J. Austin 48 Internal Auditor Melissa A. Dashnau 40 Vice President, Secretary James A. Dowd, CPA 30 Controller Edgar J. Manwaring 52 Vice President--Lending Gregory L. Mills 37 Vice President, Director of Marketing, Branch Administrator W. David Schermerhorn 37 Executive Vice President-Lending Thomas W. Schneider 37 Executive Vice President and Chief Financial Officer Barry S. Thompson 43 Senior Vice President, Compliance Officer and Security Officer
ITEM 11. EXECUTIVE COMPENSATION - -------------------------------- Information with respect to management compensation and transactions required under this item is incorporated by reference hereunder in the Company's Proxy Materials for the Annual Meeting of Stockholders under the caption "Compensation". ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------------------------------------------------------------------------ The information contained under the sections captioned "Stock Ownership of Management" is incorporated by reference to the Company's Proxy Materials for its Annual Meeting of Stockholders. 32 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------------------------------------------------------- The information required by this item is set forth under the caption "Certain Transactions" in the Definitive Proxy Materials for the Annual Meeting of Stockholders and is incorporated herein by reference. PART IV ------- ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K - -------------------------------------------------------------------------- (a)(1) Financial Statements -------------------- The exhibits and financial statement schedules filed as a part of this Form 10- K are as follows: (A) Independent Auditors' Report; (B) Consolidated Statements of Condition - December 31, 1997 and 1996. (C) Consolidated Statements of Income - years ended December 31, 1997, 1996 and 1995; (D) Consolidated Statements of Stockholders' Equity - years ended December 31, 1997, 1996 and 1995 (F) Consolidated Statements of Cash Flows - years ended December 31, 1997, 1996 and 1995; and (G) Notes to Consolidated Financial Statements. (a)(2) Financial Statement Schedules ----------------------------- All financial statement schedules have been omitted as the required information is inapplicable or has been included in the Notes to Consolidated Financial Statements. (b) Reports on Form 8-K ------------------- The Company has not filed a Current Report on Form 8-K during the fourth quarter of the fiscal year ended December 31, 1997. (c) Exhibits -------- 3.1 Certificate of Incorporation of Pathfinder Bancorp, Inc. Incorporated herein by reference to the Company's registration statement on S-4, file no. 333-36051 (the " S-4") 3.2 Bylaws of Pathfinder Bancorp, Inc. (Incorporated herein by reference to the Company's S-4 33 4 Form of Stock Certificate of Pathfinder Bancorp, Inc. Incorporated by reference to the Company's S-4 10.1 Form of Oswego City Savings Bank 1997 Stock Option Plan Incorporated by reference to the Company's S-4 10.2 Form of Oswego City Savings Bank 1997 Recognition and Retention Plan Incorporated by reference to the Company's S-4 10.3 Employment Agreement between the Bank and Chris C. Gagas, President and Chief Executive Officer Incorporated by reference to the Company's S-4 10.4 Employment Agreement between the Bank and Thomas W. Schneider, Vice President and Chief Financial Officer Incorporated by reference to the Company's S-4 10.5 Employment Agreement between the Bank and W. David Schermerhorn, Vice President - Loan Administration Incorporated by reference to the Company's S-4 13 Annual Report to Stockholders 21 Subsidiaries of Company 27 Financial Data Schedule 34 SIGNATURES Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PATHFINDER BANCORP, INC. Date: March 30, 1998 By: /s/ Chris C. Gagas ------------------------------------- Chris C. Gagas President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. By:/s/ Chris C. Gagas By:/s/ Thomas W.Schneider -------------------------------- ------------------------------------ Chris C. Gagas, President, Thomas W. Schneider, Executive Chief Executive Officer and Vice President and Chief Chairman of the Board Financial Officer (Principal (Principal Executive Officer) Financial Officer) Date: March 30, 1998 Date: March 30, 1998 By:/s/ James A. Dowd By:/s/ Chris R. Burritt -------------------------------- --------------------------------- James A. Dowd, Controller Chris R. Burritt, Director (Principal Accounting Officer) Date: March 30, 1998 Date: March 30, 1998 By:/s/ Bruce E. Manwaring By:/s/ Raymond W. Jung -------------------------------- --------------------------------- Bruce E. Manwaring., Director Raymond W. Jung, Director Date: March 30, 1998 Date: March 30, 1998 By:/s/ L. William Nelson, Jr. By:/s/Victor S. Oakes -------------------------------- --------------------------------- L. William Nelson, Jr., Director Victor S. Oakes, Director Date: March 30, 1998 Date: March 30, 1998 By:/s/ Lawrence W. O'Brien By:/s/ Corte J. Spencer -------------------------------- --------------------------------- Lawrence W. O'Brien, Director Corte J. Spencer, Director Date: March 30, 1998 Date: March 30, 1998 By:/s/ Janette Resnick -------------------------------- Janette Resnick, Director Date: March 30, 1998 35 EXHIBIT INDEX ------------- 3.1 Certificate of Incorporation of Pathfinder Bancorp, Inc. Incorporated herein by reference to the Company's registration statement on S-4, file no. 333-36051 (the "S- 4") 3.2 Bylaws of Pathfinder Bancorp, Inc. (Incorporated herein by reference to the Company's S-4 4 Form of Stock Certificate of Pathfinder Bancorp, Inc. 10.1 Form of Oswego City Savings Bank 1997 Stock Option Plan Incorporated by reference to the Company's S-4 10.2 Form of Oswego City Savings Bank 1997 Recognition and Retention Plan Incorporated by reference to the Company's S- 4 10.3 Employment Agreement between the Bank and Chris C. Gagas, President and Chief Executive Officer Incorporated by reference to the Company's S-4 10.4 Employment Agreement between the Bank and Thomas W. Schneider, Vice President and Chief Financial Officer Incorporated by reference to the Company's S-4 10.5 Employment Agreement between the Bank and W. David Schermerhorn, Vice President - Loan Administration Incorporated by reference to the Company's S-4 13 Annual Report to Stockholders 21 Subsidiaries of Company 27 Financial Data Schedule 36 EX-13 2 EXHIBIT 13 EXHIBIT 13 ANNUAL REPORT TO STOCKHOLDERS TABLE OF CONTENTS Letter to Shareholders 1 Progressive, Supportive, Reliable Financial Highlights 2 Management Discussion and Analysis 3 Independent Auditors' Report. Financial Statements Statements of Conditions 19 Statements of Income 20 Statements of Changes in Shareholders' Equity 21 Statements of Cash Flows 22 Notes to Financial Statements 23 Officers, Directors and Managers 35 Services and Shareholder Information 36
It is with great pleasure that we present the Annual Report of Pathfinder Bancorp, Inc., the newly-formed Stock Holding Company for Oswego City Savings Bank, to our Shareholders. As we mature as a publicly owned Company, we continue our tradition of growth and success. The most significant change for your Bank was Shareholder approval for the reorganization of your Bank into PATHFINDER BANCORP, INC., a Mid-Tier Holding Company. This new form of organization will afford your Bank the expanded ability to conduct broader activities. As a result of this advancement, our stock is now registered as PATHFINDER BANCORP, INC. and can be found on the NASDAQ SmallCap stock market listing as PathBcp s. One of the many measures for the success of any investment is Total Return - or the return to the investor, including stock price appreciation and dividends. In recognition of the price appreciation and the desire to make more shares available to the public, your Board of Directors on January 25, 1998 declared a 3 for 2 stock split payable February 5, 1998. The Bank not only placed in the top 25 in the nation among Thrift Stocks for Total Return of 225% but, in fact, we were number 3. In June 1997, the Bank increased the dividend to stockholders by 40%. Recognition of the efforts and the impact of individuals on our overall performance was manifested in the promotion of Thomas Schneider and David Schermerhorn as Executive Vice Presidents of your Bank. Tom continues as Chief Financial Officer and David as the head of the Loan Department. In September 1997, a Definitive Agreement was signed with Oswego County Savings Bank whereby Oswego County Savings Bank will be merged into your Bank. We are in the process of filing the necessary applications with the regulatory agencies and anticipate the successful completion by early Fall 1998. This is a very forward move and most appropriate for the Banks and the community. Your Bank will grow in size to over $300 million in assets and eight offices as a result. The benefits realized should manifest many times over in the future. In our 139th year, we continue to offer the latest in financial services in an efficient and customer-friendly manner. Again this year, we increased our electronic banking facilities with the addition of an ATM at the newly-opened Dunkin Donuts in Pulaski, N.Y. Our Loan Department has increased the scope and size of its portfolio in every category including the origination of mortgages with the intent to sell into the secondary market. Some of the new products developed include an E-Z open CD which is our way of offering the benefits of higher interest rates to people desirous of participating but not having the necessary amount of money to begin. With as little as $25/month, an E-Z open CD grows and the interest rate increases from the Regular Passbook rate plus 1% as succeeding levels of deposit are attained. Continuing our commitment to the economic well being of our community, your Bank was recognized twice in 1997 - once by the Greater Oswego Chamber of Commerce for our commitment to economic development and, again, as "The People's Choice" as the best all around Bank by popular vote of the people conducted by The Palladium-Times, our daily newspaper. 1998 represents our 150th year as a City (sesquicentennial) and our 139th year as a State Chartered financial institution. We are proud to present the financial details in this Annual Report which reflect our operating results and our financial condition for the fiscal year ended December 3l, 1997. Total assets increased $6.8 million to $196.8 million, while Shareholder's equity grew to $23.6 million. Net income for the year was $1.9 million, an increase of $583,000 or 45.8%. While 1997 was a very successful year by all measures, we look forward to continuing our long record of achievement in 1998. We reaffirm our commitment to creating enhanced value for our Shareholders, employees, customers, and the communities we serve. Our goals in 1998 include continued growth in assets, expansion of products and services, increased employee and customer pride, and maximum return for our Shareholders. We are confident of our success in the next year. Sincerely, Chris C. Gagas Chairman, President & CEO 1 On January 14, 1997, the Board of Directors adopted an Agreement and Plan of Reorganization to reorganize the Oswego City Savings Bank ("City Savings") and its existing mutual holding company into a two-tier mutual holding company structure (the "Reorganization") with the establishment of a Delaware chartered corporation as the stock holding company parent of the Bank. Upon completion of the Reorganization, Pathfinder Bancorp, MHC, City Savings' existing mutual holding company, will own a majority of the common stock of the new stock holding company (Pathfinder Bancorp,Inc., which will own 100% of the common stock of Oswego City Savings Bank). On December 30, 1997, the Reorganization was implemented pursuant to the Agreement and Plan of Reorganization approved by the City Savings' stockholders and regulatory authorities. Pursuant to the Reorganization, each share of City Savings' common stock held by existing stockholders of City Savings was exchanged for a share of common stock of Pathfinder Bancorp, Inc.. The Reorganization of City Savings was structured as a tax-free reorganization and accounted for in a manner similar to a pooling of interests. As of December 31, 1997, the company's total assets and shareholders' equity were $196.8 million and $23.6 million, respectively. Pathfinder Bancorp, Inc.'s common stock currently trades on the NASDAQ SmallCap Stock Market under the symbol "PBHC".
1997 1996 1995 1994 1993 - --------------------------------------------------------------------------------------------------------------- FOR THE YEAR (In Thousands) Interest Income $ 14,168 $ 13,213 $ 12,205 $ 10,443 $ 9,858 Interest Expense 6,892 6,414 6,259 4,697 4,062 Net Interest Income 7,276 6,799 5,946 5,746 5,796 Net Income 1,854 1,272 990 1,146 1,802 PER COMMON SHARE (b) Net Income: Basic and diluted 0.66 0.68 0.10 NA NA Book Value 8.40 7.22 7.00 NA NA Cash dividends declared 0.26 0.20 0.00 NA NA Stock Price: IOP --- --- 5.00 High 20.00 7.083 7.167 NA NA Low 6.250 5.333 5.583 NA NA Close 20.00 6.250 7.00 NA NA YEAR END (In Thousands) Total assets $196,770 $189,937 $180,752 $170,715 $129,270 Interest-earning deposits at other financial institutions -- 1,550 8,200 13,627 7,962 Investment securities 33,663 36,673 44,932 48,135 33,776 Mortgage-backed securities 23,158 22,829 7,953 992 1,408 Loans Receivable, net: Real estate 109,543 99,047 91,023 83,563 74,150 Consumer and other 10,495 9,695 9,126 6,105 4,663 Total loans receivable, net 120,038 108,742 100,149 89,668 78,813 Intangible assets 3,605 3,921 4,236 4,552 -- Deposits 152,399 158,998 158,324 155,764 115,344 Borrowed funds 18,242 7,610 -- -- -- Notes Payable ESOP 430 486 425 -- -- Equity 23,583 21,390 20,751 13,990 12,953 SELECTED PERFORMANCE RATIOS Return on average assets 0.97% 0.69% 0.56% 0.74% 1.40% Return on average equity 8.35 6.09 6.31 8.20 14.99 Return on tangible equity 9.28 7.28 5.99 12.14 13.91 Dividend payout ratio 26.19 29.37 -- N/A N/A Average equity to average assets 11.59 11.32 8.74 9.00 9.33 Equity to total assets 11.98 11.26 11.47 8.19 10.02 Net interest rate spread 3.98 3.88 3.72 4.01 4.68 Non interest expense to total assets 2.94 2.82 2.94 2.83 2.72 Nonperforming loans to net loans receivable 1.28 2.05 0.92 1.24 1.00 Nonperforming assets to total assets 1.17 1.54 0.83 1.01 1.24 Allowance for loan losses to net loans receivable 0.69 0.83 0.35 0.35 0.36 Number of full service offices 5 5 5 5 3
(a) Earnings per share for 1995 are based on the period from November 15, 1995 to December 31, 1995. (b) Per Common Share data has been retroactively restated to reflect the three for two stock split paid on February 6, 1988 to Shareholders of record on January 26, 1988. 2 GENERAL Throughout the Management's Discussion and Analysis the term, "the Bank", refers to the consolidated entity of Pathfinder Bancorp, Inc. and Oswego City Savings Bank. At December 31, 1997, Pathfinder Bancorp, Inc.'s only business was the 100% ownership of Oswego City Savings Bank. 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 Bank's market area, changes in policies by regulatory agencies, fluctuations in interest rates, demand for loans in the Bank's market areas and competition, that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. The Bank wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The Bank wishes to advise readers that the factors listed above could affect the Bank's financial performance and could cause the Bank'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 Bank does not undertake, and specifically declines any obligation, to publicly release the result 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 Bank's net income is primarily dependent on its net interest income, which is the difference between interest income earned on its investments in mortgage loans, investment securities and other loans, and its cost of funds consisting of interest paid on deposits and other borrowings. The Bank's net income also is affected by its provision for loan losses, as well as by the amount of non interest income, including income from fees and service charges, net gains and losses on sales of securities, and non interest expense such as employee compensation and benefits, deposit insurance premiums, occupancy and equipment costs, data processing costs and income taxes. Earnings of the Bank 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 Bank. In particular, the general level of market rates tends to be highly cyclical. On January 14, 1997, the Board of Directors adopted an Agreement and Plan of Reorganization to reorganize the Oswego City Savings Bank ("City Savings") and its existing mutual holding company into a two-tier mutual holding company structure (the "Reorganization") with the establishment of a Delaware chartered corporation as the stock holding company parent of the Bank. Upon completion of the Reorganization, Pathfinder Bancorp, MHC, City Savings' existing mutual holding company, will own a majority of the common stock of the new stock holding company (Pathfinder Bancorp,Inc., which will own 100% of the common stock of Oswego City Savings Bank). On December 30, 1997, the Reorganization was implemented pursuant to the Agreement and Plan of Reorganization approved by the City Savings' stockholders and regulatory authorities. Pursuant to the Reorganization, each share of City Savings' common stock held by existing stockholders of City Savings was exchanged for a share of common stock of Pathfinder Bancorp, Inc.. The Reorganization of City Savings was structured as a tax-free reorganization and accounted for in a manner similar to a pooling of interests. On September 5, 1997, the Board of Directors of the Bank, in conjunction with the Board of Trustees of Oswego County Savings Bank, a New York State chartered mutual savings bank headquartered in Oswego, New York, announced the adoption of a definitive merger agreement under which the banks will be combined. The proposed transaction is subject to regulatory approval, as well as approval of the shareholders of Pathfinder Bancorp, Inc.. The merger is expected to be completed prior to the end of 1998. As of December 31, 1997, Oswego County Savings Bank had total assets of approximately $112.1 million, deposits of $97.9 million and net worth of $11.2 million. On January 13, 1998, the Board of Directors of Pathfinder Bancorp, Inc. declared a three for two stock split in the form of a dividend on the holdings company's outstanding common stock. The stock split was paid on February 3 5, 1998 to shareholders of record as of January 26, 1998. The stock split has been applied retroactively to all per share data reported in the financial statements presented in this report. The Year 2000 issue is the result of computer programs being written using two digits rather than four to define the applicable year. The Bank's computer programs that have date sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. Left unresolved, the year 2000 issue could result in a system failure or miscalculations causing disruptions of operations including, but not limited to, a temporary inability to process transactions, calculate interest, or engage in similar normal business activities. In early 1997, the Bank formed a Year 2000 committee to address the issues surrounding the problem. The committee has adopted a policy statement and plan of action to identify, correct, test, and implement solutions to ensure that the Bank's systems are ready to process in the year 2000 and beyond. The policy statement comprises three phases: the assessment phase, the renovation phase, and the validation phase. During 1997, the Bank completed its assessment phase and has identified its computer and electronic software systems that will require modification or replacement. The committee has determined that the required changes are minimal, and that such changes will resolve the Bank's Year 2000 computer systems issues. Testing and implementation of solutions will continue through 1998 with a goal to be fully tested by December 31, 1998. The Bank will utilize both internal and external resources to program, replace, and test the software for Year 2000 modifications. The Bank is also communicating with its third party data processing vendors, as well as its significant suppliers and commercial customers, to determine the Bank's exposure should any of these parties fail to resolve their own significant Year 2000 issues. During 1998, the committee will evaluate the risk from these third parties and establish action plans to reduce or eliminate the risk. In some cases, the Bank will rely on third party information which may be inaccurate and unverifiable. Should third party entities, including Federal and State governments and agencies fail to resolve their own Year 2000 issues, an adverse effect on the Bank could result. The costs of the remedial actions and the date on which the Bank plans to complete the Year 2000 modifications, are based on management's best estimates and assumptions including the continued availability of third party services, their modification plans, and other factors. To date, the cost of the project has been minimal, and the Bank expects the total cost of completing the project to have no material affect on the Bank's results of operations and financial condition. On March 29, 1996, Bennett Funding Group, Inc., headquartered in Syracuse, NY filed for Chapter 11 bankruptcy protection from its creditors. At March 29, 1996, Oswego City Savings Bank had credit extended on lease financing investments through Bennett Funding Group, Inc. and its affiliates of approximately $1.1 million, in the aggregate. In the third quarter of 1996, the Bank established a specific reserve for loan losses of $420,000 to cover potential losses associated with the Bennett lease investments. During 1996 and 1997 the Bank received payments totaling $470,000 and $356,000, respectively. These payments reduced the Bank's outstanding balance in related lease receivables to $319,000. This amount was charged off, in September 1997, against the previously established reserve of $420,000. Any future receipts of settlement funds, which are not expected to be significant, will be treated as loan loss allowance recoveries. BUSINESS STRATEGY The Bank's business strategy is to operate as a well-capitalized, profitable and independent community-oriented savings bank dedicated to providing quality customer service. Generally, the Bank 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 and in investment securities. Specifically, the Bank's business strategy incorporates the following elements: (i) operating as a community-oriented financial institution, maintaining a strong customer base; (ii) maintaining capital in excess of regulatory requirements; (iii) emphasizing investment in one-to-four family residential mortgage loans, and investment securities; and (iv) maintaining a strong retail deposit base. Highlights of the Bank's business strategy are as follows: COMMUNITY-ORIENTED INSTITUTION. 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 believes it is large enough to provide a full range of personal and business financial services, and yet is small enough to be able to provide such services on a personalized and efficient basis. Management believes that the Bank can be more effective in servicing its 4 customers than many of its non-locally headquartered competitors because of the Bank's ability to quickly and effectively provide senior management responses to customer needs and inquiries. The Bank's ability to provide these services is enhanced by the stability of the Bank's senior management, which has an average tenure with the Bank of over 15 years. Management believes that the following actions over the past four years have helped to enhance and preserve its' presence as a community bank: the 1994 acquisition of two branches of the former Columbia Federal Savings located in the cities of Oswego and Fulton (the "Acquisition"); the expansion of the Bank's small business lending services, the introduction of an investment services unit, the public offering and subsequent reorganization into the two-tier holding company structure to further enhance growth and independence, and the signing of a definitive merger agreement with Oswego County Savings Bank. CAPITAL AND ASSET GROWTH. The Bank's net worth has increased from $13.0 million at December 31, 1993 to $23.6 million at December 31, 1997. The Bank's ratio of shareholders' equity to total assets was 12.0% at December 31, 1997. Total assets have increased by $67.5 million, or 52.2%, since December 31, 1993. The Bank's capital exceeds all regulatory capital requirements (see footnote # 13 of the consolidated financial statements for Pathfinder Bancorp, Inc.). EMPHASIS ON RESIDENTIAL MORTGAGE LENDING AND INVESTMENT SECURITIES. Since its inception, the Bank has emphasized residential real estate financing and anticipates a continued commitment to financing the purchase or improvement of residential real estate in its market area. Historically, the Bank has not been an active purchaser of loans or loan participations. To supplement local mortgage loan originations, the Bank invests in investment securities consisting primarily of investment grade corporate debt instruments, securities issued by the United States Government, state and municipal obligations, mutual funds, equity securities, and mortgage-backed securities. By investing in these types of assets, the bank 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. At December 31, 1997, 91.2% of the Bank's total loan portfolio consisted of loans secured by real estate. In addition, at December 31, 1997, 28.9% of the Bank's total assets consisted of investment securities. Generally, the yield on mortgage loans originated by the Bank is greater than that of investment securities and mortgage-backed securities purchased by the Bank. STRONG RETAIL DEPOSIT BASE. The Bank has a relatively strong retail base drawn from the five full-service offices in its market area. At December 31, 1997, 55.8% of the Bank's deposit base of $152.4 million consisted of core deposits, which included non-interest-bearing demand accounts, NOW accounts, passbook and club savings accounts and money market deposit accounts. In connection with the Acquisition, in 1994 the Bank assumed $42.3 million of deposit liabilities of which $24.5 million consisted of non-interest bearing checking, interest bearing checking and savings deposit accounts, and $17.8 million consisted of certificates of deposit. Core deposits are considered to be a more stable and lower cost source of funds than certificates of deposit or outside borrowings. The Bank will continue to emphasize retail deposits by maintaining its network of full service offices, and providing depositors with a full range of accounts. ASSET AND LIABILITY MANAGEMENT-INTEREST SENSITIVITY ANALYSIS The extent to which such assets and liabilities are "interest rate sensitive" can be measured by an institution's interest rate sensitivity "gap". An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and that amount of interest- bearing liabilities maturing or repricing within that time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income while a positive gap would tend to positively affect net interest income. Conversely, during a period of falling interest rates, a negative gap would tend to positively affect net interest income while a positive gap would tend to adversely affect net interest income. 5 The Bank does not maintain in its portfolio fixed interest rate loans with terms exceeding 20 years. In addition, ARM loans are originated with terms that provide that the interest rate on such loans cannot adjust below the initial rate. Generally, the Bank tends to fund longer term loans and mortgage-backed securities with shorter term time deposits, repurchase agreements, and advances. The impact of this asset/liability mix creates an inherent risk to earnings in a rising interest rate environment. In a rising interest rate environment, the Bank's cost of shorter term deposits may rise faster than its earnings on longer term loans and investments. Additionally, the prepayment of principal on real estate loans and mortgage-backed securities tends to decrease as rates rise, providing less available funds to invest in the higher rate environment. Conversely, as interest rates decrease the prepayment of principal on real- estate loans and mortgage-backed securities tends to increase, causing the Bank to invest funds in a lower rate environment. The potential impact on earnings from this mismatch, is mitigated to a large extent by the size and stability of the Bank's savings accounts. Savings accounts have traditionally provided a source of relatively low cost funding that have demonstrated historically a low sensitivity to interest rate changes. The Bank generally matches a percentage of these, which are deemed core, against longer term loans and investments. In addition, the Bank has sought to extend the terms of its time deposits. In this regard, the Bank has on occasion offered certificates of deposits with three and four year terms which allow depositors to make a one-time election, at any time during the term of the certificate of deposit, to adjust the rate of the certificate of deposit to the then prevailing rate for a certificate of deposit with the same term. The Bank has further sought to reduce the term of a portion of its rate sensitive assets by originating one year ARM loans, five year/one year ARM loans (mortgage loans which are fixed rate for the first five years and adjustable annually thereafter), and by maintaining a relatively short term investment securities (original maturities of three to five years) portfolio with staggered maturities. The Bank manages its interest rate sensitivity by monitoring (through simulation and net present value techniques) the impact on it's GAP position, net interest income, and the market value of portfolio equity to changes in interest rates on its current and forecast mix of assets and liabilities. The Bank has an Asset-Liability Management Committee which is responsible for reviewing the Bank's assets and liability policies, setting prices and terms on rate-sensitive products, and monitoring and measuring the impact of interest rate changes on the Bank's earnings. The Committee meets monthly on a formal basis and reports to the Board of Directors on interest rate risks and trends, as well as liquidity and capital ratios and requirements. The Bank does not have a targeted gap range, rather the Board of Directors has set parameters of percentage change by which net interest margin and the market value of portfolio equity are affected by changing interest rates. The Board and management deem these measures to be a more significant and realistic means of measuring interest rate risk. The results of these techniques are outlined below the GAP table. At December 31, 1997, the total interest bearing liabilities maturing or repricing within one year exceeded total interest-earning assets maturing or repricing in the same period by $13.8 million, representing a cumulative one- year gap ratio of a negative 7.04%. GAP TABLE The following table sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 1997, which are expected to reprice or mature based upon certain assumptions in each of the future time periods shown. The Bank has assumed that its passbook savings, NOW, and money market accounts which totalled $85.0 million at December 31, 1997 are withdrawn at the annual percentage rates set forth below. These withdrawal rates are based upon historical industry experience. Management believes that these assumptions approximate actual experience and considers them appropriate and reasonable.
Amounts Maturing or Repricing Within 3 to 12 1 to 3 3 to 5 5 to 10 More than 3 Months Months Years Years Years 10 Years Total - ------------------------------------------------------------------------------------------------------------------------------ ( Dollars In Thousands) Interest-earning assets: Real estate loans: Residential one-to-four family: Market index ARM's $19,360 $ 18,131 $ 6,555 $ 3,801 $ 579 -- $ 48,426 Fixed rate 370 1,855 8,787 7,531 10,533 5,159 34,235 Commercial and multi-family: ARM's 3,003 4,419 4,199 536 -- -- 12,157 Fixed 105 512 2,321 1,902 2,259 486 7,585
6 Home equity fixed rate loans 101 325 1,040 1,360 2,517 5,343 Home equity line of credit 4,219 -- -- -- -- -- 4,219 Consumer loans 347 1,229 2,271 428 16 -- 4,291 Commercial business loans 396 888 3,512 1,676 -- 2,888 6,472 Mortgage-backed securities (1) 2,931 4,659 3,076 4,112 5,357 2,888 23,023 Investment securities (1) 5,532 8,104 4,589 2,990 9,429 1,893 32,537 Interest earning deposits at other financial institutions -- -- -- -- -- -- -- Total interest-earning assets $36,364 $ 40,122 $ 36,350 $ 24,336 $30,690 $10,426 $178,288 - ------------------------------------------------------------------------------------------------------------------------------ Interest-bearing liabilities: Passbook accounts $ 4,587 $ 14.629 $ 19,166 $ 25,555 -- -- $ 63,937 NOW accounts 2,536 6,586 4,524 -- -- -- 13,646 Money market accounts 113 -- -- -- -- -- 113 Certificate accounts 16,947 27,691 19,168 3,253 -- -- 67,059 Repurchase agreements 13,692 3,550 1,000 -- -- -- 18,242 Total interest-bearing liabilities $37,875 $ 52,456 $ 43,858 $ 28,808 $ 0 $ 0 $162,997 - ------------------------------------------------------------------------------------------------------------------------------ Interest-earning assets less interest- bearing liabilities ("interest rate sensitivity gap") (1,511) (12,334) (7,508) (4,472) 30,690 10,426 Cumulative excess (deficiency) of interest-sensitive assets over interest-sensitive liabilities (1,511) (13,845) (21,353) (25,825) 4,865 15,291 Interest sensitivity gap to total assets -.77% -6.27% -3.82% -2.27% 15.60% 5.30% Cumulative interest sensitivity gap to total assets -.77% -7.04% -10.85% -13.12% 2.47% 7.77% Ratio of interest-earning assets to interest-bearing liabilities 96.01% 76.49% 82.88% 84.48% -- -- Cumulative ratio of interest-earning assets to interest-bearing liabilities 96.01% 84.67% 84.09% 84.16% 102.98% 109.38%
(1) Mortgage backed and Investment Securities are presented at amortized cost. - -------------------------------------------------------------------------------- NOW, passbook and money market accounts will decay at the following rates:
Over 1 Over 3 1 Year through through Over Or Less 3 Years 5 Years 5 Years - -------------------------------------------------------------------------------- Now accounts..................... 66% 34% --- --- Passbook, club account........... 30% 30% 40% --- Money market deposit accounts.... 100% --- --- ---
The above assumptions are annual percentage rates based on remaining balances and should not be regarded as indicative of the actual withdrawals that may be experienced by the Bank. Moreover, certain shortcomings are inherent in the analysis presented by the foregoing table. For example, interest rates on certain types of liabilities may fluctuate in advance of or lag behind changes in market interest rates. Moreover, in the event of a change in interest rates, withdrawal levels would likely deviate significantly from those assumed in calculating the table. CHANGES IN NET INTEREST INCOME AND NET PORTFOLIO VALUE. The following table measures the Bank's interest rate risk exposure in terms of the percentage change in its net interest income and net portfolio value as a result of hypothetical changes in 100 basis point increments in market interest rates. Net portfolio value (also referred to as market value of portfolio equity) represent the fair value of net assets ( determined as the market value of assets minus the market value of liabilities). The table quantifies the changes in net interest income and net portfolio value to parallel shifts in the yield curve. The column "Net Interest Income Percent Change" measures the change to the next twelve month's projected net interest income, due to parallel shifts in the yield curve. The column "Net Portfolio Value Percent Change" measures changes in the current net mark-to-market value of 7 assets and liabilities due to parallel shifts in the yield curve. The base case assumes December 31, 1997 interest rates. The Bank uses these percentage changes as a means to measure interest rate risk exposure and quantifies those changes against guidelines set by the Board of Directors as part of the Bank's Interest Rate Risk policy. The bank's current interest rate risk exposure is within those guidelines set forth.
CHANGE IN INTEREST RATES INCREASE(DECREASE) BASIS POINTS NET INTEREST INCOME NET PORTFOLIO VALUE (Rate Shock) PERCENTAGE CHANGE PERCENTAGE CHANGE -------------- ------------------- ------------------- 300 -13.47% -28.60% 200 -8.58 -19.27 100 -4.07 -9.45 Base Case - - (100) 3.37 6.87 (200) 6.80 13.11 (300) 10.31 20.32
CHANGES IN FINANCIAL CONDITION COMPARISON AT DECEMBER 31, 1997 AND DECEMBER 31, 1996. Total assets increased $6.8 million, or 3.6%, to $196.8 million at December 31, 1997 from $189.9 million at December 31, 1996. The increase in assets is primarily the result of increases in the balance of net loans receivable to $120.0 million from $108.7 million, an increase of $11.3 million, or 10.4%. This increases was primarily attributable to the continued deployment of maturing short term investments and excess liquidity to fund the demand for the Bank's loan products, principally one to four family mortgage loans and commercial real estate loans. Additionally, the Bank began originating mortgage loans underwritten to conform to the standards of the Federal National Mortgage Association ("FNMA") for the purpose of securitizing and selling such loans into the secondary market. These originations consist of 15 year and 30 year fixed rate mortgages. The purpose of undertaking this strategy is to further penetrate the mortgage market in the Bank's market area and expand mortgage underwriting into new geographic regions without incurring the credit risk of holding such loans in the Banks portfolio. The Bank intends to service these mortgages and will recognize fee income from the amortization of mortgage servicing rights. At December 31, 1997, the Bank's mortgage loans-held for sale was $1.5 million. Increases also occurred in the following areas: mortgage-backed securities increased $329,000, premises and equipment increased $336,000, other real estate owned increased $67,000, and other assets increased $626,000. These increases were partially offset by decreases in cash and due from banks and interest- earning deposits at other financial institutions of $4.0 million to $4.3 million from $8.3 million, investment securities of $2.9 million to $33.7 million from $36.5 million, and intangible assets of $316,000 to $3.6 million from 3.9 million. Non-performing loans (defined as loans past due 90 days or more) decreased $460,000, or 23.0%, to $1.5 million at December 31, 1997, from $2.0 million at the end of the prior year. The non-performing loans to total loans ratio at December 31, 1997 was 1.3% compared to 1.8% at December 31, 1996. The Bank's allowance for loan losses to total loans and non-performing loans was .67% and 53.8%, respectively, at December 31, 1997. Total liabilities increased $4.6 million, or 2.8%, to $173.2 million from $168.5 million. The increase was primarily attributable to a $10.6 million increase in borrowed funds to $18.2 million at December 31, 1997, from $7.6 million at December 31, 1996. The increase in borrowing was partially offset by a decrease in deposits of $6.6 million, or 4.2%, to $152.4 million from $159.0 million. The borrowings, consisting of 1 and 2 year term advances, 90 day reverse repurchase agreements, and an overnight line of credit, were utilized to fund the Bank's growth in its loan portfolio. The decrease in deposits is primarily attributable to a shift in consumer preferences from lower fixed rate deposits to the higher potential returns of equity securities. The Bank's investment unit, an agency relationship with a third party vendor, participated in a portion of this shift. Investments by Bank depositors in the Bank's investment unit totaled approximately $1.5 million during 1997. The Bank recognizes fee income on these 8 transactions. The decrease in deposits, especially passbook savings accounts, has caused the Bank to rely, at times, on overnight borrowings for liquidity purposes. A significant decrease in deposits in the future could result in the Bank having to seek other sources of funds for liquidity purposes. Such sources could include, but are not limited to, additional borrowings, brokered deposits, negotiated time deposits, the sale of "available-for-sale" investment securities, the sale of securitized loans, or the sale of whole loans. Such actions could result in higher interest expense costs and/or losses on the sale of securities or loans. Other liabilities increased $663,000, or 45.6%, to $2.1 million at December 31, 1997 from $1.5 million at the prior fiscal year end. Shareholders' equity increased $2.2 million, or 10.3%, to $23.6 million at December 31, 1997 from $21.4 million at December 31, 1996. The increase is attributable to net income of $1.9 million, an increase in the unrealized appreciation on investment securities available for sale of $330,000, a net decrease in unearned ESOP shares of $127,000, and in unearned stock based compensation plans of $367,000, partially offset by dividends declared of $486,000. COMPARISON AT DECEMBER 31, 1996 AND DECEMBER 31, 1995. Total assets increased $9.0 million, or 5.0%, to $189.9 million at December 31, 1996 from $180.9 million at December 31, 1995. The increase in assets is primarily the result of increases in the balance of net loans receivable to $108.7 million from $100.1 million and mortgage-backed securities to $22.8 million from $8.0 million. These increases were primarily attributable to the continued deployment of maturing short term investments and excess liquidity into higher yielding assets. These increases were partially offset by decreases in interest-earning deposits at other financial institutions to $1.6 million from $8.2 million, and investment securities to $36.7 million from $44.9 million. Non-performing loans increased $1.1 million, or 117.4%, to $2.0 million at December 31, 1996, from $919,000 at the end of the prior year. The increase in non-performing loans is primarily the result of higher delinquent payments on one-to-four family and multi-family real estate mortgages. The average loan-to- value collateral ratios on these mortgage is approximately 65%. The non- performing loans to total loans ratio at December 31, 1996 was 1.8% compared to .9% at December 31, 1995. The Bank's allowance for loan losses to total loans and non-performing loans was .82% and 45.4%, respectively, at December 31, 1996. While it is management's intention to improve these coverage ratios, it is not anticipated that the level of non-performing loans will significantly impact the Bank's future earnings. Management plans to continue regular increases in the allowance for loan loss while controlling the level of non-performing loans through collections management. Total liabilities increased $8.3 million, or 5.2%, to $168.5 million from $160.2 million. The increase was primarily attributable to a $7.6 million increase in borrowed funds, and a $674,000, or .4%, increase in deposits. The bank had no borrowed funds at December 31, 1995. The borrowed funds were obtained from a repurchase agreement with Morgan Stanley and Company. The total contractual line with Morgan Stanley and Company was $10 million at December 31, 1996. The increase in total liabilities was also attributable to an increase in notes payable on an ESOP loan of $61,000, or 14.4%, to $486,000 and an increase of $2,000 in other liabilities to $1.4 million at December 31, 1996. Shareholders' equity increased $639,000 to $21.4 million at December 31, 1996 from $20.8 million at December 31, 1995. The increase is attributable to net income of $1.3 million, partially offset by a decrease in the unrealized appreciation on investment securities available for sale of $209,000, dividends declared of $373,000, and a net increase in unearned ESOP shares of $60,000. RESULTS OF OPERATIONS GENERAL The Bank had net income of $1.9 million, $1.3 million, and $990,000 for the fiscal years ended December 31, 1997, 1996 and 1995, respectively. The increase in net income for the year ended December 31, 1997, compared to 1996 resulted primarily from increases in net interest income of $477,000, or 7.0%, to $7.3 million, and non-interest income of $400,000, or 40.8%, to $1.4 million, as well as a $375,000 decrease in the provision for loan losses. The increased income was partially offset by an increase in non-interest expense of $413,000, or 9 7.7%, and an increase in the provision for income taxes of $256,000. The Bank's return on average assets and return on shareholders' equity for the years ended December 31, 1997, 1996 and 1995 were .97% and 8.35%, .69% and 6.09%, and .56% and 6.31% , respectively. These performance ratios tend to be below the Bank's peer group during the period. The peer group is derived from the FDIC Uniform Bank Performance Report and comprises all FDIC insured savings banks having assets between $100 million and $300 million. The peer groups return on average assets for the periods ended September 30, 1997 and December 31, 1996 and 1995 were .97%, .82%, and .94%, respectively. The peer groups return on average equity for the periods ended September 30, 1997 and December 31, 1996 and 1995 were 9.10%, 7.72%, and 8.89%, respectively. The primary reasons for lower than peer returns are higher operating expenses, as a percent of total assets, and higher levels of shareholders' equity to total assets. Management is committed to decreasing it's operating expenses as a percentage of total assets and effectively leveraging it's equity to provide results which meet or exceed the Bank's peers group. Management believes that a well structured and executed merger with Oswego County Savings Bank will create a combined organization with a level of critical mass and synergies of operation to allow the Bank to achieve these goals. COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996 INTEREST INCOME Interest income increased by $955,000, or 7.2%, to $14.2 million for the year ended December 31, 1997 from $13.2 million for the year ended December 31, 1996. The increase in interest income was principally attributable to an increase of $9.9 million, or 6.0%, in the average balance of interest earning-assets, to $176.0 million from $166.0 million, and an increase in the average yield on interest-earning assets to 8.16% from 8.06%. The increase in average interest- earning assets was primarily attributable to the deployment of an additional $10.6 million in borrowed funds, partially offset by a reduction in deposits of $6.6 million. The utilization of borrowed funds, and a re-deployment of short term investments resulted in a $9.5 million increase in the average balance of real estate loans, a $6.9 million increase in the average balance of mortgage- backed securities, and decreases of $2.5 million in the average balance of investment securities and $3.8 million in the average balance of interest- earning deposits in other financial institutions. The average balance on consumer and other loans decreased by $177,000. The increase in the average yield on interest-earning assets was primarily attributable to the restructuring of the balance sheet from short term investments into higher yielding, longer term mortgage backed securities and real estate loans, including commercial real estate, and the origination of commercial business loans at rates higher than the existing real estate loan portfolio. The shift in earning assets from shorter to longer-term investments increases the Bank's interest rate sensitivity. More specifically, in a rising rate environment, the cost of interest-bearing liabilities is likely to rise more rapidly than the yield on interest earning assets resulting in a compression of net interest rate spread. (For more information regarding the impact of changes in interest rates on the Bank's earnings see "Asset and Liability Management - Interest Sensitivity Analysis") Interest income on real estate loans increased $721,000, or 8.7%, to $9.0 million for the year ended December 31, 1997, from $8.3 million for the year ended December 31, 1996. The increase was due to a $9.5 million, or 10.1%, increase in the average balance of real estate loans, partially offset by a decrease in the average yield on real estate loans of 10 basis points to 8.66% from 8.76%. The increase in the average balance on real estate loans was principally due to the origination of fixed rate mortgages with terms from 10 to 30 years, adjustable rate mortgages with a fixed rate of interest for the first five years adjustable annually thereafter, and commercial real estate loans. Fixed rate mortgages with terms greater than 20 years are principally originated with the intent to sell those loans into the secondary market. The decrease in the average yield on real estate loans was principally due to the reduction in medium and long term market interest rates that occurred during the second half of 1997. Interest income on consumer and other loans increased $87,000, or 8.6%, to $1.1 million for the year ended December 31, 1997 from $1.0 million for the year ended December 31, 1996. The increase was due to an increase in the average yield on consumer and other loans to 10.87% from 9.84%, partially offset by a decrease in the average balance on consumer and other loans of $177,000, or 1.7%, to $10.1 million from $10.2 million. The increase in the average yield on consumer and other loans reflects the Bank's continuing efforts to provide lending to qualified local businesses, which tend to carry higher interest rates. The decrease in the average balance on consumer and other loans results from softer demand in consumer lending for higher rate unsecured loans. 10 Interest income on mortgage-backed securities increased $496,000, or 45.2%, to $1.6 million from $1.1 million. The increase was attributable to a $6.9 million, or 42.5%, increase in the average balance on mortgage-backed securities to $23.2 million from $16.3 million, as well as an increase in the average yield on mortgage-backed securities to 6.84% from 6.71%. The increase in the average balance on mortgage-backed securities was due to the deployment of borrowed funds into mortgage-backed securities as part of a strategy, during the first half of 1997, to leverage the Bank's strong capital position to increase incrementally net interest income. The use of short term borrowings for investment into longer term securities, such as mortgage-backed securities, increases the sensitivity of the Bank's earnings to future increases in interest rates. As part of engaging in such a strategy, the Bank performed extensive analysis on the interest rate sensitivity of its entire balance sheet. Historically, savings account deposit interest rates have not adjusted commensurate with market interest rate movements and, more specifically, has tended to lag upward adjustments in market interest rates. The Bank's large base of savings account deposits tends to mitigate the otherwise potential negative ramifications of rising market interest rates. Bank policy on leverage transactions dictates that such transactions be "unwound" (by selling the security and paying down the borrowing) if interest rate movements result in a compression of the original spread beyond certain levels. The unwinding of such transactions during a period of sharply rising interest rates would likely result in the realization of losses on sales of securities. Interest income on investment securities decreased $105,000, or 4.0%, to $2.5 million for the year ended December 31, 1997 from $2.6 million for the year ended December 31, 1996, notwithstanding an increase in the average yield on investment securities to 7.10% from 6.91%, on a tax equivalent basis. The decrease in interest income was primarily attributable to a $2.5 million, or 6.6%, decrease in the average balance of investment securities to $35.6 million at December 31, 1997 from $38.1 million at the end of the prior year. The decrease in the average balance of investment securities is the result of funds from maturities and redemptions being reinvested in the Bank's real estate loan portfolio rather than reinvested in investment securities. The increase in the average yield on investment securities, on a tax equivalent basis, was primarily due to the maturity and redemption of securities with lower interest rates than those securities remaining in the portfolio. Interest income on interest-earning deposits decreased $221,000, or 56.1%, to $173,000 for the year ended December 31, 1997 from $394,000 for the prior year. The decrease was due to a $3.8 million, or 52.4%, decrease in the average balance on interest-earning deposits and a decrease in the average yield on such deposits to 5.05% from 5.47%. INTEREST EXPENSE Interest expense increased $478,000 or 8.0%, to $6.9 million for the year ended December 31 1997, from $6.4 million for the prior year. The increase was primarily attributable to a shift in passbook savings accounts to higher rate certificates of deposit and an increase in interest expense associated with borrowings. Interest expense on savings and club accounts decreased $117,000, or 5.6%, while the interest expense on term deposits increased $89,000, or 2.3%. The average balance on savings and club accounts decreased $4.0 million, to $65.4 million for the year ended December 31, 1997 from $69.4 for the prior year, while the average cost of such deposits remained 3.01%. The average balance on time deposits increased $1.1 million, or 1.6%, to $70.6 for the year ended December 31, 1997 from $69.5 million at December 31, 1996, while the average cost of time deposits increased to 5.63% from 5.59%. The Bank's borrowings consist of term and overnight advances from the Federal Home Loan Bank of New York, funds obtained through repurchase agreements("repos"), and a loan by another financial institution to finance the purchase of shares of the Bank's common stock for the Employee Stock Ownership Plan ("ESOP"). The average balance on the term and overnight advances for the year ended December 31, 1997 was $1.1 million, at an average cost of 6.93%, resulting in interest expense of $66,000. The average balance on the repos for the year ended December 31, 1997 was $8.4 million, at an average cost of 5.68%, resulting in interest expense of $475,000. The ESOP loan had an average balance of $465,000, at an average cost of 7.41%, resulting in $34,000 in interest expense for the year. 11 Average Balance Sheet The following table sets forth certain 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 for the three years ended December 31, 1997, 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.
Years Ended December 31, 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------------------------ Average Average Average Average Average Average Balance Interest Yield/Cost Balance Interest Yield/Cost Balance Interest Yield/Cost - ------------------------------------------------------------------------------------------------------------------------------------ (in thousands) Interest Earning Assets: Real Estate Loans $103,600 $ 8,971 8.66% $ 94,126 $ 8,250 8.76% $ 88,163 $ 7,533 8.54% Consumer & Other Loans 10,051 1,093 10.87% 10,228 1,006 9.84% 7,816 792 10.13% Mortgage-backed Securities 23,244 1,591 6.84% 16,312 1,095 6.71% 3,292 231 7.02% Taxable investment securities 29,160 1,974 6.77% 32,643 2,148 6.58% 44,865 2,834 6.32% Non-taxable investment securities 6,432 554 8.61% 5,471 485 8.86% 4,561 417 9.14% Interest-earning deposits 3,426 173 5.05% 7,206 394 5.47% 9,445 539 5.71% - ------------------------------------------------------------------------------------------------------------------------------------ Total interest-earning assets $175,913 $14,356 8.16% $165,986 $ 13,378 8.06% $158,142 $12,346 7.81% Non Interest Earning Assets: Other assets 16,017 18,671 19,240 Allowance for loan losses (936) (492) (329) Net unrealized gains (losses) on available for sale portfolio 648 366 402 Total Assets $191,642 $184,531 $177,455 - ------------------------------------------------------------------------------------------------------------------------------------ Interest-bearing Liabilities: Now accounts $ 13,346 $ 341 2.56% $ 12,709 $ 322 2.53% $ 12,830 $ 357 2.78% Savings and club accounts 65,383 1,971 3.01% 69,354 2,088 3.01% 75,270 2,256 3.00% Time deposits 70,591 3,975 5.63% 69,470 3,886 5.59% 65,047 3,643 5.60% Borrowings 10,677 639 5.98% 1,894 118 6.23% 35 3 8.57% Total Interest bearing liabilities $159,997 $ 6,926 4.33% $153,427 $ 6,414 4.18% $153,182 $ 6,259 4.09% - ------------------------------------------------------------------------------------------------------------------------------------ Non-Interest-Bearing Liabilities: Demand deposits 7,633 7,869 6,789 Other liabilities 1,798 2,345 1,793 - ------------------------------------------------------------------------------------------------------------------------------------ Total liabilities 169,428 163,641 161,764 Shareholder's equity 22,214 20,890 15,691 - ------------------------------------------------------------------------------------------------------------------------------------ Total liabilities & shareholder's equity $191,642 $184,531 $177,455 Net interest income $ 7,430 $ 6,964 $ 6,087 Net interest rate spread 3.83% 3.88% 3.72% Net interest margin 4.22% 4.20% 3.85% - ------------------------------------------------------------------------------------------------------------------------------------ Ratio of average interest-earning assets to average interest-bearing liabilities 109.95% 108.19% 103.24% - ------------------------------------------------------------------------------------------------------------------------------------
12 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 Bank'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) the net change.
Year Ended December 31, - ----------------------------------------------------------------------------------------------------------------------------- 1997 vs. 1996 1996 vs. 1995 Increase (Decrease) Due to Increase (Decrease) Due to - ----------------------------------------------------------------------------------------------------------------------------- Total Increase Volume Rate (Decrease) Volume Rate (Decrease) - ----------------------------------------------------------------------------------------------------------------------------- (in thousands) Interest Income: Real estate loans $ 817 ($96) $ 721 $ 519 $198 $ 717 Consumer and other loans (17) 104 87 238 (24) 214 Mortgage-backed securities 474 22 496 875 (11) 864 Taxable investment securities (235) 61 (174) (800) 114 (686) Non-taxable investment securities 83 (14) 69 82 (14) 68 Interest-earning deposits (193) (28) (221) (123) (22) (145) - ----------------------------------------------------------------------------------------------------------------------------- Total interest income 929 49 978 791 241 1,032 Interest Expense: Now and escrow accounts 15 4 19 (3) (32) (35) Savings and club accounts (117) 0 (117) (181) 13 (168) Time deposits 62 27 89 250 (7) 243 Borrowings 493 (6) 487 116 (1) 115 Total Interest expense: 453 25 478 182 (27) 155 - ----------------------------------------------------------------------------------------------------------------------------- Net change in interest income $ 476 $ 24 $ 500 $ 609 $268 $ 877 - -----------------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME Net interest income increased $478,000, on a tax equivalent basis, for the year ended December 31, 1997 as compared to December 31, 1996. The increase occurred due to an increase in the ratio of average interest-earning assets to average interest bearing liabilities to 110.27% from 108.19%, partially offset by a decrease in the Bank's net interest rate spread to 3.84% from 3.88%. These ratios are the result of a $9.9 million, or 6.0%, increase in average interest- earning assets, and an increase in the average yield on interest-earning assets to 8.16% from 8.06%. These increases were offset in part by an increase in the average balance of interest bearing liabilities of $6.1 million, or 4.0%, and an increase in the average cost on interest bearing liabilities to 4.32% from 4.18%. PROVISION FOR LOAN LOSSES. The Bank maintains an allowance for loan losses based upon a quarterly 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. Loan loss provisions are based upon management's estimate of the fair value of the collateral and the bank's actual loss experience, as well as standards applied by the FDIC. The Bank established a provision for possible loan losses for the year ended December 31, 1997 of $261,000 as compared to a provision of $636,000 for the year ended December 31, 1996. The decrease in the provision for loan losses was partially attributable to a $420,000 specific reserve established in September 1996 for the Bank's investments in lease finance packages acquired from the Bennett Funding Group. The Bank's loan loss provision for 1997 increased $45,000 over the prior year, after adjusting for the specific provision in 1996. The Bank's allowance for loan losses as a percentage of net loans receivable at December 31, 1997 was .68%. 13 NON INTEREST INCOME Non interest income consists of servicing income and fee income, gains (losses) on the sale of investment securities and other operating income. Non interest income increased $400,000, or 40.8%, to $1.4 million for the year ended December 31, 1997, as compared to $979,000 for the year ended December 31, 1996. The increase in non interest income was primarily attributable to an increase in fees and service charges of $52,000, or 9.1%, to $622,000 from $570,000 additional gains on the sale of investment securities of $228,000, an increase in other charges, commissions, and fees to $371,000 from $265,000, and an increase in mortgage servicing fees of $12,000. The increase in fees and service charges is primarily attributable to higher fees on checking accounts and increased mortgage servicing activity, as well as a $56,000 increase in fees generated by the Bank's investment unit. The gains on the sale of investment securities is the result of the recognition of the unrealized increased market value on the Bank's investment in the IIMF mutual fund. The increase in other charges and commissions is primarily the result of the recognition of increases in the cash surrender value on life insurance policies used to fund deferred and supplemental compensation plans. NON INTEREST EXPENSE Non interest expense increased $413,000, or 7.7%, to $5.8 million for the year ended December 31, 1997 from $5.4 million for the prior year. The increase in non interest expense was primarily attributable to increases in employee compensation and benefits of $573,000, or 24.4%, data processing costs of $12,000, or 3.2%, professional service expense increases of $7,000, and other expense increases of $48,000, or 5.5%. The increases in the employee compensation and benefits is primarily the result of recognition of the impact of the increase in the market value on the Bank's common stock on the stock based compensation plans. The increases were partially offset by a decrease in occupancy costs of $25,000, or 3.6%, and a reduction, in deposit insurance premiums of $203,000. The Bank's overhead and efficiency ratios for the years ended December 31, 1996 were 3.01% and 60.45%, respectively. The stock based compensation plan expenses and the Bank's amortization of goodwill represent non-cash expenses. If these non-cash expenses were deducted from the Bank's overhead and efficiency ratios, those adjusted ratios for the year ended December 31, 1997, would be 2.69% and 51.83%, respectively. The Bank's efforts to prepare its data processing systems for the impact of the Year 2000 were not a significant component of expense in 1997 and are not expected to materially impact earnings in the future. INCOME TAX EXPENSE Income tax expense increased $256,000, or 50.7% to $762,000 for the year ended December 31, 1997 from $506,000 for the prior year. The increase in income tax expense reflected higher pre-tax income during the year. COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1996, AND 1995 INTEREST INCOME Interest income increased by $1.0 million, or 8.3%, to $13.2 million for the year ended December 31, 1996 from $12.2 million for the year ended December 31, 1995. The increase in interest income was principally attributable to an increase of $7.8 million, or 5.0%, in the average balance of interest earning- assets, to $166.0 million from 158.1 million, and an increase in the average yield on interest-earning assets to 8.06% from 7.81%. The increase in average interest-earning assets was primarily attributable to the deployment of $7.6 million in borrowed funds and increased deposits of $674,000. The utilization of these additional funds, and a re-deployment of short term investments resulted in a $5.9 million increase in the average balance of real estate loans, a $2.4 million increase in the average balance of consumer and other loans, a $13.0 million increase in the average balance of mortgage-backed securities, and decreases of $11.3 million in the average balance of investment securities and $2.2 million in the average balance of interest-earning deposits in other financial institutions. The increase in the average yield on interest-earning assets was primarily attributable to this deployment of short term investments 14 into higher yielding investments, upward rate increases on adjustable rate mortgages, and the origination of commercial loans at rates higher than the existing real estate loan portfolio. Interest income on real estate loans increased $717,000, or 9.5%, to $8.3 million for the year ended December 31, 1996, from $7.5 million for the year ended December 31, 1995. The increase was due to a $6.0 million, or 6.8%, increase in the average balance on real estate loans, combined with an increase in the average yield on real estate loans to 8.76% from 8.54%. The increase in the average balance on real estate loans was principally due to the origination of fixed rate mortgages with terms from 10 to 20 years and commercial real estate loans. Interest income on consumer and other loans increased $214,000, or 27.0%, to $1.0 million for the year ended December 31, 1996 from $792,000 for the year ended December 31, 1995. The increase was due to an increase in the average balance on consumer and other loans of $2.4 million, or 30.9%, partially offset by a decrease in the average yield to 9.84% from 10.13%. The increase in the average balance on consumer and other loans reflects the Bank's continuing efforts to provide lending to qualified local businesses and an increased focus on the consumer loan portfolio. The decrease in the average yield on these loans reflects the Bank's pricing to the competitive rates provided on business loans in response to the interest rate environment in the market area. Interest income on mortgage-backed securities increased $864,000, or 374.5%, to $1.1 million from $231,000. The increase was attributable to a $13.0 million, or 395.5%, increase in the average balance of mortgage-backed securities to $13.0 million from $3.3 million, partially offset by a decrease in the average yield on mortgage-backed securities to 6.71% from 7.02%. The increase in the average balance of mortgage-backed securities was due to the deployment of borrowed funds and cash flows from maturing short term corporate and government agency bonds, into higher yielding asset-backed securities. The emphasis on mortgage-backed securities is part of a strategic realignment and diversification of the securities portfolio to utilize loan surrogate products to increase interest income without accepting undue interest rate risk. Mortgage-backed securities, however, do contain embedded options in that the mortgagee may pre-pay principal at any time during the life of the loan. Historically, prepayments have tended to occur more rapidly in lower interest rate environments, which may cause the Bank to invest these cash flows in lower yielding alternatives. Interest income on investment securities decreased $642,000, or 20.6%, to $2.5 million for the year ended December 31, 1996 from $3.1 million for the year ended December 31, 1995, notwithstanding an increase in the average yield on investment securities to 6.91% from 6.58%, on a tax equivalent basis. The decrease in interest income was primarily attributable to an $11.3 million, or 22.9%, decrease in the average balance on investment securities to $38.1 million at December 31, 1996 from $49.4 million at the end of the prior year. The decrease in the average balance of investment securities and the increase in the average yield earned on investment securities is consistent with the Bank's strategy of divesting the portfolio of shorter term, lower yielding corporate and agency bonds. Interest income on interest-earning deposits decreased $145,000, or 26.9%, to $394,000 for the year ended December 31, 1996 from $539,000 for the prior year. The decrease was due to a $2.2 million, or 23.7%, decrease in the average balance on interest-earning deposits and a decrease in the average yield on such deposits to 5.47% from 5.71%. INTEREST EXPENSE Interest expense increased $155,000, or 2.5%, to $6.4 million for the year ended December 31 1996, from $6.3 million for the prior year. The increase was primarily attributable to an increase in interest expense on borrowings. The borrowings consist of a loan by another financial institution to finance the purchase of shares of the Bank's common stock for the Employee Stock Ownership Plan("ESOP"), and funds obtained through repurchase agreements("repos"). The average balance on the repos for the year ended December 31, 1996 was $1.5 million, at an average cost of 5.90%, resulting in interest expense of $87,000. The ESOP loan had an average balance of $422,000, at an average rate of 7.34%, resulting in $31,000 in interest expense for the year. Interest expense on deposits increased $40,000, or .6%. The decrease in the average balance on deposits of $1.6 million to $151.5 million at December 31, 1996 from $153.1 million for the prior year, was more than offset by an increase in the average cost of deposits to 4.15% from 4.08%. 15 NET INTEREST INCOME Net interest income, on a tax equivalent basis, increased $877,000 for the year ended December 31, 1996 as compared to December 31, 1995. The increase in net interest income resulted from a $7.8 million increase in average interest- earning assets, and an increase in the average yield on interest-earning assets to 8.06% from 7.81%. These increases were offset in part by an increase in the average cost on interest bearing liabilities to 4.18% from 4.09%. The result is that the Bank's net interest rate spread rose to 3.88% from 3.72%. PROVISION FOR LOAN LOSSES. The Bank established a provision for possible loan losses for the year ended December 31, 1996 of $636,000 as compared to a provision $103,000 for the year ended December 31, 1995. The increase in the provision for loan losses was partly attributable to a $420,000 specific reserve established for the Bank's investments in lease finance packages acquired from the Bennett Funding Group. The Bank's allowance for loan losses as a percentage of net loans receivable at December 31, 1996 was .83%. NON INTEREST INCOME Non interest income consists of servicing income and fee income, gains (losses) on the sale of investment securities and other operating income. Non interest income increased $164,000, or 20.0%, to $979,000 for the year ended December 31, 1996, as compared to $816,000 for the year ended December 31, 1995. The increase in non interest income was primarily attributable to an increase in fees and service charges to $608,000 from $472,000, an increase of 28.8%, additional gains on the sale of investment securities of $62,000, and an increase in other charges, commissions, and fees to $265,000 from $245,000. These increases for the year ended December 31, 1996 were partially offset by a rebate received on FDIC insurance of $54,000 in the prior year. The overall increase in non interest income reflects the Bank's strategy to diversify and increment its sources of income. One such strategy was the introduction of investment services, initiated in June 1996, which resulted in additional income of $53,000 for the year ended December 31, 1996. NON INTEREST EXPENSE Non interest expense increased $55,000, or 1.0%, to $5.4 million for the year ended December 31, 1996 from $5.3 million for the prior year. The increase in non interest expense was primarily attributable to increases in employee compensation and benefits of $64,000, or 2.3%, building occupancy expense increases of $31,000, professional service expense increases of $226,000, and other expense increases of $98,000. The increases in the professional service expenses were the result of additional attorney fees, consulting fees and advertising expense. A portion of these additional fees are attributable to events which are not considered to be recurring. These increase were partially offset by reductions in expense associated with data processing of $34,000, and a reduction of deposit insurance premiums of $90,000 to $236,000 from $325,000. Non interest expense for the year ended December 31, 1995 was also impacted by a $240,000 reserve against possible losses due to the liquidation of Nationar. The Bank's overhead ratio for the year ended December 31, 1996 improved to 2.82% from 2.93%. Continued reduction of the overhead ratio is a primary strategic objective of the Bank. INCOME TAX EXPENSE Income tax expense increased $146,000, or 40.5% to $506,000 for the year ended December 31, 1996 from $360,000 for the prior year. LIQUIDITY AND CAPITAL RESOURCES The Bank's primary sources of funds are deposits, borrowed funds, amortization and prepayment of loans and maturities of investment securities and other short- term investments, and earnings and funds provided from operations. While scheduled principal repayments on loans are a relatively predictable source of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and 16 competition. The Bank manages the pricing of deposits to maintain a desired deposit balance. In addition, the Bank invests excess funds in short-term interest-bearing and other assets, which provide liquidity to meet lending requirements. For additional information about cash flows from the Bank's operating, financing, and investing activities, see Statements of Cash Flows included in the Financial Statements. The Bank adjusts its liquidity levels in order to meet funding needs of deposit outflows, payment of real estate taxes on mortgage loans and loan commitments. The Bank also adjusts liquidity as appropriate to meet its asset and liability management objectives. The Bank's liquidity has been enhanced by its membership in the Federal Home Loan Bank of New York, whose competitive advance programs and lines of credit will provide the Bank with a safe, reliable and convenient source of funds. A major portion of the Bank's liquidity consists of cash and cash equivalents, which are a product of operating, investing, and financing activities. The primary sources of cash were net income, principal repayments on loans and increases in deposit accounts and borrowed funds. The Bank has experienced a decrease in savings account deposits during the past two years. Savings account balances decreased $7.1 million, or 10.0%, from $71.0 million at December 31, 1995 to $63.9 million at December 31, 1997. The decrease in savings account deposits has caused the Bank to rely, at times, on overnight borrowings for liquidity purposes. A significant decrease in deposits in the future could result in the Bank having to seek other sources of funds for liquidity purposes. Such sources could include, but are not limited to, additional borrowings, brokered deposits, negotiated time deposits, the sale of "available-for-sale" investment securities, the sale of securitized loans, or the sale of whole loans. Such actions could result in higher interest expense costs and/or losses on the sale of securities or loans. At December 31, 1997, the Bank had outstanding loan commitments of $14.0 million. This amount includes the unfunded portion of loans in process. Certificates of deposit scheduled to mature in less that one year at December 31, 1997 totaled $38.9 million. Based on prior experience, management believes that a significant portion of such deposits will remain with the Bank. NEW ACCOUNTING PRONOUNCEMENTS Reporting Comprehensive Income. In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 130, "Reporting Comprehensive Income" effective 1998. This statement will require the Bank to report comprehensive income. For the Bank, comprehensive income is determined by adding unrealized investment holding gains or losses during the period to net income. Disclosures about Segments of an Enterprise and Related Information. In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of and Enterprise and Related Information". This statement requires companies to disclose financial and descriptive information about its reportable business segments. Management believes the Bank only operates one segment, which is the banking segment. Therefore, disclosures required under this pronouncement will not affect the financial statements of the Bank. IMPACT OF INFLATION AND CHANGING PRICES The financial statements of the Bank and notes thereto, presented elsewhere herein, have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Bank's operations. Unlike most industrial companies, nearly all the assets and liabilities of the Bank are monetary. As a result, interest rates have a greater impact of the Bank's performance that do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services. COMMON STOCK AND RELATED MATTERS The common stock of Pathfinder Bancorp, Inc. trades and is listed on The Nasdaq SmallCap Stock Market under the symbol "PBHC" and the short name PathBcp. The stock was issued on November 15, 1995 at $5.00 per share (adjusted for the three for two stock split on February 5, 1998. As of March 20, 1998, there were 449 shareholders of record and 2,874,999 outstanding shares of common stock. 17 The following table sets forth the high and low closing bid prices and dividends paid per share of common stock for the periods indicated, adjusted retroactively for the three for two stock split paid on February 5, 1998.
Dividends Quarter ended High Low Paid ------------------- ------- ------- --------- December 31, 1997 $20.000 $14.000 $.0467 September 30, 1997 14.750 8.583 $.0467 June 30, 1997 9.333 7.250 $.0467 March 31, 1997 8.667 6.250 $.0333 December 30, 1996 7.083 5.833 $.0333 September 30, 1996 6.000 5.333 $.0333 June 30, 1996 6.000 5.500 $.0333 March 31, 1996 6.833 5.833 $.0333 December 31, 1995 7.167 5.583 $.0333
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, Oswego City Savings Bank's results of operations and financial condition, tax considerations, and general economic conditions. No assurance can be given that dividends will be declared or, if declared, what the amount of dividends will be, or whether such dividends, once declared, will continue. 18
December 31, ------------- 1997 1996 - ------------------------------------------------------------------------------------------------- ASSETS: Cash and due from banks $ 4,334,072 $ 6,802,959 Federal funds sold ---- 1,550,000 - ------------------------------------------------------------------------------------------------- Total cash and cash equivalents 4,334,072 8,352,959 Investment securities (approximate fair value $56,847,000 and $59,597,000) 56,821,317 59,502,156 Mortgage loans held-for-sale 1,547,354 ---- Loans: Real estate 110,416,494 99,842,835 Consumer and other 10,763,277 10,174,563 - ------------------------------------------------------------------------------------------------- Total loans 121,179,771 110,017,398 Less: Allowance for loan losses 827,521 906,567 Unearned discounts and origination fees 314,322 368,885 - ------------------------------------------------------------------------------------------------- Loans receivable, net 120,037,928 108,741,946 Premises and equipment, net 3,720,270 3,384,480 Accrued interest receivable 1,443,175 1,466,003 Other real estate 766,619 699,921 Intangible assets 3,604,876 3,920,632 Other assets 4,494,775 3,869,108 ------------------------------------------------------------------------------------------------- $196,770,386 $189,937,205 ------------------------------------------------------------------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY: Deposits Interest bearing $144,754,879 $151,656,742 Non-interest bearing 7,644,262 7,341,096 ------------ ------------ Total deposits 152,399,141 158,997,838 Borrowed Funds 18,242,000 7,610,000 Note payable - ESOP 430,126 485,926 Other liabilities 2,116,384 1,453,357 - ------------------------------------------------------------------------------------------------- Total liabilities 173,187,651 168,547,121 Shareholders' equity: Common stock, par value $.10 per share; authorized 9,900,000 shares; 2,874,999 shares issued and outstanding 287,500 1,916,666 Additional paid-in-capital 7,643,084 3,750,726 Retained earnings 17,156,415 15,787,666 Unearned stock based compensation (1,836,250) ---- Unearned ESOP shares (411,050) (477,908) Unrealized appreciation on securities available-for-sale 743,036 412,934 - ------------------------------------------------------------------------------------------------- Total shareholders' equity 23,582,735 21,390,084 ------------------------------------------------------------------------------------------------- $196,770,386 $189,937,205 -------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of the consolidated financial statements 19
Years Ended December 31, 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------ INTEREST INCOME: Loans $10,063,659 $ 9,256,360 $ 8,325,213 Interest and dividends on investments: U.S. Treasury and agencies 407,628 509,275 718,924 State and political subdivisions 372,376 320,192 274,681 Corporate 1,477,630 1,610,326 2,008,538 Marketable equity securities 82,819 27,857 107,337 Mortgage-backed 1,590,701 1,094,837 230,721 Federal funds sold and interest-bearing deposits 172,839 393,871 539,109 - ------------------------------------------------------------------------------------------------------------------ Total interest income 14,167,652 13,212,718 12,204,523 INTEREST EXPENSE: Interest on deposits 6,287,117 6,295,592 6,255,020 Interest on borrowed funds 604,844 118,132 3,846 ---------- ---------- ---------- Total interest expense 6,891,961 6,413,724 6,258,866 - ------------------------------------------------------------------------------------------------------------------ Net interest income 7,275,691 6,798,994 5,945,657 Provision for loan losses 261,112 636,410 102,500 - ------------------------------------------------------------------------------------------------------------------ Net interest income after provision for loan losses 7,014,579 6,162,584 5,843,157 - ------------------------------------------------------------------------------------------------------------------ OTHER INCOME: Service charges on deposit accounts 622,222 570,464 436,574 Mortgage servicing fees 49,811 37,364 35,645 Net securities gains (losses) 335,262 106,638 44,397 Deposit insurance refund ---- ---- 54,318 Other charges, commissions and fees 371,964 264,871 244,842 - ------------------------------------------------------------------------------------------------------------------ Total other income 1,379,259 979,337 815,776 - ------------------------------------------------------------------------------------------------------------------ OTHER EXPENSES: Salaries and employee benefits 2,917,470 2,344,218 2,280,656 Building occupancy 666,082 691,101 659,774 Data processing expenses 387,741 375,557 409,400 Professional and other services 529,724 522,800 297,040 Deposit insurance premiums 33,139 235,843 325,735 Amortization 315,756 315,755 315,755 Provision for loss contingency ---- ---- 240,000 Other expenses 927,478 879,049 780,684 - ------------------------------------------------------------------------------------------------------------------ Total other expenses 5,777,390 5,364,323 5,309,044 Income before income taxes 2,616,448 1,777,598 1,349,889 Provision for income taxes 762,087 505,838 360,000 - ------------------------------------------------------------------------------------------------------------------ Net income $ 1,854,361 $ 1,271,760 $ 989,889 - ------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------ Earnings per share-basic and diluted $0.66 $0.45 $0.07 - ------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of the consolidated financial statements 20
UNREALIZED APPRECIATION ADDITIONAL UNEARNED (DEPRECIATION) COMMON STOCK PAID IN RETAINED STOCK BASED ON INVESTMENT SHARES AMOUNT CAPITAL EARNINGS COMPENSATION SECURITIES - ----------------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1994 $14,099,486 $(109,363) Net income 989,889 Net proceeds from issuance of common stock 1,916,666 $ 1,916,666 $3,748,248 Acquisition of unearned ESOP shares ESOP shares earned 31 Capital contribution to Pathfinder Bancorp, M.H.C. (200,000) Change in unrealized net appreciation (depreciation) on investment securities 731,721 - ----------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1995 1,916,666 1,916,666 3,748,279 14,889,375 622,358 Net Income 1,271,760 Acquisition of unearned ESOP shares ESOP shares earned 2,447 Change in unrealized net appreciation (depreciation) on investment securities (209,424) Dividends declared ($0.13 per share) (373,469) - ----------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1996 1,916,666 1,916,666 3,750,726 15,787,666 412,934 Net Income 1,854,361 ESOP shares earned 59,692 Unearned stock-based compensation awarded 2,203,500 (2,203,500) Stock based compensation earned 367,250 Change in unrealized net appreciation (depreciation) on investment securities 330,102 Dividends declared ($0.17 per share) (485,612) Three-for-two stock split and reduction in par value of common stock 958,333 (1,629,166) 1,629,166 - ----------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1997 2,874,999 $ 287,500 $7,643,084 $17,156,415 ($1,836,250) $ 743,036 =================================================================================================================================== Unearned ESOP Shares Total - ----------------------------------------------------------------------------- Balance at December 31, 1994 $ 13,990,123 Net income 989,889 Net proceeds from issuance of common stock 5,664,914 Acquisition of unearned ESOP shares ($436,250) (436,250) ESOP shares earned 10,950 10,981 Capital contribution to Pathfinder Bancorp, M.H.C. (200,000) Change in unrealized net appreciation (depreciation) on investment securities 731,721 - ----------------------------------------------------------------------------- Balance, December 31, 1995 (425,300) 20,751,378 Net Income 1,271,760 Acquisition of unearned ESOP shares (110,047) (110,047) ESOP shares earned 57,439 59,886 Change in unrealized net appreciation (depreciation) on investment securities (209,424) Dividends declared ($0.13 per share) (373,469) - ----------------------------------------------------------------------------- Balance, December 31, 1996 (477,908) 21,390,084 Net Income 1,854,361 ESOP shares earned 66,858 126,550 Unearned stock-based compensation awarded Stock based compensation earned 367,250 Change in unrealized net appreciation (depreciation) on investment securities 330,102 Dividends declared ($0.17 per share) 485,612 Three-for-two stock split and reduction in par value of common stock - ----------------------------------------------------------------------------- Balance, December 31, 1997 ($411,050) $23,582,735 =============================================================================
The accompanying notes are an integral part of the consolidated financial statements 21
Years Ended December 31, 1997 1996 1995 - ----------------------------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES: Net Income $ 1,854,361 $ 1,271,760 $ 989,889 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan, investment and other real estate losses 261,112 675,152 136,754 Provision for Nationar Loss ---- ---- 240,000 Deferred compensation 169,773 164,926 160,075 ESOP and other stock-based compensation earned 493,800 59,886 10,981 Deferred income tax provision 256,249 (62,775) (58,434) Realized and unrealized losses (gains) on investment securities (335,262) (106,638) (44,397) Net loss on sale of other real estate ---- 3,602 29,783 Depreciation 235,282 248,105 327,827 Amortization of intangibles 315,756 315,755 315,755 Net amortization of premiums and discounts on investment securities 65,923 114,115 348,485 Decrease (increase) in interest receivable 22,827 3,659 (69,291) (Increase) decrease in other assets (437,353) (234,633) 307,135 (Decrease) Increase in other liabilities (137,440) (106,771) 308,012 - ----------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 2,765,028 2,346,143 3,002,574 - ----------------------------------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES Purchase of investment securities available for sale (8,482,036) (28,604,061) (23,346,873) Proceeds from maturities and principal reductions of investment securities held to maturity 4,790,000 250,000 1,104,302 Proceeds from maturities and principal reductions of investment securities available for sale 6,420,245 10,995,832 11,692,557 Proceeds from sale of investment securities available for sale 792,352 10,393,686 7,684,119 Net increase in loans (13,478,076) (9,674,236) (11,228,831) Purchase of premises and equipment (571,072) (813,086) (1,135,676) Proceeds from sale of other real estate owned 586,109 289,153 628,486 Increase in surrender value of life insurance (188,315) (138,210) (142,970) Other investment activity (279,179) ---- ---- - ----------------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (10,409,972) (17,300,922) (14,744,886) - ----------------------------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES Net decrease in demand deposits, NOW accounts, savings accounts, money market deposit accounts and escrow deposits (1,191,170) (4,454,805) (7,404,864) Net (decrease)increase in time deposits (5,407,527) 5,128,707 9,635,211 Proceeds from borrowings 10,632,000 7,720,047 436,250 Repayments of borrowings (55,800) (48,799) (11,572) Cash dividends (351,446) (277,636) ---- Common stock acquired by ESOP ---- (110,047) (436,250) Proceeds from the sale of common stock ---- ---- 5,664,914 - ----------------------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 3,626,057 7,957,467 7,883,689 - ----------------------------------------------------------------------------------------------------------------------------- Reclass of Nationar deposits from cash equivalents to other assets (see Note 12) ---- 2,783,000 (2,960,000) - ----------------------------------------------------------------------------------------------------------------------------- (Decrease) in cash and cash equivalent (4,018,887) (4,214,312) (6,818,623) Cash and cash equivalents at beginning of year 8,352,959 12,567,271 19,385,894 - ----------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 4,334,072 $ 8,352,959 $ 12,567,271 - ----------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------- CASH PAID DURING THE PERIOD FOR: Interest $ 6,835,301 $ 6,285,566 $ 6,255,153 Income Taxes Paid 795,705 529,477 215,000 NON-CASH INVESTING ACTIVITY: Transfer of loans to other real estate 373,628 445,035 644,936 Gross change in unrealized appreciation (depreciation) on securities available for sale 564,402 (349,040) 1,219,540 NON-CASH FINANCING ACTIVITY: Dividends declared and unpaid 130,922 93,138 ----
The accompanying notes are an integral part of the consolidated financial statements 22 NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS The accompanying consolidated financial statements include the accounts of Pathfinder Bancorp, Inc. (the "Company") and its wholly owned subsidiary, Oswego City Savings Bank (the "Bank"). All inter-company accounts and activity have been eliminated in consolidation. The Bank has five full service offices located in its market area consisting of Oswego County. 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 investment securities. Pathfinder Bancorp, M.H.C., (the "Holding Company") a mutual holding company whose activity is not included in the accompanying financial statements, owns approximately 54% of the outstanding common stock of the Company. Salaries, employee benefits and rent approximating $48,000 were allocated from the Bank to Pathfinder Bancorp, M.H.C. during 1997. Effective December 1997, the Bank and Pathfinder Bancorp, M.H.C., reorganized through the formation of Pathfinder Bancorp, Inc., a state-chartered, stock holding company. The reorganization was effected by the exchange of outstanding shares of the Bank for shares of Pathfinder Bancorp, Inc. In September 1997, the Bank entered into a definitive agreement to merge with Oswego County Savings Bank, a mutual, state-chartered savings bank with assets of approximately $112 million. The merger requires approval of applicable regulators, the shareholders of Pathfinder Bancorp, Inc., and the depositors of Oswego County Savings Bank and is expected to be consummated in the second half of 1998. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash on hand, amounts due from banks, interest-bearing deposits (with original maturity of three months or less) and federal funds sold. Generally, federal funds are purchased and sold for one-day periods. Short-term cash investments include certificates of deposit and money market funds. The estimated fair value of cash and cash equivalents approximates carrying value. INVESTMENT SECURITIES The Company classifies investment securities as held-to-maturity or available- for-sale. Held-to-maturity securities are those that the Company has the positive intent and ability to hold to maturity, and are reported at cost, adjusted for amortization of premiums and accretion of discounts. Investment securities not classified as held-to-maturity are classified as available-for- sale and are reported at fair value, with net unrealized gains and losses reflected as a separate component of shareholders' equity, net of the applicable income tax effect. None of the Company's investment securities have been classified as trading securities. Gains or losses on investment security transactions are based on the amortized cost of the specific securities sold. Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. Premiums and discounts on securities are amortized and accreted into income using the interest method over the period to maturity. MORTGAGE LOANS HELD-FOR-SALE Mortgage loans held-for-sale are carried at the lower of cost or fair value. Fair value is determined in the aggregate. LOANS Loans are stated at unpaid principal balances, less the allowance for loan losses and net deferred loan origination fees and costs. Interest income is generally recognized when income is earned using the interest method. Nonrefundable loan fees received and related direct origination costs incurred are deferred and amortized over the life of the loan using the interest method, resulting in a constant effective yield over the loan term. Deferred fees are recognized into income immediately upon prepayment of the related loan. 23 For variable rate loans that reprice frequently and with no significant credit risk, fair values are based on carrying values. Fair values for fixed rate loans are estimated using discounted cash flow analysis, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The carrying amount of accrued interest approximates its fair value. ALLOWANCE FOR POSSIBLE LOAN LOSSES The allowance for loan losses is maintained at a level considered adequate to provide for potential loan losses. The allowance is increased by provisions charged to expense and reduced by net charge-offs. The level of the allowance is based upon management's evaluation of potential losses related to outstanding loans, as well as prevailing economic conditions. INCOME RECOGNITION ON IMPAIRED AND NON-ACCRUAL LOANS Loans, including impaired loans, are generally classified as non-accrual if they are past due as to maturity or payment of principal or interest for a period of more than 90 days. When a loan is classified as non-accrual and the future collectibility of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to principal outstanding. When future collectibility of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccrual loan had been partially charged off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Cash interest receipts in excess of that amount are recorded as recoveries to the allowance for possible credit losses until prior charge-offs have been fully recovered. PREMISES AND EQUIPMENT Premises and equipment are stated at cost, less accumulated depreciation. Depreciation is computed generally on a straight-line basis over the estimated useful lives of the related assets. Maintenance and repairs are charged to operating expenses as incurred. OTHER REAL ESTATE Properties acquired through foreclosure, or by deed in lieu of foreclosure, are carried at the lower of cost (fair value at the date of foreclosure) or fair value less estimated disposal costs. INTANGIBLE ASSETS Intangible assets represent goodwill arising from branch acquisitions and are being amortized on a straight-line basis over a 15-year period. The Company periodically reviews the carrying value of intangible assets using fair value methodologies. Accumulated amortization totaled approximately $1,131,458 and $816,000 at December 31, 1997 and 1996, respectively. DEPOSITS Interest on deposits is accrued and paid to the depositors or credited to the depositors accounts monthly, quarterly or annually. Fair values disclosed for demand, savings, variable rate money market accounts and time accounts approximate their carrying values at the reporting date. Fair values for fixed rate time accounts are estimated using a discounted cash flow calculation that applies interest rates currently being offered on similar certificates to a schedule of aggregated expected monthly maturities on time deposits. The carrying value of accrued interest approximates fair value. INCOME TAXES Provisions for income taxes are based on taxes currently payable or refundable and deferred income taxes on temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements. Deferred tax assets and liabilities are reported in the financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets and liabilities are expected to be realized or settled. EARNINGS PER SHARE Basic earnings per share are computed by dividing net income by the weighted average number of common shares outstanding throughout each year (2,798,610, 2,801,503, and 2,816,279 for 1997, 1996, and November 15, 1995 through December 31, 1995, respectively as adjusted to reflect the 3 for 2 stock split). Diluted earnings per share gives effect to weighted average shares which would be outstanding assuming the exercise of issued stock options using the treasury stock method (2,804,365 for 1997). 24 In conjunction with the formation of Pathfinder Bancorp, Inc. in December 1997, the Company changed the par value of its common stock from $1.00 to $.10. On January 13, 1998, the Board of Directors declared a three-for-two stock split of the Company's common stock to be effected in the form of a stock dividend distributed February 5, 1998 to shareholders of record on January 26, 1998. The effect of the stock split has been retroactively reflected as of December 31, 1997 in the consolidated statement of condition and statement of shareholders' equity. All references to number of shares, per share amounts and stock option data in the consolidated financial statements have been restated. The Company adopted Statement of Financial Accounting Standards No. 128, "Earnings Per Share" in 1997, which had no affect on quarterly or annual earnings as previously reported. FAIR VALUES OF FINANCIAL INSTRUMENTS Financial Accounting Standards Board Statement No. 107, "Disclosure About Fair Value of Financial Instruments," requires disclosure of fair value information of financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair values estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Statement No. 107 excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. The carrying amounts and estimated fair values of financial instruments at December 31, are as follows:
1997 1996 Carrying Estimated Carrying Estimated Amounts Fair Values Amounts Fair Values ---------------------------------------------------------------------------------------------------------- Cash and cash equivalents $ 4,334,072 $ 4,334,000 $ 8,352,959 $ 8,353,000 Investment Securities 56,821,317 56,847,000 59,502,156 59,597,000 Mortgage loans held-for-sale 1,547,354 1,554,550 -- -- Loans 120,037,928 123,969,000 108,741,946 113,047,000 Accrued interest receivable & other assets 1,443,175 1,443,000 1,466,003 1,446,000 Deposits 152,399,141 148,044,000 158,997,838 154,888,000 Borrowed funds 18,242,000 18,242,000 7,610,000 7,610,000 Note payable - ESOP 430,126 430,000 485,926 486,000
The fair value of options and commitments to extend credit is not significant. RECLASSIFICATION Certain amounts from 1996 and 1995 have been reclassified to conform to the current years presentation. These reclassifications had no affect on net income as previously reported. NOTE 2: INVESTMENT SECURITIES The amortized cost and estimated fair value of investment securities are summarized as follows:
December 31, 1997 Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value - ----------------------------------------------------------------------------------------------------- Held-to-maturity: Corporate debt $ 5,115,232 $ 32,260 $ 6,131 $ 5,141,360 - ----------------------------------------------------------------------------------------------------- Available-for-sale: Bond investments: U.S. Treasury and agencies 4,856,250 36,312 8,224 4,884,338 State and political subdivision 6,635,657 424,830 545 7,059,942 Corporate 13,006,129 204,018 6,412 13,203,735 Mortgage-backed 23,023,302 189,011 54,374 23,157,939 - ----------------------------------------------------------------------------------------------------- Total 47,521,338 854,171 69,555 48,305,954 Stock investments: Federal Home Loan Bank and Other 2,923,670 476,461 -- 3,400,131 - -----------------------------------------------------------------------------------------------------
25
Total available-for-sale $50,445,008 $1,330,632 $ 69,555 $51,706,085 - ----------------------------------------------------------------------------------------------------- Net unrealized gain on available-for-sale 1,261,077 Grand total carrying value $56,821,317 - -----------------------------------------------------------------------------------------------------
December 31, 1996 Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value Held-to-maturity: Corporate debt $ 9,629,303 $ 110,966 $ 16,009 $ 9,724,260 - ----------------------------------------------------------------------------------------------------- Available-for-sale: Bond investments: U.S. Treasury and agencies 5,879,451 40,018 25,733 5,893,736 State and political subdivision 6,172,638 333,556 12,761 6,493,433 Corporate 12,430,395 192,478 40,292 12,582,581 Mortgage-backed 22,965,752 69,397 206,082 22,829,067 - ----------------------------------------------------------------------------------------------------- Total 47,448,236 635,449 284,868 47,798,817 Stock investments: Federal Home Loan Bank and Other 1,734,623 339,413 -- 2,074,036 Total available-for-sale $49,182,859 $ 974,862 $284,868 $49,872,853 - ----------------------------------------------------------------------------------------------------- Net unrealized gain on available-for-sale 689,994 Grand total carrying value $59,502,156 - --------------------------------------------------------------------------------------------
The amortized cost and estimated fair value of debt investments at December 31, 1997 by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.
Available for Sale Held-to Maturity December 31, 1997 December 31, 1997 - ---------------------------------------------------------------------------------------------------------------- Estimated Estimated Amortized Fair Amortized Fair Cost Value Cost Value - ---------------------------------------------------------------------------------------------------------------- Due in one year or less $4,635,248 $4,678,344 $4,270,688 $4,293,934 Due after one year through five years 6,116,119 6,239,412 -- -- Due after five years through ten years 10,543,456 10,894,299 774,109 776,991 Due after ten years 3,203,213 3,335,960 70,435 70,435 Mortgage-backed securities 23,023,302 23,157,939 -- -- Totals $47,521,338 $48,305,954 $5,115,232 $5,141,360 - ----------------------------------------------------------------------------------------------------------------
Proceeds from the sales of debt securities for 1997, 1996, and 1995 were $792,352, $10,393,686, and $7,624,121, respectively. Gross gains of $4,102, $3,643, and $31,040 and gross losses of $15,698, $49,996 and $58,563 were realized on these sales for 1997, 1996, and 1995, respectively. The sale of marketable equity securities resulted in realized losses of $38,078 for 1995. 26 NOTE 3: LOANS Major classifications of loans at December 31, are as follows:
1997 1996 -------------------------------------------------------------- Real estate mortgages: Conventional $ 79,346,064 $ 72,357,149 Second mortgage loans 9,561,252 9,082,632 Construction 1,579,261 2,496,673 FHA insured 94,677 115,576 VA guaranteed 93,448 122,298 Commercial 19,741,792 15,668,507 -------------------------------------------------------------- 110,416,494 99,842,835 -------------------------------------------------------------- Other loans: Consumer 4,106,503 3,275,268 Lease financing 564,333 1,152,521 Passbook loans 170,854 206,133 Student 13,286 58,168 Commercial 5,908,301 5,482,472 10,763,277 10,174,563 $121,179,771 $110,017,398 --------------------------------------------------------------
The Company grants mortgage and consumer loans to customers throughout Oswego and parts of Onondaga counties. Although the Company has a diversified loan portfolio, a substantial portion of its debtors ability to honor their contracts is dependent upon the counties employment and economic conditions. At December 31, 1997, loans to officers and directors were not significant. During 1997, the Company began originating loans which conform to Federal National Mortgage Association ("FNMA") underwriting standards with the intent to securitize and sell such loans into the secondary market. The terms of the loans originated for sale are limited to one-to-four family 15-year and 30-year fixed rate mortgages. In conjunction with the origination and pending sale of such mortgages, the Company has engaged in certain transactions to mitigate or eliminate the impact of changes in interest rates on the market value of the loans pending sale. At December 31, 1997, the company had $3.0 million in notional amount outstanding put options to hedge loans committed or loans closed and pending sale. The put options are accounted for as hedging instruments. The put options provide the bank the option to sell FNMA 30-year mortgage-backed securities at a specified strike price prior to the maturity date. The unamortized carrying value of the option premiums at December 31, 1997 was $26,000. The maturity dates on the outstanding options are January 14 and February 5, 1998. NOTE 4: ALLOWANCES FOR LOAN LOSSES Changes in the allowance for loan losses are presented in the following summary:
1997 1996 1995 -------------------------------------------------------------- Balance at beginning of period $ 906,567 $345,660 $315,050 Recoveries credited 18,113 17,498 8,631 Provision for loan losses 261,112 636,410 102,500 Loans charged off (358,271) (93,001) (80,521) Balance at end of period $ 827,521 $906,567 $345,660 --------------------------------------------------------------
At December 31, 1997, the Company had no loans for which specific valuation allowances were recorded. During 1996, the Company had approximately $1.1 million of collateralized loans outstanding with a lease financing company and its affiliates that were determined to be impaired under SFAS No. 114. The Company established a $420,000 reserve to reflect the estimated impairment. During 1996 and 1997, the Company received payments reducing its outstanding balance in the loans receivable to approximately $319,000. Loans charged off during 1997 of $358,271 included approximately $319,000 relating to these loans receivable. 27 For the year ended December 31, 1996, the average recorded investment in impaired loans was approximately $1,036,000, with $29,000 of interest income recognized on these loans on a cash basis. NOTE 5: PREMISES AND EQUIPMENT A summary of premises and equipment is as follows:
1997 1996 ----------------------------------------------------------- Land $ 631,773 $ 416,993 Buildings 2,953,032 2,532,626 Furniture, fixture and equipment 1,839,156 1,781,615 Construction in progress 484,763 635,611 ----------------------------------------------------------- 5,908,724 5,366,845 Less: Accumulated depreciation 2,188,454 1,982,365 $3,720,270 $3,384,480 -----------------------------------------------------------
NOTE 6: DEPOSITS A summary of amounts due to depositors is shown as follows:
1997 1996 -------------------------------------------------------------------- Savings accounts $ 63,937,467 $ 65,634,242 Money market accounts 112,842 173,758 Time accounts 67,058,897 72,466,425 Demand deposits interest bearing 13,306,129 13,081,669 Demand deposits non-interest bearing 7,644,262 7,341,096 Mortgages escrow funds 339,544 300,648 $152,399,141 $158,997,838 --------------------------------------------------------------------
Time deposits with balances in excess of $100,000 amounted to approximately $8,455,000 and $11,216,000 at December 31, 1997 and 1996, respectively. The approximate maturity of time deposits is as follows:
1997 1996 - ----------------------------------------------------------------------------------- Year of Maturity Amount Percent Amount Percent 1 $38,860,000 57.9% $52,929,000 73.0% 2 17,960,000 26.8% 7,886,000 10.9% 3 to 5 8,621,000 12.9% 9,035,000 12.5% 5 and over 1,618,000 2.4% 2,616,000 3.6% - ----------------------------------------------------------------------------------- $67,059,000 100.0% $72,466,000 100.0% - -----------------------------------------------------------------------------------
NOTE 7: BORROWED FUNDS The Company has available a $550,870 line of credit in connection with the Employee Stock Ownership Plan, of which $430,126 was outstanding at December 31, 1997. Principal and interest are payable quarterly at prime minus one over 10 years. The Company maintains an unsecured overnight line of credit with the Federal Home Loan Bank for liquidity purposes. At December 31, 1997, $9,500,000 was available under this line of which $5,750,000 was outstanding. Interest on this line is determined at the time of borrowing. The average rate paid on the overnight line during 1997 approximated 5.8%. The outstanding balance is Collateralized by Certain Mortgage loans under a pledge agreement with the Federal Home Loan Bank. The Company has term borrowings in the form of repurchase agreements and advances. At December 31, 1997, repurchase agreements totalled $7.9 million and advances totalled $4.6 million. The repurchase agreements mature within 90 days and carry interest rates varying from 5.65% and 5.84%. The repurchase agreements are collateralized by mortgage-backed securities which had a carrying value of $8.3 million at December 31, 1997. The principal balance, interest rates, and maturities on the term advances are as follows: Principal Rate Term Maturity Date --------- ---- ---- ------------- $ 850,000 6.12% 1 yr. 12/29/98 $ 1,000,000 5.98% 1 yr. 8/13/98 $ 1,000,000 6.24% 2 yrs. 8/13/99 $ 1,700,000 6.96% 1 yr. 10/29/98 NOTE 8: EMPLOYEE BENEFITS The Company has a noncontributory defined benefit pension plan covering substantially all employees. Under the plan, retirement benefits are primarily a function of both the years of service and level of compensation. It is the Company's policy to fund the plan in amounts sufficient to pay liabilities. Plan assets consist primarily of temporary cash investments and listed stocks and bonds. The following table represents a reconciliation of the funded status of the plan at October 1 (date of the most recent actuarial study): 28 Plan assets at fair value $3,231,500 $2,627,000 - ---------------------------------------------------------------------------------------------------------------------------- Actuarial present value of benefit obligations Vested benefits 2,034,500 1,755,900 Nonvested benefits 54,500 87,500 - ---------------------------------------------------------------------------------------------------------------------------- Accumulated benefit obligations 2,089,000 1,843,400 Effect of future salary increases 370,200 366,800 Projected benefit obligation 2,459,200 2,210,200 - ---------------------------------------------------------------------------------------------------------------------------- Plan assets in excess of projected benefit obligation 772,400 416,800 Unrecognized net loss (173,100) 147,400 Unrecognized past service liability 5,500 6,600 Unrecognized transition obligation -- (34,200) Prepaid pension asset included in other assets $ 604,800 $ 536,600 - -----------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------- Net periodic pension cost for the years ended December 31 is as follows: 1997 1996 1995 - ----------------------------------------------------------------------------------------------------------------------------- Service cost benefits earned during the year $ 76,262 $ 94,076 $ 99,664 Interest cost on projected benefit obligations 169,405 162,256 148,160 Return on plan assets (582,197) (314,657) (377,065) Net amortization and deferral 340,840 99,445 203,924 Net periodic pension expense $ 4,310 $ 41,120 $ 74,683 - ----------------------------------------------------------------------------------------------------------------------------- - -----------------------------------------------------------------------------------------------------------------------------
The actuarial present value of the projected benefit obligation shown in the above table is based on a discount rate of 7.25% and 7.75% for 1997 and 1996, respectively and an assumed rate of increase in future compensation levels of 5.0%. The expected long-term rate of return on assets was 8% for 1997 and 1996. The Company provides certain health and life insurance benefits for eligible retired employees. Employees with less than 14 years of service as of January 1, 1995 are not eligible for these benefits. The costs of post-retirement health and life insurance benefits are accrued for during the service lives of employees. The Company elected the prospective transition approach, and is amortizing the transition obligation over a 20 year period. The effect of this accounting change in 1995 was to decrease net income by approximately $34,000. Net periodic post-retirement benefit cost at December 31, includes the following components:
1997 1996 1995 ----------------------------------------------------------------------------------------------------------------------------- Service Cost $ 3,014 $ 3,748 $ 3,344 Amortization of transition obligation 18,450 18,978 18,978 Interest on APBO less interest on expected benefit payments 24,898 24,976 26,238 Net periodic post-retirement benefit costs $46,362 $47,702 $48,560 -----------------------------------------------------------------------------------------------------------------------------
A 10% percent annual rate of increase in the per capita costs of covered health care benefits was assumed for 1997, gradually decreasing to 5.5 percent by the year 2005. Increasing the assumed health care cost trend rates by one percentage point would increase the accumulated post-retirement benefit obligation as of December 31, 1997 by $17,766, and increase the aggregate of the service cost and interest cost components of net periodic post-retirement benefit cost for 1997 by $1,205. A discount rate of 7.00% was used to determine the accumulated post- retirement obligation. The funded status of the plan as of December 31, is as follows:
1997 1996 ------------------------------------------------------------------------------------------------------------------------------ Accumulated Post-retirement Benefit Obligation (APBO): Retirees $299,681 $ 277,142 Other active plan participants 78,048 92,110 - -------------------------------------------------------------------------------------------------------------------------------- Total APBO 377,729 369,252 Plan Assets -- -- - -------------------------------------------------------------------------------------------------------------------------------- APBO in excess of plan assets (377,729) (369,252) Unrecognized portion of net obligation at transition 273,909 292,887 Unrecognized net loss 11,594 12,779 - -------------------------------------------------------------------------------------------------------------------------------- Accrued post-retirement benefit cost $(92,226) $ (63,586) - --------------------------------------------------------------------------------------------------------------------------------
29 The Company has a Salary Deferral Program which covers employees who have completed one year of service (1,000 hours per year) and are 21 years of age. The plan includes a Section 401(k) provision as defined under the Internal Revenue Code. The 401(k) provision permits employees to contribute the lessor of $9,500, or 15% of their total compensation on a pretax basis for the plan year ended December 31, 1997. The Company's contributions are at the discretion of the board of directors. Company contributions associated with the Plan amounted to $41,400, $35,400, and $0 for the years ended December 31, 1997, 1996, and 1995, respectively. NOTE 9: DEFERRED COMPENSATION AND SUPPLEMENTAL RETIREMENT PLANS The Company maintains optional deferred compensation plans for its directors whereby fees normally received are deferred and paid by the Company based upon a payment schedule commencing at age 65 and continue monthly for 10 years. Directors must serve on the board for a minimum of 5 years to be eligible for the Plan. At December 31, 1997 and 1996, other liabilities include approximately $565,000 and $539,000, respectively, relating to deferred compensation. Deferred compensation expense for the years ended December 31, 1997, 1996 and 1995 amounted to approximately $60,000, $49,000, and $39,000, respectively. The Company has a supplemental executive retirement plan and a director emeritus plan for the benefit of directors and certain executive officers. Benefits under the Supplemental executive retirement plan are intended to provide a 15 year income stream which approximates 70-75% of final compensation including defined benefit and defined contribution plans and social security payments. Benefits under the director emeritus plans are provided to directors after retirement from the Board as a defined benefit retirement plan. The plans have been funded with single premium life insurance policies on the participating directors and officers, with the Company as owner and beneficiary of the policies. Cash surrender value related to these policies approximates $3,378,000 at December 31, 1997 and $3,190,171 at December 31, 1996 and is included in other assets. At December 31, 1997 and 1996, other liabilities include approximately $425,000 and $281,000 accrued under these plans. Compensation expense includes approximately $136,000, $131,000, and $121,000 relating to the supplemental executive retirement plan and director emeritus plan for 1997, 1996 and 1995, respectively. NOTE 10: STOCK BASED COMPENSATION PLANS During 1997, shareholders approved the 1997 Stock Option Plan and Management Recognition and Retention Plan for directors, officers and key employees. Under the Stock Option Plan, up to 88,166 options have been authorized for grant of incentive stock options and non-qualified stock options. All options have a 10- year term and vest and become exercisable ratably over a 6-year period. Activity in the Stock Option Plan for 1997 is as follows:
Options Option Price Shares Outstanding Per Share Exercisable - -------------------------------------------------------------------------------- Outstanding at December 31, 1996 0 - - Granted 132,000 $ 6.58 0 Exercised - - - Forfeited - - - Outstanding at December 31, 1997 132,000 $ 6.58 0 - --------------------------------------------------------------------------------
In February 1997, the Board approved option grants with an exercise price equal to the market value of the Company's shares at the date of grant, subject to shareholder approval. Upon shareholder approval of the plans in December 1997, the excess of market value over exercise price for approved options approximated $1,330,000. This amount has been recorded as unearned stock-based compensation within the stockholders' equity section of the statement of condition and will be recognized as compensation expense ratably over the 6-year vesting period of the options. During 1997, the Company awarded 52,350 shares (52,950 authorized) of restricted stock under the Management Recognition and Retention Plan. The market value of shares awarded at the date of grant approximated $873,000 and has been recognized in the accompanying statement of condition as unearned stock-based compensation, net of compensation expense of approximately $145,000 for 1997. The market value of shares awarded will be recognized as compensation expense ratably over the 6-year restriction period. The Company has elected to account for its stock-based compensation plans in accordance with Accounting Principles Board Opinion No. 25. Pro forma amounts of net income and earnings per share under Statement of Financial Accounting Standards No. 123 are as follows:
1997 - -------------------------------------------------------------------------------- Net Income: As reported $1,854,361 Pro forma 1,804,108
30 Earnings per share (basic and diluted): As reported $ .66 Pro forma .65 The fair value of these options was estimated at the date of grant using a Black-Scholes options pricing model with the following assumptions: risk free interest rate 5.77%; dividend yield 2.0%; market price volatility 36.95%; weighted average option life - 6 years. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. Therefore, the foregoing pro forma results are not likely to be representative of the effects of reported net income of future periods due to additional years of vesting. The weighted-average fair value per share of discounted options granted during 1997 is $13.32. The Company sponsors an externally leveraged Employee Stock Ownership Plan (ESOP) for employees who have attained age 21 and who have completed a 12 month period of employment with the Company during which they worked at least 1,000 hours. Unearned ESOP shares are pledged as collateral on the borrowings. As the debt is repaid, earned shares are released from collateral and become eligible for allocation. Cash dividends received on unearned shares are allocated among participants and are reported as compensation expense. Shares are allocated among participants on the basis of compensation subject to limitations. The debt of the ESOP is recorded as a liability of, and guaranteed by, the Company and the shares pledged as collateral are reported as unearned ESOP shares in the Company's statement of financial condition. As shares are earned, the Company reports compensation expense equal to the current market price of the shares, and the shares become outstanding for earnings per share computations. ESOP compensation expense approximated $167,000 and $70,000 for the fiscal years ended December 31, 1997 and 1996, respectively. Of the 92,574 shares acquired on behalf of the ESOP, 23,052 and 11,722 shares were released as of December 31, 1997 and 1996, respectively. The estimated fair value of the remaining 69,522 shares at December 31, 1997 is $1,390,000. NOTE 11: INCOME TAXES The provision (benefit) for income taxes consists of the following:
1997 1996 1995 --------------------------------------------------------------------------- Current $839,029 $568,613 $418,434 Deferred (76,942) (62,775) (58,434 $762,087 $505,838 $360,000 - --------------------------------------------------------------------------------
The components of deferred income taxes, included in other assets (liabilities), consist of the following:
December 31, 1997 1996 ------------------------------------------------------------------------------------------------ Assets: Loan origination fees $125,540 $147,333 Deferred compensation 395,218 327,411 Allowance for loan losses 144,233 102,547 Stock based compensation 146,680 -- ESOP 7,619 7,824 Postretirement benefits 34,592 21,700 Other 6,091 6,091 - ------------------------------------------------------------------------------------------------------- 859,973 612,906 Liabilities Pension benefits 198,631 165,081 Depreciation 10,845 21,784 Investments 719,167 377,675 928,643 564,540 Net deferred tax asset (liability) $(68,670) $ 48,366 - -------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------- The Company has determined that no valuation allowance is necessary as it is more likely than not deferred tax assets will be realized through carryback to taxable income in prior years, future reversals of existing temporary differences and through future taxable income. A reconciliation of the federal statutory income tax rate to the effective income tax rate at December 31, is as follows:
------------------------------------------------------------------------------------ 1997 1996 1995 - -------------------------------------------------------------------------------------- Federal statutory income tax rate 34.0% 34.0% 34.0%
32 State tax, net of federal benefit 4.3 2.7 3.8 Tax-exempt interest income (6.7) (8.0) (9.7) Dividends received deduction (0.1) (0.3) (1.7) Other (2.4) 0.1 0.1 - -------------------------------------------------------------------------------- Effective income tax rate 29.1% 28.5% 26.5% ------------------------------------------------------------------------------
NOTE 12: COMMITMENTS AND CONTINGENCIES The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments consist primarily of commitments to extend credit, which involve, to varying degrees, elements of credit risk in excess of the amount recognized in the statement of condition. The contract amount of those commitments to extend credit reflects the extent of involvement the Commitment has in this particular class of financial instrument. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of the instrument. The Company uses the same credit policies in making commitments as it does for on-balance sheet instruments.
Contract Amount - ----------------------------------------------------------------------------------------------- Financial instruments whose contract amounts represent credit risk at December 31: 1997 $14,009,007 1996 6,399,157
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitment amounts are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the counter party. Collateral held varies but may include residential real estate and income-producing commercial properties. The Company leases land for a branch under an operating lease expiring in 2013. Rent expense totaled approximately $15,000 in 1997, $14,000 in 1996, and $13,000 in 1995. The lease provides for renewal options for two 10 year periods at specified amounts ranging from $18,000 to $24,000 per year. Rental payments are subject to increases based upon the preceding years Revised Consumer Price Index, but limited to 5% in any one year. Approximate minimum rental commitments for the non-cancelable operating lease is as follows:
Year ending December 31: 1998 15,200 1999 15,200 2000 15,200 2001 16,200 2002 16,200 Thereafter 199,600 - -------------------------------------------------------------------------------- Total minimum lease payments $277,600 -------------------------------------------------------------------------------
During 1995, the New York Superintendent of Banks ("Superintendent") was appointed conservator of Nationar, a New York chartered commercial Company owned by savings banks throughout the state. The Superintendent froze all assets of Nationar at the time he was appointed conservator. The Company had approximately $3.0 million on deposit with Nationar against which a provision for possible losses of $240,000 was recorded for the year ended December 31, 1995. During 1996, distributions were made from the Nationar estate to settle all accepted claims. In connection with this settlement, the Company charged $177,000 against the $240,000 reserve established during 1995, and recognized income of $63,000 associated with the remaining reserve recovery during 1996. NOTE 13: DIVIDENDS AND RESTRICTIONS The board of trustees of Pathfinder Bancorp, M.H.C., determines whether the Holding Company will waive or receive dividends declared by the Company each time the Company declares a dividend, which is expected to be on a quarterly basis. The Holding Company may elect to receive dividends and utilize such funds to pay expenses or for other allowable purposes. The Federal Reserve Bank (the "FRB") has indicated that (i) the Holding Company shall provide the FRB annually with written notice of its intent to waive its dividends prior to the proposed date of the dividend, and the FRB shall have the authority to approve or deny any dividend waiver request; (ii) if a waiver is granted, dividends waived by the Holding Company will not be available for payment to the minority shareholders and such amounts will be excluded from the 32 Company's capital accounts for purposes of calculating dividend payments to minority shareholders; (iii) the Company shall establish a restricted capital account in the amount of any dividends waived by the Holding Company, and such restricted capital account would be added to any liquidation account in the Company established in connection with a conversion of the Holding Company to stock form and would be maintained in accordance with OTS requirements. During 1997, the Company paid cash dividends totaling $248,400 to the Holding Company. The restricted capital account has a $0 balance as of December 31, 1997. Retained earnings of the Bank are subject to certain restrictions under New York State Banking regulations. The amount of retained earnings restricted under these regulations approximated $3,389,000 as of December 31, 1997. NOTE 14: REGULATORY MATTERS The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guideline and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classifications are also subject to qualitative judgements by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 1997, that the Bank meets all capital adequacy requirements to which it is subject and is "well capitalized" under the regulatory framework for prompt corrective action. To be categorized as "well Capitalized" the Bank must maintain minimum total risk-based, Tier 1 risk based, and Tier 1 leverage ratios as set forth in the following table.
To be "Well Capitalized" For Capital Under Prompt Adequacy Corrective Action Actual Purposes Provisions Amount Ratio Amount Ratio Amount Ratio - ------------------------------------------------------------------------------------------------------------------------------------ AS OF DECEMBER 31, 1997: Total Core Capital (to Risk Weighted Assets) $20,062,344 17.1% $9,428,960 8.0% $11,786,200 10.0% Tier 1 Capital (to Risk Weighted assets) $19,234,823 16.4% $4,714,480 4.0% $ 7,071,720 6.0% Tier 1 Capital (to Average Assets) $19,234,823 10.1% $7,665,120 4.0% $ 9,581,400 5.0% - ----------------------------------------------------------------------------------------------------------------------------------- AS OF DECEMBER 31, 1996: Total Core Capital (to Risk Weighted Assets) $18,376,019 15.7% $9,383,121 8.0% $11,728,901 10.0% Tier 1 Capital (to Risk Weighted assets) $17,469,452 14.9% $4,691,560 4.0% $ 7,037,340 6.0% Tier 1 Capital (to Average Assets) $17,469,452 9.5% $7,319,520 4.0% $ 9,149,400 5.0%
NOTE 15: FINANCIAL CONDITION - PARENT COMPANY As discussed in Note 1, on December 30, 1997 the Company reorganized through the formation of Pathfinder Bancorp, Inc., a state-chartered, stock holding company. The following represents the condensed balance sheet of Pathfinder Bancorp, Inc. at December 31, 1997. STATEMENT OF CONDITION ---------------------- Assets Receivable from subsidiary $ 3,000,000 Investment in Bank subsidiary 20,582,735 ========== $ 23,582,735 ============ Shareholders' equity $ 23,582,735 ============ 33 CITY SAVINGS BOARD of Directors Chris R. Burritt Chris C. Gagas Raymond W. Jung Bruce E. Manwaring L. William Nelson Victor S. Oakes Lawrence W. O'Brien Janette Resnick Corte J. Spencer CITY SAVINGS OFFICERS: Chris C. Gagas Chairman, President Chief Executive Officer Barry S. Thompson Senior Vice President Thomas W. Schneider Vice President Chief Financial Officer W. David Schermerhorn Vice President, Loan Administration Edgar J. Manwaring Vice President, Loan Origination Melissa A. Dashnau Vice President, Corporate Secretary Gregory L. Mills Vice President, Marketing, Branch Administration James A. Dowd Controller Laurie Lockwood Assistant Controller Anita A. Austin Auditor Pamela S. Knox Assistant Vice President, Lending Michele Torbitt Assistant Vice President CITY SAVINGS BRANCH MANAGERS Charlene M. Himple Assistant Vice President, Plaza Office Cynthia L. Claflin, Mexico Office Joyce E. Daniels, Eastside Office Jeannine M. Crahan, Fulton Office 35 CITY SAVINGS SERVICES Savings Accounts Young Investors Club Prestige Plus Accounts Prestige Personal Accounts Business Manager Program Christmas Club Accounts Certificates of Deposit Money Management Accounts Checking Accounts NOW Accounts Business Checking Check Protection Checking Line-of-Credit Home Mortgage Loans Home Improvement Loans Home Equity Loans/Lines of Credit Passbook Loans Automatic Loan Payments Commercial Loans Commercial Lines-of-Credit Consumer Loans Education Loans Safety Deposit Boxes Money Orders Travelers Checks Savings Bank Life Insurance Investment Services IRAs Direct Deposit Bank-by-Mail Credit Cards Free Notary Service CORPORATE HEADQUARTERS 214 West First Street Oswego, NY 13126 (315) 343-0057 36 ANNUAL MEETING Wednesday, April 30, 1997 10:00 AM Oswego City Savings Bank Board Room 214 West First St. Oswego, NY 13126 STOCK LISTING Electronic Bulletin Board Symbol: PBHC COUNSEL Doren P. Norfleet Oswego City Savings Bank 214 West First Street, Third Floor Oswego, NY 13126 SPECIAL COUNSEL Luse Lehman Gorman Pomerenk & Schick 5335 Wisconsin Avenue N.W. Suite 400 Washington, DC 20015 INDEPENDENT AUDITORS Coopers & Lybrand L.L.P. One Lincoln Center Syracuse, NY 13202 TRANSFER AGENT Chemical Mellon Shareholder Services L.L.C. 85 Challenger Road Ridgefield Park, NJ 07660 37 INVESTOR RELATIONS Chris C. Gagas Chairman, President, Chief Executive Officer Thomas W. Schneider Vice President, Chief Financial Officer 214 West First Street Oswego, NY 13126 (315) 343-0057 GENERAL INQUIRIES AND REPORTS A copy of the Bank's 1996 Annual Report to the Federal Deposit Insurance Corporation, Form F-2, may be obtained without charge by written request of shareholders to: Melissa A. Dashnau Vice President, Corporate Secretary Oswego City Savings Bank 214 West First Street Oswego, NY 13126 FDIC DISCLAIMER This Annual Report has not been reviewed, or confimed for accuracy or relevance, by the FDIC. 38 EX-21 3 EXHIBIT 21 EXHIBIT 21 SUBSIDIARIES OF THE COMPANY Company Percent Owned - ----------------------- ------------- Oswego City Savings Bank 100% EX-27 4 EXHIBIT 27
9 1,000 12-MOS DEC-31-1997 DEC-31-1997 4,334 0 0 0 51,706 5,115 5,141 121,180 828 196,770 152,399 18,242 2,116 430 0 0 288 23,582 196,770 10,064 3,931 173 14,168 6,287 605 7,276 261 335 5,777 2,616 0 0 0 1,854 .66 .66 8.16 1,538 0 0 0 907 358 18 827 0 0 827
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