UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 Washington,
D.C.  20549
 _____________________________
 
 FORM
10-Q
 
 [X] QUARTERLY REPORT PURSUANT
TO SECTION 13 OR 15(d) OF THE SECURITIES
 EXCHANGE
ACT OF 1934
 
 For
the quarterly period ending September 30, 2008
 
 OR
 
 [  ]TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
 EXCHANGE
ACT OF 1934
 
 For
the transition period from _______ to _______
 
 Commission
File Number: 000-23601
 
 PATHFINDER
BANCORP, INC.
 (Exact
Name of Company as Specified in its Charter)
 
 FEDERAL
                16-1540137(State
      or Other Jurisdiction of Incorporation or Organization)
                (I.R.S.
      Employer Identification Number)
 
 214 West First Street,
Oswego, NY 13126
 (Address
of Principal Executive Office) (Zip Code)
 
 (315)
343-0057
 (Issuer's
Telephone Number including area code)
 
 
 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 is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See definitions of “large accelerated filer,” “accelerated
filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check
one):
 
 Large accelerated filer*               
  Accelerated filer*                 
 Non-accelerated filer*                  Smaller
reporting company  T
 
 (Do not
check if a smaller reporting company)
 
 
 Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act).   YES *     NO
T
 
 As
of  November 13, 2008, there were 2,972,119 shares issued and
2,484,832 shares outstanding of the Registrant’s Common Stock.
 
  PATHFINDER
BANCORP, INC.
 INDEX
 
 
 PART
      I - FINANCIAL INFORMATION
              PAGE
      NO.Item
      1.
              Consolidated
      Financial Statements (Unaudited)Consolidated
      Statements of Condition
              3Consolidated
      Statements of Income
              4Consolidated
      Statements of Changes in Shareholders' Equity
              6Consolidated
      Statements of Cash Flows
              7Notes
      to Consolidated Financial Statements
              8Item
      2.
              Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations
              14Item
      3.
              Quantitative
      and Qualitative Disclosures About Market Risk
              25Item
      4T.
              Controls
      and Procedures
              25PART
      II - OTHER INFORMATION
              26Item
      1.
              Legal
      proceedingsItem
      1A.
              Risk
      FactorsItem
      2.
              Unregistered
      sales of equity securities and use of proceedsItem
      3.
              Defaults
      upon senior securitiesItem
      4.
              Submission
      of matters to a vote of security holdersItem
      5.
              Other
      informationItem
      6.
              ExhibitsSIGNATURES
              27EXHIBITS
              28


PART
      I - FINANCIAL INFORMATION
                Item
      1 – Consolidated Financial Statements
              
              PATHFINDER BANCORP,
      INC.CONSOLIDATED
      STATEMENTS OF CONDITIONSeptember
      30, 2008 and December 31, 2007(Unaudited)September
      30,
            
            
            December
      31,(In
      thousands, except share data)
            
            2008
            
            
            2007ASSETS:Cash
      and due from banks
            
            $
            11,365
            
            
            $
            9,908Interest
      earning deposits
            
            
            312
            
            
            
            305Total
      cash and cash equivalents
            
            
            11,677
            
            
            
            10,213Investment
      securities, at fair value
            
            
            75,080
            
            
            
            65,010Federal
      Home Loan Bank stock, at cost
            
            
            2,782
            
            
            
            2,128Loans
            
            
            243,223
            
            
            
            222,749Less:
      Allowance for loan losses
            
            
            2,241
            
            
            
            1,703Loans
      receivable, net
            
            
            240,982
            
            
            
            221,046Premises
      and equipment, net
            
            
            7,484
            
            
            
            7,807Accrued
      interest receivable
            
            
            1,637
            
            
            
            1,673Foreclosed
      real estate
            
            
            253
            
            
            
            865Goodwill
            
            
            3,840
            
            
            
            3,840Bank
      owned life insurance
            
            
            6,617
            
            
            
            6,437Other
      assets
            
            
            2,436
            
            
            
            1,672Total
      assets
            
            $
            352,788
            
            
            $
            320,691LIABILITIES AND SHAREHOLDERS'
      EQUITY:Deposits:Interest-bearing
            
            $
            238,040
            
            
            $
            228,319Noninterest-bearing
            
            
            26,713
            
            
            
            22,766Total
      deposits
            
            
            264,753
            
            
            
            251,085Short-term
      borrowings
            
            
            21,755
            
            
            
            18,400Long-term
      borrowings
            
            
            35,400
            
            
            
            20,010Junior
      subordinated debentures
            
            
            5,155
            
            
            
            5,155Other
      liabilities
            
            
            5,134
            
            
            
            4,337Total
      liabilities
            
            
            332,197
            
            
            
            298,987Shareholders'
      equity:Preferred
      stock, authorized shares 1,000,000; no shares issued or
      outstandingCommon
      stock, par value $0.01; authorized 10,000,000 shares;2,972,119
      and 2,971,019 share issued and 2,484,832 and 2,483,732
    sharesoutstanding,
      respectively
            
            
            30
            
            
            
            30Additional
      paid in capital
            
            
            7,909
            
            
            
            7,899Retained
      earnings
            
            
            20,878
            
            
            
            21,734Accumulated
      other comprehensive loss
            
            
            (1,724
            )
            
            
            (1,457
            )Treasury
      stock, at cost; 487,287 shares
            
            
            (6,502
            )
            
            
            (6,502
            )Total
      shareholders' equity
            
            
            20,591
            
            
            
            21,704Total
      liabilities and shareholders' equity
            
            $
            352,788
            
            
            $
            320,691The
      accompanying notes are an integral part of the consolidated financial
      statements.




- 3
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 Table of Contents


PATHFINDER  BANCORP,
      INC.CONSOLIDATED
      STATEMENTS OF INCOME(Unaudited)For
      the three
              
              For
      the threemonths
      ended
              
              months
      ended(In
      thousands, except per share data)
              September
      30, 2008
              
              September
      30, 2007Interest
      and dividend income:Loans,
      including fees
              $              3,755
              
              $                  3,546Debt
      securities:Taxable
              764
              
              623Tax-exempt
              44
              
              42Dividends
              91
              
              83Federal
      funds sold and interest earning deposits
              5
              
              6Total
      interest income
              4,659
              
              4,300Interest
      expense:Interest
      on deposits
              1,320
              
              1,734Interest
      on short-term borrowings
              103
              
              99Interest
      on long-term borrowings
              455
              
              314Total
      interest expense
              1,878
              
              2,147Net
      interest income
              2,781
              
              2,153Provision for loan
      losses
              270
              
              155Net
      interest income after provision for loan losses
              2,511
              
              1,998Noninterest
      (loss) income:Service
      charges on deposit accounts
              397
              
              366Earnings
      on bank owned life insurance
              56
              
              56Loan
      servicing fees
              67
              
              72Net
      (losses) gains on sales and impairment of investment
      securities
              (1,808)
              
              111Net
      (losses) gains on sales of loans and foreclosed real
estate
              (85)
              
              11Debit
      card interchange fees
              71
              
              62Other
      charges, commissions & fees
              127
              
              114Total
      noninterest (loss) income
              (1,175)
              
              792Noninterest
      expense:Salaries
      and employee benefits
              1,284
              
              1,263Building
      occupancy
              331
              
              305Data
      processing expenses
              335
              
              339Professional
      and other services
              158
              
              130Amortization
      of intangible asset
              -
              
              55Other
      expenses
              354
              
              320Total
      noninterest expense
              2,462
              
              2,412(Loss)
      income before income taxes
              (1,126)
              
              378(Benefit)
      provision for income taxes
              (288)
              
              72Net
      (loss) income
              $                     (838)
              
              $                            306Net
      (loss) income per share - basic
              $                    (0.34)
              
              $                           0.12Net
      (loss) income per share - diluted
              $                    (0.34)
              
              $                           0.12Dividends
      per share
              $                  0.1025
              
              $                       0.1025




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






- 4
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 Table of Contents




PATHFINDER BANCORP,
      INC.CONSOLIDATED
      STATEMENTS OF INCOME(Unaudited)For
      the nine
              
              
              For
      the ninemonths
      ended
              
              
              months
      ended(In
      thousands, except per share data)
              
              September
      30, 2008
              
              
              September
      30, 2007Interest
      and dividend income:Loans,
      including fees
              
              $
              10,943
              
              
              $
              10,393Debt
      securities:Taxable
              
              
              2,219
              
              
              
              1,937Tax-exempt
              
              
              126
              
              
              
              128Dividends
              
              
              318
              
              
              
              249Federal
      funds sold and interest earning deposits
              
              
              59
              
              
              
              199Total
      interest income
              
              
              13,665
              
              
              
              12,906Interest
      expense:Interest
      on deposits
              
              
              4,332
              
              
              
              5,215Interest
      on short-term borrowings
              
              
              329
              
              
              
              111Interest
      on long-term borrowings
              
              
              1,174
              
              
              
              1,178Total
      interest expense
              
              
              5,835
              
              
              
              6,504-Net
      interest income
              
              
              7,830
              
              
              
              6,402Provision
      for loan losses
              
              
              550
              
              
              
              280Net
      interest income after provision for loan losses
              
              
              7,280
              
              
              
              6,122Noninterest
      income:Service
      charges on deposit accounts
              
              
              1,131
              
              
              
              1,060Earnings
      on bank owned life insurance
              
              
              179
              
              
              
              169Loan
      servicing fees
              
              
              218
              
              
              
              186Net
      (losses) gains on sales and impairment of investment
      securities
              
              
              (2,150
              )
              
              
              108Net
      (losses) gains on sales of loans and foreclosed real
estate
              
              
              (79
              )
              
              
              42Debit
      card interchange fees
              
              
              207
              
              
              
              178Other
      charges, commissions & fees
              
              
              334
              
              
              
              317Total
      noninterest (loss) income
              
              
              (160
              )
              
              
              2,060Noninterest
      expense:Salaries
      and employee benefits
              
              
              3,863
              
              
              
              3,764Building
      occupancy
              
              
              1,009
              
              
              
              935Data
      processing expenses
              
              
              974
              
              
              
              1,033Professional
      and other services
              
              
              580
              
              
              
              593Amortization
      of intangible asset
              
              
              -
              
              
              
              166Other
      expenses
              
              
              982
              
              
              
              906Total
      noninterest expense
              
              
              7,408
              
              
              
              7,397(Loss)
      income before income taxes
              
              
              (288
              )
              
              
              785(Benefit)
      provision for income taxes
              
              
              (82
              )
              
              
              148Net
      (loss) income
              
              $
              (206
              )
              
              $
              637Net
      (loss) income per share - basic
              
              $
              (0.08
              )
              
              $
              0.26Net
      (loss) income per share - diluted
              
              $
              (0.08
              )
              
              $
              0.26Dividends
      per share
              
              $
              0.3075
              
              
              $
              0.3075The
      accompanying notes are an integral part of the consolidated financial
      statements.






- 5
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 Table of Contents








PATHFINDER
      BANCORP, INC.CONSOLIDATED
      STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITYNINE
      MONTHS ENDED SEPTEMBER 30, 2008 AND SEPTEMBER 30, 2007(Unaudited)AccumulatedCommon
              
              
              Common
              
              
              Additional
              
              
              
              
              
              Other
      Com-Stock
              
              
              Stock
              
              
              Paid
      in
              
              
              Retained
              
              
              prehensive
              
              
              Treasury(In
      thousands, except share data)
              
              Shares
              
              
              Amount
              
              
              Capital
              
              
              Earnings
              
              
              Loss
              
              
              Stock
              
              
              Total<S>Balance,
      January 1, 2008
              
              
              2,971,019
              
              
              $
              30
              
              
              $
              7,900
              
              
              $
              21,734
              
              
              $
              (1,458
              )
              
              $
              (6,502
              )
              
              $
              21,704Cumulative
      effect of a change in accountingprinciple
      upon the change in definedemployee
      benefit plans' measurement dateunder
      SFAS 158 (net of $8 tax expense)
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (48
              )
              
              
              13
              
              
              
              
              
              
              
              (35
              )Comprehensive
      loss:Net
      loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (206
              )
              
              
              
              
              
              
              
              
              
              
              (206
              )Other
      comprehensive (loss) income, net of tax:Unrealized
      holding losses on securitiesavailable
      for sale (net of $175 tax benefit)
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (317
              )
              
              
              
              
              
              
              (317
              )Retirement
      plan gains and losses and pastservice
      liability not recognized in planexpenses
      (net of $26 tax expense)
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              38
              
              
              
              
              
              
              
              38Total
      Comprehensive loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (485
              )Stock
      options exercised
              
              
              1,100
              
              
              
              
              
              
              
              9
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              9Dividends
      declared ($0.3075 per share)
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (602
              )
              
              
              
              
              
              
              
              
              
              
              (602
              )Balance,  September
      30, 2008
              
              
              2,972,119
              
              
              $
              30
              
              
              $
              7,909
              
              
              $
              20,878
              
              
              $
              (1,724
              )
              
              $
              (6,502
              )
              
              $
              20,591Balance,
      January 1, 2007
              
              
              2,953,619
              
              
              $
              29
              
              
              $
              7,786
              
              
              $
              21,307
              
              
              $
              (1,770
              )
              
              $
              (6,502
              )
              
              $
              20,850Comprehensive
      income:Net
      income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              637
              
              
              
              
              
              
              
              
              
              
              
              637Other
      comprehensive income, net of tax:Unrealized
      holding losses on securitiesavailable
      for sale (net of $39 tax expense)
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              59
              
              
              
              
              
              
              
              59Total
      Comprehensive income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              696Stock
      options exercised
              
              
              17,200
              
              
              
              1
              
              
              
              113
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              114Dividends
      declared ($0.3075 per share)
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (604
              )
              
              
              
              
              
              
              
              
              
              
              (604
              )Balance,
      September 30, 2007
              
              
              2,970,819
              
              
              $
              30
              
              
              $
              7,899
              
              
              $
              21,340
              
              
              $
              (1,711
              )
              
              $
              (6,502
              )
              
              $
              21,056The
      accompanying notes are an integral part of the unaudited consolidated
      financial statements.




- 6
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 Table of Contents


PATHFINDER
      BANCORP, INC.CONSOLIDATED
      STATEMENTS OF CASH FLOWS(Unaudited)For
      the nine
            
            
            For
      the ninemonths
      ended
            
            
            months
      endedSeptember
      30,
            
            
            September
      30,(In
      thousands)
            
            2008
            
            
            2007OPERATING
      ACTIVITIESNet
      (loss) income
            
            $
            (206
            )
            
            $
            637Adjustments
      to reconcile net (loss) income to net cashprovided
      by operating activities:Provision
      for loan losses
            
            
            550
            
            
            
            280Proceeds
      from sales of loans
            
            
            -
            
            
            
            3,000Originations
      of loans held-for-sale
            
            
            -
            
            
            
            (2,973
            )Realized
      losses (gains) on sales of:Foreclosed
      real estate
            
            
            79
            
            
            
            (15
            )Loans
            
            
            -
            
            
            
            (27
            )Available-for-sale
      investment securities
            
            
            (26
            )
            
            
            (108
            )Impairment
      write-down on available-for-sale securities
            
            
            2,176
            
            
            
            -Depreciation
            
            
            529
            
            
            
            559Amortization
      of intangible asset
            
            
            -
            
            
            
            166Amortization
      of deferred financing costs
            
            
            -
            
            
            
            15Amortization
      of mortgage servicing rights
            
            
            24
            
            
            
            37Earnings
      on bank owned life insurance
            
            
            (180
            )
            
            
            (169
            )Net
      amortization of premiums and discounts on investment
      securities
            
            
            85
            
            
            
            78Decrease
      in accrued interest receivable
            
            
            36
            
            
            
            69Net
      change in other assets and liabilities
            
            
            64
            
            
            
            (18
            )Net
      cash provided by operating activities
            
            
            3,131
            
            
            
            1,531INVESTING
      ACTIVITIESPurchase
      of investment securities available-for-sale
            
            
            (31,730
            )
            
            
            (17,352
            )Net
      purchases of Federal Home Loan Bank stock
            
            
            (654
            )
            
            
            (81
            )Proceeds
      from maturities and principal reductions ofinvestment
      securities available-for-sale
            
            
            15,402
            
            
            
            14,150Proceeds
      from sale of:Available-for-sale
      investment securities
            
            
            3,494
            
            
            
            359Real
      estate acquired through foreclosure
            
            
            773
            
            
            
            276Premises
      and equipment
            
            
            -
            
            
            
            33Net
      increase in loans
            
            
            (20,729
            )
            
            
            (12,886
            )Purchase
      of premises and equipment
            
            
            (206
            )
            
            
            (602
            )Net
      cash used in investing activities
            
            
            (33,650
            )
            
            
            (16,103
            )FINANCING
      ACTIVITIESNet
      increase in demand deposits, NOW accounts,savings
      accounts, money market deposit accounts, MMDAaccounts
      and escrow deposits
            
            
            12,832
            
            
            
            7,351Net
      increase in time deposits
            
            
            837
            
            
            
            2,983Net
      proceeds from short-term borrowings
            
            
            3,355
            
            
            
            9,000Payments
      on long-term borrowings
            
            
            (8,610
            )
            
            
            (11,350
            )Proceeds
      from long-term borrowings
            
            
            24,000
            
            
            
            4,000Proceeds
      from trust preferred obligation
            
            
            -
            
            
            
            5,000Payments
      on trust preferred obligation
            
            
            -
            
            
            
            (5,000
            )Proceeds
      from exercise of stock options
            
            
            9
            
            
            
            114Cash
      dividends paid
            
            
            (440
            )
            
            
            (440
            )Net
      cash provided by financing activities
            
            
            31,983
            
            
            
            11,658Increase
      (decrease) in cash and cash equivalents
            
            
            1,464
            
            
            
            (2,914
            )Cash
      and cash equivalents at beginning of period
            
            
            10,213
            
            
            
            13,723Cash
      and cash equivalents at end of period
            
            $
            11,677
            
            
            $
            10,809NON-CASH
      INVESTING ACTIVITYTransfer
      of loans to foreclosed real estate
            
            $
            243
            
            
            $
            109





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




- 7
-




PATHFINDER
BANCORP, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)
 
 
 (1)
Basis of Presentation
  The
accompanying unaudited consolidated financial statements of Pathfinder Bancorp,
Inc. and its wholly owned subsidiaries have been prepared in accordance with
accounting principles generally accepted in the United States of America for
interim financial information, the instructions for Form 10-Q and Article 10 of
Regulation S-X.  Accordingly, they do not include all of the
information and footnotes necessary for a complete presentation of consolidated
financial position, results of operations, and cash flows in conformity with
generally accepted accounting principles.  In the opinion of
management, all adjustments, consisting of normal recurring accruals, considered
necessary for a fair presentation have been included.
  The
following material under the heading "Management's Discussion and Analysis of
Financial Condition and Results of Operations" is written with the presumption
that the users of the interim financial statements have read, or have access to,
the Company's latest audited financial statements and notes thereto, together
with Management's Discussion and Analysis of Financial Condition and Results of
Operations as of December 31, 2007 and for the two year period then
ended.  Therefore, only material changes in financial condition and
results of operations are discussed in the remainder of Part 1.
  Operating
results for the three and nine months ended September 30, 2008, are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2008.
  (2)
Earnings (Loss) per Share
  Basic
earnings per share have been computed by dividing net income (loss) by the
weighted average number of common shares outstanding throughout the three months
and nine months ended September 30, 2008 and 2007, using 2,484,364 and 2,483,532
weighted average common shares outstanding for the three month period and
2,483,944 and 2,482,886 for the nine months ended,
respectively.  Diluted earnings per share for the three months and
nine months ended September 30, 2008 and 2007 have been computed using 2,484,364
and 2,487,732 for the three month period and 2,483,944 and 2,489,292 for the
nine months ended, respectively.  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.  There was no dilutive effect during the three and nine months
ended September 30, 2008 since the Company was in a loss
position.  The number of dilutive options excluded from the diluted
earnings per share calculations were 1,062 and 2,892 for the three and nine
months ended September 30, 2008.
  (3)
Pension and Postretirement Benefits
 
 On
January 1, 2008, the Company recorded a $48,000 charge to retained earnings,
representing the cumulative effect adjustment upon adopting the measurement date
transition rule for the Company’s pension plan and postretirement benefit
plan.  In accordance with SFAS 158, Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans, measurement date
provisions, plan assets and obligations are to be measured as of the employer’s
balance sheet date.  The Company previously measured its pension and
postretirement plans as of October 1 of each year.  As a result of the
measurement date provisions, the Company decreased its retirement plan assets
with a corresponding charge to retained earnings, representing the net periodic
benefit cost for the period between the October 1, 2007 measurement date and
January 1, 2008.
  - 8
-
  The
composition of net periodic pension plan costs for the three months and nine
months ended September 30, is as follows:
  For the three months
              
              
              For the nine monthsended September 30,
              
              
              ended September 30,(In
      thousands)
              
              2008
              
              
              2007
              
              
              2008
              
              
              2007Service
      cost
              
              $
              54
              
              
              $
              49
              
              
              $
              162
              
              
              $
              147Interest
      cost
              
              
              79
              
              
              
              68
              
              
              
              237
              
              
              
              204Expected
      return on plan assets
              
              
              (112
              )
              
              
              (98
              )
              
              
              (335
              )
              
              
              (294
              )Amortization
      of net losses
              
              
              16
              
              
              
              22
              
              
              
              49
              
              
              
              66Net
      periodic benefit cost
              
              $
              37
              
              
              $
              41
              
              
              $
              113
              
              
              $
              123
 
 The
composition of net periodic postretirement plan costs for the three months and
nine months ended September 30, is as follows:
  For the three months
              
              
              For the nine monthsended September 30,
              
              
              ended September 30,(In
      thousands)
              
              2008
              
              
              2007
              
              
              2008
              
              
              2007Service
      cost
              
              $
              1
              
              
              $
              1
              
              
              $
              2
              
              
              $
              2Interest
      cost
              
              
              5
              
              
              
              5
              
              
              
              16
              
              
              
              16Amortization
      of transition obligation
              
              
              5
              
              
              
              5
              
              
              
              14
              
              
              
              14Net
      periodic benefit cost
              
              $
              11
              
              
              $
              11
              
              
              $
              32
              
              
              $
              32
 
 The
Company previously disclosed in its consolidated financial statements for the
year ended December 31, 2007, that it expects to contribute $233,000 to its
plans in 2008.  As of September 30, 2008,  $135,000 has been
contributed to the plans.
 
 (4)
Comprehensive Income (Loss)
 
 Accounting principles generally
accepted in the United States of America, require that recognized revenue,
expenses, gains and losses be included in net income.  Although
certain changes in assets and liabilities, such as unrealized gains and losses
on available-for-sale securities, and gains and losses, prior service costs and
transition assets or obligations for defined benefit pension and postretirement
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 income (loss) and related tax effects for the
three and nine months ended September 30, are as follows:
  For
      the three months
              
              
              For
      the nine monthsended
      September 30,
              
              
              ended
      September 30,(In
      thousands)
              
              2008
              
              
              2007
              
              
              2008
              
              
              2007Unrealized
      holding gains (losses) on securities available for sale:Unrealized
      holding (losses) gains arising during the period
              
              $
              (952
              )
              
              $
              516
              
              
              $
              (2,678
              )
              
              $
              206Reclassification
      adjustment for losses (gains) included in net income
              
              
              1,808
              
              
              
              (111
              )
              
              
              2,150
              
              
              
              (108
              )Net
      unrealized gains (losses) on securities available for sale
              
              
              856
              
              
              
              405
              
              
              
              (528
              )
              
              
              98Defined
      benefit pension and postretirement plans:Reclassification
      adjustment for amortization of benefit plans'net
      loss and prior service liability recognized in netperiodic
      expense
              
              
              21
              
              
              
              -
              
              
              
              63
              
              
              
              -Other
      comprehensive gain (loss) before tax
              
              
              877
              
              
              
              405
              
              
              
              (465
              )
              
              
              98Tax
      effect
              
              
              (350
              )
              
              
              (162
              )
              
              
              186
              
              
              
              (39
              )Other
      comprehensive income (loss)
              
              $
              527
              
              
              $
              243
              
              
              $
              (279
              )
              
              $
              59
  - 9
-
 The
components of other comprehensive income, net of related tax effects, at
September 30, 2008 and December 31, 2007 are as follows:
  September
      30,
              
              
              December
      31,(In
      thousands)
              
              2008
              
              
              2007Unrealized
      losses on securities available for sale (net of taxbenefit
      2008 - $653; 2007 - $441)
              
              $
              (978
              )
              
              $
              (662
              )Net
      pension losses and past service liability (net of taxbenefit
      2008 - $468; 2007 - $495)
              
              
              (703
              )
              
              
              (742
              )Net
      postretirement losses and past service liability (net of
    taxbenefit
      2008 - $29; 2007 - $36)
              
              
              (43
              )
              
              
              (54
              )$
              (1,724
              )
              
              $
              (1,458
              )
 
 (5)
Guarantees
 
 The
Company does not issue any guarantees that would require liability recognition
or disclosure, other than its standby letters of credit.  Standby
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.  The Company had $1.8 million
of standby letters of credit as of September 30, 2008.  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 current amount of the liability as of September
30, 2008, for guarantees under standby letters of credit issued is not
material.
 
 (6)
Fair Value Measurements
 
 In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements,
(“SFAS 157”) which defines fair value, establishes a framework for measuring
fair value under GAAP, and expands disclosures about fair value measurements.
SFAS 157 applies to other accounting pronouncements that require or permit
fair value measurements. SFAS 157 establishes a fair value hierarchy about the
assumptions used to measure fair value and clarifies assumptions about risk and
the effect of a restriction on the sale or use of an asset.   The
standard became effective for the Company January 1, 2008, including interim
periods.  In February 2008, the FASB issued FASB Staff Position (FSP)
No. FAS 157-2, “Effective Date of FASB Statement No. 157.”  This FSP
delays the effective date of FAS 157 for all nonfinancial assets and
nonfinancial liabilities, except those that are recognized or disclosed at fair
value on a recurring basis (at least annually) to January 1,
2009.  This delay relates to non-financial assets and liabilities that
are not measured at fair value on an ongoing basis, but are subject to fair
value adjustments in certain circumstances (for example, when there is evidence
of impairment).
 
 In
October 2008, the FASB issued FSP SFAS No. 157-3, “Determining the Fair Value of
a Financial Asset When the Market for that Asset is Not Active” (FSP 157-3), to
clarify the application of the provisions of SFAS 157 in an inactive market and
how an entity would determine fair value in an inactive market.  FSP
157-3 is effective immediately and applies to our September 30, 2008
consolidated financial statements.  The application of the provisions
of FSP 157-3 did not materially affect the results of operations or financial
condition as of and for the period ended September 30, 2008.
 
 
 SFAS 157
specifies a hierarchy of valuation techniques based on whether the inputs to
those valuation techniques are observable or unobservable. Observable inputs
reflect market data obtained from independent sources, while unobservable inputs
reflect our market assumptions. In accordance with SFAS 157, these two types of
inputs have created the following fair value hierarchy:
 
 ·
              Level
      1 – Quoted prices (unadjusted) for identical assets or liabilities in
      active markets, that the entity has the ability to access as of the
      measurement date.
  - 10
-
 Table of Contents
 ·
              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.
  The
Company used the following methods and significant assumptions to estimate fair
value:
 
 Investment
securities:  The fair values of securities available for sale are
determined by obtaining quoted prices on nationally recognized securities
exchanges (Level 1) or 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).
 
 Impaired
loans: Impaired loans are those that are accounted for under SFAS 114, Accounting by Creditors for
Impairment of a Loan, in which the Company has measured impairment
generally based on the fair value of the loan’s collateral.  Fair
value is generally determined based upon independent third party appraisals of
the properties, or discounted cash flows based upon expected
proceeds.  These assets are included as Level 3 fair values, based
upon the lowest level of input that is significant to the fair value
measurements.  The fair value consists of loan balances less their
valuation allowances as determined under SFAS 114.
 
 Assets
and liabilities measured at fair value on a recurring basis, are summarized
below:
  Fair Value Measurements,
    UsingQuoted
      Prices
                Significant
                SignificantIn
      Active Markets
                Other
      Observable
                UnobservableFor
      Identical Assets
                Inputs
                Inputs(In
      thousands)
                September
      30, 2008
                (Level
      1)
                (Level
      2)
                (Level
      3)Assets:Investment
      securities available for sale:
                $75,080
                $    -
                $75,080
                $   -
  
 Changes
in the fair value of available-for-sale securities are recorded on the balance
sheet under accumulated-other-comprehensive loss, while gains and losses from
sales and impairment losses are recognized in income.
 
 From time
to time, certain assets may be recorded at fair value on a non-recurring basis.
These non-recurring fair value adjustments typically are a result of the
application of lower of cost or market accounting or a write-down occurring
during the period.
 
 Assets
and liabilities measured at fair value on a nonrecurring basis, are summarized
below:
 
 Fair Value Measurements,
    UsingQuoted
      Prices
              Significant
              SignificantIn
      Active Markets
              Other
      Observable
              UnobservableFor
      Identical Assets
              Inputs
              Inputs(In
      thousands)
              September 30, 2008
              (Level
      1)
              (Level
      2)
              (Level
      3)Assets:Impaired
      loans:
              $2,774
              $    -
              $    -
              $2,774
  Impaired
loans, which are measured for impairment using the fair value of the collateral
for collateral dependent loans, are recorded net of a valuation allowance of
$145,000.  There was no additional provision for loan losses resulting
from loan impairment during the nine months ended September 30,
2008.
 
 - 11
-
 Table of Contents
 
 (7)
New Accounting Pronouncements
 
 In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities - Including an Amendment of FASB Statement No.
115 (SFAS 159). This standard permits an entity with an option to choose
to measure selected financial assets and liabilities at fair value. Most of the
provisions in SFAS 159 are elective; however, the amendment to SFAS 115, Accounting for Certain Investments
in Debt and Equity Securities, applies to all entities with
available-for-sale and trading securities. The FASB's stated objective in
issuing this standard is as follows: "to improve financial reporting by
providing entities with the opportunity to mitigate volatility in reported
earnings caused by measuring related assets and liabilities differently without
having to apply complex hedge accounting provisions."  The fair value
option established by SFAS 159 permits all entities to choose to measure
eligible items at fair value at specified election dates.  SFAS 159 is
effective for the Company as of January 1, 2008. The Company did not elect the
fair value option for any financial assets or financial liabilities as of
January 1, 2008.
 
 In
December 2007, the FASB issued Statement No. 141 (R), Business Combinations (SFAS
141R). This Statement establishes principles and requirements for how the
acquirer of a business recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed, and any noncontrolling
interest in the acquiree. The Statement also provides guidance for recognizing
and measuring the goodwill acquired in the business combination and determines
what information to disclose to enable users of the financial statements to
evaluate the nature and financial effects of the business combination. The
guidance will become effective for the Company January 1, 2009. This
pronouncement will impact the Company’s accounting for business combinations
completed beginning January 1, 2009.
 
 In
December 2007, the FASB issued Statement No. 160, Noncontrolling Interests in
Consolidated Financial Statements—an amendment of ARB No. 51. This
Statement establishes accounting and reporting standards for the noncontrolling
interest in a subsidiary and for the deconsolidation of a subsidiary. The
guidance will become effective for the Company January 1, 2009.  The
Company does not expect the adoption of SFAS No. 160 to have a material impact
on its consolidated financial statements.
 
 Staff
Accounting Bulletin No. 109 (SAB 109), "Written Loan Commitments Recorded at
Fair Value Through Earnings" expresses the views of the staff regarding written
loan commitments that are accounted for at fair value through earnings under
generally accepted accounting principles. To make the staff's views consistent
with current authoritative accounting guidance, the SAB revises and rescinds
portions of SAB No. 105, "Application of Accounting Principles to Loan
Commitments."  Specifically, the SAB revises the SEC staff's views on
incorporating expected net future cash flows related to loan servicing
activities in the fair value measurement of a written loan commitment. The SAB
retains the staff's views on incorporating expected net future cash flows
related to internally-developed intangible assets in the fair value measurement
of a written loan commitment. The staff expects registrants to apply the views
in Question 1 of SAB 109 on a prospective basis to derivative loan commitments
issued or modified in fiscal quarters beginning after December 15, 2007. The
adoption of SAB 109 did not have a material impact on the Company’s financial
statements.
 
 In
February 2008, the FASB issued a FASB Staff Position (FSP) FAS 140-3,
“Accounting for Transfers of Financial Assets and Repurchase Financing
Transactions.” This FSP addresses the issue of whether or not these transactions
should be viewed as two separate transactions or as one "linked" transaction.
The FSP includes a "rebuttable presumption" that presumes linkage of the two
transactions unless the presumption can be overcome by meeting certain criteria.
The FSP will be effective for fiscal years beginning after November 15, 2008 and
will apply only to original transfers made after that date; early adoption will
not be allowed. The Company is currently evaluating the potential impact the new
pronouncement will have on its consolidated financial statements.
 
 In March
2008, the FASB issued Statement No. 161, Disclosures about Derivative
Instruments and Hedging Activities—an amendment of FASB Statement No. 133
(SFAS 161).  SFAS 161 requires entities that utilize derivative
instruments to provide qualitative disclosures about their objectives and
strategies for using such instruments, as well as any details of
credit-risk-related contingent features contained within
derivatives.  SFAS 161 also requires entities to disclose additional
information about the amounts and location of derivatives located within the
financial statements, how the provisions of SFAS 133 have been applied, and the
impact that hedges have on an entity’s financial position, financial
performance, and cash flows.  SFAS 161 is effective for fiscal years
and interim periods beginning after November 15, 2008, with early application
encouraged. The Company is currently evaluating the potential impact the new
pronouncement will have on its consolidated financial statements.
  - 12
-
 Table of Contents
 
 In May
2008, the FASB issued SFAS No. 162 “The Hierarchy of Generally Accepted
Accounting Principles”, (SFAS 162).  The purpose of SFAS 162 is to
improve financial reporting by providing a consistent framework for determining
what accounting principles should be applied when preparing GAAP financial
statements.  The FASB believes that issuing the GAAP hierarchy as a
FASB standard, recategorizing the existing GAAP hierarchy into two levels of
accounting literature (authoritative and non-authoritative), and elevating the
conceptual framework within the GAAP hierarchy are key objectives of achieving
the FASB’s goal of improving the quality of accounting standards and the
standard-setting process.  SFAS 162 is effective 60 days following the
SEC’s approval of Public Company Accounting Oversight Board (“PCAOB”) amendment
to AU Section 411.  The Company’s adoption of SFAS 162 is not expected
to have a material impact on its consolidated financial condition or results of
operations.
 
 In April
2008, the FASB issued FSP FAS 142-3, “Determination of the Useful Life of
Intangible Assets.”  This FSP amends the factors that should be
considered in developing renewal or extension assumptions used to determine the
useful life of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible
Assets (SFAS 142).  The intent of this FSP is to improve the
consistency between the useful life of a recognized intangible asset under SFAS
142 and the period of expected cash flows used to measure the fair value of the
asset under SFAS 141R, and other GAAP.  This FSP is effective for
financial statements issued for fiscal years beginning after December 15, 2008,
and interim periods within those fiscal years.  Early adoption is
prohibited.  The Company does not expect this pronouncement will have
a material impact on its consolidated financial statements.
 
 In May
2008, the FASB issued FSP APB 14-1, “Accounting for Convertible Debt Instruments
That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)”
which clarifies the accounting for convertible debt instruments that may be
settled in cash (including partial cash settlement) upon
conversion.  The FSP requires issuers to account separately for the
liability and equity components of certain convertible debt instruments in a
manner that reflects the issuer’s nonconvertible debt borrowing rate when
interest cost is recognized.  The FSP requires bifurcation of a
component of the debt, classification of that component in equity and the
accretion of the resulting discount on the debt to be recognized as part of
interest expense. The FSP requires retrospective application to the terms of
instruments as they existed for all periods presented.  The FSP is
effective for fiscal years beginning after December 15, 2008, and interim
periods within those years.  Early adoption is not
permitted.  The Company is currently evaluating the potential impact
the new pronouncement will have on its consolidated financial
statements.
 
 In June
2008, the FASB issued FSP EITF 03-6-1, “Determining Whether Instruments Granted
in Share-Based Payment Transactions Are Participating
Securities.”  This FSP clarifies that all outstanding unvested
share-based payment awards that contain rights to nonforfeitable dividends
participate in undistributed earnings with common
shareholders.  Awards of this nature are considered participating
securities and the two-class method of computing basic and diluted earnings per
share must be applied.  This FSP is effective for fiscal years
beginning after December 15, 2008.  The Company does not expect this
pronouncement will have a material impact on its consolidated financial
statements.
 
 In June
2008, the FASB ratified EITF Issue No. 07-5, “Determining Whether an Instrument
(or an Embedded Feature) Is Indexed to an Entity’s Own Stock” (EITF
07-5).  EITF 07-5 provides that an entity should use a two step
approach to evaluate whether an entity-linked financial instrument (or embedded
feature) is indexed to its own stock, including evaluating the instrument’s
contingent exercise and settlement provisions.  It also clarifies the
impact of foreign currency denominated strike prices and market-based employee
stock option valuation instruments on the evaluation.  EITF 07-5 is
effective for fiscal years beginning after December 15, 2008.  The
Company does not expect this pronouncement will have a material impact on its
consolidated financial statements.
 
  - 13
-
 Table of Contents
 Item
2 - Management's Discussion and Analysis of Financial Condition and Results of
Operations
  General
 
 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 I are wholly owned subsidiaries of
Pathfinder Bancorp, Inc., however, Pathfinder Statutory Trust I is not
consolidated for reporting purposes.  Pathfinder Commercial Bank,
Pathfinder REIT, Inc. and Whispering Oaks Development Corp. represent wholly
owned subsidiaries of Pathfinder Bank.  At September 30, 2008,
Pathfinder Bancorp, M.H.C, the Company’s mutual holding company parent, whose
activities are not included in the MD&A, held 63.7% of the Company’s
outstanding common stock and the public held 36.3%.
 
 The
following discussion reviews the Company's financial condition at September 30,
2008 and the results of operations for the three months and nine months ended
September 30, 2008.
 
 Statement
Regarding Forward-Looking Statements
 
 This
Quarterly Report contains certain "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995.  Such
statements are subject to certain risks and uncertainties, including, among
other things, changes in economic conditions in the Company's market area,
changes in policies by regulatory agencies, fluctuations in interest rates,
demand for loans in the Company's market areas and competition, that could cause
actual results to differ materially from historical earnings and those presently
anticipated or projected.  The Company wishes to caution readers not
to place undue reliance on any such forward-looking statements, which speak only
as of the date made.  The Company wishes to advise readers that the
factors listed above could affect the Company's financial performance and could
cause the Company's actual results for future periods to differ materially from
any opinions or statements expressed with respect to future periods in any
current statements.
 
 The
Company does not undertake, and specifically declines any obligation, to
publicly release the results of any revisions that may be made to any
forward-looking statements to reflect events or circumstances after the date of
such statements or to reflect the occurrence of anticipated or unanticipated
events.
 
 Statement
Regarding Non-GAAP Financial Measures
 
 This
release contains supplemental financial information determined by methods other
than in accordance with Accounting Principles Generally Accepted in the United
States of America (“GAAP”).  The Company’s management believes that
such non-GAAP financial measures are useful to management and investors as it
enhances their ability to evaluate and compare the Company’s operating results
from period to period in a meaningful manner, as operating results excluding
other than temporary impairment charges on its investment security holdings are
essential in understanding the financial performance of the Company, and is more
representative of the basis that management utilizes to monitor financial
performance.  Readers are cautioned that non-GAAP measures should not
be considered as an alternative to any measure of performance as promulgated
under GAAP,  and should consider the impairment charges recorded
during 2008 in assessing the Company’s performance.  Non-GAAP measures
have limitations as analytical tools, and investors should not consider them in
isolation or as a substitute for analyzing the Company’s performance under GAAP,
nor are they necessarily comparable to non-GAAP measures presented by other
companies.
 
 Application
of Critical Accounting Policies
 
 The
Company's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America and
follow practices within the banking industry.  Application of these
principles requires management to make estimates, assumptions and judgments that
affect the amounts reported in the consolidated financial statements and
accompanying notes.  These estimates, assumptions and judgments are
based on information available as of the date of the financial statements;
accordingly, as this information changes, the financial statements could reflect
different estimates, assumptions and judgments.  Certain policies
inherently have a greater reliance on the use of estimates, assumptions and
judgments and as such have a greater possibility of producing results that could
be materially different than originally reported.  Estimates,
assumptions and judgments are necessary when assets and liabilities are required
to be recorded at fair value or when an asset or liability needs to be recorded
contingent upon a future event.  Carrying assets and liabilities at
fair value inherently results in more financial statement
volatility.  The fair values and information used to record valuation
adjustments for certain assets and liabilities are based on quoted market prices
or are provided by other third-party sources, when available.  When
third party information is not available, valuation adjustments are estimated in
good faith by management.
  
 - 14
-
 Table of Contents
  The most
significant accounting policies followed by the Company are presented in Note 1
to the consolidated financial statements included in the 2007 Annual Report on
Form 10-K ("the Consolidated Financial Statements").   Beginning
with its 2007 Annual Report, the Company has elected to file its Exchange Act
reports under the rules and regulations applicable to smaller reporting
companies.
 
 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 determination
of the allowance for loan losses, the evaluation of investment securities for
other than temporary impairment, and accounting for deferred income taxes to be
the accounting areas that require the most subjective and complex judgments,
and, as such, could be the most subject to revision as new information becomes
available.
 
 The
allowance for loan losses represents management's estimate of probable loan
losses inherent in the loan portfolio.  Determining the amount of the
allowance for loan losses is considered a critical accounting estimate because
it requires significant judgment and the use of estimates related to the amount
and timing of expected future cash flows on impaired loans, estimated losses on
pools of homogeneous loans based on historical loss experience, and
consideration of current economic trends and conditions, all of which may be
susceptible to significant change.  The loan portfolio also represents
the largest asset type on the consolidated statement of
condition.  Note 1 to the Consolidated Financial Statements describes
the methodology used to determine the allowance for loan losses, and a
discussion of the factors driving changes in the amount of the allowance for
loan losses is included in this report.
 
 The
Company carries all of its investments at fair value with any unrealized gains
or losses reported net of tax as an adjustment to shareholders' equity, except
for security impairment losses, which are charged to earnings.  The
Company's ability to fully realize the value of its investments in various
securities, including corporate debt securities, is dependent on the underlying
creditworthiness of the issuing organization.  In evaluating the
security portfolio for other-than-temporary impairment losses, management
considers (1) the length of time and the extent to which the fair value has been
less than cost, (2) the financial condition and near-term prospects of the
issuer, and (3) the intent and ability of the Company to retain its investment
in the issuer for a period of time sufficient to allow for any anticipated
recovery in fair value.  Based on management's assessments during the
nine months ended September 30, 2008, the Company held  positions in a
bond and two mutual funds whose fair value declines were expected to be other
than temporary.  As a result of these determinations,
other-than-temporary impairment charges of $2,176,000 relating to the Company’s
holdings in these securities were recorded.  These charges relate to
Company holdings in a senior unsecured bond issued by Lehman Brothers Holdings,
Inc., a position in the AMF Large Cap Equity Fund and its holdings in the AMF
Ultra Short Mortgage Fund. The securities’ value declines are the result of a
corporate bankruptcy filing by the bond issuer, weakness in the trading market
of the underlying securities and a deterioration in the credit quality of a
portion of one mutual fund’s underlying private label mortgage-backed security
holdings.
 
 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 losses 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 $212,000 was established
during the three and nine months ended September 30, 2008, as management
believes it may not generate sufficient capital gains to offset its capital loss
carry forward.  The Company’s effective tax rate differs from the
statutory rate due to non-taxable investment securities, bank owned life
insurance offset by the valuation allowance established on the capital loss
carry forwards.
 
 - 15
-
 Table of Contents
  Overview
 
 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
loans, investment securities and other loans, and its cost of funds consisting
of interest accrued on deposits and borrowed funds.  The Company's net
income is also affected by its provision for loan losses, as well as by the
amount of other income, including income from fees and service charges on
deposit accounts, net gains and losses on sales and the impairment of
securities, loans and foreclosed real estate, and other expenses such as
salaries and employee benefits, building occupancy and equipment costs, data
processing and income taxes.  Earnings of the Company also are
affected significantly by general economic and competitive conditions,
particularly changes in market interest rates, government policies and actions
of regulatory authorities, which events are beyond the control of the
Company.  In particular, the general level of market interest rates
which tend to be highly cyclical have a significant impact on our
earnings.
 
 The
Company reported a net loss of $838,000, or $0.34 per basic and diluted share,
for the three months ended September 30, 2008, as compared to net income of
$306,000, or $0.12 per basic and diluted share, for the same period in
2007.  For the nine months ended September 30, 2008, the Company
reported a net loss of $206,000, or $0.08 per basic and diluted share as
compared to net income of $637,000, or $0.26 per basic and diluted share for the
same period in 2007.  The 2008 losses were the result of the Company
recording impairment charges on investment security holdings totaling $1.3
million, net of the related tax benefits of $522,000, during the third quarter
of 2008.  In addition, during the second quarter of 2008, the Company
recorded an investment security impairment charge of $205,000, net of tax
benefits of $137,000.  Core earnings, which represent earnings
exclusive of investment portfolio other-than-temporary impairment losses,
resulted in net income of $474,000 or $0.19 per diluted share for the three
months ended September 30, 2008 and $1.3 million, or $0.53 per diluted share for
the nine months ended September 30, 2008.
 
 The
following table reconciles the Company’s net loss to core earnings, including
per share figures, for the periods presented.
  For
      the three
                
                
                For
      the ninemonths
      ended
                
                
                months
      endedSeptember
      30, 2008
                
                
                September
      30, 2008Net
      Loss
                
                $
                (838,000
                )
                
                $
                (206,000
                )Other
      than temporary impairment charge - investments
                
                
                1,834,000
                
                
                
                2,176,000Related
      tax benefit
                
                
                (522,000
                )
       *
                
                
                (659,000
                )
      *Core
      earnings
                
                $
                474,000
                
                
                $
                1,311,000Diluted
      (loss) earnings per share
                
                $
                (0.34
                )
                
                $
                (0.08
                )Other
      than temporary impairment charge, net of tax
                
                
                0.53
                
                
                
                0.61Core
      earnings, diluted earnings per share
                
                $
                0.19
                
                
                $
                0.53*Net
      of a deferred tax asset valuation reserve of $212,000 for the three month
      and nine month period, respectively.
  - 16
-
 Table
of Contents
  Results
of Operations
 
 The
return on average assets and return on average shareholders' equity were (0.97)%
and (15.65)%, respectively, for the three months ended September 30, 2008,
compared with 0.39% and 5.80%, respectively, for the three months ended
September 30, 2007.  During the third quarter of 2008, when compared
to the third quarter of 2007, net interest income increased $628,000, and
noninterest income before (losses) gains on sales and impairment of assets
increased $48,000.  The increase in net interest income was offset by
an increased provision for loan losses of $115,000.  Total noninterest
income was negatively impacted by impairment charges of $1,834,000 on
available-for-sale securities.  Noninterest expenses increased
$50,000.
 
 Net
Interest Income
 
 Net
interest income is the Company's primary source of operating income for payment
of operating expenses and providing for loan losses.  It is the amount
by which interest earned on loans, interest-earning deposits and investment
securities, exceeds the interest paid on deposits and other interest-bearing
liabilities.  Changes in net interest income and net interest margin
result from the interaction between the volume and composition of
interest-earning assets, interest-bearing liabilities, related yields and
associated funding costs.  The Company benefited from a steepening of
the yield curve during 2008.  This was in contrast to the flat and
inverted yield curve that characterized the interest rate environment for most
of 2007.
 
 Net
interest income, on a tax-equivalent basis, increased to $2.8 million for the
three months ended September 30, 2008, from $2.2 million for the three months
ended September 30, 2007.  The Company's net interest margin for the
third quarter of 2008 increased to 3.50% from 3.10% when compared to the same
quarter in 2007.  Recent actions by the Federal Reserve to reduce
short-term interest rates have resulted in a positively sloped yield
curve.  Consequently, the Company’s cost of funds in 2008 were lower
than in 2007.  This, combined with efforts to maintain the current
levels of earning asset yields, has resulted in an expansion of the Company’s
net interest margin. The increase in net interest income reflects a decrease of
73 basis points in the average cost of interest bearing liabilities, which was
partially offset by a decrease of 29 basis points in the average yield earned on
earning assets for the three-month period ended September 30, 2008 as compared
to the same period in 2007.  Average interest-earning assets increased
14% to $321.4 million for the three months ended September 30, 2008, as compared
to $282.5 million for the three months ended September 30, 2007.  The
increase in average earning assets is primarily attributable to a $26.5 million
increase in loans receivable, an $11.5 million increase in average investment
securities and an $890,000 increase in interest earning
deposits.  Average interest-bearing liabilities increased $33.9
million to $294.5 million from $260.6 million for the three months ended
September 30, 2007. The increase in the average balance of interest-bearing
liabilities resulted primarily from a $26.8 million increase in borrowings and a
$7.1 million increase in average deposits.  The increase in borrowings
is primarily comprised of short and mid-term advances from the Federal Home Loan
Bank of New York.
 
 For the
nine months ended September 30, 2008, net interest income, on a tax-equivalent
basis, increased to $7.9 million from $6.5 million for the nine months ended
September 30, 2007.  Net interest margin increased 34 basis points, to
3.38% for the nine months ended September 30, 2008 from 3.04% for the nine
months ended September 30, 2007. Average interest-earning assets increased 10%
to $313.2 million for the nine months ended September 30, 2008 as compared to
$284.6 million for the nine months ended September 30, 2007, and the yield on
interest-earning assets decreased 22 basis points to 5.86% from 6.08% for the
comparable period.   The increase in average interest-earning
assets was primarily attributable to a $22.7 million increase in loans
receivable and a $7.0 million increase in investment securities, partially
offset by a $1.2 million decrease in interest earning
deposits.  Average interest-bearing liabilities increased $24.7
million, but the cost of funds decreased 59 basis points to 2.70% for the nine
months ended September 30, 2008, from 3.29% for the same period in
2007.  The increase in the average balance of interest-bearing
liabilities resulted primarily from a $16.6 million, or 54.0%, increase in
borrowings and an $8.0 million, or 3.5%, increase in average
deposits.
 
 Interest
Income
 
 Total
interest income, on a tax-equivalent basis, for the quarter ended September 30,
2008, increased $366,000, or 8.5%, to $4.7 million from $4.3 million for the
quarter ended September 30, 2007.
 
 - 17
-
 Table of Contents
  The
average balance of loans increased $26.5 million to $237.4 million, with average
yields decreasing 40 basis points to 6.35% during the third quarter of
2008.  Average residential real estate loans increased $13.7 million,
or 11.5%, and experienced a decrease in the average yield to 5.70% from 5.82% in
the comparable quarter of 2007.   Average commercial real estate
loans increased $4.3 million, while the average yield on those loans decreased
to 7.37% from 7.64% from the period a year earlier. Average commercial loans
increased $6.4 million and experienced a decrease in the average yield of 175
basis points, to 6.72% for the quarter ended September 30, 2008, from 8.47%, in
the quarter ended September 30, 2007. The decrease in the average yield on
commercial loans was the result of new commercial loan origination activity
taking place at lower yields, variable rate loans pricing downwards, and the
reversal of interest due on nonperforming commercial loans during the third
quarter of 2008. Average consumer loans increased $2.6 million, or 10.7%, while
the average yield decreased by 86 basis points. The Company's municipal loan
portfolio decreased $545,000, or 17.2%, when comparing the third quarter of 2008
to the same period in 2007.  The average tax-equivalent yield on the
municipal loan portfolio decreased to 5.63% in the third quarter of 2008 from
6.55% for the same period in 2007.
 
 Average
investment securities (taxable and tax-exempt) for the quarter ended September
30, 2008, increased by $11.5 million, with an increase in tax-equivalent
interest income from investments of $159,000, or 20.8%, when compared to the
third quarter of 2007.  The average tax-equivalent yield of the
portfolio increased 17 basis points, to 4.46% from 4.29%. The increase in
average investment securities was primarily due to the purchase of $16.1 million
of mortgage-backed securities that were acquired with excess liquidity resulting
from retail deposit growth outpacing loan portfolio growth during the first six
months of the year. The security activity was also a result of a pre-funding
strategy whereby securities were acquired in advance of significant scheduled
maturity activity anticipated over the next 9 to 12 months. These purchases were
offset by the scheduled maturity of short-term investments that were acquired
during the first quarter of 2007 in connection with the collateralization of
increasing municipal deposit levels.  In addition, the Company entered
into a $5 million leverage transaction whereby investment securities were
purchased and used as collateral associated with a new borrowing arrangement
with a third party.  Thus, $5 million of new long-term borrowings were
used to fund the acquisition of $5 million in security purchases.
 
 Total
interest income, on a tax-equivalent basis, for the nine months ended September
30, 2008 increased $786,000, or 6%, when compared to the nine months ended
September 30, 2007.
 
 Average
loans increased $22.7 million, with average yields decreasing 35 basis points to
6.39% from 6.74% for the nine-month period ended September 30, 2008 when
compared with the same period in 2007.  Average residential real
estate loans increased $11.3 million, or 9.5%, and experienced a slight decrease
in the average yield of 5 basis points from the comparable nine-month period
ended September 30, 2007.   Average commercial real estate loans
increased $4.8 million, while the average yield on those loans decreased to
7.38% from 7.71% from the period a year earlier. Average commercial loans
increased $3.3 million and experienced a decrease in the average yield of 173
basis points, to 6.75% for the nine months ended September 30, 2008, from 8.48%,
for the nine months ended September 30, 2007. The decrease in the average yield
on commercial loans was the result of new commercial loan origination activity
taking place at lower yields, variable rate loans pricing downwards, and the
reversal of interest due on nonperforming commercial loans during the second
quarter of 2008. Average consumer loans increased $3.6 million, or 16.3%, while
the average yield decreased by 86 basis points. The Company's municipal loan
portfolio decreased $324,000 when comparing the first three quarters of 2008 to
the same period in 2007.  The average tax equivalent yield on the
municipal loan portfolio increased to 6.49%, for the first three quarters of
2008, from 6.36% for the same period in 2007.
 
 For the
nine months ended September 30, 2008, tax-equivalent interest income from
investment securities increased $369,000, or 15.6%, compared to the same period
in 2007.   The average tax-equivalent yield of the portfolio
increased 23 basis points, to 4.53% from 4.30%.   Moreover, there
was a $7.0 million increase in the average balance of investment securities,
reflecting the purchase of mortgage-backed securities previously
mentioned.
 
 Interest
Expense
 
 Total
interest expense decreased $269,000 for the three months ended September 30,
2008, compared to the same quarter in 2007, as the average cost of funds
decreased 73 basis points to 2.55% in 2008 from 3.28% in
2007.  Average money management accounts decreased $327,000, combined
with a 41 basis point reduction in the cost of funds.  Average
balances of savings accounts decreased $1.5 million and the cost of these funds
decreased 25 basis points.  These decreases were offset by the
increases noted in other deposit
  - 18
-
 Table of Contents
  types.  The
average balance of NOW accounts increased $2.5 million and the average cost of
such deposits decreased by 13 basis points compared with the same three-month
period in 2007.  Additionally, the average balance of money market
demand accounts, for the three months ended September 30, 2008, increased $6.2
million from the three-month average at September 30, 2007.  The
average cost of these funds decreased to 1.70% for the three months ended
September 30, 2008 from 3.93% for the three months ended September 30,
2007.  Average time deposits increased by $251,000 while the average
cost of time deposits decreased to 3.69% from 4.58% in 2007.
 
 Interest
expense on borrowings increased by 35.4%, from the prior three-month period as a
result of $26.8 million in additional borrowings used to fund loan growth not
covered by slower deposit growth.  The increase in the average balance
of borrowings was partially offset by the reduction in its average cost of funds
to 3.95% from 5.53% in 2007.
 
 Total
interest expense decreased $669,000 for the nine months ended September 30,
2008, compared to the same period in 2007, as the average cost of funds
decreased 59 basis points to 2.70% in 2008 from 3.29% in
2007.  Average money management accounts decreased $974,000, combined
with a 30 basis point reduction in the average cost of funds.  Average
savings deposits also decreased by $713,000 for the nine-month
period.  These decreases were offset by the increases noted in other
deposit types.  The average balance of NOW accounts increased $1.7
million and the resulting increase in interest expense was offset by a 10 basis
point reduction in the average cost of funds from the nine-month period in
2007.  Additionally, the average balance of money market demand
accounts, for the nine months ended September 30, 2008, increased $6.0 million
from the same period average at September 30, 2007.  The average cost
of money market demand accounts decreased to 2.06% from
4.09%.  Average time deposits increased $2.1 million from the average
balance for the nine months ended September 30, 2007.  The average
cost of time deposits decreased to 3.9% from 4.51% in 2007.
 
 Interest
expense on borrowings increased 16.7% from the prior nine-month period. The
reduction in the average cost of borrowings to 4.23% from 5.58% in 2007, was
offset by an increase in average borrowings of $16.6 million.
 
 Provision
for Loan Losses
 
 Provision
for loan losses increased $115,000 and $270,000 for the three-month and
nine-month periods ended September 30, 2008 when compared to the same periods in
2007, respectively.  The increased provision is reflective of a
growing loan portfolio and one more heavily weighted to commercial term and
commercial real estate, which have higher inherent risk characteristics than a
traditional consumer real estate portfolio, as well as a general weakening in
economic conditions.  The Company's ratio of allowance for loan losses
to period-end loans increased to 0.92% at September 30, 2008, as compared to
0.76% at December 31, 2007.  Nonperforming loans to period end loans
increased to 1.10% at September 30, 2008 from 0.71% at December 31, 2007.
General delinquencies have risen above the lows experienced in recent
years.  While these current levels are not outside of the B ank’s
historic delinquency trends, the generally weak economic conditions nationally
and the strain on consumer discretionary income, have caused management to
carefully monitor and react to these trends by increasing the provision for loan
losses, adhering to strict underwriting standards and carefully monitoring the
performance of the loan portfolio.  The increase in nonperforming
loans is primarily comprised of a number of smaller commercial lending
relationships.  Management believes the financial strength of the
individual borrowers, combined with the related value of any underlying
collateral, will not result in any recorded loss beyond currently established
reserves.
 
 Noninterest
Income
 
 The
Company's noninterest income is primarily comprised of fees on deposit account
balances and transactions, loan servicing, commissions, and net gains (losses)
on securities, loans and foreclosed real estate.  The following table
sets forth certain information on noninterest income for the periods
indicated:
 
  - 19
-
 
 Three
      Months Ended September 30,(In
      thousands)
              
              2008
              
              
              2007
              
              
              ChangeService
      charges on deposit accounts
              
              $
              397
              
              
              $
              366
              
              
              $
              31
              
              
              
              8.5
              %Earnings
      on bank owned life insurance
              
              
              56
              
              
              
              56
              
              
              
              -
              
              
              
              0.0
              %Loan
      servicing fees
              
              
              67
              
              
              
              72
              
              
              
              (5
              )
              
              
              -6.9
              %Debit
      card interchange fees
              
              
              71
              
              
              
              62
              
              
              
              9
              
              
              
              14.5
              %Other
      charges, commissions and fees
              
              
              127
              
              
              
              114
              
              
              
              13
              
              
              
              11.4
              %Noninterest
      income before (losses) gains on sales and impairment of
    assets
              
              
              718
              
              
              
              670
              
              
              
              48
              
              
              
              7.2
              %Net
      (losses) gains on sales and impairment of investment
      securities
              
              
              (1,808
              )
              
              
              111
              
              
              
              (1,919
              )
              
              
              -100.0
              %Net
      (losses) gains on sales of loans and foreclosed real
estate
              
              
              (85
              )
              
              
              11
              
              
              
              (96
              )
              
              
              -100.0
              %Total
      noninterest (loss) income
              
              $
              (1,175
              )
              
              $
              792
              
              
              $
              (1,967
              )
              
              
              -248.4
              %Nine
      Months Ended September 30,(In
      thousands)
              
              2008
              
              
              2007
              
              
              ChangeService
      charges on deposit accounts
              
              $
              1,131
              
              
              $
              1,060
              
              
              $
              71
              
              
              
              6.7
              %Earnings
      on bank owned life insurance
              
              
              179
              
              
              
              169
              
              
              
              10
              
              
              
              5.9
              %Loan
      servicing fees
              
              
              218
              
              
              
              186
              
              
              
              32
              
              
              
              17.2
              %Debit
      card interchange fees
              
              
              207
              
              
              
              178
              
              
              
              29
              
              
              
              16.3
              %Other
      charges, commissions and fees
              
              
              334
              
              
              
              317
              
              
              
              17
              
              
              
              5.4
              %Noninterest
      income before (losses) gains on sales and impairment of
    assets
              
              
              2,069
              
              
              
              1,910
              
              
              
              159
              
              
              
              8.3
              %Net
      (losses) gains on sales and impairment of investment
      securities
              
              
              (2,150
              )
              
              
              108
              
              
              
              (2,258
              )
              
              
              -100.0
              %Net
      (losses) gains on sales of loans and foreclosed real
estate
              
              
              (79
              )
              
              
              42
              
              
              
              (121
              )
              
              
              100.0
              %Total
      noninterest (loss) income
              
              $
              (160
              )
              
              $
              2,060
              
              
              $
              (2,220
              )
              
              
              -107.8
              %
 
  For the
three months ended September 30, 2008, noninterest income before (losses) gains
on sales and impairment of assets increased $48,000, or 7.2%, when compared with
the three months ended September 30, 2007. The increase in service charges on
deposit accounts was primarily attributable to an increase in both ATM fees and
other miscellaneous fees charged to depositor accounts. The increase in other
charges, commissions and fees was primarily due to an increase in fees
associated with ATM surcharges and interchange income.  The increase
in net securities losses is a result of recording other-than-temporary
impairment charges of $1.8 million, as previously discussed.  The
increase in net losses on the sale of loans and foreclosed real estate is the
result of selling three foreclosed properties at losses and the write down in
value of two additional properties.
 
 For the
nine months ended September 30, 2008, noninterest income before (losses) gains
on sales and impairment of assets increased $159,000, or 8.3%, when compared
with the nine months ended September 30, 2007.   The majority of
the increase in noninterest income before (losses) gains on sales and impairment
of assets was comprised of an increase in service charges on deposit accounts,
loan servicing fees and an increase in debit card interchange
fees.  The overall increase in service charges on deposit accounts was
primarily attributable to an increase in the overall number of deposit accounts.
The increase in loan servicing fees was from new loan charges for the discharge
of collateral and forfeited rate-lock fees, which were implemented in late 2007
and early 2008.  The increase in debit card interchange fees was due
to an increase in issued Visa debit cards and an increase in their
usage.  The change in losses on securities is attributable to the
other-than-temporary impairment charges on available-for-sale securities, as
previously discussed.
  - 20
-
 Noninterest
Expense
 
 The
following table sets forth certain information on noninterest expense for the
periods indicated:
  
 Three
      Months Ended September 30,(In
      thousands)
              
              2008
              
              
              2007
              
              
              ChangeSalaries
      and employee benefits
              
              $
              1,284
              
              
              $
              1,263
              
              
              $
              21
              
              
              
              1.7
              %Building
      occupancy
              
              
              331
              
              
              
              305
              
              
              
              26
              
              
              
              8.5
              %Data
      processing
              
              
              335
              
              
              
              339
              
              
              
              (4
              )
              
              
              -1.2
              %Professional
      and other services
              
              
              158
              
              
              
              130
              
              
              
              28
              
              
              
              21.5
              %Amortization
      of intangible assets
              
              
              -
              
              
              
              55
              
              
              
              (55
              )
              
              
              -100.0
              %Other
      operating
              
              
              354
              
              
              
              320
              
              
              
              34
              
              
              
              10.6
              %Total
      noninterest expense
              
              $
              2,462
              
              
              $
              2,412
              
              
              $
              50
              
              
              
              2.1
              %Nine
      Months Ended September 30,(In
      thousands)
              
              2008
              
              
              2007
              
              
              ChangeSalaries
      and employee benefits
              
              $
              3,863
              
              
              $
              3,764
              
              
              $
              99
              
              
              
              2.6
              %Building
      occupancy
              
              
              1,009
              
              
              
              935
              
              
              
              74
              
              
              
              7.9
              %Data
      processing
              
              
              974
              
              
              
              1,033
              
              
              
              (59
              )
              
              
              -5.7
              %Professional
      and other services
              
              
              580
              
              
              
              593
              
              
              
              (13
              )
              
              
              -2.2
              %Amortization
      of intangible assets
              
              
              -
              
              
              
              166
              
              
              
              (166
              )
              
              
              -100.0
              %Other
      operating
              
              
              982
              
              
              
              906
              
              
              
              76
              
              
              
              8.4
              %Total
      noninterest expense
              
              $
              7,408
              
              
              $
              7,397
              
              
              $
              11
              
              
              
              0.1
              %
 
  Total
noninterest expense increased $50,000 for the three months ended September 30,
2008 when compared to the same period for 2007.  An increase in
salaries and employee benefits of $21,000 was primarily due to merit based wage
adjustments.  Building occupancy expenses were $26,000 higher than the
comparable quarter of 2007 as a result of increases in both depreciation and
equipment maintenance expenses.  Professional and other services
expense increased $28,000 primarily from an increased number of advertising
campaigns and investment management fees.  Other operating expenses
increased $34,000 due to expenses related to other real estate owned and office
supplies.  These increases were offset by decreases in information
technology and amortization expenses.  Amortization expense decreased
$55,000 as core deposit intangibles, from a 2002 branch acquisition, became
fully amortized in October 2007.  Information technology expenses were
$4,000 lower than the comparable quarter of 2007 as a result of decreased
depreciation.
 
 Total
noninterest expense increased $11,000 for the nine months ended September 30,
2008 when compared to the same period for 2007.  The increase in
salaries and employee benefits was the result of normal merit increases and
increased employee benefit costs.  The $74,000 increase in building
occupancy expenses was primarily due to increases in property taxes,
depreciation and equipment maintenance. Data processing expenses were $59,000
lower than the comparable period in 2007 as a result of decreases in both
depreciation and check processing charges.   Professional and
other services expense decreased $13,000 primarily from the elimination of
consulting fees related to the Sarbanes Oxley 404 review process, which were
incurred in 2007, offset by new consulting relationships relating to product
pricing and compensation evaluation.  Amortization expense decreased
$166,000 as the previously mentioned core deposit intangibles became fully
amortized in October 2007.  The increase in other expenses was
primarily the result of higher costs associated with foreclosed real estate
properties.
 
 During
2009, we anticipate that our noninterest expense will increase significantly as
a result of higher FDIC deposit insurance premiums being assessed.
 
 Income
Tax Expense
 
 The
Company realized a $288,000 and $82,000 tax benefit for the three and nine
months ended September 30, 2008, respectively.  Income taxes decreased
$360,000 for the quarter ended September 30, 2008, as compared to the same
period in 2007. For the nine-month period ended September 30, 2008 income taxes
decreased $230,000.  The effective tax rate was
  - 21
-
 Table of Contents
  28.5%
(benefit) and 18.9% (expense) for the nine months ended September 30, 2008 and
September 30, 2007, respectively.  The decrease in income tax expense
and the effective tax rate in 2008 compared to 2007, resulted from significant
losses from investment impairment charges.  The Company has reduced
its tax rate from the statutory rate of 34% primarily through the ownership of
tax-exempt investment securities, bank owned life insurance and other tax saving
strategies, offset by a valuation allowance established on deferred tax assets
relating to capital losses generated by the impairment charges.
 
 As of
September 30, 2008, management evaluated its deferred tax assets to determine if
the benefit of the temporary differences would more likely than not be
realized.  Based on this evaluation, management concluded that a
portion of the capital loss generated by the impairment charges on the mutual
funds would most likely not be realized, as there were not sufficient capital
gains to absorb the capital losses.  Accordingly, the income tax
benefit recorded for the three and nine months ended September 30, 2008 was
reduced by $212,000 to account for the valuation allowance
recorded.
 
 Changes
in Financial Condition
 
 Assets
 
 Total
assets increased approximately $32.2 million, or 10%, to $352.9 million at
September 30, 2008, from $320.7 million at December 31, 2007.  The
increase in total assets was primarily the result of an increase of $10.1
million, or 15.5%, in investment securities, a $19.9 million increase in net
loans receivable and a $1.5 million increase in cash and cash
equivalents.  Investment securities portfolio growth is the result of
purchases of mortgage-backed securities, corporate bonds and a $2.0 million
certificate of deposit invested with a large money center financial institution.
The loan portfolio increase primarily reflects small business commercial loan
and residential real estate loan originations.  The Company continues
to transform its traditional thrift balance sheet toward that of a community
bank with a more diverse mix of residential, consumer and commercial loans. The
increase in cash and cash equivalents was primarily the result of higher
month-end Federal Reserve check processing activity.
 
 Based on
management's assessment, at September 30, 2008, the Company held securities in
which management determined that its decline in fair value was expected to be
other-than-temporary.  As a result of this determination, an
other-than-temporary impairment charge of $875,000 relating to the Company’s
$1,000,000 holdings in a senior unsecured bond issued by Lehman Brothers
Holdings Inc., which filed a Chapter 11 Bankruptcy petition on September 15,
2008, was recorded.  In addition to this charge, the Company also
recorded an other-than-temporary impairment charge of $690,000 relating to its
holdings in the AMF Large Cap Equity Fund and $269,000 relating to its holdings
in the AMF Ultra Short Mortgage Fund.  At September 30, 2008, the
total carrying value of the Company’s remaining investment in the AMF Large Cap
Equity Fund was approximately $2,192,000.  The carrying value of the
AMF Ultra Short Mortgage Fund at September 30, 2008 was approximately
$2,804,000.It is
possible that the Company will have to recognize future losses on these
investments, absent improvement in the real estate and mortgage securities
markets.
 
 Management
has reviewed the remainder of its loan and mortgage-backed securities portfolios
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, or originating these types of investments
or loans.
 
 Liabilities
 
 Total
liabilities increased $33.2 million, or 11.1%, to $332.2 million at September
30, 2008, from $299.0 million at December 31, 2007.  Deposits
increased $13.7 million, or 5.4%, long-term borrowings increased $15.4 million,
and short-term borrowings increased $3.4 million.  The increase in
deposits was the result of an increase of $5.5 million in municipal customer
deposits, combined with an $8.2 million increase in retail
deposits.  The municipal deposit increase was driven by the receipt of
tax revenues by our municipal customers.  The increase in retail
deposits was primarily the result of increased business demand deposit and MMDA
accounts.
  - 22
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  Loan
and Asset Quality and Allowance for Loan Losses
 
 The
following table represents information concerning the aggregate amount of
nonperforming assets:
 
 September
      30,
              
              
              December
      31,
              
              
              September
      30,(In
      thousands)
              
              2008
              
              
              2007
              
              
              2007Nonaccrual
      loans:Commercial
      real estate and commercial
              
              $
              1,665
              
              
              $
              521
              
              
              $
              1,001Consumer
              
              
              43
              
              
              
              150
              
              
              
              143Real
      estate -  Mortgage
              
              
              969
              
              
              
              920
              
              
              
              894Total
      nonaccrual loans
              
              
              2,677
              
              
              
              1,591
              
              
              
              2,038Total
      non-performing loans
              
              
              2,677
              
              
              
              1,591
              
              
              
              2,038Foreclosed
      real estate
              
              
              253
              
              
              
              865
              
              
              
              310Total
      non-performing assets
              
              $
              2,930
              
              
              $
              2,456
              
              
              $
              2,348Non-performing
      loans to total loans
              
              
              1.10
              %
              
              
              0.71
              %
              
              
              0.94
              %Non-performing
      assets to total assets
              
              
              0.85
              %
              
              
              0.77
              %
              
              
              0.75
              %
 
 
 Total
non-performing loans increased 68% at September 30, 2008, when compared to
December 31, 2007.  The increase in total non-performing loans is
primarily the result of deteriorating national and regional general economic
conditions; the increase is comprised of a number of smaller commercial lending
relationships, which are being actively monitored.Management believes that
the underlying collateral and associated guarantees, combined with the existing
reserves provided, are adequate to cover potential losses that may occur from
the remediation process.
 
 The
allowance for loan losses at September 30, 2008 and December 31, 2007 was $2.2
million and $1.7 million, or 0.92% and 0.76% of period end loans,
respectively.
 
 Capital
 
 Shareholders'
equity at September 30, 2008, was $20.7 million as compared to $21.7 million at
December 31, 2007.  The Company’s retained earnings were reduced as
the result of a net loss for the nine months ended September 30, 2008 of
$206,000, which was primarily due to the impact of impairment charges taken in
the third quarter.  Retained earnings were also reduced by cash
dividends declared of $602,000. Total capital was further reduced by unrealized
holding losses, net of tax, on securities of $210,000. The cumulative effect
adjustment to reflect the change in measurement date under SFAS 158 and the
amortization of the pension plan net losses and prior service liability and
postretirement transition obligation netted to increase capital by
$3,000.
 
 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, which supports growth and expansion
activities while at the same time exceeding regulatory standards.  At
September 30, 2008, Pathfinder Bank exceeded all regulatory required minimum
capital ratios and continues to meet 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’s actual capital amounts and ratios as of September 30, 2008 and December
31, 2007 are presented in the following table.
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 MinimumTo
      Be "WellMinimum
              
              
              Capitalized"For
      Capital
              
              
              Under
      PromptActual
              
              
              Adequacy
      Purposes
              
              
              Corrective
      Provisions(Dollars
      in thousands)
              
              Amount
              
              
              Ratio
              
              
              Amount
              
              
              Ratio
              
              
              Amount
              
              
              RatioAs
      of September 30, 2008:Total
      Core Capital (to Risk-Weighted Assets)
              
              $
              25,439
              
              
              
              10.9
              %
              
              $
              18,598
              
              
              
              8.0
              %
              
              $
              23,247
              
              
              
              10.0
              %Tier
      1 Capital (to Risk-Weighted Assets)
              
              $
              23,197
              
              
              
              10.0
              %
              
              $
              9,299
              
              
              
              4.0
              %
              
              $
              13,948
              
              
              
              6.0
              %Tier
      1 Capital (to Average Assets)
              
              $
              23,197
              
              
              
              6.8
              %
              
              $
              13,702
              
              
              
              4.0
              %
              
              $
              17,127
              
              
              
              5.0
              %As
      of December 31, 2007:Total
      Core Capital (to Risk-Weighted Assets)
              
              $
              25,447
              
              
              
              12.2
              %
              
              $
              16,648
              
              
              
              8.0
              %
              
              $
              20,810
              
              
              
              10.0
              %Tier
      1 Capital (to Risk-Weighted Assets)
              
              $
              23,744
              
              
              
              11.4
              %
              
              $
              8,324
              
              
              
              4.0
              %
              
              $
              12,486
              
              
              
              6.0
              %Tier
      1 Capital (to Average Assets)
              
              $
              23,744
              
              
              
              7.7
              %
              
              $
              12,437
              
              
              
              4.0
              %
              
              $
              15,548
              
              
              
              5.0
              %
 
 The board
of directors and management are presently analyzing the potential merits of
participating in the Capital Purchase Program (CPP) of the Treasury Department’s
Troubled Asset Relief Program (TARP).  It is the general view of the
board and management that in the present national economic risk environment,
enhancing the Bank’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 bank’s lending activities to individuals, families, and businesses in our
community.
 
 Liquidity
 
 Liquidity
management involves the Company’s ability to generate cash or otherwise obtain
funds at reasonable rates to support asset growth, meet deposit withdrawals,
maintain reserve requirements, and otherwise operate the Company on an ongoing
basis.  The Company's primary sources of funds are deposits, borrowed
funds, amortization and prepayment of loans and maturities of investment
securities and other short-term investments, and earnings and funds provided
from operations.  While scheduled principal repayments on loans are a
relatively predictable source of funds, deposit flows and loan prepayments are
greatly influenced by general interest rates, economic conditions and
competition.  The Company manages the pricing of deposits to maintain
a desired deposit balance.  In addition, the Company invests excess
funds in short-term interest-earning and other assets, which provide liquidity
to meet lending requirements.
 
 The
Company's liquidity has been enhanced by its membership in the 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 available to
it.  The combined aggregate amount of credit available in connection
with its existing facilities is approximately $75.0 million at September 30,
2008.
 
 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 September 30, 2008, management reported to the Board
of Directors that the Company is in compliance with its liquidity policy
guidelines.
  - 24
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  Item
3 – Quantitative and Qualitative Disclosures About Market Risk
 
 A smaller
reporting company is not required to provide the information relating to this
item.
 
 Item
4T  - Controls and Procedures
 
 Under the
supervision and with the participation of the Company's management, including
our Chief Executive Officer and Chief Financial Officer, the Company has
evaluated the effectiveness of the design and operation of its disclosure
controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the
Exchange Act) as of the end of the period covered by this quarterly
report.  Based upon that evaluation, the Chief Executive Officer and
Chief Financial Officer concluded that, as of the end of the period covered by
this report, the Company's disclosure controls and procedures are effective to
ensure that information required to be disclosed in the reports that the Company
files or submits under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported, within the time periods specified in the
Securities and Exchange Commission's rules and forms.  There has been
no change in the Company's internal control over financial reporting during the
most recent fiscal quarter that has materially affected, or is reasonable likely
to materially affect, the Company's internal control over financial
reporting.
  - 25
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  PART
II - OTHER INFORMATION
 
 Item
1 - Legal Proceedings
 
 None
 
 Item
1A – Risk Factors
 
 A smaller
reporting company is not required to provide the information relating to this
item.
 
 Item
2 – Unregistered Sales of Equity Securities and Use of Proceeds
 
 None
 
 Item
3 - Defaults Upon Senior Securities
 
 None
 
 Item
4 - Submission of Matters to a Vote of Security Holders
 
 None
 
 Item
5 - Other Information
 
 None
 
 Item
6 - Exhibits
 
 Exhibit
No.                                Description
 
 31.1                      Rule
13a-14(a) / 15d-14(a) Certification of the Chief Executive Officer
 31.2                      Rule
13a-14(a) / 15d-14(a) Certification of the Chief Financial Officer
 32.1                     
Section 1350 Certification of the Chief Executive Officer and Chief
Financial
 Officer
 
 
 
 
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 SIGNATURES
 
 Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
 
 PATHFINDER BANCORP,
INC.
 
 
 November 13,
2008                                                       
     /s/ Thomas W.
Schneider
 Date:                                                                       
            Thomas
W. Schneider
 President
and Chief Executive Officer
 
 November 13,
2008             
                                          
     /s/ James A.
Dowd
 Date:                            
                                                         James
A. Dowd
 Senior Vice President and Chief
Financial Officer


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