UNITED
STATES


SECURITIES
EXCHANGE COMMISSION


Washington,
D.C. 20549


FORM
10-K





T
            ANNUAL
      REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934


For the
fiscal year ended December 31, 2008.


or


*TRANSITION REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934


For the
transition period from ______________ to ______________.





Commission file number: 000-23601


PATHFINDER
BANCORP, INC.


(Exact name
of registrant as specified in its charter)


Federal                                                                                                                                                                                      16-1540137


(State or
other jurisdiction
of                                                                                                                                                        
                                
(I.R.S. Employer


incorporation
or
organization)                                                                                                                                                      
                               
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 *      NO
T




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 *NO T




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 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*NOT





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, 2008, as reported by the Nasdaq Capital Market, was approximately
$5.8 million.




As of
March 13, 2009, there were 2,972,119 shares issued and 2,484,832 shares
outstanding of the Registrant’s Common Stock.





DOCUMENTS
INCORPORATED BY REFERENCE:




(1) Proxy
Statement for the 2009 Annual Meeting of Stockholders of the Registrant (Part
III).




(2) Annual Report to Stockholders
(Part II and IV).












TABLE
OF CONTENTS





FORM 10-K
ANNUAL REPORT


FOR THE
YEAR ENDED


DECEMBER
31, 2008


PATHFINDER
BANCORP, INC.




Page


PART
I


Item
1.                 Business                                                                                                                                     
                                         
1


Item
1A.             Risk
Factors                                                                                                                                                                    
    11


Item
1B.              Unresolved
Staff
Comments                                                                                                                                           
 14


Item
2.                 Properties                                                                                                                                                                            15


Item
3.                 Legal
Proceedings                                                                                                                                                             
15


Item
4.                 Submission
of Matters to a Vote of Security
Holders                                                                                                  15





PART
II


Item
5.                 Market
for Registrant's Common Equity, Related Stockholder Matters and
Issuer                                                16


Purchases of Equity
Securities


Item
6.                 Selected
Financial
Data                                                                                                                                                    
17


Item
7.                 Management's
Discussion and Analysis of Financial Condition and Results of
Operations                              
18


Item
7A.             
Quantitative and Qualitative Disclosures About Market
Risk        
                                                                          34


Item
8.                 Financial
Statements and Supplementary
Data                                                                                                             35


Item
9.                 Changes
In and Disagreements With Accountants on Accounting and Financial
Disclosure                            71


Item
9A(T).        Controls and
Procedures                                                                                                                                                   71


Item
9B.              Other
Information                                                                                                                                                               71





PART
III


Item
10.                 Directors,
Executive Officers and Corporate
Governance                                                                                        
 72


Item
11.                 Executive
Compensation                                                                                                                                                
72


Item
12.                 Security
Ownership of Certain Beneficial Owners and Management and
Related                                                72


Stockholder Matters


Item
13.                 Certain
Relationships and Related Transactions, and Director
Independence                                                      72


Item
14.                 Principal
Accountant Fees and
Services                                                                                                                      72





PART
IV


Item
15.                 Exhibits
and Financial Statement
Schedules                                                                                                                73














PART
I




FORWARD-LOOKING
STATEMENTS





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, those
discussed under “Risk Factors” in Part I, Item 1A of this Annual Report on Form
10-K.  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.





SIGNIFICANT
REGULATORY DEVELOPMENTS





The
Company is engaged in the financial services industry.  This industry
has undergone, and will most likely further undergo, significant regulatory
developments.  Significant regulatory developments as of the date of
this report are described in the “Regulation and Supervision” section
below.  The regulatory landscape changes nearly daily and readers are
cautioned not to rely solely on the disclosures contained herein.





ITEM 1: BUSINESS





GENERAL




Pathfinder
Bancorp, Inc.





Pathfinder
Bancorp, Inc. (the "Company") is a Federally chartered mid-tier holding company
headquartered in Oswego, New York.  The primary business of the
Company is its investment in Pathfinder Bank (the "Bank").  The
Company is majority owned by Pathfinder Bancorp, M.H.C., a federally-chartered
mutual holding company (the "Mutual Holding Company").   At
December 31, 2008, the Mutual Holding Company held 1,583,239 shares of the
Company’s common stock (“Common Stock”) and the public held 901,593 shares of
Common Stock (the "Minority shareholders").  At December 31, 2008,
Pathfinder Bancorp, Inc. had total assets of $352.8 million, total deposits of
$269.4 million and shareholders' equity of $19.5 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.





Pathfinder
Bank





The Bank
is a New York-chartered savings bank headquartered in Oswego, New
York.  The Bank operates from its main office as well as six branch
offices located in its market area consisting of Oswego County and the
contiguous counties.  The Bank's deposits are insured by the Federal
Deposit Insurance Corporation ("FDIC").  The Bank was chartered as a
New York savings bank in 1859 as Oswego City Savings Bank.  The Bank
is a customer-oriented institution dedicated to providing mortgage loans and
other traditional financial services to its customers.  The Bank is
committed to meeting the financial needs of its customers in Oswego County, New
York, and the contiguous counties.








The Bank
is primarily engaged in the business of attracting deposits from the general
public in the Bank's market area, and investing such deposits, together with
other sources of funds, in loans secured by one- to four-family residential real
estate and commercial real estate.  At December 31, 2008, $190.4
million, or 76% of the Bank's total loan portfolio consisted
 of loans
secured by real estate, of which $135.3 million, or 71%, were loans secured by
one- to four-family residences and $55.1 million, or 29%, were secured by
commercial real estate.  Additionally, $24.4 million, or 10%, of total
loans, were secured by second liens on residential properties that are
classified as consumer loans.  The Bank also originates commercial and
consumer loans that totaled $30.7 million and $3.5 million, respectively, or
14%, of the Bank's total loan portfolio at December 31, 2008.  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 borrowings from correspondent
financial institutions.  The principal source of income is interest on
loans and investment securities.  The Bank's principal expenses are
interest paid on deposits, and employee compensation and benefits.


Pathfinder
Bank formed a New York state chartered limited purpose commercial bank
subsidiary, Pathfinder Commercial Bank, in October of
2002.  Pathfinder Commercial Bank was established to serve the
depository needs of public entities in its market area.





In April
1999, the Bank established Pathfinder REIT, Inc., a New York corporation, as the
Bank's wholly-owned real estate investment trust subsidiary.  At
December 31, 2008, Pathfinder REIT, Inc. held $21.7 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.  This subsidiary is currently
inactive.





In
addition, 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 trust preferred securities.





Employees





As of
December 31, 2008, the Bank had 89 full-time employees and 18 part-time
employees.  The employees are not represented by a collective
bargaining unit and we consider our relationship with our employees to be
good.





MARKET
AREA AND COMPETITION





The
economy in the Bank's market area is manufacturing-oriented and is also
significantly dependent upon the State University of New York College at
Oswego.  The major manufacturing employers in the Bank's market area
are Entergy Nuclear Northeast, Novelis, Constellation, NRG and
Huhtamaki.  The Bank is the largest depository institution
headquartered in Oswego County.  However, the Bank encounters
competition from a variety of sources.  The Bank's business and
operating results are significantly affected by the general economic conditions
prevalent in its market areas.


The Bank
encounters strong competition both in attracting deposits and in originating
real estate loans and other loans.  Its most direct competition for
deposits has historically come 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 and a wide range of competitively priced
financial services.  The Bank competes for real estate loans primarily
through the interest rates and loan fees it charges and advertising, as well as
by originating and holding in its portfolio mortgage loans which do
  Page
2
 not
necessarily conform to secondary market underwriting standards.  The
recent 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 deeply
impacted other regions on a national basis, certain mortgage brokers and finance
companies 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 muted.  Management
believes that these conditions have created a window of reduced competition for
residential loans, and to a lesser extent, commercial real estate
loans.
  REGULATION
AND SUPERVISION





General





The Bank
is a New York-chartered stock savings bank and its deposit accounts are insured
up to applicable limits by the FDIC through the Deposit  Insurance
Fund (“DIF ”).  The Bank is subject to extensive regulation by the New
York State Banking Department (the “Department”), as its chartering agency, and
by the FDIC, as its deposit insurer and primary federal
regulator.  The Bank is required to file reports with, and is
periodically examined by, the FDIC and the Superintendent of the Department
concerning its activities and financial condition and must obtain regulatory
approvals prior to entering into certain transactions, including, but not
limited to, mergers with or acquisitions of other banking
institutions.  The Bank is a member of the Federal Home Loan Bank of
New York (“FHLBNY”) and is subject to certain regulations by the Federal Home
Loan Bank System.  The Company and the Mutual Holding Company are
federally chartered.  Consequently, they are subject to regulations of
the Office of Thrift Supervision ("OTS") as savings and loan holding
companies.  Any change in such regulations, whether by the Department,
the FDIC, or the OTS could have a material adverse impact on the Bank, the
Company or the Mutual Holding Company.





Regulatory
requirements applicable to the Bank, the Company and the Mutual Holding Company
are referred to below or elsewhere herein.





Recent
Regulatory Developments





In
response to the financial crises affecting the banking system and financial
markets and going concern threats to investment banks and other financial
institutions, on October 3, 2008, the Emergency Economic Stabilization Act of
2008 (the “EESA”) was signed into law.  EESA provides, among other
things, for a Troubled Assets Relief Program (“TARP”), under which the U.S.
Department of the Treasury has the authority to purchase up to $700 billion of
securities and certain other financial instruments from financial institutions
for the purpose of stabilizing and providing liquidity to the U.S. financial
markets.





On
October 14, 2008, the Treasury Department announced a Capital Purchase Program
(“CPP”) under the TARP pursuant to which it would acquire equity investments,
usually preferred stock, in banks and thrifts and their holding
companies.  Participating financial institutions also were required to
adopt the Treasury Department’s standards for executive compensation and
corporate governance for the period during which the department holds equity
issued under the CPP.  We have filed an application to receive an
investment of up to approximately $7 million under the CPP.  However,
Treasury has not yet provided the terms for CPP participation by companies in
the mutual holding company form of organization.  Accordingly, we have
not yet determined whether or not we will accept a CPP investment, or the amount
of such investment, if our application is approved.  When the terms
for CPP participation by companies in the mutual holding company structure are
announced by Treasury, we will evaluate whether to pursue participation in the
program.





On
February 10, 2009, Treasury announced its Capital Assistance Program (“CAP”)
under which Treasury will make capital available to financial institutions
through Treasury’s purchase of cumulative mandatorily convertible preferred
stock. The preferred shares will mandatorily convert to common stock after seven
years. Prior to that time, the preferred shares are convertible in whole or in
part at the option of the institution, subject to the approval of the
institution’s primary federal regulator.  Institutions that have
received an investment




Page
3


from
Treasury under the CPP may use proceeds from the CAP to redeem preferred shares
issued in the CPP, effectively exchanging the preferred stock sold under the CPP
for CAP


convertible
preferred stock.  As with the CPP, Treasury has not yet provided the
terms for CAP participation by companies in the mutual holding company
structure.  Accordingly, we have not yet determined whether we will
apply for or accept a CAP investment.  When the terms for CAP
participation by companies in the mutual holding company structure are announced
by Treasury, we will evaluate whether to pursue participation in the
program.




On
December 22, 2008, the FDIC published a final rule that raises the current
deposit insurance assessment rates uniformly for all institutions by 7 basis
points (to a range from 12 to 50 basis points) effective for the first quarter
of 2009.  On February 27, 2009, the FDIC also issued a final rule that
revises the way the FDIC calculates federal deposit insurance assessment rates
beginning in the second quarter of 2009.  Under the new rule, the
total base assessment rate will range from 7 to 77.5 basis points of the
institution’s deposits, depending on the risk category of the institution and
the institution’s levels of unsecured debt, secured liabilities, and brokered
deposits.  Additionally, the FDIC issued an interim rule that would
impose a special 20 basis points assessment on June 30, 2009, which would be
collected on September 30, 2009. However, the FDIC has indicated a willingness
to decrease the special assessment to 10 basis points under certain
circumstances concerning the overall financial health of the insurance fund.
Special assessments of 10 and 20 basis points would result in additional expense
of approximately $300,000 to $600,000, respectively. The interim rule also
allows for additional special assessments.





On
October 14, 2008, the FDIC announced the Temporary Liquidity Guarantee Program
(“TLGP”).  This program has two components. One guarantees newly
issued senior unsecured debt of the participating organizations, up to certain
limits established for each institution, issued between October 14, 2008 and
June 30, 2009. The other component of the program provides full FDIC insurance
coverage for non-interest bearing transaction deposit accounts, regardless of
dollar amount, until December 31, 2009. An annualized 10 basis point assessment
on balances in noninterest-bearing transaction accounts that exceed the existing
deposit insurance limit of $250,000 will be assessed on a quarterly basis to
insured depository institutions participating in this component of the
TLGP.  The Company has chosen to participate in both components of the
TLGP.  The additional expense related to this coverage is not expected
to be significant for Pathfinder Bank.





The
American Recovery and Reinvestment Act of 2009 (“ARRA”), more commonly known as
the economic stimulus or economic recovery package, was signed into law on
February 17, 2009, by President Obama.  ARRA includes a wide variety
of programs intended to stimulate the economy and provide for extensive
infrastructure, energy, health, and education needs.  In addition,
ARRA imposes certain new executive compensation and corporate expenditure limits
on all current and future TARP recipients until the recipient has repaid the
Treasury, which is now permitted under ARRA without penalty and without the need
to raise new capital, subject to the Treasury’s consultation with the
recipient’s appropriate regulatory agency.





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.






Page
4


FDIC
Insurance on Deposits





The Bank
is a member of the DIF, which is administered by the FDIC.  Deposits
are insured up to applicable limits by the FDIC and such insurance is backed by
the full faith and credit of the U.S. Government.





The
Federal Deposit Insurance Reform Act of 2005 was signed into law on February 8,
2006, and gives the FDIC increased flexibility in assessing premiums on banks
and savings associations, including the Bank, to pay for deposit insurance and
in managing its deposit insurance reserves.  The reform legislation
provided a credit to all insured institutions, based on the amount of their
insured deposits at year-end 1996, to offset the premiums that they may be
assessed; combined the BIF and SAIF to form a single Deposit Insurance Fund;
increased deposit insurance to $250,000 for Individual Retirement Accounts; and
authorized inflation-based increases in deposit insurance on other accounts
every 5 years. In 2008, Congress has temporarily extended the $250,000 insurance
limit to all other depositor accounts through December 31, 2009.





The
credit provided by the 2005 Act is determined based on the assessment base of
the institution as of December31, 1996 as
compared with the combined aggregate assessment base of all eligible
institutions as of that date. Those institutions having credits could use them
to offset up to 100% of the 2007 DIF assessment, and if not completely used in
2007, may apply the remaining credits to not more than 90% of each of the
aggregate 2008, 2009 and 2010 DIF assessments. Pathfinder Bank offset 90% of its
DIF assessments with available one-time assessment credits for the first two
quarters of 2008 and took the remaining balance of the credit against the third
quarter assessment. For the first nine months of 2008, credits utilized to
offset amounts assessed for Pathfinder Bank totaled $76,000. Fourth quarter 2008
assessments for Pathfinder Bank, which will be assessed in March 2009 and will
not be offset by credits, are estimated to be approximately
$45,000.





See the
discussion of recent regulatory developments relating to the FDIC and its
anticipated impact on the Company discussed above under the caption “Recent Regulatory
Developments”.





Regulatory
Capital Requirements





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





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




In
addition, the FDIC has established regulations prescribing a minimum Tier I
leverage ratio (Tier I capital to adjusted total assets as specified in the
regulations).  These regulations provide for a minimum Tier I leverage
ratio of 3% for banks that meet certain specified criteria, including that they
have the highest examination rating and are not experiencing or
  Page
5
 anticipating
significant growth. All other banks are required to maintain a Tier I leverage
ratio of 3% plus an additional cushion of at least 100 to 200 basis
points.  The FDIC and the other federal banking regulators have
proposed amendments to their minimum capital regulations to provide that the
minimum leverage capital ratio for a depository institution that has been
assigned the highest composite rating of 1 under the Uniform Financial
Institutions Rating System will be 3% and that the minimum leverage capital
ratio for any other depository institution will be 4% unless a higher leverage
capital ratio is warranted by the particular circumstances or risk profile of
the depository institution.  The FDIC may, however, set higher
leverage and risk-based capital requirements on individual institutions when
particular circumstances warrant. Savings banks experiencing or anticipating
significant growth are expected to maintain capital ratios, including tangible
capital positions, well above the minimum levels.
  Limitations
on Dividends and Other Capital Distributions





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





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
lessthan
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).





The Bank
currently meets the criteria to be classified as a "well capitalized" savings
institution.





Transactions
With Affiliates and Insiders




Under
current federal law, transactions between depository institutions and their
affiliates are governed by Sections 23A and 23B of the Federal Reserve Act and
its implementing regulations. An affiliate of a savings bank is any company or
entity that controls, is controlled by, or is under common control with the
savings bank, other than a subsidiary of the savings bank. In a holding company
context, at a minimum, the parent holding company of a savings bank, and any
companies 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, the purchase of, or
an investment in, the securities of an affiliate; the acceptance of securities
of an affiliate as collateral for a loan or extension of credit to any person;
or issuance of a guarantee,
  Page
6
 acceptance,
or letter of credit on behalf of an affiliate. Section 23A also establishes
specific collateral requirements for loans or extensions of credit to, or
guarantees, acceptances on letters of credit issued on behalf of an affiliate.
Section 23B requires that covered transactions and a broad list of other
specified transactions be on terms substantially the same, or no less favorable,
to the savings bank or its subsidiary as similar transactions with
nonaffiliates.
  Further,
Section 22(h) of the Federal Reserve Act and its implementing regulations
restrict a savings bank with respect to loans to directors, executive officers,
and principal stockholders. Under Section 22(h), loans to directors, executive
officers and stockholders who control, directly or indirectly, 10% or more of
voting securities of a savings bank and certain related interests of any of the
foregoing, may not exceed, together with all other outstanding loans to such
persons and affiliated entities, the savings bank's total 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.





Federal
Holding Company Regulation





General.  The Company and
the Mutual Holding Company are 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 OTS and are subject to OTS
regulations, examinations, supervision and reporting requirements.  As
such, the OTS has enforcement authority over the Company and the Mutual Holding
Company, and their non-savings institution subsidiaries.  Among other
things, this authority permits the OTS to restrict or prohibit activities that
are determined to be a serious risk to the subsidiary savings
institution.





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


The Home
Owners' Loan Act prohibits a savings and loan holding company, directly or
indirectly, or through one or more subsidiaries, from acquiring another savings
association or holding company thereof, without prior written approval of the
OTS.  It also prohibits the acquisition or retention of, with certain
exceptions, more than 5% of a nonsubsidiary savings
  Page
7
 association,
a nonsubsidiary holding company, or a nonsubsidiary company engaged in
activities other than those permitted by the Home Owners' Loan Act; or acquiring
or retaining control of an institution that is not federally
insured.  In evaluating applications by holding companies to acquire
savings associations, the OTS must consider the financial and managerial
resources, future prospects of the company and association involved, the effect
of the acquisition on the risk to the insurance fund, the convenience and needs
of the community and competitive factors.


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





Waivers of
Dividends by Mutual Holding Company.  OTS regulations
require the Mutual Holding Company to notify the OTS of any proposed waiver of
its receipt of dividends from the Company.  The OTS may object to such
waivers.





Conversion of the
Mutual Holding Company to Stock Form.  OTS regulations
permit the Mutual Holding Company to convert from the mutual form of
organization to the capital stock form of organization (a "Conversion
Transaction").  There can be no assurance when, if ever, a Conversion
Transaction will occur, and the Board of Directors has no current intention or
plan to undertake a Conversion Transaction.  In a Conversion
Transaction a new holding company would be formed 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 that ensures that Minority Stockholders
own the same percentage of common stock in the New Holding Company as they owned
in the Company immediately prior to the Conversion Transaction.  Under
OTS regulations, Minority Stockholders would not be diluted because of any
dividends waived by the Mutual Holding Company (and waived dividends would not
be considered in determining an appropriate exchange ratio), in the event the
Mutual Holding Company converts to stock form.  The total number of
shares held by Minority Stockholders after a Conversion Transaction also would
be increased by any purchases by Minority Stockholders in the stock offering
conducted as part of the Conversion Transaction.





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.





Federal
Reserve System





The
Federal Reserve Board requires all depository institutions to maintain
noninterest-bearing reserves at specified levels against their transaction
accounts (primarily checking, money management and NOW checking
accounts).  At December 31, 2008, the Bank was in compliance with
these reserve requirements.








Page
8


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





The
Bank's NYCRA rating as of its latest examination was
"satisfactory."





The
USA PATRIOT Act





The USA
PATRIOT Act (“the PATRIOT Act”) was signed into law on October 26,
2001.  The PATRIOT Act gives the federal government new powers to
address terrorist threats through enhanced domestic security measures, expanded
surveillance powers, increased information sharing and broadened anti-money
laundering requirements.  The PATRIOT Act also requires the federal
banking agencies to take into consideration the effectiveness of controls
designed to combat money laundering activities in determining whether to approve
a merger or other acquisition application of a member
institution.  Accordingly, if the Company were to engage in a merger
or other acquisitions, its controls designed to combat money laundering would be
considered as part of the application process.  The Company and the
Bank have established policies, procedures and systems designed to comply with
these regulations.





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.  Recently revised dates for compliance with Section 404
have given non-accelerated filers some relief by extending the date for
compliance with auditor attestation requirements to the year ending December 31,
2009.  We have existing policies, procedures and systems designed to
comply with these regulations, and are further enhancing and documenting such
policies, procedures and systems to ensure continued compliance with these
regulations.




Page
9


Emergency Economic Stabilization
Act of 2008




The
Emergency Economic Stabilization Act of 2008 ("EESA") was enacted on
October 3, 2008. EESA enables the federal government, under terms and
conditions to be developed by the Secretary of the Treasury, to insure troubled
assets, including mortgage-backed securities, and collect premiums from
participating financial institutions. EESA includes, among other provisions:
(a) the $700 billion Troubled Assets Relief Program ("TARP"), under
which the Secretary of the Treasury is authorized to purchase, insure, hold, and
sell a wide variety of financial instruments, particularly those that are based
on or related to residential or commercial mortgages originated or issued on or
before March 14, 2008; and (b) an increase in the amount of deposit
insurance provided by the FDIC.




Under the
TARP, the United States Department of Treasury authorized a voluntary Capital
Purchase Program to purchase up to $250 billion of senior preferred shares
of qualifying financial institutions that elected to participate by
November 14, 2008. The board of directors and management analyzed the
potential merits of participating in the Capital Purchase Program (“CPP”) of the
Treasury Department’s TARP.  It is the general view of the board and
management that in the present national economic risk environment, enhancing the
Company’s capital ratios is both prudent, given the current climate, and
potentially opportunistic as we move into the next business
cycle.  Additionally, any increase to capital will continue to support
the Company’s lending activities to individuals, families, and businesses in our
community.  In November, Pathfinder Bancorp, M.H.C., the mutual
holding company parent of Pathfinder Bancorp, Inc. filed its original
application requesting CPP funds.  Management is currently awaiting a
response from the treasury relating to its application.  Treasury has
yet to provide a term sheet for mutually chartered
companies.  Companies participating in the CPP were required to adopt
certain standards relating to executive compensation. The terms of the CPP also
limit certain uses of capital by the issuer, including with respect to
repurchases of securities and increases in dividends.





See the
discussion of recent regulatory developments relating to the Emergency Economic
Stabilization Act of 2008and the economic recovery package discussed
above under the caption “Recent Regulatory
Developments”.





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





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





FEDERAL
AND STATE TAXATION





Federal
Taxation





The
following discussion of federal taxation is intended only to summarize certain
pertinent federal income tax matters and is not a comprehensive description of
the tax rules applicable to the Company or the Bank.





Bad Debt
Reserves.  Prior to the 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.  These additions could, within specified formula limits, be
deducted in arriving at the Bank's taxable income.  As a result of the
1996 Act, the Bank must use the small bank experience method in computing its
bad debt deduction.





Page
10


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 definitionaltests.  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.





Neither
the Internal Revenue Service or New York State have examined our federal or
state tax returns within the past 5 years.





State
Taxation





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





ITEM
1A: RISK FACTORS





The
material risks and uncertainties that management believes affect the Company are
described below. The risks and uncertainties described below are not the only
ones facing the Company. Additional risks and uncertainties that management is
not aware of or that management currently deems immaterial may also impair the
Company’s business operations. This report is qualified in its entirety by these
risk factors. If any of the following risks actually occur, the Company’s
financial condition and results of operations could be materially and adversely
affected.




Changes
in Interest Rates Can Have an Adverse Effect on Profitability




The
Company’s earnings and cash flows are largely dependent upon its net interest
income. Net interest income is the difference between interest income earned on
interest earning assets such as loans and investment securities and interest
expense paid on interest bearing liabilities such as deposits and borrowed
funds. Interest rates are highly sensitive to many factors that are beyond the
Company’s control, including general economic conditions, competition, and
policies of various governmental and regulatory agencies and, in particular, the
Board of Governors of the Federal Reserve System. Changes in monetary policy,
including changes in interest rates, could influence not only the interest the
Company receives on loans and investment securities and the amount of interest
it pays on deposits and borrowings, but such changes could also affect
(i) the Company’s ability to originate loans and obtain deposits,
(ii) the fair value of the Company’s financial assets and liabilities, and
(iii) the average duration of the Company’s assets and liabilities. If the
interest rates paid on deposits and other borrowings increase at a faster rate
than the interest rates received on loans and other investments, the Company’s
net interest income, and therefore earnings, could be adversely affected.
Earnings could also be adversely affected if the interest rates received on
loans and other investments fall more quickly than the interest rates paid on
deposits and other borrowings.






Page
11


Although
management believes it has implemented effective asset and liability management
strategies to reduce the potential effects of changes in interest rates on the
Company’s results of operations, any substantial, unexpected, prolonged change
in market interest rates could have a material adverse effect on the Company’s
financial condition and results of operations.




The Company’s Increased Emphasis on
Commercial Business and Real Estate Lending May Expose It To Increased Lending
Risks.





At
December 31, 2008, the Company’s loan portfolio consisted of $55.1 million, or
22% of commercial real estate loans, and $30.7 million, or 12% of commercial
business loans.  The Company intends to increase its emphasis on these
types of loans.  These types of loans generally expose a lender to
greater risk of non-payment and loss than one- to four-family residential
mortgage loans because repayment of the loans often depends on the successful
operation of the property, and the income stream of the
borrowers.  Such loans typically involve larger loan balances to
single borrowers or groups of related borrowers compared to one- to four-family
residential mortgage loans.  Commercial business loans expose the
Company to additional risks since they typically are made on the basis of the
borrower’s ability to make repayments from the cash flow of the borrower’s
business and are secured by non-real estate collateral that may depreciate over
time.  In addition, since such loans generally entail greater risk
than one- to four-family residential mortgage loans, the Company may need to
increase its allowance for loan losses in the future to account for the likely
increase in probable incurred credit losses associated with the growth of such
loans.





Continued
or Further Declines in the Value of Certain Investment Securities Could Require
Write-Downs, Which Would Reduce the Company’s Earnings.





During
2008, the Company recorded losses from other-than-temporary impairment on
investment securities totaling $1.6 million, net of the related tax benefits of
$659,000. At December 31, 2008, gross unrealized losses in the Company’s
investment portfolio equaled approximately $2.4 million relating to securities
with an aggregate fair value of $72.1 million.  There can be no
assurance that future factors or combinations of factors will not cause the
Company to conclude in one or more future reporting periods that an unrealized
loss that exists with respect to any of its securities constitutes an impairment
that is other than temporary.





If
the Company’s Investment in the Federal Home Loan Bank of New York is Classified
as Other-Than-Temporarily Impaired or as Permanently Impaired, Its Earnings and
Stockholders’ Equity Could Decrease





The
Company owns common stock of the Federal Home Loan Bank of New York (FHLB-NY).
The Company holds the FHLB-NY common stock to qualify for membership in the
Federal Home Loan Bank System and to be eligible to borrow funds under the
FHLB-NY’s advance program. The aggregate cost and fair value of our FHLB-NY
common stock as of December 31, 2008 was $2.5 million based on its par value.
There is no market for our FHLB-NY common stock.





Recent
published reports indicate that certain member banks of the Federal Home Loan
Bank System may be subject to accounting rules and asset quality risks that
could result in materially lower regulatory capital levels. In an extreme
situation, it is possible that the capitalization of a Federal Home Loan Bank,
including the FHLB-NY, could be substantially diminished or reduced to zero.
Consequently, the Company believes that there is a risk that our investment in
FHLB-NY common stock could be deemed other-than-temporarily impaired at some
time in the future, and if this occurs, it would cause our earnings and
stockholders’ equity to decrease by the after-tax amount of the impairment
charge.





Allowance
For Loan Losses May Be Insufficient




The
Company’s loan customers may not repay their loans according to their terms and
the collateral securing the payment of these loans may be insufficient to assure
repayment. The Company may experience significant loan losses, which would have
a material adverse effect on earnings. Management makes various assumptions and
judgments about the collectibility of the loan portfolio, including the
creditworthiness of borrowers and the value of the real estate and other assets
serving as collateral for the repayment of loans.





Page
12


The
Company maintains an allowance for loan losses in an attempt to cover any loan
losses inherent in the portfolio. In determining the size of the allowance,
management relies on an analysis of the loan portfolio based on historical loss
experience, volume and types of loans, trends in classification, volume and
trends in delinquencies and non-accruals, national and local economic conditions
and other pertinent information. If those assumptions are incorrect, the
allowance may not be sufficient to cover future loan losses and adjustments may
be necessary to allow for different economic conditions or adverse developments
in the loan portfolio.  In addition, regulatory agencies review the
Company’s allowance for loan losses and may require additions to the allowance
based on their judgment about information available to them at the time of their
examination. An increase in the Company’s allowance for loan losses would reduce
its earnings.




Extensive
Regulation and Supervision




The
Company, primarily through its principal subsidiaries, Pathfinder Bank and
Pathfinder Commercial Bank, and certain non-bank subsidiaries, is subject to
extensive federal and state regulation and supervision. Banking regulations are
primarily intended to protect depositors’ funds, federal deposit insurance funds
and the banking system as a whole, not shareholders. These regulations affect
the Company’s lending practices, capital structure, investment practices,
dividend policy and growth, among other things. The Company is also subject to a
number of federal laws, which, among other things, require it to lend to various
sectors of the economy and population, and establish and maintain comprehensive
programs relating to anti-money laundering and customer identification. Congress
and federal regulatory agencies continually review banking laws, regulations and
policies for possible changes and have been increasingly active in the current
economic environment. Changes to statutes, regulations or regulatory policies,
including changes in interpretation or implementation of statutes, regulations
or policies, could affect the Company in substantial and unpredictable ways.
Such changes could subject the Company to additional costs, limit the types of
financial services and products it may offer and/or increase the ability of
non-banks to offer competing financial services and products, among other
things. Failure to comply with laws, regulations or policies could result in
sanctions by regulatory agencies, civil money penalties and/or reputation
damage, which could have a material adverse effect on the Company’s business,
financial condition and results of operations. The Company’s compliance with
certain of these laws will be considered by banking regulators when reviewing
bank merger and bank holding company acquisitions. While the Company has
policies and procedures designed to prevent any such violations, there can be no
assurance that such violations will not occur. See the “Regulation and
Supervision” section in Item 1, “Business” and Note 17 to the
consolidated financial statements included in Item 8, “Financial Statements
and Supplementary Data”, which are located elsewhere in this
report.





Local
Market Economies




The
Company’s business is concentrated in Oswego and parts of Onondaga counties of
New York State.  The economy in the Company’s market area is
manufacturing-oriented and dependent on the State University of New York College
at Oswego.  As a result, its financial condition, results of
operations and cash flows are subject to changes if there are changes in the
economic conditions in these areas. Throughout 2008 and into the current year,
there have been considerable concerns about the deepening economic downturn in
both national and international markets; the level and volatility of energy
prices; a weakened housing market; the troubled state of financial and credit
markets; Federal Reserve positioning of monetary policy; rising private sector
layoffs and unemployment, which caused consumer spending to slow; the underlying
impact on businesses’ operations and abilities to repay loans as consumer
spending slowed; continued stagnant population growth in upstate New York; and
continued slowing of automobile sales. Late in 2008, the U.S economy was
identified as having been in recession since the fourth quarter of 2007.
However, given that all of the Company’s loans are to customers in upstate New
York, which is a traditionally slower growth or stagnant region of New York, the
impact of deteriorating national market conditions was not as pronounced on
borrowers in this region as compared with other areas of the country. Therefore,
despite the conditions, as previously described, the Company has not experienced
severe credit issues through 2008. A prolonged period of economic recession or
other adverse economic conditions in one or both of these counties could have a
negative impact on the Company. The Company can provide no assurance that
conditions in its market area economies will not deteriorate in the future and
that such deterioration would not have a material adverse effect on the
Company.





Page
13


Competition in the Financial
Services Industry




The
Company faces substantial competition in all areas of its operations from a
variety of different competitors, many of which are larger and may have more
financial resources. The Company competes with other providers of financial
services such as other bank holding companies, commercial and savings banks,
savings and loan associations, credit unions, money market and mutual funds,
mortgage companies, asset managers, insurance companies and a growing list of
other local, regional and national institutions which offer financial services.
If the Company is unable to compete effectively, it will lose market share and
income generated from loans, deposits, and other financial products will
decline.





Loss
of Executive Officers or Other Key Personnel




Our
success depends, to a great extent, upon the services of our executive
officers.  The unexpected loss of these individuals could have an
adverse effect on our operations.  From time to time, we also need to
recruit personnel to fill vacant positions for experienced lending officers and
branch staff.  Competition for qualified personnel in the banking
industry is significant, and there is no assurance that we will continue to be
successful in attracting, recruiting and retaining the necessary skilled
managerial, sales and technical personnel for the successful operation of our
existing lending, operations, accounting and administrative functions or to
support the needs of our organization resulting from future
growth.  Our inability to hire or retain key personnel could have an
adverse effect on the Company’s results of operations.





The
Company’s Expenses Will Increase As A Result Of Increases in FDIC Insurance
Premiums.





On
December 22, 2008, the FDIC published a final rule raising the current deposit
insurance assessment rates uniformly for all institutions by seven basis points
(to a range from 12 to 50 basis points) for the first quarter of 2009. On
February 27, 2009, the FDIC issued a final rule changing the way that the FDIC
calculates federal deposit insurance assessment rates beginning in the second
quarter of 2009. Additionally, the FDIC issued an interim rule that would impose
a special 20 basis points assessment on June 30, 2009, which would be collected
on September 30, 2009. For more information on FDIC assessments, see “Regulation
and Supervision—FDIC Insurance on Deposits”.





Future
Legislative or Regulatory Actions Responding to Perceived Financial and Market
Problems Could Impair the Company’s Rights Against Borrowers.





There
have been proposals made by members of Congress and others that would reduce the
amount distressed borrowers are otherwise contractually obligated to pay under
their mortgage loans and limit an institution’s ability to foreclose on mortgage
collateral. Were proposals such as these, or other proposals limiting the
Company’s rights as a creditor, to be implemented, the Company could experience
increased credit losses or increased expense in pursuing its remedies as a
creditor.








ITEM
1B:  UNRESOLVED STAFF COMMENTS





None








Page
14
 ITEM 2: PROPERTIES
  The Bank
conducts its business through its main office located in Oswego, New York, and
six branch offices located in Oswego County.  The following table sets
forth certain information concerning the main office and each branch office of
the Bank at December 31, 2008.  The aggregate net book value of
the Bank's premises and equipment was $7.5 million at December 31,
2008.  For additional information regarding the Bank's properties, see
Notes 7 and 15 to the Consolidated Financial Statements.





LOCATION
            OPENING
      DATE
            OWNED/LEASEDMain
      Office
              214
      West First Street
              Oswego,
      New York  13126
            1874
            OwnedPlaza
      Branch
              Route
      104, Ames Plaza
              Oswego,
      New York  13126
            1989
            Owned
      (1)Mexico
      Branch
              Norman
      & Main Streets
              Mexico,
      New York  13114
            1978
            OwnedOswego
      East Branch
              34
      East Bridge Street
              Oswego,
      New York  13126
            1994
            OwnedLacona
      Branch
              1897
      Harwood Drive
              Lacona,
      New York 13083
            2002
            OwnedFulton
      Branch
              5
      West First Street South
              Fulton,
      New York  13069
              
              Central
      Square Branch
              3025
      East Ave
              Central
      Square, New York  13036
            2003
              
              
              
              2005
            Owned
      (2)
              
              
              
              Owned


(1)
            The
      building is owned; the underlying land is leased with an annual rent of
      $21,000


(2)
            The
      building is owned; the underlying land is leased with an annual rent of
      $30,000








ITEM
3: LEGAL PROCEEDINGS





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






ITEM
4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS





No
matters were submitted during the fourth quarter of fiscal 2008 to a vote of the
Company’s shareholders.








Page
15


PART II




ITEM
5:  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES





Pathfinder
Bancorp, Inc.'s common stock currently trades on the Nasdaq Capital Market under
the symbol "PBHC".  There were 367 shareholders of record as of March
11, 2009.  The following table sets forth the high and low closing bid
prices and dividends paid per share of common stock for the periods
indicated:




DividendQuarter
      Ended:
                  
                  High
                  
                  
                  Low
                  
                  
                  PaidDecember
      31, 2008
                  
                  
                  $13.500
                  
                  
                  
                  $6.000
                  
                  
                  
                  $0.1025September
      30, 2008
                  
                  
                  10.250
                  
                  
                  
                  6.890
                  
                  
                  
                  0.1025June
      30, 2008
                  
                  
                  11.250
                  
                  
                  
                  7.000
                  
                  
                  
                  0.1025March
      31, 2008
                  
                  
                  16.550
                  
                  
                  
                  9.720
                  
                  
                  
                  0.1025December
      31, 2007
                  
                  
                  $10.880
                  
                  
                  
                  $9.070
                  
                  
                  
                  $0.1025September
      30, 2007
                  
                  
                  12.390
                  
                  
                  
                  9.350
                  
                  
                  
                  0.1025June
      30, 2007
                  
                  
                  13.250
                  
                  
                  
                  11.930
                  
                  
                  
                  0.1025March
      31, 2007
                  
                  
                  14.000
                  
                  
                  
                  12.780
                  
                  
                  
                  0.1025





Dividends
and Dividend History





The
Company has historically paid regular quarterly cash dividends on its common
stock, and the Board of Directors presently intends to continue the payment of
regular quarterly cash dividends, subject to the need for those funds for debt
service and other purposes.  Payment of dividends on the common stock
is subject to determination and declaration by the Board of Directors and will
depend upon a number of factors, including capital requirements, regulatory
limitations on the payment of dividends, Pathfinder Bank and its subsidiaries
results of operations and financial condition, tax considerations, and general
economic conditions.  Given
deteriorating economic conditions, the Company’s focus is on the retention and
growth of capital, and it is, therefore, unlikely to replicate the historical
dividend payout in 2009.The Company's mutual holding company,
Pathfinder Bancorp, M.H.C., may elect to waive or  receive dividends each
time the Company declares a dividend.  The election to waive the
dividend receipt requires prior non-objection of the OTS.  Pathfinder
Bancorp, M.H.C. elected to waive its dividend for the quarter ended June 30,
2008, receiving dividends for the other three quarters.  During 2009,
Pathfinder Bancorp, M.H.C. expects to waive two quarterly dividends, however the
OTS has not yet issued its non-objection letter thereto.





If the
Company chooses to participate in the Treasury’s CPP program, its ability to pay
dividends to its stockholders may be restricted.




Page
16




ITEM 6: SELECTED FINANCIAL
DATA




Pathfinder
Bancorp, Inc. (“the Company”) is the parent company of Pathfinder Bank and
Pathfinder Statutory Trust
I.  Pathfinder Bank has three operating subsidiaries – Pathfinder
Commercial Bank, Pathfinder REIT, Inc., and Whispering Oaks Development
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.





2008
                
                
                2007
                
                
                2006
                
                
                2005
                
                
                2004Year
      End (In
      thousands)Total
      assets
                
                
                $352,760
                
                
                
                $320,691
                
                
                
                $301,382
                
                
                
                $296,948
                
                
                
                $302,037Loans
      receivable, net
                
                
                247,400
                
                
                
                221,046
                
                
                
                201,713
                
                
                
                187,889
                
                
                
                185,125Deposits
                
                
                269,438
                
                
                
                251,085
                
                
                
                245,585
                
                
                
                236,377
                
                
                
                236,672Shareholders’
      Equity
                
                
                19,495
                
                
                
                21,704
                
                
                
                20,850
                
                
                
                20,928
                
                
                
                21,826For
      the Year (In
      thousands)Net
      interest income
                
                
                $10,675
                
                
                
                $8,667
                
                
                
                $8,346
                
                
                
                $8,742
                
                
                
                $8,905Noninterest
      income
                
                
                551
                
                
                
                3,042
                
                
                
                2,615
                
                
                
                2,040
                
                
                
                3,047Noninterest
      expense
                
                
                9,935
                
                
                
                9,838
                
                
                
                9,668
                
                
                
                10,060
                
                
                
                9,307Net
      income
                
                
                368
                
                
                
                1,122
                
                
                
                1,028
                
                
                
                462
                
                
                
                1,405Per
      ShareNet
      income (basic)
                
                
                $0.15
                
                
                
                $0.45
                
                
                
                $0.42
                
                
                
                $0.19
                
                
                
                $0.58Book
      value
                
                
                8.04
                
                
                
                8.74
                
                
                
                8.45
                
                
                
                8.50
                
                
                
                8.91Tangible
      book value (a)
                
                
                6.50
                
                
                
                7.19
                
                
                
                6.82
                
                
                
                6.77
                
                
                
                7.04Cash
      dividends declared
                
                
                0.41
                
                
                
                0.41
                
                
                
                0.41
                
                
                
                0.41
                
                
                
                0.41RatiosReturn
      on average assets
                
                
                0.11
                %
                
                
                0.36
                %
                
                
                0.34
                %
                
                
                0.15
                %
                
                
                0.47
                %Return
      on average equity
                
                
                1.70
                
                
                
                5.27
                
                
                
                4.86
                
                
                
                2.16
                
                
                
                6.45Return
      on average tangible equity (a)
                
                
                2.07
                
                
                
                6.47
                
                
                
                6.04
                
                
                
                2.72
                
                
                
                8.17Average
      equity to average assets
                
                
                6.32
                
                
                
                6.82
                
                
                
                7.03
                
                
                
                6.95
                
                
                
                7.29Dividend
      payout ratio (b)
                
                
                232.61
                
                
                
                62.03
                
                
                
                66.73
                
                
                
                147.84
                
                
                
                47.54Allowance
      for loan losses to loans receivable
                
                
                0.99
                
                
                
                0.76
                
                
                
                0.74
                
                
                
                0.89
                
                
                
                0.98Net
      interest rate spread
                
                
                3.22
                
                
                
                2.81
                
                
                
                2.92
                
                
                
                3.07
                
                
                
                3.22Noninterest
      income to average assets
                
                
                0.16
                
                
                
                0.98
                
                
                
                0.87
                
                
                
                0.66
                
                
                
                1.02Noninterest
      expense to average assets
                
                
                2.91
                
                
                
                3.15
                
                
                
                3.21
                
                
                
                3.28
                
                
                
                3.12Efficiency
      ratio (c)
                
                
                73.02
                
                
                
                85.89
                
                
                
                88.71
                
                
                
                89.16
                
                
                
                84.21





(a)
            Tangible
      equity excludes intangible assets.


(b)
            The
      dividend payout ratio is calculated using dividends declared and not
      waived by the Company’s mutual holding company parent, Pathfinder Bancorp,
      M.H.C., divided by net income.


(c)
            The efficiency ratio is
      calculated as noninterest expense divided by the sum of taxable-equivalent
      net interest income and noninterest income excluding net (losses) gains on
      sales and impairment of investment securities and net (losses) gains on
      sales of loans and foreclosed real estate.




Page
17





ITEM
7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS




INTRODUCTION





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 10 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, 2008, 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
63.7% of the Company’s outstanding common stock and the public held
36.3%.





This
Annual Report contains supplemental financial information determined by methods
other than in accordance with Accounting Principles Generally Accepted in the
United States of America (“GAAP”).  The Company’s management believes
that such non-GAAP financial measures are useful to management and investors as
it enhances their ability to evaluate and compare the Company’s operating
results from period to period in a meaningful manner, as operating results
excluding other than temporary impairment charges on its investment security
holdings are essential in understanding the financial performance of the
Company, and is more representative of the basis that management utilizes to
monitor financial performance.  Readers are cautioned that non-GAAP
measures should not be considered as an alternative to any measure of
performance as promulgated under GAAP, and should consider the impairment
charges recorded during 2008 in assessing the Company’s
performance.  Non-GAAP measures have limitations as analytical tools,
and investors should not consider them in isolation or as a substitute for
analyzing the Company’s performance under GAAP, nor are they necessarily
comparable to non-GAAP measures presented by other companies.





The
Company's business strategy is to operate as a well-capitalized, profitable and
independent community bank dedicated to providing value-added products and
services to our customers.  Generally, the Company has sought to
implement this strategy by emphasizing retail deposits as its primary source of
funds and maintaining a substantial part of its assets in locally-originated
residential first mortgage loans, loans to business enterprises operating in its
markets, and in investment securities.  Specifically, the Company's
business strategy incorporates the following elements: (i) operating as an
independent 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 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 also is affected by its provision for loan losses, as well as by the
amount of noninterest income, including income from fees, service charges and
servicing rights, net gains and losses on sales of securities, loans and
foreclosed real estate, and noninterest expense such as employee compensation
and benefits, occupancy and equipment costs, data processing costs and income
taxes.  Earnings of the Company also are affected significantly by
general economic and competitive conditions, particularly changes in market
interest rates, government policies and actions of regulatory authorities, of
which these events are beyond the control of the Company.  In
particular, the general level of market rates tends to be highly
cyclical.





APPLICATION
OF CRITICAL ACCOUNTING POLICIES





The
Company's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States and follow
practices within the banking industry.  Application of these
principles requires management to make estimates, assumptions and judgments that
affect the amounts reported in the financial statements and accompanying
notes.  These estimates, assumptions and judgments are based on
information available as of the date of the financial statements; accordingly,
as this information




Page
18


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
goodwill for impairment, the evaluation of investment securities for other than
temporary 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, and as such, could be the most subject to revision as new
information becomes available.





The
allowance for loan losses represents management's estimate of probable loan
losses inherent in the loan portfolio. Determining the amount of the allowance
for loan losses is considered a critical accounting estimate because it requires
significant judgment and the use of estimates related to the amount and timing
of expected future cash flows on impaired loans, estimated losses on pools of
homogeneous loans based on historical loss experience, and consideration of
current economic trends and conditions, all of which may be susceptible to
significant change.  The loan portfolio also represents the largest
asset type on the consolidated 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 attributable to 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
effect 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.  To the extent that 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 $540,000 was established
during the year ended December 31, 2008, 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 to non-taxable investment securities, and bank owned life insurance
offset by the valuation allowance established on a portion of the capital loss
carry forwards.





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, rate of future compensation increases and the length of time the
Company will have to provide those benefits. The assumptions used by management
are discussed in Note 11 to the consolidated financial statements.





As a
result of deteriorating economic conditions in the financial markets, which
impacted the trading value of the Company’s common stock, management engaged an
independent third party to test the Company’s goodwill for impairment as of
December 31, 2008.  Testing was performed by utilizing a three-step
valuation approach which is described in Note 8 to the consolidated financial
statements.





Page
19





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, except
for security impairment losses, 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
security portfolio for other-than-temporary impairment losses, management
considers (1) the length of time and the extent to which the fair value has been
less than cost, (2) the financial condition and near-term prospects of the
issuer, and (3) the intent and ability of the Company to retain its investment
in the issuer for a period of time sufficient to allow for any anticipated
recovery in fair value.  Based on management's assessments during the
year ended December 31, 2008, the Company recorded other than temporary
impairment charges of $ 2,253,000, including an $875,000 charge on a $1,000,000
holding in a senior unsecured note issued by Lehman Brothers Holdings Inc.,
which filed a Chapter 11 Bankruptcy petition on September 15,
2008,  the AMF Large Cap Equity Fund in the amount of $690,000,
$269,000 in the AMF Ultra Short Mortgage Fund, $67,000 in the Financial
Institutions Fund and $10,000 on a stock investment in The Phoenix
Companies.   In addition to the impairment charges, the Company’s
available for sale investment portfolio at December 31, 2008 includes unrealized
losses of $2.4 million.  See Note 3 to the consolidated financial
statements for further discussion of the unrealized
losses.  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.








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.  Note 18 in the consolidated financial statements provides
additional information on how we determine fair values. The fair values of
foreclosed real estate and the underlying collateral value of impaired loans are
typically determined based on appraisals by third parties, less estimated costs
to sell. If necessary, appraisals are updated to reflect changes in market
conditions.





EXECUTIVE
SUMMARY





Total
deposits for the Company increased 7%, to $269.4 million at December 31, 2008,
while the average balance of deposits increased $10.0 million to $265.8 million
at December 31, 2008.  The Company will continue to focus on building
market share in the Central Square and Fulton markets where the existing
Pathfinder Bank share of the market is 20% or less.  In all other
market areas, Pathfinder Bank currently has the majority of the current deposit
market share. Pathfinder seeks to continue to develop core deposit relationships
in all markets through the acquisition of demand deposit
relationships.  Efforts will also be focused on the expansion of
commercial deposit relationships with the Bank’s existing commercial lending
relationships.





Total
assets increased 10.0%, primarily in the loan and investment security
portfolios.  The loan portfolio increased 12% with net growth in all
loan categories. The Company expects to concentrate on continued commercial
mortgage and commercial loan portfolio growth during
2009. The ratio of non-performing assets to total assets was 0.75% at December
31, 2008 compared to 0.77% in the prior year.  Although this ratio has
remained relatively stable, there was a decrease in asset quality of the loan
portfolio.  Non-performing loans increased $732,000, primarily due to
commercial loan relationships.  This decrease in loan quality was
offset by the reduction of foreclosed real estate of $530,000.





Page
20


Net
income for 2008 was $368,000, or $0.15 per share, as compared to $1.1 million,
or $0.45 per share, in 2007.   The decline in income was
primarily the result of the Company recording impairment charges on investment
security holdings totaling $1.6 million, net of the related tax benefits of
$659,000.  Core earnings, which
represent earnings exclusive of investment portfolio other-than-temporary
impairment losses, resulted in net income of $2 million or $0.79 per diluted
share for the year ended December 31, 2008.


The
following table reconciles the Company’s 2008 net income to core earnings,
including per share figures.





For
      the year endedDecember
      31, 2008Net
      Income
                                      
                                      
                                      $  
      368,000Other
      than temporary impairment charge - investments
                                      
                                      
                                      2,253,000Related
      tax benefit
                                      
                                      
                                      (659,000
                                      )  *Core
      earnings
                                      
                                      
                                      $1,962,000Diluted
      earnings per share
                                      
                                      
                                      $0.15Other
      than temporary impairment charge, net of tax, per share
                                      
                                      
                                      0.64Core
      earnings, diluted earnings per share
                                      
                                      
                                      $0.79*Net
      of a deferred tax asset valuation reserve of $242,000 for the year ended
      December 31, 2008.





RESULTS
OF OPERATIONS





Net
income for 2008 was $368,000, a decrease of $754,000, or 67%, compared to net
income of $1.1 million for 2007.  Basic and diluted earnings per share
decreased to $0.15 per share for the year ended December 31, 2008 from $0.45 per
share, for the year ended December 31, 2007.  Return on average equity
decreased to 1.70% in 2008 from 5.27% in 2007.  All of these declines
in performance were primarily the result of the impairment charges described
above.





Net
interest income, on a tax equivalent basis, increased $2 million, or 22%,
resulting from both volume increases in all loan categories and total investment
securities and significant rate decreases applied to all interest-earning
liabilities.  The provision for loan losses for the year ended
December 31, 2008 increased $455,000, reflecting the increased inherent risk
within the expanding commercial lending activities, the
overall growth in the total loan portfolio and general weakening of economic
conditions.  The Company experienced an 82% decrease in noninterest
income.  Noninterest income increased 6%, exclusive of securities
gains and losses, primarily attributable to increased cash surrender values of
bank-owned life insurance, an increase in issued Visa Debit cards and increased
usage from the existing customer base and increased loan servicing fees related
to collateral discharges and new rate lock fees on loans that did not close.
Noninterest expense increased only 1% due to increases in personnel expense,
building occupancy, and other operating expenses, partially offset by a
reduction in amortization of intangibles.





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 and interest-bearing liabilities, and their respective yields and funding
costs.






Page
21


Net
interest income, on a tax-equivalent basis, increased $2 million, or 22%, to
$10.8 million for the year ended December 31, 2008, as compared to $8.8 million
for the year ended December 31, 2007.  The Company's net interest
margin for 2008 increased to 3.43% from 3.07% in 2007.  The increase
in net interest income is attributable to an increase in the average balance of
interest earning assets, combined with increased yields on interest earning
assets and a decrease in the cost of interest-bearing
liabilities.  The average balance of interest-earning assets increased
$28.2 million, or 10%, during 2008 and the average balance of interest-bearing
liabilities increased by $26.2 million, or 10%.  The increase in the
average balance of interest earning assets primarily resulted from a $22.7
million increase in the average balance of the loan portfolio and a $7.7 million
increase in the average balance of the security investment portfolio, offset by
a $2.2 million reduction in the average balance of interest earning deposits.
The increase in the average balance of interest-bearing liabilities primarily
resulted from a $7.3 million, or 3%, increase in the average balance of
deposits, combined with a $18.9 million, or 60%, increase in the average balance
of borrowed funds.  Interest income, on a tax-equivalent basis,
increased $1.0 million, or 6%, during 2008, as the decrease in yield on interest
earning assets to 5.87% in 2008 from 6.08% in 2007 was offset by the 10%
increase in volume.  Interest expense on deposits decreased $1.2
million, or 18%, as the cost of deposits dropped 60 basis points to 2.36% in
2008 from 2.96% in 2007.  Interest expense on borrowings increased
$273,000, or 16%, during 2008 as the increase in the average balance of borrowed
funds by 60% was partially offset by a decrease in the cost of borrowed funds to
4.00% in 2008 from 5.52% in 2007.
 Page
22





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 31,2008
                                        
                                        
                                        2007
                                        
                                        
                                        2006Average
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        Average
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        AverageAverage
                                        
                                        
                                        
                                        
                                        
                                        Yield
      /
                                        
                                        
                                        Average
                                        
                                        
                                        
                                        
                                        
                                        Yield
      /
                                        
                                        
                                        Average
                                        
                                        
                                        
                                        
                                        
                                        Yield/(Dollars
      in thousands)
                                        
                                        Balance
                                        
                                        
                                        Interest
                                        
                                        
                                        Cost
                                        
                                        
                                        Balance
                                        
                                        
                                        Interest
                                        
                                        
                                        Cost
                                        
                                        
                                        Balance
                                        
                                        
                                        Interest
                                        
                                        
                                        CostInterest-earning
      assets:Real
      estate loans residential
                                        
                                        
                                        $130,702
                                        
                                        
                                        
                                        $7,527
                                        
                                        
                                        
                                        5.76
                                        %
                                        
                                        
                                        $120,079
                                        
                                        
                                        
                                        $6,945
                                        
                                        
                                        
                                        5.78
                                        %
                                        
                                        
                                        $119,417
                                        
                                        
                                        
                                        $6,876
                                        
                                        
                                        
                                        5.76
                                        %Real
      estate loans commercial
                                        
                                        
                                        49,040
                                        
                                        
                                        
                                        3,620
                                        
                                        
                                        
                                        7.38
                                        %
                                        
                                        
                                        43,573
                                        
                                        
                                        
                                        3,309
                                        
                                        
                                        
                                        7.59
                                        %
                                        
                                        
                                        35,076
                                        
                                        
                                        
                                        2,705
                                        
                                        
                                        
                                        7.71
                                        %Commercial
      loans
                                        
                                        
                                        27,033
                                        
                                        
                                        
                                        1,751
                                        
                                        
                                        
                                        6.48
                                        %
                                        
                                        
                                        23,710
                                        
                                        
                                        
                                        1,976
                                        
                                        
                                        
                                        8.33
                                        %
                                        
                                        
                                        19,961
                                        
                                        
                                        
                                        1,574
                                        
                                        
                                        
                                        7.88
                                        %Consumer
      loans
                                        
                                        
                                        26,291
                                        
                                        
                                        
                                        1,915
                                        
                                        
                                        
                                        7.28
                                        %
                                        
                                        
                                        23,011
                                        
                                        
                                        
                                        1,894
                                        
                                        
                                        
                                        8.23
                                        %
                                        
                                        
                                        20,153
                                        
                                        
                                        
                                        1,641
                                        
                                        
                                        
                                        8.14
                                        %Taxable
      investment securities
                                        
                                        
                                        74,105
                                        
                                        
                                        
                                        3,365
                                        
                                        
                                        
                                        4.54
                                        %
                                        
                                        
                                        66,230
                                        
                                        
                                        
                                        2,881
                                        
                                        
                                        
                                        4.35
                                        %
                                        
                                        
                                        66,788
                                        
                                        
                                        
                                        2,658
                                        
                                        
                                        
                                        3.97
                                        %Tax-exempt
      investment securities
                                        
                                        
                                        5,252
                                        
                                        
                                        
                                        255
                                        
                                        
                                        
                                        4.86
                                        %
                                        
                                        
                                        5,446
                                        
                                        
                                        
                                        258
                                        
                                        
                                        
                                        4.74
                                        %
                                        
                                        
                                        10,240
                                        
                                        
                                        
                                        481
                                        
                                        
                                        
                                        4.70
                                        %Interest-earning
      deposits
                                        
                                        
                                        2,851
                                        
                                        
                                        
                                        61
                                        
                                        
                                        
                                        2.14
                                        %
                                        
                                        
                                        5,050
                                        
                                        
                                        
                                        211
                                        
                                        
                                        
                                        4.18
                                        %
                                        
                                        
                                        1,779
                                        
                                        
                                        
                                        91
                                        
                                        
                                        
                                        5.12
                                        %Total
      interest-earning assets
                                        
                                        
                                        315,274
                                        
                                        
                                        
                                        18,494
                                        
                                        
                                        
                                        5.87
                                        %
                                        
                                        
                                        287,099
                                        
                                        
                                        
                                        17,474
                                        
                                        
                                        
                                        6.08
                                        %
                                        
                                        
                                        273,414
                                        
                                        
                                        
                                        16,026
                                        
                                        
                                        
                                        5.86
                                        %Noninterest-earning
      assets:Other
      assets
                                        
                                        
                                        30,274
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        27,774
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        31,600Allowance
      for loan losses
                                        
                                        
                                        (2,006
                                        )
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        (1,583
                                        )
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        (1,661
                                        )Net
      unrealized losseson
      available for sale securities
                                        
                                        
                                        (1,690
                                        )
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        (1,372
                                        )
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        (2,142
                                        )Total
      assets
                                        
                                        
                                        $341,852
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        $311,918
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        $301,211Interest-bearing
      liabilities:NOW
      accounts
                                        
                                        
                                        $23,762
                                        
                                        
                                        
                                        95
                                        
                                        
                                        
                                        0.40
                                        %
                                        
                                        
                                        $22,235
                                        
                                        
                                        
                                        113
                                        
                                        
                                        
                                        0.51
                                        %
                                        
                                        
                                        $21,094
                                        
                                        
                                        
                                        102
                                        
                                        
                                        
                                        0.48
                                        %Money
      management accounts
                                        
                                        
                                        10,574
                                        
                                        
                                        
                                        52
                                        
                                        
                                        
                                        0.49
                                        %
                                        
                                        
                                        11,348
                                        
                                        
                                        
                                        89
                                        
                                        
                                        
                                        0.78
                                        %
                                        
                                        
                                        13,318
                                        
                                        
                                        
                                        110
                                        
                                        
                                        
                                        0.83
                                        %MMDA
      accounts
                                        
                                        
                                        29,181
                                        
                                        
                                        
                                        570
                                        
                                        
                                        
                                        1.95
                                        %
                                        
                                        
                                        23,682
                                        
                                        
                                        
                                        937
                                        
                                        
                                        
                                        3.96
                                        %
                                        
                                        
                                        20,608
                                        
                                        
                                        
                                        786
                                        
                                        
                                        
                                        3.81
                                        %Savings
      and club accounts
                                        
                                        
                                        52,482
                                        
                                        
                                        
                                        168
                                        
                                        
                                        
                                        0.32
                                        %
                                        
                                        
                                        53,359
                                        
                                        
                                        
                                        279
                                        
                                        
                                        
                                        0.52
                                        %
                                        
                                        
                                        58,997
                                        
                                        
                                        
                                        266
                                        
                                        
                                        
                                        0.45
                                        %Time
      deposits
                                        
                                        
                                        124,267
                                        
                                        
                                        
                                        4,777
                                        
                                        
                                        
                                        3.84
                                        %
                                        
                                        
                                        122,333
                                        
                                        
                                        
                                        5,483
                                        
                                        
                                        
                                        4.48
                                        %
                                        
                                        
                                        103,596
                                        
                                        
                                        
                                        4,203
                                        
                                        
                                        
                                        4.06
                                        %Junior
      subordinated debentures
                                        
                                        
                                        5,155
                                        
                                        
                                        
                                        257
                                        
                                        
                                        
                                        4.99
                                        %
                                        
                                        
                                        6,454
                                        
                                        
                                        
                                        511
                                        
                                        
                                        
                                        7.81
                                        %
                                        
                                        
                                        5,155
                                        
                                        
                                        
                                        448
                                        
                                        
                                        
                                        8.57
                                        %Borrowings
                                        
                                        
                                        45,239
                                        
                                        
                                        
                                        1,756
                                        
                                        
                                        
                                        3.88
                                        %
                                        
                                        
                                        25,063
                                        
                                        
                                        
                                        1,230
                                        
                                        
                                        
                                        4.91
                                        %
                                        
                                        
                                        33,589
                                        
                                        
                                        
                                        1,608
                                        
                                        
                                        
                                        4.79
                                        %Total
      interest-bearing liabilities
                                        
                                        
                                        290,660
                                        
                                        
                                        
                                        7,675
                                        
                                        
                                        
                                        2.64
                                        %
                                        
                                        
                                        264,474
                                        
                                        
                                        
                                        8,642
                                        
                                        
                                        
                                        3.27
                                        %
                                        
                                        
                                        256,357
                                        
                                        
                                        
                                        7,523
                                        
                                        
                                        
                                        2.93
                                        %Noninterest-bearing
      liabilities:Demand
      deposits
                                        
                                        
                                        25,493
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        22,828
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        20,745Other
      liabilities
                                        
                                        
                                        4,088
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        3,338
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        2,943Total
      liabilities
                                        
                                        
                                        320,241
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        290,640
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        280,045Shareholders'
      equity
                                        
                                        
                                        21,611
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        21,278
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        21,166Total
      liabilities & shareholders' equity
                                        
                                        
                                        $341,852
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        $311,918
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        $301,211Net
      interest income
                                        
                                        
                                        
                                        
                                        
                                        
                                        $10,819
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        $8,832
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        $8,503Net
      interest rate spread
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        3.22
                                        %
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        2.81
                                        %
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        2.93
                                        %Net
      interest margin
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        3.43
                                        %
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        3.07
                                        %
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        3.11
                                        %Ratio
      of average interest-earning assetsto
      average interest-bearing liabilities
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        108.47
                                        %
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        108.55
                                        %
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        
                                        106.65
                                        %






Page
23


Interest Income




Changes
in interest income result from changes in the average balances of loans and
securities and the related yields on those balances.  Interest income
on a tax-equivalent basis increased $1.0 million, or 5.8%.  Average
loans increased 10.8% in 2008, with yields decreasing 35 basis points to 6.36%.
The Company's average residential mortgage loan portfolio increased $10.6
million, or 8.8%, when comparing 2008 to 2007.  The average yield on
the residential mortgage loan portfolio decreased 2 basis points to 5.76% in
2008 from 5.78% in 2007. The average balance of commercial real estate loans
increased $5.5 million, or 12.5%, while the yield decreased to 7.38% in 2008
from 7.59% in 2007. Average commercial loans increased 14.0% and the
tax-equivalent yield decreased to 6.48% in 2008 compared to 8.33%, in
2007.  The average balance of consumer loans increased $3.3 million,
or 14.3% when compared to 2007. The average yield decreased 95 basis points, to
7.28% from 8.23% in 2007.





Interest
income on investment securities increased 15.3% from 2007, resulting from an
increase in the average balance of investment securities (taxable and
tax-exempt) of $7.7 million, or 10.7%, to $79.4 million in 2008 from $71.7
million in 2007.  The average yield increased 18 basis points to 4.56%
in 2008 from 4.38% in 2007.





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 $967,000, or 11.2%, in 2008, when compared to
2007.  The decrease in the cost of funds resulted from a decrease in
the average cost of interest-bearing liabilities of 63 basis points, to 2.64% in
2008 from 3.27% in 2007, partially offset by a $26.2 million increase in the
average balance of interest-bearing liabilities during 2008.  The
average cost of deposits decreased 60 basis points to 2.36% during 2008 from
2.96% for 2007.  The average balance of deposits increased $7.3
million to $240.3 million in 2008 from $233 million in 2007.  The
increase in the average balance of deposits primarily resulted from a $5.5
million, or 23.2%, increase in the average balance of MMDA accounts and a $1.9
million, or 1.6%, increase in the average balance of time
deposits.  The cost of junior subordinated debentures decreased 282
basis points, decreasing interest expense by $254,000, due to the new
subordinated debentures rate of 3-month LIBOR plus 1.65% for 2008 versus 3 month
LIBOR plus 3.45% for 2007.  The average balance of borrowed funds
increased $20.2 million to $45.2 million at 2008 from $25 million at
2007.  The average cost of borrowed funds decreased 103 basis points,
to 3.88% in 2008 from 4.91% in 2007.







Page
24





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.





For
      the Years Ended December 31,2008 vs. 2007
                    
                    
                    2007 vs. 2006Increase/(Decrease) Due to
                    
                    
                    Increase/(Decrease) Due toTotal
                    
                    
                    
                    
                    
                    
                    
                    
                    TotalIncrease
                    
                    
                    
                    
                    
                    
                    
                    
                    Increase(In
      thousands)
                    
                    Volume
                    
                    
                    Rate
                    
                    
                    (Decrease)
                    
                    
                    Volume
                    
                    
                    Rate
                    
                    
                    (Decrease)Interest
      Income:Real
      estate loans residential
                    
                    
                    $606
                    
                    
                    
                    $(24
                    )
                    
                    
                    $582
                    
                    
                    
                    $42
                    
                    
                    
                    $27
                    
                    
                    
                    $69Real
      estate loans commercial
                    
                    
                    405
                    
                    
                    
                    (94
                    )
                    
                    
                    311
                    
                    
                    
                    647
                    
                    
                    
                    (43
                    )
                    
                    
                    604Commercial
      loans
                    
                    
                    252
                    
                    
                    
                    (477
                    )
                    
                    
                    (225
                    )
                    
                    
                    310
                    
                    
                    
                    92
                    
                    
                    
                    402Consumer
      loans
                    
                    
                    253
                    
                    
                    
                    (232
                    )
                    
                    
                    21
                    
                    
                    
                    235
                    
                    
                    
                    18
                    
                    
                    
                    253Taxable
      investment securities
                    
                    
                    344
                    
                    
                    
                    140
                    
                    
                    
                    484
                    
                    
                    
                    (24
                    )
                    
                    
                    231
                    
                    
                    
                    207Tax-exempt
      investment securities
                    
                    
                    (9
                    )
                    
                    
                    6
                    
                    
                    
                    (3
                    )
                    
                    
                    (227
                    )
                    
                    
                    4
                    
                    
                    
                    (223
                    )Interest-earning
      deposits
                    
                    
                    (71
                    )
                    
                    
                    (79
                    )
                    
                    
                    (150
                    )
                    
                    
                    140
                    
                    
                    
                    (20
                    )
                    
                    
                    120Total
      interest income
                    
                    
                    1,780
                    
                    
                    
                    (760
                    )
                    
                    
                    1,020
                    
                    
                    
                    1,123
                    
                    
                    
                    309
                    
                    
                    
                    1,432Interest
      Expense:NOW
      accounts
                    
                    
                    7
                    
                    
                    
                    (25
                    )
                    
                    
                    (18
                    )
                    
                    
                    5
                    
                    
                    
                    6
                    
                    
                    
                    11Money
      management accounts
                    
                    
                    (6
                    )
                    
                    
                    (31
                    )
                    
                    
                    (37
                    )
                    
                    
                    (15
                    )
                    
                    
                    (6
                    )
                    
                    
                    (21
                    )MMDA
      accounts
                    
                    
                    184
                    
                    
                    
                    (551
                    )
                    
                    
                    (367
                    )
                    
                    
                    119
                    
                    
                    
                    32
                    
                    
                    
                    151Savings
      and club accounts
                    
                    
                    (5
                    )
                    
                    
                    (106
                    )
                    
                    
                    (111
                    )
                    
                    
                    (26
                    )
                    
                    
                    39
                    
                    
                    
                    13Time
      deposits
                    
                    
                    86
                    
                    
                    
                    (792
                    )
                    
                    
                    (706
                    )
                    
                    
                    831
                    
                    
                    
                    450
                    
                    
                    
                    1,281Junior
      subordinated debentures
                    
                    
                    (90
                    )
                    
                    
                    (164
                    )
                    
                    
                    (254
                    )
                    
                    
                    105
                    
                    
                    
                    (42
                    )
                    
                    
                    63Borrowings
                    
                    
                    828
                    
                    
                    
                    (302
                    )
                    
                    
                    526
                    
                    
                    
                    (418
                    )
                    
                    
                    39
                    
                    
                    
                    (379
                    )Total
      interest expense
                    
                    
                    1,004
                    
                    
                    
                    (1,971
                    )
                    
                    
                    (967
                    )
                    
                    
                    601
                    
                    
                    
                    518
                    
                    
                    
                    1,119Net
      change in net interest income
                    
                    
                    $776
                    
                    
                    
                    $1,211
                    
                    
                    
                    $1,987
                    
                    
                    
                    $522
                    
                    
                    
                    $(209
                    )
                    
                    
                    $313





Provision
for Loan Losses





The
provision for loan losses increased $455,000 to $820,000 for the year ended
December 31, 2008, as compared to the prior year.  The increased
provision is reflective of a growing loan portfolio that is also more heavily
weighted to commercial term and commercial real estate loans, which have higher
inherent risk characteristics than a traditional consumer real estate portfolio,
as well as a general weakening in economic conditions, resulting in increased
levels of non-performing loans. Specifically, commercial and commercial real
estate loans on non-accrual increased $934,000 to $1.5 million at December 31,
2008, as compared to $521,000 at the end of the prior year.  The
current level of non-performing assets does not fall significantly outside of
the Bank’s historic trend levels, however, the generally weak economic
conditions nationally, and the current strain on consumer discretionary income
have caused management to carefully monitor and react to these trends by
increasing the provision for loan losses, maintaining the Company’s strict loan
underwriting standards and carefully monitor the performance of the loan
portfolio.




Page
25


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.




For the Years Ended December 31,(In
      thousands)
                    
                    2008
                    
                    
                    2007Service
      charges on deposit accounts
                    
                    
                    $1,492
                    
                    
                    
                    $1,474Earnings
      on bank owned life insurance
                    
                    
                    293
                    
                    
                    
                    225Loan
      servicing fees
                    
                    
                    281
                    
                    
                    
                    250Debit
      card interchange fees
                    
                    
                    275
                    
                    
                    
                    246Other
      charges, commissions and fees
                    
                    
                    445
                    
                    
                    
                    427Core
      noninterest income
                    
                    
                    2,786
                    
                    
                    
                    2,622Net
      (losses) gains on sales and impairment of investment
      securities
                    
                    
                    (2,191
                    )
                    
                    
                    378Net
      (losses) gains on sales of loans and foreclosed real
estate
                    
                    
                    (44
                    )
                    
                    
                    42Total
      noninterest income
                    
                    
                    $551
                    
                    
                    
                    $3,042





Noninterest
income in 2008 decreased 82%, when compared to 2007, as a result of a 6%
increase in core noninterest income offset by net losses on sales and impairment
of investment securities and net losses on sales of loans and foreclosed real
estate. Earnings on bank owned life insurance increased 30% based on the growth
in the cash surrender values of the insurance policies.  Loan
servicing fees increased 12% due to new loan charges for the discharge of
collateral and rate lock fees (recorded as income when a loan does not close),
which were implemented in late 2007 and early 2008. The growth in interchange
fees is due to an increase in issued Visa Debit cards and an increase in their
usage.  Other charges, commissions and fees increased primarily due to
foreign ATM usage fees.  Total noninterest income was significantly
impacted by net losses on investment securities as a result of recording other
than temporary impairment charges of $2,253,000 as discussed
previously.  Net losses on the sale of loans/foreclosed real estate is
due to the sale of six properties at a loss and the write down in value of two
properties held in foreclosed real estate.





Noninterest
Expense





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




For the Years Ended December 31,(In
      thousands)
                    
                    2008
                    
                    
                    2007Salaries
      and employee benefits
                    
                    
                    $5,172
                    
                    
                    
                    $5,094Building
      occupancy
                    
                    
                    1,322
                    
                    
                    
                    1,254Data
      processing
                    
                    
                    1,330
                    
                    
                    
                    1,333Professional
      and other services
                    
                    
                    771
                    
                    
                    
                    769Amortization
      of intangible assets
                    
                    
                    -
                    
                    
                    
                    182Other
      operating
                    
                    
                    1,340
                    
                    
                    
                    1,206Total
      noninterest expense
                    
                    
                    $9,935
                    
                    
                    
                    $9,838





Noninterest
expenses increased $97,000, or 1%, for the year ended December 31, 2008 when
compared to 2007.  Salaries and employee benefits increased 2% in 2008
primarily due to normal salary merit increases and incentive
compensation.  A 5% increase in building occupancy expense was due to
depreciation expenses and equipment maintenance.  The increase in
other expenses was primarily due to expenses related to foreclosed real
estate.  These increases were offset by a decrease in amortization
expense of $182,000, as core deposit intangibles from a 2002 branch acquisition
became fully amortized in October 2007.








Page
26


Income
Tax Expense




In 2008,
the Company reported income tax expense of $103,000 compared with $384,000 in
2007.  The effective tax rate decreased to 22% in 2008 compared to a
tax rate of 25% in 2007.  The decrease in income tax expense resulted
primarily from lower pretax income of $1 million.  The Company has
reduced its tax rate from the statutory rate primarily through the ownership of
tax-exempt investment securities, bank owned life insurance and other tax saving
strategies.  See Note 13 to the consolidated financial statements for
the reconciliation of the statutory tax rate to the effective tax
rate.





CHANGES
IN FINANCIAL CONDITION





Investment
Securities





The
investment portfolio represents 22% of the Company’s earning assets and is
designed to generate a favorable rate of return consistent with safety of
principal while assisting the Company in meeting its liquidity needs and
interest rate risk strategies.  All of the Company’s investments are
classified as available for sale.  The Company invests in securities
consisting primarily of mortgage-backed securities, securities issued by United
States Government agencies and sponsored enterprises, state and municipal
obligations, mutual funds, equity securities, investment grade corporate debt
instruments, and common stock issued by the Federal Home Loan Bank of New York
(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, 2008, there were two securities that exceeded 10% of consolidated
shareholders’ equity.  These securities were the AMF Large Cap Equity
Fund, with a carrying value and fair value of approximately $2,192,000 and
$1,734,000, respectively and the AMF Ultra Short Mortgage Fund, with a carrying
value of $2,804,000 and a fair value of $2,517,000 as of December 31,
2008.  See Note 3 to the consolidated financial statements for further
discussion of these two securities.





Investment
securities increased $7.5 million to $74.7 million at December 31, 2008 from
$67.1 million at December 31, 2007.  The increase in investment
securities was primarily attributable to the investment of excess liquidity into
corporate and mortgage-backed securities during the first two fiscal quarters of
2008.





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




At December 31,(In
      Thousands)
                    
                    2008
                    
                    
                    2007
                    
                    
                    2006Investment
      Securities:US
      treasury and agencies
                    
                    
                    $9,126
                    
                    
                    
                    $18,672
                    
                    
                    
                    $19,966State
      and political subdivisions
                    
                    
                    5,020
                    
                    
                    
                    5,342
                    
                    
                    
                    5,870Corporate
                    
                    
                    12,181
                    
                    
                    
                    6,392
                    
                    
                    
                    5,575Other
                    
                    
                    2,100
                    
                    
                    
                    -
                    
                    
                    
                    -Mortgage-backed
                    
                    
                    39,478
                    
                    
                    
                    28,615
                    
                    
                    
                    25,481Equity
      securities and FHLB stock
                    
                    
                    3,044
                    
                    
                    
                    2,706
                    
                    
                    
                    2,406Mutual
      funds
                    
                    
                    4,996
                    
                    
                    
                    6,514
                    
                    
                    
                    6,336$75,945
                    
                    
                    
                    $68,241
                    
                    
                    
                    $65,634Unrealized
      loss on available for sale portfolio
                    
                    
                    (1,258
                    )
                    
                    
                    (1,103
                    )
                    
                    
                    (1,415
                    )Total
      investments in securities
                    
                    
                    $74,687
                    
                    
                    
                    $67,138
                    
                    
                    
                    $64,219




Page
27


The
following table sets forth the scheduled maturities, amortized cost, fair values
and average yields for the Company's investment securities at December 31,
2008. 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 YearsAnnualized
                                            
                                            Annualized
                                            
                                            AnnualizedAmortized
                                            Weighted
                                            Amortized
                                            Weighted
                                            Amortized
                                            Weighted(Dollars
      in thousands)
                                            Cost
                                            Average
      Yield
                                            Cost
                                            Average
      Yield
                                            Cost
                                            Average
      YieldDebt
      investment securities:US
      Treasury and agencies
                                            $1,530
                                            2.71%
                                            $3,582
                                            5.04%
                                            $3,014
                                            4.78%State
      and political subdivisions
                                            547
                                            3.65%
                                            1,858
                                            3.55%
                                            1,472
                                            3.94%Corporate
                                            -
                                            -
                                            4,169
                                            5.62%
                                            3,994
                                            5.52%Other
                                            -
                                            -
                                            2,100
                                            4.74%
                                            -
                                            -Total
                                            2,077
                                            2.96%
                                            11,709
                                            4.96%
                                            8,480
                                            4.98%Mortgage-backed
      securities:Mortgage-backed
                                            432
                                            4.20%
                                            4,964
                                            4.16%
                                            6,285
                                            4.79%Total
                                            432
                                            4.20%
                                            4,964
                                            4.16%
                                            6,285
                                            4.79%Other
      non-maturity investments:Mutual
      funds
                                            4,996
                                            4.25%
                                            -
                                            -
                                            -
                                            -Equity
      securities and FHLB stock
                                            3,044
                                            4.69%
                                            -
                                            -
                                            -
                                            -Total
                                            8,040
                                            4.42%
                                            -
                                            -
                                            -
                                            -Total
      investment securities
                                            $10,549
                                            4.12%
                                            $16,673
                                            4.72%
                                            $14,765
                                            4.90%
   TotalMore
      Than Ten Years
                            
                            Investment
      SecuritiesAnnualized
                            
                            
                            AnnualizedAmortized
                            Weighted
                            Amortized
                            Fair
                            Weighted(Dollars
      in thousands)
                            Cost
                            Average
      Yield
                            Cost
                            Value
                            Average
      YieldDebt
      investment securities:US
      Treasury and agencies
                            $1,000
                            5.20%
                            $9,126
                            $9,469
                            4.94%State
      and political subdivisions
                            1,143
                            3.75%
                            5,020
                            4,973
                            3.72%Corporate
                            4,018
                            4.01%
                            12,181
                            10,826
                            5.06%Other
                            -
                            -
                            2,100
                            2,100
                            4.74%Total
                            6,161
                            4.15%
                            28,427
                            27,368
                            4.75%Mortgage-backed
      securities:Mortgage-backed
                            27,797
                            5.10%
                            39,478
                            40,030
                            4.92%Total
                            27,797
                            5.10%
                            39,478
                            40,030
                            4.92%Other
      non-maturity investments:Mutual
      funds
                            -
                            -
                            4,996
                            4,251
                            4.25%Equity
      securities and FHLB stock
                            -
                            -
                            3,044
                            3,038
                            4.69%Total
                            -
                            -
                            8,040
                            7,289
                            4.42%Total
      investment securities
                            $33,958
                            4.93%
                            $75,945
                            $74,687
                            4.81%




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 75% of the Company’s earning assets and account for the
greatest portion of total interest income.  The Company emphasizes
residential real estate financing and anticipates a continued commitment to
financing the purchase or improvement of residential real estate in its market
area.  The Company also extends credit to businesses within its
marketplace secured by commercial real estate, equipment, inventories and
accounts receivable.  It is anticipated that small business lending in
the form of mortgages, term loans, leases, and lines of credit will provide the
most opportunity for balance sheet and revenue growth over the near
term.  Commercial and municipal loans comprise 12% of the total loan
portfolio.  At December 31, 2008, 77% of the Company’s total loan
portfolio consisted of loans secured by real estate, and 22% of the total
consisted of commercial real estate loans.




Page
28




December
      31,(In
      thousands)
                    
                    2008
                    
                    
                    2007
                    
                    
                    2006
                    
                    
                    2005
                    
                    
                    2004Residential
      real estate (1)
                    
                    
                    $136,218
                    
                    
                    
                    $126,666
                    
                    
                    
                    $118,494
                    
                    
                    
                    $119,707
                    
                    
                    
                    $123,898Commercial
      real estate
                    
                    
                    55,061
                    
                    
                    
                    45,490
                    
                    
                    
                    40,501
                    
                    
                    
                    31,845
                    
                    
                    
                    29,874Commercial
      and municipal loans
                    
                    
                    30,685
                    
                    
                    
                    25,288
                    
                    
                    
                    23,001
                    
                    
                    
                    18,334
                    
                    
                    
                    16,834Consumer
      loans
                    
                    
                    27,908
                    
                    
                    
                    25,305
                    
                    
                    
                    21,213
                    
                    
                    
                    19,682
                    
                    
                    
                    18,505Total
      loans receivable
                    
                    
                    $249,872
                    
                    
                    
                    $222,749
                    
                    
                    
                    $203,209
                    
                    
                    
                    $189,568
                    
                    
                    
                    $189,111





(1)
Includes loans held for sale. (None at December 31, 2008 and 2007.)





The
following table shows the amount of loans outstanding as of December 31, 2008
which, based on remaining scheduled repayments of principal, are due in the
periods indicated.  Demand loans having no stated schedule of
repayments and no stated maturity, and overdrafts are reported as 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, and fixed rate loans are included in the period
in which the final contractual repayment is due.





Due
      Under
                            
                            
                            Due
      1-5
                            
                            
                            Due
      Over(In
      thousands)
                            
                            One
      Year
                            
                            
                            Years
                            
                            
                            Five
      Years
                            
                            
                            TotalReal
      estate:Commercial
      real estate
                            
                            
                            $12,322
                            
                            
                            
                            $35,132
                            
                            
                            
                            $7,607
                            
                            
                            
                            $55,061Residential
      real estate
                            
                            
                            11,661
                            
                            
                            
                            38,088
                            
                            
                            
                            86,469
                            
                            
                            
                            136,21823,983
                            
                            
                            
                            73,220
                            
                            
                            
                            94,076
                            
                            
                            
                            191,279Commercial
      and municipal loans
                            
                            
                            17,964
                            
                            
                            
                            10,540
                            
                            
                            
                            2,181
                            
                            
                            
                            30,685Consumer
                            
                            
                            11,105
                            
                            
                            
                            4,468
                            
                            
                            
                            12,335
                            
                            
                            
                            27,908Total
      loans
                            
                            
                            $53,052
                            
                            
                            
                            $88,228
                            
                            
                            
                            $108,592
                            
                            
                            
                            $249,872Interest
      rates:Fixed
                            
                            
                            $3,451
                            
                            
                            
                            $12,519
                            
                            
                            
                            $100,397
                            
                            
                            
                            $116,367Variable
                            
                            
                            49,601
                            
                            
                            
                            75,709
                            
                            
                            
                            8,195
                            
                            
                            
                            133,505Total
      loans
                            
                            
                            $53,052
                            
                            
                            
                            $88,228
                            
                            
                            
                            $108,592
                            
                            
                            
                            $249,872





Total loans receivable
increased 12% when compared to the prior year.Residential
real estate loans increased $9.6 million, or 8%, during 2008.  The
residential real estate portfolio consists of 64% fixed-rate mortgages and 36%
adjustable-rate mortgages.  The increase in the residential real
estate portfolio is principally due to an increase in 30-year fixed rate
mortgages of $13 million and a $7 million increase in 15-year fixed rate
mortgages, offset by a decrease in the 5/1 and 7/1 adjustable rate mortgage
portfolio.  The increase in the fixed rate mortgage portfolio resulted
from a decrease in the lending rate set by the Federal Reserve Bank to historic
lows.  The Company does not originate sub-prime, Alt-A, negative
amortizing or other higher risk structured residential mortgages.





Commercial
real estate loans increased $9.6 million, or 21%, from the prior year as new
loan products and relationships were added to the portfolio.





Commercial
loans, including loans to municipalities, increased 21% over the prior year to
$30.7 million at December 31, 2008.  The increase in commercial loans
was primarily the result of new lending relationships with an expanding
commercial customer base.  The Company has continued its efforts to
transform its more traditional thrift balance sheet, which emphasized
residential real estate lending, to a more diversified balance sheet, which
includes a greater proportion of commercial lending products.


Page
29
 Consumer
loans, which include second mortgage loans, home equity lines of credit, direct
installment and revolving credit loans, increased 10% to $27.9 million at
December 31, 2008.  The increase resulted from an increase in home
equity lines of credit.  The Company has promoted its home equity
products by offering the customer loans with no closing costs at competitive
market rates.





Non-performing
Loans and Assets





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





December
      31,(In
      thousands)
                        
                        2008
                        
                        
                        2007
                        
                        
                        2006
                        
                        
                        2005
                        
                        
                        2004Nonaccrual
      loans:Commercial
      real estate and commercial
                        
                        
                        $1,455
                        
                        
                        
                        $521
                        
                        
                        
                        $481
                        
                        
                        
                        $757
                        
                        
                        
                        $776Consumer
                        
                        
                        254
                        
                        
                        
                        150
                        
                        
                        
                        125
                        
                        
                        
                        89
                        
                        
                        
                        122Residential
      real estate
                        
                        
                        614
                        
                        
                        
                        920
                        
                        
                        
                        566
                        
                        
                        
                        834
                        
                        
                        
                        953Total
      nonaccrual loans
                        
                        
                        2,323
                        
                        
                        
                        1,591
                        
                        
                        
                        1,172
                        
                        
                        
                        1,680
                        
                        
                        
                        1,851Total
      non-performing loans
                        
                        
                        2,323
                        
                        
                        
                        1,591
                        
                        
                        
                        1,172
                        
                        
                        
                        1,680
                        
                        
                        
                        1,851Foreclosed
      real estate
                        
                        
                        335
                        
                        
                        
                        865
                        
                        
                        
                        471
                        
                        
                        
                        743
                        
                        
                        
                        798Total
      non-performing assets
                        
                        
                        $2,658
                        
                        
                        
                        $2,456
                        
                        
                        
                        $1,643
                        
                        
                        
                        $2,423
                        
                        
                        
                        $2,649Non-performing
      loans to total loans
                        
                        
                        0.93
                        %
                        
                        
                        0.71
                        %
                        
                        
                        0.57
                        %
                        
                        
                        0.89
                        %
                        
                        
                        0.98
                        %Non-performing
      assets to total assets
                        
                        
                        0.75
                        %
                        
                        
                        0.77
                        %
                        
                        
                        0.54
                        %
                        
                        
                        0.82
                        %
                        
                        
                        0.88
                        %Interest
      income that would have been recordedunder
      the original terms of the loans
                        
                        
                        $131
                        
                        
                        
                        $71
                        
                        
                        
                        $53
                        
                        
                        
                        $34
                        
                        
                        
                        $64





The asset
quality of the Company has remained relatively unchanged when compared to the
prior year.  Total non-performing assets (non-performing loans and
foreclosed real estate) at December 31, 2008 were 0.75% of total assets as
compared to 0.77% of total assets at December 31, 2007.  Total
non-performing loans (past due 90 days or more) increased $732,000, or 46%,
during 2008.  The increase in non-performing loans is primarily the
result of increased commercial loan delinquencies.  Approximately 63%
of the Company’s non-performing loans at December 31, 2008 are commercial real
estate and commercial loans.  The increase in
non-performing loans is primarily comprised of a number of smaller commercial
lending relationships.  Management believes the financial strength of
the individual borrowers, combined with the related value of any underlying
collateral, will not result in any significant loss beyond currently established
reserves.The increase is being driven by general economic
conditions in the market area. Total delinquent loans (those 30 days or more
delinquent) as a percentage of total loans were 2.16% at December 31, 2008 as
compared to 2.40% at December 31, 2007.  Approximately 63% of the
Company’s non-performing loans at December 31, 2008 are secured by real estate
with loss potential expected to be manageable within the allocated
reserves.





The
Company generally places a loan on nonaccrual status and ceases accruing
interest when loan payment performance is deemed unsatisfactory and the loan is
past due 90 days or more.  The Company considers a loan impaired when,
based on current information and events, it is probable that the Company will be
unable to collect the scheduled payments of principal and interest when due
according to the contractual terms of the loan.





The
measurement of impaired loans is generally based upon the present value of
future cash flows discounted at the historical effective interest rate, except
that all collateral-dependent loans are measured for impairment based on fair
value of the collateral.  The Company used the fair value of
collateral to measure impairment on commercial and commercial real estate
loans.  At December 31, 2008 and 2007, the Company had $2.4 million
and $1.7 million in loans, which were deemed to be impaired, having valuation
allowances of $141,000 and $152,000, respectively.


Page
30
 Management
has identified additional potential problem loans totaling $4.1 million as of
December 31, 2008. These loans have been internally classified as substandard or
lower, yet are not currently considered past due or in nonaccrual status.
Management has identified potential credit problems which may result in the
borrower not being able to comply with the current loan repayment terms and
which may result in it being included in subsequent past due reporting.
Management believes that the current allowance for loan losses is adequate to
cover probable credit losses in the current loan portfolio.


Allowance
for Loan Losses





The
allowance for loan losses is a reserve established through charges to expense in
the form of a provision for loan losses and reduced by loan charge-offs net of
recoveries.  The allowance for loan losses represents the amount
available for probable credit losses in the Company’s loan portfolio as
estimated by management.  The Company maintains an allowance for loan
losses based upon a monthly evaluation of known and inherent risks in the loan
portfolio, which includes a review of the balances and composition of the loan
portfolio as well as analyzing the level of delinquencies in each segment of the
loan portfolio.  The Company uses a general allocation method for the
residential real estate and consumer loan pools based upon a methodology that
uses loss factors applied to loan balances and reflects actual loss experience,
delinquency trends and current economic conditions.  The Company
reviews individually commercial real estate and commercial loans greater than
$150,000 that are not accruing interest and that are risk rated under the
Company’s risk rating system as special mention, substandard, doubtful or loss
to determine if the loans require an impairment reserve.  If
impairment is noted, the Company establishes a specific reserve
allocation.  The specific allocation is determined based on the most
recent valuation of the loan’s collateral and the customer’s ability to
pay.  For all other commercial real estate and commercial loans, the
Company uses the general allocation method that establishes a reserve for each
risk-rating category.  The general allocation method for commercial
real estate and commercial loans considers the same factors that are considered
when evaluating residential real estate and consumer loan pools.  The
allowance for loan losses reflects management’s best estimate of probable loan
losses at December 31, 2008.





The
allowance for loan losses was $2.5 million at December 31, 2008, a 45% increase
from December 31, 2007.  The allowance for loan losses as a percentage
of total loans increased to 0.99% at December 31, 2008 from 0.76% in the prior
year.  Net loan charge-offs were $51,000 during 2008 as compared to
$158,000 in 2007.  The majority of the current year charge-off
activity is the result of the write off of small consumer and commercial
relationships.





The
following table sets forth the allocation of allowance for loan losses by loan
category for the periods indicated.  The allocation of the allowance
by category is not necessarily indicative of future losses and does not restrict
the use of the allowance to absorb losses in any category.





2008
                    
                    
                    2007
                    
                    
                    2006
                    
                    
                    2005
                    
                    
                    2004%
      Gross
                    
                    
                    
                    
                    
                    %
      Gross
                    
                    
                    
                    
                    
                    %
      Gross
                    
                    
                    
                    
                    
                    %
      Gross
                    
                    
                    
                    
                    
                    %
      Gross(Dollars
      in thousands)
                    
                    Amount
                    
                    
                    Loans
                    
                    
                    Amount
                    
                    
                    Loans
                    
                    
                    Amount
                    
                    
                    Loans
                    
                    
                    Amount
                    
                    
                    Loans
                    
                    
                    Amount
                    
                    
                    LoansCommercial
      real estate and loans
                    
                    
                    $1,412
                    
                    
                    
                    34.3
                    %
                    
                    
                    $956
                    
                    
                    
                    31.8
                    %
                    
                    
                    $985
                    
                    
                    
                    31.3
                    %
                    
                    
                    $1,282
                    
                    
                    
                    26.5
                    %
                    
                    
                    $1,483
                    
                    
                    
                    24.7
                    %Consumer
      loans
                    
                    
                    381
                    
                    
                    
                    11.2
                    %
                    
                    
                    283
                    
                    
                    
                    11.3
                    %
                    
                    
                    339
                    
                    
                    
                    10.4
                    %
                    
                    
                    289
                    
                    
                    
                    10.4
                    %
                    
                    
                    270
                    
                    
                    
                    9.8
                    %Residential
      real estate
                    
                    
                    679
                    
                    
                    
                    54.5
                    %
                    
                    
                    464
                    
                    
                    
                    56.9
                    %
                    
                    
                    172
                    
                    
                    
                    58.3
                    %
                    
                    
                    108
                    
                    
                    
                    63.1
                    %
                    
                    
                    74
                    
                    
                    
                    65.5
                    %Total
                    
                    
                    $2,472
                    
                    
                    
                    100.0
                    %
                    
                    
                    $1,703
                    
                    
                    
                    100.0
                    %
                    
                    
                    $1,496
                    
                    
                    
                    100.0
                    %
                    
                    
                    $1,679
                    
                    
                    
                    100.0
                    %
                    
                    
                    $1,827
                    
                    
                    
                    100.0
                    %





Page
31




The following table sets forth the roll forward of
the allowance for loan losses for the periods indicated, and related
ratios:




(In
      thousands)
                          
                          2008
                          
                          
                          2007
                          
                          
                          2006
                          
                          
                          2005
                          
                          
                          2004Balance
      at beginning of year
                          
                          
                          $1,703
                          
                          
                          
                          $1,496
                          
                          
                          
                          $1,679
                          
                          
                          
                          $1,827
                          
                          
                          
                          $1,715Provisions
      charged to operating expenses
                          
                          
                          820
                          
                          
                          
                          365
                          
                          
                          
                          23
                          
                          
                          
                          311
                          
                          
                          
                          738Recoveries
      of loans previously charged-off:Commercial
      real estate and loans
                          
                          
                          17
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          25
                          
                          
                          
                          41Consumer
                          
                          
                          30
                          
                          
                          
                          27
                          
                          
                          
                          18
                          
                          
                          
                          14
                          
                          
                          
                          20Residential
      real estate
                          
                          
                          -
                          
                          
                          
                          23
                          
                          
                          
                          4
                          
                          
                          
                          10
                          
                          
                          
                          -Total
      recoveries
                          
                          
                          47
                          
                          
                          
                          50
                          
                          
                          
                          22
                          
                          
                          
                          49
                          
                          
                          
                          61Loans
      charged off:Commercial
      real estate and loans
                          
                          
                          (46
                          )
                          
                          
                          (85
                          )
                          
                          
                          (114
                          )
                          
                          
                          (284
                          )
                          
                          
                          (439
                          )Consumer
                          
                          
                          (52
                          )
                          
                          
                          (77
                          )
                          
                          
                          (89
                          )
                          
                          
                          (137
                          )
                          
                          
                          (126
                          )Residential
      real estate
                          
                          
                          -
                          
                          
                          
                          (46
                          )
                          
                          
                          (25
                          )
                          
                          
                          (87
                          )
                          
                          
                          (122
                          )Total
      charged-off
                          
                          
                          (98
                          )
                          
                          
                          (208
                          )
                          
                          
                          (228
                          )
                          
                          
                          (508
                          )
                          
                          
                          (687
                          )Net
      charge-offs
                          
                          
                          (51
                          )
                          
                          
                          (158
                          )
                          
                          
                          (206
                          )
                          
                          
                          (459
                          )
                          
                          
                          (626
                          )Balance
      at end of year
                          
                          
                          $2,472
                          
                          
                          
                          $1,703
                          
                          
                          
                          $1,496
                          
                          
                          
                          $1,679
                          
                          
                          
                          $1,827Net
      charge-offs to average loans outstanding
                          
                          
                          0.02
                          %
                          
                          
                          0.08
                          %
                          
                          
                          0.11
                          %
                          
                          
                          0.24
                          %
                          
                          
                          0.33
                          %Allowance
      for loan losses to year-end loans
                          
                          
                          0.99
                          %
                          
                          
                          0.76
                          %
                          
                          
                          0.74
                          %
                          
                          
                          0.89
                          %
                          
                          
                          0.98
                          %





Deposits





The
Company’s deposit base is drawn from seven full-service offices in its market
area.  The deposit base consists of demand deposits, money management
and money market deposit accounts, savings and time deposits. During 2008, 85%
of the Company's average deposit base of $265.8 million consisted of core
deposits.  Core deposits are considered to be more stable and provide
the Company with a lower cost source of funds.  The Company will
continue to emphasize retail core deposits by maintaining its network of full
service offices and providing depositors with a full range of deposit product
offerings.  Pathfinder Commercial Bank will seek business growth by
focusing on its local identification and service
excellence.  Pathfinder Commercial Bank had an average balance of
$30.8 million in municipal deposits in 2008, primarily concentrated in money
market deposit accounts.





Average
deposits increased $10.0 million, or 4%, when compared to 2007.  The
increase in average deposits primarily related to a $2.1 million increase in the
average balance of municipal deposits and a $7.9 million increase in retail
deposits.





The
Company's average deposit mix in 2008, as compared to 2007, reflected increases
in demand deposits, MMDA and time deposits with small shifts from savings and
money market accounts to higher interest bearing products.   The
Company's average demand deposits, both interest and noninterest bearing
accounts, represented 19% of total average deposits for 2008 and 18% for
2007.  The Company's MMDA accounts, which grew 23% in 2008,
represented 11% of total deposits for 2008 and 9% for 2007. The Company’s time
deposit accounts, although higher than the previous year, represented 47% of
total deposits versus 48% for the same period in 2007. The Company promotes its
MMDA and time deposit accounts by offering competitive rates to retain existing
and attract new customers.





At
December 31, 2008, time deposits in excess of $100,000 totaled $40.7 million, or
31%, of time deposits and 15% of total deposits.  At December 31,
2007, these deposits totaled $33.0 million, or 28% of time deposits and 13% of
total deposits.








Page
32





The following table indicates
the amount of the Company's certificates of deposit of $100,000 or more by time
remaining until maturity as of December 31, 2008:
  (Dollars
      in thousands)Remaining
      Maturity:Three
      months or less
                      
                      
                      $8,698Three
      through six months
                      
                      
                      11,573Six
      through twelve months
                      
                      
                      10,738Over
      twelve months
                      
                      
                      9,722Total
                      
                      
                      $40,731





Borrowings





Short-term
borrowings are comprised primarily of advances and overnight borrowing at the
FHLBNY.  There were $17.6 million in short-term borrowings outstanding
at December 31, 2008.  At December 31, 2007, there were $18.4 million
in short-term borrowings outstanding.





The
following table represents information regarding short-term borrowings during
2008, 2007 and 2006:





(Dollars
      in thousands)
                    
                    2008
                    
                    
                    2007
                    
                    
                    2006Maximum
      outstanding at any month end
                    
                    
                    $23,795
                    
                    
                    
                    $18,400
                    
                    
                    
                    $15,000Average
      amount outstanding during the year
                    
                    
                    14,151
                    
                    
                    
                    4,528
                    
                    
                    
                    5,321Average
      interest rate during the year
                    
                    
                    2.85
                    %
                    
                    
                    5.05
                    %
                    
                    
                    4.99
                    %





At
December 31, 2008, the weighted average interest rate associated with the
Company’s short-term borrowings was approximately 1.09%.





Long-term
borrowed funds consist of advances and repurchase agreements from the FHLBNY,
Citi Group repurchase agreements and junior subordinated
debentures.  Long-term borrowed funds and junior subordinated
debentures totaled $39.6 million at December 31, 2008 as compared to $25.2
million at December 31, 2007.





Capital





Shareholders’
equity decreased $2.2 million to $19.5 million at December 31,
2008.  The Company added $368,000 to retained earnings through net
income, which was offset by cash dividends returned to its shareholders of
$856,000 and a $48,000 adjustment taken directly to retained earnings
representing the cumulative change in accounting principle upon the change in
the retirement plan measurement date under SFAS No. 158. Accumulated other
comprehensive loss increased $1.7 million to $3.1 million at December 31, 2008,
resulting primarily from losses on retirement plan assets due to significant
decreases in the market value of the underlying plan assets, net of tax
benefits.  Unrealized holding losses on securities, net of tax, also
resulted in an increase in accumulated other comprehensive loss of
$392,000.





The
Company’s mutual holding company parent, Pathfinder Bancorp, M.H.C., waived its
right to receive the dividend for the quarter ended June 30,
2008.  The dividend waiver anticipated for the quarter ended December
31, 2008, in the amount of $162,000, was not granted by the OTS and therefore
was accrued at December 31, 2008 and paid to the Company’s mutual holding
company parent in 2009.





Risk-based
capital provides the basis for which all banks are evaluated in terms of capital
adequacy.  Capital adequacy is evaluated primarily by the use of
ratios which measure capital against total assets, as well as against total
assets that are weighted based on defined risk characteristics.  The
Company’s goal is to maintain a strong capital position, consistent with the
risk profile of its subsidiary banks that supports growth and expansion
activities while at the same time exceeding regulatory standards.  At
December 31, 2008, Pathfinder Bank exceeded all regulatory required minimum
capital ratios and met the regulatory definition of a “well-capitalized”
institution, i.e. a leverage capital ratio exceeding 5%, a Tier 1 risk-based
capital ratio exceeding 6% and a total risk-based capital ratio exceeding
10%.  See Note 17 in the accompanying consolidated financial
statements for Pathfinder Bank’s capital ratios.







Page
33


LIQUIDITY




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





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





The Asset
Liability Management Committee (ALCO) of the Company is responsible for
implementing the policies and guidelines for the maintenance of prudent levels
of liquidity.  As of December 31, 2008, the Company is in compliance
with its policy guidelines with regard to liquidity.





Despite
the fact that the junior subordinated note was not contractually due until 2032,
we called the note in June 2007 and replaced it with a newly originated junior
subordinated note with a lower carrying cost. In addition, the Company, in the
conduct of ordinary business operations, routinely enters into contracts for
services.  These contracts may require payment for services to be
provided in the future and may also contain penalty clauses for the early
termination of the contract.  Management is not aware of any
additional commitments or contingent liabilities, which may have a material
adverse impact on the liquidity or capital resources of the
Company.





OFF-BALANCE
SHEET ARRANGEMENTS





The
Company is also a party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its
customers.  These financial instruments include commitments to extend
credit and standby letters of credit.  At December 31, 2008, the
Company had $26.1 million in outstanding commitments to extend credit and
standby letters of credit.  See Note 15 in the accompanying
consolidated financial statements.








ITEM
7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





Incorporated
by reference to the discussion contained in Part II, Item 7, “Management’s
Discussion and Analysis of Financial Condition and Results of Operations,” under
the captions “Liquidity” and “Capital”.





Page
34


ITEM
8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA





Index
to Consolidated Financial Statements


Pathfinder Bancorp,
Inc.





Page





Management’s
Report On Internal Control Over Financial
Reporting                                                                                     
 36


Report of
Independent Registered Public Accounting
Firm                                                                                                       
37


Consolidated
Statements of Condition – December 31, 2008 and
2007                                                                                    
 38


Consolidated
Statements of Income – Years ended December 31, 2008 and
2007                                                                
   39


Consolidated
Statements of Changes in Shareholders’ Equity – Years ended December 31, 2008
and
2007                     
40


Consolidated
Statements of Cash Flows – Years ended December 31, 2008 and
2007                                                            41


Notes to
Consolidated Financial
Statements                                                                                                                                 
42











Page
35


MANAGEMENT'S
REPORT ON INTERNAL CONTROLS OVER FINANCIAL REPORTING




The
Company’s management is responsible for establishing and maintaining adequate
internal control over financial reporting, as such term is defined in Rules
13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934, as amended.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with policies or procedures may deteriorate. The Company’s internal control over
financial reporting is a process designed under the supervision of the Company’s
principal executive officer and principal financial officer to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of the Company’s financial statements for external reporting
purposes in accordance with United States generally accepted accounting
principles.





Under the
supervision and with the participation of management, including the Company’s
principal executive officer and principal financial officer, the Company
conducted an evaluation of the effectiveness of its internal control over
financial reporting based on the framework in Internal Control – Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission. Based on its evaluation under that framework, management
concluded that the Company’s internal control over financial reporting was
effective as of December 31, 2008. In addition, based on our assessment,
management has determined that there were no material weaknesses in the
Company’s internal controls over financial reporting.





This
annual report does not include an attestation report of the Company’s
independent registered public accounting firm regarding internal control over
financial reporting pursuant to temporary rules of the Securities and Exchange
Commission that permit the Company to provide only management’s report in this
annual report.







/s/
      Thomas W. Schneider
            
            
            
            /s/
      James A. DowdThomas
      W. Schneider
            
            
            
            James
      A. DowdPresident &
      Chief Executive Officer
            
            
            
            Senior
      Vice President and Chief Financial Officer




Oswego,
New York


March 27,
2009










Page
36








Report
of Independent Registered Public Accounting Firm
























To the
Board of Directors and Shareholders


Pathfinder
Bancorp, Inc.


Oswego,
New York






We have
audited the accompanying consolidated statements of condition of Pathfinder
Bancorp, Inc. and subsidiaries as of December 31, 2008 and 2007, and the related
consolidated statements of income, changes in shareholders’ equity and cash
flows for the years then ended.  Pathfinder Bancorp, Inc.’s management
is responsible for these consolidated financial statements.  Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.




We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the consolidated financial statements are free of material
misstatement.  The Company is not required to have, nor were we
engaged to perform, an audit of its internal control over financial
reporting.  Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting.  Accordingly, we express no such opinion.  An
audit also includes examining, on a test basis, evidence supporting the amounts
and disclosures in the consolidated financial statements, assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation.  We
believe that our audits provide a reasonable basis for our opinion.




In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Pathfinder
Bancorp, Inc. and subsidiaries as of December 31, 2008 and 2007, and the
consolidated results of their operations and their cash flows for the years then
ended in conformity with accounting principles generally accepted in the United
States of America.














/s/ BEARD MILLER COMPANY
LLP









Beard
Miller Company LLP


Syracuse,
New York


March 27,
2009





Page
37




CONSOLIDATED
      STATEMENTS OF CONDITIONDecember
      31,(In
      thousands, except share data)
                                
                                2008
                                
                                
                                2007ASSETS:Cash
      and due from banks
                                
                                
                                $7,365
                                
                                
                                
                                $9,908Interest
      earning deposits
                                
                                
                                313
                                
                                
                                
                                305Total
      cash and cash equivalents
                                
                                
                                7,678
                                
                                
                                
                                10,213Investment
      securities, at fair value
                                
                                
                                72,138
                                
                                
                                
                                65,010Federal
      Home Loan Bank stock, at cost
                                
                                
                                2,549
                                
                                
                                
                                2,128Loans
                                
                                
                                249,872
                                
                                
                                
                                222,749Less:
      Allowance for loan losses
                                
                                
                                2,472
                                
                                
                                
                                1,703Loans
      receivable, net
                                
                                
                                247,400
                                
                                
                                
                                221,046Premises
      and equipment, net
                                
                                
                                7,450
                                
                                
                                
                                7,807Accrued
      interest receivable
                                
                                
                                1,678
                                
                                
                                
                                1,673Foreclosed
      real estate
                                
                                
                                335
                                
                                
                                
                                865Goodwill
                                
                                
                                3,840
                                
                                
                                
                                3,840Bank
      owned life insurance
                                
                                
                                6,731
                                
                                
                                
                                6,437Other
      assets
                                
                                
                                2,961
                                
                                
                                
                                1,672Total
      assets
                                
                                
                                $352,760
                                
                                
                                
                                $320,691LIABILITIES AND SHAREHOLDERS'
      EQUITY:Deposits:Interest-bearing
                                
                                
                                $243,288
                                
                                
                                
                                $228,319Noninterest-bearing
                                
                                
                                26,150
                                
                                
                                
                                22,766Total
      deposits
                                
                                
                                269,438
                                
                                
                                
                                251,085Short-term
      borrowings
                                
                                
                                17,575
                                
                                
                                
                                18,400Long-term
      borrowings
                                
                                
                                34,400
                                
                                
                                
                                20,010Junior
      subordinated debentures
                                
                                
                                5,155
                                
                                
                                
                                5,155Other
      liabilities
                                
                                
                                6,697
                                
                                
                                
                                4,337Total
      liabilities
                                
                                
                                333,265
                                
                                
                                
                                298,987Shareholders'
      equity:Preferred
      stock, authorized shares 1,000,000; no shares issued or
      outstandingCommon
      stock, par value $0.01; authorized 10,000,000 shares;2,972,119
      and 2,971,019 shares issued and 2,484,832 and 2,483,732
    sharesoutstanding,
      respectively
                                
                                
                                30
                                
                                
                                
                                30Additional
      paid in capital
                                
                                
                                7,909
                                
                                
                                
                                7,899Retained
      earnings
                                
                                
                                21,198
                                
                                
                                
                                21,734Accumulated
      other comprehensive loss
                                
                                
                                (3,140
                                )
                                
                                
                                (1,457
                                )Treasury
      stock, at cost; 487,287 shares
                                
                                
                                (6,502
                                )
                                
                                
                                (6,502
                                )Total
      shareholders' equity
                                
                                
                                19,495
                                
                                
                                
                                21,704Total
      liabilities and shareholders' equity
                                
                                
                                $352,760
                                
                                
                                
                                $320,691The
      accompanying notes are an integral part of the consolidated financial
      statements.




Page
38


CONSOLIDATED
      STATEMENTS OF INCOMEYears
      Ended December 31,(In
      thousands, except per share data)
                            
                            2008
                            
                            
                            2007Interest
      and dividend income:Loans,
      including fees
                            
                            
                            $14,756
                            
                            
                            
                            $14,047Debt
      securities:Taxable
                            
                            
                            2,956
                            
                            
                            
                            2,529Tax-exempt
                            
                            
                            171
                            
                            
                            
                            170Dividends
                            
                            
                            406
                            
                            
                            
                            352Federal
      funds sold and interest earning deposits
                            
                            
                            61
                            
                            
                            
                            211Total
      interest income
                            
                            
                            18,350
                            
                            
                            
                            17,309Interest
      expense:Interest
      on deposits
                            
                            
                            5,661
                            
                            
                            
                            6,901Interest
      on short-term borrowings
                            
                            
                            403
                            
                            
                            
                            229Interest
      on long-term borrowings
                            
                            
                            1,611
                            
                            
                            
                            1,512Total
      interest expense
                            
                            
                            7,675
                            
                            
                            
                            8,642Net
      interest income
                            
                            
                            10,675
                            
                            
                            
                            8,667Provision
      for loan losses
                            
                            
                            820
                            
                            
                            
                            365Net
      interest income after provision for loan losses
                            
                            
                            9,855
                            
                            
                            
                            8,302Noninterest
      income:Service
      charges on deposit accounts
                            
                            
                            1,492
                            
                            
                            
                            1,474Earnings
      on bank owned life insurance
                            
                            
                            293
                            
                            
                            
                            225Loan
      servicing fees
                            
                            
                            281
                            
                            
                            
                            250Net
      (losses) gains on sales and impairment of investment
      securities
                            
                            
                            (2,191
                            )
                            
                            
                            378Net
      (losses) gains on sales of loans and foreclosed real
estate
                            
                            
                            (44
                            )
                            
                            
                            42Debit
      card interchange fees
                            
                            
                            275
                            
                            
                            
                            246Other
      charges, commissions & fees
                            
                            
                            445
                            
                            
                            
                            427Total
      noninterest income
                            
                            
                            551
                            
                            
                            
                            3,042Noninterest
      expense:Salaries
      and employee benefits
                            
                            
                            5,172
                            
                            
                            
                            5,094Building
      occupancy
                            
                            
                            1,322
                            
                            
                            
                            1,254Data
      processing expenses
                            
                            
                            1,330
                            
                            
                            
                            1,333Professional
      and other services
                            
                            
                            771
                            
                            
                            
                            769Amortization
      of intangible asset
                            
                            
                            -
                            
                            
                            
                            182Other
      expenses
                            
                            
                            1,340
                            
                            
                            
                            1,206Total
      noninterest expenses
                            
                            
                            9,935
                            
                            
                            
                            9,838Income
      before income taxes
                            
                            
                            471
                            
                            
                            
                            1,506Provision
      for income taxes
                            
                            
                            103
                            
                            
                            
                            384Net
      income
                            
                            
                            $368
                            
                            
                            
                            $1,122Earnings
      per share - basic
                            
                            
                            $0.15
                            
                            
                            
                            $0.45Earnings
      per share - diluted
                            
                            
                            $0.15
                            
                            
                            
                            $0.45Dividends
      per share
                            
                            
                            $0.41
                            
                            
                            
                            $0.41The
      accompanying notes are an integral part of the consolidated financial
      statements.


Page
39


CONSOLIDATED STATEMENTS OF
CHANGES IN SHAREHOLDERS' EQUITY
  AccumulatedAdditional
                  
                  OtherCommon
      Stock Issued
                  Paid
      in
                  Retained
                  Comprehensive
                  Treasury(In
      thousands, except share data)
                  Shares
                  Amount
                  Capital
                  Earnings
                  Loss
                  Stock
                  Total




Balance,
      January 1, 2007
                2,953,619
                $29
                $7,786
                $21,307
                $(1,770)
                $(6,502)
                $20,850Comprehensive
      income:Net
      income
                
                
                
                1,122
                
                
                1,122Other
      comprehensive income, net of tax:Unrealized
      holding gains on securitiesavailable
      for sale (net of $125 tax expense)
                
                
                
                
                188
                
                188Retirement
      plan net gains not recognized inplan
      expenses (net of $83 tax expense)
                
                
                
                
                125
                
                125Total
      Comprehensive income
                
                
                
                
                
                
                1,435Stock
      options exercised
                17,400
                1
                113
                
                
                
                114Dividends
      declared ($0.41 per share)
                
                
                
                (695)
                
                
                (695)Balance,
      December 31, 2007
                2,971,019
                30
                7,899
                21,734
                (1,457)
                (6,502)
                21,704Cumulative
      effect of a change in accountingprinciple
      upon the change in definedbenefit
      retirement plans' measurement dateunder
      SFAS 158 (net of $8 tax expense)
                
                
                
                (48)
                13
                
                (35)Comprehensive
      loss:Net
      income
                
                
                
                368
                
                
                368Other
      comprehensive loss, net of tax:Unrealized
      holding losses on securitiesavailable
      for sale (including $237 tax expense)
                
                
                
                
                (392)
                
                (392)Retirement
      plan net losses not recognized inplan
      expenses (net of $869 tax benefit)
                
                
                
                
                (1,304)
                
                (1,304)Total
      Comprehensive loss
                
                
                
                
                
                
                (1,328)Stock
      options exercised
                1,100
                
                10
                
                
                
                10Dividends
      declared ($0.41 per share)
                
                
                
                (856)
                
                
                (856)Balance,
      December 31, 2008
                2,972,119
                $30
                $7,909
                $21,198
                $(3,140)
                $(6,502)
                $19,495




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








Page
40




CONSOLIDATED
      STATEMENTS OF CASH FLOWSYears Ended December 31,(In
      thousands)
                            
                            2008
                            
                            
                            2007OPERATING
      ACTIVITIESNet
      income
                            
                            
                            $368
                            
                            
                            
                            $1,122Adjustments
      to reconcile net income to net cash provided by operating
      activities:Provision
      for loan losses
                            
                            
                            820
                            
                            
                            
                            365Deferred
      income tax benefit
                            
                            
                            (388
                            )
                            
                            
                            (48
                            )Proceeds
      from sales of loans
                            
                            
                            174
                            
                            
                            
                            3,000Originations
      of loans held-for-sale
                            
                            
                            (172
                            )
                            
                            
                            (2,973
                            )Realized
      losses (gains) on sales of:Foreclosed
      real estate
                            
                            
                            46
                            
                            
                            
                            (15
                            )Loans
                            
                            
                            (2
                            )
                            
                            
                            (27
                            )Available-for-sale
      investment securities
                            
                            
                            (62
                            )
                            
                            
                            (378
                            )Impairment
      write-down on available-for-sale securities
                            
                            
                            2,253
                            
                            
                            
                            -Depreciation
                            
                            
                            698
                            
                            
                            
                            734Amortization
      of intangible asset
                            
                            
                            -
                            
                            
                            
                            181Amortization
      of deferred financing costs
                            
                            
                            -
                            
                            
                            
                            15Amortization
      of mortgage servicing rights
                            
                            
                            28
                            
                            
                            
                            46Earnings
      on bank owned life insurance
                            
                            
                            (293
                            )
                            
                            
                            (225
                            )Net
      amortization of premiums and discounts on investment
      securities
                            
                            
                            112
                            
                            
                            
                            144(Increase)
      decrease in accrued interest receivable
                            
                            
                            (5
                            )
                            
                            
                            21Net
      change in other assets and liabilities
                            
                            
                            (299
                            )
                            
                            
                            962Net
      cash provided by operating activities
                            
                            
                            3,278
                            
                            
                            
                            2,924INVESTING
      ACTIVITIESPurchase
      of investment securities available-for-sale
                            
                            
                            (31,756
                            )
                            
                            
                            (23,503
                            )Net
      purchases of Federal Home Loan Bank stock
                            
                            
                            (421
                            )
                            
                            
                            (549
                            )Proceeds
      from maturities and principal reductions of investment securities
      available-for-sale
                            
                            
                            18,633
                            
                            
                            
                            18,951Proceeds
      from sale of:Available-for-sale
      investment securities
                            
                            
                            3,531
                            
                            
                            
                            2,728Real
      estate acquired through foreclosure
                            
                            
                            979
                            
                            
                            
                            276Premises
      and equipment
                            
                            
                            -
                            
                            
                            
                            34Net
      increase in loans
                            
                            
                            (27,672
                            )
                            
                            
                            (20,362
                            )Purchase
      of premises and equipment
                            
                            
                            (341
                            )
                            
                            
                            (978
                            )Net
      cash used in investing activities
                            
                            
                            (37,047
                            )
                            
                            
                            (23,403
                            )FINANCING
      ACTIVITIESNet
      increase in demand deposits, NOW accounts, savings accounts, money market
      deposit accounts,MMDA
      accounts and escrow deposits
                            
                            
                            6,003
                            
                            
                            
                            5,368Net
      increase in time deposits
                            
                            
                            12,350
                            
                            
                            
                            132Net
      (repayments on) proceeds from short-term borrowings
                            
                            
                            (825
                            )
                            
                            
                            18,400Payments
      on long-term borrowings
                            
                            
                            (11,610
                            )
                            
                            
                            (11,350
                            )Proceeds
      from long-term borrowings
                            
                            
                            26,000
                            
                            
                            
                            5,000Proceeds
      from trust preferred obligation
                            
                            
                            -
                            
                            
                            
                            5,155Payments
      on trust preferred obligation
                            
                            
                            -
                            
                            
                            
                            (5,155
                            )Proceeds
      from exercise of stock options
                            
                            
                            10
                            
                            
                            
                            114Cash
      dividends paid
                            
                            
                            (694
                            )
                            
                            
                            (695
                            )Net
      cash provided by financing activities
                            
                            
                            31,234
                            
                            
                            
                            16,969Decrease
      in cash and cash equivalents
                            
                            
                            (2,535
                            )
                            
                            
                            (3,510
                            )Cash
      and cash equivalents at beginning of period
                            
                            
                            10,213
                            
                            
                            
                            13,723Cash
      and cash equivalents at end of period
                            
                            
                            $7,678
                            
                            
                            
                            $10,213CASH
      PAID DURING THE PERIOD FOR:Interest
                            
                            
                            $7,714
                            
                            
                            
                            $8,553Income
      Taxes
                            
                            
                            162
                            
                            
                            
                            185NON-CASH
      INVESTING ACTIVITYTransfer
      of loans to foreclosed real estate
                            
                            
                            498
                            
                            
                            
                            664The
      accompanying notes are an integral part of the consolidated financial
      statements.






Page
41


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE 1:SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES





Nature
of Operations





The
accompanying consolidated financial statements include the accounts of
Pathfinder Bancorp, Inc. (the “Company”) and its wholly owned subsidiary,
Pathfinder Bank (the “Bank”). The Bank has three wholly owned operating
subsidiaries, Pathfinder Commercial Bank, Whispering Oaks Development Corp. and
Pathfinder REIT, Inc. All inter-company accounts and activity have been
eliminated in consolidation.  The Company has seven offices located in
Oswego County.  The Company is primarily engaged in the business of
attracting deposits from the general public in the Company’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, business
assets and in investment securities.





Pathfinder
Bancorp, M.H.C., (the “Holding Company”) a mutual holding company whose activity
is not included in the accompanying financial statements, owns approximately
63.7% of the outstanding common stock of the Company.  Salaries,
employee benefits and rent approximating $167,000 and $144,000 were allocated
from the Company to the Holding Company during 2008 and 2007,
respectively.  As of December 31, 2008, the Bank had a loan receivable
from the Holding Company of $1,075,000.





Use
of Estimates in the Preparation of Financial Statements





The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.  Management has identified the allowance for loan losses,
deferred income taxes, pension obligations, the evaluation of goodwill for
impairment and the evaluation of investment securities for other than temporary
impairment to be the accounting areas that require the most subjective and
complex judgments, and as such, could be the most subject to revision as new
information becomes available.





The
Company is subject to the regulations of various governmental
agencies.  The Company also undergoes periodic examinations by the
regulatory agencies which may subject it to further changes with respect to
asset valuations, amounts of required loss allowances, and operating
restrictions resulting from the regulators' judgments based on information
available to them at the time of their examinations.





Significant
Group Concentrations of Credit Risk





Most of
the Company’s activities are with customers located primarily in Oswego and
parts of Onondaga counties of New York State.  Note 3 discusses the
types of securities that the Company invests in.  Note 4 discusses the
types of lending that the Company engages in.  The Company does not
have any significant concentrations to any one industry or
customer.





Advertising





The
Company follows the policy of charging the costs of advertising to expense as
incurred.  Advertising costs included in other operating expenses were
$264,000 and $297,000 for the years ended December 31, 2008 and 2007,
respectively.





Page
42





Cash
and Cash Equivalents





Cash and
cash equivalents include cash on hand, amounts due from banks and
interest-bearing deposits (with original maturity of three months or
less).





Investment
Securities





The
Company classifies investment securities as
available-for-sale.  Available-for-sale securities are reported at
fair value, with net unrealized gains and losses reflected as a separate
component of shareholders’ equity, net of the applicable income tax effect. None
of the Company’s investment securities have been classified as trading or
held-to-maturity.





Gains or
losses on investment security transactions are based on the amortized cost of
the specific securities sold.  Premiums and discounts on securities
are amortized and accreted into income using the interest method over the period
to maturity.





The
Company monitors investment securities for impairment on a quarterly
basis.  Declines in the fair value of investment securities below cost
that are deemed to be other-than-temporary are reflected in earnings as realized
losses.  In estimating other-than-temporary impairment losses,
management considers (1) the length of time and the extent to which the fair
value has been less than cost, (2) the financial condition and near-term
prospects of the issuer, and (3) the intent and ability of the Company to retain
its investment in the issuer for a period of time sufficient to allow for any
anticipated recovery in fair value.





Federal
Home Loan Bank Stock





Federal
law requires a member institution of the Federal Home Loan Bank (“FHLB”) system
to hold stock of its district FHLB according to a predetermined
formula.  The stock is carried at cost.





Mortgage
Loans Held-for-Sale





Mortgage
loans held-for-sale are carried at the lower of cost or fair
value.  Fair value is determined in the aggregate.  There
were no forward commitments outstanding as of December 31, 2008 and
2007.





Transfers
of Financial Assets





Transfers
of financial assets, including sales of loans and loan participations, are
accounted for as sales when control over the assets has been
surrendered.  Control over transferred assets is deemed to be
surrendered when (1) the assets have been isolated from the Company, (2) the
transferee obtains the right (free of conditions that constrain it from taking
advantage of that right) to pledge or exchange the transferred assets, and (3)
the Company does not maintain effective control over the transferred assets
through an agreement to repurchase them before their maturity.





Loans





The
Company grants mortgage, commercial and consumer loans to
customers.  Loans that management has the intent and ability to hold
for the foreseeable future or until maturity or pay-off, generally are stated at
unpaid principal balances, less the allowance for loan losses and plus net
deferred loan origination costs. The ability of the Company’s debtors to honor
their contracts is dependent upon the real estate and general economic
conditions in the market area.  Interest income is generally
recognized when income is earned using the interest method. Nonrefundable loan
fees received and related direct origination costs incurred are deferred and
amortized over the life of the loan using the interest method, resulting in a
constant effective yield over the loan term. Deferred fees are recognized into
income and deferred costs are charged to income immediately upon prepayment of
the related loan.





Page
43


Allowance
for Loan Losses





The
allowance for loan losses is established as losses are estimated to have
occurred through a provision for loan losses charged to
earnings.  Loan losses are charged against the allowance when
management believes the uncollectibility of a loan balance is
confirmed.  Subsequent recoveries, if any, are credited to the
allowance.  The Company periodically evaluates the adequacy of the
allowance for loan losses in order to maintain the allowance at a level that is
sufficient to absorb probable and estimable credit losses.





The
allowance consists of specific, general and unallocated
components.  It includes amounts specifically allocated to impaired
loans.  A loan is considered impaired, based on current information
and events, if it is probable the Company will be unable to collect the
scheduled payments of principal or interest when due according to the
contractual terms of the loan agreement.  Specific reserves are
established based on the fair value of underlying collateral or discounted cash
flows, as appropriate, when those values are lower than the carrying value of
the loan.  The allowance is also comprised of general reserves, which
are established by applying loss factors to the aggregate balance of major loan
categories or pools of smaller balance homogeneous loans.  The loss
factors are determined by management based on an evaluation of historical loss
experience, delinquency trends, volume and type of lending conducted, and the
impact of current economic conditions in the market area.  An
unallocated component of the allowance may be maintained to cover uncertainties
that could affect management’s estimate of probable losses.  The
unallocated component reflects the margin of imprecision inherent in the
underlying assumptions used in the methodologies for estimating specific and
general losses in the portfolio.  While management uses the best
information available to make evaluations, future adjustments to the allowance
may be necessary if conditions differ substantially from the assumptions used in
making the evaluation.





Income
Recognition on Impaired and Non-accrual Loans





Loans,
including impaired loans, are generally classified as non-accrual if they are
past due as to maturity or payment of principal or interest for a period of more
than 90 days. When a loan is classified as non-accrual and the future
collectibility of the recorded loan balance is doubtful, collections of interest
and principal are generally applied as a reduction to principal
outstanding.





When
future collectibility of the recorded loan balance is expected, interest income
may be recognized on a cash basis. In the case where a non-accrual loan had been
partially charged off, recognition of interest on a cash basis is limited to
that which would have been recognized on the recorded loan balance at the
contractual interest rate. Cash interest receipts in excess of that amount are
recorded as recoveries to the allowance for loan losses until prior charge-offs
have been fully recovered.





Off-Balance
Sheet Credit Related Financial Instruments





In the
ordinary course of business, the Company has entered into commitments to extend
credit, including commitments under standby letters of credit.  Such
financial instruments are recorded when they are funded.





Premises
and Equipment





Premises
and equipment are stated at cost, less accumulated depreciation. Depreciation is
computed on a straight-line basis over the estimated useful lives of the related
assets, ranging up to 40 years for premises and 10 years for equipment.
Maintenance and repairs are charged to operating expenses as
incurred.  The asset cost and accumulated depreciation are removed
from the accounts for assets sold or retired and any resulting gain or loss is
included in the determination of income.





Page
44





Foreclosed
Real Estate





Properties
acquired through foreclosure, or by deed in lieu of foreclosure, are recorded at
their fair value less estimated disposal costs. Fair value is determined based
on a current appraisal and inspection.  Costs incurred in connection
with preparing the foreclosed real estate for disposition are capitalized to the
extent that they enhance the overall fair value of the property. Write downs of,
and expenses related to, foreclosed real estate holdings are included in
noninterest expense and were $133,000 and $98,000 in 2008 and 2007,
respectively.





Intangible
Assets





Intangible
assets represent core deposit intangibles and goodwill arising from
acquisitions.  Core deposit intangibles represent the premium the
Company has paid for deposits acquired in excess of the cost incurred had the
funds been purchased in the capital markets.  Core deposit intangibles
were amortized on a straight-line basis over a period of five
years.  As of October 2007, all core deposit intangibles are fully
amortized.  Goodwill represents the excess cost of an acquisition over
the fair value of the net assets acquired.  Goodwill is not amortized
but is evaluated annually for impairment.





Mortgage
Servicing Rights





Originated
mortgage servicing rights are recorded at their fair value at the time of
transfer and are amortized in proportion to and over the period of estimated net
servicing income or loss.  The carrying value of the originated
mortgage servicing rights is periodically evaluated for impairment.





Stock-Based
Compensation





Compensation
costs related to share-based payment transactions are recognized based on the
grant-date fair value of the stock-based compensation issued. Compensation costs
are recognized over the period that an employee provides service in exchange for
the award.  No options were granted during 2008 or 2007, and all
outstanding options were fully vested on January 1, 2006 and, accordingly, there
was no impact on the Company’s results of operations for the periods
presented.




Retirement
Benefits





The
Company has established tax qualified retirement plans covering substantially
all full-time employees and certain part-time employees.  Pension
expense under these plans is charged to current operations and consists of
several components of net pension cost based on various actuarial assumptions
regarding future experience under the plans.





In 2006,
the Company adopted SFAS 158, which required the recognition of the underfunded
status of pension and other postretirement benefit plans on the consolidated
statements of condition.  Under SFAS 158, gains and losses, prior
service costs and credits, and any remaining transition amounts under SFAS 87
and SFAS 106 that have not yet been recognized through net periodic benefit cost
are recognized in accumulated other comprehensive loss, net of tax effects,
until they are amortized as a component of net periodic cost.  On
January 1, 2008, the Company recorded a charge to retained earnings,
representing the cumulative effect adjustment upon adopting the measurement date
transition rule for the Company’s pension plan and postretirement benefit
plan.  In accordance with SFAS 158 measurement date provisions, plan
assets and obligations are to be measured as of the date of the employer’s
Statement of Condition.  The Company previously measured its pension
and postretirement plans as of October 1 of each year.





In
addition, the Company has unfunded deferred compensation and supplemental
executive retirement plans for selected current and former employees and
officers that provide benefits that cannot be paid from a qualified retirement
plan due to Internal Revenue Code restrictions. These plans are nonqualified
under the Internal Revenue Code, and assets used to fund benefit payments are
not segregated from other assets of the Company, therefore, in general, a
participant's or beneficiary's claim to benefits under these plans is as a
general creditor.





Page
45


Income
Taxes





Provisions
for income taxes are based on taxes currently payable or refundable and deferred
income taxes on temporary differences between the tax basis of assets and
liabilities and their reported amounts in the consolidated financial statements.
Deferred tax assets and liabilities are reported in the consolidated financial
statements at currently enacted income tax rates applicable to the period in
which the deferred tax assets and liabilities are expected to be realized or
settled.





Earnings
per Share





Basic
earnings per share are computed by dividing net income by the weighted average
number of common shares outstanding throughout each year.  Diluted
earnings per share gives effect to weighted average shares that would be
outstanding assuming the exercise of issued stock options using the treasury
stock method.





Other
Comprehensive (Loss) Income





Accounting
principles generally accepted in the United States of America, require that
recognized revenue, expenses, gains and losses be included in net
income.  Although certain changes in assets and liabilities, such as
unrealized gains and losses on available-for-sale securities, and unrecognized
gains and losses, prior service costs and transition assets or obligations for
defined benefit pension and post-retirement plans are reported as a separate
component of the shareholders’ equity section of the consolidated statements of
condition, such items, along with net income, are components of comprehensive
(loss) income.





The
components of other comprehensive (loss) income and related tax effect at and
for the years ended December 31, are as follows:





(In
      thousands)
                    
                    2008
                    
                    
                    2007Unrealized
      holding (losses) gains on securities available for sale:Unrealized
      holding (losses) gains arising during the year
                    
                    
                    $(2,346
                    )
                    
                    
                    $690Reclassification
      adjustment for losses (gains) included in net income
                    
                    
                    2,191
                    
                    
                    
                    (378
                    )Net
      unrealized (losses) gains on securities available for sale
                    
                    
                    (155
                    )
                    
                    
                    312Defined
      benefit pension and post retirement plans:Additional
      plan (losses) gains
                    
                    
                    (2,257
                    )
                    
                    
                    103Reclassification
      adjustment for amortization of benefit plans'net
      loss and transition obligation recognized in netperiodic
      expense
                    
                    
                    84
                    
                    
                    
                    105Net
      change in defined benefit plan assets and obligations
                    
                    
                    (2,173
                    )
                    
                    
                    208Other
      comprehensive (loss) income before tax
                    
                    
                    (2,328
                    )
                    
                    
                    520Tax
      effect
                    
                    
                    632
                    
                    
                    
                    (207
                    )Other
      comprehensive (loss) income
                    
                    
                    $(1,696
                    )
                    
                    
                    $313





The
components of accumulated other comprehensive loss, net of related tax effects,
at December 31, are as follows:




(In
      thousands)
                  
                  2008
                  
                  
                  2007Unrealized
      losses on securities available for sale(net
      of tax benefit 2008 - $205; 2007 - $441)
                  
                  
                  $(1,053
                  )
                  
                  
                  $(661
                  )Net
      pension losses(net
      of tax benefit 2008 - $1352; 2007 - $495)
                  
                  
                  (2,027
                  )
                  
                  
                  (742
                  )Net
      post-retirement losses and transition obligation(net
      of tax benefit 2008 - $40; 2007 - $36)
                  
                  
                  (60
                  )
                  
                  
                  (54
                  )$(3,140
                  )
                  
                  
                  $(1,457
                  )








Page
46


Reclassifications





Certain
amounts in the 2007 consolidated financial statements have been reclassified to
conform to the current year presentation.  These reclassifications had
no effect on net income as previously reported.





NOTE
2:  NEW ACCOUNTING PRONOUNCEMENTS





In
December 2007, the FASB issued Statement No. 141 (R), Business Combinations (SFAS
141R). This Statement establishes principles and requirements for how the
acquirer of a business recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed, and any noncontrolling
interest in the acquiree. The Statement also provides guidance for recognizing
and measuring the goodwill acquired in the business combination and determines
what information to disclose to enable users of the financial statements to
evaluate the nature and financial effects of the business combination. The
guidance will become effective for the Company January 1, 2009. This
pronouncement will impact the Company’s accounting for business combinations
completed beginning January 1, 2009.





Staff
Accounting Bulletin No. 109 (SAB 109), "Written Loan Commitments Recorded at
Fair Value Through Earnings" expresses the views of the staff regarding written
loan commitments that are accounted for at fair value through earnings under
generally accepted accounting principles. To make the staff's views consistent
with current authoritative accounting guidance, the SAB revises and rescinds
portions of SAB No. 105, "Application of Accounting Principles to Loan
Commitments."  Specifically, the SAB revises the SEC staff's views on
incorporating expected net future cash flows related to loan servicing
activities in the fair value measurement of a written loan commitment. The SAB
retains the staff's views on incorporating expected net future cash flows
related to internally-developed intangible assets in the fair value measurement
of a written loan commitment. The staff expects registrants to apply the views
in Question 1 of SAB 109 on a prospective basis to derivative loan commitments
issued or modified in fiscal quarters beginning after December 15, 2007. The
adoption of SAB 109 did not have a material impact on the Company’s financial
statements.





In
February 2008, the FASB issued a FASB Staff Position (FSP) FAS 140-3,
“Accounting for Transfers of Financial Assets and Repurchase Financing
Transactions.” This FSP addresses the issue of whether or not these transactions
should be viewed as two separate transactions or as one "linked" transaction.
The FSP includes a "rebuttable presumption" that presumes linkage of the two
transactions unless the presumption can be overcome by meeting certain criteria.
The FSP will be effective for fiscal years beginning after November 15, 2008 and
will apply only to original transfers made after that date; early adoption will
not be allowed. The Company is currently evaluating the potential impact the new
pronouncement will have on its consolidated financial statements.





In April
2008, the FASB issued FSP FAS 142-3, “Determination of the Useful Life of
Intangible Assets.”  This FSP amends the factors that should be
considered in developing renewal or extension assumptions used to determine the
useful life of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible
Assets (SFAS 142).  The intent of this FSP is to improve the
consistency between the useful life of a recognized intangible asset under SFAS
142 and the period of expected cash flows used to measure the fair value of the
asset under SFAS 141R and other GAAP.  This FSP is effective for
financial statements issued for fiscal years beginning after December 15, 2008,
and interim periods within those fiscal years.  Early adoption is
prohibited.  The Company does not expect this pronouncement will have
a material impact on its consolidated financial statements.





In May
2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted
Accounting Principles”, (SFAS 162).  The purpose of SFAS 162 is to
improve financial reporting by providing a consistent framework for determining
what accounting principles should be applied when preparing GAAP financial
statements.  The FASB believes that issuing the GAAP hierarchy as a
FASB standard, recategorizing the existing GAAP hierarchy into two levels of
accounting literature (authoritative and non-authoritative), and elevating the
conceptual framework within the GAAP hierarchy are key objectives of achieving
the FASB’s goal of improving the quality of accounting standards and the
standard-setting process.  SFAS 162 is effective 60 days following the
SEC’s approval of Public Company Accounting Oversight Board (“PCAOB”) amendment
to AU Section 411.  The Company’s adoption of SFAS 162 is not expected
to have a material impact on its consolidated financial condition or results of
operations.





Page
47


In
October 2008, the FASB issued FSP SFAS No. 157-3,“Determining the Fair Value
of a Financial Asset When The Market for That Asset Is Not
Active”  (FSP 157-3), to clarify the application of the
provisions of SFAS 157 in an inactive market and how an entity would
determine fair value in an inactive market.  FSP 157-3 is
effective immediately and applied to our 2008 consolidated financial
statements.  The application of the provisions of FSP 157-3 did
not materially affect our results of operations or financial
condition.





In
November 2008, the SEC released a proposed roadmap regarding the potential use
by U.S. issuers of financial statements prepared in accordance with
International Financial Reporting Standards (IFRS). IFRS is a comprehensive
series of accounting standards published by the International Accounting
Standards Board (“IASB”). Under the proposed roadmap, the Company may be
required to prepare financial statements in accordance with IFRS as early as
2014. The SEC will make a determination in 2011 regarding the mandatory adoption
of IFRS. The Company is currently assessing the impact that this potential
change would have on its consolidated financial statements, and it will continue
to monitor the development of the potential implementation of IFRS.




In
December 2008, the FASB issued FSP FAS 132(R)-1, “Employers’ Disclosures about
Postretirement Benefit Plan Assets”.  This FSP amends SFAS 132(R),
“Employers’ Disclosures about Pensions and Other Postretirement Benefits”, to
provide guidance on an employer’s disclosures about plan assets of a defined
benefit pension or other postretirement plan.  The disclosures about
plan assets required by this FSP shall be provided for fiscal years ending after
December 15, 2009.  The Company is currently reviewing the effect this
new pronouncement will have on its consolidated financial
statements.




NOTE
3: INVESTMENT SECURITIES – AVAILABLE-FOR-SALE





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





December 31, 2008Gross
                      
                      
                      Gross
                      
                      
                      EstimatedAmortized
                      
                      
                      Unrealized
                      
                      
                      Unrealized
                      
                      
                      FairCost
                      
                      
                      Gains
                      
                      
                      Losses
                      
                      
                      Value(In
      thousands)Bond
      investment securities:US
      Treasury and agencies
                      
                      
                      $9,126
                      
                      
                      
                      $342
                      
                      
                      
                      $-
                      
                      
                      
                      $9,468State
      and political subdivisions
                      
                      
                      5,020
                      
                      
                      
                      23
                      
                      
                      
                      (70
                      )
                      
                      
                      4,973Corporate
                      
                      
                      12,181
                      
                      
                      
                      117
                      
                      
                      
                      (1,472
                      )
                      
                      
                      10,826Mortgage-backed
                      
                      
                      39,478
                      
                      
                      
                      707
                      
                      
                      
                      (155
                      )
                      
                      
                      40,030Total
                      
                      
                      65,805
                      
                      
                      
                      1,189
                      
                      
                      
                      (1,697
                      )
                      
                      
                      65,297Equity
      and other investments
                      
                      
                      7,591
                      
                      
                      
                      -
                      
                      
                      
                      (750
                      )
                      
                      
                      6,841Total
      investment securities
                      
                      
                      $73,396
                      
                      
                      
                      $1,189
                      
                      
                      
                      $(2,447
                      )
                      
                      
                      $72,138






Page
48


December 31, 2007Gross
                            
                            
                            Gross
                            
                            
                            EstimatedAmortized
                            
                            
                            Unrealized
                            
                            
                            Unrealized
                            
                            
                            FairCost
                            
                            
                            Gains
                            
                            
                            Losses
                            
                            
                            Value(In
      thousands)Bond
      investment securities:US
      Treasury and agencies
                            
                            
                            $18,672
                            
                            
                            
                            $27
                            
                            
                            
                            $(53
                            )
                            
                            
                            $18,646State
      and political subdivisions
                            
                            
                            5,342
                            
                            
                            
                            5
                            
                            
                            
                            (20
                            )
                            
                            
                            5,327Corporate
                            
                            
                            6,392
                            
                            
                            
                            1
                            
                            
                            
                            (366
                            )
                            
                            
                            6,027Mortgage-backed
                            
                            
                            28,615
                            
                            
                            
                            87
                            
                            
                            
                            (325
                            )
                            
                            
                            28,377Total
                            
                            
                            59,021
                            
                            
                            
                            120
                            
                            
                            
                            (764
                            )
                            
                            
                            58,377Equity
      and other investments
                            
                            
                            7,092
                            
                            
                            
                            14
                            
                            
                            
                            (473
                            )
                            
                            
                            6,633Total
      investment securities
                            
                            
                            $66,113
                            
                            
                            
                            $134
                            
                            
                            
                            $(1,237
                            )
                            
                            
                            $65,010





Gross
gains of $85,000 and $385,000 for 2008 and 2007, respectively and gross losses
of $23,000 and $7,000 for 2008 and 2007, respectively were realized on sales of
available for sale securities.





Investment
securities with a carrying value of approximately $37,815,000 at December 31,
2008 were pledged to collateralize certain deposit and borrowing
arrangements.





The
amortized cost and estimated fair value of debt investments at December 31, 2008
by contractual maturity are shown below. Expected maturities may differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without penalties.




Amortized
                    
                    
                    EstimatedCost
                    
                    
                    Fair
      Value(In
      thousands)Due
      in one year or less
                    
                    
                    $2,077
                    
                    
                    
                    $2,091Due
      after one year through five years
                    
                    
                    13,535
                    
                    
                    
                    13,192Due
      after five years through ten years
                    
                    
                    4,554
                    
                    
                    
                    4,469Due
      after ten years
                    
                    
                    6,161
                    
                    
                    
                    5,515Mortgage-backed
      securities
                    
                    
                    39,478
                    
                    
                    
                    40,030Totals
                    
                    
                    $65,805
                    
                    
                    
                    $65,297





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




December 31, 2008Less
      than Twelve Months
                                                                                    
                                                                                    
                                                                                    Twelve
      Months or More
                                                                                    
                                                                                    
                                                                                    TotalUnrealized
                                                                                    
                                                                                    
                                                                                    Fair
                                                                                    
                                                                                    
                                                                                    Unrealized
                                                                                    
                                                                                    
                                                                                    Fair
                                                                                    
                                                                                    
                                                                                    Unrealized
                                                                                    
                                                                                    
                                                                                    FairLosses
                                                                                    
                                                                                    
                                                                                    Value
                                                                                    
                                                                                    
                                                                                    Losses
                                                                                    
                                                                                    
                                                                                    Value
                                                                                    
                                                                                    
                                                                                    Losses
                                                                                    
                                                                                    
                                                                                    Value(In
      thousands)State
      and political subdivisions
                                                                                    
                                                                                    
                                                                                    $(70
                                                                                    )
                                                                                    
                                                                                    
                                                                                    $2,134
                                                                                    
                                                                                    
                                                                                    
                                                                                    $-
                                                                                    
                                                                                    
                                                                                    
                                                                                    $-
                                                                                    
                                                                                    
                                                                                    
                                                                                    $(70
                                                                                    )
                                                                                    
                                                                                    
                                                                                    $2,134Corporate
                                                                                    
                                                                                    
                                                                                    (327
                                                                                    )
                                                                                    
                                                                                    
                                                                                    5,349
                                                                                    
                                                                                    
                                                                                    
                                                                                    (1,145
                                                                                    )
                                                                                    
                                                                                    
                                                                                    2,805
                                                                                    
                                                                                    
                                                                                    
                                                                                    (1,472
                                                                                    )
                                                                                    
                                                                                    
                                                                                    8,154Mortgage-backed
                                                                                    
                                                                                    
                                                                                    (150
                                                                                    )
                                                                                    
                                                                                    
                                                                                    7,491
                                                                                    
                                                                                    
                                                                                    
                                                                                    (5
                                                                                    )
                                                                                    
                                                                                    
                                                                                    734
                                                                                    
                                                                                    
                                                                                    
                                                                                    (155
                                                                                    )
                                                                                    
                                                                                    
                                                                                    8,225Equity
      and other investments
                                                                                    
                                                                                    
                                                                                    (744
                                                                                    )
                                                                                    
                                                                                    
                                                                                    4,251
                                                                                    
                                                                                    
                                                                                    
                                                                                    (6
                                                                                    )
                                                                                    
                                                                                    
                                                                                    21
                                                                                    
                                                                                    
                                                                                    
                                                                                    (750
                                                                                    )
                                                                                    
                                                                                    
                                                                                    4,272$(1,291
                                                                                    )
                                                                                    
                                                                                    
                                                                                    $19,225
                                                                                    
                                                                                    
                                                                                    
                                                                                    $(1,156
                                                                                    )
                                                                                    
                                                                                    
                                                                                    $3,560
                                                                                    
                                                                                    
                                                                                    
                                                                                    $(2,447
                                                                                    )
                                                                                    
                                                                                    
                                                                                    $22,785




Page
49





December
      31, 2007Less
      than Twelve Months
                            
                            
                            Twelve
      Months or More
                            
                            
                            TotalUnrealized
                            
                            
                            Fair
                            
                            
                            Unrealized
                            
                            
                            Fair
                            
                            
                            Unrealized
                            
                            
                            FairLosses
                            
                            
                            Value
                            
                            
                            Losses
                            
                            
                            Value
                            
                            
                            Losses
                            
                            
                            Value(In
      thousands)US
      Treasury and agencies
                            
                            
                            $(1
                            )
                            
                            
                            $1,004
                            
                            
                            
                            $(52
                            )
                            
                            
                            $10,599
                            
                            
                            
                            $(53
                            )
                            
                            
                            $11,603State
      and political subdivisions
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            (20
                            )
                            
                            
                            3,362
                            
                            
                            
                            (20
                            )
                            
                            
                            3,362Corporate
                            
                            
                            (94
                            )
                            
                            
                            885
                            
                            
                            
                            (272
                            )
                            
                            
                            3,692
                            
                            
                            
                            (366
                            )
                            
                            
                            4,577Mortgage-backed
                            
                            
                            (16
                            )
                            
                            
                            4,973
                            
                            
                            
                            (309
                            )
                            
                            
                            17,169
                            
                            
                            
                            (325
                            )
                            
                            
                            22,142Equity
      and other investments
                            
                            
                            (2
                            )
                            
                            
                            12
                            
                            
                            
                            (471
                            )
                            
                            
                            6,043
                            
                            
                            
                            (473
                            )
                            
                            
                            6,055$(113
                            )
                            
                            
                            $6,874
                            
                            
                            
                            $(1,124
                            )
                            
                            
                            $40,865
                            
                            
                            
                            $(1,237
                            )
                            
                            
                            $47,739





The
Company reviews its securities portfolio for potential impairment issues at
least quarterly.  During the year 2008, the Company recorded other
than temporary impairment charges on: a $1,000,000 holding in a senior unsecured
note issued by Lehman Brothers Holdings Inc., which filed a Chapter 11
Bankruptcy petition on September 15, 2008, in the amount of $875,000, the AMF
Large Cap Equity Fund in the amount of $690,000, $269,000 in the AMF Ultra Short
Mortgage Fund, $67,000 in the Financial Institutions Fund and $10,000 on a stock
investment in The Phoenix Companies. No impairment losses were recorded during
2007.




At
December 31, 2008, 5 state and political subdivision securities had unrealized
losses.  During January 2009, the Company sold the majority of its
state and political subdivision portfolio.  Only 5 holdings, all of
which have final maturity dates within the next 12 months, were not
liquidated.  The portfolio was sold to take advantage of historically
high pricing levels, while generating liquidity to fund loan portfolio
growth.  Only one of the 5 securities that were in unrealized loss
positions at December 31 was actually sold at a loss.  The loss
totaled $5,500, or 1.2%, of the security’s carrying value.  The total
sale of these holdings resulted in an overall gain recognized by the Company of
$85,000.  Management has the intent and ability to hold the remaining
short-term positions to maturity.





At
December 31, 2008, 12 corporate securities were in unrealized loss
positions.  The two securities in the largest unrealized loss position
represent trust-preferred issuances from large money center financial
institutions.  The JP Morgan Chase floating rate trust-preferred
security has a carrying value of $984,000 and a fair value of $525,000. The Bank
of America floating rate trust-preferred security has a carrying value of
$979,000 and a fair value of $678,000.  The securities are rated A1
and A2 by Moody’s.  The securities are both floating rate notes that
adjust quarterly to LIBOR.  These securities reflect net unrealized
losses due to the fact that current similar issuances are being originated at
much higher spreads to LIBOR, as the market currently demands a greater pricing
premium for the associated risk in the current economic
environment.  Management has performed a detailed credit analysis on
the underlying companies and has concluded that each issue is not credit
impaired.  Due to the fact that each security has in excess of 18
years until final maturity, and management has determined that there is no
related credit impairment, the associated pricing risk is managed similar to
long-term, low yielding, 15 and 30 year fixed rate residential mortgages carried
in the Company’s loan portfolio.  The risk is managed through the
Company’s extensive interest rate risk management
procedures.  Management has the intent and ability to hold these
securities to maturity or market price recovery, thus, the securities are not
deemed to be other-than-temporarily impaired.





The next
group of 8 corporate securities represent fixed rate notes with varying yields
and maturities.  The unrealized loss positions principally relate to
changes in interest rates subsequent to the security acquisition date, as well
as a greater amount of credit spread currently being priced into similar
security offerings.  All eight securities are currently A rated or
better by Moody’s and S & P.  Management has performed a detailed
credit review on each security issuer and determined that none of the issues are
credit impaired.  Management has the intent and ability to hold these
securities to maturity or market price recovery, thus, the securities are not
deemed to be other-than- temporarily impaired.




Page
50


The final
two corporate securities in unrealized loss positions are a senior unsecured
bond issued by Lehman Brothers, which was written down to its market value at
September 30, 2008, and a senior unsecured fixed rate bond issued by CIT
Group.  Management has obtained current pricing quotes on its Lehman
holding.  Based on the quotes, management deems the current carrying
value of the bond to be appropriate.  The CIT Group bond, with a
carrying value of $996,000, matures in February 2010 and carries a rating of
Baa2 from Moody’s.  The bond’s fair value at December 31, 2008 was
$861,000 and had improved 25% when compared to its historic low, which was
experienced during the third quarter of 2008.   The bond
valuation has continued to improve through February 2009.  CIT Group
has strengthened its balance sheet by exchanging old debt for cash and
subordinated notes due in 2018, as well as by raising additional
capital.  Management has performed a detailed credit review of the
issuer and continues to stay apprised of issues impacting this holding and
currently feels that the security is not other than temporarily
impaired.  Management has the intent and ability to hold this security
to maturity.





At
December 31, 2008, 33 mortgage-backed securities have unrealized
losses.  The unrealized losses relate primarily to securities issued
by FNMA, FHLMC and GNMA and are currently rated AAA by Moody’s Investor Services
(‘Moody’s”) and Standards and Poor (“S & P”).  These unrealized
losses relate principally to changes in interest rates subsequent to the
acquisition of the specific securities.  None of the securities in
this category had an unrealized loss that exceeded 10%, and the vast majority
had unrealized losses under 1%, or $1,000.  The Company has the intent
and ability to hold the individual securities to maturity or market price
recovery.





At
December 31, 2008, 4 holdings, classified as equity and other investments, had
unrealized net losses.  Two of the individual holdings had losses of
approximately $7,000 in total at December 31, 2008.  One of the two
remaining holdings, the AMF Ultra Short Mortgage Fund (“the Fund”), represents
an investment in a mutual fund backed by short-duration adjustable rate
mortgage-backed security products.  At September 30, 2008, the Company
recorded other-than-temporary impairment charges totaling $612,000, or 18%, of
the Fund’s carrying value, to the stated NAV.  At December 31, 2008,
the carrying value of the Company’s remaining investment in the AMF Ultra Short
Mortgage Fund was $2,804,000.  The fair value was $2,517,000. The
Fund’s value decline is a result of both the weakness in the trading market of
the underlying securities and the deterioration in the credit quality of a
portion of the Fund’s private label mortgage-backed security
holdings.  The Company’s ability to reduce its investment position in
the Fund is limited by the Fund instituting its in-kind redemption
provisions.  In particular, the Fund is limiting cash redemptions to
$250,000 every 90 days, with any excess redemption paid by transferring
underlying assets (in-kind) held by the Fund.  The Company requested,
and received, an initial $250,000 cash redemption in April 2008; two additional
partial redemptions would have been available to the Company during fiscal year
2008.  Management decided to forgo taking additional partial
redemptions as a reflection of its intent and ability to hold the Fund until its
value improves.





The
current Fund value is not a compilation of the daily trading prices of the
underlying securities, but rather is derived from matrix pricing in an illiquid
market, thus it is more reflective of liquidation pricing than of the Fund’s
true fair value.  Fund cash flows have been uninterrupted, as no
individual security has experienced a default of contractual principal or
interest payments. The Fund continues to reinvest excess cash flows into
short-term federal agency backed mortgage-backed securities, thus improving the
overall risk profile of the Fund. During 2008, the Fund composition has shifted
from 75% private label holdings and 25% agency holdings to 50% private label and
50% federal agency holdings.  In addition, a detailed review of the
Funds holdings at December 31, 2008, indicates that only 14.6% of the Fund
holdings are rated below the Company’s definition of investment grade, (A rated
or better by Moody’s or S & P).





Many of
the Government’s initiative to reinvigorate the economy and improve asset
valuations are just beginning to take effect.  Significant
improvements in market conditions should be realized in the near
term.  Management has displayed the intent and ability to hold this
security until its value improves.  Given all these facts, it is
management’s opinion that the current carrying value of the Fund is reasonable
and that additional adjustments to the Fund’s carrying value are not necessary
at this time.





The last
holding in an unrealized loss position at December 31, 2008, is the Company’s
investment in the AMF Large Cap Equity Institutional Fund, (“the Fund”), a
mutual fund consisting of investment grade, dividend paying common stocks of
large capitalization companies (companies with market capitalization in excess
of $5 billion).  Management recorded an other-than-temporary
impairment charge of $690,000, or 23.9%, of the Funds value, as of September 30,
2008.  At December 31, 2008, the carrying value of the Company’s
remaining




Page
51


investment
in the AMF Large Cap Equity Institutional Fund was $2,192,000.  The
fair value was $1,734,000. Management believes that the underlying investment
grade securities represent equity positions in well-managed companies with a
diverse cross section of various industries.  Management has performed
a review of each underlying holding comprising the Fund.  The review
and analysis indicates that there are no individually impaired holdings and
there is no indication that the profitability of the individual companies is
impaired beyond the current economic cycle.  The Fund value is highly
correlated to the overall stock market performance and management believes that
the market will return to previous valuation levels over the next economic
cycle.  Many of the Government’s initiatives to reinvigorate the
economy are just beginning to take effect and significant improvements in
overall market conditions should be realized in the near
term.  Management has the intent and ability to hold this security
until its value improves.  As such, the recent decline in market value
since September 30, 2008 is not considered to be
other-than-temporary.





NOTE
4: LOANS





Major
classifications of loans at December 31, are as follows:





(In
      thousands)
                    
                    2008
                    
                    
                    2007Real
      estate mortgages:Residential
                    
                    
                    $132,825
                    
                    
                    
                    $122,045Construction
                    
                    
                    2,508
                    
                    
                    
                    3,776Commercial
                    
                    
                    55,061
                    
                    
                    
                    45,490190,394
                    
                    
                    
                    171,311Other
      loans:Consumer
                    
                    
                    3,516
                    
                    
                    
                    3,926Home
      Equity/Second Mortgage
                    
                    
                    24,392
                    
                    
                    
                    21,379Lease
      financing
                    
                    
                    2,308
                    
                    
                    
                    777Commercial
                    
                    
                    25,215
                    
                    
                    
                    20,576Municipal
      loans
                    
                    
                    3,162
                    
                    
                    
                    3,93558,593
                    
                    
                    
                    50,593Total
      loans
                    
                    
                    248,987
                    
                    
                    
                    221,904Net
      deferred loan costs
                    
                    
                    885
                    
                    
                    
                    845Less
      allowance for loan losses
                    
                    
                    (2,472
                    )
                    
                    
                    (1,703
                    )Loans
      receivable, net
                    
                    
                    $247,400
                    
                    
                    
                    $221,046





The
Company grants mortgage and consumer loans to customers throughout Oswego and
parts of Onondaga counties. Although the Company has a diversified loan
portfolio, a substantial portion of its debtors’ abilities to honor their
contracts is dependent upon the counties’ employment and economic
conditions.





The
following represents the activity associated with loans to executive officers
and directors and their affiliated entities during the year ended December 31,
2008:





(In
      thousands)Balance
      at Beginning of year
                  
                  
                  $3,835Originations
                  
                  
                  2,940Principal
      payments
                  
                  
                  (323
                  )Balance
      at end of year
                  
                  
                  $6,452








Page
52




NOTE
5: ALLOWANCE FOR LOAN LOSSES





Changes
in the allowance for loan losses for the years ended December 31, are summarized
as follows:





(In
      thousands)
                      
                      2008
                      
                      
                      2007Balance
      at beginning of year
                      
                      
                      $1,703
                      
                      
                      
                      $1,496Recoveries
      credited:Commercial
                      
                      
                      17
                      
                      
                      
                      -Mortgage
                      
                      
                      -
                      
                      
                      
                      23Consumer
                      
                      
                      30
                      
                      
                      
                      27Total
      recoveries
                      
                      
                      47
                      
                      
                      
                      50Loans
      charged-off:Commercial
                      
                      
                      (46
                      )
                      
                      
                      (85
                      )Mortgage
                      
                      
                      -
                      
                      
                      
                      (46
                      )Consumer
                      
                      
                      (52
                      )
                      
                      
                      (77
                      )Total
      charged-off
                      
                      
                      (98
                      )
                      
                      
                      (208
                      )Net
      charge-offs
                      
                      
                      (51
                      )
                      
                      
                      (158
                      )Provision
      for loan losses
                      
                      
                      820
                      
                      
                      
                      365Balance
      at end of year
                      
                      
                      $2,472
                      
                      
                      
                      $1,703Ratio
      of net charge-offs to average loans outstanding
                      
                      
                      0.02
                      %
                      
                      
                      0.08
                      %








The
following is a summary of information pertaining to impaired loans for the years
ended December 31:


(In
      thousands)
                  
                  2008
                  
                  
                  2007Impaired
      loans without a valuation allowance
                  
                  
                  $2,020
                  
                  
                  
                  $1,312Impaired
      loans with a valuation allowance
                  
                  
                  436
                  
                  
                  
                  409Total
      impaired loans
                  
                  
                  $2,456
                  
                  
                  
                  $1,721Valuation
      allowance related to impaired loans
                  
                  
                  $  
      141
                  
                  
                  
                  $  
      152Average
      investment in impaired loans
                  
                  
                  $2,252
                  
                  
                  
                  $1,749Interest
      income recognized on impaired loans
                  
                  
                  $  
      176
                  
                  
                  
                  $    
      92Interest
      income recognized on a cash basis onimpaired
      loans
                  
                  
                  $      
      -
                  
                  
                  
                  $      
      -





The
amount of loans on which the Company has ceased accruing interest aggregated
approximately $2,323,000 and $1,591,000 at December 31, 2008 and 2007,
respectively.  There were no loans past due ninety days or more and
still accruing interest at December 31, 2008 or 2007.





NOTE
6: SERVICING





Loans
serviced for others are not included in the accompanying consolidated statements
of condition.  The unpaid principal balances of mortgage and other
loans serviced for others were $46,095,000 and $50,409,000 at December 31, 2008
and 2007, respectively.





The
balance of capitalized servicing rights included in other assets at December 31,
2008 and 2007, was $15,000 and $43,000, respectively.








Page
53





The
following summarizes mortgage-servicing rights capitalized and
amortized:





(In
      thousands)
                  
                  2008
                  
                  
                  2007Mortgage
      servicing rights capitalized
                  
                  
                  $  
      -
                  
                  
                  
                  $24Mortgage
      servicing rights amortized
                  
                  
                  $28
                  
                  
                  
                  $46





NOTE
7: PREMISES AND EQUIPMENT





A summary
of premises and equipment at December 31, is as follows:





(In
      thousands)
                
                2008
                
                
                2007Land
                
                
                $1,226
                
                
                
                $1,226Buildings
                
                
                7,007
                
                
                
                6,963Furniture,
      fixtures and equipment
                
                
                7,090
                
                
                
                6,861Construction
      in progress
                
                
                134
                
                
                
                6615,457
                
                
                
                15,116Less:
      Accumulated depreciation
                
                
                8,007
                
                
                
                7,309$7,450
                
                
                
                $7,807





NOTE
8: GOODWILL AND INTANGIBLE ASSETS





A summary
of goodwill and other intangible assets at December 31, is as
follows:





2008
                
                
                2007Gross
                
                
                
                
                
                GrossCarrying
                
                
                Accumulated
                
                
                Carrying
                
                
                Accumulated(In
      thousands)
                
                Amount
                
                
                Amortization
                
                
                Amount
                
                
                AmortizationGoodwill
                
                
                $3,840
                
                
                
                $       
      -
                
                
                
                $3,840
                
                
                
                $        
      -Core
      deposit intangibles
                
                
                1,111
                
                
                
                (1,111
                )
                
                
                1,111
                
                
                
                (1,111
                )





Core
deposit intangibles became fully amortized in October 2007. Amortization of
goodwill and core deposit intangibles is deductible for tax
purposes.





As a
result of deteriorating economic conditions in the financial markets, which
impacted the trading value of the Company’s common stock, management engaged an
independent third party to test the Company’s goodwill for impairment pursuant
to SFAS No. 142, “Goodwill and Other Intangible Assets”.  Management
considers the Company, which includes all banking operations on a consolidated
basis, as the “reporting unit” under SFAS 142 for the purpose of testing for
goodwill impairment.  Testing was performed by utilizing a three-step
valuation approach using a measurement date of December 31, 2008:





(1)
            The
      estimated fair value of the Company as of the measurement date was
      determined utilizing three valuation methodologies including the
      Comparable Transactions approach, the Control Premium approach and the
      Discounted Cash Flow approach.  All approaches were considered
      in the final estimate of fair value, with the results of the approaches
      weighted based upon their level within the SFAS No.157 hierarchy and
      management’s comfort level with each approach. In the final determination,
      the greatest emphasis was placed on approaches utilizing primarily Level 2
      inputs (the Comparable Transaction and Control Premium approaches), and
      less weight was placed on the Discounted Cash Flow approach due to the
      number of Level 3 inputs that were
utilized.





Page
54


(2)
            The
      amount of goodwill that would be generated if the Company were to be sold
      at a price equal to its estimated fair value was
    calculated.





(3)
            A
      comparison of the estimated fair value of goodwill, determined in steps
      (1) and (2) above, to the current carrying value of goodwill on the
      Company’s books as of the measurement date was
  performed.





As a
result of the above steps, it was determined that the estimated fair value of
goodwill exceeded the Company’s carrying value, and thus there was no goodwill
impairment at December 31, 2008.





NOTE
9: DEPOSITS





A summary
of deposits at December 31, is as follows:





(In
      thousands)
                      
                      2008
                      
                      
                      2007Savings
      accounts
                      
                      
                      $49,550
                      
                      
                      
                      $50,789Time
      accounts
                      
                      
                      91,223
                      
                      
                      
                      86,588Time
      accounts over $100,000
                      
                      
                      40,731
                      
                      
                      
                      33,016Money
      management accounts
                      
                      
                      10,300
                      
                      
                      
                      9,657MMDA
      accounts
                      
                      
                      27,594
                      
                      
                      
                      24,882Demand
      deposit interest-bearing
                      
                      
                      20,916
                      
                      
                      
                      20,467Demand
      deposit noninterest-bearing
                      
                      
                      26,150
                      
                      
                      
                      22,766Mortgage
      escrow funds
                      
                      
                      2,974
                      
                      
                      
                      2,920$269,438
                      
                      
                      
                      $251,085





At
December 31, 2008, the scheduled maturities of time deposits are as
follows:





(In
      thousands)Year
      of Maturity:2009
                  
                  
                  $93,2512010
                  
                  
                  19,4102011
                  
                  
                  7,4752012
                  
                  
                  6,5262013
                  
                  
                  1,681Thereafter
                  
                  
                  3,611$131,954





NOTE
10: BORROWED FUNDS





The
composition of borrowings (excluding junior subordinated debentures) at December
31, is as follows:





(In
      thousands)
                      
                      2008
                      
                      
                      2007Short-term:FHLB
      Advances
                      
                      
                      $4,000
                      
                      
                      
                      $9,000Overnight
      Line of Credit with FHLB
                      
                      
                      13,575
                      
                      
                      
                      9,400Total
      short-term borrowings
                      
                      
                      $17,575
                      
                      
                      
                      $18,400Long-term:FHLB
      repurchase agreements
                      
                      
                      $2,400
                      
                      
                      
                      $2,400FHLB
      advances
                      
                      
                      27,000
                      
                      
                      
                      17,610Citi
      Group repurchase agreements
                      
                      
                      5,000
                      
                      
                      
                      -Total
      long-term borrowings
                      
                      
                      $34,400
                      
                      
                      
                      $20,010






Page
55


The
principal balances, interest rates and maturities of the above fixed rate
borrowings at December 31, 2008 is as follows:




Term
                  
                  Principal
                  
                  
                  Rates(Dollars
      in thousands)Short-term
      advances with FHLB
                  
                  
                  $17,575
                  
                  
                  
                  0.46%-3.95
                  %Long-term:Repurchase
      agreements with FHLB (due in 2009)
                  
                  
                  $2,400
                  
                  
                  
                  5.56%-5.76
                  %Repurchase
      agreements with Citi Group (due in 2013)
                  
                  
                  5,000
                  
                  
                  
                  2.95
                  %Advances
      with FHLBdue
      within 1 years
                  
                  
                  3,000
                  
                  
                  
                  4.03%-6.00
                  %due
      within 2 years
                  
                  
                  12,000
                  
                  
                  
                  2.42%-4.39
                  %due
      within 3 years
                  
                  
                  5,000
                  
                  
                  
                  4.02%-4.19
                  %due
      within 4 years
                  
                  
                  3,000
                  
                  
                  
                  4.91
                  %due
      within 5 years
                  
                  
                  4,000
                  
                  
                  
                  4.46%-4.53
                  %Total
      advances with FHLB
                  
                  
                  27,000Total
      long-term borrowings
                  
                  
                  $34,400





The
repurchase agreements with the Federal Home Loan Bank ("FHLB") and Citi Group
are collateralized by certain investment securities having a carrying value of
$8,260,000 at December 31, 2008.  The collateral is under the
Company’s control.  The overnight line of credit agreement with the
FHLB is used for liquidity purposes.   Interest on this line is
determined at the time of borrowing.  The average rate paid on the
overnight line during 2008 approximated 1.61%.  At December 31, 2008,
$20,103,000 was available under the overnight line.  As a companion to
the overnight line with the FHLB, the Company also has access to a One-Month
Overnight Repricing Line of Credit.  This allows the Company to borrow
funds for a term of one month, which reprice daily over the term, thus freeing
up the overnight line for daily liquidity needs.  The Company has
$33,678,000 available under this facility, yet has never accessed the one-month
overnight repricing line. In addition to the overnight line of credit program,
the Company also has access to the FHLB’s Term Advance Program under which it
can borrow at various terms and interest rates.  Residential mortgage
loans with a carrying value of $77,471,000 and FHLB stock with a carrying value
of $2,549,000 have been pledged by the Company under a blanket collateral
agreement to secure the Company’s line of credit and term
borrowings.  The total outstanding indebtedness under all three
borrowing facilities with the FHLB can not exceed the total value of the assets
pledged under the blanket collateral agreement.  The Company also
maintains a $5,000,000 line of credit with a correspondent
bank.  Interest on the line is determined at the time of
borrowing.  The Company did not draw on the line during
2008.  In order to utilize the line, the Company is required to secure
the outstanding balance with marketable investment securities.





The
Company has a non-consolidated subsidiary trust, Pathfinder Statutory Trust II,
of which 100% of the common equity is owned by the Company.  The Trust
issued $5,000,000 of 30 year floating rate Company-obligated pooled capital
securities of Pathfinder Statutory Trust II.  The Company borrowed the
proceeds of the capital securities from its subsidiary by issuing floating rate
junior subordinated deferrable interest debentures having substantially similar
terms.  The capital securities mature in 2037 and are treated as Tier
1 capital by the Federal Deposit Insurance Corporation and the Office of Thrift
Supervision.  The capital securities of the trust are a pooled trust
preferred fund of Preferred Term Securities VI, Ltd. and are tied to the 3-month
LIBOR plus 1.65% (3.65% at December 31, 2008) with a five-year call
provision.  The Company guarantees all of these
securities.





The
Company's equity interest in the trust subsidiary of $155,000 is reported in
"Other assets".  For regulatory reporting purposes, the Federal
Reserve Board has indicated that the preferred securities will continue to
qualify as Tier 1 Capital subject to previously specified limitations, until
further notice. If regulators make a determination that Trust Preferred
Securities can no longer be considered in regulatory capital, the securities
become callable and the Company may redeem them.




Page
56


The
Company retired its original trust preferred issuance of $5,000,000 during June
2007, at its earliest call date.  The original issuance of pooled
capital securities were tied to the 3-month LIBOR plus 3.45%.  The
proceeds from the new issuance of Pathfinder Statutory Trust II were used to
retire the original issuance of Pathfinder Statutory Trust I.




NOTE 11: EMPLOYEE BENEFITS AND DEFERRED COMPENSATION
AND SUPPLEMENTAL RETIREMENT PLANS




The
Company has a noncontributory defined benefit pension plan covering
substantially all employees. The plan provides defined benefits based on years
of service and final average salary. In addition, the Company provides certain
health and life insurance benefits for eligible retired
employees.  The healthcare plan is contributory with participants’
contributions adjusted annually; the life insurance plan is
noncontributory.  Employees with less than 14 years of service as of
January 1, 1995, are not eligible for the health and life insurance retirement
benefits.





On
January 1, 2008, the Company recorded a $48,000 charge to retained earnings,
representing the cumulative effect adjustment upon adopting the measurement date
transition rule for the Company’s pension plan and postretirement benefit
plan.  In accordance with SFAS 158, Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans, measurement date
provisions, plan assets and obligations are to be measured as of the employer’s
balance sheet date.  The Company previously measured its pension and
postretirement plans as of October 1 of each year.  As a result of the
measurement date provisions, the Company increased its retirement plan
liabilities with a corresponding charge to retained earnings, representing the
net periodic benefit cost for the period between the October 1, 2007 measurement
date and January 1, 2008.





The
following tables set forth the changes in the plans’ benefit obligations, fair
value of plan assets and the plans’ funded status as of December
31:




Pension Benefits
                        
                        
                        Postretirement
      Benefits(In
      thousands)
                        
                        2008
                        
                        
                        2007
                        
                        
                        2008
                        
                        
                        2007Change
      in benefit obligations:Benefit
      obligations at beginning of year
                        
                        
                        $4,843
                        
                        
                        
                        $4,439
                        
                        
                        
                        $335
                        
                        
                        
                        $346Adjustment
      for measurement date change
                        
                        
                        132
                        
                        
                        
                        -
                        
                        
                        
                        6
                        
                        
                        
                        -Service
      cost
                        
                        
                        214
                        
                        
                        
                        196
                        
                        
                        
                        3
                        
                        
                        
                        3Interest
      cost
                        
                        
                        316
                        
                        
                        
                        273
                        
                        
                        
                        21
                        
                        
                        
                        21Actuarial
      loss (gain)
                        
                        
                        174
                        
                        
                        
                        83
                        
                        
                        
                        32
                        
                        
                        
                        (13
                        )Benefits
      paid
                        
                        
                        (186
                        )
                        
                        
                        (148
                        )
                        
                        
                        (28
                        )
                        
                        
                        (22
                        )Benefit
      obligations at end of year
                        
                        
                        5,493
                        
                        
                        
                        4,843
                        
                        
                        
                        369
                        
                        
                        
                        335Change
      in plan assets:Fair
      value of plan assets at beginning of year
                        
                        
                        4,977
                        
                        
                        
                        4,338
                        
                        
                        
                        -
                        
                        
                        
                        -Actual
      return on plan assets
                        
                        
                        (1,493
                        )
                        
                        
                        565
                        
                        
                        
                        -
                        
                        
                        
                        -Benefits
      paid
                        
                        
                        (186
                        )
                        
                        
                        (148
                        )
                        
                        
                        (28
                        )
                        
                        
                        (22
                        )Employer
      contributions
                        
                        
                        163
                        
                        
                        
                        222
                        
                        
                        
                        28
                        
                        
                        
                        22Fair
      value of plan assets at end of year
                        
                        
                        3,461
                        
                        
                        
                        4,977
                        
                        
                        
                        -
                        
                        
                        
                        -Funded
      Status -  (liability) asset
                        
                        
                        $(2,032
                        )
                        
                        
                        $134
                        
                        
                        
                        $(369
                        )
                        
                        
                        $(335
                        )








Page
57





Amounts
recognized in accumulated other comprehensive loss as of December
31,


(In
      thousands)
                      
                      
                      2008
                      2007Unrecognized
      transition obligation
                      
                      
                      $      
      56
                      $             79Net
      loss
                      
                      
                      3,423
                      1,2483,479
                      1,327Tax
      Effect
                      
                      
                      1,392
                      531$ 
      2,087
                      $            796





The
accumulated benefit obligation for the defined benefit pension plan was
$4,537,000 and $3,953,000 at December 31, 2008 and 2007,
respectively.  The postretirement plan had an accumulated benefit
obligation of $369,000 and $335,000 at December 31, 2008 and 2007,
respectively.





The
significant assumptions used in determining the benefit obligations as of
December 31, 2008 and 2007 are as follows:




Pension
      Benefits
                                              
                                              
                                              Postretirement
      Benefits2008
                                              
                                              
                                              2007
                                              
                                              
                                              2008
                                              
                                              
                                              2007Weighted
      average discount rate
                                              
                                              
                                              6.13
                                              %
                                              
                                              
                                              6.63
                                              %
                                              
                                              
                                              6.13
                                              %
                                              
                                              
                                              6.63
                                              %Rate
      of increase in future compensation levels
                                              
                                              
                                              3.50
                                              %
                                              
                                              
                                              4.00
                                              %
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -








Assumed
health care cost trend rates have a significant effect on the amounts reported
for the postretirement health care plan.   The annual rates of
increase in the per capita cost of covered medical and prescription drug
benefits for year-end calculations were assumed to be 9.00% and 7.75%,
respectively.  The rates were assumed to decrease gradually to 5.00%
in 2013 and remain at that level thereafter.  A one-percentage point
change in the health care cost trend rates would have the following
effects:




1
      Percentage
                    
                    
                    1
      PercentagePoint
                    
                    
                    Point(In
      thousands)
                    
                    Increase
                    
                    
                    DecreaseEffect
      on total of service and interestcost
      components
                    
                    
                    $1
                    
                    
                    
                    $(1
                    )Effect
      on post retirement benefit obligation
                    
                    
                    10
                    
                    
                    
                    (9
                    )








The
composition of the net periodic benefit plan cost for the years ended December
31, 2008 and 2007 is as follows:




Pension
      Benefits
                    
                    
                    Postretirement
      Benefits2008
                    
                    
                    2007
                    
                    
                    2008
                    
                    
                    2007(In
      thousands)Service
      cost
                    
                    
                    $214
                    
                    
                    
                    $196
                    
                    
                    
                    $ 
      3
                    
                    
                    
                    $ 
      3Interest
      cost
                    
                    
                    316
                    
                    
                    
                    273
                    
                    
                    
                    21
                    
                    
                    
                    21Amortization
      of transition obligation
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    18
                    
                    
                    
                    18Amortization
      of net losses
                    
                    
                    66
                    
                    
                    
                    87
                    
                    
                    
                    -
                    
                    
                    
                    -Expected
      return on plan assets
                    
                    
                    (447
                    )
                    
                    
                    (392
                    )
                    
                    
                    -
                    
                    
                    
                    -Net
      periodic benefit plan cost
                    
                    
                    $149
                    
                    
                    
                    $164
                    
                    
                    
                    $42
                    
                    
                    
                    $42








Page
58





The
significant assumptions used in determining the net periodic benefit plan cost
for years ended December 31 were as follows:




Pension
      Benefits
                                  
                                  
                                  Postretirement
      Benefits2008
                                  
                                  
                                  2007
                                  
                                  
                                  2008
                                  
                                  
                                  2007Weighted
      average discount rate
                                  
                                  
                                  6.63
                                  %
                                  
                                  
                                  6.25
                                  %
                                  
                                  
                                  6.63
                                  %
                                  
                                  
                                  6.25
                                  %Expected
      long term rate of return on plan assets
                                  
                                  
                                  9.00
                                  %
                                  
                                  
                                  9.00
                                  %
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Rate
      of increase in future compensation levels
                                  
                                  
                                  4.00
                                  %
                                  
                                  
                                  3.00
                                  %
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -





The
long-term rate-of-return-on-assets assumption was set based on historical
returns earned by equities and fixed income securities, adjusted to reflect
expectations of future returns as applied to the plan’s target allocation of
asset classes.  Equities and fixed income securities were assumed to
earn real rates of return in the ranges of 5-9.0% and 2-6.0%,
respectively.  The long-term inflation rate was estimated to be
3.0%.  When these overall return expectations are applied to the
plan’s target allocation, the expected rate of return was determined to be 9.0%,
which is roughly the midpoint of the range of expected return.





The
expected long-term rate of return for 2009 has been decreased to 8.0% to reflect
current economic conditions and expected returns.  The estimated net
actuarial loss that will be amortized from accumulated other comprehensive loss
into net periodic benefit plan cost during 2009 is $261,000.  The
estimated amortization of the unrecognized transition obligation in 2009 is
$18,000.  Based on these factors, and a lower expected rate of return
on plan assets, the expected net periodic benefit plan cost for 2009 is
estimated at $593,000.  The negative impact on earnings resulting from
the projected increase in costs in 2009 is the result of increased amortization
of net pension losses and lower expected return on plan assets, both primarily
due to the decrease in value of plan assets in the defined benefit pension
plan.





The
Company’s pension plan weighted-average asset allocations at December 31, 2008,
and October 1, 2007, the plan measurement dates, by asset category are as
follows:





Asset
      Category
                
                2008
                
                
                2007Equity
      securities
                
                
                59
                %
                
                
                70
                %Debt
      securities
                
                
                41
                %
                
                
                30
                %Total
                
                
                100
                %
                
                
                100
                %





Plan
assets are invested in diversified investment funds of the RSI Retirement Trust
(the “Trust”), a series of no-load private placement funds.  The
investment funds include equity funds and bond funds, each with its own
investment objectives, investment strategies and risks, as detailed in the
Private Placement Memorandum.  The Trust has been given discretion by
the Plan Sponsor to determine the appropriate strategic asset allocation versus
plan liabilities, as governed by the Trust’s Statement of Investment Objectives
and Guidelines (the “Guidelines”).





The
long-term investment objective is to be invested 65% in equity securities
(equity mutual funds) and 35% in debt securities (bond mutual
funds).  If the plan is underfunded under the Guidelines, the bond
fund portion will be temporarily increased to 50% in order to lessen asset value
volatility.  When the plan is no longer underfunded, the bond fund
portion will be decreased back to 35%.  Asset rebalancing is scheduled
when the investment mix varies more than 10% from the target (i.e., a 20% target
range).





The
investment goal is to achieve investment results that will contribute to the
proper funding of the pension plan by exceeding the rate of inflation over the
long-term.  In addition, investment managers for the Trust are
expected to provide above average performance when compared to their peer
managers.  Performance volatility is also
monitored.  Risk/volatility is further managed by the distinct
investment objectives of each of the Trust funds and the diversification within
each fund.





Page
59





Due to
recent changes in pension funding law and sharp declines in asset fair values, a
good estimate of expected contributions for the fiscal year ending December 31,
2009 cannot be determined at this time.





The
following benefit payments, which reflect expected future service, as
appropriate, are expected to be paid.





Years
      ending December 31:(In
      thousands)2009
                    
                    
                    $ 
      1732010
                    
                    
                    1772011
                    
                    
                    1842012
                    
                    
                    1962013
                    
                    
                    211Years
      2014 - 2018
                    
                    
                    $1,391





The
Company also offers a 401(k) plan to its employees.  Contributions to
this plan by the Company were $116,000 and $148,000 for 2008 and 2007,
respectively.





The
Company maintains optional deferred compensation plans for its directors, and
certain executive officers, whereby fees and income normally received are
deferred and paid by the Company based upon a payment schedule commencing at age
65 and continuing monthly for 10 years. Directors must serve on the board for a
minimum of 5 years to be eligible for the Plan. At December 31, 2008 and 2007,
other liabilities include approximately $1,741,000 and $1,660,000, respectively,
relating to deferred compensation. Deferred compensation expense for the years
ended December 31, 2008 and 2007 amounted to approximately $225,000 and
$212,000, respectively.





The
Company has a supplemental executive retirement plan for the benefit of certain
executive officers.  At December 31, 2008 and 2007, other liabilities
included approximately $333,000 and $366,000 accrued under this plan.
Compensation expense includes approximately $49,000 relating to the supplemental
executive retirement plan for both 2008 and 2007.





To fund
the benefits under these plans, the Company is the owner of single premium life
insurance policies on participants in the non-qualified retirement
plans.  At December 31, 2008 and 2007, the cash surrender values of
these policies were $6,731,000 and $6,437,000, respectively.





NOTE
12:STOCK BASED COMPENSATION PLANS





In
February 1997, the Board of Directors approved a stock option plan and granted
options thereunder with an exercise price equal to the market value of the
Company’s shares at the date of grant.  Under the Stock Option Plan,
up to 132,249 options had been authorized for grant of incentive stock options
and nonqualified stock options, of which none remain at December 31,
2008.  The options granted have a 10-year term with one-third vesting
upon the grant date and the remaining vesting and becoming exercisable ratably
over a 2-year period.





Page
60








Activity
in the Stock Option Plan is as follows:


WeightedOptions
                  
                  
                  Average
                  
                  
                  Shares(Shares
      in thousands)
                  
                  Outstanding
                  
                  
                  Exercise
      Price
                  
                  
                  ExercisableOutstanding
      at January 1, 2007
                  
                  
                  37
                  
                  
                  
                  $7.53
                  
                  
                  
                  37Exercised
                  
                  
                  (17
                  )
                  
                  
                  6.60Outstanding
      at December 31, 2007
                  
                  
                  20
                  
                  
                  
                  8.34
                  
                  
                  
                  20Exercised
                  
                  
                  (1
                  )
                  
                  
                  8.34Outstanding
      at December 31, 2008
                  
                  
                  19
                  
                  
                  
                  8.34
                  
                  
                  
                  19





The
aggregate intrinsic value of a stock option represents the total pre-tax
intrinsic value (the amount by which the current market value of the underlying
stock exceeds the exercise price of the option) that would have been received by
the option holders had all option holders exercised their options on December
31, 2008.  The intrinsic value changes based on fluctuations in the
market value of the Company’s stock.  At December 31, 2008, the market
value of the Company’s stock was less than the stock option price, and
therefore, the outstanding and exercisable stock options had no aggregate
intrinsic value.





The stock
options exercised during 2008 had no intrinsic value.





At
December 31, 2008, the 18,850 options outstanding all had an exercise price of
$8.34 and an average remaining contractual life of 2.5 years.





NOTE 13:INCOME
TAXES





The
provision for income tax expense (benefit) for the years ended December 31, is
as follows:





(In
      thousands)
                      
                      2008
                      
                      
                      2007Current
                      
                      
                      $491
                      
                      
                      
                      $432Deferred
                      
                      
                      (388
                      )
                      
                      
                      (48
                      )$103
                      
                      
                      
                      $384





The
provision for income taxes includes the following:





(In
      thousands)
                      
                      2008
                      
                      
                      2007Federal
      Income Tax
                      
                      
                      $191
                      
                      
                      
                      $405New
      York State Franchise Tax
                      
                      
                      (88
                      )
                      
                      
                      (21
                      )$103
                      
                      
                      
                      $384











Page
61







The
components of the net deferred tax asset, included in other assets as of
December 31, are as follows:




(In
      thousands)
                      
                      2008
                      
                      
                      2007Assets:Deferred
      compensation
                      
                      
                      $802
                      
                      
                      
                      $783Allowance
      for loan losses
                      
                      
                      956
                      
                      
                      
                      659Postretirement
      benefits
                      
                      
                      144
                      
                      
                      
                      129Pension
      liability
                      
                      
                      786
                      
                      
                      
                      -Mortgage
      recording tax credit carryforward
                      
                      
                      417
                      
                      
                      
                      408Investment
      securities
                      
                      
                      503
                      
                      
                      
                      441Other
                      
                      
                      841
                      
                      
                      
                      944,449
                      
                      
                      
                      2,514Liabilities:Pension
      asset
                      
                      
                      -
                      
                      
                      
                      (52
                      )Depreciation
                      
                      
                      (475
                      )
                      
                      
                      (517
                      )Accretion
                      
                      
                      (45
                      )
                      
                      
                      (57
                      )Loan
      origination fees
                      
                      
                      (349
                      )
                      
                      
                      (335
                      )Intangible
      assets
                      
                      
                      (841
                      )
                      
                      
                      (651
                      )Prepaid
      expenses
                      
                      
                      (177
                      )
                      
                      
                      (107
                      )(1,887
                      )
                      
                      
                      (1,719
                      )2,562
                      
                      
                      
                      795Less:
      deferred tax asset valuation allowance
                      
                      
                      (540
                      )
                      
                      
                      -Net
      deferred tax asset
                      
                      
                      $2,022
                      
                      
                      
                      $795





Realization
of deferred tax assets is dependent upon the generation of future taxable income
or the existence of sufficient taxable income within the carry back
period.  A valuation allowance is provided when it is more likely than
not that some portion, or all of the deferred tax assets, will not be
realized.  In assessing the need for a valuation allowance, management
considers the scheduled reversal of the deferred tax liabilities, the level of
historical taxable income and the projected future level of taxable income over
the periods in which the temporary differences comprising the deferred tax
assets will be deductible.  The judgment about the level of future
taxable income is inherently subjective and is reviewed on a continual basis as
regulatory and business factors change. A valuation allowance of $540,000 was
established as of December 31, 2008, as management believes it may not generate
sufficient capital gains to offset its capital loss carry forward.





A
reconciliation of the federal statutory income tax rate to the effective income
tax rate for the years ended December 31, is as follows:




2008
                      
                      
                      2007Federal
      statutory income tax rate
                      
                      
                      34.0
                      %
                      
                      
                      34.0
                      %State
      tax
                      
                      
                      (12.5
                      )
                      
                      
                      (0.9
                      )Tax-exempt
      interest income
                      
                      
                      (17.7
                      )
                      
                      
                      (6.1
                      )Increase
      in value of life insurance
                      
                      
                      (19.2
                      )
                      
                      
                      (5.1
                      )Deferred
      tax valuation allowance
                      
                      
                      45.2
                      
                      
                      
                      -Other
                      
                      
                      (7.9
                      )
                      
                      
                      3.6Effective
      income tax rate
                      
                      
                      21.9
                      %
                      
                      
                      25.5
                      %





The
adoption of FIN 48 at January 1, 2007 did not have an impact on the Company’s
consolidated financial statements.  At December 31, 2008 and 2007, the
Company did not have any uncertain tax positions.  The Company’s
policy is to recognize interest and penalties on unrecognized tax benefits, if
any, in income tax expense in the Consolidated Statements of
Income.  The tax years subject to examination by the taxing
authorities are the years ended December 31, 2008, 2007, 2006, and
2005.





Page
62


NOTE 14:EARNINGS
PER SHARE





The
following is a reconciliation of basic to diluted earnings per share for the
years ended December 31:





(In
      thousands, except per share data)
                    
                    Earnings
                    
                    
                    Shares
                    
                    
                    EPS2008
      Net Income
                    
                    
                    $368Basic
      EPS
                    
                    
                    368
                    
                    
                    
                    2,484
                    
                    
                    
                    $0.15Effect
      of dilutive securitiesStock
      options
                    
                    
                    -
                    
                    
                    
                    1
                    
                    
                    
                    -Diluted
      EPS
                    
                    
                    $368
                    
                    
                    
                    2,485
                    
                    
                    
                    $0.152007
      Net Income
                    
                    
                    $1,122Basic
      EPS
                    
                    
                    1,122
                    
                    
                    
                    2,483
                    
                    
                    
                    $0.45Effect
      of dilutive securitiesStock
      options
                    
                    
                    -
                    
                    
                    
                    4
                    
                    
                    
                    -Diluted
      EPS
                    
                    
                    $1,122
                    
                    
                    
                    2,487
                    
                    
                    
                    $0.45





NOTE 15:COMMITMENTS AND CONTINGENCIES





The
Company is a party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit and standby letters
of credit.  Such commitments involve, to varying degrees, elements of
credit risk in excess of the amount recognized in the consolidated statement of
condition. The contractual amount of those commitments to extend credit reflects
the extent of involvement the Company has in this particular class of financial
instrument. The Company’s exposure to credit loss in the event of nonperformance
by the other party to the financial instrument for commitments to extend credit
is represented by the contractual amount of the instrument.  The
Company uses the same credit policies in making commitments as it does for
on-balance sheet instruments.





At
December 31, 2008 and 2007, the following financial instruments were outstanding
whose contract amounts represent credit risk:




Contract
      Amount(In
      thousands)
                                
                                2008
                                
                                
                                2007Commitments
      to grant loans
                                
                                
                                $8,723
                                
                                
                                
                                $9,677Unfunded
      commitments under lines of credit
                                
                                
                                15,710
                                
                                
                                
                                17,912Standby
      letters of credit
                                
                                
                                1,639
                                
                                
                                
                                1,744





Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Commitments generally
have fixed expiration dates or other termination clauses and may require payment
of a fee. Since some of the commitment amounts are expected to expire without
being drawn upon, the total commitment amounts do not necessarily represent
future cash requirements. The Company evaluates each customer’s creditworthiness
on a case-by-case basis. The amount of collateral obtained, if deemed necessary
by the Company upon extension of credit, is based on management’s credit
evaluation of the counter party. Collateral held varies but may include
residential real estate and income-producing commercial
properties.  Loan commitments outstanding at December 31, 2008 with
fixed interest rates amounted to approximately $6.1 million. Loan commitments,
including unused lines of credit, outstanding at December 31, 2008 with variable
interest rates amounted to approximately $20.0 million.  These
outstanding loan commitments carry current market rates. Unfunded
commitments under standby letters of credit, revolving credit lines and
overdraft protection agreements are commitments for possible future extensions
of credit to existing customers.  These lines of credit usually do not
contain a specified maturity date and may not be drawn upon to the total extent
to which the Company is committed.





Page
63


Outstanding
letters of credit written are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party.  The
majority of these standby letters of credit expire within the next twelve
months.  The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending other loan
commitments.  The Bank requires collateral supporting these letters of
credit as deemed necessary.  Management believes that the proceeds
obtained through a liquidation of such collateral would be sufficient to cover
the maximum potential amount of future payments required under the corresponding
guarantees.  The amount of the liability as of December 31, 2008 and
2007 for guarantees under standby letters of credit issued is not
material.





The
Company leases land and leasehold improvements under agreements that expire in
various years with renewal options over the next 30 years.  Rental
expense, included in building occupancy expense, amounted to $66,000 and $63,000
in 2008 and 2007, respectively.  In October 2002, the Company entered
into a land lease with one of its directors on an arms-length basis. In January
2006, the Company entered into a lease with Pathfinder Bancorp, MHC for the use
of a training facility.  This lease was also executed on an
arms-length basis.  The rent expense paid to the related parties
during 2008 and 2007 was $45,000 and $43,000, respectively. Approximate minimum
rental commitments for noncancelable operating leases are as
follows:


Years
      Ending December 31:(In
      thousands)2009
              
              
              $662010
              
              
              662011
              
              
              522012
              
              
              432013
              
              
              21Thereafter
              
              
              -Total
      minimum lease payments
              
              
              $248





NOTE 16:DIVIDENDS
AND RESTRICTIONS





The Board
of Directors of Pathfinder Bancorp, M.H.C., determines whether the Holding
Company will waive or receive dividends declared by the Company each time the
Company declares a dividend, which is expected to be on a quarterly basis. The
Holding Company may elect to receive dividends and utilize such funds to pay
expenses or for other allowable purposes. The Office of Thrift Supervision
(“OTS”) has indicated that (i) the Holding Company shall provide the OTS
annually with written notice of its intent to waive its dividends prior to the
proposed date of the dividend and the OTS shall have the authority to approve or
deny any dividend waiver request; (ii) if a waiver is granted, dividends waived
by the Holding Company will be excluded from the Company’s capital accounts for
purposes of calculating dividend payments to minority
shareholders.  During 2008, the Company paid or accrued dividends
totaling $487,000 to the Holding Company. For the second quarter ended June 30,
2008, the Holding Company waived the right to receive its portion of the cash
dividends declared on June 24, 2008, which totaled $163,000.  During
2007, the Holding Company waived dividends totaling $325,000.





The
Company's ability to pay dividends to its shareholders is largely dependent on
the Bank's ability to pay dividends to the Company.  In addition to
state law requirements and the capital requirements discussed in Note 17,
federal statutes, regulations and policies limit the circumstances under which
the Bank may pay dividends.  The amount of retained earnings legally
available under these regulations approximated $1,971,000 as of December 31,
2008.  Dividends paid by the Bank to the Company would be prohibited
if the effect thereof would cause the Bank’s capital to be reduced below
applicable minimum capital requirements.





Page
64


NOTE 17:REGULATORY
MATTERS





The Bank
is subject to various regulatory capital requirements administered by the
federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
Company’s financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of its assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. The capital amounts and classifications are also subject
to qualitative judgments by the regulators about components, risk weightings,
and other factors.





Quantitative
measures established by regulation to ensure capital adequacy require the Bank
to maintain amounts and ratios (set forth in the table below) of total and Tier
1 capital (as defined in the regulations) to risk-weighted assets (as defined),
and of Tier 1 capital (as defined) to average assets (as defined). Management
believes, as of December 31, 2008, that the Bank meets all capital adequacy
requirements to which it is subject.





As of
December 31, 2008, the Bank’s most recent notification from the Federal Deposit
Insurance Corporation categorized the Bank as “well-capitalized”, under the
regulatory framework for prompt corrective action.  To be categorized
as “well-capitalized”, the Bank must maintain total risk based, Tier 1
risk-based and Tier 1 leverage ratios as set forth in the tables below. There
are no conditions or events since that notification that management believes
have changed the Bank’s category.





The
Bank’s actual capital amounts and ratios as of December 31, 2008 and 2007 are
also presented in the following table.




MinimumTo
      Be "Well-Minimum
                      
                      
                      Capitalized"For Capital
                      
                      
                      Under PromptActual
                      
                      
                      Adequacy Purposes
                      
                      
                      Corrective Provisions(Dollars
      in thousands)
                      
                      Amount
                      
                      
                      Ratio
                      
                      
                      Amount
                      
                      
                      Ratio
                      
                      
                      Amount
                      
                      
                      RatioAs
      of December 31, 2008:Total
      Core Capital (to Risk-Weighted Assets)
                      
                      
                      $25,625
                      
                      
                      
                      10.8
                      %
                      
                      
                      $18,944
                      
                      
                      
                      8.0
                      %
                      
                      
                      $23,680
                      
                      
                      
                      10.0
                      %Tier
      1 Capital (to Risk-Weighted Assets)
                      
                      
                      $23,152
                      
                      
                      
                      9.8
                      %
                      
                      
                      $9,472
                      
                      
                      
                      4.0
                      %
                      
                      
                      $14,208
                      
                      
                      
                      6.0
                      %Tier
      1 Capital (to Average Assets)
                      
                      
                      $23,152
                      
                      
                      
                      6.8
                      %
                      
                      
                      $13,702
                      
                      
                      
                      4.0
                      %
                      
                      
                      $17,128
                      
                      
                      
                      5.0
                      %As
      of December 31, 2007:Total
      Core Capital (to Risk-Weighted Assets)
                      
                      
                      $25,447
                      
                      
                      
                      12.2
                      %
                      
                      
                      $16,648
                      
                      
                      
                      8.0
                      %
                      
                      
                      $20,810
                      
                      
                      
                      10.0
                      %Tier
      1 Capital (to Risk-Weighted Assets)
                      
                      
                      $23,744
                      
                      
                      
                      11.4
                      %
                      
                      
                      $8,324
                      
                      
                      
                      4.0
                      %
                      
                      
                      $12,486
                      
                      
                      
                      6.0
                      %Tier
      1 Capital (to Average Assets)
                      
                      
                      $23,744
                      
                      
                      
                      7.7
                      %
                      
                      
                      $12,437
                      
                      
                      
                      4.0
                      %
                      
                      
                      $15,548
                      
                      
                      
                      5.0
                      %





The Bank
is required to maintain average balances on hand or with the Federal Reserve
Bank.  At December 31, 2008 and 2007, these reserve balances amounted
to $2,306,000 and $2,130,000, respectively.





NOTE
18:FAIR VALUE
MEASUREMENTS





In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements,
(“SFAS 157”) which defines fair value, establishes a framework for measuring
fair value under GAAP, and expands disclosures about fair value measurements.
SFAS 157 applies to other accounting pronouncements that require or permit
fair value measurements. SFAS 157 establishes a fair value hierarchy about the
assumptions used to measure fair value and clarifies assumptions about risk and
the effect of a restriction on the sale or use of an asset.   The
standard




Page
65


became
effective for the Company January 1, 2008, including interim
periods.  In February 2008, the FASB issued FASB Staff Position (FSP)
No. FAS 157-2, “Effective Date of FASB Statement No. 157.”  This FSP
delays the effective date of FAS 157 for all non-financial assets and
non-financial liabilities, except those that are recognized or disclosed at fair
value on a recurring basis (at least annually) to January 1,
2009.  This delay relates to non-financial assets and liabilities that
are not measured at fair value on an ongoing basis, but are subject to fair
value adjustments in certain circumstances (for example, when there is evidence
of impairment).  The Company has delayed its disclosure requirements
of non-financial assets and liabilities.  Certain assets, such as
foreclosed real estate, with write-downs subsequent to foreclosure, are carried
at fair value at the statement of condition date for which the Company has not
yet adopted the provisions of SFAS 157.





In
October 2008, the FASB issued FSP SFAS No. 157-3, “Determining the Fair Value of
a Financial Asset When the Market for that Asset is Not Active” (FSP 157-3), to
clarify the application of the provisions of SFAS 157 in an inactive market and
how an entity would determine fair value in an inactive market.  FSP
157-3 was effective immediately and applied to our 2008 consolidated financial
statements.  The application of the provisions of FSP 157-3 did not
materially affect our results of operations or financial condition as of and for
the year ended December 31, 2008.





SFAS 157
specifies a hierarchy of valuation techniques based on whether the inputs to
those valuation techniques are observable or unobservable. Observable inputs
reflect market data obtained from independent sources, while unobservable inputs
reflect our market assumptions. In accordance with SFAS 157, these two types of
inputs have created the following fair value hierarchy:





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





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





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





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





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





Investment
securities:  The fair values of securities available for sale are
obtained from an independent third party and are based on quoted prices on
nationally recognized exchange (Level 1), where available.  If quoted
prices are not available, fair values are measured by utilizing matrix pricing,
which is a mathematical technique used widely in the industry to value debt
securities without relying exclusively on quoted prices for specific securities
but rather by relying on the securities’ relationship to other benchmark quoted
securities (Level 2).  Management made no adjustment to the fair value
quotes that were received from the independent third party pricing
service.





Impaired
loans: Impaired loans are those that are accounted for under SFAS 114, Accounting by Creditors for
Impairment of a Loan, in which the Company has measured impairment
generally based on the fair value of the loan’s collateral.  Fair
value is generally determined based upon independent third party appraisals of
the properties, or discounted cash flows based upon expected
proceeds.  These assets are included as Level 3 fair values, based
upon the lowest level of input that is significant to the fair value
measurements.  The fair value consists of loan balances less their
valuation allowances as determined under SFAS 114.








Page
66


Financial
assets measured at fair value on a recurring basis, are summarized
below:





Fair Value Measurements,
    UsingQuoted
      Prices
                Significant
                SignificantIn
      Active Markets
                Other
      Observable
                UnobservableFor
      Identical Assets
                Inputs
                Inputs(In
      thousands)
                December
      31, 2008
                (Level
      1)
                (Level
      2)
                (Level
      3)Investment
      securities available for sale:
                $72,138
                $    1,918
                $70,220
                $   -








Financial
assets measured at fair value on a nonrecurring basis, are summarized
below:


Fair Value Measurements,
    UsingQuoted
      Prices
                Significant
                SignificantIn
      Active Markets
                Other
      Observable
                UnobservableFor
      Identical Assets
                Inputs
                Inputs(In
      thousands)
                December
      31, 2008
                (Level
      1)
                (Level
      2)
                (Level
      3)Impaired
      loans:
                $295
                $    -
                $    -
                $295







Impaired
loans are recorded net of a valuation allowance of $141,000.  There
was no additional provision for loan losses resulting from loan impairment
during the year ended December 31, 2008.





NOTE 19:FAIR
VALUES OF FINANCIAL INSTRUMENTS





SFAS No.
107, Disclosure About Fair
Value of Financial Instruments, requires disclosure of fair value
information of financial instruments, whether or not recognized in the
consolidated statement of condition, for which it is practicable to estimate
that value. In cases where quoted market prices are not available, fair values
are based on estimates using present value or other valuation techniques. Those
techniques are significantly affected by the assumptions used, including the
discount rate and estimates of future cash flows. In that regard, the derived
fair value estimates cannot be substantiated by comparison to independent
markets and, in many cases, could not be realized in immediate settlement of the
instrument.





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





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








Page
67





Cash and cash equivalents –
the carrying amounts approximate fair value.





Investment securities – the
fair values of securities available for sale are obtained from an independent
third party and are based on quoted prices on nationally recognized exchange
(Level 1), where available.  If quoted prices are not available, fair
values are measured by utilizing matrix pricing, which is a mathematical
technique used widely in the industry to value debt securities without relying
exclusively on quoted prices for specific securities but rather by relying on
the securities’ relationship to other benchmark quoted securities (Level
2).  Management made no adjustment to the fair value quotes that were
received from the independent third party pricing service.





Loans and mortgage loans
held-for-sale – the fair values of portfolio loans, including commercial
and commercial real estate loans are estimated using an option adjusted
discounted cash flow model that discounts future cash flows using recent market
interest rates, market volatility and credit spread assumptions.





Federal Home Loan Bank Stock –
the carrying amount approximates fair value.





Mortgage servicing rights -
the carrying amount approximates fair value.





Accrued interest receivable and
payable – the carrying amounts approximate fair values.





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





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





Junior subordinated debentures
– Current economic conditions have rendered the market for this liability
inactive.  As such, we are unable to determine a good estimate of fair
value.  Since the rate paid on the debentures held is lower than what
would be required to secure an interest in the same debt at year end, and we are
unable to obtain a current fair value, we have disclosed that the carrying value
approximates the fair value.





Off-balance sheet instruments
– Fair values for the Company’s off-balance sheet instruments are based on fees
currently charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the counterparties’ credit
standing.








Page
68





The
carrying amounts and fair values of the Company’s financial instruments as of
December 31 are presented in the following table:







2008
                  
                  
                  2007Carrying
                  
                  
                  Estimated
                  
                  
                  Carrying
                  
                  
                  Estimated(Dollars
      in thousands)
                  
                  Amounts
                  
                  
                  Fair
      Values
                  
                  
                  Amounts
                  
                  
                  Fair
      ValuesFinancial
      assets:Cash
      and cash equivalents
                  
                  
                  $7,678
                  
                  
                  
                  $7,678
                  
                  
                  
                  $10,213
                  
                  
                  
                  $10,213Investment
      securities
                  
                  
                  72,138
                  
                  
                  
                  72,138
                  
                  
                  
                  65,010
                  
                  
                  
                  65,010Net
      loans
                  
                  
                  247,400
                  
                  
                  
                  250,020
                  
                  
                  
                  221,046
                  
                  
                  
                  224,397Federal
      Home Loan Bank stock
                  
                  
                  2,549
                  
                  
                  
                  2,549
                  
                  
                  
                  2,128
                  
                  
                  
                  2,128Accrued
      interest receivable
                  
                  
                  1,678
                  
                  
                  
                  1,678
                  
                  
                  
                  1,673
                  
                  
                  
                  1,673Mortgage
      servicing rights
                  
                  
                  15
                  
                  
                  
                  15
                  
                  
                  
                  43
                  
                  
                  
                  43Financial
      liabilities:Deposits
                  
                  
                  $269,438
                  
                  
                  
                  $272,207
                  
                  
                  
                  $251,085
                  
                  
                  
                  $251,655Borrowed
      funds
                  
                  
                  51,975
                  
                  
                  
                  53,777
                  
                  
                  
                  38,410
                  
                  
                  
                  38,192Junior
      subordinated debentures
                  
                  
                  5,155
                  
                  
                  
                  5,155
                  
                  
                  
                  5,155
                  
                  
                  
                  5,155Accrued
      interest payable
                  
                  
                  211
                  
                  
                  
                  211
                  
                  
                  
                  250
                  
                  
                  
                  250Off-balance
      sheet instruments:Standby
      letters of credit
                  
                  
                  $
      -
                  
                  
                  
                  $
      -
                  
                  
                  
                  $
      -
                  
                  
                  
                  $
      -Commitments
      to extend credit
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -








NOTE 20:PARENT
COMPANY – FINANCIAL INFORMATION





The
following represents the condensed financial information of Pathfinder Bancorp,
Inc. as of and for the years ended December 31:





Statements
      of Condition
                                          
                                          2008
                                          
                                          
                                          2007(In
      thousands)AssetsCash
                                          
                                          
                                          $10
                                          
                                          
                                          
                                          $178Investments
                                          
                                          
                                          18
                                          
                                          
                                          
                                          20Investment
      in bank subsidiary
                                          
                                          
                                          24,603
                                          
                                          
                                          
                                          26,587Investment
      in non-bank subsidiary
                                          
                                          
                                          155
                                          
                                          
                                          
                                          155Other
      assets
                                          
                                          
                                          149
                                          
                                          
                                          
                                          16Total
      assets
                                          
                                          
                                          $24,935
                                          
                                          
                                          
                                          $26,956Liabilities
      and Shareholders' EquityAccrued
      liabilities
                                          
                                          
                                          285
                                          
                                          
                                          
                                          97Junior
      subordinated debentures
                                          
                                          
                                          5,155
                                          
                                          
                                          
                                          5,155Shareholders'
      equity
                                          
                                          
                                          19,495
                                          
                                          
                                          
                                          21,704Total
      liabilities and shareholders' equity
                                          
                                          
                                          $24,935
                                          
                                          
                                          
                                          $26,956





Page
69


Statements
      of Income
                  
                  2008
                  
                  
                  2007(In
      thousands)IncomeDividends
      from bank subsidiary
                  
                  
                  $900
                  
                  
                  
                  $900Dividends
      from non-bank subsidiary
                  
                  
                  7
                  
                  
                  
                  15Dividends
      on other investments
                  
                  
                  -
                  
                  
                  
                  70Total
      income
                  
                  
                  907
                  
                  
                  
                  985ExpensesInterest
                  
                  
                  257
                  
                  
                  
                  511Operating
                  
                  
                  126
                  
                  
                  
                  93Total
      expenses
                  
                  
                  383
                  
                  
                  
                  604Income
      before taxes and (excess of) equity in undistributednet
      income of subsidiaries
                  
                  
                  524
                  
                  
                  
                  381Tax
      benefit (expense)
                  
                  
                  100
                  
                  
                  
                  (2
                  )Income
      before (excess of) equity in undistributed net incomeof
      subsidiaries
                  
                  
                  624
                  
                  
                  
                  379(Excess
      of) equity in undistributed net income of subsidiaries
                  
                  
                  (256
                  )
                  
                  
                  743Net
      income
                  
                  
                  $368
                  
                  
                  
                  $1,122









Statements
      of Cash Flows
                  
                  2008
                  
                  
                  2007(In
      thousands)Operating
      ActivitiesNet
      Income
                  
                  
                  $368
                  
                  
                  
                  $1,122Excess
      of (equity in) undistributed loss of subsidiaries
                  
                  
                  256
                  
                  
                  
                  (743
                  )Amortization
      of deferred financing costs
                  
                  
                  -
                  
                  
                  
                  15Other
      operating activities
                  
                  
                  (108
                  )
                  
                  
                  265Net
      cash provided by operating activities
                  
                  
                  516
                  
                  
                  
                  659Investing
      ActivitiesInvestment
      in unconsolidated subsidiary trust
                  
                  
                  -
                  
                  
                  
                  (155
                  )Liquidation
      of unconsolidated subsidiary trust
                  
                  
                  -
                  
                  
                  
                  155Net
      cash provided by investing activities
                  
                  
                  -
                  
                  
                  
                  -Financing
      activitiesProceeds
      from exercise of stock options
                  
                  
                  10
                  
                  
                  
                  114Proceeds
      from issuance of subordinated debt
                  
                  
                  -
                  
                  
                  
                  5,155Redemption
      of subordinated debt
                  
                  
                  -
                  
                  
                  
                  (5,155
                  )Cash
      dividends
                  
                  
                  (694
                  )
                  
                  
                  (695
                  )Net
      cash used in financing activities
                  
                  
                  (684
                  )
                  
                  
                  (581
                  )(Decrease)
      increase in cash and cash equivalents
                  
                  
                  (168
                  )
                  
                  
                  78Cash
      and cash equivalents at beginning of year
                  
                  
                  178
                  
                  
                  
                  100Cash
      and cash equivalents at end of year
                  
                  
                  $10
                  
                  
                  
                  $178






Page
70


ITEM
9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE





None.






ITEM
9A(T): CONTROLS AND PROCEDURES





REPORT
OF MANAGEMENT’S RESPONSIBILITY





The
Company’s management, including the Company’s principal executive officer and
principal financial officer, have evaluated the effectiveness of the Company’s
“disclosure controls and procedures,” as such term is defined in Rule 13a-15(e)
promulgated under the Securities Exchange Act of 1934, as amended, (the
“Exchange Act”). Based upon their evaluation, the principal executive officer
and principal financial officer concluded that, as of the end of the period
covered by this report, the Company’s disclosure controls and procedures were
effective for the purpose of ensuring that the information required to be
disclosed in the reports that the Company files or submits under the Exchange
Act with the Securities and Exchange Commission (the “SEC”) (1) is recorded,
processed, summarized and reported within the time periods specified in the
SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s
management, including its principal executive and principal financial officers,
as appropriate to allow timely decisions regarding required
disclosure.





MANAGEMENT’S
REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING





Management’s
report on internal control over financial reporting is contained in “Item 8 –
Financial Statements and Supplementary Data” in this annual report in Form
10-K.





This
annual report does not include an attestation report of the Company’s
independent registered public accounting firm regarding internal control over
financial reporting pursuant to temporary rules of the Securities and Exchange
Commission that permit the Company to provide only management’s report in this
annual report.





CHANGES
IN INTERNAL CONTROL OVER FINANCIAL REPORTING





There
were no changes in the Company’s internal control over financial reporting that
occurred during the Company’s last fiscal quarter that have materially affected,
or are reasonably likely to materially affect, the Company’s internal control
over financial reporting.






ITEM
9B: OTHER INFORMATION





None





Page
71





PART
III





ITEM
10: DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSONS AND CORPORATE
GOVERNANCE, COMPLIANCE WITH SECTIONS 16 (A) OF EXCHANGE ACT





(a)
            Information
      concerning the directors of the Company is incorporated by reference
      hereunder in the Company's Proxy Materials for the Annual Meeting of
      Stockholders.


(b)
            Set
      forth below is information concerning the Executive Officers of the
      Company at December 31, 2008.





Name
            Age
            Positions
      Held With the CompanyThomas
      W. Schneider
            47
            President
      and Chief Executive OfficerJames
      A. Dowd, CPA
            41
            Senior
      Vice President, Chief Financial OfficerEdward
      A. Mervine
            52
            Senior
      Vice President, General CounselMelissa
      A. Miller
            51
            Senior
      Vice President, Chief Operating OfficerRonald
      Tascarella
            50
            Senior
      Vice President, Chief Credit
Officer






ITEM
11: EXECUTIVE COMPENSATION





Information
with respect to management compensation and transactions required under this
item is incorporated by reference hereunder in the Company's Proxy Materials for
the Annual Meeting of Stockholders under the caption "Compensation
Committee".






ITEM
12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS





The
information required by this item is incorporated by reference hereunder in the
Company’s Proxy Materials for the Annual Meeting of Stockholders under the
caption "Voting Securities and Principal Holders Thereof"






ITEM
13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE





The
information required by this item is incorporated by reference hereunder in the
Company’s Proxy Materials for the Annual Meeting of Stockholders under the
caption "Transactions with Certain Related Persons”.






ITEM
14: PRINCIPAL ACCOUNTANT FEES AND SERVICES





The
information required by this item is incorporated by reference hereunder in the
Company’s Proxy Materials for the Annual Meeting of Stockholders under the
caption "Audit and Related Fees".




Page
72


PART
IV





ITEM
15: EXHIBITS AND FINANCIAL STATEMENT SCHEDULES


(a)(1)
            Financial
      Statements - The Company’s consolidated financial statements, for the
      years ended December 31, 2008 and 2007, together with the Report of
      Independent Registered Public Accounting Firm are filed as part of this
      Form 10-K report.  See “Item 8: Financial Statements and
      Supplementary Data.”(a)(2)
            Financial
      Statement Schedules - All financial statement schedules have been omitted
      as the required information is inapplicable or has been included in “Item
      7: Management Discussion and Analysis.”(b)
            Exhibits3.1
            Certificate
      of Incorporation of Pathfinder Bancorp, Inc. (Incorporated herein by
      reference to the Company's Current Report on Form 8-K filed on June 25,
      2001)3.2
            Bylaws
      of Pathfinder Bancorp, Inc. (Incorporated herein by reference to the
      Company's Quarterly Report on Form 10-Q filed on August 15, 2005 and
      November 28, 2007)4
            Form
      of Stock Certificate of Pathfinder Bancorp, Inc. (Incorporated herein by
      reference to the Company's Current Report on Form 8-K dated June 25,
      2001)10.1
            Form
      of Pathfinder Bank 1997 Stock Option Plan (Incorporated herein by
      reference to the Company's S-8 file no. 333-53027)10.2
            Form
      of Pathfinder Bank 1997 Recognition and Retention Plan (Incorporated by
      reference to the Company's S-8 file no. 333-53027)10.3
            2003
      Executive Deferred Compensation Plan (Incorporated herein by reference to
      the Company’s Annual Report on Form 10-K for the year ended December 31,
      2008 file no. 000-23601)10.4
            2003
      Trustee Deferred Fee Plan (Incorporated herein by reference to the
      Company’s Annual Report on Form 10-K for the year ended December 31, 2008
      file no. 000-23601)10.5
            Employment
      Agreement between the Bank and Thomas W. Schneider, President and Chief
      Executive Officer (Incorporated by reference to the Company's Annual
      Report on Form 10-K for the year ended December 31, 2008 file no.
      000-23601)10.6
            Employment
      Agreement between the Bank and Edward A. Mervine, Vice President, General
      Counsel and Secretary (Incorporated by reference to the Company's Annual
      Report on Form 10-K for the year ended December 31, 2008 file no.
      000-23601)10.7
              
              
              10.8
            Change
      of Control Agreement between the Bank and Ronald Tascarella (Incorporated
      by reference to the Company’s Annual Report on Form 10-K for the year
      ended December 31, 2008 file no. 000-23601)
              
              Change
      of Control Agreement between the Bank and James A. Dowd (Incorporated by
      reference to the Company’s Annual Report on Form 10-K for the year ended
      December 31, 2008 file no. 000-23601)





Page
73


10.9
              
              
              10.10
              
              
              
              10.11
            Change
      of Control Agreement between the Bank and Melissa A. Miller (Incorporated
      by reference to the Company’s Annual Report on Form 10-K for the year
      ended December 31, 2008 file no. 000-23601)
              
              Executive
      Supplemental Retirement Agreement between the Bank and Chris C. Gagas
      (Incorporated by reference to the Company’s Annual Report on Form 10-K for
      the year ended December 31, 2008 file no. 000-23601)
              
              Executive
      Supplemental Retirement Agreement between the Bank and Thomas W. Schneider
      (Incorporated by reference to the Company’s Annual Report on Form 10-K for
      the year ended December 31, 2008 file no. 000-2360114
            Code
      of Ethics (Incorporated by reference to the Company’s Annual Report on
      Form 10-K for the year ended December 31, 2003)21
            Subsidiaries
      of Company23
            Consent
      of Beard Miller Company LLP31.1
            Rule
      13a-14(a) / 15d-14(a) Certification of the Chief Executive
      Officer31.2               
      Rule 13a-14(a) / 15d-14(a) Certification of the Chief Financial
      Officer


32.1               
Section 1350 Certification of the Chief Executive and Chief Financial
Officer




Page
74


Signatures





Pursuant
      to the requirements of Section 13 of the Securities Exchange Act of 1934,
      the Company has duly caused this report to be signed on its behalf by the
      undersigned, thereunto duly authorized.Pathfinder
      Bancorp, Inc.Date:
                              March
      27, 2009
                              By:
                              /s/
      Thomas W. Schneider
                                Thomas
      W. Schneider
                                President
      and Chief Executive OfficerPursuant
      to the requirements of the Securities Exchange of 1934, this report has
      been signed below by the following persons on behalf of the Registrant and
      in the capacities and on the dates indicated.By:
                              /s/
      Janette Resnick
                                Janette
      Resnick, Chairman of the BoardDate:
                              March
      27, 2009By:
                              /s/
      Thomas W. Schneider
                                Thomas
      W. Schneider, President and Chief Executive Officer
                              By:
                              /s/
      Chris R. Burritt
                                Chris
      R. Burritt, Director(Principal
      Executive Officer)Date:
                              March
      27, 2009
                              Date:
                              March
      27, 2009By:
                              /s/
      James A. Dowd
                                James
      A. Dowd, Senior Vice President and Chief Financial Officer
                              By:
                              /s/
      George P. Joyce
                                George
      P. Joyce, Director(Principal
      Financial Officer)Date:
                              March
      27, 2009
                              Date:
                              March
      27, 2009By:
                              /s/
      Shelley Tafel
                                Shelley
      Tafel, Vice President and Controller
                              By:
                              /s/
      Corte J. Spencer
                                Corte
      J. Spencer, Director(Principal
      Accounting Officer)Date:
                              March
      27, 2009
                              Date:
                              March
      27, 2009By:
                              /s/
      Bruce B. Manwaring
                                Bruce
      E. Manwaring, Director
                              By:
                              /s/
      Lloyd Stemple
                                Lloyd
      Stemple, DirectorDate:
                              March
      27, 2009
                              Date:
                              March
      27, 2009By:
                              /s/
      L. William Nelson, Jr.
                                L.
      William Nelson, Jr., DirectorDate:
                              March
      27, 2009By:
                              /s/
      Steven W. ThomasSteven
      W. Thomas, DirectorDate:
                              March
      27, 2009





Page
75


EXHIBIT
21:  SUBSIDIARIES OF THE COMPANY





Company
            Percent
      Owned
            Jurisdiction
      or Stateof
              IncorporationPathfinder
      Bank
            100%
            New
      YorkPathfinder
      Statutory Trust II
            100%
            DelawarePathfinder
      Commercial Bank (1)
            100%
            New
      YorkPathfinder
      REIT, Inc. (1)
            100%
            New
      YorkWhispering
      Oaks Development Corp. (1)
            100%
            New
      York





(1)
Wholly owned subsidiary of Pathfinder Bank.





EXHIBIT
23: CONSENT OF BEARD MILLER COMPANY LLP





CONSENT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMPathfinder
      Bancorp, Inc.
              Oswego,
      New YorkWe
      hereby consent to the incorporation by reference in the Registration
      Statement on Form S-8 (No. 333-53027) of Pathfinder Bancorp, Inc. of our
      report dated March 27, 2009, relating to the consolidated financial
      statements, which appear in this Form 10-K.Beard
      Miller Company LLP
              Syracuse,
      New York
              March
      27, 2009
            /s/
      BEARD MILLER COMPANY LLP




Page
76





EXHIBIT
31.1: Rule 13a-14(a) / 15d-14(a) Certification of the Chief Executive
Officer





Certification
      of Chief Executive Officer
              
              Pursuant
      to Section 302 of the Sarbanes-Oxley Act of 2002I,
      Thomas W. Schneider, President and Chief Executive Officer, certify
      that:1.I
      have reviewed this Annual report on Form 10-K of Pathfinder Bancorp,
      Inc.;2.Based
      on my knowledge, this report does not contain any untrue statement of a
      material fact or omit to state a material fact necessary to make the
      statements made, in light of the circumstances under which such statements
      were made, not misleading with respect to the period covered by this
      report;3.Based
      on my knowledge, the financial statements, and other financial information
      included in this report, fairly present in all material respects the
      financial condition, results of operations and cash flows of the
      registrant as of, and for, the periods presented in this
      report;4.The
      registrant's other certifying officer and I are responsible for
      establishing and maintaining disclosure controls and procedures (as
      defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
      control over financial reporting (as defined in Exchange Act Rules
      13a-15(f) and 15d-15(f)) for the registrant and have:(a)Designed
      such disclosure controls and procedures, or caused such disclosure
      controls and procedures to be designed under our supervision, to ensure
      that material information relating to the registrant, including its
      consolidated subsidiaries, is made known to us by others within those
      entities, particularly during the period in which this report is being
      prepared;
              (b)Designed
      such internal control over financial reporting, or caused such internal
      control over financial reporting, to be designed under our supervision, to
      provide reasonable assurance regarding the reliability of financial
      reporting and the preparation of financial statements for external
      purposes in accordance with generally accepted accounting
      principles;(c)Evaluated
      the effectiveness of the registrant's disclosure controls and procedures
      and presented in this report our conclusions about the effectiveness of
      the disclosure controls and procedures, as of the end of the period
      covered by this report based on such evaluation; and(d)Disclosed
      in this report any change in the registrant's internal control over
      financial reporting that occurred during the registrant's most recent
      fiscal quarter (the registrant's fourth fiscal quarter in the case of an
      annual report) that has materially affected, or is reasonably likely to
      materially affect, the registrant's internal control over financial
      reporting; and5.The
      registrant's other certifying officer and I have disclosed, based on our
      most recent evaluation of internal control over financial reporting, to
      the registrant's auditors and the audit committee of the registrant's
      board of directors:(a)All
      significant deficiencies and material weaknesses in the design or
      operation of internal control over financial reporting which are
      reasonably likely to adversely affect the registrant's ability to record,
      process, summarize and report financial information;
and(b)Any
      fraud, whether or not material, that involves management or other
      employees who have a significant role in the registrant's internal control
      over financial reporting.March
      27, 2009
            /s/
      Thomas W. Schneider
              Thomas
      W. Schneider
              President
      and Chief Executive Officer





Page
77


EXHIBIT
31.2: Rule 13a-14(a) / 15d-14(a) Certification of the Chief Financial
Officer





Certification
      of Chief Financial Officer
              
              Pursuant
      to Section 302 of the Sarbanes-Oxley Act of 2002I,  James
      A. Dowd, Senior Vice President and Chief Financial Officer, certify
      that:1.I
      have reviewed this Annual report on Form 10-K of Pathfinder Bancorp,
      Inc.;2.Based
      on my knowledge, this report does not contain any untrue statement of a
      material fact or omit to state a   material fact necessary
      to make the statements made, in light of the circumstances under which
      such statements were made, not misleading with respect to the period
      covered by this report;3.Based
      on my knowledge, the financial statements, and other financial information
      included in this report, fairly present in all material respects the
      financial condition, results of operations and cash flows of the
      registrant as of, and for, the periods presented in this
      report;4.The
      registrant's other certifying officer and I are responsible for
      establishing and maintaining disclosure controls and procedures (as
      defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
      control over financial reporting (as defined in Exchange Act Rules
      13a-15(f) and 15d-15(f)) for the registrant and have:(a)Designed
      such disclosure controls and procedures, or caused such disclosure
      controls and procedures to be designed under our supervision, to ensure
      that material information relating to the registrant, including its
      consolidated subsidiaries, is made known to us by others within those
      entities, particularly during the period in which this report is being
      prepared;
              (b)Designed
      such internal control over financial reporting, or caused such internal
      control over financial reporting, to be designed under our supervision, to
      provide reasonable assurance regarding the reliability of financial
      reporting and the preparation of financial statements for external
      purposes in accordance with generally accepted accounting
      principles;(c)Evaluated
      the effectiveness of the registrant's disclosure controls and procedures
      and presented in this report our conclusions about the effectiveness of
      the disclosure controls and procedures, as of the end of the period
      covered by this report based on such evaluation; and(d)Disclosed
      in this report any change in the registrant's internal control over
      financial reporting that occurred during the registrant's most recent
      fiscal quarter (the registrant's fourth fiscal quarter in the case of an
      annual report) that has materially affected, or is reasonably likely to
      materially affect, the registrant's internal control over financial
      reporting; and5.The
      registrant's other certifying officer and I have disclosed, based on our
      most recent evaluation of internal control over financial reporting, to
      the registrant's auditors and the audit committee of the registrant's
      board of directors:(a)All
      significant deficiencies and material weaknesses in the design or
      operation of internal control over financial reporting which are
      reasonably likely to adversely affect the registrant's ability to record,
      process, summarize and report financial information;
and(b)Any
      fraud, whether or not material, that involves management or other
      employees who have a significant role in the registrant's internal control
      over financial reporting.March
      27, 2009
            /s/
      James A. Dowd
              James
      A. Dowd
              Senior
      Vice President and Chief Financial Officer





Page
78


EXHIBIT
32.1  Section 1350 Certification of the Chief Executive and Chief
Financial Officer





Certification
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002Thomas
      W. Schneider, President and Chief Executive Officer, and James A. Dowd,
      Senior Vice President and Chief Financial Officer of Pathfinder Bancorp,
      Inc. (the "Company"), each certify in his capacity as an officer of the
      Company that he has reviewed the Annual Report of the Company on Form 10-K
      for the year ended December 31, 2008 and that to the best of his
      knowledge:1.the
      report fully complies with the requirements of Sections 13(a) of the
      Securities Exchange Act of 1934; and2.the
      information contained in the report fairly presents, in all material
      respects, the financial condition and results of operations of the
      Company.The
      purpose of this statement is solely to comply with Title 18, Chapter 63,
      Section 1350 of the United States Code, as amended by Section 906 of the
      Sarbanes-Oxley Act of 2002.March
      27, 2009
            /s/
      Thomas W. Schneider
              Thomas
      W. Schneider
              President
      and Chief Executive OfficerMarch
      27, 2009
            /s/
      James A. Dowd
              James
      A. Dowd
              Senior
      Vice President and Chief Financial
Officer





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79