SECURITIES EXCHANGE COMMISSION


Washington, D.C. 20549





FORM 10-K/A


AMENDMENT NO. 1






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


For the fiscal year ended December 31, 2010.


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 className 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 whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).       YES *        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, 2010, as reported by the NASDAQ Capital Market, was approximately $5.4 million.




As of March 18, 2011, there were 2,484,832 shares outstanding of the Registrant’s Common Stock.




DOCUMENTS INCORPORATED BY REFERENCE:




(1) Proxy Statement for the 2011 Annual Meeting of Stockholders of the Registrant (Part III).


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







EXPLANATORY NOTE:




PART II




Item 8 - Financial Statements and Supplementary Data




Item 8 is being amended herein because the original filing of Form 10-K lacked the electronic signature of our independent auditor due to a filing error.  The signed audit report is included with this amendment.




Except as described above, the Original filing has not been amended, updated or otherwise modified.






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TABLE OF CONTENTS





FORM 10-K ANNUAL REPORT


FOR THE YEAR ENDED


DECEMBER 31, 2010


PATHFINDER BANCORP, INC.





PagePART IItem 1.
Business
3Item 1A.
Risk Factors
14Item 1B.
Unresolved Staff Comments
14Item 2.
Properties
15Item 3.
Legal Proceedings
16Item 4.
(Removed and Reserved)
16PART IIItem 5.
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer
16Purchases of Equity SecuritiesItem 6.
Selected Financial Data
17Item 7.
Management's Discussion and Analysis of Financial Condition and Results of Operations
18Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
35Item 8.
Financial Statements and Supplementary Data
36Item 9.
Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
84Item 9A
Controls and Procedures
84Item 9B.
Other Information
84PART IIIItem 10.
Directors, Executive Officers and Corporate Governance
85Item 11.
Executive Compensation
85Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related
85Stockholder MattersItem 13.
Certain Relationships and Related Transactions, and Director Independence
85Item 14.
Principal Accounting Fees and Services
85PART IVItem 15.
Exhibits and Financial Statement Schedules
86


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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:


§credit quality and the effect of credit quality on the adequacy of our allowance for loan losses;§deterioration in financial markets that may result in impairment charges relating to our securities portfolio;§competition in our primary market areas;.§significant government regulations, legislation and potential changes thereto;§a reduction in our ability to generate or originate revenue-producing assets as a result of compliance with heightened capital standards;

§increased cost of operations due to greater regulatory oversight, supervision and examination of banks and bank holding companies, and higher deposit insurance premiums;

§the limitation on our ability to expand consumer product and service offerings due to anticipated stricter consumer protection laws and regulations: and

§other risks described herein and in the other reports and statements we file with the SEC.


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





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, 2010, 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 Stockholders").  At December 31, 2010, Pathfinder Bancorp, Inc. and subsidiaries had total assets of $408.5 million, total deposits of $326.5 million and shareholders' equity of $30.6 million.





The Company's executive office is located at 214 West First Street, Oswego, New York and the telephone number at that address is (315) 343-0057.








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Pathfinder Bank





The Bank is a New York-chartered savings bank headquartered in Oswego, New York.  The Bank operates from its main office as well as seven branch offices located in its market area consisting of Oswego County and the contiguous counties.  The seventh branch was added in Cicero, New York and opened to the public on February 1, 2011.  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, 2010, $216.3 million, or 76% of the Bank's total loan portfolio consisted of loans secured by real estate, of which $147.2 million, or 68%, were loans secured by one- to four-family residences and $69.1 million, or 32%, were secured by commercial real estate.  Additionally, $25.2 million, or 9%, 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 $39.7 million and $3.4 million, respectively, or 15%, of the Bank's total loan portfolio at December 31, 2010.  The Bank invests a portion of its assets in securities issued by the United States Government and its agencies and sponsored enterprises, state and municipal obligations, corporate debt securities, mutual funds, and equity securities.  The Bank also invests in mortgage-backed securities primarily issued or guaranteed by United States Government sponsored enterprises.  The Bank's principal sources of funds are deposits, principal and interest payments on loans and investments, as well as borrowings from correspondent financial institutions.  The principal source of income is interest on loans and investment securities.  The Bank's principal expenses are interest paid on deposits, and employee compensation and benefits.





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





The Bank has Pathfinder REIT, Inc., a New York corporation, as its wholly-owned real estate investment trust subsidiary.  At December 31, 2010, Pathfinder REIT, Inc. held $14.7 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.





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





Employees





As of December 31, 2010, the Bank had 95 full-time employees and 21 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.  The Bank's business and operating results are significantly affected by the general economic conditions prevalent in its market areas.





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The Bank encounters strong competition both in attracting deposits and in originating real estate and other loans.  Its most direct competition for deposits has historically come from commercial 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 not necessarily conform to secondary market underwriting standards.  The turmoil in the residential mortgage sector of the United States economy has caused certain competitors to be less effective in the market place.  While Central New York did not experience the level of speculative lending and borrowing in residential real estate that has adversely affected other regions on a national basis, certain mortgage brokers and finance companies in our area are either no longer operating, or have limited aggressive lending practices.  Additionally, as certain money centers and large regional banks grapple with current economic conditions and the related credit crisis, their ability to compete as effectively has been muted.  Management believes that these conditions have created a window of reduced competition for local community and regional banks in residential loans, and to a lesser extent, commercial real estate loans.  Of course, there are others, including tax-exempt credit unions, that are aggressively taking advantage of that window.





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 currently subject to regulations of the Office of Thrift Supervision ("OTS") as savings and loan holding companies.However, under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which is discussed further below, the OTS’s functions relating to savings and loan holding companies will be transferred to the Federal Reserve Board by July 21, 2011, unless extended by up to six months by the Secretary of the Treasury.





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





Dodd-Frank Act





The Dodd-Frank Act will significantly change the current bank regulatory structure and affect the lending, investment, trading and operating activities of financial institutions and their holding companies.  The Dodd-Frank Act will eliminate the current primary federal regulator of the Company and the Mutual Holding Company, the OTS.  Under the Dodd-Frank Act, the Federal Reserve Board will supervise and regulate all savings and loan holding companies, such as the Company and the Mutual Holding Company, in addition to bank holding companies, which the Federal Reserve Board currently regulates.  As a result, the Federal Reserve Board’s current regulations applicable to bank holding companies, including holding company capital requirements, will apply to savings and loan holding companies like the Company, unless an exemption exists.  The bank holding company capital requirements are substantially similar to the capital requirements currently applicable to the Bank, as described in “Regulatory Capital Requirements.”  The Dodd-Frank Act also requires the Federal Reserve Board to set minimum capital levels for bank holding companies that are as stringent as those required for the insured depository subsidiaries, and the components of Tier 1 capital would be restricted to capital instruments that are currently considered to be Tier 1 capital for insured depository institutions.  Bank holding companies with assets of less than $500 million are exempt from these capital requirements.  Under the Dodd-Frank Act, the proceeds of trust preferred securities are excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010 by bank or savings and loan holding companies with less than $15 billion of assets.  The legislation also establishes a floor for capital of insured depository institutions that cannot be lower than the standards in effect today, and directs the federal banking regulators to implement new leverage and capital requirements within 18 months.  These new leverage and capital requirements must take into account off-balance sheet activities and other risks, including risks relating to securitized products and derivatives.  Moreover, the Mutual Holding Company will require the approval of the Federal Reserve Board before it may waive the receipt of any dividends from the Company, and there is no assurance that the Federal Reserve Board will approve future dividend waivers or what conditions it may impose on such waivers.  See “Federal Holding Company Regulation—Waivers of Dividends by Mutual Holding Company” below.





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The Dodd-Frank Act also creates a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws.  The Consumer Financial Protection Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions such as Pathfinder Bank, including the authority to prohibit “unfair, deceptive or abusive” acts and practices.  The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets.  Banks and savings institutions with $10 billion or less in assets will be examined by their applicable bank regulators.  The new legislation also weakens the federal preemption available for national banks and federal savings associations, and gives state attorneys general the ability to enforce applicable federal consumer protection laws.





The Dodd-Frank Act also broadens the base for Federal Deposit Insurance Corporation insurance assessments.  Assessments will now be based on the average consolidated total assets less tangible equity capital of a financial institution.  The legislation also permanently increases the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2008, and non-interest bearing transaction accounts have unlimited deposit insurance through December 31, 2012.  Lastly, the Dodd-Frank Act will increase stockholder influence over boards of directors by requiring companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments, and authorizing the Securities and Exchange Commission to promulgate rules that would allow stockholders to nominate and solicit votes for their own candidates using a company’s own proxy materials.  The legislation also directs the Federal Reserve Board to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded or not.





New York State Banking Law and FDIC Regulation





The Bank derives its lending, investment and other authority primarily from the applicable provisions of New York State Banking Law and the regulations of the Department, as limited by FDIC regulations. In particular, the applicable provisions of New York State Banking Law and regulations governing the investment authority and activities of an FDIC insured state-chartered savings bank have been substantially limited by the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") and the FDIC regulations issued pursuant thereto.  Under these laws and regulations, savings banks, including the Bank, may invest in real estate mortgages, consumer and commercial loans, certain types of debt securities, including certain corporate debt securities and obligations of federal, state and local governments and agencies, certain types of corporate equity securities and certain other assets.  New York State chartered savings banks may also invest in subsidiaries under their service corporation investment authority.  A savings bank may use this power to invest in corporations that engage in various activities authorized for savings banks, plus any additional activities, which may be authorized by the Banking Board.  Under FDICIA and the FDIC’s implementation of regulations, the Bank’s investment and service corporation activities are limited to activities permissible for a national bank unless the FDIC otherwise permits it.





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





FDIC Insurance on Deposits





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





Under the FDIC’s current risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other risk factors. The rates for nearly all of the financial institutions industry vary between five and seven cents for every $100 of domestic deposits.





As part of its plan to restore the Deposit Insurance Fund in the wake of the large number of bank failures following the financial crisis, the FDIC imposed a special assessment of 5 basis points for the second quarter of 2009.  In addition, the FDIC has required all insured institutions to prepay their quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011 and 2012.   As part of this prepayment, the FDIC assumed a 5% annual growth in the assessment base and applied a 3 basis point increase in assessment rates effective January 1, 2011.  Prepaid assessments for 2010 totaled $477,000.





In February 2011, the FDIC published a final rule under the Dodd-Frank Act to reform the deposit insurance assessment system.  The rule redefines the assessment base used for calculating deposit insurance assessments effective April 1, 2011.  Under the new rule, assessments will be based on an institution’s average consolidated total assets minus average tangible equity as opposed to total deposits.  Since the new base will be much larger than the current base, the FDIC also lowered assessment rates so that the total amount of revenue collected from the industry will not be significantly altered.  The new rule is expected to benefit smaller financial institutions, which typically rely more on deposits for funding, and shift more of the burden for supporting the insurance fund to larger institutions, which have greater access to non-deposit sources of funding.





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





In addition to the FDIC assessments, the Financing Corporation (“FICO”) is authorized to impose and collect, with the approval of the FDIC, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. The bonds issued by the FICO are due to mature in 2017 through 2019. During the year ended December 31, 2010, the Bank paid $35,000 in fees related to the FICO.





Insurance of deposits may be terminated by the FDIC upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. We do not currently know of any practice, condition or violation that may lead to termination of our deposit insurance.





Regulatory Capital Requirements





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





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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 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.





Since the Company has chosen to participate in the Treasury’s CPP program, its ability to increase dividends to its stockholders is limited without prior approval by the United States Treasury Department.





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).





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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, 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.





Supervisory Agreement





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





Federal Holding Company Regulation





General.  The Company and the Mutual Holding Company 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.  Upon the sunset of the OTS, the Company, and the Mutual Holding Company, will be regulated by the Board of Governors of the Federal Reserve.  See “The Dodd-Frank Act” above.





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





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





The 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.The Mutual Holding Company currently waives its right to receive its dividends on its shares of the Company, which means that the Company has more cash resources to pay dividends to our public stockholders than if the Mutual Holding Company accepted such dividends.  OTS regulations allow federally chartered mutual holding companies to waive dividends without taking into account the amount of waived dividends in determining an appropriate exchange ratio in the event of a conversion of a mutual holding company to stock form.  The Mutual Holding Company is required to obtain OTS approval before it may waive its receipt of dividends. However, under the Dodd-Frank Act, the powers and duties of the OTS relating to mutual holding companies will be transferred to the Federal Reserve Board, and the Mutual Holding Company will be required to give the Federal Reserve Board notice before waiving the receipt of dividends.  The Dodd-Frank Act also sets forth the standards for granting a waiver, including a requirement that waived dividends be considered in determining an appropriate exchange ratio in the event of a conversion of the mutual holding company to stock form.  The Dodd-Frank Act, however, further provides that the Federal Reserve Board may not consider waived dividends in determining an appropriate exchange ratio in a conversion to stock form by any federal mutual holding company, such as the Mutual Holding Company, that has waived dividends prior to December 1, 2009.  The Federal Reserve Board historically has generally not allowed mutual holding companies to waive the receipt of dividends, and there can be no assurance as to the conditions, if any, the Federal Reserve Board will place on future dividend waiver requests by grandfathered mutual holding companies such as the Mutual Holding Company.  The Mutual Holding Company has not requested a current dividend waiver and is not planning to waive future dividends at this time.





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Conversion of the Mutual Holding Company to Stock Form.  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 (determined by an independent valuation) that ensures that Minority Stockholders own the same percentage of common stock in the New Holding Company as they owned in the Company immediately prior to the Conversion Transaction.    The total number of shares held by Minority Stockholders after a Conversion Transaction also would be increased by any purchases by Minority Stockholders in the stock offering conducted as part of the Conversion Transaction.





Federal Securities Law





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





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





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, 2010, the Bank was in compliance with these reserve requirements.





Federal Community Reinvestment Regulation





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





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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 financial 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.  As part of the Dodd-Frank Act,  the outside auditor attestation requirement on internal controls of companies with less than $75 million in market capitalization, like the Company, was rescinded.  Disclosure of management attestations on internal control over financial reporting will continue to be required for smaller reporting companies, including the Company.  We have existing policies, procedures and systems designed to comply with these regulations, and continue to further enhance and document our policies, procedures and systems to ensure continued compliance with these regulations.




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.




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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. Theprogram was developed to attract broad participation by strong financial institutions, to stabilize the financial system and increase lending to benefit the national economy and citizens of the United States.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 was 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.  Companies participating in the CPP are 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.





On September 11, 2009, the Company entered into a Purchase Agreement with the Treasury Department pursuant to which the Company has issued and sold to Treasury: (i) 6,771 shares of the Company’s Series A Preferred Stock, having a liquidation amount per share equal to $1,000, for a total price of $6,771,000; and (ii) a Warrant to purchase 154,354 shares of the Company’s common stock, par value $0.01 per share, at an exercise price per share of $6.58.





The Chief Executive Officer and the Chief Financial Officer are required to certify compliance with the compensation provisions of the CPP program.  Our certifications are appended to this 10-K in Exhibit 99.1 and 99.2.





Securities and Exchange Commission Reporting





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





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





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.





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.





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





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





State Taxation





New York Taxation.  The 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.





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








ITEM 1A: RISK FACTORS





Not required of a smaller reporting company.








ITEM 1B:  UNRESOLVED STAFF COMMENTS





None.








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ITEM 2: PROPERTIES





The Bank conducts its business through its main office located in Oswego, New York, six branch offices located in Oswego County, and a new branch, opened February 1, 2011, in Onondaga County.  Management believes that the Bank’s facilities are adequate for the business conducted. The following table sets forth certain information concerning the main office and each branch office of the Bank at December 31, 2010.  The aggregate net book value of the Bank's premises and equipment was $9.4 million at December 31, 2010.  For additional information regarding the Bank's properties, see Notes 7 and 15 to the Consolidated Financial Statements.





LOCATION

OPENING DATE

OWNED/LEASEDMain Office


1874

Owned214 West First StreetOswego, New York  13126Plaza Branch


1989

Owned (1)Route 104, Ames PlazaOswego, New York  13126Mexico Branch


1978

OwnedNorman & Main StreetsMexico, New York  13114Oswego East Branch


1994

Owned34 East Bridge StreetOswego, New York  13126Lacona Branch


2002

Owned1897 Harwood DriveLacona, New York 13083Fulton Branch


2003

Owned (2)5 West First Street SouthFulton, New York  13069Central Square Branch


2005

Owned3025 East AveCentral Square, New York  13036Cicero Branch


2011

Owned6194 State Route 31Cicero, New York 13039








(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








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ITEM 3: LEGAL PROCEEDINGS





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




ITEM 4: (REMOVED AND RESERVED)








PART II




ITEM5:  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 476 shareholders of record as of March 18, 2011.  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, 2010

$
8.500


$
7.750


$
0.0300September 30, 2010


8.000



6.030



0.0300June 30, 2010


6.690



6.000



0.0300March 31, 2010


8.000



5.600



0.0300December 31, 2009

$
7.000


$
5.550


$
0.0300September 30, 2009


7.980



5.430



0.0300June 30, 2009


8.000



4.950



0.0600March 31, 2009


8.200



4.750



-





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, and the Company’s focus on the retention and growth of capital, it is unlikely that future, near-term dividends will replicate the historical dividend payouts of 2008 and prior years.  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 has required prior non-objection of the OTS in the past.  Following the sunset of the OTS, dividend waivers must receive the non-objection of the Federal Reserve.  Historically, the Federal Reserve has not provided its non-objection to the waiver of dividends by mutual holding companies.  The Mutual Holding Company did not waive the right to receive its portion of the cash dividends declared during 2010 or 2009.


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ITEM 6:SELECTED FINANCIAL DATA





The Company is the parent company of the Bank and Pathfinder Statutory Trust I.  The Bank has three operating subsidiaries – Pathfinder Commercial Bank, Pathfinder REIT, Inc., and Whispering Oaks Development Corp.





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





2010


2009


2008


2007


2006Year End (In thousands)Total assets

$
408,545


$
371,692


$
352,760


$
320,691


$
301,382Loans receivable, net


281,648



259,387



247,400



221,046



201,713Deposits


326,502



296,839



269,438



251,085



245,585Equity


30,592



29,238



19,495



21,704



20,850For the Year (In thousands)Net interest income

$
13,331


$
11,777


$
10,675


$
8,667


$
8,346Core noninterest income (a)


2,854



2,724



2,786



2,622



2,396Net gains/(losses) on sales, redemptions andimpairment of investment securities


211



112



(2,191
)


378



299Net (losses) gains on sales of loans andforeclosed real estate


(45
)


54



(44
)


42



(80
)Noninterest expense (b)


11,274



10,381



9,882



9,799



9,646Regulatory assessments


515



745



53



39



22Net income


2,505



1,615



368



1,122



1,028Per ShareNet income (basic)

$
0.82


$
0.61


$
0.15


$
0.45


$
0.42Book value per common share


9.81



9.31



8.04



8.74



8.45Tangible book value per common share (c)


8.26



7.77



6.50



7.19



6.82Cash dividends declared


0.12



0.12



0.41



0.41



0.41RatiosReturn on average assets


0.64
%


0.45
%


0.11
%


0.36
%


0.34
%Return on average equity


8.07



7.04



1.70



5.27



4.86Return on average tangible equity (c)


9.20



8.45



2.07



6.47



6.04Average equity to average assets


7.89



6.40



6.32



6.82



7.03Dividend payout ratio (d)


11.90



18.45



232.61



62.03



66.73Allowance for loan losses to loans receivable


1.28



1.17



0.99



0.76



0.74Net interest rate spread


3.58



3.40



3.22



2.81



2.92Noninterest income to average assets


0.77



0.81



0.16



0.98



0.87Noninterest expense to average assets


3.00



3.10



2.91



3.15



3.21Efficiency ratio (e)


71.95



76.36



73.02



85.89



88.71





(a)
Exclusive of net gains (losses) on sales and impairment of investment securities and net gains (losses) on sales of loans and foreclosed real estate.


(b)
Exclusive of regulatory assessments.


(c)
Tangible equity excludes intangible assets.


(d)
The dividend payout ratio is calculated using dividends declared and not waived by the Mutual Holding Company, divided by net income.


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





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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, 2010, 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% of the outstanding common stock.





The Company's business strategy is to operate as a well-capitalized, profitable and independent community bank dedicated to providing value-added products and services to our customers.  Generally, the Company has sought to implement this strategy by emphasizing retail 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 and redemptions 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 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.





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The allowance for loan losses represents management's estimate of probable loan losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment 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 statements 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 $458,000 was maintained at December 31, 2010, 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 statutoryrate due to non-taxable income from investment securities and bank owned life insurance offset, in 2009, 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 annual financial statements.





Management performs an annual valuation of the Company’s goodwill for possible impairment. Based on the results of this testing, management has determined that the carrying value of goodwill is not impaired as of December 31, 2010. The valuation approach is described in Note 8 of the consolidated financial statements.





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





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





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


EXECUTIVE SUMMARY





Total deposits increased 10.0%, to $326.5 million at December 31, 2010, while the average balance of deposits increased $29.4 million to $317.9 million for the year ended December 31, 2010.  Overall, in Oswego County, Pathfinder Bank has the majority of the current deposit market share. The Company will continue to focus on building market share in the Central Square and Fulton markets, while emphasizing the development of a new share of the market in the Cicero area of Onondaga County.  The Bank continues to develop core deposit relationships in all markets by developing demand deposit relationships.  Efforts will also be focused on the expansion of commercial deposit relationships with the Bank’s existing commercial lending customers.





Total assets increased 9.9% from December 31, 2009 to December 31, 2010, primarily in the loan portfolio.  The loan portfolio increased 8.6% with net growth primarily in the commercial loan and residential mortgage loan categories. The Company expects to concentrate on continued commercial mortgage and commercial loan portfolio growth during 2011. Increasing the commercial loan portfolio will increase inherent risk in the loan portfolio, but the Company continues to diversify its loan portfolio and addresses the higher risk by monitoring the level of the allowance for loan losses and making provisions as necessary.





The ratio of non-performing assets to total assets was 1.54% at December 31, 2010, compared to 0.67% at the prior year end.  Non-performing loans increased $3.6 million and foreclosed real estate increased $194,000 since December 31, 2009.  The increase in non-performing loans was primarily the result of the delinquency of a small number of  relatively large commercial loan relationships.  The increase in foreclosed real estate is a reflection of a lower than normal level of foreclosed real estate in the prior year.


Net income for 2010 was $2.5 million, as compared to $1.6 million in 2009.  Net income available to common shareholders, after preferred stock dividends and discount accretion, was $2.0 million, or $0.82 per share, compared to $0.61 per share for the previous year.   The improvement in income was primarily the result of a $1.6 million increase in net interest income during 2010.The income improvement was partially offset by increased noninterest operating expenses of $663,000, or 6%.





RESULTS OF OPERATIONS





Net income for 2010 was $2.5 million, an increase of $890,000, or 55.1%, compared to net income of $1.6 million for 2009.  Basic and diluted earnings per share increased to $0.82 per share for the year ended December 31, 2010 from $0.61 per share, for the year ended December 31, 2009.  Return on average equity increased to 8.07% in 2010 from 7.04% in 2009.





Net interest income, on a tax equivalent basis, increased $1.7 million, or 14.2%, resulting from the combination of volume increases in all loan categories and rate decreases applied to all interest-bearing liabilities, with the exception of the junior subordinated debentures.  The provision for loan losses for the year ended December 31, 2010 increased $174,000, or 19.9%. The elevated level of provisioning by the Company during the prior two years reflects management’s assessment of the increased inherent risk associated with increasing commercial lending activities, the overall growth in the total loan portfolio and deteriorated economic conditions.  The Company experienced a 4.5% increase in noninterest income, which was primarily due to an increase in income from bank owned life insurance.  Noninterest expenses increased 6% primarily due to increases in personnel costs.





Page 20
 Table of Contents


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.





Net interest income, on a tax-equivalent basis, increased $1.7 million, or 14.2%, to $13.5 million for the year ended December 31, 2010, as compared to $11.8 million for the year ended December 31, 2009.  The Company's net interest margin for 2010 increased to 3.73% from 3.56% in 2009.  The increase in net interest income is attributable to a decrease in the cost of interest-bearing liabilities, partially offset by an increase in the average balance of interest-bearing deposits.  Although the average balance of interest-earning assets increased 9.3%, the decline in the yield on those assets partially offset the overall volume increase, resulting in only a 2.6% increase in interest income earned, on a tax-equivalent basis.





The average balance of interest-earning assets increased $30.7 million, or 9.3%, during 2010 and the average balance of interest-bearing liabilities increased by $22.8 million, or 7.5%.  The increase in the average balance of interest earning assets primarily resulted from an $18.8 million increase in the average balance of the loan portfolio and an $11.3 million increase in the average balance of the security investment portfolio, combined with a $629,000 increase in the average balance of interest earning deposits. The increase in the average balance of interest-bearing liabilities primarily resulted from a $26.0 million, or 9.9%, increase in the average balance of deposits, offset by a $3.2 million, or 7.6%, decrease in the average balance of borrowed funds.  Interest income, on a tax-equivalent basis, increased $465,000, or 2.6%, during 2010. The decrease in yield on interest earning assets to 5.05% in 2010 from 5.38% in 2009 was offset by the 9.3% increase in volume.  Interest expense on deposits decreased $1.0 million, or 23.1%, as the cost of deposits dropped 51 basis points to 1.18% in 2010 from 1.69% in 2009.  Interest expense on borrowings decreased $196,000, or 12.3%, during 2010 as the 7.6% decrease in the average balance of borrowed funds was combined with a decrease in the cost of borrowed funds to 3.56% in 2010 from 3.75% in 2009.








Page 21
 Table of Contents


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 31,2010


2009


2008Average








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

$
138,497


$
7,672



5.54
%

$
133,442


$
7,463



5.59
%

$
130,702


$
7,527



5.76
%Real estate loans commercial


65,120



4,044



6.21
%


58,424



4,024



6.89
%


49,040



3,620



7.38
%Commercial loans


37,700



1,894



5.02
%


31,665



1,607



5.08
%


27,033



1,751



6.48
%Consumer loans


29,506



1,774



6.01
%


28,487



1,767



6.20
%


26,291



1,915



7.28
%Taxable investment securities


75,660



2,549



3.37
%


71,455



2,942



4.12
%


74,105



3,365



4.54
%Tax-exempt investment securities


8,587



399



4.65
%


1,464



65



4.44
%


5,252



255



4.86
%Interest-earning deposits


8,140



7



0.09
%


7,511



6



0.08
%


2,851



61



2.14
%Total interest-earning assets


363,210



18,339



5.05
%


332,448



17,874



5.38
%


315,274



18,494



5.87
%Noninterest-earning assets:Other assets


32,087











29,704











30,274Allowance for loan losses


(3,420
)










(2,731
)










(2,006
)Net unrealized gains (losses)on available for sale securities


1,513











(620
)










(1,690
)Total assets

$
393,390










$
358,801










$
341,852Interest-bearing liabilities:NOW accounts

$
29,816



79



0.26
%

$
26,055



72



0.28
%

$
23,762



95



0.40
%Money management accounts


12,101



39



0.32
%


11,037



35



0.32
%


10,574



52



0.49
%MMDA accounts


50,722



336



0.66
%


35,571



246



0.69
%


29,181



570



1.95
%Savings and club accounts


57,810



84



0.15
%


53,726



87



0.16
%


52,482



168



0.32
%Time deposits


137,975



2,871



2.08
%


135,965



3,994



2.94
%


124,267



4,777



3.84
%Junior subordinated debentures


5,155



164



3.18
%


5,155



149



2.89
%


5,155



257



4.99
%Borrowings


34,102



1,235



3.62
%


37,340



1,446



3.87
%


45,239



1,756



3.88
%Total interest-bearing liabilities


327,681



4,808



1.47
%


304,849



6,029



1.98
%


290,660



7,675



2.64
%Noninterest-bearing liabilities:Demand deposits


29,479











26,114











25,493Other liabilities


5,173











4,888











4,088Total liabilities


362,333











335,851











320,241Shareholders' equity


31,057











22,950











21,611Total liabilities & shareholders' equity

$
393,390










$
358,801










$
341,852Net interest income





$
13,531










$
11,845










$
10,819Net interest rate spread










3.58
%










3.40
%










3.23
%Net interest margin










3.73
%










3.56
%










3.43
%Ratio of average interest-earning assetsto average interest-bearing liabilities










110.84
%










109.05
%










108.47
%





Page 22
 Table of Contents


Interest Income




Changes in interest income result from changes in the average balances of loans, securities and interest-earning deposits and the related yields on those balances.  Interest income on a tax-equivalent basis increased $465,000, or 2.6%.  Average loans increased 7.5% in 2010, with yields decreasing 22 basis points to 5.68%. The Company's average residential mortgage loan portfolio increased $5.1 million, or 3.8%, when comparing 2010 to 2009.  The average yield on the residential mortgage loan portfolio decreased 5 basis points to 5.54% in 2010. The average balance of commercial real estate loans increased $6.7 million, or 11.5%, while the yield decreased 68 basis points to 6.21% in 2010 from 6.89% in 2009. Average commercial loans increased $6.0 million, or 19.1% and the tax-equivalent yield decreased to 5.02% in 2010 compared to 5.08% in 2009.  The average balance of consumer loans increased $1.0 million, or 3.6% when compared to 2009. The average yield decreased to 6.01% from 6.20% in 2009.





Interest income on investment securities decreased 2.0% from 2009. The average yield decreased 63 basis points to 3.50% in 2010 from 4.13% in 2009, offset by an increase in the average balance of investment securities (taxable and tax-exempt) of $11.3 million, or 15.5%, to $84.2 million in 2010 from $72.9 million in 2009.




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 $1.2 million, or 20.3%, in 2010, when compared to 2009.  The decrease in the cost of funds resulted from a decrease in the average cost of interest-bearing liabilities of 51 basis points, to 1.47% in 2010 from 1.98% in 2009, partially offset by a $22.8 million increase in the average balance of interest-bearing liabilities during 2010.  The average cost of deposits decreased 51 basis points to 1.18% during 2010 from 1.69% for 2009.  The average balance of interest-bearing deposits increased $26.0 million to $288.4 million in 2010 from $262.4 million in 2009.  The increase in the average balance of deposits resulted from increases in all deposit categories.   The largest increases in average deposits came from a 42.6% increase in MMDA accounts, a 14.4% increase in interest-bearing demand deposit accounts, a 9.6% increase in money management accounts, and a 7.6% increase in savings accounts.  The cost of junior subordinated debentures underlying our trust preferred securities increased 29 basis points, and represented the only increase in rates affecting liabilities.  It resulted in an increase in interest expense of $15,000, due to the interest rate swap entered into on a portion of the subordinated debentures.  The swap converted $2.0 million of the debentures from an adjustable rate being tied to LIBOR to a fixed rate of 4.96%.  The fixed rate paid during 2010 was significantly higher than the floating rate paid in 2009, prior to entering into the swap.   The average balance of borrowed funds decreased $3.2 million to $34.1 million in 2010 from $37.3 million in 2009.  The average cost of borrowed funds decreased 25 basis points, to 3.62% in 2010 from 3.87% in 2009.











Page 23
 Table of Contents




Rate/Volume Analysis





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




Years Ended December 31,2010 vs. 2009


2009 vs. 2008Increase/(Decrease) Due to


Increase/(Decrease) Due toTotal








TotalIncrease








Increase(In thousands)

Volume


Rate


(Decrease)


Volume


Rate


(Decrease)Interest Income:Real estate loans residential

$
277


$
(68
)

$
209


$
158


$
(222
)

$
(64
)Real estate loans commercial


438



(418
)


20



657



(253
)


404Commercial loans


306



(19
)


287



281



(425
)


(144
)Consumer loans


62



(55
)


7



151



(299
)


(148
)Taxable investment securities


165



(558
)


(393
)


(117
)


(304
)


(421
)Tax-exempt investment securities


331



3



334



(170
)


(20
)


(190
)Interest-earning deposits


1



2



3



40



(97
)


(57
)Total interest income


1,580



(1,113
)


467



1,000



(1,620
)


(620
)Interest Expense:NOW accounts


12



(5
)


7



8



(31
)


(23
)Money management accounts


4



-



4



2



(19
)


(17
)MMDA accounts


101



(11
)


90



104



(428
)


(324
)Savings and club accounts


4



(7
)


(3
)


4



(85
)


(81
)Time deposits


58



(1,181
)


(1,123
)


417



(1,200
)


(783
)Junior subordinated debentures


-



15



15



-



(108
)


(108
)Borrowings


(121
)


(90
)


(211
)


(305
)


(5
)


(310
)Total interest expense


58



(1,279
)


(1,221
)


230



(1,876
)


(1,646
)Net change in net interest income

$
1,522


$
166


$
1,688


$
770


$
256


$
1,026





Provision for Loan Losses





The provision for loan losses increased $174,000 to $1.1 million for the year ended December 31, 2010, as compared to the prior year.   This increase reflects additional provisions recorded throughout the year to address an increase in delinquency of commercial loans and a growing loan portfolio that is more heavily weighted to commercial term and commercial real estate loans.  These loans generally have higher inherent risk characteristics than a traditional residential real estate portfolio.  It has been the Company’s intention to continue to provide for future loan losses at a consistently higher level in light of the general weakening in economic conditions and overall asset quality.  All of the increase in the provision has been allocated to commercial lending.  The Company's ratio of allowance for loan losses to period-end loans increased to 1.28% at December 31, 2010 as compared to 1.17% at December 31, 2009.  Non-performing loans to period end loans increased to 2.08% at December 31, 2010 from 0.88% at December 31, 2009. The increase in non-performing loans is primarily the result of an increase in delinquency of a small number of relatively large commercial real estate loan relationships.  Management believes that the existing allowances provided on these loans are sufficient to cover anticipated losses.





Page 24
 Table of Contents


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)

2010


2009Service charges on deposit accounts

$
1,375


$
1,496Earnings and gains on bank owned life insurance


434



225Loan servicing fees


206



233Debit card interchange fees


316



280Other charges, commissions and fees


523



490Noninterest income before gains (losses)


2,854



2,724Net gains on sales, redemptions and impairment of investment securities


211



112Net (losses) gains on sales of loans and foreclosed real estate


(45
)


54Total noninterest income

$
3,020


$
2,890





For the year ended December 31, 2010, noninterest income before gains (losses) increased $130,000, or 4.8%, when compared with the year ended December 31, 2009.   The increase was comprised of increases in earnings and gains on bank owned life insurance, debit card interchange fees, and other charges and commissions and fees, which were offset by decreases in service charges on deposit accounts and loan servicing fees.  Earnings and gains on bank owned life insurance increased $209,000, or 92.9%, which is primarily due to insurance proceeds received relating to the death benefit associated with life insurance coverage on a former director.  The increase in debit card interchange fees is due to increased customer activity, which is driven by the debit card rewards program that was established late in the third quarter of 2009.  As a result of the Dodd-Frank Act mandated limits on interchange fees of larger institutions, and market pressure on the Company that may follow, debit card interchange fee income may decrease in the future.  The $33,000 increase in other charges, commissions and fees was attributable to an increase in investment services revenue and automated teller machine fees due to increased activity.  The increases were partially offset by a $121,000 decrease in service charges on deposit accounts associated with a decrease in customer use of the Company’s extended overdraft program.  The customer’s usage of the program was negatively impacted by the Federal Reserve Board’s issuance, during November 2009, of a final rule revising the provisions of Regulation E.  As part of these revisions, financial institutions were prohibited from charging consumers fees for paying overdrafts on automated teller machine (ATM) and one-time debit card transactions, unless a consumer consents, or opts in, to the overdraft service for those types of transactions. The final rule became effective on July 1, 2010.





Net gains and losses from the sale, redemption or impairment of securities increased to a net gain of $211,000 for the year ended December 31, 2010 as compared to a net gain of $112,000 for the same period of 2009.  The increase is due to gains recognized on the sale of securities and from cash redemptions from the SHAY Assets large cap equity fund and ultra short mortgage fund, as compared to the recording of other-than-temporary impairment charges during 2009.  Net losses from the sales of loans and foreclosed real estate totaled $45,000 for the year ended December 31, 2010, as compared to a net gain of $54,000 when compared to the same period in 2009.   The decrease is due to losses recognized on the sale of foreclosed properties in 2010 compared to the gains that were recognized on loan sales to the secondary market of 30-year fixed rate residential mortgages during 2009.


Page 25
 Table of Contents


Noninterest Expense





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





For the Years Ended December 31,(In thousands)

2010


2009Salaries and employee benefits

$
6,126


$
5,577Building occupancy


1,281



1,246Data processing


1,372



1,307Professional and other services


831



844FDIC assessments


515



745Other expenses


1,664



1,407Total noninterest expense

$
11,789


$
11,126





Noninterest expenses increased $663,000, or 6.0% for the year ended December 31, 2010.  The increase in noninterest expense is due to an increase of $549,000 in salaries and employee benefits, a $257,000 increase in other expenses, a $65,000 increase in data processing and a $35,000 increase in building occupancy.  These increases were partially offset by a $230,000 decrease in FDIC assessments.  The increase in salaries and employee benefits was due to the addition of 6 full-time equivalent positions, annual merit based wage adjustments and other incentive based compensation costs.  The increase in other expenses is partially due to expenses related to the Company’s debit card rewards program, which was not in place for the most of 2009.  FDIC assessments decreased when compared to 2009 due to a special assessment of $165,000 levied during 2009, as well as adjustments made to reflect a change in the structure and amount of the regular regulatory assessment.  As a result of the Dodd-Frank Act and other Federal and State government regulatory initiatives, additional compliance costs are anticipated in the future.





Income Tax Expense





In 2010, the Company reported income tax expense of $1.0 million compared with $1.1 million in 2009.  The effective tax rate decreased to 28.7% in 2010 compared to a tax rate of 39.4% in 2009.  The consistency in income tax expense, despite the higher pretax income earned in 2010, was the result of the lower effective tax rate.  The Company’s tax rate has decreased primarily as a result of deferred tax asset valuation allowance adjustments recorded in the prior year, combined with an increase in tax-exempt income from the investment portfolio and the receipt of tax-exempt life insurance proceeds relating to the death benefit associated with coverage on a former director.  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 21% of the Company’s average earning assets and is designed to generate a favorable rate of return consistent with safety of principal while assisting the Company in meeting its liquidity needs and interest rate risk strategies.  All of the Company’s investments are classified as available for sale.  The Company invests primarily in securities issued by United States Government agencies and sponsored enterprises, mortgage-backed securities, state and municipal obligations, mutual funds, equity securities, investment grade corporate debt instruments, and common stock issued by the Federal Home Loan Bank of New York (FHLBNY).  By investing in these types of assets, the Company reduces the credit risk of its asset base, but must accept lower yields than would typically be available on loan products.  Our mortgage backed securities portfolio is comprised predominantly of pass-through securities guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae and does not, to our knowledge, include any securities backed by sub-prime or other high-risk mortgages.





Page 26
 Table of Contents


At December 31, 2010, investment securities increased 17.2% to $87.5 million from $74.7 million at December 31, 2009.  There were no securities that exceeded 10% of consolidated shareholders’ equity.  See Note 3 to the consolidated financial statements for further discussion on securities.





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





(In Thousands)

2010


2009Investment Securities:US treasury, agencies and GSEs

$
20,023


$
14,532State and political subdivisions


18,979



8,928Corporate


5,600



4,965Residential mortgage-backed


37,246



36,940Mutual funds


3,024



4,814Equity securities


455



372Other


-



2,203Total investments in securities

$
85,327


$
72,754





Certain individual securities have been reclassified in the prior year table above to conform to the current year presentation.  The reclassifications had no effect on the total investment portfolios previously reported.





The following table sets forth the scheduled maturities, amortized cost, fair values and average yields for the Company's investment securities at December 31, 2010. 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


Avg Yield


Cost


Avg Yield


Cost


Avg YieldDebt investment securities:US Treasury, agencies and GSEs

$
-



-


$
17,107



1.55
%

$
2,030



2.08
%State and political subdivisions


96



1.50
%


2,195



2.33
%


8,374



4.04
%Corporate


502



5.17
%


3,126



5.13
%


-



-Total


598



4.58
%


22,428



2.12
%


10,404



3.65
%Mortgage-backed securities:Residential mortgage-backed


264



4.10
%


629



4.41
%


5,639



3.53
%Total


264



4.10
%


629



4.41
%


5,639



3.53
%Other non-maturity investments:Mutual funds


2,844



3.43
%


-



-



-



-Equity securities


450



2.03
%


-



-



-



-Total


3,294



2.96
%


-



-



-



-Total investment securities

$
4,156



3.49
%

$
23,057



2.19
%

$
16,043



3.61
%








Page 27
 Table of Contents








More Than Ten Years





Total Investment SecuritiesAnnualized








AnnualizedAmortized


Weighted


Amortized


Fair


Weighted(Dollars in thousands)

Cost


Avg Yield


Cost


Value


Avg YieldDebt investment securities:US Treasury, agencies and GSEs

$
1,000



5.20
%

$
20,137


$
20,023



1.78
%State and political subdivisions


8,562



4.56
%


19,227



18,979



4.06
%Corporate


2,237



0.90
%


5,865



5,600



3.52
%Total


11,799



3.92
%


45,229



44,602



2.97
%Mortgage-backed securities:Residential mortgage-backed


29,998



3.86
%


36,530



37,246



3.82
%Total


29,998



3.86
%


36,530



37,246



3.82
%Other non-maturity investments:Mutual funds


-



-



2,844



3,024



3.43
%Equity securities


-



-



450



455



2.03
%Total


-



-



3,294



3,479



3.24
%Total investment securities

$
41,797



3.88
%

$
85,053


$
85,327



3.35
%








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 69% of the Company’s average 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 14% of the total loan portfolio.  At December 31, 2010, 76% of the Company’s total loan portfolio consisted of loans secured by real estate, and 24% of the total loan portfolio consisted of commercial real estate loans.





December 31,(In thousands)

2010


2009


2008


2007


2006Residential real estate (1)

$
147,722


$
135,102


$
136,218


$
126,666


$
118,494Commercial real estate


69,060



62,250



55,061



45,490



40,501Commercial and municipal


39,833



35,447



30,685



25,288



23,001Home equity and junior liens


25,271



26,086



24,392



21,379



18,054Consumer


3,410



3,580



3,516



3,926



3,159Total loans receivable

$
285,296


$
262,465


$
249,872


$
222,749


$
203,209





(1) Includes loans held for sale. (None at December 31, 2010, 2009, 2008 and 2007.)








Page 28
 Table of Contents








The following table shows the amount of loans outstanding as of December 31, 2010 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

$
22,103


$
42,322


$
4,635


$
69,060Residential real estate


12,195



24,912



110,615



147,72234,298



67,234



115,250



216,782Other Commercial


31,890



7,312



631



39,833Home Equity and junior liens


14,552



960



9,759



25,271Consumer


643



2,342



425



3,410Total loans

$
81,383


$
77,848


$
126,065


$
285,296Interest rates:Fixed

$
6,439


$
10,688


$
121,083


$
138,210Variable


74,944



67,161



4,981



147,086Total loans

$
81,383


$
77,849


$
126,064


$
285,296





Total loans receivable increased 8.7% when compared to the prior year.Residential real estate loans increased $12.6 million, or 9.3%, during 2010.  The residential real estate portfolio consists of 74% fixed-rate mortgages and 26% adjustable-rate mortgages.  There was a 6% shift to fixed rate mortgages from adjustable rate mortgages when compared to the portfolio composition as of December 31, 2009.  The increase in the fixed rate mortgage portfolio resulted from increased demand for fixed rate products due to the historically low interest rate environment that was prevalent during 2010.  The Company does not originate sub-prime, Alt-A, negative amortizing or other higher risk structured residential mortgages.





Commercial real estate loans increased $6.8 million, or 10.9%, from the prior year as new loan products and relationships were added to the portfolio.





Commercial loans, including loans to municipalities, increased 12.4% over the prior year to $39.8 million at December 31, 2010.  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.





Consumer loans, which include second mortgage loans, home equity lines of credit, direct installment and revolving credit loans, decreased 3.3% to $28.6 million at December 31, 2010.  The decrease resulted from an decrease in home equity lines of credit as a result of the current market and economic conditions.








Page 29
 Table of Contents







Non-performing Loans and Assets





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





December 31,(In thousands)

2010


2009


2008


2007


2006Non-accrual loans:Commercial real estate and commercial

$
4,224


$
1,021


$
1,455


$
521


$
481Consumer


365



111



254



150



125Residential real estate


1,335



1,181



614



920



566Total non-accrual loans


5,924



2,313



2,323



1,591



1,172Total non-performing loans


5,924



2,313



2,323



1,591



1,172Foreclosed real estate


375



181



335



865



471Total non-performing assets

$
6,299


$
2,494


$
2,658


$
2,456


$
1,643Non-performing loans to total loans


2.08
%


0.88
%


0.93
%


0.71
%


0.57
%Non-performing assets to total assets


1.54
%


0.67
%


0.75
%


0.77
%


0.54
%Interest income that would have been recordedunder the original terms of the loans

$
260


$
113


$
131


$
71


$
53





Total non-performing loans increased approximately $3.6 million at December 31, 2010, when compared to December 31, 2009.  The increase in non-performing loans was primarily the result of the delinquency of a small number of relatively large commercial loan relationships.  These large commercial relationships are monitored closely by management and met with on a regular basis to work out repayment plans and alternative strategies for collection.  It is management’s intention to work closely and patiently with the small business owners as they adapt to the new market dynamics.  Management continues to monitor and react to national and local economic trends as well as general portfolio conditions, which may impact the quality of the portfolio.  In response to recent trends and risk management the Bank has increased the provision for loan losses, maintaining the Company’s strict loan underwriting standards and carefully monitoring the performance of the loan portfolio.





The current level of non-performing assets would not have fallen outside of the Bank's historic level trends were it not for the inclusion of three large commercial relationships.  The increase in non-performing loans since December 31, 2009 is comprised of primarily these three large relationships totaling $3.2 million.   The largest of these relationships totals $2.2 million in non-performing loans at December 31, 2010.  Of the balance outstanding, approximately $2.0 million is secured by commercial real estate and equipment.    A current evaluation of the commercial real estate and equipment was obtained from a third party in June 2010.  Management believes that the appraised fair value of the underlying collateral, discounted for selling costs, along with the associated guarantees of business principals and the existing allowance provided against these loans of $313,600, are adequate to cover the carrying amounts of the loans.  During the third quarter of 2010, two other relatively large commercial relationships, with a combined loan balance of approximately $1.0 million, became non-performing.  Both lending relationships are secured by commercial real estate and equipment, as well as personal and SBA guarantees.  Management believes that the collateral securing these loans, along with the guarantees of either business principals or government entities, and the existing allowance specifically allocated for the loans of $42,400, are adequate to cover the carrying amounts of the loans.





Appraisals are obtained at the time a real estate secured loan is originated.  Collateral is reevaluated should the loan become 45 days delinquent to best determine the bank’s level of exposure.  For commercial real estate held as collateral, the property is inspected every two years.  When evaluating our ability to collect from secondary sources, appraised values are adjusted to reflect the age of appraisal, the condition of the property, the current local real estate market, and cost to sell.  Properties are re-appraised when our evaluation of the current property condition and the local real estate market suggests values may not be accurate.





Page 30
 Table of Contents


The Company generally places a loan on non-accrual status and ceases accruing interest when loan payment performance is deemed unsatisfactory and the loan is past due 90 days or more.  There are no loans that are past due 90 or more and are still accruing interest.  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 the 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, 2010 and 2009, the Company had $7.0 million and $3.2 million in loans, which were deemed to be impaired, having valuation allowances of $1.1 million and $79,000, respectively.




Management has identified additional potential problem loans totaling $3.5 million as of December 31, 2010, compared to $5.0 million in potential problem loans as of December 31, 2009.  These loans have been internally classified as special mention or substandard, yet are not currently considered past due, impaired or in non-accrual status.  Management has identified potential credit problems which may result in the borrowers not being able to comply with the current loan repayment terms and which may result in it being included in future past due reporting. Management believes that the current allowance for loan losses is adequate to cover probable credit losses in the current loan portfolio.





In the normal course of business, Pathfinder Bank has sold residential mortgage loans and participation interests in commercial loans. As is typical in the industry, the bank makes certain representations and warranties to the buyer. Pathfinder maintains a quality control program for closed loans and has never been asked to repurchase a sold loan.  Therefore, management considers the risks and uncertainties associated with potential repurchase requirements to be minimal.  There are no known or alleged defects in the securitization process or in the mortgage documentation.  Any future risk of exposure would be immaterial.





Allowance for Loan Losses





The allowance for loan losses is 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 individually reviews 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 allowance for impairment.  Large residential real estate loans may also be included in this individual loan review.  If impairment is noted, the Company establishes a specific 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 an allowance 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, 2010.





The allowance for loan losses at December 31, 2010 and 2009 was $3.6 million and $3.1 million, or 1.28% and 1.17% of total period end loans, respectively.Net loan charge-offs were $480,000 during 2010, as compared to $270,000 in 2009.  The majority of the increase in current year charge-off activity is the result of the write off of a $200,000 loan that was part of the largest non-performing commercial relationship previously discussed.





Page 31
 Table of Contents


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.





2010


2009


2008


2007


2006Allocation


Percent of


Allocation


Percent of


Allocation


Percent of


Allocation


Percent of


Allocation


Percent ofof the


Loans to


of the


Loans to


of the


Loans to


of the


Loans to


of the


Loans to(Dollars in thousands)

Allowance


Total Loans


Allowance


Total Loans


Allowance


Total Loans


Allowance


Total Loans


Allowance


Total LoansResidential real estate

$
750



51.8
%

$
763



51.5
%

$
679



54.5
%

$
464



56.9
%

$
172



58.3
%Commercial real estate


1,204



24.2
%


1,009



23.7
%


907



22.0
%


614



20.4
%


628



19.9
%Commercial and municipal


1,083



13.9
%


864



13.5
%


505



12.3
%


342



11.3
%


357



11.3
%Home equity and junior liens


424



8.9
%


390



9.9
%


333



9.8
%


239



9.6
%


289



8.9
%Consumer loans


89



1.2
%


76



1.4
%


48



1.4
%


44



1.8
%


50



1.6
%Unallocated


98







(24
)






-







-







-Total

$
3,648



100.0
%

$
3,078



100.0
%

$
2,472



100.0
%

$
1,703



100.0
%

$
1,496



100.0
%








The following table sets forth the allowance for loan losses for the periods indicated, and related ratios.





(In thousands)

2010


2009


2008


2007


2006Balance at beginning of year

$
3,078


$
2,472


$
1,703


$
1,496


$
1,679Provisions charged to operating expenses


1,050



876



820



365



23Recoveries of loans previously charged-off:Commercial real estate and commercial


55



-



17



-



-Consumer


36



20



30



27



18Residential real estate


19



3



-



23



4Total recoveries


110



23



47



50



22Loans charged off:Commercial real estate and commercial


(385
)


(74
)


(46
)


(85
)


(114
)Consumer


(157
)


(134
)


(52
)


(77
)


(89
)Residential real estate


(48
)


(85
)


-



(46
)


(25
)Total charged-off


(590
)


(293
)


(98
)


(208
)


(228
)Net charge-offs


(480
)


(270
)


(51
)


(158
)


(206
)Balance at end of year

$
3,648


$
3,078


$
2,472


$
1,703


$
1,496Net charge-offs to average loans outstanding


0.18
%


0.11
%


0.02
%


0.08
%


0.11
%Allowance for loan losses to year-end loans


1.28
%


1.17
%


0.99
%


0.76
%


0.74
%











Page 32
 Table of Contents










Deposits





The Company’s deposit base is drawn from seven full-service offices in its market area and will expand to include an eighth office opened in Cicero, New York on February 1, 2011.  The deposit base consists of demand deposits, money management and money market deposit accounts, savings and time deposits. During 2010, 57% of the Company's average deposit base of $317.9 million consisted of core deposits.  Core deposits, which exclude time deposits, are considered to be more stable and provide the Company with a lower cost source of funds than time deposits.  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.  In addition, Pathfinder Commercial Bank, our commercial bank subsidiary, will seek business growth by focusing on its local identification and service excellence.  Pathfinder Commercial Bank had an average balance of $47.4 million in municipal deposits in 2010, primarily concentrated in money market deposit accounts.





Average deposits increased $29.4 million, or 10.2%, when compared to 2009.  The increase in average deposits primarily related to a $7.1 million increase in the average balance of municipal deposits and a $22.3 million increase in retail deposits.





The Company's average deposit mix in 2010, as compared to 2009, reflected a similar product line composition.   The Company's average demand deposits, both interest and noninterest bearing accounts, represented 18% of total average deposits for 2010 and 2009.  The Company's average MMDA accounts, which grew 43% in 2010, represented 16% of total deposits for 2010 and 12% for 2009. Savings accounts and money management accounts remained consistent at 19% and 4% of average deposits, respectively, for both 2010 and 2009.  The Company’s time deposit accounts represented 43% of total deposits for 2010 and 47% for 2009. The Company promotes its MMDA accounts by offering competitive rates to retain existing and attract new customers.





At December 31, 2010, time deposits in excess of $100,000 totaled $57.4 million, or 40%, of time deposits and 18% of total deposits.  At December 31, 2009, these deposits totaled $53.4 million, or 38% of time deposits and 18% of total deposits.





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, 2010:





(In thousands)Remaining Maturity:Three months or less

$
18,839Three through six months


8,039Six through twelve months


10,771Over twelve months


19,746Total

$
57,395











Page 33
 Table of Contents





Borrowings





Short-term borrowings are comprised primarily of advances and overnight borrowing at the FHLBNY.  At December 31, 2010, there were $13.0 million in short-term borrowings outstanding.  There were no short-term borrowings outstanding at December 31, 2009.





The following table represents information regarding short-term borrowings during 2010, 2009 and 2008:





(Dollars in thousands)

2010


2009


2008Maximum outstanding at any month end

$
13,000


$
1,400


$
23,795Average amount outstanding during the year


745



1,724



14,151Average interest rate during the year


0.47
%


1.84
%


2.85
%





Long-term borrowed funds consist of advances and repurchase agreements from the FHLBNY and Citi Group and junior subordinated debentures.  Long-term borrowed funds and junior subordinated debentures totaled $33.2 million at December 31, 2010 as compared to $41.2 million at December 31, 2009.





Capital





Shareholders' equity at December 31, 2010, was $30.6 million as compared to $29.2 million at December 31, 2009.  The Company added $2.5 million to retained earnings through net income.  The increase in retained earnings was offset by an increase of $514,000 in accumulated other comprehensive loss, which increased to $1.9 million from $1.4 million at December 31, 2009. Unrealized holding losses on securities, net of tax, resulted in an increase in accumulated other comprehensive loss of $85,000.  In addition, unrealized losses on the interest rate derivative, net of tax expense, added $66,000 and retirement plan losses and transition obligation amortization, net of tax expense, added $363,000 to accumulated other comprehensive loss.  Common stock dividends declared reduced capital by $298,000.   Preferred stock dividends paid to the United States Treasury, under the terms of the agreement entered into in 2009 as part of the Company’s $6.8 million participation in the Capital Purchase Plan, reduced capital by $339,000.





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, 2010, 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%.  As a result of the Dodd-Frank Act, the Company’s ability to raise new capital through the use of trust preferred securities may be limited because these securities will no longer be included in Tier 1 capital.  In addition, our ability to generate or originate additional revenue producing assets may be constrained in the future in order to comply with anticipated heightened capital standards required by state and federal regulation. See note 17 to the consolidated financial statements for further discussion on regulatory capital requirements.





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.





Page 34
 Table of Contents


The Company's liquidity has been enhanced by its membership in the Federal Home Loan Bank of New York, whose competitive advance programs and lines of credit 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 Company has a number of existing credit facilities.  Total credit available under the existing lines is approximately $93 million.  At December 31, 2010, the Company had $41 million outstanding under existing credit facilities with $52 million available.




The Asset Liability Management Committee of the Company is responsible for implementing the policies and guidelines for the maintenance of prudent levels of liquidity.  As of December 31, 2010, management reported to the Board of Directors that the Company is in compliance with its liquidity policy guidelines.





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, 2010, the Company had $30.1 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





Not required of a smaller reporting company.








Page 35


ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA





Index to Consolidated Financial Statements


Pathfinder Bancorp, Inc.




PageManagement's Report on Internal Control over Financial Reporting
37Report of Independent Registered Public Accounting Firm
38Consolidated Statements of Condition - December 31, 2010 and 2009
39Consolidated Statements of Income - Years ended December 31, 2010 and 2009
40Consolidated Statements of Changes of Shareholders' Equity - Years ended December 31, 2010 and 2009
41Consolidated Statements of Cash Flows - Years ended December 31, 2010 and 2009
42Notes to Consolidated Financial Statements
44
  Page 36
 Table of Contents





MANAGEMENT’S REPORT ON INTERNAL CONTROL 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, 2010. 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 the rules of the Dodd-Frank Act that exempts the Company from such attestation and requires only management’s 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 24, 2011

















Page 37
 Table of Contents








ParenteBeard


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 (the “Company”) as of December 31, 2010 and 2009, and the related consolidated statements of income, changes in shareholders’ equity and cash flows for each of the years in the two-year period ended December 31, 2010.  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, 2010 and 2009, and the consolidated results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America.
















/s/ ParenteBeard LLC                                                                            ParenteBeard LLC




Syracuse, New York


March 24, 2011







Page 38
 Table of Contents


CONSOLIDATED STATEMENTS OF CONDITION


December 31,


(In thousands, except share data)

2010


2009ASSETS:Cash and due from banks

$
6,366


$
8,678Interest earning deposits


7,397



5,953Total cash and cash equivalents


13,763



14,631Investment securities, at fair value


85,327



72,754Federal Home Loan Bank stock, at cost


2,134



1,899Loans


285,296



262,465Less: Allowance for loan losses


3,648



3,078Loans receivable, net


281,648



259,387Premises and equipment, net


9,432



7,173Accrued interest receivable


1,709



1,482Foreclosed real estate


375



181Goodwill


3,840



3,840Bank owned life insurance


6,915



6,956Other assets


3,402



3,389Total assets

$
408,545


$
371,692LIABILITIES AND SHAREHOLDERS' EQUITY:Deposits:Interest-bearing

$
295,786


$
269,539Noninterest-bearing


30,716



27,300Total deposits


326,502



296,839Short-term borrowings


13,000



0Long-term borrowings


28,000



36,000Junior subordinated debentures


5,155



5,155Other liabilities


5,296



4,460Total liabilities


377,953



342,454Shareholders' equity:Preferred stock, par value $0.01 per share; $1,000 liquidation preference; 1,000,000 shares authorized; 6,771 shares issued and outstanding


6,225



6,101Common stock, par value $0.01; authorized 10,000,000 shares; 2,972,119 and 2,484,832 shares issued and outstanding, respectively


30



30Additional paid in capital


8,615



8,615Retained earnings


24,163



22,419Accumulated other comprehensive loss


(1,939
)


(1,425
)Treasury stock, at cost; 487,287 shares


(6,502
)


(6,502
)Total shareholders' equity


30,592



29,238Total liabilities and shareholders' equity

$
408,545


$
371,692The accompanying notes are an integral part of the consolidated financial statements.





Page 39
 Table of Contents





CONSOLIDATED STATEMENTS OF INCOME


Years Ended December 31,


(In thousands, except per share data)

2010


2009Interest and dividend income:Loans, including fees

$
15,319


$
14,815Debt securities:Taxable


2,329



2,603Tax-exempt


264



43Dividends


220



339Federal funds sold and interest earning deposits


7



6Total interest income


18,139



17,806Interest expense:Interest on deposits


3,409



4,434Interest on short-term borrowings


4



32Interest on long-term borrowings


1,395



1,563Total interest expense


4,808



6,029Net interest income


13,331



11,777Provision for loan losses


1,050



876Net interest income after provision for loan losses


12,281



10,901Noninterest income:Service charges on deposit accounts


1,375



1,496Earnings and gains on bank owned life insurance


434



225Loan servicing fees


206



233Losses on impairment of investment securities


-



(693
)Net gains on sales and redemptions of investment securities


211



805Net (losses) gains on sales of loans and foreclosed real estate


(45
)


54Debit card interchange fees


316



280Other charges, commissions & fees


523



490Total noninterest income


3,020



2,890Noninterest expense:Salaries and employee benefits


6,126



5,577Building occupancy


1,281



1,246Data processing


1,372



1,307Professional and other services


831



844FDIC assessments


515



745Other expenses


1,664



1,407Total noninterest expenses


11,789



11,126Income before income taxes


3,512



2,665Provision for income taxes


1,007



1,050Net income


2,505



1,615Preferred stock dividends and discount accretion


462



96Net income available to common shareholders

$
2,043


$
1,519Earnings per common share - basic

$
0.82


$
0.61Earnings per common share - diluted

$
0.82


$
0.61Dividends per common share

$
0.12


$
0.12The accompanying notes are an integral part of the consolidated financial statements.








Page 40
 Table of Contents





CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY





AccumulatedAdditional





Other Com-Preferred


Common


Paid in


Retained


prehensive


Treasury(In thousands, except share data)

Stock


Stock


Capital


Earnings


Loss


Stock


TotalBalance, January 1, 2010

$
6,101


$
30


$
8,615


$
22,419


$
(1,425
)

$
(6,502
)

$
29,238Comprehensive income:Net income














2,505











2,505Other comprehensive income (loss), net of tax:Unrealized holding losses on securitiesavailable for sale (net of $56 tax benefit)


















(85
)






(85
)Unrealized holding loss on financialderivative (net of $44 tax benefit)


















(66
)






(66
)Retirement plan net losses and transitionobligation recognized in plan expenses(net of $242 tax benefit)


















(363
)






(363
)Total comprehensive income


























1,991Preferred stock discount accretion


124











(124
)










-Preferred stock dividends














(339
)










(339
)Common stock dividends declared ($0.12 per share)














(298
)










(298
)Balance, December 31, 2010

$
6,225


$
30


$
8,615


$
24,163


$
(1,939
)

$
(6,502
)

$
30,592Balance, January 1, 2009

$
-


$
30


$
7,909


$
21,198


$
(3,140
)

$
(6,502
)

$
19,495Comprehensive income:Net income














1,615











1,615Other comprehensive income, net of tax:Unrealized holding gains on securitiesavailable for sale (net of $371 tax expense)


















1,302







1,302Retirement plan net gains and transitionobligation recognized in plan expenses(net of $275 tax expense)


















413







413Total comprehensive income


























3,330Preferred stock andcommon stock warrants issued


6,065







706















6,771Preferred stock discount accretion


36











(36
)










-Preferred stock dividends














(60
)










(60
)Common stock dividends declared ($0.12 per share)














(298
)










(298
)Balance, December 31, 2009

$
6,101


$
30


$
8,615


$
22,419


$
(1,425
)

$
(6,502
)

$
29,238








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












Page 41
 Table of Contents



























CONSOLIDATED STATEMENTS OF CASH FLOWSYears Ended December 31,(In thousands)

2010


2009OPERATING ACTIVITIESNet income

$
2,505


$
1,615Adjustments to reconcile net income to net cash provided by operating activities:Provision for loan losses


1,050



876Deferred income tax expense


263



704Proceeds from sales of loans


264



9,659Originations of loans held-for-sale


(256
)


(9,540
)Realized losses (gains) on sales of:Real estate acquired through foreclosure


53



65Loans


(8
)


2Premises and equipment


1



(119
)Available-for-sale investment securities


(211
)


(805
)Impairment write-down on available-for-sale securities


-



693Depreciation


644



657Amortization of mortgage servicing rights


28



32Amortization of deferred loan costs


230



240Earnings on bank owned life insurance


(279
)


(225
)Realized gain on proceeds from bank owned life insurance


(155
)


-Net amortization of premiums and discounts on investment securities


319



254(Increase) decrease in accrued interest receivable


(227
)


196Net change in other assets and liabilities


163



(3,203
)Net cash provided by operating activities


4,384



1,101INVESTING ACTIVITIESPurchase of investment securities available-for-sale


(60,459
)


(43,666
)Net (purchases of) proceeds from the redemption of Federal Home Loan Bank stock


(235
)


650Proceeds from maturities and principal reductions of investment securities available-for-sale


37,431



22,151Proceeds from sale of:Available-for-sale investment securities


10,206



22,430Real estate acquired through foreclosure


210



498Premises and equipment


24



1Proceeds from bank owned life insurance


474



-Net increase in loans


(24,001
)


(13,488
)Purchase of premises and equipment


(2,928
)


(383
)Net cash used in investing activities


(39,278
)


(11,807
)FINANCING ACTIVITIESNet increase in demand deposits, NOW accounts, savings accounts,money management deposit accounts, MMDA accounts and escrow deposits


36,753



18,129Net (decrease) increase in time deposits


(7,090
)


9,272Net proceeds from (repayments on) short-term borrowings


13,000



(17,575
)Payments on long-term borrowings


(12,000
)


(5,400
)Proceeds from long-term borrowings


4,000



7,000Proceeds from the issuance of preferred stock and common stock warrants


-



6,771Cash dividends paid to preferred shareholders


(339
)


(60
)Cash dividends paid to common shareholders


(298
)


(478
)Net cash provided by financing activities


34,026



17,659(Decrease) increase in cash and cash equivalents


(868
)


6,953


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Cash and cash equivalents at beginning of period


14,631



7,678Cash and cash equivalents at end of period

$
13,763


$
14,631CASH PAID DURING THE PERIOD FOR:Interest

$
4,845


$
6,051Income taxes


403



524NON-CASH INVESTING ACTIVITYTransfer of loans to foreclosed real estate


460



385The accompanying notes are an integral part of the consolidated financial statements.
  Page 43
 Table of Contents


NOTESTO 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 and a new branch, which opened for business on February 1, 2011 in  northern Onondaga 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 and employee benefits approximating $113,000 were allocated from the Company to the Holding Company during 2009.  No personnel expense was allocated to the Holding Company in 2010.  The Holding Company recorded $24,000 as rental income from the Bank in 2010 and $15,000 for 2009.  As of December 31, 2010, the Bank had a loan receivable from the Holding Company of $1,217,000.





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 $268,000 and $353,000 for the years ended December 31, 2010 and 2009, respectively.  The advertising expense in 2009 was higher as a result of marketing efforts associated with the Bank’s celebration of 150 years of operation.


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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.





Note 3 to the consolidated financial statements includes additional information about the Company’s accounting policies with respect to the impairment of investment securities.





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 loans held-for-sale or forward commitments outstanding as of December 31, 2010 and 2009.


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 are stated at their outstanding 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.





The loans receivable portfolio is segmented into residential mortgage, commercial and consumer loans.  The residential mortgage segment consists of one-to-four family first-lien residential mortgages and construction loans.  Commercial loans consist of the following classes: real estate, other commercial and industrial, lines of credit and municipal loans.  Consumer loans include both home equity lines of credit and loans with junior liens and other consumer loans.





Page 45
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Allowance for Loan Losses





The allowance for loan losses represents management’s estimate of losses inherent in the loan portfolio as of the date of the statement of condition and it is recorded as a reduction of loans.  The allowance is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries.  Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance.  All, or part, of the principal balance of loans receivable are charged off to the allowance as soon as it is determined that the repayment of all, or part, of the principal balance is highly unlikely.  Non-residential consumer loans are generally charged off no later than 120 days past due on a contractual basis, unless productive collection efforts are providing results.  Consumer loans may be charged off earlier in the event of bankruptcy, or if there is an amount that is deemed uncollectible.  Because all identified losses are immediately charged off, no portion of the allowance for loan losses is restricted to any individual loan and the entire allowance is available to absorb any and all loan losses.





The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated.  Management performs a quarterly evaluation of the adequacy of the allowance.  The allowance is based on the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors.  This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revision as more information becomes available.





The allowance consists of specific, general and unallocated components.  The specific component relates to loans that are classified as impaired.  For loans that are classified impaired, an allowance is established when the discounted cash flows or collateral value of the impaired loan are lower than the carrying value of that loan.





The general component covers pools of loans, by loan class, including commercial loans not considered impaired, as well as smaller balance homogenous loans, such as residential real estate, home equity and other consumer loans.  These pools of loans are evaluated for loss exposure based on historical loss rates for each of these categories of loans, which are adjusted for qualitative factors.  The qualitative factors include:


§
Lending policies and procedures, including underwriting standards and collection, charge-off and recovery practices


§
National, regional and local economic and business conditions as well as the condition of various market segments, including the value of underlying collateral for collateral dependent loans


§
Nature and volume of the portfolio and terms of the loans


§
Experience, ability and depth of the lending management and staff


§
Volume and severity of past due, classified and non-accrual loans, as well as other loan modifications


§
Quality of the Company’s loan review system and the degree of oversight by the Company’s Board of Directors


Each factor is assigned a value to reflect improving, stable or declining conditions based on management’s best judgment using relevant information available at the time of the evaluation.  Adjustments to the factors are supported through documentation of changes in conditions in a narrative accompanying the allowance for loan loss analysis and calculation.





Each portfolio class carries its own risk characteristics.  Real estate loans, including residential mortgages, commercial real estate loans and home equity, comprise approximately 85% of the portfolio in both 2010 and 2009.  Loans secured by real estate provide the best collateral protection and thus significantly reduce the inherent risk in the portfolio.





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 Table of Contents


An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses.  The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.





A loan is considered impaired when, based on current information and events, it is probable that 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.  Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due.  Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and shortfalls on a case-by case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length and reason for the delay, the borrower’s prior payment record and the amount of shortfall in relation to what is owed.  Impairment is measured on a loan-by-loan basis for commercial real estate loans and other commercial or industrial loans by either the present value of the expected future cash flows discounted at the loan’s effective interest rate or the fair value of the underlying collateral if the loan is collateral dependent.





An allowance for loan loss is established for an impaired loan if its carrying value exceeds its estimated fair value.  The estimated fair values of substantially all of the Company’s impaired loans are measured based on the estimated fair value of the loan’s collateral.  For commercial loans secured by real estate, estimated fair values are determined primarily through third-party appraisals.  When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary.  This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal, and the condition of the property.  Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value.  The discounts also include estimated costs to sell the property.





For commercial and industrial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, account receivable agings or equipment appraisals or invoices.  Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets.





Large groups of homogeneous loans are collectively evaluated for impairment.  Accordingly, the Company does not separately identify individual residential mortgage loans, home equity and other consumer loans for impairment disclosures, unless such loans have significant balances or they are the subject to a troubled debt restructuring agreement.





Loans whose terms are modified are classified as troubled debt restructurings if the Company grants such borrowers concessions and it is deemed that those borrowers are experiencing financial difficulty.  Concessions granted under a troubled debt restructuring generally involve a temporary reduction in the interest rate or an extension of a loan’s stated maturity date.  Loans classified as troubled debt restructurings are designated as impaired and evaluated as discussed above.





The allowance calculation methodology includes further segregation of loan classes into risk rating categories.  The borrower’s overall financial condition, repayment sources, guarantors and value of the collateral, if appropriate, are evaluated annually for commercial loans or when credit deficiencies arise on all loans.  Credit quality risk ratings include regulatory classifications of special mention, substandard, doubtful and loss.  Loans classified as special mention have potential weaknesses that deserve management’s close attention.  If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects.  Loans classified as substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of debt.  They include loans that are inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged.  Loans classified as doubtful have all the weaknesses inherent in loans classified substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable.  Loans classified as loss are considered uncollectible and are charged to the allowance for loan losses.  Loans that are not classified are rated pass.





Page 47
 Table of Contents


In addition, Federal regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses and may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management.  Based on management’s comprehensive analysis of the loan portfolio, management believes the current level of the allowance for loan losses is adequate.





Income Recognition on Impaired and Non-accrual Loans





For all classes of loans receivable, the accrual of interest is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectibility of principal or interest, even though the loan may be currently performing.  A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured.  When a loan is placed on non-accrual status, unpaid interest is reversed and charged to interest income.  Interest received on non-accrual loans, including impaired loans, generally is either applied against principal or reported as interest income, according to management’s judgment as to the collectibility of principal.  Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectibility of the total contractual principal and interest is no longer in doubt.  Non-accrual troubled debt restructurings are restored to accrual status if principal and interest payments, under the modified terms, are current for six consecutive months after modification.





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.





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 other noninterest expense and were $219,000 and $90,000 in 2010 and 2009, respectively.  The increase in the expenses related to foreclosed property is largely due to one commercial property.





Page 48
 Table of Contents


Goodwill





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 2010 or 2009, 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.





Gains and losses, prior service costs and credits, and any remaining transition amounts 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.  Plan assets and obligations are measured as of the Company’s statement of condition date.





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.


Derivative Financial Instruments


Derivatives are recorded on the statement of condition as assets and liabilities measured at their fair value. The accounting for increases and decreases in the value of derivatives depends upon the use of derivatives and whether the derivatives qualify for hedge accounting.  The Company currently has one interest rate swap, which has been determined to be a cash flow hedge.  The fair value of cash-flow hedging instruments (“Cash Flow Hedge”) is recorded in either other assets or other liabilities. On an ongoing basis, the statement of condition is adjusted to reflect the then current fair value of the Cash Flow Hedge. The related gains or losses are reported in other comprehensive income and are subsequently reclassified into earnings, as a yield adjustment in the same period in which the related interest on the hedged item (primarily a variable-rate debt obligation) affect earnings. To the extent that the Cash Flow Hedge is not effective, the ineffective portion of the Cash Flow Hedge is immediately recognized as interest expense.




Page 49
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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 Common Share





Basic earnings per common share are computed by dividing net income, after preferred stock dividends and preferred stock discount accretion, 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, the effective portion of cash-flow hedges, 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 income.





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







(In thousands)

2010


2009Unrealized holding (losses) gains on securities available for sale:Unrealized holding gains (losses) arising during the period

$
70


$
1,785Reclassification adjustment for net gains included in net income


(211
)


(112
)Net unrealized gains on securities available for sale


(141
)


1,673Unrealized holding losses on financial derivative:Unrealized holding losses arising during the period


(170
)


-Reclassification adjustment for interest expense included in net income


60Net unrealized losses on financial derivative


(110
)


-Defined benefit pension and post retirement plans:Additional plan (losses) gains


(823
)


409Reclassification adjustment for amortization of benefit plans' net lossand transition obligation recognized in net periodic expense


218



279Net change in defined benefit plan


(605
)


688Other comprehensive income before tax


(856
)


2,361Tax effect


342



(646
)Other comprehensive (loss) income

$
(514
)

$
1,715







Page 50
 Table of Contents


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





(In thousands)

2010


2009Unrealized gains on securities available for sale (net of taxexpense 2010 - $110; 2009 - $166)

$
164


$
249Unrealized losses on financial derivative (net of taxbenefit 2010 - $44)


(66
)


-Net pension losses and past service liability (net of taxbenefit 2010 - $1,334; 2009 - $1,100)


(2,001
)


(1,649
)Net post-retirement losses and past service liability (net of taxbenefit 2010 - $25; 2009 - $17)


(36
)


(25
)$
(1,939
)

$
(1,425
)





Reclassifications





Certain amounts in the 2009 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





The FASB has issued ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. This ASU requires some new disclosures and clarifies some existing disclosure requirements about fair value measurement as set forth in Codification Subtopic 820-10. The FASB’s objective is to improve these disclosures and, thus, increase the transparency in financial reporting. Specifically, ASU 2010-06 amends Codification Subtopic 820-10 to now require:


§
A reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers; and


§
In the reconciliation for fair value measurements using significant unobservable inputs, a reporting entity should present separately information about purchases, sales, issuances, and settlements.


In addition, ASU 2010-06 clarifies the requirements of the following existing disclosures:


§
For purposes of reporting fair value measurement for each class of assets and liabilities, a reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities; and


§
A reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements.


ASU 2010-06 was effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years.  This standard has been adopted and did not have an impact on the Company.





ASU 2010-18, Receivables (Topic 310): Effect of a Loan Modification When the Loan Is Part of a Pool That Is Accounted for as a Single Asset,codifies the consensus reached in EITF Issue No. 09-I, “Effect of a Loan Modification When the Loan Is Part of a Pool That Is Accounted for as a Single Asset.” The amendments to the Codification provide that modifications of loans that are accounted for within a pool under Subtopic 310-30 do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring.  An entity will continue to be required to consider whether the pool of assets in which the loan is included is impaired if expected cash flows for the pool change.  ASU 2010-18 does not affect the accounting for loans under the scope of Subtopic 310-30 that are not accounted for within pools.  Loans accounted for individually under Subtopic 310-30 continue to be subject to the troubled debt restructuring accounting provisions within Subtopic 310-40.  ASU 2010-18 was effective prospectively for modifications of loans accounted for within pools under Subtopic 310-30 occurring in the first interim or annual period ending on or after July 15, 2010. Early application is permitted. Upon initial adoption of ASU 2010-18, an entity may make a one-time election to terminate accounting for loans as a pool under Subtopic 310-30.  This election may be applied on a pool-by-pool basis and does not preclude an entity from applying pool accounting to subsequent acquisitions of loans with credit deterioration.  The Company no longer pools loans and holds one single asset that consists of a very small number of individual loans.  The adoption of this standard did not have an impact on the Company.





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ASU 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, will help investors assess the credit risk of a company’s receivables portfolio and the adequacy of its allowance for credit losses held against the portfolios by expanding credit risk disclosures.


This ASU requires more information about the credit quality of financing receivables in the disclosures to financial statements, such as aging information and credit quality indicators.  Both new and existing disclosures must be disaggregated by portfolio segment or class.  The disaggregation of information is based on how a company develops its allowance for credit losses and how it manages its credit exposure.   The amendments in this Update apply to all public and nonpublic entities with financing receivables.  Financing receivables include loans and trade accounts receivable.  However, short-term trade accounts receivable, receivables measured at fair value or lower of cost or fair value, and debt securities are exempt from these disclosure amendments.  The effective date of ASU 2010-20 differs for public and nonpublic companies.  For public companies, the amendments that require disclosures as of the end of a reporting period were effective for periods ending on or after December 15, 2010.  The amendments that require disclosures about activity that occurs during a reporting period are effective for periods beginning on or after December 15, 2010.  This update  has been adopted and required the Company to provide additional disclosures related to loan receivables and credit quality.





The FASB has issued ASU 2011-01, which amends ASU 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. The amendments in this Update temporarily delay the effective date of the disclosures about troubled debt restructurings in Update 2010-20 for public entities. Under the existing effective date in Update 2010-20, public-entity creditors would have provided disclosures about troubled debt restructurings for periods ending on or after December 15, 2010. The delay is intended to allow the Board time to complete its deliberations on what constitutes a troubled debt restructuring. The effective date of the new disclosures about troubled debt restructurings for public entities and the guidance for determining what constitutes a troubled debt restructuring will then be coordinated. Currently, that guidance is anticipated to be effective for interim and annual periods ending after June 15, 2011.  The deferral in this amendment is effective upon issuance.







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NOTE 3: INVESTMENT SECURITIES – AVAILABLE-FOR-SALE





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





December 31, 2010Gross


Gross


EstimatedAmortized


Unrealized


Unrealized


Fair(In thousands)

Cost


Gains


Losses


ValueDebt investment securities:US Treasury, agencies and GSEs

$
20,137


$
139


$
(253
)

$
20,023State and political subdivisions


19,227



174



(422
)


18,979Corporate


5,865



228



(493
)


5,600Residential mortgage-backed - agency


35,714



934



(239
)


36,409Residential mortgage-backed - private label


816



21



-



837Total


81,759



1,496



(1,407
)


81,848Equity investment securities:Mutual funds:Ultra short mortgage fund


1,532



26



-



1,558Large cap equity fund


1,129



93



-



1,222Other mutual funds


183



61



-



244Common stock - financial services industry


450



5



-



455Total


3,294



185



-



3,479Total investment securities

$
85,053


$
1,681


$
(1,407
)

$
85,327








December 31, 2009Gross


Gross


EstimatedAmortized


Unrealized


Unrealized


Fair(In thousands)

Cost


Gains


Losses


ValueDebt investment securities:US Treasury, agencies and GSEs

$
14,528


$
30


$
(26
)

$
14,532State and political subdivisions


8,989



20



(81
)


8,928Corporate


5,333



194



(562
)


4,965Residential mortgage-backed - agency


34,838



989



(144
)


35,683Residential mortgage-backed - private label


1,286



-



(29
)


1,257Total


64,974



1,233



(842
)


65,365Equity investment securities:Mutual funds:Ultra short mortgage fund


2,519



-



-



2,519Large cap equity fund


2,088



-



-



2,088Other mutual funds


183



24



-



207Common stock - financial services industry


372



-



-



372Total


5,162



24



-



5,186Other investments


2,203



-



-



2,203Total investment securities

$
72,339


$
1,257


$
(842
)

$
72,754





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The amortized cost and estimated fair value of debt investments at December 31, 2010 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

$
598


$
611Due after one year through five years


22,428



22,565Due after five years through ten years


10,404



10,334Due after ten years


11,799



11,092Mortgage-backed securities


36,530



37,246Totals

$
81,759


$
81,848





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, 2010Less than Twelve Months


Twelve Months or More


TotalUnrealized


Fair


Unrealized


Fair


Unrealized


FairLosses


Value


Losses


Value


Losses


Value(In thousands)US Treasury, agencies and GSEs

$
(253
)

$
9,260


$
-


$
-


$
(253
)

$
9,260State and political subdivisions


(422
)


10,173



-



-



(422
)


10,173Corporate


-



-



(493
)


1,473



(493
)


1,473Residential mortgage-backed - agency


(239
)


8,861



-



-



(239
)


8,861$
(914
)

$
28,294


$
(493
)

$
1,473


$
(1,407
)

$
29,767December 31, 2009Less than Twelve Months


Twelve Months or More


TotalUnrealized


Fair


Unrealized


Fair


Unrealized


FairLosses


Value


Losses


Value


Losses


Value(In thousands)US Treasury, agencies and GSEs

$
(26
)

$
4,996


$
-


$
-


$
(26
)

$
4,996State and political subdivisions


(81
)


2,988



-



-



(81
)


2,988Corporate


-



-



(562
)


1,402



(562
)


1,402Residential mortgage-backed - agency


(144
)


8,954



-



-



(144
)


8,954Residential mortgage-backed - private label


(5
)


711



(24
)


545



(29
)


1,256$
(256
)

$
17,649


$
(586
)

$
1,947


$
(842
)

$
19,596








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We conduct a formal review of investment securities on a quarterly basis for the presence of other-than-temporary impairment (“OTTI”). We assess whether OTTI is present when the fair value of a debt security is less than its amortized cost basis at the statement of condition date. Under these circumstances, OTTI is considered to have occurred (1) if we intend to sell the security; (2) if it is “more likely than not” we will be required to sell the security before recovery of its amortized cost basis; or (3) the present value of expected cash flows is not sufficient to recover the entire amortized cost basis. The guidance requires that credit-related OTTI is recognized in earnings while non-credit-related OTTI on securities not expected to be sold is recognized in other comprehensive income (“OCI”). Non-credit-related OTTI is based on other factors, including illiquidity. Presentation of OTTI is made in the consolidated statement of income on a gross basis, including both the portion recognized in earnings as well as the portion recorded in OCI. Normally, the gross OTTI would then be offset by the amount of non-credit-related OTTI, showing the net as the impact on earnings.  All OTTI charges have been credit-related to date, and therefore no offset has been presented on the consolidated statements of income.





At December 31, 2010, eight U.S. government agency and GSE bonds are in unrealized loss positions. Three of these holdings are callable agency bullet bonds issued by the Federal Home Loan Bank and the Federal National Mortgage Association.  All three are AAA rated by Moody’s and S&P.   One bond has been in an unrealized loss position for three months with an unrealized loss of 2.9% of the current carrying value. The second bond has been in an unrealized loss position for two months with an unrealized loss of 2.6% of the current carrying value. The third bond has been in an unrealized loss position for one month and has an unrealized loss of 6.2%. The unrealized losses relate principally to changes in interest rates subsequent to the acquisition of the specific securities.  No OTTI is deemed present on these securities.  Of the remaining five government agency  and GSE bonds currently in unrealized loss positions, only one has been in an unrealized loss position for more than one month.  The largest unrealized loss on these bonds is 2.8% of the current carrying value. All five positions are AAA rated.  No OTTI is deemed present on these securities.





At December 31, 2010, 15 state and political subdivision securities are in unrealized loss positions. Two of the securities represent taxable offerings issued by Ennis Texas Economic Development Corp and the city of Columbus, Ohio.  The securities are AA+, and AAA rated by S&P respectively.  The Ennis Texas position is insured with an underlying rating of A-.    The maximum unrealized loss for any of the thirteen remaining state and political holdings is less than 5% of the related book value and only two of these holdings have been in unrealized loss positions for more than two months.  Municipal valuations have been negatively impacted by a 60 – 80 basis point increase in the longer term portion of the municipal bond yield curve over the past 2 months. The unrealized losses relate principally to changes in interest rates subsequent to the acquisition of the specific securities.  No other than temporary impairment is deemed present on these securities.





At December 31, 2010, two corporate securities were in unrealized loss positions and represent trust-preferred issuances from large money center financial institutions.  The JP Morgan Chase floating rate trust-preferred security has a carrying value of $985,000 and a fair value of $781,000. The Bank of America floating rate trust-preferred security has a carrying value of $981,000 and a fair value of $691,000.  The securities are rated A2 and Baa3 by Moody’s, respectively.  The securities are both floating rate notes that adjust quarterly to LIBOR. These securities are reflecting a net unrealized loss due to current similar offerings being originated at higher spreads to LIBOR, as the market currently demands a greater pricing premium for the associated risk. Management has performed a detailed credit analysis on the underlying companies and has concluded that neither issue is credit impaired.  Due to the fact that each security has approximately 16 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.  The Company expects the present value of expected cash flows will be sufficient to recover the amortized cost basis.  Thus, the securities are not deemed to be other-than-temporarily impaired.




Eight government agency and government sponsored enterprise (GSE) residential mortgage-backed security holdings have an unrealized loss as of December 31, 2010.  The securities were issued by the Government National Mortgage Association, Federal National Mortgage Association and Federal Home Loan Mortgage Corporation.  The unrealized losses have been in place for three months or less.  All securities are AAA rated. The unrealized losses relates principally to changes in interest rates subsequent to the acquisition of the specific security.    No OTTI is deemed present on these securities.





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In determining whether OTTI has occurred for equity securities, the Company considers the applicable factors described above and the length of time the equity security’s fair value has been below the carrying amount. Management has determined that we have the intent and ability to retain the equity securities for a sufficient period of time to allow for recovery. The Company holds one equity security that had a fair value less than the carrying value at December 31, 2010.   A small common stock investment in The Phoenix Companies has an unrealized loss of less than $1,000.  Due to the relatively small size of the unrealized loss and short duration of the loss period, no OTTI is deemed present in relation to this security.





The following table presents a roll-forward of the amount related to credit losses recognized in earnings for the years ended December 31:





(In thousands)

2010


2009Beginning balance – January 1

$
875


$
875Initial credit impairment


-



298Subsequent credit impairments


-



-Reductions for amounts recognized in earnings due to intent or requirement to sell


-



(298
)Reductions for securities sold


-



-Reductions for increases in cash flows expected to be collected


-



-Ending balance - December 31

$
875


$
875





Gross realized gains (losses) on sales, redemptions, and impairment of securities for the year ended December 31 are detailed below:





(In thousands)

2010


2009Realized gains

$
212


$
814Realized losses


(1
)


(9
)Other than temporary impairment


-



(693
)$
211


$
112





As of December 31, 2010 and December 31, 2009, securities with an amortized cost of $47.5 million and $45.7 million, respectively, were pledged to collateralize certain deposit and borrowing arrangements.





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





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NOTE 4: LOANS





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





(In thousands)

2010


2009Residential mortgage loans:1-4 family first-lien residential mortgages

$
143,661


$
131,929Construction


3,569



2,399147,230



134,328Commercial loans:Real estate


69,042



62,229Lines of credit


14,122



12,827Other commercial and industrial


20,779



18,966Municipal loans


4,826



3,654108,769



97,676Consumer loans:Home equity and junior liens


25,168



26,086Other consumer


3,411



3,58028,579



29,666Total loans


284,578



261,670Net deferred loan costs


718



795Less allowance for loan losses


(3,648
)


(3,078
)Loans receivable, net

$
281,648


$
259,387





The Company grants residential mortgage, commercial 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.





Loan Origination / Risk Management


The Company has lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk.  Management reviews and approves these policies and procedures on a regular basis.  A reporting system supplements the review process by frequently providing management with reports related to loan production, loan quality, loan delinquencies, non-performing and potential problem loans.  Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.





The loan portfolio is segregated into risk rating categories based on the borrower’s overall financial condition, repayment sources, guarantors, and value of collateral, if appropriate.  The risk ratings are evaluated at least annually for commercial loans or when credit deficiencies arise, such as delinquent loan payments, for commercial, residential mortgage or consumer loans.  Credit quality risk ratings include regulatory classifications of special mention, substandard, doubtful and loss.  Loans classified as loss are considered uncollectible and are charged to the allowance for loan loss.  Loans not classified are rated pass. See further discussion of risk ratings in Note 1.





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The following table presents the classes of the loan portfolio summarized by the aggregate pass rating and the classified ratings of special mention, substandard and doubtful within the Company's internal risk rating system as of December 31, 2010:





Special(In thousands)

Pass


Mention


Substandard


Doubtful


TotalResidential mortgage loans:1-4 family first-lien residential mortgages

$
138,435


$
1,725


$
3,501


$
-


$
143,661Construction


3,569



-



-



-



3,569142,004



1,725



3,501



-



147,230Commercial loans:Real estate


63,834



524



4,684



-



69,042Lines of credit


13,280



28



814



-



14,122Other commercial and industrial


19,857



163



759



-



20,779Municipal loans


4,826



-



-



-



4,826101,797



715



6,257



-



108,769Consumer loans:Home equity and junior liens


23,559



316



1,293







25,168Other consumer


3,271



30



110







3,41126,830



346



1,403



-



28,579Total loans

$
270,631


$
2,786


$
11,161


$
-


$
284,578





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





Related Party Loans


In the ordinary course of business, the Company has granted loans to certain directors, executive officers and their affiliates (collectively referred to as “related parties”).  These loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other unaffiliated parties and do not involve more than normal risk of collectibility.





The following represents the activity associated with loans to related parties during the year ended December 31, 2010:





(In thousands)Balance at the beginning of the year

$
5,882Originations


957Principal payments


(833
)Charged-off


(196
)Balance at the end of the year

$
5,810








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The related loan charge-off is on a commercial loan made to an affiliate of one of the directors.  Although the loan was secured with receivables and inventory, the value of that collateral is minimal and collection is questionable.  The loan has been charged off due to the poor financial condition of the company that is the primary borrower, and the minimal collateral value, but collection efforts continue with the guarantors of the loan.  The director and four other business principals guarantee this loan, as well as another $1.6 million non-performing loan in the relationship.  Management believes that the appraised fair value of the underlying collateral, discounted for selling costs, along with the associated guarantees of business principals and the existing allowance provided against these loans, are adequate to cover potential losses that may occur.





Non-accrual and Past Due Loans


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





An age analysis of past due loans, segregated by class of loans, as of December 31, 2010, was as follows:





30-59 Days


60-89 Days


Over


Total





Total Loans(In thousands)

Past Due


Past Due


90 Days


Past Due


Current


ReceivableResidential mortgage loans:1-4 family first-lien residential mortgages

$
2,045


$
1,078


$
1,335


$
4,458


$
139,203


$
143,661Construction


-



-



-



-



3,569



3,5692,045



1,078



1,335



4,458



142,772



147,230Commercial loans:














-







-Real estate


238



908



3,680



4,826



64,216



69,042Lines of credit


205



-



69



274



13,848



14,122Other commercial and industrial


734



301



475



1,510



19,269



20,779Municipal loans


-



-



-



-



4,826



4,8261,177



1,209



4,224



6,610



102,159



108,769Consumer loans:














-







-Home equity and junior liens


586



371



303



1,260



23,908



25,168Other consumer


15



7



62



84



3,327



3,411601



378



365



1,344



27,235



28,579Total loans

$
3,823


$
2,665


$
5,924


$
12,412


$
272,166


$
284,578










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 Table of Contents




Year-end non-accrual loans, segregated by class of loan, were as follows:





(In thousands)

2010


2009Residential mortgage loans:1-4 family first-lien residential mortgages

$
1,335


$
1,181Construction


-



-1,335



1,181Commercial loans:Real estate


3,680



892Lines of credit


69



-Other commercial and industrial


475



129Municipal loans


-



-4,224



1,021Consumer loans:Home equity and junior liens


303



111Other consumer


62



-365



111Total non-accrual loans

$
5,924


$
2,313





There were no loans past due ninety days or more and still accruing interest at December 31, 2010 or 2009.








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Impaired Loans





The following table summarizes impaired loans information by portfolio class as of December 31, 2010:





Unpaid





Average


InterestRecorded


Principal


Related


Recorded


IncomeInvestment


Balance


Allowance


Investment


RecognizedWith no related allowance recorded:1-4 family first-lien residential mortgages

$
185


$
185


$
-


$
441


$
14Residential mortgage construction


-



-



-



-



-Commercial real estate


1,919



1,919



-



2,288



91Commercial lines of credit


-



-



-



-



-Other commercial and industrial


96



96



-



73



13Municipal


-



-



-



-



-Home equity and junior liens


411



411



-



119



16Other consumer


-



-



-



-



-With an allowance recorded:1-4 family first-lien residential mortgages


1,215



1,215



255



682



61Residential mortgage construction


-



-



-



-



-Commercial real estate


2,233



2,322



352



1,262



18Commercial lines of credit


300



300



300



275



10Other commercial and industrial


346



346



78



225



4Municipal


-



-



-



-



-Home equity and junior liens


252



252



110



59



8Other consumer


-



-



-



-



-Total:1-4 family first-lien residential mortgages


1,400



1,400



255



1,123



75Residential mortgage construction


-



-



-



-



-Commercial real estate


4,152



4,241



352



3,550



109Commercial lines of credit


300



300



300



275



10Other commercial and industrial


442



442



78



298



17Municipal


-



-



-



-



-Home equity and junior liens


663



663



110



178



24Other consumer


-



-



-



-



-$
6,957


$
7,046


$
1,095


$
5,424


$
235





As of December 31, 2009, the total recorded investment in impaired loans was $3.2 million, of which $986,000 had a related allowance for loan losses of $79,000 and $2.3 million had no related allowance for loan losses.  The average recorded investment in impaired loans for the year ended December 31, 2009 was $2.9 million.  Total interest recognized on impaired loans was $159,000 for the year ended December 31, 2009.





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There was no interest recognized using the cash-basis method of accounting for the years ended December 31, 2010 or 2009.




NOTE 5: ALLOWANCE FOR LOAN LOSSES





Changes in the allowance for loan losses for the year ended December 31, 2010 are summarized as follows:




1-4 familyfirst-lien


Residential








Otherresidential


mortgage


Commercial


Commercial


commercialmortgage


construction


real estate


lines of credit


and industrialAllowance for credit losses:Beginning Balance

$
763


$
-


$
1,009


$
376


$
486Charge-offs


(48
)


-



(162
)


(196
)


(27
)Recoveries


19



-



55







-Provisions


16



-



302



399



42Ending balance

$
750


$
-


$
1,204


$
579


$
501Ending balance: individuallyevaluated for impairment

$
255


$
-


$
352


$
300


$
78Ending balance: collectivelyevaluated for impairment

$
495


$
-


$
852


$
279


$
423Loans receivables:Ending balance

$
143,661


$
3,569


$
69,042


$
14,122


$
20,779Ending balance: individuallyevaluated for impairment

$
1,400


$
-


$
4,152


$
300


$
442Ending balance: collectivelyevaluated for impairment

$
142,261


$
3,569


$
64,890


$
13,822


$
20,337Home equity


OtherMunicipal


and junior liens


Consumer


Unallocated


TotalAllowance for credit losses:Beginning Balance

$
2


$
390


$
76


$
(24
)

$
3,078Charge-offs


-



(76
)


(81
)


-



(590
)Recoveries


-



5



31



-



110Provisions


1



105



63



122



1,050Ending balance

$
3


$
424


$
89


$
98


$
3,648Ending balance: individuallyevaluated for impairment

$
-


$
110


$
-


$
-


$
1,095Ending balance: collectivelyevaluated for impairment

$
3


$
314


$
89


$
98


$
2,553Loans receivables:Ending balance

$
4,826


$
25,168


$
3,411






$
284,578Ending balance: individuallyevaluated for impairment

$
-


$
663


$
-






$
6,957Ending balance: collectivelyevaluated for impairment

$
4,826


$
24,505


$
3,411






$
277,621




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 Table of Contents


Changes in the allowance for loan losses for the year ended December 31, 2009 are summarized as follows:





(In thousands)

2009Balance at beginning of year

$
2,472Recoveries credited:Commercial


-Mortgage


3Consumer


20Total recoveries


23Loans charged-off:Commercial


(74
)Mortgage


(85
)Consumer


(134
)Total charged-off


(293
)Net charge-offs


(270
)Provision for loan losses


876Balance at end of year

$
3,078





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 $37,746,000 and $46,225,000 at December 31, 2010 and 2009, respectively.  The balance of capitalized servicing rights included in other assets at December 31, 2010 and 2009, was $35,000 and $61,000, respectively.





The following summarizes mortgage-servicing rights capitalized and amortized:





(In thousands)

2010


2009Mortgage servicing rights capitalized

$
2


$
78Mortgage servicing rights amortized

$
28


$
32





NOTE 7: PREMISES AND EQUIPMENT





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





(In thousands)

2010


2009Land

$
1,226


$
1,226Buildings


7,181



7,100Furniture, fixtures and equipment


7,531



7,342Construction in progress


2,761



15518,699



15,823Less: Accumulated depreciation


9,267



8,650$
9,432


$
7,173





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The increase in premises and equipment is the result ofthe construction of the new branch location in Cicero, New York and the remodeling of the main branch lobby in Oswego, New York.




NOTE 8: GOODWILL





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. Management performs an annual valuation of the Company’s goodwill to determine whether or not any impairment of the carrying value may exist. This valuation utilizes a three-step approach to determine three potential fair values, which are then weighted based upon their level in the fair value hierarchy to determine the fair value of the reporting unit for the impairment calculation. For purposes of this valuation, management considers the Company and its subsidiaries as a whole to be the reporting unit. Based on the results of this testing, management has determined that the carrying value of goodwill is not impaired as of December 31, 2010 and 2009.





NOTE 9: DEPOSITS





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





(In thousands)

2010


2009Savings accounts

$
55,966


$
52,663Time accounts


85,240



87,805Time accounts over $100,000


57,395



53,421Money management accounts


12,593



11,327MMDA accounts


54,799



35,788Demand deposit interest-bearing


26,449



25,367Demand deposit noninterest-bearing


30,716



27,300Mortgage escrow funds


3,344



3,168$
326,502


$
296,839





At December 31, 2010, the scheduled maturities of time deposits are as follows:




(In thousands)Year of Maturity:2011

$
83,1422012


13,3252013


14,7122014


26,1942015


1,841Thereafter


3,421$
142,635











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NOTE 10: BORROWED FUNDS





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





(In thousands)

2010


2009Short-term:FHLB Advances

$
13,000


$
-Long-term:FHLB advances

$
23,000


$
31,000Citigroup Repurchase agreements


5,000



5,000Total long-term borrowings

$
28,000


$
36,000





The principal balances, interest rates and maturities of the above fixed rate borrowings at December 31, 2010 is as follows:





Term

Principal


Rates(Dollars in thousands)Short-term advances with FHLB

$
13,000



0.36%-0.68
%Long-term:Repurchase agreements (due in 2013)

$
5,000



2.95
%Advances with FHLBdue within 1 year


6,000



2.33%-4.19
%due within 2 years


4,000



2.70%-4.91
%due within 3 years


4,000



4.46%-4.53
%due within 4 years


5,000



2.85%-3.07
%due within 5 years


2,000



2.79
%due within 7 years


2,000



2.56
%Total advances with FHLB


23,000Toal long-term borrowings

$
28,000





The repurchase agreement with Citi Group is collateralized by certain investment securities having a carrying value of $6,569,000 at December 31, 2010.  The collateral is under the Company’s control.  The Company also has access to Federal Home Loan Bank advances, under which it can borrow at various terms and interest rates.  Residential mortgage loans with a carrying value of $71,080,000 and FHLB stock with a carrying value of $2,134,000 have been pledged by the Company under a blanket collateral agreement to secure the Company’s borrowings.  The total outstanding indebtedness under borrowing facilities with the FHLB cannot exceed the total value of the assets pledged under the blanket collateral agreement.  The Company has a $6.1 million line of credit available at December 31, 2010 with the Federal Reserve Bank of New York through its Discount Window and has pledged various corporate and municipal securities against the line. The Company has an $11.0 million line of credit available with three other correspondent banks. $4.0 million of that line of credit is available on an unsecured basis and the remaining $7.0 million must be collateralized with marketable investment securities. Interest on the lines is determined at the time of borrowing.




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The Company has a non-consolidated subsidiary trust, Pathfinder Statutory Trust II, of which the Company owns 100% of the common equity.  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% (1.94% at December 31, 2010) 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.





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 a limited number of 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.





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)

2010


2009


2010


2009Change in benefit obligations:Benefit obligations at beginning of year

$
6,095


$
5,493


$
332


$
369Service cost


261



228



-



3Interest cost


376



332



20



22Actuarial loss (gain)


954



188



37



(38
)Benefits paid


(147
)


(146
)


(25
)


(24
)Benefit obligations at end of year


7,539



6,095



364



332Change in plan assets:Fair value of plan assets at beginning of year


6,252



3,461



-



-Actual return on plan assets


722



937



-



-Benefits paid


(147
)


(146
)


(25
)


(24
)Employer contributions


1,063



2,000



25



24Fair value of plan assets at end of year


7,890



6,252



-



-Funded Status - asset (liability)

$
351


$
157


$
(364
)

$
(332
)








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





(In thousands)


2010
2009Unrecognized transition obligation

$
20
$             38Net loss


3,376
2,7533,396
2,791Tax Effect


1,359
1,117$
2,037
$         1,674





The accumulated benefit obligation for the defined benefit pension plan was $6,185,000 and $5,026,000 at December 31, 2010 and 2009, respectively.  The postretirement plan had an accumulated benefit obligation of $364,000 and $332,000 at December 31, 2010 and 2009, respectively.





The significant assumptions used in determining the benefit obligations as of December 31, 2010 and 2009 are as follows:


Pension Benefits


Postretirement Benefits2010


2009


2010


2009Weighted average discount rate


5.54
%


6.25
%


5.54
%


6.25
%Rate of increase in future compensation levels


3.50
%


3.50
%


-



-





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% for each year.  The rates were assumed to decrease gradually to 5.00% in 2015 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


8



(7
)





The composition of the net periodic benefit plan cost for the years ended December 31, 2010 and 2009 is as follows:





Pension Benefits


Postretirement Benefits2010


2009


2010


2009(In thousands)Service cost

$
261


$
228


$
-


$
3Interest cost


376



332



20



22Amortization of transition obligation


-



-



18



18Amortization of net losses


200



260



-



1Expected return on plan assets


(554
)


(378
)


-



-Net periodic benefit plan cost

$
283


$
442


$
38


$
44







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





Pension Benefits


Postretirement Benefits2010


2009


2010


2009Weighted average discount rate


6.25
%


6.13
%


6.25
%


6.13
%Expected long term rate of return on plan assets


8.00
%


8.00
%


-



-Rate of increase in future compensation levels


3.50
%


3.50
%


-



-





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 5.0%-9.0% and 2.0%-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 in the range of 7.0% to 11.0%.  Management has chosen to use an 8% expected long-term rate of return to reflect current economic conditions and expected returns.





The expected long-term rate of return for 2011 will continue to be 8.0%.  The estimated net actuarial loss that will be amortized from accumulated other comprehensive loss into net periodic benefit plan cost during 2011 is $248,000.  The estimated amortization of the unrecognized transition obligation in 2011 is $18,000.  The expected net periodic benefit plan cost for 2011 is estimated at $403,000 for both retirement plans.





Plan assets are invested in diversified investment funds of the RSI Retirement Trust (the “Trust”), a private placement investment fund.  The investment funds include a series of equity and bond mutual funds or commingled trust funds, each with its own investment objectives, investment strategies and risks, as detailed in the Statement of Investment Objectives and Guidelines.  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 long-term investment objectives are to maintain plan assets at a level that will sufficiently cover long-term obligations and to generate a return on plan assets that will meet or exceed the rate at which long-term obligations will grow.  A broadly diversified combination of equity and fixed income portfolios and various risk management techniques are used to help achieve these objectives.





In addition, significant consideration is paid to the plan’s funding levels when determining the overall asset allocation.  If the plan is considered to be well-funded, approximately 65% of the plan’s assets are allocated to equities and approximately 35% allocated to fixed-income.  If the plan is does not satisfy the criteria for a well-funded plan, approximately 50% of the plan’s assets are allocated to equities and approximately 50% allocated to fixed-income.  Asset rebalancing normally occurs when the equity and fixed-income allocations vary by more than 10% from their respective targets (i.e., a 20% policy range guideline).





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.







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Pension plan assets measured at fair value are summarized below:





At December 31, 2010Total Fair(In thousands)

Level 1


Level 2


Level 3


ValueAsset Category:Mutual funds - equityLarge-cap value (a)

$
711


$
-


$
-


$
711Small-cap Core (b)


949



-



-



949Common/collective trusts - equityLarge-cap core (c)


-



810



-



810Large-cap value (d)


-



411



-



411Large-cap growth (e)


-



1,164



-



1,164International Core (f)


-



1,081



-



1,081Common/collective trusts - fixed incomeMarket duration fixed (g)


-



2,764



-



2,764Total

$
1,660


$
6,230


$
-


$
7,890








At December 31, 2009Total Fair(In thousands)

Level 1


Level 2


Level 3


ValueAsset Category:Mutual funds - equityLarge-cap value (a)

$
556


$
-


$
-


$
556Small-cap Core (b)


657



-



-



657Common/collective trusts - equityLarge-cap core (c)


-



625



-



625Large-cap value (d)


-



311



-



311Large-cap growth (e)


-



915



-



915International Core (f)


-



884



-



884Common/collective trusts - fixed incomeMarket duration fixed (g)


-



2,304



-



2,304Total

$
1,213


$
5,039


$
-


$
6,252





(a)
This category consists of investments whose sector and industry exposures are maintained within a narrow band around Russell 1000 index.  The portfolio holds approximately 150 stocks.


(b)
This category contains stocks whose sector weightings are maintained within a narrow band around those of the Russell 2000 index.  The portfolio will typically hold more than 150 stocks.


(c)
This fund tracks the performance of the S&P 500 Index by purchasing the securities represented in the Index in approximately the same weightings as the Index.


(d)
This category contains large-cap stock with above-average yield.  The portfolio typically holds between 60 and 70 stocks.


(e)
This category consists of a portfolio of between 45 and 65 stocks that will typically overweight technology and health care.


(f)
This category consists of a broadly diversified portfolio of non-U.S. domiciled stocks.  The portfolio will typically hold more than 200 stocks, with 0% - 35% invested in emerging markets securities.


(g)
This category consists of an index fund that tracks the Barclays Capital U.S. Aggregate Bond Index.  The fund invests in Treasury, agency,  corporate, mortgage-backed and asset-backed securities.





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For the fiscal year ending December 31, 2011, the Bank expects to contribute approximately $27,000 to the postretirement plan, but does not expect to make a contribution to the pension plan.





The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid from both retirement plans:





Years ending December 31:(In thousands)2011

$
1832012


1982013


2162014


2522015


276Years 2016 - 2020


1,694





The Company also offers a 401(k) plan to its employees.  Contributions to this plan by the Company were $160,000 and $188,000 for 2010 and 2009, 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, 2010 and 2009, other liabilities include approximately $1,872,000 and $1,806,000, respectively, relating to deferred compensation. Deferred compensation expense for the years ended December 31, 2010 and 2009 amounted to approximately $225,000 and $209,000, respectively.





The Company has a supplemental executive retirement plan for the benefit of certain executive officers.  At December 31, 2010 and 2009, other liabilities included approximately $259,000 and $298,000 accrued under this plan. Compensation expense includes approximately $22,000 relating to the supplemental executive retirement plan for the year ended December 31, 2010 and $50,000 for the year ended December 31, 2009.  The decrease in expense is primarily the result of the suspension of accruals related to the plan for the Company’s chief executive officer under the requirements of the agreement entered into in 2009 with the United States Department of Treasury.





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, 2010 and 2009, the cash surrender values of these policies were $6,915,000 and $6,956,000, respectively.  The decrease in the surrender values was the result ofinsurance proceeds received relating to the death benefit associated with life insurance coverage on a former director.





NOTE 12:  STOCK BASED COMPENSATION PLAN





In February 1997, the Board of Directors approved an 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.  None of the original options granted prior to July 2001 remain outstanding at December 31, 2010.




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In July 2001, the Board approved the issuance of 38,499 stock options remaining in the 1997 Stock Option Plan.  The exercise price was equal to the market value of the Company's shares at the date of grant ($8.34).  The options granted under the issuance have a 10-year term and are fully vested.











Activity in the Stock Option Plan is as follows:




WeightedOptions


Average


Shares(Shares in thousands)

Outstanding


Exercise Price


ExercisableOutstanding at January 1, 2009


19


$
8.34



19Exercised


-



-Expired


-



-Outstanding at December 31, 2009


19


$
8.34



19Exercised


-



-Expired


-



-Outstanding at December 31, 2010


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, 2010.  The intrinsic value changes based on fluctuations in the market value of the Company’s stock.  At December 31, 2010 and 2009, 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.





There were no stock options exercised during 2010.





At December 31, 2010, the 18,850 options outstanding all had an exercise price of $8.34 and an average remaining contractual life of 0.5 years.





NOTE 13: INCOME TAXES





The provision for income taxes for the years ended December 31, is as follows:





(In thousands)

2010


2009Current

$
744


$
346Deferred


263



704$
1,007


$
1,050





The provision for income taxes includes the following:





(In thousands)

2010


2009Federal Income Tax

$
911


$
993New York State Franchise Tax


96



57$
1,007


$
1,050





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





(In thousands)

2010


2009Assets:Deferred compensation

$
825


$
814Allowance for loan losses


1,411



1,191Postretirement benefits


141



128Mortgage recording tax credit carryforward


242



417Impairment losses on investment securities


686



686Other


165



2453,470



3,481Liabilities:Pension asset


(136
)


(61
)Depreciation


(359
)


(420
)Accretion


(48
)


(48
)Loan origination fees


(278
)


(308
)Intangible assets


(1,220
)


(1,030
)Investment securities


(52
)


(166
)Prepaid expenses


(168
)


(318
)(2,261
)


(2,351
)1,209



1,130Less: deferred tax asset valuation allowance


(458
)


(458
)Net deferred tax asset

$
751


$
672





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. The valuation allowance of $458,000 represents the portion of the deferred tax asset that  management believes may not be realizable, as the Company 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:




2010


2009Federal statutory income tax rate


34.0
%


34.0
%State tax, net of federal benefit


1.8



2.1Tax-exempt interest income, net of TEFRA


(3.4
)


(1.5
)Increase in value of bank owned life insurance


(2.3
)


(2.5
)Gain on proceeds from bank owned life insurance


(1.5
)


-Deferred tax valuation allowance


-



7.1Other


0.1



0.2Effective income tax rate


28.7
%


39.4
%





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At December 31, 2010 and 2009, 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, 2007 through 2010.





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


EPS2010  Net income

$
2,505Preferred stock dividends and discount accretion


462Net income available to common shareholders


2,043Basic EPS


2,043



2,485


$
0.82Effect of dilutive securities:Stock options


-



-



-Stock warrants


-



4



-Diluted EPS

$
2,043



2,489


$
0.822009  Net income

$
1,615Preferred stock dividends and discount accretion


96Net income available to common shareholders


1,519Basic EPS


1,519



2,485


$
0.61Effect of dilutive securities:Stock options


-



-



-Stock warrants


-



-



-Diluted EPS

$
1,519



2,485


$
0.61








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.




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At December 31, 2010 and 2009, the following financial instruments were outstanding whose contract amounts represent credit risk:




Contract Amount(In thousands)

2010


2009Commitments to grant loans

$
9,591


$
7,187Unfunded commitments under lines of credit


18,950



16,411Standby letters of credit


1,524



1,606





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, 2010 with fixed interest rates amounted to approximately $6.3 million. Loan commitments, including unused lines of credit and standby letters of credit, outstanding at December 31, 2010 with variable interest rates amounted to approximately $23.7 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.





Letters of credit written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party.  Generally, all letters of credit, when issued have expiration dates within one year.  The credit risk involved in issuing letters of credit is essentially the same as those that are involved in extending loan facilities to customers.  The Company generally holds collateral and/or personal guarantees supporting these commitments.  Management believes that the proceeds obtained through a liquidation of collateral and the enforcement of guarantees would be sufficient to cover the potential amount of future payments required under the corresponding guarantees.  The amount of the liability as of December 31, 2010 and 2009 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 $67,000 for 2010 and $66,000 for 2009.  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.  During 2010, the Company entered into an arm’s length lease with Pathfinder Bancorp, MHC for space that is then sub-leased by the Company to a charitable organization at below-market rents.  Rent expense paid to the related parties during 2010 and 2009 was $46,000 and $45,000, respectively.





Approximate minimum rental commitments for non-cancelable operating leases are as follows:





Years Ending December 31:(In thousands)2011

$
862012


792013


362014


-2015


-Thereafter


-Total minimum lease payments

$
201





The total amount of minimum rents to be received in the future under non-cancelable subleases is $27,000.





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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 2010, the Company paid or accrued dividends totaling $190,000 to the Holding Company. The Holding Company did not waive the right to receive its portion of the cash dividends declared during 2010 or 2009.





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 $2,789,000 as of December 31, 2010.  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.  The Company is prohibited from accepting or directing Pathfinder Bank to declare or pay a dividend or other capital distributions without prior written approval of the OTS.





Since the Company has chosen to participate in the Treasury’s CPP program, its ability to increase dividends to its stockholders is limited without prior approval by the United States Treasury Department.





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).





As of December 31, 2010, 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.





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The Bank’s actual capital amounts and ratios as of December 31, 2010 and 2009 are 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, 2010:Total Core Capital (to Risk-Weighted Assets)

$
35,837



13.5
%

$
21,197



8.0
%

$
26,496



10.0
%Tier 1 Capital (to Risk-Weighted Assets)

$
32,440



12.2
%

$
10,598



4.0
%

$
15,898



6.0
%Tier 1 Capital (to Average Assets)

$
32,440



8.1
%

$
16,001



4.0
%

$
20,002



5.0
%As of December 31, 2009:Total Core Capital (to Risk-Weighted Assets)

$
33,405



14.0
%

$
19,163



8.0
%

$
23,954



10.0
%Tier 1 Capital (to Risk-Weighted Assets)

$
30,399



12.7
%

$
9,582



4.0
%

$
14,372



6.0
%Tier 1 Capital (to Average Assets)

$
30,399



8.4
%

$
14,517



4.0
%

$
18,146



5.0
%








On September 11, 2009, the Company entered into the Purchase Agreement with the United States Department of the Treasury pursuant to which the Company has issued and sold to Treasury: (i) 6,771 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, par value $0.01 per share, having a liquidation amount per share equal to $1,000, for a total price of $6,771,000; and (ii) a Warrant to purchase 154,354 shares of the Company’s common stock, par value $0.01 per share, at an exercise price per share of $6.58.  The Company contributed to Pathfinder Bank, its subsidiary, $5,500,000 or 81.23% of the proceeds of the sale of the Series A Preferred Stock.





The $6,771,000 of proceeds was allocated to the Series A Preferred Stock and the Warrant based on their relative fair values at issuance ($6,065,000 was allocated to the Series A Preferred Stock and $706,000 to the Warrant).  The difference between the initial value allocated to the Series A Preferred Stock and the liquidation value of $6,771,000, i.e. the preferred discount, will be charged to retained earnings over the first five years of the contract as an adjustment to the dividend yield using the effective yield method.





The Series A Preferred Stock pays cumulative dividends at a rate of 5% per annum for the first five years and thereafter at a rate of 9% per annum.  The Series A Preferred Stock is generally non-voting.  Prior to September 11, 2012, and unless the Company has redeemed all of the Series A Preferred Stock or the Treasury Department has transferred all of the Series A Preferred Stock to a third party, the approval of the Treasury Department will be required for the Company to increase its common stock dividend or repurchase its common stock or other equity or capital securities, other than in certain circumstances specified in the Purchase Agreement.





The Warrant has a ten-year term and is immediately exercisable.  The Warrant provides for the adjustment of the exercise price and the number of shares of the Company’s common stock issuable upon exercise pursuant to customary anti-dilution provisions, such as upon stock splits or distributions of securities or other assets to holders of the Company’s common stock, and upon certain issuances of the Company’s common stock at or below a specified price relative to the then current market price of the Company’s common stock.  Pursuant to the Purchase Agreement, the Treasury Department has agreed not to exercise voting power with respect to any shares of common stock issued upon exercise of the Warrant.




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The Series A Preferred Stock and the Warrant were issued in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended.  The Company has agreed to register for resale the Series A Preferred Stock, the Warrant and the shares of common stock underlying the Warrant (the “Warrant Shares”), as soon as practicable after the date of the issuance of the Series A Preferred Stock and the Warrant.  Neither the Series A Preferred Stock nor the Warrant will be subject to any contractual restrictions on transfer.





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, 2010, 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%.





The Bank is required to maintain average balances on hand or with the Federal Reserve Bank.  At December 31, 2010 and 2009, these reserve balances amounted to $2,804,000 and $2,070,000, respectively.





NOTE 18: INTEREST RATE DERIVATIVE





Derivative instruments are entered into primarily as a risk management tool of the Company. Financial derivatives are recorded at fair value as other assets and other liabilities. The accounting for changes in the fair value of a derivative depends on whether it has been designated and qualifies as part of a hedging relationship. For a fair value hedge, changes in the fair value of the derivative instrument and changes in the fair value of the hedged asset or liability are recognized currently in earnings. For a cash flow hedge, changes in the fair value of the derivative instrument, to the extent that it is effective, are recorded in other comprehensive income and subsequently reclassified to earnings as the hedged transaction impacts net income. Any ineffective portion of a cash flow hedge is recognized currently in earnings.  See Note 19 for further discussion of  the fair value of the interest rate derivative.





The Company has $5 million of floating rate trust preferred debt indexed to 3-month LIBOR.  As a result, it is exposed to variability in cash flows related to changes in projected interest payments caused by changes in the benchmark interest rate.   During the fourth quarter of fiscal 2009, the Company entered into an interest rate swap agreement, with a $2.0 million notional amount, to convert a portion of the variable-rate junior subordinated debentures to a fixed rate for a term of approximately 7 years at a rate of 4.96%.  The derivative is designated as a cash flow hedge.  The hedging strategy ensures that changes in cash flows from the derivative will be highly effective at offsetting changes in interest expense from the hedged exposure.





The following table summarizes the fair value of outstanding derivatives and their presentation on the statements of condition as of December 31:





(In thousands)


2010Cash flow hedge:Interest rate swap
Other liabilities

$
110





The change in accumulated other comprehensive loss and the impact on earnings from the interest rate swap that qualifies as a cash flow hedge for the year ended December 31 were as follows:





(In thousands)

2010Balance as of January 1:

$
-Amount of (loss) gain recognized in other comprehensive income


(170
)Amount of loss reclassified from other comprehensive incomeand recognized as interest expense


60Balance as of December 31:

$
(110
)





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





The Company posted cash, of $200,000, under collateral arrangements to satisfy collateral requirements associated with the interest rate swap contract.





NOTE 19: FAIR VALUE MEASUREMENTS AND DISCLOSURES





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





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





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





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





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





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.  At this time, only the AMF Large Cap Equity Institutional Fund qualifies as a Level 1 valuation.  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.





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





Impaired loans: Impaired loans are those loans in which the Company has measured impairment 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.




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The following tables summarize assets measured at fair value on a recurring basis as of December 31, segregated by the level of valuation inputs within the hierarchy utilized to measure fair value:





At December 31, 2010Total Fair(In thousands)

Level 1


Level 2


Level 3


ValueDebt investment securities:US Treasury, agencies and GSEs

$
-


$
20,023


$
-


$
20,023State and political subdivisions


-



18,979



-



18,979Corporate


-



5,600



-



5,600Residential mortgage-backed - agency


-



36,409



-



36,409Residential mortgage-backed - private label


-



837



-



837Equity investment securities:Mutual funds:Ultra short mortgage fund


1,558



-



-



1,558Large cap equity fund


1,222



-



-



1,222Other mutual funds


-



244



-



244Common stock - financial services industry


36



419



-



455Total investment securities

$
2,816


$
82,511


$
-


$
85,327Interest rate swap derivative

$
-


$
(110
)

$
-



(110
)At December 31, 2009Total Fair(In thousands)

Level 1


Level 2


Level 3


ValueDebt investment securities:US Treasury, agencies and GSEs

$
-


$
14,532


$
-


$
14,532State and political subdivisions


-



8,928



-



8,928Corporate


-



4,965



-



4,965Residential mortgage-backed - agency


-



35,683



-



35,683Residential mortgage-backed - private label


-



1,257



-



1,257Equity investment securities:Mutual funds:Ultra short mortgage fund


2,519



-



-



2,519Large cap equity fund


2,088



-



-



2,088Other mutual funds


-



207



-



207Common stock - financial services industry


23



349



-



372Other investments


-



2,203



-



2,203Total investment securities

$
4,630


$
68,124


$
-


$
72,754








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Certain assets and liabilities are measured at fair value on a nonrecurring basis; that is, the instruments 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 following tables summarize assets measured at fair value on a nonrecurring basis as of December 31, segregated by the level of valuation inputs within the hierarchy utilized to measure fair value:





At December 31, 2010Total Fair(In thousands)

Level 1


Level 2


Level 3


ValueImpaired loans

$
-


$
-


$
3,340


$
3,340At December 31, 2009Total Fair(In thousands)

Level 1


Level 2


Level 3


ValueImpaired loans

$
-


$
-


$
907


$
907





There have been no transfers of assets in or out of any fair value measurement level.





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





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 period-ends, and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates.  As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each period-end.





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





Cash and cash equivalents – The carrying amounts of these assets approximate their fair value.




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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 – The fair values of portfolio loans, excluding impaired loans (see previous discussion of methods and assumptions), 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 of these assets approximates their fair value.





Accrued interest receivable and payable – The carrying amount of these assets approximates their fair value.





Mortgage servicing rights - The carrying amount of these assets approximates their fair value.





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





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.  Such fees were not material at December 31, 2010 and 2009.





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





2010


2009Carrying


Estimated


Carrying


Estimated(Dollars in thousands)

Amounts


Fair Values


Amounts


Fair ValuesFinancial assets:Cash and cash equivalents

$
13,763


$
13,763


$
14,631


$
14,631Investment securities


85,327



85,327



72,754



72,754Net loans


281,648



290,049



259,387



266,290Federal Home Loan Bank stock


2,134



2,134



1,899



1,899Accrued interest receivable


1,709



1,709



1,482



1,482Mortgage servicing rights


35



35



61



61Financial liabilities:Deposits

$
326,502


$
328,963


$
296,839


$
299,613Borrowed funds


41,000



41,984



36,000



37,116Junior subordinated debentures


5,155



5,155



5,155



5,155Accrued interest payable


153



153



189



189Interest rate swap derivative


110



110



-



-Off-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

2010


2009(In thousands)AssetsCash

$
1,199


$
1,242Investments


24



20Investment in bank subsidiary


34,408



32,820Investment in non-bank subsidiary


155



155Other assets


166



257Total assets

$
35,952


$
34,494Liabilities and Shareholders' EquityAccrued liabilities

$
205


$
101Junior subordinated debentures


5,155



5,155Shareholders' equity


30,592



29,238Total liabilities and shareholders' equity

$
35,952


$
34,494Statements of Income


2009



2009(In thousands)IncomeDividends from bank subsidiary

$
700


$
825Dividends from non-bank subsidiary


4



5Losses on impairment of investment security


-



(4
)Total income


704



826ExpensesInterest


164



157Operating


171



162Total expenses


335



319Income before taxes and equity in undistributed net income of subsidiaries


369



507Tax benefit


98



101Income before equity in undistributed net income of subsidiaries


467



608Equity in undistributed net income of subsidiaries


2,038



1,007Net income

$
2,505


$
1,615








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Statements of Cash Flows

2010


2009(In thousands)Operating ActivitiesNet Income

$
2,505


$
1,615Equity in undistributed earnings of subsidiaries


(2,038
)


(1,007
)Impairment write-down on investment security


-



4Other operating activities


127



(113
)Net cash provided by operating activities


594



499Investing ActivitiesCapital contributed to wholly owned bank subsidiary


-



(5,500
)Net cash used in investing activities


-



(5,500
)Financing activitiesProceeds from the issuance of preferred stock and common stock warrants


-



6,771Cash dividends paid to preferred shareholders


(339
)


(60
)Cash dividends paid to common shareholders


(298
)


(478
)Net cash (used in) provided by financing activities


(637
)


6,233(Decrease) increase in cash and cash equivalents


(43
)


1,232Cash and cash equivalents at beginning of year


1,242



10Cash and cash equivalents at end of year

$
1,199


$
1,242





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





None.





ITEM 9A: 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 the rules of the Dodd-Frank Act that exempts the Company from such attestation and requires only management’s 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




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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, 2010.





Name
Age
Positions Held With the CompanyThomas W. Schneider
49
President and Chief Executive OfficerJames A. Dowd, CPA
43
Senior Vice President, Chief Financial OfficerEdward A. Mervine
54
Senior Vice President, General CounselMelissa A. Miller
53
Senior Vice President, Chief Operating OfficerRonald Tascarella
52
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 ACCOUNTING 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".


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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, 2010 and 2009, 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)


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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 ParenteBeard LLC31.1
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





99.1
Certification of Chief Executive Officer Pursuant to Section 111(b)(4) of the Emergency Economic Stabilization Act of 2008





99.2
Certification of Chief Financial Officer Pursuant to Section 111(b)(4) of the Emergency Economic Stabilization Act of 2008


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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 24, 2011
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/ Thomas W. Schneider
By:

/s/ James A. DowdThomas W. Schneider, President and


James A. Dowd, Senior Vice President andChief Executive Officer


Chief Financial Officer(Principal Executive Officer)


(Principal Financial Officer)Date:

March 24, 2011
Date:

March 24, 2011By:

/s/ Janette Resnick
By:

/s/ Shelley J. TafelJanette Resnick, Director


Shelley J. Tafel, Vice President andChairman of the Board


Controller(Principal Accounting Officer)Date:

March 24, 2011
Date:

March 24, 2011By:

/s/ Bruce E. Manwaring
By:

/s/ Steven W. ThomasBruce E. Manwaring, Director


Steven W. Thomas, DirectorDate:

March 24, 2011
Date:

March 24, 2011By:

/s/ L. William Nelson
By:

/s/ Chris R. BurrittL. William Nelson, Director


Chris R. Burritt, DirectorDate:

March 24, 2011
Date:

March 24, 2011By:

/s/ Corte J. Spencer
By:

/s/ George P. JoyceCorte J. Spencer, Director


George P. Joyce, DirectorDate:

March 24, 2011
Date:

March 24, 2011By:

/s/ Lloyd StempleLloyd Stemple, DirectorDate:

March 24, 2011





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EXHIBIT 21:  SUBSIDIARIES OF THE COMPANY





Company

Percent Owned

Jurisdiction or State of 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 PARENTEBEARD LLC





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 24, 2011, relating to the consolidated financial statements, which appear in this Annual Report on Form 10-K.ParenteBeard LLC

Syracuse, New York

March 24, 2011
/s/ PARENTEBEARD LLC





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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 24, 2011
/s/ Thomas W. Schneider

Thomas W. Schneider

President and Chief Executive Officer





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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 24, 2011
/s/ James A. Dowd

James A. Dowd

Senior Vice President and Chief Financial Officer





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





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, 2010 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 24, 2011
/s/ Thomas W. Schneider

Thomas W. Schneider

President and Chief Executive OfficerMarch 24, 2011
/s/ James A. Dowd

James A. Dowd

Senior Vice President and Chief Financial Officer














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EXHIBIT 99.1  Certification of Chief Executive Officer Pursuant to Section 111(b)(4) of the Emergency Economic Stabilization Act of 2008





I, Thomas W. Schneider, the Chief Executive Officer of Pathfinder Bancorp, Inc. (the “Company”) certify, based on my knowledge, that:





(i) The compensation committee of the Company has discussed, reviewed, and evaluated with senior risk officers at least every six months during any part of the most recently completed fiscal year that was a TARP period, senior executive officer (SEO) compensation plans and employee compensation plans and the risks these plans pose to the Company;





(ii) The Committee has identified and limited during the applicable period any features of the SEO compensation plans that could lead SEOs to take unnecessary and excessive risks that could threaten the value of the Company, and identified any features in the employee compensation plans that pose risks to the Company and limited those features to ensure that the Company is not unnecessarily exposed to risks;





(iii) The Committee has reviewed at least every six months during the applicable period the terms of each employee compensation plan and identified the features in the plan that could encourage the manipulation of reported earnings of the Company to enhance the compensation of an employee and has limited those features;





(iv) The Committee will certify to the reviews of the SEO compensation plans and employee compensation plans required under (i) and (iii) above;





(v) The Committee will provide a narrative description of how it limited during any part of the most recently completed fiscal year that included a TARP period the features in


(A)
SEO compensation plans that could lead SEOs to take unnecessary and excessive risks that could threaten the value of the Company;


(B)
Employee compensation plans that unnecessarily expose the Company to risks; and


(C)
Employee compensation plans that could encourage the manipulation of reported earnings of the Company to enhance the compensation of an employee;





(vi) The Company has required that bonus payments, as defined in the regulations and guidance established under section 111 of EESA (bonus payments), of the SEOs and twenty next most highly compensated employees be subject to a recovery or ‘‘clawback’’ provision during any part of the most recently completed fiscal year that was a TARP period if the bonus payments were based on materially inaccurate financial statements or any other materially inaccurate performance metric criteria;





(vii) The Company has prohibited any golden parachute payment, as defined in the regulations and guidance established under section 111 of EESA, to a SEO or any of the next five most highly compensated employees during any part of the most recently completed fiscal year that was a TARP period;





(viii) The Company has limited bonus payments to its applicable employees in accordance with section 111 of EESA and the regulations and guidance established thereunder during any part of the most recently completed fiscal year that was a TARP period;





(ix) The Company and its employees have complied with the excessive or luxury expenditures policy, as defined in the regulations and guidance established under section 111 of EESA, during any part of the most recently completed fiscal year that was a TARP period; and any expenses that, pursuant to this policy, required approval of the board of directors, a committee of the board of directors, a SEO, or an executive officer with a similar level of responsibility, were properly approved;





(x) The Company will permit a non-binding shareholder resolution in compliance with any applicable federal securities rules and regulations on the disclosures provided under the federal securities laws related to SEO compensation paid or accrued during any part of the most recently completed fiscal year that was a TARP period;





(xi) The Company will disclose the amount, nature, and justification for the offering during any part of the most recently completed fiscal year that was a TARP period of any perquisites, as defined in the regulations and guidance established under section 111 of EESA, whose total value exceeds $25,000 for each employee subject to the bonus payment limitations identified in paragraph (vii);





(xii) The Company will disclose whether the Company, the board of directors of the Company, or the Committee has engaged during any part of the most recently completed fiscal year that was a TARP period a compensation consultant; and the services the compensation consultant or any affiliate of the compensation consultant provided during this period;





(xiii) The Company has prohibited the payment of any gross-ups, as defined in the regulations and guidance established under section 111 of EESA, to the SEOs and the next twenty most highly compensated employees during any part of the most recently completed fiscal year that was a TARP period;





(xiv) The Company has substantially complied with all other requirements related to employee compensation that are provided in the agreement between the Company and Treasury, including any amendments;





(xv) The Company has submitted to Treasury a complete and accurate list of SEOs and the twenty next most highly compensated employees for the current fiscal year and the most recently completed fiscal year, with the non-SEOs ranked in descending order of level of annual compensation, with the name, title, and employer of each SEO and most highly compensated employee identified; and





(xvi) I understand that a knowing and willful false or fraudulent statement made in connection with this certification may be punished by fine, imprisonment, or both. (See,for example, 18 U.S.C. 1001.)











Date:  March 24, 2011                                                          /s/ Thomas W. Schneider


Thomas W. Schneider,


President and Chief Executive Officer





























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EXHIBIT 99.2 Certification of Chief Financial Officer Pursuant to Section 111(b)(4) of the Emergency Economic Stabilization Act of 2008





I, James A. Dowd, the Chief Financial Officer of Pathfinder Bancorp, Inc. (the “Company”) certify, based on my knowledge, that:





(i) The compensation committee of the Company has discussed, reviewed, and evaluated with senior risk officers at least every six months during any part of the most recently completed fiscal year that was a TARP period, senior executive officer (SEO) compensation plans and employee compensation plans and the risks these plans pose to the Company;





(ii) The Committee has identified and limited during the applicable period any features of the SEO compensation plans that could lead SEOs to take unnecessary and excessive risks that could threaten the value of the Company, and identified any features in the employee compensation plans that pose risks to the Company and limited those features to ensure that the Company is not unnecessarily exposed to risks;





(iii) The Committee has reviewed at least every six months during the applicable period the terms of each employee compensation plan and identified the features in the plan that could encourage the manipulation of reported earnings of the Company to enhance the compensation of an employee and has limited those features;





(iv) The Committee will certify to the reviews of the SEO compensation plans and employee compensation plans required under (i) and (iii) above;





(v) The Committee will provide a narrative description of how it limited during any part of the most recently completed fiscal year that included a TARP period the features in


(A)
SEO compensation plans that could lead SEOs to take unnecessary and excessive risks that could threaten the value of the Company;


(B)
Employee compensation plans that unnecessarily expose the Company to risks; and


(C)
Employee compensation plans that could encourage the manipulation of reported earnings of the Company to enhance the compensation of an employee;





(vi) The Company has required that bonus payments, as defined in the regulations and guidance established under section 111 of EESA (bonus payments), of the SEOs and twenty next most highly compensated employees be subject to a recovery or ‘‘clawback’’ provision during any part of the most recently completed fiscal year that was a TARP period if the bonus payments were based on materially inaccurate financial statements or any other materially inaccurate performance metric criteria;





(vii) The Company has prohibited any golden parachute payment, as defined in the regulations and guidance established under section 111 of EESA, to a SEO or any of the next five most highly compensated employees during any part of the most recently completed fiscal year that was a TARP period;





(viii) The Company has limited bonus payments to its applicable employees in accordance with section 111 of EESA and the regulations and guidance established thereunder during any part of the most recently completed fiscal year that was a TARP period;





(ix) The Company and its employees have complied with the excessive or luxury expenditures policy, as defined in the regulations and guidance established under section 111 of EESA, during any part of the most recently completed fiscal year that was a TARP period; and any expenses that, pursuant to this policy, required approval of the board of directors, a committee of the board of directors, a SEO, or an executive officer with a similar level of responsibility, were properly approved;







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(x) The Company will permit a non-binding shareholder resolution in compliance with any applicable federal securities rules and regulations on the disclosures provided under the federal securities laws related to SEO compensation paid or accrued during any part of the most recently completed fiscal year that was a TARP period;





(xi) The Company will disclose the amount, nature, and justification for the offering during any part of the most recently completed fiscal year that was a TARP period of any perquisites, as defined in the regulations and guidance established under section 111 of EESA, whose total value exceeds $25,000 for each employee subject to the bonus payment limitations identified in paragraph (vii);





(xii) The Company will disclose whether the Company, the board of directors of the Company, or the Committee has engaged during any part of the most recently completed fiscal year that was a TARP period a compensation consultant; and the services the compensation consultant or any affiliate of the compensation consultant provided during this period;





(xiii) The Company has prohibited the payment of any gross-ups, as defined in the regulations and guidance established under section 111 of EESA, to the SEOs and the next twenty most highly compensated employees during any part of the most recently completed fiscal year that was a TARP period;





(xiv) The Company has substantially complied with all other requirements related to employee compensation that are provided in the agreement between the Company and Treasury, including any amendments;





(xv) The Company has submitted to Treasury a complete and accurate list of SEOs and the twenty next most highly compensated employees for the current fiscal year and the most recently completed fiscal year, with the non-SEOs ranked in descending order of level of annual compensation, with the name, title, and employer of each SEO and most highly compensated employee identified; and





(xvi) I understand that a knowing and willful false or fraudulent statement made in connection with this certification may be punished by fine, imprisonment, or both. (See,for example, 18 U.S.C. 1001.)











Date:  March 24, 2011                                                         /s/ James A. Dowd


James A. Dowd,


Senior Vice President and Chief Financial Officer





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