Washington, D.C. 20549

                     For the fiscal year ended December 31, 2012.
For the fiscal year ended December 31, 2012
 For the transition period from ______________ to ______________.

Commission file number: 000-23601
        (Exact name of registrant as specified in its charter)
                                       Federal                                                                                                                                                                                                                                                                                                                16-1540137
(State or other jurisdiction of incorporation or organization                                                                                                                                                                                                                                      (I.R.S. Employer Identification No.

                   214 West First Street Oswego NY                                                                                                                                                                    13126
             (Address of principal executive offices)                                                                                                                                                                                                                                                                 (Zip Code)              

Registrant's telephone number, including area code:  (315) 343-0057
Securities registered pursuant to Section 12(b) of the Act:  
                                                                                                                                      Title of each class                                                                  Name of each exchange on which registered
                                                                                                                             Common Stock, $0.01 par value                                                                                                                              The NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES*   NOT

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES* NOT 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES T        NO * 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).          YES T        NO *
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) 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 amendment to this Form 10-K.*

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
                                                                                      Large accelerated filer  *      Accelerated filer  *        Non-accelerated filer  *      Smaller reporting company  T
(Do not check if a smaller reporting company)

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant, computed by reference to the last sale price on June 30, 2012, as reported by the NASDAQ Capital Market, was approximately $9.3 million.
As of March  12, 2013, there were 2,618,182 shares outstanding of the Registrant’s Common Stock.
(1) Proxy Statement for the 2013 Annual Meeting of Stockholders of the Registrant (Part III).
(2) Annual Report to Stockholders (Part II and IV).



DECEMBER 31, 2012

Item 1.
Item 1A.
Risk Factors
Item 1B.
Unresolved Staff Comments
Item 2.
Item 3.
Legal Proceedings
Item 4.
Mine Safety Disclosure
Item 5.
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
Item 10.
Directors, Executive Officers, Promoters, Control Persons and Corporate Governance, Compliance with Sections 16 (A) of Exchange Act
Item 11.
Executive Compensation
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
Item 13.
Certain Relationships and Related Transactions, and Director Independence
Item 14.
Principal Accounting Fees and Services
Item 15.
Exhibits and Financial Statement Schedules



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. By identifying these forward-looking statements for you in this manner, the Company is alerting you to the possibility that its actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in these forward-looking statements. Important factors that could cause the Company’s actual results and financial condition to differ from those indicated in the forward-looking statements include, among others:

Credit quality and the effect of credit quality on the adequacy of our allowance for loan losses
Deterioration in financial markets that may result in impairment charges relating to our securities portfolio
Competition in our primary market areas
Significant government regulations, legislation and potential changes thereto
A reduction in our ability to generate or originate revenue-producing assets as a result of compliance with heightened capital standards
Increased cost of operations due to greater regulatory oversight, supervision and examination of banks and bank holding companies, and higher deposit insurance premiums
Limitations on our ability to expand consumer product and service offerings due to anticipated stricter consumer protection laws and regulations
Other risks described herein and in the other reports and statements we file with the SEC

These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made.  The Company wishes to advise readers that the factors listed above could affect the Company’s financial performance and could cause the Company’s actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.  Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.



Pathfinder Bancorp, Inc.

Pathfinder Bancorp, Inc. (the "Company") is a federally chartered mid-tier holding company headquartered in Oswego, New York.  The primary business of the Company is its investment in Pathfinder Bank (the "Bank").  The Company is majority owned by Pathfinder Bancorp, M.H.C., a federally-chartered mutual holding company (the "Mutual Holding Company").   At December 31, 2012, the Mutual Holding Company held 1,583,239 shares of the Company’s common stock (“Common Stock”), the public and the Employee Stock Ownership Plan (“ESOP”), collectively, held 1,034,943 shares (the "Minority Stockholders").  At December 31, 2012, Pathfinder Bancorp, Inc. and subsidiaries had total assets of $477.8 million, total deposits of $391.8 million and shareholders' equity of $40.7 million.

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.

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Pathfinder Bank

The Bank is a New York-chartered stock savings bank and its deposit accounts are insured up to applicable limits by the FDIC through the Deposit Insurance Fund (“DIF”).  The Bank is subject to extensive regulation by the New York State Department of Financial Services (the “Department”), as its chartering agency, and by the FDIC, as its deposit insurer and primary federal regulator.  The Bank is required to file reports with, and is periodically examined by, the FDIC and the Department concerning its activities and financial condition and must obtain regulatory approvals prior to entering into certain transactions, including, but not limited to, mergers with or acquisitions of other banking institutions.  The Bank is a member of the Federal Home Loan Bank of New York (“FHLBNY”) and is subject to certain regulations by the Federal Home Loan Bank System.

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, commercial real estate, small business loans, and consumer loans.  The Bank invests a portion of its assets in securities issued by the United States Government and its agencies and sponsored enterprises, state and municipal obligations, corporate debt securities, mutual funds, and equity securities.  The Bank also invests in mortgage-backed securities primarily issued or guaranteed by United States Government sponsored enterprises.  The Bank's principal sources of funds are deposits, principal and interest payments on loans and investments, as well as 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, employee compensation and benefits, data processing and facilities.

Pathfinder Bank also operates through a limited purpose commercial bank subsidiary, Pathfinder Commercial Bank, which serves the depository needs of municipalities and public entities in its market area.

The Bank has Pathfinder REIT, Inc., a New York corporation, as its wholly-owned real estate investment trust subsidiary.  At December 31, 2012, Pathfinder REIT, Inc. held $21.6 million in mortgages and mortgage related assets.  All disclosures in this Form 10-K relating to the Bank's loans and investments include loans and investments that are held by Pathfinder REIT, Inc.

The Bank also has 100% ownership in Whispering Oaks Development Corp., a New York corporation, which is retained in case the need to operate or develop foreclosed real estate emerges.

Additionally, the Bank has 100% ownership in Pathfinder Risk Management Company, Inc. which was established to record the 51% controlling interest upon the purchase of the Fitzgibbons Agency, an Oswego County property and casualty and life and health insurance business with $400,000 in annual revenues.  The Company has received all required regulatory approvals and, pending the completion of the final stages of due diligence to affirm the purchase price allocation, this transaction is targeted to close prior to mid-year 2013.

Finally, the Company has a non-consolidated Delaware statutory trust subsidiary, Pathfinder Statutory Trust II, of which 100% of the common equity is owned by the Company.  Pathfinder Statutory Trust II was formed in connection with the issuance of $5.2 million in trust preferred securities.


As of December 31, 2012, the Bank had 102 full-time employees and 16 part-time employees.  The employees are not represented by a collective bargaining unit and we consider our relationship with our employees to be good.

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The economy in the Bank's market area is manufacturing-oriented and is also significantly dependent upon the State University of New York College at Oswego.  The major manufacturing employers in the Bank's market area are Entergy Nuclear Northeast, Novelis, Constellation, NRG and Huhtamaki.  The Bank is the largest depository institution headquartered in Oswego County.  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 comes from commercial banks, 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 competes for deposits by offering depositors a high level of personal service, a wide range of competitively priced financial services, and a strong network of branches, ATMs, and electronic banking.  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.  The turmoil in the residential mortgage sector of the United States economy has caused certain competitors to be less effective in the market place.  While Central New York did not experience the level of speculative lending and borrowing in residential real estate that has adversely affected other regions on a national basis, certain mortgage brokers and finance companies in our area are either no longer operating, or have limited aggressive lending practices.  Additionally, as certain money centers and large regional banks grapple with current economic conditions and the related credit crisis, their ability to compete as effectively has been reduced.  Management believes that these conditions have created a window of reduced competition for local community and regional banks in residential loans, and to a lesser extent, commercial real estate and small business loans.  Of course, there are others, including tax-exempt credit unions, which are aggressively taking advantage of that window.



The Company and the Mutual Holding Company are federally chartered and, up until July 21, 2011, were subject to the regulations of the Office of Thrift Supervision ("OTS") as savings and loan holding companies.  However, under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which is discussed further below, the OTS’s functions relating to savings and loan holding companies were thereafter transferred to the Board of Governors of the Federal Reserve System (“Federal Reserve”).  The Company and the Mutual Holding Company (“MHC”) are regulated as of the above date by the Federal Reserve.

Regulatory requirements applicable to the Bank, the Company and the Mutual Holding Company are referred to below or elsewhere herein.  This description of statutory and regulatory provisions does not purport to be a complete description of all such statutes and regulations applicable to the MHC, the Company, or the Bank.  Any change in these laws or regulations, whether by Congress or the applicable regulatory agencies, could have a material adverse impact on the Bank, the Company or the Mutual Holding Company.

Dodd-Frank Act

The Dodd-Frank Act is significantly changing the current bank regulatory structure and affecting the lending, investment, trading and operating activities of financial institutions and their holding companies.  The Dodd-Frank Act has changed the current primary federal regulator of the Company and the Mutual Holding Company from the OTS to the Federal Reserve.  Under the Dodd-Frank Act, the Federal Reserve now supervises and regulates all savings and loan holding companies, such as the Company and the Mutual Holding Company.  The Dodd-Frank Act requires the Federal Reserve to set minimum capital levels for depository institution holding companies that are as stringent as those required for the insured depository subsidiaries, and the components of Tier 1 capital would be restricted to capital instruments that are currently considered to be Tier 1 capital for insured depository institutions.  Under the Dodd-Frank Act, the proceeds of trust preferred securities are excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010 by bank or savings and loan holding companies with less than $15 billion of assets.  The legislation also establishes a floor for capital requirements of insured depository institutions, which cannot be lower than the standards in effect when the legislation was enacted and directs the federal banking regulators to implement new leverage and capital requirements.  These new leverage and capital requirements must take into account off-balance sheet activities and other risks, including risks relating to securitized products and derivatives.  Moreover, the Mutual Holding Company requires the approval of the Federal Reserve before it may waive the receipt of any dividends from the Company, and there is no assurance that the Federal Reserve will approve future dividend waivers or what conditions it may impose on such waivers. In fact, by adopting Section 239.8(d) of regulation MM of the Interim final rule regarding dividends waived by Mutual Holding Companies, the Federal Reserve has practically assured that Mutual Holding Companies such as Pathfinder Bancorp, MHC will not be able to waive dividend payments from their mid-tier holding companies.  See “Federal Holding Company Regulation—Waivers of Dividends by Mutual Holding Company” below.

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The Dodd-Frank Act also created a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws.  The Consumer Financial Protection Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions such as Pathfinder Bank, including the authority to prohibit “unfair, deceptive or abusive” acts and practices.  The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets.  Banks and savings institutions with $10 billion or less in assets will be examined by their applicable bank regulators.  The Dodd-Frank Act also provides for regulations requiring originators of certain securitized loans to retain a percentage of the risk for transferred loans, established regulatory rate-setting for certain debit and interchange fees, repealed restrictions on the payment of interest on commercial demand deposits and contained a number of reforms related to mortgage originations.  The legislation also weakened the federal preemption available for national banks and federal savings associations, and gives state attorneys general the ability to enforce applicable federal consumer protection laws.

The Dodd-Frank Act broadened the base for Federal Deposit Insurance Corporation insurance assessments.  Assessments are now being based on the average consolidated total assets less tangible equity capital of a financial institution.  The legislation also permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor,  and non-interest bearing transaction accounts had unlimited deposit insurance through December 31, 2012.  The Dodd-Frank Act increased stockholder influence over boards of directors by requiring companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments, and authorizing the Securities and Exchange Commission to promulgate rules that would allow stockholders to nominate and solicit votes for their own candidates using a company’s own proxy materials. These particular requirements were not imposed on the Company in 2012.  The legislation also directs the Federal Reserve to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded or not.

New York State Banking Law and FDIC Regulation

The Bank derives its lending, investment and other authority primarily from the applicable provisions of New York State Banking Law and the regulations of the Department, as limited by FDIC regulations. 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.  Under these laws and regulations, savings banks, including the Bank, may invest in real estate mortgages, consumer and commercial loans, certain types of debt securities, including certain corporate debt securities and obligations of federal, state and local governments and agencies, certain types of corporate equity securities and certain other assets.  New York State chartered savings banks may also invest in subsidiaries under their service corporation investment authority.  A savings bank may use this power to invest in corporations that engage in various activities authorized for savings banks, plus any additional activities, which may be authorized by the Banking Board.  Under FDICIA and the FDIC’s implementation of regulations, the Bank’s investment and service corporation activities are limited to activities permissible for a national bank unless the FDIC otherwise permits it.

The FDIC and the Superintendent have broad enforcement authority over the Bank.  Under this authority, the FDIC and the Superintendent have the ability to issue formal or informal orders to correct violations of laws or unsafe or unsound banking practices.
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FDIC Insurance on Deposits

The Federal Deposit Insurance Corporation, or FDIC, insures deposits at FDIC insured financial institutions such as the Bank. Deposit accounts in the Bank are insured by the FDIC generally up to a maximum of $250,000 per depositor and up to a maximum of $250,000 for self-directed retirement accounts.  The FDIC charges the insured financial institutions assessments to maintain the Deposit Insurance Fund.

Under the FDIC’s current risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other risk factors.  Assessments are based on the risk category to which an institution is assigned and certain risk adjustments assigned by FDIC regulations.

In February 2011, the FDIC published a final rule under the Dodd-Frank Act to reform the deposit insurance assessment system.  The rule redefined the assessment base used for calculating deposit insurance assessments effective April 1, 2011.  Under the new rule, assessments are based on an institution’s average consolidated total assets minus average tangible equity as opposed to total deposits.  Since the new base is much larger than the former base, the FDIC also lowered assessment rates so that the total amount of revenue collected from the industry was not significantly altered.  The new range is 2½ basis points to 45 basis points of total consolidated assets less tangible equity.  The new rule benefitted smaller financial institutions, which typically rely more on deposits for funding, and shifts more of the burden for supporting the insurance fund to larger institutions, which have greater access to non-deposit sources of funding.  As a result of the change in the assessment base, the Company experienced an approximate 50% reduction in its quarterly assessment charges effective with the second quarter of 2011.

The Dodd-Frank Act also extended the unlimited deposit insurance on non-interest bearing transaction accounts through December 31, 2012.  Unlike the FDIC’s Temporary Liquidity Guarantee Program, the insurance provided under the Dodd-Frank Act did not extend to low-interest NOW accounts, and there was no separate assessment on covered accounts.

In addition to the FDIC assessments, the Financing Corporation (“FICO”) is authorized to impose and collect, with the approval of the FDIC, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. The bonds issued by the FICO are due to mature in 2017 through 2019. During the year ended December 31, 2012, the Bank paid $27,000 in fees related to the FICO.

Insurance of deposits may be terminated by the FDIC upon a finding that an 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. We do not currently know of any practice, condition or violation that may lead to termination of our deposit insurance.

Regulatory Capital Requirements

The FDIC has adopted risk-based capital guidelines to which the Bank is subject. The guidelines establish a systematic analytical framework that makes regulatory capital requirements more sensitive to differences in risk profiles among banking organizations. The Bank is required to maintain certain levels of regulatory capital in relation to regulatory risk-weighted assets. The ratio of such regulatory capital to regulatory risk-weighted assets is referred to as the Bank's "risk-based capital ratio." Risk-based capital ratios are determined by allocating assets and specified off-balance sheet items to four risk-weighted categories ranging from 0% to 100%, with higher levels of capital being required for the categories perceived as representing greater risk.

These guidelines divide a savings bank's capital into two tiers. The first tier ("Tier I") includes common equity, retained earnings, certain non-cumulative perpetual preferred stock (excluding auction rate issues) and minority interests in equity accounts of consolidated subsidiaries, less goodwill and other intangible assets (except mortgage servicing rights and purchased credit card relationships subject to certain limitations). Supplementary ("Tier II") capital includes, among other items, Tier 1 capital, cumulative perpetual and long-term limited-life preferred stock, mandatory convertible securities, certain hybrid capital instruments, term subordinated debt and the allowance for loan and lease losses, subject to certain limitations, less required deductions. Savings banks are required to maintain a total risk-based capital ratio of at least 8%, and a Tier I risk based capital level of at least 4%.

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In addition, the FDIC has established regulations prescribing a minimum Tier I leverage ratio (Tier I capital to adjusted total average assets as specified in the regulations). These regulations provide for a minimum Tier I leverage ratio of 3% for banks that meet certain specified criteria, including that they have the highest examination rating and are not experiencing or anticipating significant growth. All other banks are required to maintain a Tier I leverage ratio of at least 4%.

The FDIC may set higher leverage and risk-based capital requirements on individual institutions when particular circumstances warrant. Savings banks experiencing or anticipating significant growth are expected to maintain capital ratios, including tangible capital positions, well above the minimum levels.

On June 6, 2012, the FDIC and the other federal bank regulatory agencies issued a series of proposed rules that would revise their leverage and risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act.  The proposed rules would apply to all FDIC-insured depository institutions, top-tier bank holding companies with total consolidated assets of $500 million or more and top-tier savings and loan holding companies.  Among other things, the proposed rules establish a new common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets) and a higher minimum Tier 1 capital to risk-based assets requirement (6% of risk-weighted assets) and assign higher risk weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and certain commercial real estate facilities that finance the acquisition, development or construction of real property.  The proposed rules also require unrealized gains and losses on certain securities holdings to be included for purposes of calculating regulatory capital requirements.  The proposed rules limit a banking organization’s capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of a specified amount of common equity Tier 1 capital in addition to the amount necessary to meet its minimum risk-based capital requirements.  The proposed rules indicated that the final rules would become effective on January 1, 2013, and the changes set forth in the final rules would be phased in from January 1, 2013 through January 1, 2019.  However, the agencies have indicated that, due to the volume of public comments received, the final rule has been delayed past January 1, 2013.

SBLF Participation

On September 1, 2011, the Company entered into a Securities Purchase Agreement with the Secretary of the Treasury (“Treasury”) pursuant to which the Company sold to the Treasury 13,000 shares of its Senior Non-Cumulative Perpetual Preferred Stock, Series B (“Series B Preferred Stock”), having a liquidation preference of $1,000 per share for aggregate proceeds of $13,000,000.  This transaction was entered into as part of the Treasury’s Small Business Lending Fund Program (“SBLF”).  In connection therewith, the Company redeemed all 6,771 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred Stock”) it sold to the Treasury on September 11, 2009 in connection with the Treasury’s Capital Purchase Program (“CPP”).  The Company paid $6,786,045 to the Treasury to redeem the Series A Preferred Stock, which included the original investment of $6,771,000, plus accrued dividends.  In connection with our participation in SBLF, the Company repurchased from Treasury, a warrant (the “Warrant”) to purchase 154,354 shares of the Company’s common stock at an exercise price per share of $6.58.  The Warrant was previously issued to Treasury in connection with the Company’s participation in the CPP.  The repurchase price of the Warrant was an agreed upon price of $537,633.

Accordingly, the Company is no longer subject to restrictions of the CPP program.  The SBLF program does have its own requirements, which are summarized below:

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The Series B Preferred Stock is entitled to receive non-cumulative dividends payable quarterly, on each January 1, April 1, July 1 and October 1, beginning October 1, 2011.  The dividend rate, which is calculated on the aggregate Liquidation Amount, was initially set at 4.2% per annum based upon the current level of “Qualified Small Business Lending”, or “QSBL” (as defined in the Securities Purchase Agreement) by the Bank.  The dividend rate for dividend periods subsequent to the initial period will be set based upon the “Percentage Change in Qualified Lending” (as defined in the Securities Purchase Agreement) between each dividend period and the “Baseline” QSBL level.  Such dividend rate may vary from 1% per annum to 5% per annum for the second through tenth dividend periods, from 1% per annum to 7% per annum for the eleventh through the first half of the nineteenth dividend periods.   If the Series B Preferred Stock remains outstanding for more than four-and-one-half years, the dividend rate will be fixed at 9%.  Prior to that time, in general, the dividend rate decreases as the level of the Bank’s QSBL increases.   The Company’s dividend rate as of the date of this report is 1.00%. Such dividends are not cumulative, but the Company may only declare and pay dividends on its common stock (or any other equity securities junior to the Series B Preferred Stock) if it has declared and paid dividends for the current dividend period on the Series B Preferred Stock, and is subject to other restrictions on its ability to repurchase or redeem other securities.  

The Company may redeem the shares of Series B Preferred Stock, in whole or in part, at any time at a redemption price equal to the sum of the Liquidation Amount per share and the per-share amount of any unpaid dividends for the then-current period, subject to any required prior approval by the Company’s primary federal banking regulator.

The Company’s ability to pay common stock dividends is conditional on payment of the Series B Preferred Stock Dividends described above.  In addition, the SBLF program requires the Company to file quarterly reports on QSBL lending, which must be audited annually.  The Company must also outreach and advertise the availability of QSBL to organizations and individuals who represent minorities, woman and veterans.  The Company must annually certify that no business loans are made to principals of businesses who have been convicted of a sex crime against a minor.  Finally, the SBLF program requires the Company to file quarterly, annual and other reports provided to shareholders concurrently with the Treasury.

Limitations on Dividends and Other Capital Distributions

The FDIC has the authority to use its enforcement powers to prohibit a savings bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice.  Federal law also prohibits the payment of dividends by a bank that will result in the bank failing to meet its applicable capital requirements on a pro forma basis.  New York law also restricts the Bank from declaring a dividend that would reduce its capital below the amount that is required to be maintained by state law and regulation.  The Bank is also subject to dividend notification requirements to the Federal Reserve by virtue of the Company being a savings and loan holding company.  The Federal Reserve may object to a proposed dividend if the Bank will become undercapitalized or the dividend is deemed to be unsafe or unsound or violate a law, regulation or order.

Since the Company has chosen to participate in the Treasury’s SBLF program, it is permitted to pay dividends on its common stock provided certain Tier 1 capital minimums are exceeded and SBLF dividends have been declared and paid to Treasury as of the most recent dividend period.

Prompt Corrective Action

The federal banking agencies have promulgated regulations to implement the system of prompt corrective action required by federal law.  Under the regulations, a bank shall be deemed to be (i) "well capitalized" if it has total risk-based capital of 10% or more, has a Tier I risk-based capital ratio of 6% or more, has a Tier I leverage capital ratio of 5% or more and is not subject to any written capital order or directive; (ii) "adequately capitalized" if it has a total risk based capital ratio of 8% or more, a Tier I risk-based capital ratio of 4% or more and a Tier I leverage capital ratio of 4% or more (3% under certain circumstances) and does not meet the definition of "well capitalized"; (iii) "undercapitalized" if it has a total risk-based capital ratio that is less than 8%, a Tier I risk-based capital ratio that is less than 4% or a Tier I leverage capital ratio that is less than 4% (3% under certain circumstances); (iv) "significantly undercapitalized" if it has a total risk-based capital ratio that is less than 6%, a Tier I risk-based capital ratio that is less than 3% or a Tier I leverage capital ratio that is less than 3%; and (v) "critically undercapitalized" if it has a ratio of tangible equity to total assets that is equal to or less than 2%.  Federal law and regulations also specify circumstances under which a federal banking agency may reclassify a well capitalized institution as adequately capitalized and may require an adequately capitalized institution to comply with supervisory actions as if it were in the next lower category (except that the FDIC may not reclassify a significantly undercapitalized institution as critically undercapitalized).

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The FDIC may order savings banks that have insufficient capital to take corrective actions.  For example, a savings bank that is categorized as “undercapitalized” would be subject to growth limitations, could generally not make capital distributions, including paying dividends, and would be required to submit an acceptable capital restoration plan.  A holding company that controls such a savings bank would be required to guarantee that the savings bank complies with the restoration plan in an amount of up to the lesser of 5% of the institution’s total assets or the amount of capital needed for the institution to achieve compliance with regulatory capital requirements.  A “significantly undercapitalized” savings bank would be subject to additional restrictions.  Savings banks deemed by the FDIC to be “critically undercapitalized” would be subject to the appointment of a receiver or conservator within specified time frames.

The Bank currently meets the criteria to be classified as a "well capitalized" savings institution.  The previously mentioned proposed capital rules that would increase regulatory capital requirements would adjust the prompt corrective action categories accordingly.

Transactions with Affiliates and Insiders

Under current federal law, transactions between depository institutions and their affiliates are governed by Sections 23A and 23B of the Federal Reserve Act and its implementing regulations. An affiliate of a savings bank is any company or entity that controls, is controlled by, or is under common control with the savings bank, other than a subsidiary of the savings bank. In a holding company context, at a minimum, the parent holding company of a savings bank, and any companies that are controlled by such parent holding company, are affiliates of the savings bank. Generally, Section 23A limits the extent to which the savings bank or its subsidiaries may engage in “covered transactions” with any one affiliate to an amount equal to 10% of such savings bank’s capital stock and surplus and contains an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital stock and surplus. The term “covered transaction” includes the making of loans or other extensions of credit to an affiliate, the purchase of assets from an affiliate, an investment in the securities of an affiliate, the acceptance of securities of an affiliate as collateral for a loan or extension of credit, the issuance of a guarantee, acceptance, or letter of credit on behalf of an affiliate and certain other transactions resulting in credit exposure to an affiliate.  Section 23A also establishes specific collateral requirements for certain transactions such as loans or extensions of credit to, or guarantees, acceptances on letters of credit issued on behalf of an affiliate. Section 23B requires that covered transactions and a broad list of other specified transactions be on terms substantially the same, or no less favorable, to the savings bank or its subsidiary as similar transactions with nonaffiliates.

Further, Section 22(h) of the Federal Reserve Act and its implementing regulations restrict a savings bank with respect to loans to directors, executive officers, and principal stockholders. Under Section 22(h), loans to directors, executive officers and stockholders who control, directly or indirectly, 10% or more of voting securities of a savings bank and certain related interests of any of the foregoing, may not exceed, together with all other outstanding loans to such persons and affiliated entities, the savings bank's total unimpaired capital and unimpaired surplus. Section 22(h) also prohibits loans above amounts prescribed by the appropriate federal banking agency to directors, executive officers, and stockholders who control 10% or more of voting securities of a stock savings bank, and their respective related interests, unless such loan is approved in advance by a majority of the board of directors of the savings bank. Any "interested" director may not participate in the voting. Further, pursuant to Section 22(h), loans to directors, executive officers and principal stockholders must generally be made on terms substantially the same as offered in comparable transactions to other persons. Section 22(g) of the Federal Reserve Act places additional limitations on loans to executive officers.

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In order for the Company and the Mutual Holding Company to be regulated as savings and loan holding companies (rather than as bank holding companies), Pathfinder Bank must qualify as a Qualified Thrift Lender.  To qualify as a Qualified Thrift Lender, Pathfinder Bank must be a “domestic building and loan association,” as defined in the Internal Revenue Code, or comply with the Qualified Thrift Lender test.  Under the Qualified Thrift Lender test, a savings bank is required to maintain at least 65% of its “portfolio assets” (total assets less: (1) specified liquid assets up to 20% of total assets; (2) intangibles, including goodwill; and (3) the value of property used to conduct business) in certain “qualified thrift investments” (primarily residential mortgages and related investments, including certain mortgage-backed and related securities) in at least nine months out of each 12-month period.  As of December 31, 2012 Pathfinder Bank met the Qualified Thrift Lender test.

Supervisory Agreement

During May 2009, the Company entered into a Supervisory Agreement with the OTS.  The agreement was issued in connection with the identification of certain violations of applicable statutory and regulatory restrictions on capital distributions and transactions with affiliates.  As a result of the identified violations, the Company recorded $41,000 of income relating to certain transactions with its unconsolidated parent company Pathfinder Bancorp, MHC.  In addition the Company is prohibited from accepting or directing Pathfinder Bank to declare or pay a dividend or other capital distributions without the prior written approval of the OTS.  With the change in our Holding Company regulator to the Federal Reserve, this Supervisory Agreement is now with that Regulator.  All violations have been corrected and the Company believes it is in compliance with the Agreement.

Federal Holding Company Regulation

General.  The Company and the Mutual Holding Company have elected to be regulated as nondiversified savings and loan holding companies within the meaning of the Home Owners’ Loan Act.  The Company and the Mutual Holding Company are registered with the Federal Reserve and are subject to Federal Reserve regulations, examinations, supervision and reporting requirements.  As such, the Federal Reserve has enforcement authority over the Company and the Mutual Holding Company, and their non-savings institution subsidiaries.  Among other things, this authority permits the Federal Reserve to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution.  The Federal Reserve assumed regulatory authority over savings and loan holding companies from OTS on July 21, 2011, pursuant to the Dodd-Frank Act.  See “The Dodd-Frank Act” above.

Permitted Activities.  Under federal regulation and policy, a mutual holding company and a federally chartered mid-tier holding company, such as the Company, may engage in the following activities: (i) investing in the stock of a savings association; (ii) acquiring a mutual association through the merger of such association into a savings association subsidiary of such holding company or an interim savings association subsidiary of such holding company; (iii) merging with or acquiring another holding company, one of whose subsidiaries is a savings association; (iv) investing in a corporation, the capital stock of which is available for purchase by a savings association under federal law or under the law of any state where the subsidiary savings association or associations share their home offices; (v) furnishing or performing management services for a savings association subsidiary of such company; (vi) holding, managing or liquidating assets owned or acquired from a savings subsidiary of such company; (vii) holding or managing properties used or occupied by a savings association subsidiary of such company; (viii) acting as trustee under deeds of trust; (ix) any other activity that (A)  has been deemed to be permissible for bank holding companies under Section 4(c) of the Bank Holding Company Act of 1956, unless the Federal Reserve, by regulation, prohibits or limits any such activity for savings and loan holding companies; or (B) in which multiple savings and loan holding companies were authorized (by regulation) to directly engage in March 5, 1987; (x) any activity permissible for financial holding companies under Section 4(k) of the Bank Holding Company Act (provided certain criteria are met), including securities and insurance underwriting; and (xi) purchasing, holding, or disposing of stock acquired in connection with a qualified stock issuance if the purchase of such stock by such savings and loan holding company is approved by the Federal Reserve.  If a mutual holding company acquires or merges with another holding company, the holding company acquired or the holding company resulting from such merger or acquisition may only invest in assets and engage in activities listed in (i) through (xi) above, and has a period of two years to cease any nonconforming activities and divest of any nonconforming investments.

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The Home Owners’ Loan Act prohibits a savings and loan holding company, directly or indirectly, or through one or more subsidiaries, from acquiring another savings association or holding company thereof, without prior written approval of the Federal Reserve.  It also prohibits the acquisition or retention of, with certain exceptions, more than 5% of a nonsubsidiary savings association, a nonsubsidiary holding company, or a nonsubsidiary company engaged in activities other than those permitted by the Home Owners’ Loan Act; or acquiring or retaining control of an institution that is not federally insured.  In evaluating applications by holding companies to acquire savings associations, the Federal Reserve must consider the financial and managerial resources, future prospects of the company and association involved, the effect of the acquisition on the risk to the insurance fund, the convenience and needs of the community and competitive factors.

The Federal Reserve is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings associations in more than one state, subject to two exceptions: (i) the approval of interstate supervisory acquisitions by savings and loan holding companies, and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions.  The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.

Unlike bank holding companies, savings and loan holding companies are not currently subject to specific consolidated regulatory capital requirements.  The Dodd-Frank Act, however, requires the promulgation of such capital requirements for depository institution holding companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to institutions themselves.  That will eliminate the inclusion of certain instruments from tier 1 capital that are currently includable for bank holding companies, such as trust preferred securities.  The Dodd-Frank Act provides that instruments issued before May 19, 2010 will be grandfathered for companies of consolidated assets of $15 billion or less.  The Dodd-Frank Act further provides that holding companies that were not regulated by the Federal Reserve as of May 19, 2010 (which would include most savings and loan holding companies) are subject to a five-year transition period from the July 21, 2010 date of enactment of the Dodd-Frank Act before such capital requirements apply.  The proposed capital rules discussed earlier would implement the consolidated capital requirements for savings and loan holding companies.  However, notwithstanding the Dodd-Frank Act’s language, the proposed rules did not incorporate the referenced grandfather for instruments issued before May 19, 2010 or the transition period, so it is uncertain whether any final rule will do so.

The Dodd-Frank Act extended the “source of strength” doctrine to savings and loan holding companies.  The regulatory agencies must promulgate regulations implementing the “source of strength” policy that requires holding companies act as a source of strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial stress.

The Federal Reserve has issued a policy statement regarding the payment of dividends and other capital distributions by bank holding companies that it has made applicable to savings and loan holding companies as well.  In general, the policy provides that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition.  Regulatory guidance provides for prior regulatory consultation with respect to capital distributions in certain circumstances such as where the company’s net income for the past three years, net of dividends previously paid over that period, is insufficient to fully fund the dividend or the company’s overall rate of earnings retention is inconsistent with the company’s capital needs and overall financial condition.  The ability of a holding company to pay dividends may be restricted if a subsidiary depository institution becomes undercapitalized.  These regulatory policies could affect the ability of the Company to pay dividends, repurchase shares of common stock or otherwise engage in capital distributions.

Waivers of Dividends by Mutual Holding Company.  The Dodd-Frank Act requires federally-chartered mutual holding companies to give the Federal Reserve notice before waiving the receipt of dividends, and provides that in the case of “grandfathered” mutual holding companies, like the Mutual Holding Company, the Federal Reserve “may not object” to a dividend waiver if the board of directors of the mutual holding company waiving dividends determines that the waiver: (i) would not be detrimental to the safe and sound operation of the subsidiary savings bank; and (ii) is consistent with the board’s fiduciary duties to members of the mutual holding company.  To qualify as a grandfathered mutual holding company, a mutual holding company must have been formed, issued stock and waived dividends prior to December 1, 2009.  The Dodd-Frank Act further provides that the Federal Reserve may not consider waived dividends in determining an appropriate exchange ratio upon the conversion of a grandfathered mutual holding company to stock form.  In September 2011, however, the Federal Reserve issued an interim final rule that also requires, as a condition to waiving dividends, that each mutual holding company obtain the approval of a majority of the eligible votes of its members within 12 months prior to the declaration of the dividend being waived.  The Federal Reserve has requested comments on the interim final rule, and there can be no assurance that the rule will be amended to eliminate or modify the member vote requirement for dividend waivers by grandfathered mutual holding companies, such as the Mutual Holding Company in the future, or as to what conditions the Federal Reserve may place on any dividend waivers.  The Mutual Holding Company has not requested a current dividend waiver and, is not planning to waive future dividends at this time.
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Conversion of the Mutual Holding Company to Stock Form.  Federal regulations permit the Mutual Holding Company to convert from the mutual form of organization to the capital stock form of organization (a "Conversion Transaction").  There can be no assurance when, if ever, a Conversion Transaction will occur, and the Board of Directors has no current intention or plan to undertake a Conversion Transaction.  In a Conversion Transaction a new holding company would be formed as the successor to the Company (the "New Holding Company"), the Mutual Holding Company's corporate existence would end, and certain depositors of the Bank would receive the right to subscribe for additional shares of the New Holding Company.  In a Conversion Transaction, each share of common stock held by stockholders other than the Mutual Holding Company ("Minority Stockholders") would be automatically converted into a number of shares of common stock of the New Holding Company determined pursuant to an exchange ratio (determined by an independent valuation) that ensures that Minority Stockholders own the same percentage of common stock in the New Holding Company as they owned in the Company immediately prior to the Conversion Transaction.    The total number of shares held by Minority Stockholders after a Conversion Transaction also would be increased by any purchases by Minority Stockholders in the stock offering conducted as part of the Conversion Transaction.
Federal Securities Law

The common stock of the Company is registered with the SEC under the Securities Exchange Act of 1934, as amended (“Exchange Act”).  The Company is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the SEC under the Exchange Act.

The Company Common Stock held by persons who are affiliates (generally officers, directors and principal stockholders) of the Company may not be resold without registration or unless sold in accordance with certain resale restrictions.  If the Company meets specified current public information requirements, each affiliate of the Company is able to sell in the public market, without registration, a limited number of shares in any three-month period.

Securities and Exchange Commission Reporting

The Company maintains an Internet website located at www.pathfinderbank.com on which, among other things, the Company makes available, free of charge, various reports that it files with or furnishes to the Securities and Exchange Commission, including its Annual Report on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K.  These reports are made available as soon as reasonably practicable after filing with the Securities and Exchange Commission.  The Company has also made available on its website its Audit Committee Charter, Compensation Committee Charter, Governance Guidelines (which serve as the Nominating / Governance Committee’s charter) and Code of Ethics.

The Company's Annual Report on Form 10-K may be accessed on the Company's website at www.pathfinderbank.com/annualmeeting.

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Federal Reserve System

The Federal Reserve requires all depository institutions to maintain noninterest-bearing reserves at specified levels against their transaction accounts (primarily checking, money management and NOW checking accounts).  At December 31, 2012, the Bank was in compliance with these reserve requirements.

Federal Community Reinvestment Regulation

Under the Community Reinvestment Act, as amended (the "CRA"), as implemented by FDIC regulations, a savings bank has a continuing and affirmative obligation, consistent with its safe and sound operation, to help meet the credit needs of its entire community, including low and moderate income neighborhoods.  The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA.  The CRA requires the FDIC, in connection with its examination of a savings institution, to assess the institution's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution.  The CRA requires the FDIC to provide a written evaluation of an institution's CRA performance utilizing a four-tiered descriptive rating system.  The Bank's latest CRA rating was "satisfactory."

New York State Community Reinvestment Regulation

The Bank is also subject to provisions of the New York State Banking Law which impose continuing and affirmative obligations upon banking institutions organized in New York State to serve the credit needs of its local community ("NYCRA") which are substantially similar to those imposed by the CRA.  Pursuant to the NYCRA, a bank must file an annual NYCRA report and copies of all federal CRA reports with the Department.  The NYCRA requires the Department to make a biennial written assessment of a bank's compliance with the NYCRA, utilizing a four-tiered rating system and make such assessment available to the public.  The NYCRA also requires the Superintendent to consider a bank's NYCRA rating when reviewing a bank's application to engage in certain transactions, including mergers, asset purchases and the establishment of branch offices or automated teller machines, and provides that such assessment may serve as a basis for the denial of any such application.  The Bank's NYCRA rating as of its latest examination was "satisfactory."

Sarbanes-Oxley Act of 2002

The Sarbanes-Oxley Act of 2002 (“Sarbanes Oxley”) was signed into law on July 30, 2002.  Sarbanes-Oxley is a law that addresses, among other issues, corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information.  As directed by Section 302(a) of Sarbanes-Oxley, the Company’s Chief Executive Officer and Chief Financial Officer are each required to certify that the Company’s quarterly and annual reports do not contain any untrue statement of a material fact.  The rules have several requirements, including having these officers certify that: they are responsible for establishing, maintaining and regularly evaluating the effectiveness of our internal controls; they have made certain disclosures to our auditors and the audit committee of the Board of Directors about our internal controls; and they have included information in our quarterly and annual reports about their evaluation and whether there have been significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to the evaluation.  As part of the Dodd-Frank Act, the outside auditor attestation requirement on internal controls of companies with less than $75 million in market capitalization, like the Company, was rescinded.  Disclosure of management attestations on internal control over financial reporting will continue to be required for smaller reporting companies, including the Company.  We have existing policies, procedures and systems designed to comply with these regulations, and continue to further enhance and document our policies, procedures and systems to ensure continued compliance with these regulations.

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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 Tax Reform Act of 1996 (“the 1996 Act”), the Bank was permitted to establish a reserve for bad debts and to make annual additions to the reserve.  The Bank has chosen to be on the direct charge-off method, net of recoveries, in its calculation of taxable income.

Taxable Distributions and Recapture.  Prior to the 1996 Act, bad debt reserves created prior to January 1, 1988 were subject to recapture into taxable income should the Bank fail to meet certain thrift asset and definitional tests.  New federal legislation eliminated these thrift related recapture rules.  However, under current law, pre-1988 reserves remain subject to recapture should the Bank cease to retain a bank or thrift charter or make certain non-dividend distributions.

Minimum Tax.   The Internal Revenue Code imposes an alternative minimum tax ("AMT") at a rate of 20% on a base of regular taxable income plus certain tax preferences ("alternative minimum taxable income" or "AMTI").  The AMT is payable to the extent such AMTI is in excess of an exemption amount.  Net operating losses can offset no more than 90% of AMTI.  Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years.

Net Operating Loss Carryovers.  A financial institution may carry back net operating losses to the preceding two taxable years and forward to the succeeding 20 taxable years.

State Taxation

New York Taxation.  The Company is subject to the New York State Franchise Tax on Banking Corporations in an annual amount equal to the greater of (i) 7.1% 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 Company’s "alternative entire net income" allocable to New York State, or (c) $1,250.  Entire net income is similar to federal taxable income, subject to certain modifications and alternative entire net income is equal to entire net income without certain modifications.  Net operating losses arising in the current period can be carried forward to the succeeding 20 taxable years.

Neither the Internal Revenue Service nor New York State has examined our federal or state tax returns within the past 5 years.


Not required of a smaller reporting company.



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The Bank conducts its business through its main office located in Oswego, New York, six branch offices located in Oswego County, and a branch location in Onondaga County.  Management believes that the Bank’s facilities are adequate for the business conducted. The following table sets forth certain information concerning the main office and each branch office of the Bank at December 31, 2012.  The aggregate net book value of the Bank's premises and equipment was $10.1 million at December 31, 2012.  For additional information regarding the Bank's properties, see Notes 8 and 16 to the Consolidated Financial Statements.

Main Office
214 West First Street
Oswego, New York  13126
Plaza Branch
     Owned (1)
Route 104, Ames Plaza
Oswego, New York  13126
Mexico Branch
Norman & Main Streets
Mexico, New York  13114
Oswego East Branch
34 East Bridge Street
Oswego, New York  13126
Lacona Branch
1897 Harwood Drive
Lacona, New York 13083
Fulton Branch
     Owned (2)
5 West First Street South
Fulton, New York  13069
Central Square Branch
3025 East Ave
Central Square, New York  13036
Cicero Branch
6194 State Route 31
Cicero, New York 13039

The building is owned; the underlying land is leased with an annual rent of $22,000
The building is owned; the underlying land is leased with an annual rent of $31,000

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There are various claims and lawsuits to which the Company is periodically involved that are incidental to the Company's business.  In the opinion of management, such claims and lawsuits in the aggregate are not expected to have a material adverse impact on the Company's consolidated financial condition and results of operations.


Not applicable



Pathfinder Bancorp, Inc.'s common stock currently trades on the NASDAQ Capital Market under the symbol "PBHC".  There were 442 shareholders of record as of March 12, 2013.  The following table sets forth the high and low closing bid prices and dividends paid per share of common stock for the periods indicated:

Quarter Ended:
December 31, 2012
  $ 11.00     $ 10.00     $ 0.03  
September 30, 2012
  $ 10.65     $ 9.00     $ 0.03  
June 30, 2012
  $ 10.00     $ 8.80     $ 0.03  
March 31, 2012
  $ 9.75     $ 8.83     $ 0.03  
December 31, 2011
  $ 10.20     $ 8.01     $ 0.03  
September 30, 2011
  $ 10.08     $ 8.33     $ 0.03  
June 30, 2011
  $ 10.25     $ 8.87     $ 0.03  
March 31, 2011
  $ 10.15     $ 8.18     $ 0.03  

Dividends and Dividend History

The Company has historically paid regular quarterly cash dividends on its common stock.  The Board of Directors presently intends to continue the payment of regular quarterly cash dividends, subject to the need for those funds for debt service and other purposes.  Payment of dividends on the common stock is subject to determination and declaration by the Board of Directors and will depend upon a number of factors, including capital requirements, regulatory limitations on the payment of dividends, Pathfinder Bank and its subsidiaries results of operations and financial condition, tax considerations, and general economic conditions.  The Company's mutual holding company, Pathfinder Bancorp, M.H.C., may elect to waive or receive dividends each time the Company declares a dividend.  Dividend waivers must receive the non-objection of the Federal Reserve and the approval of the Mutual Holding Company’s members who are comprised of the Bank’s depositors.  Historically, the Federal Reserve has not provided its non-objection to the waiver of dividends by mutual holding companies.  The Mutual Holding Company did not waive the right to receive its portion of the cash dividends declared during 2012 or 2011.
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The Company is the parent company of the Bank and Pathfinder Statutory Trust II.  The Bank has three operating subsidiaries – Pathfinder Commercial Bank, Pathfinder REIT, Inc., and Whispering Oaks Development Corp.

The following selected consolidated financial data sets forth certain financial highlights of the Company and should be read in conjunction with the consolidated financial statements and related notes, and the "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere  in this annual report on  Form 10-K.

Year End (In thousands)
Total assets
  $ 477,796     $ 442,980     $ 408,545     $ 371,692     $ 352,760  
Loans receivable, net
    329,247       300,770       281,648       259,387       247,400  
    391,805       366,129       326,502       296,839       269,438  
    40,747       37,841       30,592       29,238       19,495  
For the Year (In thousands)
Net interest income
  $ 14,857     $ 14,263     $ 13,331     $ 11,777     $ 10,675  
Core noninterest income (a)
    2,627       2,451       2,854       2,724       2,786  
Net gains/(losses) on sales, redemptions and
impairment of investment securities
    375       791       211       112       (2,191 )
Net gains (losses) on sales of loans and
foreclosed real estate
    61       (50 )     (45 )     54       (44 )
Noninterest expense (b)
    13,207       12,758       11,274       10,381       9,882  
Regulatory assessments
    311       390       515       745       53  
Net income
    2,648       2,323       2,505       1,615       368  
Per Share
Net income (basic)
  $ 0.88     $ 0.53     $ 0.82     $ 0.61     $ 0.15  
Net income (diluted)
    0.87       0.52       0.82       0.61       0.15  
Book value per common share
    10.60       9.49       9.81       9.31       8.04  
Tangible book value per common share (c)
    9.13       8.02       8.26       7.77       6.50  
Cash dividends declared
    0.12       0.12       0.12       0.12       0.41  
Return on average assets
    0.57 %     0.55 %     0.64 %     0.45 %     0.11 %
Return on average equity
    6.68       6.75       8.07       7.04       1.70  
Return on average tangible equity (c)
    7.40       7.59       9.20       8.45       2.07  
Average equity to average assets
    8.48       8.21       7.89       6.40       6.32  
Dividend payout ratio (d)
    11.37       12.87       11.90       18.45       232.61  
Allowance for loan losses to loans receivable
    1.35       1.31       1.28       1.17       0.99  
Net interest rate spread
    3.38       3.62       3.58       3.40       3.22  
Noninterest income to average assets
    0.66       0.76       0.77       0.81       0.16  
Noninterest expense to average assets
    2.89       3.14       3.00       3.10       2.91  
Efficiency ratio (e)
    75.53       77.56       71.95       76.36       73.02  

Exclusive of net gains (losses) on sales and impairment of investment securities and net gains (losses) on sales of loans and foreclosed real estate.
Exclusive of regulatory assessments.
Tangible equity excludes intangible assets.
The dividend payout ratio is calculated using dividends declared and not waived by the Mutual Holding Company, divided by net income.
The efficiency ratio is calculated as noninterest expense, including regulatory assessments, divided by the sum of taxable-equivalent net interest income and noninterest income excluding net gains (losses) on sales, redemptions and impairment of investment securities and net gains (losses) on sales of loans and foreclosed real estate.

Page 18



Throughout Management’s Discussion and Analysis (“MD&A”) the term, “the Company”, refers to the consolidated entity of Pathfinder Bancorp, Inc.  Pathfinder Bank and Pathfinder Statutory Trust II are wholly owned subsidiaries of Pathfinder Bancorp, Inc., however, Pathfinder Statutory Trust II is not consolidated for reporting purposes (see Note 11 of the consolidated financial statements).  Pathfinder Commercial Bank, Pathfinder REIT, Inc., and Whispering Oaks Development Corp. are wholly owned subsidiaries of Pathfinder Bank.  At December 31, 2012, Pathfinder Bancorp, M.H.C, the Company’s mutual holding company parent, whose activities are not included in the consolidated financial statements or the MD&A, held 60.5% of the Company’s outstanding common stock and the public held 39.5% of the outstanding common stock.

The Company's business strategy is to operate as a well-capitalized, profitable, and independent community bank dedicated to providing value-added products and services to our customers.  Generally, the Company has sought to implement this strategy by emphasizing retail, business, and municipal deposits as its primary source of funds.  These funds are redeployed in locally-originated residential first mortgage loans, loans to business enterprises operating in its markets, and, to a lesser extent, in investment securities. Specifically, the Company's business strategy incorporates the following elements: (i) operating as an independent community-oriented financial institution; (ii) maintaining capital in excess of regulatory requirements; (iii) emphasizing investment in one-to-four family residential mortgage loans, loans to small businesses, and investment securities; and (iv) maintaining a strong retail, business and municipal deposit base.

The Company's net income is primarily dependent on its net interest income, which is the difference between interest income earned on its investments in mortgage and other loans, investment securities and other assets, and its cost of funds consisting of interest paid on deposits and borrowings.  The Company's net income is also affected by its provision for loan losses, noninterest income; (service charges and servicing rights, net gains and losses on sales and redemptions of securities, loans and foreclosed real estate), noninterest expense; (employee compensation and benefits, occupancy and equipment costs, data processing costs), and income taxes.  Earnings of the Company are also  affected significantly by general economic and competitive conditions, particularly changes in market interest rates, government policies, and actions of regulatory authorities.  These events are beyond the control of the Company.  In particular, the general level of market interest rates tend to be highly cyclical.


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

The most significant accounting policies followed by the Company are presented in Note 1 to the consolidated financial statements.  These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how significant assets and liabilities are valued in the consolidated financial statements and how those values are determined.  Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the allowance for loan losses, deferred income taxes, pension obligations, the evaluation of investment securities for other than temporary impairment, the annual evaluation of the Company’s goodwill for possible impairment, and the estimation of fair values for accounting and disclosure purposes to be the accounting areas that require the most subjective and complex judgments.  These areas could be the most subject to revision as new information becomes available. Management performs an annual evaluation of the Company’s goodwill for possible impairment.  Based on the results of the 2012 evaluation, management has determined that the carrying value of goodwill is not impaired as of December 31, 2012.  The evaluation approach is described in Note 9 of the consolidated financial statements.

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The allowance for loan losses represents management's estimate of probable loan losses inherent in the loan portfolio.  Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment on the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change.  The Company establishes a specific allowance for all loans identified as being impaired with a balance in excess of $100,000 which are on nonaccrual and have been risk rated under the Company’s risk rating system as substandard, doubtful, or loss. In addition, an accruing substandard loan could be identified as being impaired.  The measurement of impaired loans is generally based upon the present value of future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral, less costs to sell.  The majority of the Company’s impaired loans are collateral-dependent.  For all other loans and leases, the Company uses the general allocation methodology that establishes an allowance to estimate the probable incurred loss for each risk-rating category.  The loan portfolio also represents the largest asset type on the consolidated statement of condition.  Note 1 to the consolidated financial statements describes the methodology used to determine the allowance for loan losses and a discussion of the factors driving changes in the amount of the allowance for loan losses is included in this report.

Deferred income tax assets and liabilities are determined using the liability method.  Under this method, the net deferred tax asset or liability is recognized for the future tax consequences.  This is attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases as well as net operating and capital loss carry forwards.  Deferred tax assets and liabilities are measured using enacted tax rates applied to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The affect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period that includes the enactment date.  If current available evidence about the future raises doubt about the likelihood of a deferred tax asset being realized, a valuation allowance is established.  The judgment about the level of future taxable income, including that which is considered capital, is inherently subjective and is reviewed on a continual basis as regulatory and business factors change.  A valuation allowance of $458,000 was maintained at December 31, 2012, as management believes it may not generate sufficient capital gains to offset its capital loss carry forward.  The Company’s effective tax rate differs from the statutory rate due primarily to non-taxable income from investment securities and bank owned life insurance.
Pension and post-retirement benefit plan liabilities and expenses are based upon actuarial assumptions of future events, including fair value of plan assets, interest rates, and the length of time the Company will have to provide those benefits.  The assumptions used by management are discussed in Note 12 to the consolidated annual financial statements.

The Company carries all of its investments at fair value with any unrealized gains or losses reported net of tax as an adjustment to shareholders' equity and included in accumulated other comprehensive income (loss), except for the credit-related portion of debt security impairment losses and other-than-temporary impairment (“OTTI”) of equity securities, which are charged to earnings.  The Company's ability to fully realize the value of its investments in various securities, including corporate debt securities, is dependent on the underlying creditworthiness of the issuing organization.  In evaluating the debt security portfolio for other-than-temporary impairment losses, management considers (1) if we intend to sell the security; (2) if it is “more likely than not” we will be required to sell the security before recovery of its amortized cost basis; or (3) if the present value of expected cash flows is not sufficient to recover the entire amortized cost basis.   In determining whether OTTI has occurred for equity securities, the Company considers the applicable factors described above and the length of time the equity security’s fair value has been below the carrying amount.  Management continually analyzes the portfolio to determine if further impairment has occurred that may be deemed as other-than-temporary.  Further charges are possible depending on future economic conditions.

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The estimation of fair value is significant to several of our assets, including investment securities available for sale, the interest rate derivative, intangible assets, foreclosed real estate, and the value of loan collateral when valuing loans.  These are all recorded at either fair value, or the lower of cost or fair value. Fair values are determined based on third party sources, when available.  Furthermore, accounting principles generally accepted in the United States require disclosure of the fair value of financial instruments as a part of the notes to the consolidated financial statements.  Fair values on our available-for-sale securities may be influenced by a number of factors, including market interest rates, prepayment speeds, discount rates and the shape of yield curves.

Fair values for securities available for sale are obtained from an independent third party pricing service.  Where available, fair values are based on quoted prices on a nationally recognized securities exchange.  If quoted prices are not available, fair values are measured using quoted market prices for similar benchmark securities.  Management made no adjustments to the fair value quotes that were provided by the pricing source.  The fair values of foreclosed real estate and the underlying collateral value of impaired loans are typically determined based on evaluations by third parties, less estimated costs to sell.  When necessary, appraisals are updated to reflect changes in market conditions.


Earnings performance metrics for 2012 were generally improved over those reported for 2011 as net income and return on assets increased.

Net income for 2012 was $2.6 million, a $325,000 increase from 2011 and return on average assets and return on average equity were 0.57% and 6.68%, respectively, as compared to 0.55% and 6.75% in 2011.  Net interest income increased $594,000 in 2012 as compared to 2011 due to an increase in earning assets and a reduction in the rates paid on interest bearing liabilities.  Additionally, a reduction in the provision for loan losses of $115,000 and a reduction in the provision for income taxes of $115,000 supported the improvement in net income. Offsets to these increases included additional personnel expenses of $420,000 and a reduction in the net gains on sales and redemptions of investment securities of $416,000.  The reasons for these changes are provided in the sections titled “Noninterest Income” and “Noninterest Expense”.

Total assets increased $34.8 million to $477.8, partially funded by deposits which grew by $25.7 million during 2012 primarily as a result of increases in money market deposit accounts and CDARS deposits.  Both product increases were in support of the Company’s strategy to accommodate the funding needs of the loan growth that was expected in its marketplace through 2012.  As such, the loan portfolio represented a greater proportion of the increase in assets with a smaller proportion of the increase within the investment securities portfolio.  The loan portfolio recorded a year over year increase of $29.0 million to $333.7 million at December 31, 2012 whereas the investment securities portfolio recorded an increase of $7.9 million to $108.3 million at December 31, 2012.  The Company will continue to emphasize its focus in the Cicero, Central Square, and Fulton markets where it feels further market penetration opportunities exist.  Additionally, we will pursue expanding commercial deposit relationships with our existing lending customers as well as expanding our commercial loan growth in the greater Syracuse market.

Asset quality continues to remain stable as net loan charge-offs as a percentage of total loans for 2012 were 0.10%, significantly less than the 0.21% recorded in 2011.  Net charge-offs for 2012 were $304,000 as compared to $608,000 in 2011 and $480,000 in 2010.  Management continues to adhere to conservative underwriting policies and works closely with borrowers who have experienced difficulty in this uncertain economic climate to mitigate loss to the Bank. The ratio of allowance for loan losses to period end loans increased slightly to 1.35% at December 31, 2012 as compared to 1.31% at December 31, 2011 and 1.28% at December 31, 2010.  Nonperforming loans to period end loans increased to 1.66% at December 31, 2012 from 1.55% at December 31, 2011 but decreased significantly from 2.08% recorded at December 31, 2010.
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The Company improved its equity position in 2012 by $2.9 million when compared to year end 2011 through additional retained earnings of $2.1 million, an improvement in the after tax impact of unrealized holding gains of its available-for-sale securities portfolio, and the positive impact of the pension plan freeze which occurred in the second quarter of 2012.  Partially offsetting this improvement was the Company’s election to purchase the CPP warrants from the U.S. Treasury, causing a $537,000 reduction to equity.

Net Interest Income

Net interest income is the Company's primary source of operating income for payment of operating expenses and providing for possible loan losses.  It is the amount by which interest earned on interest-earning deposits, loans and investment securities exceeds the interest paid on deposits and borrowed money.  Changes in net interest income and the net interest margin ratio result from the interaction between the volume and composition of earning assets, interest-bearing liabilities, and their respective yields and funding costs.

The following comments refer to the table of Average Balances and Rates and the Rate/Volume Analysis, both of which follow below.

Net interest income, on a tax-equivalent basis, increased $771,000, or 5.3%, to $15.3 million for the year ended December 31, 2012, as compared to $14.5 million for the year ended December 31, 2011.  The Company's net interest margin for 2012 decreased to 3.50% from 3.76% in 2011.  The increase in net interest income is attributable exclusively to an increase in average earning assets.  When comparing 2012 against 2011, the yield on average earning assets declined by 48 basis points, whereas the rates paid on interest bearing liabilities declined by 24 basis points.

The average balance of interest-earning assets increased $50.2 million, or 13.0%, during 2012 and the average balance of interest-bearing liabilities increased by $39.1 million, or 11.4%.  The increase in the average balance of interest earning assets primarily resulted from a $23.0 million increase in the average balance of the loan portfolio and a $26.1 million increase in the average balance of the security investment portfolio.  This was funded by a $39.1 million increase in interest-bearing liabilities driven largely by an increase in money market deposit accounts (“MMDA”) and time deposits.  The makeup of the latter increase was largely composed of CDARS deposits. These increases in interest bearing liabilities, initiated to fund the loan growth needs, were the direct result of the Company’s strategic plan previously addressed.  Interest income, on a tax-equivalent basis, increased $338,000, or 1.8%, during 2012. The decrease in yield on interest earning assets to 4.40% in 2012 from 4.88% in 2011 was more than offset by the 13.0% increase in average volume.  This increase in average volume was primarily centered in average investment securities and, secondarily, average residential real estate loans and commercial loans.  Interest expense on interest-bearing liabilities decreased $433,000, or 10.0%, as the rates paid dropped 24 basis points to 1.02% in 2012 from 1.26% in 2011.  The principal reason for the decline in rates paid was due to the greater concentration of CDARS deposits within time deposits, as the Company elected to acquire shorter term CDARS deposits at current low market rates to provide the liquidity for the expected loan growth.

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Average Balances and Rates

The following table sets forth information concerning average interest-earning assets and interest-bearing liabilities and the yields and rates thereon. Interest income and resultant yield information in the table is on a fully tax-equivalent basis using marginal federal income tax rates of 34%. Averages are computed on the daily average balance for each month in the period divided by the number of days in the period. Yields and amounts earned include loan fees. Non-accrual loans have been included in interest-earning assets for purposes of these calculations.

For the Years Ended December 31,
Yield /
Yield /
Yield /
(Dollars in thousands)
Interest-earning assets:
Real estate loans residential
  $ 168,354     $ 8,233       4.89 %   $ 153,735     $ 8,029       5.22 %   $ 138,497     $ 7,672       5.54 %
Real estate loans commercial
    72,894       4,194       5.75 %     70,050       4,372       6.24 %     65,120       4,044       6.21 %
Commercial loans
    45,598       2,161       4.74 %     38,533       1,904       4.94 %     37,700       1,894       5.02 %
Consumer loans
    26,956       1,535       5.69 %     28,468       1,726       6.06 %     29,506       1,774       6.01 %
Taxable investment securities
    93,352       1,927       2.06 %     79,236       2,231       2.82 %     75,660       2,549       3.37 %
Tax-exempt investment securities
    23,716       1,100       4.64 %     11,716       571       4.87 %     8,587       399       4.65 %
Interest-earning time deposit
    1,994       24       1.20 %     176       2       1.14 %     -       -       0.00 %
Interest-earning deposits
    3,426       4       0.12 %     4,147       5       0.12 %     8,140       7       0.09 %
Total interest-earning assets
    436,290       19,178       4.40 %     386,061       18,840       4.88 %     363,210       18,339       5.05 %
Noninterest-earning assets:
Other assets
    32,593                       35,647                       32,087                  
Allowance for loan losses
    (4,224 )                     (3,872 )                     (3,420 )                
Net unrealized gains
on available for sale securities
    2,594                       1,293                       1,513                  
Total assets
  $ 467,253                     $ 419,129                     $ 393,390                  
Interest-bearing liabilities:
NOW accounts
  $ 31,819       82       0.26 %   $ 30,274       87       0.29 %   $ 29,816       79       0.26 %
Money management accounts
    14,395       43       0.30 %     12,964       43       0.33 %     12,101       39       0.32 %
MMDA accounts
    77,401       427       0.55 %     64,352       438       0.68 %     50,722       336       0.66 %
Savings and club accounts
    63,962       54       0.08 %     60,713       78       0.13 %     57,810       84       0.15 %
Time deposits
    159,283       2,290       1.44 %     139,299       2,590       1.86 %     137,975       2,871       2.08 %
Junior subordinated debentures
    5,155       169       3.28 %     5,155       163       3.16 %     5,155       164       3.18 %
    31,079       843       2.71 %     31,255       942       3.01 %     34,102       1,235       3.62 %
Total interest-bearing liabilities
    383,094       3,908       1.02 %     344,012       4,341       1.26 %     327,681       4,808       1.47 %
Noninterest-bearing liabilities:
Demand deposits
    40,759                       35,971                       29,479                  
Other liabilities
    3,765                       4,722                       5,173                  
Total liabilities
    427,618                       384,705                       362,333                  
Shareholders' equity
    39,635                       34,424                       31,057                  
Total liabilities & shareholders' equity
  $ 467,253                     $ 419,129                     $ 393,390                  
Net interest income
          $ 15,270                     $ 14,499                     $ 13,531          
Net interest rate spread
                    3.38 %                     3.62 %                     3.58 %
Net interest margin
                    3.50 %                     3.76 %                     3.73 %
Ratio of average interest-earning assets
to average interest-bearing liabilities
                    113.89 %                     112.22 %                     110.84 %

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Interest Income

Changes in interest income result from changes in the average balances of loans, securities, and interest-earning deposits and the related yields on those balances.  Interest income on a tax-equivalent basis increased $338,000, or 1.8%.

Average interest earning asset balances increased 13.0% in 2012, with yields decreasing 48 basis points to 4.40%.  The Company's average residential mortgage loan portfolio increased $14.6 million, or 9.5%, when comparing 2012 to 2011. The average yield on this portfolio decreased 33 basis points to 4.89% in 2012 as higher rate amortizing mortgages were replaced with new originations reflecting current market rates.  The average balance of commercial real estate loans recorded a modest increase of $2.8 million, or 4.1%, and the yield decreased 49 basis points to 5.75% in 2012.  Average commercial loans recorded a significant increase of $7.1 million, or 18.3%, while the yield decreased 20 basis points to 4.74% in 2012.  This increase in average commercial loans is in direct support of the Company’s plan to continue to diversify its loan portfolio.

Interest income on taxable investment securities decreased 13.6% from 2011 as the average yield decreased 76 basis points to 2.06% in 2012 from 2.82% in 2011.  This was offset by an increase of $14.1 million, or 17.8%, in the average balance of taxable investment securities.  Interest income on tax-exempt securities increased $529,000, or 92.6%, when compared to the prior year as tax equivalent yields on these issues continued to be attractive investment alternatives.

Interest Expense

Changes in interest expense result from changes in the average balances of deposits and borrowings and the related interest costs on those balances.  Interest expense decreased $433,000, or 10.0%, in 2012 compared to 2011.  The average rate paid on all interest-bearing deposits was 1.02% in 2012 as compared to 1.26% in 2011, a 24 basis point decrease.  Average balances for total interest-bearing liabilities increased by $39.1 million in 2012 when compared to 2011, principally due to a $13.0 million increase in average MMDA and a $20.0 million increase in time deposits.  While average balances in both of these major deposit areas increased, the rates paid on each of these decreased 13 basis points and 42 basis points, respectively, resulting in a year over year decrease in interest expense of $11,000 and $300,000, respectively.  Time deposits include certificates of deposits and CDARS deposits.  Maturing certificates of deposits continue to be replaced with current lower cost certificates, contributing to the decrease in rates paid on time deposits.

The decrease in the cost of interest bearing liabilities also resulted from a decrease of 30 basis points in the average cost of borrowings, as the maturities of borrowings, generally the Federal Home Loan Bank of New York, with higher rates have been replaced by lower rates on borrowings and reflecting current market conditions.  Savings and club accounts, a significant source of core deposits, recorded average balances of $64.0 million in 2012 reflecting a 5.4% increase over 2011.  Average rates paid on these accounts decreased 5 basis points to 0.08%.

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Rate/Volume Analysis

Net interest income can also be analyzed in terms of the impact of changing interest rates on interest-earning assets and interest-bearing liabilities, and changes in the volume or amount of these assets and liabilities. The following table represents the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Company’s interest income and interest expense during the periods indicated. Information is provided in each category with respect to: (i) changes attributable to changes in volume (change in volume multiplied by prior rate); (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) total increase or decrease.  Changes attributable to both rate and volume have been allocated ratably.

Years Ended December 31,
2012 vs. 2011
2011 vs. 2010
Increase/(Decrease) Due to
Increase/(Decrease) Due to
(In thousands)
Interest Income:
Real estate loans residential
  $ 732     $ (528 )   $ 204     $ 815     $ (458 )   $ 357  
Real estate loans commercial
    173       (351 )     (178 )     308       20       328  
Commercial loans
    337       (80 )     257       41       (31 )     10  
Consumer loans
    (89 )     (102 )     (191 )     (63 )     15       (48 )
Taxable investment securities
    358       (662 )     (304 )     115       (433 )     (318 )
Tax-exempt investment securities
    557       (28 )     529       152       20       172  
Interest-earning time deposits
    22       -       22       2       -       2  
Interest-earning deposits
    (3 )     2       (1 )     (4 )     2       (2 )
Total interest income
    2,087       (1,749 )     338       1,366       (865 )     501  
Interest Expense:
NOW accounts
    4       (9 )     (5 )     1       7       8  
Money management accounts
    4       (4 )     -       3       1       4  
MMDA accounts
    81       (92 )     (11 )     92       10       102  
Savings and club accounts
    4       (28 )     (24 )     5       (11 )     (6 )
Time deposits
    338       (638 )     (300 )     27       (308 )     (281 )
Junior subordinated debentures
    -       6       6       -       (1 )     (1 )
    (5 )     (94 )     (99 )     (97 )     (196 )     (293 )
Total interest expense
    426       (859 )     (433 )     31       (498 )     (467 )
Net change in net interest income
  $ 1,661     $ (890 )   $ 771     $ 1,335     $ (367 )   $ 968  

Provision for Loan Losses

This year, 2012, the Company recorded $825,000 in provision for loan losses as compared to $940,000 recorded in the prior year.  This year over year decrease is due to lower levels of net charge-offs, offset partially by the need for additional provision due to the growth in the loan portfolio. The Company views its current level of allowance for loan losses as adequate to absorb the probable and estimable losses within its loan portfolio.

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Noninterest Income

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

The following table sets forth certain information on noninterest income for the years indicated.

Twelve Months Ended December 31,
(In thousands)
Service charges on deposit accounts
  $ 1,112     $ 1,131     $ (19 )     -1.7 %
Earnings and gain on bank owned life insurance
    309       224       85       37.9 %
Loan servicing fees
    211       196       15       7.7 %
Debit card interchange fees
    426       369       57       15.4 %
Other charges, commissions and fees
    569       531       38       7.2 %
Noninterest income before gains (losses)
    2,627       2,451       176       7.2 %
Net gains on sales and redemptions of investment securities
    375       791       (416 )     -52.6 %
Net gains (losses) on sales of loans and foreclosed real estate
    61       (50 )     111       -222.0 %
Total noninterest income
  $ 3,063     $ 3,192     $ (129 )     -4.0 %

As indicated in the above table, total noninterest income for the twelve months ended December 31, 2012 decreased from the prior year due principally to the lower level of net gains on sales and redemptions of investment securities. In 2011, the Company restructured a portion of its investment securities portfolio due to falling interest rates and a significant mismatch between the demand for, and available supply of, bank qualified fixed income products in the marketplace at that time.  Partially offsetting this decrease was a year over year improvement in net gains on sales of loans and foreclosed real estate, an increase in earnings and gain on bank owned life insurance (stemming from the recorded gain on life insurance proceeds due to the death of a former Company director), and an increase in debit card interchange fees driven by increased usage.

Noninterest Expense

The following table sets forth certain information on noninterest expense for the years indicated.

Twelve Months Ended December 31,
(In thousands)
Salaries and employee benefits
  $ 7,496     $ 7,076     $ 420       5.9 %
Building occupancy
    1,427       1,395       32       2.3 %
Data processing
    1,437       1,398       39       2.8 %
Professional and other services
    654       681       (27 )     -4.0 %
    453       437       16       3.7 %
FDIC assessments
    311       390       (79 )     -20.3 %
Audits and exams
    248       162       86       53.1 %
Other expenses
    1,492       1,609       (117 )     -7.3 %
Total noninterest expenses
  $ 13,518     $ 13,148     $ 370       2.8 %

As indicated above, total noninterest expense for 2012 increased over the prior year due largely to the increase in salaries and employee benefits stemming from wage increases, stock option and ESOP compensation expenses.  The annualized rate of pension costs did not decrease until the pension freeze was announced by the Company on May 14, 2012.  Further, pension costs in 2013 will decrease $249,000 from the 2012 level.  The Company did not begin recording stock option costs until the second quarter of 2011 and ESOP compensation expenses until the third quarter of 2011, hence 2012 was the first full year of recorded expenses under the stock option awards granted in June 2011, and the ESOP plan initiated in July 2011.  Partially offsetting these expense increases was a reduction in other expenses due to a change in program characteristics of the Company’s debit rewards card program and reduced FDIC assessment expenses due to the new assessment base formula adopted in 2011.
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Income Tax Expense

In 2012, the Company reported income tax expense of $929,000 compared with $1.0 million in 2011.  The effective tax rate decreased to 26.0% in 2012 compared to a tax rate of 31.0% in 2011 due to additional income from tax exempt securities and additional earnings and gains on bank owned life insurance.  See Note 15 to the consolidated financial statements for the reconciliation of the statutory tax rate to the effective tax rate.

Earnings Per Share

Basic earnings per share was $0.88 in 2012 as compared to $0.53 in 2011.  Diluted earnings per share was $0.87 in 2012 as compared to $0.52 in 2011.  These increases in basic and diluted earnings per share were due principally to the accelerated accretion of the discount on preferred stock which totaled $470,000 or $0.19 per basic and diluted share in 2011 related to the Company’s participation in and exit from the CPP and, separately, the dividends on the preferred stock related to the Company’s participation in the SBLF.   Additionally, the $325,000 increase in net income between 2011 and 2012 resulted in an increase of $0.13 per basic and diluted share between these two years.


Investment Securities

The investment portfolio represents 27% of the Company’s average earning assets and is designed to generate a favorable rate of return consistent with safety of principal while assisting the Company in meeting its liquidity needs and interest rate risk strategies.  All of the Company’s investments are classified as available for sale.  The Company invests primarily in securities issued by United States Government agencies and sponsored enterprises, mortgage-backed securities, state and municipal obligations, mutual funds, equity securities, investment grade corporate debt instruments, and common stock issued by the Federal Home Loan Bank of New York (FHLBNY).  By investing in these types of assets, the Company reduces the credit risk of its asset base but must accept lower yields than would typically be available on loan products.  Our mortgage backed securities portfolio is comprised predominantly of pass-through securities guaranteed by Fannie Mae, Freddie Mac, or Ginnie Mae and does not, to our knowledge, include any securities backed by sub-prime or other high-risk mortgages.

At December 31, 2012, investment securities increased 7.9% to $108.3 million from $100.4 million at December 31, 2011.  There were no securities that exceeded 10% of consolidated shareholders’ equity.  See Note 4 to the consolidated financial statements for further discussion on securities.

The following table sets forth the carrying value of the Company's investment portfolio at December 31:

(In Thousands)
Investment Securities:
US Treasury, agencies and GSEs
  $ 6,183     $ 5,073  
State and political subdivisions
    27,471       20,304  
    23,006       20,434  
Residential mortgage-backed
    48,556       51,575  
Mutual funds
    2,691       2,565  
Equity securities
    432       444  
    Total investment securities
  $ 108,339     $ 100,395  

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The following table sets forth the scheduled maturities, amortized cost, fair values and average yields for the Company's investment securities at December 31, 2012. Average yield is calculated on the amortized cost to maturity and adjusted to a fully tax-equivalent basis.

One Year or Less
One to Five Years
Five to Ten Years
(Dollars in thousands)
Avg Yield
Avg Yield
Avg Yield
Debt investment securities:
US Treasury, agencies and GSEs
  $ 3,001       1.38 %   $ 2,154       0.83 %   $ 1,020       1.54 %
State and political subdivisions
    1,347       1.71 %     4,357       1.88 %     6,374       3.18 %
    3,559       1.34 %     15,016       2.00 %     1,011       3.16 %
  $ 7,907       1.42 %   $ 21,527       1.86 %   $ 8,405       2.98 %
Mortgage-backed securities:
Residential mortgage-backed
  $ -       -     $ 210       5.27 %   $ 11,768       2.41 %
  $ -       -     $ 210       5.27 %   $ 11,768       2.41 %
Other non-maturity investments:
Mutual funds
  $ 2,374       3.47 %   $ -       -     $ -       -  
Equity securities
    420       2.54 %     -       -       -       -  
  $ 2,794       3.33 %   $ -       -     $ -       -  
Total investment securities
  $ 10,701       1.92 %   $ 21,737       1.89 %   $ 20,173       2.64 %

More Than Ten Years
Total Investment Securities
(Dollars in thousands)
Avg Yield
Avg Yield
Debt investment securities:
US Treasury, agencies and GSEs
  $ -       -     $ 6,175     $ 6,183       1.22 %
State and political subdivisions
    14,335       3.25 %     26,413       27,471       2.93 %
    3,356       2.43 %     22,942       23,006       2.01 %
  $ 17,691       3.09 %   $ 55,530     $ 56,660       2.37 %
Mortgage-backed securities:
Residential mortgage-backed
  $ 35,431       2.34 %   $ 47,409     $ 48,556       2.37 %
  $ 35,431       2.34 %   $ 47,409     $ 48,556       2.37 %
Other non-maturity investments:
Mutual funds
  $ -       -     $ 2,374     $ 2,691       3.47 %
Equity securities
    -       -       420       432       2.54 %
  $ -       -     $ 2,794     $ 3,123       3.34 %
Total investment securities
  $ 53,122       2.59 %   $ 105,733     $ 108,339       2.39 %

The above noted yield information does not give effect to changes in fair value that are reflected in accumulated other comprehensive loss in consolidated shareholders’ equity.

Loans Receivable

Loans receivable represent 72% of the Company’s average earning assets and account for the greatest portion of total interest income.  The Company currently has the largest portion of its loan portfolio in the residential real estate product segment and it anticipates a continued commitment to financing the purchase or improvement of residential real estate in its market area.  The Company also extends credit to businesses within its marketplace secured by commercial real estate, equipment, inventories, and accounts receivable.  In support of the strategy to diversify its loan portfolio, it is anticipated that small business lending in the form of mortgages, term loans, leases, and lines of credit will provide the most opportunity for balance sheet and revenue growth over the near term.  At December 31, 2012, commercial and municipal loans comprised 15% of the total loan portfolio, and 78% of the Company’s total loan portfolio consisted of loans secured by first mortgages on residential and commercial real estate.
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December 31,
(In thousands)
Residential real estate (1)
  $ 176,968     $ 162,395     $ 147,722     $ 135,102     $ 136,218  
Commercial real estate
    82,357       73,628       69,060       62,250       55,061  
Commercial and municipal loans
    48,826       40,336       39,833       35,447       30,685  
Home Equity and junior liens
    22,141       24,251       25,271       26,086       24,392  
Consumer loans
    3,456       4,140       3,410       3,580       3,516  
  Total loans receivable
  $ 333,748     $ 304,750     $ 285,296     $ 262,465     $ 249,872  

(1) Includes loans held for sale at December 31, 2009. (None at December 31, 2012, 2011, 2010, and 2008)

The following table shows the amount of loans outstanding, including net deferred costs, as of December 31, 2012 which, based on remaining scheduled repayments of principal, are due in the periods indicated.  Demand loans having no stated schedule of repayments, no stated maturity, and overdrafts are reported as one year or less.  Adjustable and floating rate loans are included in the period on which interest rates are next scheduled to adjust, rather than the period in which they contractually mature.  Fixed rate loans are included in the period in which the final contractual repayment is due.

Due Under
Due 1-5
Due Over
(In thousands)
One Year
Five Years
Real estate:
Commercial real estate
  $ 103     $ 5,471     $ 76,783     $ 82,357  
Residential real estate
    83       4,761       172,124       176,968  
Total real estate
    186       10,232       248,907       259,325  
Other commercial
    24,218       16,457       8,151       48,826  
Home equity and junior liens
    40       1,056       21,045       22,141  
    550       2,108       798       3,456  
Total loans
  $ 24,994     $ 29,853     $ 278,901     $ 333,748  
Interest rates:
  $ 6,294     $ 19,515     $ 152,991     $ 178,800  
    18,700       10,338       125,910       154,948  
Total loans
  $ 24,994     $ 29,853     $ 278,901     $ 333,748  

Total loans receivable increased $29.0 million or 9.5% when compared to the prior year, primarily due to a $14.6 million or 9.0% increase in residential real estate loans.  The Company does not originate sub-prime, Alt-A, negative amortizing or other higher risk structured residential mortgages. Commercial and municipal loans increased $8.5 million or 21.0% in support of the Company’s strategy to balance its diversification among its product segments.  Commercial real estate loans also reported significant growth as this segment reported a $8.7 million or 11.9% year over year increase.  At December 31, 2012, total loans receivable having a fixed interest rate represented 53.6% of the portfolio as compared to 51.3% at December 31, 2011.  This represents a continuing shift to fixed interest rate products, given the historically lower fixed rates and the market’s desire to lock in lower borrowing costs.

Consumer loans, which include second mortgage loans, home equity lines of credit, direct installment, and revolving credit loans, decreased 9.8% to $25.6 million at December 31, 2012.  The decrease resulted from a decrease in home equity lines of credit as a result of the current market and economic conditions.
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Non-performing Loans and Assets

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

December 31,
(In thousands)
Nonaccrual loans:
Commercial real estate and commercial
  $ 2,726     $ 2,594     $ 4,224     $ 1,021     $ 1,455  
    776       706       365       111       254  
Residential real estate
    2,046       1,428       1,335       1,181       614  
Total nonaccrual loans
    5,548       4,728       5,924       2,313       2,323  
Total non-performing loans
    5,548       4,728       5,924       2,313       2,323  
Foreclosed real estate
    426       536       375       181       335  
Total non-performing assets
  $ 5,97