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 June 30, 2009
 
 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 has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files).
 YES *        NO
*
 
 Indicate
by check mark 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
August 10, 2009, there were 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
                    
                    18and
      Results of OperationsItem
      3.
                    Quantitative and Qualitative Disclosures About Market
      Risk
                    
                    26Item
      4T.
                    Controls and Procedures
                    
                    26PART II - OTHER INFORMATION
                    
                    27Item
      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
                    
                    29EXHIBITS
                    
                    30
  
 Table of
Contents






PART
I FINANCIAL INFORMATION


Item
1 – Consolidated Financial Statements





Pathfinder
Bancorp, Inc.


Consolidated
Statements of Condition


(Unaudited)


June
      30,
                  
                  
                  December
      31,(In
      thousands, except share data)
                  
                  2009
                  
                  
                  2008ASSETS:Cash
      and due from banks
                  
                  
                  $6,930
                  
                  
                  
                  $7,365Interest
      earning deposits
                  
                  
                  1,295
                  
                  
                  
                  313Total
      cash and cash equivalents
                  
                  
                  8,225
                  
                  
                  
                  7,678Investment
      securities, at fair value
                  
                  
                  67,223
                  
                  
                  
                  72,138Federal
      Home Loan Bank stock, at cost
                  
                  
                  1,917
                  
                  
                  
                  2,549Loans
                  
                  
                  250,187
                  
                  
                  
                  249,872Less:
      Allowance for loan losses
                  
                  
                  2,772
                  
                  
                  
                  2,472Loans
      receivable, net
                  
                  
                  247,415
                  
                  
                  
                  247,400Premises
      and equipment, net
                  
                  
                  7,307
                  
                  
                  
                  7,450Accrued
      interest receivable
                  
                  
                  1,518
                  
                  
                  
                  1,678Foreclosed
      real estate
                  
                  
                  251
                  
                  
                  
                  335Goodwill
                  
                  
                  3,840
                  
                  
                  
                  3,840Bank
      owned life insurance
                  
                  
                  6,843
                  
                  
                  
                  6,731Other
      assets
                  
                  
                  2,685
                  
                  
                  
                  2,961Total
      assets
                  
                  
                  $347,224
                  
                  
                  
                  $352,760LIABILITIES AND SHAREHOLDERS'
      EQUITY:Deposits:Interest-bearing
                  
                  
                  $255,131
                  
                  
                  
                  $243,288Noninterest-bearing
                  
                  
                  25,775
                  
                  
                  
                  26,150Total
      deposits
                  
                  
                  280,906
                  
                  
                  
                  269,438Short-term
      borrowings
                  
                  
                  1,000
                  
                  
                  
                  17,575Long-term
      borrowings
                  
                  
                  35,400
                  
                  
                  
                  34,400Junior
      subordinated debentures
                  
                  
                  5,155
                  
                  
                  
                  5,155Other
      liabilities
                  
                  
                  4,649
                  
                  
                  
                  6,697Total
      liabilities
                  
                  
                  327,110
                  
                  
                  
                  333,265Shareholders'
      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 2,484,832 shares issued and outstanding respectively
                  
                  
                  30
                  
                  
                  
                  30Additional
      paid in capital
                  
                  
                  7,909
                  
                  
                  
                  7,909Retained
      earnings
                  
                  
                  21,658
                  
                  
                  
                  21,198Accumulated
      other comprehensive loss
                  
                  
                  (2,981
                  )
                  
                  
                  (3,140
                  )Treasury
      stock, at cost; 487,287 shares
                  
                  
                  (6,502
                  )
                  
                  
                  (6,502
                  )Total
      shareholders' equity
                  
                  
                  20,114
                  
                  
                  
                  19,495Total
      liabilities and shareholders' equity
                  
                  
                  $347,224
                  
                  
                  
                  $352,760The
      accompanying notes are an integral part of the consolidated financial
      statements.








-3-
 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)
                
                June
      30, 2009
                
                
                June
      30, 2008Interest and dividend income:Loans,
      including fees
                
                
                $3,685
                
                
                
                $3,550Debt
      securities:Taxable
                
                
                672
                
                
                
                775Tax-exempt
                
                
                3
                
                
                
                59Dividends
                
                
                80
                
                
                
                112Federal
      funds sold and interest earning deposits
                
                
                1
                
                
                
                10Total
      interest income
                
                
                4,441
                
                
                
                4,506Interest
      expense:Interest
      on deposits
                
                
                1,154
                
                
                
                1,413Interest
      on short-term borrowings
                
                
                6
                
                
                
                92Interest
      on long-term borrowings
                
                
                405
                
                
                
                364Total
      interest expense
                
                
                1,565
                
                
                
                1,869Net
      interest income
                
                
                2,876
                
                
                
                2,637Provision
      for loan losses
                
                
                272
                
                
                
                135Net
      interest income after provision for loan losses
                
                
                2,604
                
                
                
                2,502Noninterest
      income:Service
      charges on deposit accounts
                
                
                360
                
                
                
                355Earnings
      on bank owned life insurance
                
                
                56
                
                
                
                56Loan
      servicing fees
                
                
                55
                
                
                
                61Losses
      on impairment of investment securities
                
                
                (298
                )
                
                
                (342
                )Net
      losses on sales of loans and foreclosed real estate
                
                
                (15
                )
                
                
                -Debit
      card interchange fees
                
                
                73
                
                
                
                70Other
      charges, commissions & fees
                
                
                114
                
                
                
                111Total
      noninterest income
                
                
                345
                
                
                
                311Noninterest
      expense:Salaries
      and employee benefits
                
                
                1,377
                
                
                
                1,242Building
      occupancy
                
                
                306
                
                
                
                332Data
      processing expenses
                
                
                336
                
                
                
                330Professional
      and other services
                
                
                242
                
                
                
                203Other
      expenses
                
                
                555
                
                
                
                314Total
      noninterest expenses
                
                
                2,816
                
                
                
                2,421Income
      before income taxes
                
                
                133
                
                
                
                392Provision
      for income taxes
                
                
                102
                
                
                
                92Net
      income
                
                
                $31
                
                
                
                $300Earnings
      per share - basic
                
                
                $0.01
                
                
                
                $0.12Earnings
      per share - diluted
                
                
                $0.01
                
                
                
                $0.12Dividends
      per share
                
                
                $0.06
                
                
                
                $0.1025





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






-4-
 Table of Contents


Pathfinder
Bancorp, Inc.


Consolidated
Statements of Income


(Unaudited)





For
      the six
                          
                          
                          For
      the sixmonths
      ended
                          
                          
                          months
      ended(In
      thousands, except per share data)
                          
                          June
      30, 2009
                          
                          
                          June
      30, 2008Interest
      and dividend income:Loans,
      including fees
                          
                          
                          $7,312
                          
                          
                          
                          $7,188Debt
      securities:Taxable
                          
                          
                          1,383
                          
                          
                          
                          1,455Tax-exempt
                          
                          
                          13
                          
                          
                          
                          82Dividends
                          
                          
                          161
                          
                          
                          
                          227Federal
      funds sold and interest earning deposits
                          
                          
                          2
                          
                          
                          
                          54Total
      interest income
                          
                          
                          8,871
                          
                          
                          
                          9,006Interest
      expense:Interest
      on deposits
                          
                          
                          2,451
                          
                          
                          
                          3,012Interest
      on short-term borrowings
                          
                          
                          20
                          
                          
                          
                          226Interest
      on long-term borrowings
                          
                          
                          811
                          
                          
                          
                          719Total
      interest expense
                          
                          
                          3,282
                          
                          
                          
                          3,957Net
      interest income
                          
                          
                          5,589
                          
                          
                          
                          5,049Provision
      for loan losses
                          
                          
                          407
                          
                          
                          
                          280Net
      interest income after provision for loan losses
                          
                          
                          5,182
                          
                          
                          
                          4,769Noninterest
      income:Service
      charges on deposit accounts
                          
                          
                          711
                          
                          
                          
                          734Earnings
      on bank owned life insurance
                          
                          
                          112
                          
                          
                          
                          123Loan
      servicing fees
                          
                          
                          111
                          
                          
                          
                          151Losses
      on impairment of investment securities
                          
                          
                          (298
                          )
                          
                          
                          (342
                          )Net
      gains on sales of investment securities
                          
                          
                          87
                          
                          
                          
                          -Net
      gains on sales of loans and foreclosed real estate
                          
                          
                          65
                          
                          
                          
                          6Debit
      card interchange fees
                          
                          
                          137
                          
                          
                          
                          136Other
      charges, commissions & fees
                          
                          
                          219
                          
                          
                          
                          207Total
      noninterest income
                          
                          
                          1,144
                          
                          
                          
                          1,015Noninterest
      expense:Salaries
      and employee benefits
                          
                          
                          2,749
                          
                          
                          
                          2,579Building
      occupancy
                          
                          
                          629
                          
                          
                          
                          678Data
      processing expenses
                          
                          
                          675
                          
                          
                          
                          639Professional
      and other services
                          
                          
                          414
                          
                          
                          
                          422Other
      expenses
                          
                          
                          922
                          
                          
                          
                          628Total
      noninterest expenses
                          
                          
                          5,389
                          
                          
                          
                          4,946Income
      before income taxes
                          
                          
                          937
                          
                          
                          
                          838Provision
      for income taxes
                          
                          
                          327
                          
                          
                          
                          206Net  income
                          
                          
                          $610
                          
                          
                          
                          $632Earnings
      per share - basic
                          
                          
                          $0.25
                          
                          
                          
                          $0.25Earnings
      per share - diluted
                          
                          
                          $0.25
                          
                          
                          
                          $0.25Dividends
      per share
                          
                          
                          $0.06
                          
                          
                          
                          $0.205The
      accompanying notes are an integral part of the consolidated financial
      statements.







-5-
 Table of Contents


Pathfinder
      Bancorp, Inc.Consolidated
      Statements of Changes in Shareholders' EquitySix
      Months Ended June 30, 2009 and June 30, 2008(Unaudited)





AccumulatedAdditional
                                  
                                  
                                  
                                  
                                  
                                  Other
      Com-Common
      Stock Issued
                                  
                                  
                                  Paid
      in
                                  
                                  
                                  Retained
                                  
                                  
                                  prehensive
                                  
                                  
                                  Treasury(In
      thousands, except share data)
                                  
                                  Shares
                                  
                                  
                                  Amount
                                  
                                  
                                  Capital
                                  
                                  
                                  Earnings
                                  
                                  
                                  Loss
                                  
                                  
                                  Stock
                                  
                                  
                                  TotalBalance, January 1, 2009
                                  
                                  
                                  2,972,119
                                  
                                  
                                  
                                  $30
                                  
                                  
                                  
                                  $7,909
                                  
                                  
                                  
                                  $21,198
                                  
                                  
                                  
                                  $(3,140
                                  )
                                  
                                  
                                  $(6,502
                                  )
                                  
                                  
                                  $19,495Comprehensive
      income:Net
      income
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  610
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  610Other
      comprehensive income, net of tax:Unrealized
      holding gains on securitiesavailable
      for sale (net of $132 tax expense)
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  76
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  76Retirement
      plan net losses and transitionobligation
      recognized in plan expenses(net
      of $56 tax expense)
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  83
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  83Total
      Comprehensive income
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  769Dividends
      declared ($0.06 per share)
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  (150
                                  )
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  (150
                                  )Balance,
      June 30, 2009
                                  
                                  
                                  2,972,119
                                  
                                  
                                  
                                  $30
                                  
                                  
                                  
                                  $7,909
                                  
                                  
                                  
                                  $21,658
                                  
                                  
                                  
                                  $(2,981
                                  )
                                  
                                  
                                  $(6,502
                                  )
                                  
                                  
                                  $20,114Balance,
      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
      income
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  632
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  632Other
      comprehensive income (loss), net of tax:Unrealized
      holding losses on securitiesavailable
      for sale (net of $654 tax benefit)
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  (831
                                  )
                                  
                                  
                                  
                                  
                                  
                                  
                                  (831
                                  )Retirement
      plan net losses and transitionobligation
      recognized in plan expenses(net
      of $17 tax expense)
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  25
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  25Total
      Comprehensive loss
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  (174
                                  )Dividends
      declared ($0.2050 per share)
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  (348
                                  )
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  (348
                                  )Balance,
      June 30, 2008
                                  
                                  
                                  2,971,019
                                  
                                  
                                  
                                  $30
                                  
                                  
                                  
                                  $7,900
                                  
                                  
                                  
                                  $21,970
                                  
                                  
                                  
                                  $(2,251
                                  )
                                  
                                  
                                  $(6,502
                                  )
                                  
                                  
                                  $21,147





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





-6-
 Table of Contents


Pathfinder
Bancorp, Inc.


Consolidated
Statements of Cash Flows


(Unaudited)


For
      the six
                              
                              
                              For
      the sixmonths
      ended
                              
                              
                              months
      ended(In
      thousands)
                              
                              June
      30, 2009
                              
                              
                              June
      30, 2008OPERATING ACTIVITIESNet
      income
                              
                              
                              $610
                              
                              
                              
                              $632Adjustments
      to reconcile net income to net cash (used in) provided by operating
      activities:Provision
      for loan losses
                              
                              
                              407
                              
                              
                              
                              280Proceeds
      from sales of loans
                              
                              
                              6,513
                              
                              
                              
                              -Originations
      of loans held-for-sale
                              
                              
                              (6,427
                              )
                              
                              
                              -Realized
      losses (gains) on sales of:Foreclosed
      real estate
                              
                              
                              21
                              
                              
                              
                              (6
                              )Loans
                              
                              
                              (86
                              )
                              
                              
                              -Available-for-sale
      investment securities
                              
                              
                              (87
                              )
                              
                              
                              -Impairment
      write-down on available-for-sale securities
                              
                              
                              298
                              
                              
                              
                              342Depreciation
                              
                              
                              327
                              
                              
                              
                              358Amortization
      of mortgage servicing rights
                              
                              
                              13
                              
                              
                              
                              17Earnings
      on bank owned life insurance
                              
                              
                              (112
                              )
                              
                              
                              (123
                              )Net
      (accretion) amortization of premiums and discounts on investment
      securities
                              
                              
                              (144
                              )
                              
                              
                              62Decrease
      (increase) in accrued interest receivable
                              
                              
                              160
                              
                              
                              
                              (49
                              )Net
      change in other assets and liabilities
                              
                              
                              (1,654
                              )
                              
                              
                              (152
                              )Net
      cash (used in) provided by operating activities
                              
                              
                              (161
                              )
                              
                              
                              1,361INVESTING
      ACTIVITIESPurchase
      of investment securities available-for-sale
                              
                              
                              (12,653
                              )
                              
                              
                              (29,683
                              )Net
      proceeds from the redemption of (purchases of) Federal Home Loan Bank
      stock
                              
                              
                              632
                              
                              
                              
                              (259
                              )Proceeds
      from maturities and principal reductions ofinvestment
      securities available-for-sale
                              
                              
                              11,150
                              
                              
                              
                              12,808Proceeds
      from sale of:Available-for-sale
      investment securities
                              
                              
                              6,559
                              
                              
                              
                              984Real
      estate acquired through foreclosure
                              
                              
                              132
                              
                              
                              
                              315Net
      increase in loans
                              
                              
                              (491
                              )
                              
                              
                              (10,310
                              )Purchase
      of premises and equipment
                              
                              
                              (184
                              )
                              
                              
                              (94
                              )Net
      cash provided by (used in) investing activities
                              
                              
                              5,145
                              
                              
                              
                              (26,239
                              )FINANCING
      ACTIVITIESNet
      increase in demand deposits, NOW accounts, savings
    accounts,money
      market deposit accounts, MMDA accounts and escrow deposits
                              
                              
                              9,438
                              
                              
                              
                              8,920Net
      increase in time deposits
                              
                              
                              2,030
                              
                              
                              
                              6,824Net
      repayments on short-term borrowings
                              
                              
                              (16,575
                              )
                              
                              
                              (10,430
                              )Payments
      on long-term borrowings
                              
                              
                              (1,000
                              )
                              
                              
                              (3,610
                              )Proceeds
      from long-term borrowings
                              
                              
                              2,000
                              
                              
                              
                              24,000Cash
      dividends paid
                              
                              
                              (330
                              )
                              
                              
                              (348
                              )Net
      cash (used in) provided by financing activities
                              
                              
                              (4,437
                              )
                              
                              
                              25,356Increase
      in cash and cash equivalents
                              
                              
                              547
                              
                              
                              
                              478Cash
      and cash equivalents at beginning of period
                              
                              
                              7,678
                              
                              
                              
                              10,213Cash
      and cash equivalents at end of period
                              
                              
                              $8,225
                              
                              
                              
                              $10,691CASH
      PAID DURING THE PERIOD FOR:Interest
                              
                              
                              $3,312
                              
                              
                              
                              $4,005Income
      taxes
                              
                              
                              521
                              
                              
                              
                              160NON-CASH
      INVESTING ACTIVITYTransfer
      of loans to foreclosed real estate
                              
                              
                              69
                              
                              
                              
                              112The
      accompanying notes are an integral part of the consolidated financial
      statements.








-7-
 Table of Contents


Pathfinder
Bancorp, Inc.


Note
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.  Certain amounts
in the 2008 consolidated financial statements have been reclassified to conform
to the current period presentation.  These reclassifications had no
effect on net income as previously reported.  The Company has
evaluated subsequent events and transactions occurring through the date of
issuance of the financial data included herein, August 14,
2009.




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, 2008 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 six months ended June 30, 2009, are not necessarily indicative
of the results that may be expected for the year ending December 31,
2009.




(2)
Earnings per Share




Basic
earnings per share has been computed by dividing net income by the weighted
average number of common shares outstanding throughout the three months and six
months ended June 30, 2009 and 2008, using 2,484,832 and 2,483,732 weighted
average common shares outstanding, respectively. Diluted earnings per share for
the three months and six months ended June 30, 2009 and 2008, have been computed
using 2,484,832 and 2,486,197 for the three month periods and 2,484,832 and
2,487,562 for the six month periods, 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 six months
ended June 30, 2009, since the current trading price of the Company’s common
stock is lower that the average strike price of the outstanding stock
options.  The number of options excluded from the diluted earnings per
share calculation was 4,364 for the three months ended June 30, 2009 and 6,413
for the six months ended June 30, 2009.




(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 post retirement 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 plan
as of October 1 of each year.  As a result of the measurement date
provisions, the Company decreased its pension plan asset with a corresponding
charge to retained earnings, representing the net periodic benefit cost for the
period between the October 1, 2007 measurement date and January 1,
2008.





The
composition of net periodic pension plan costs for the three months and six
months ended June 30, is as follows:




For
      the three months
                        
                        
                        For
      the six monthsended
      June 30,
                        
                        
                        ended
      June 30,(In
      thousands)
                        
                        2009
                        
                        
                        2008
                        
                        
                        2009
                        
                        
                        2008Service
      cost
                        
                        
                        $57
                        
                        
                        
                        $54
                        
                        
                        
                        $114
                        
                        
                        
                        $107Interest
      cost
                        
                        
                        83
                        
                        
                        
                        79
                        
                        
                        
                        166
                        
                        
                        
                        158Expected
      return on plan assets
                        
                        
                        (68
                        )
                        
                        
                        (112
                        )
                        
                        
                        (136
                        )
                        
                        
                        (223
                        )Amortization
      of net losses
                        
                        
                        65
                        
                        
                        
                        16
                        
                        
                        
                        130
                        
                        
                        
                        33Net
      periodic benefit cost
                        
                        
                        $137
                        
                        
                        
                        $37
                        
                        
                        
                        $274
                        
                        
                        
                        $75





-8-
 Table of Contents


The
composition of net periodic postretirement plan costs for the three months and
six months ended June 30, is as follows:




For the three months
                  
                  
                  For the six monthsended June 30,
                  
                  
                  ended June 30,(In
      thousands)
                  
                  2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Service
      cost
                  
                  
                  $1
                  
                  
                  
                  $1
                  
                  
                  
                  $2
                  
                  
                  
                  $1Interest
      cost
                  
                  
                  5
                  
                  
                  
                  5
                  
                  
                  
                  10
                  
                  
                  
                  10Amortization
      of transition obligation
                  
                  
                  5
                  
                  
                  
                  5
                  
                  
                  
                  10
                  
                  
                  
                  10Net
      periodic benefit cost
                  
                  
                  $11
                  
                  
                  
                  $11
                  
                  
                  
                  $22
                  
                  
                  
                  $21





The
Company made a non-recurring contribution to the defined benefit pension plan
of  $2,000,000 during the second quarter of 2009.  The large
contribution was made to reduce the overall plan funding shortfall and mitigate
future anticipated pension expense increases.





(4)
Comprehensive Income





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





The
components of other comprehensive income (loss) and related tax effects for the
three and six months ended June 30 are as follows:




For
      the three months
                  
                  
                  For the six monthsended June 30,
                  
                  
                  ended June 30,(In
      thousands)
                  
                  2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Unrealized
      holding gains (losses) on securities available for sale:Unrealized
      holding gains (losses) arising during the period
                  
                  
                  $217
                  
                  
                  
                  $(2,102
                  )
                  
                  
                  $(3
                  )
                  
                  
                  $(1,726
                  )Reclassification
      adjustment for impairment charges included in net income
                  
                  
                  298
                  
                  
                  
                  342
                  
                  
                  
                  298
                  
                  
                  
                  342Reclassification
      adjustment for net gains included in net income
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (87
                  )
                  
                  
                  0Net
      unrealized gains (losses) on securities available for sale
                  
                  
                  515
                  
                  
                  
                  (1,760
                  )
                  
                  
                  208
                  
                  
                  
                  (1,384
                  )Defined
      benefit pension and post retirement plans:Reclassification
      adjustment for amortization of benefit plans'net
      loss and transition obligation recognized in netperiodic
      expense
                  
                  
                  70
                  
                  
                  
                  42
                  
                  
                  
                  140
                  
                  
                  
                  42Net
      change in defined benefit plan
                  
                  
                  70
                  
                  
                  
                  42
                  
                  
                  
                  140
                  
                  
                  
                  42Other
      comprehensive income (loss) before tax
                  
                  
                  585
                  
                  
                  
                  (1,718
                  )
                  
                  
                  348
                  
                  
                  
                  (1,342
                  )Tax
      effect
                  
                  
                  (162
                  )
                  
                  
                  686
                  
                  
                  
                  (189
                  )
                  
                  
                  536Other
      comprehensive income (loss)
                  
                  
                  $423
                  
                  
                  
                  $(1,032
                  )
                  
                  
                  $159
                  
                  
                  
                  $(806
                  )





The
components of accumulated other comprehensive loss and related tax effects for
the periods indicated are as follows:





June
      30,
                      
                      December
      31,(In
      thousands)
                      
                      
                      2009
                      
                      2008Unrealized
      losses on securities available for sale(net
      of tax benefit 2009 - $73; 2008 - $205)
                      
                      
                      $(977)
                      
                      $ (1,053)Net
      pension losses(net
      of tax benefit 2009 - $1,300; 2008 - $1,352)
                      
                      
                      (1,950)
                      
                      (2,027)Net
      post-retirement losses and transition obligation(net
      of tax benefit 2009 - $36; 2008 - $40)
                      
                      
                      (54)
                      
                      (60)$(2,981)
                      
                      $ (3,140)








-9-
 Table of Contents


(5)
Investment Securities





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





June
      30, 2009Gross
                        
                        
                        Gross
                        
                        
                        EstimatedAmortized
                        
                        
                        Unrealized
                        
                        
                        Unrealized
                        
                        
                        Fair(In
      thousands)
                        
                        Cost
                        
                        
                        Gains
                        
                        
                        Losses
                        
                        
                        ValueBond
      investment securities:US
      Treasury and agencies
                        
                        
                        $9,093
                        
                        
                        
                        $225
                        
                        
                        
                        $-
                        
                        
                        
                        $9,318State
      and political subdivisions
                        
                        
                        2,112
                        
                        
                        
                        2
                        
                        
                        
                        (31
                        )
                        
                        
                        2,083Corporate
                        
                        
                        10,016
                        
                        
                        
                        41
                        
                        
                        
                        (1,200
                        )
                        
                        
                        8,857Residential
      mortgage-backed
                        
                        
                        39,409
                        
                        
                        
                        869
                        
                        
                        
                        (86
                        )
                        
                        
                        40,192Total
                        
                        
                        60,630
                        
                        
                        
                        1,137
                        
                        
                        
                        (1,317
                        )
                        
                        
                        60,450Equity
      investment securities:Mutual
      funds
                        
                        
                        5,179
                        
                        
                        
                        -
                        
                        
                        
                        (865
                        )
                        
                        
                        4,314Common
      stock
                        
                        
                        313
                        
                        
                        
                        -
                        
                        
                        
                        (5
                        )
                        
                        
                        308Total
                        
                        
                        5,492
                        
                        
                        
                        -
                        
                        
                        
                        (870
                        )
                        
                        
                        4,622Other
      investments
                        
                        
                        2,151
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        2,151Total
      investment securities
                        
                        
                        $68,273
                        
                        
                        
                        $1,137
                        
                        
                        
                        $(2,187
                        )
                        
                        
                        $67,223December
      31, 2008Gross
                        
                        
                        Gross
                        
                        
                        EstimatedAmortized
                        
                        
                        Unrealized
                        
                        
                        Unrealized
                        
                        
                        Fair(In
      thousands)
                        
                        Cost
                        
                        
                        Gains
                        
                        
                        Losses
                        
                        
                        ValueBond
      investment securities:US
      Treasury and agencies
                        
                        
                        $9,126
                        
                        
                        
                        $342
                        
                        
                        
                        $-
                        
                        
                        
                        $9,468State
      and political subdivisions
                        
                        
                        5,020
                        
                        
                        
                        23
                        
                        
                        
                        (70
                        )
                        
                        
                        4,973Corporate
                        
                        
                        12,181
                        
                        
                        
                        117
                        
                        
                        
                        (1,472
                        )
                        
                        
                        10,826Residential
      mortgage-backed
                        
                        
                        39,478
                        
                        
                        
                        707
                        
                        
                        
                        (155
                        )
                        
                        
                        40,030Total
                        
                        
                        65,805
                        
                        
                        
                        1,189
                        
                        
                        
                        (1,697
                        )
                        
                        
                        65,297Equity
      investment securities:Mutual
      funds
                        
                        
                        5,179
                        
                        
                        
                        -
                        
                        
                        
                        (744
                        )
                        
                        
                        4,435Common
      stock
                        
                        
                        313
                        
                        
                        
                        -
                        
                        
                        
                        (6
                        )
                        
                        
                        307Total
                        
                        
                        5,492
                        
                        
                        
                        -
                        
                        
                        
                        (750
                        )
                        
                        
                        4,742Other
      investments
                        
                        
                        2,099
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        2,099Total
      investment securities
                        
                        
                        $73,396
                        
                        
                        
                        $1,189
                        
                        
                        
                        $(2,447
                        )
                        
                        
                        $72,138








The
amortized cost and estimated fair value of debt investments at June 30, 2009 by
contractual maturity are shown below. Expected maturities may differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without penalties.





Amortized
                  
                  
                  Estimated(In
      thousands)
                  
                  Cost
                  
                  
                  Fair
      ValueDue
      in one year or less
                  
                  
                  $3,996
                  
                  
                  
                  $4,036Due
      after one year through five years
                  
                  
                  9,203
                  
                  
                  
                  9,256Due
      after five years through ten years
                  
                  
                  3,002
                  
                  
                  
                  2,930Due
      after ten years
                  
                  
                  5,020
                  
                  
                  
                  4,036Residential
      mortgage-backed securities
                  
                  
                  39,409
                  
                  
                  
                  40,192Totals
                  
                  
                  $60,630
                  
                  
                  
                  $60,450





-10-
 Table of Contents





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





June
      30, 2009Less
      than Twelve Months
                                    
                                    
                                    Twelve
      Months or More
                                    
                                    
                                    TotalUnrealized
                                    
                                    
                                    Fair
                                    
                                    
                                    Unrealized
                                    
                                    
                                    Fair
                                    
                                    
                                    Unrealized
                                    
                                    
                                    Fair(In
      thousands)
                                    
                                    Losses
                                    
                                    
                                    Value
                                    
                                    
                                    Losses
                                    
                                    
                                    Value
                                    
                                    
                                    Losses
                                    
                                    
                                    ValueState
      and political subdivisions
                                    
                                    
                                    $(31
                                    )
                                    
                                    
                                    $1,836
                                    
                                    
                                    
                                    $-
                                    
                                    
                                    
                                    $-
                                    
                                    
                                    
                                    $(31
                                    )
                                    
                                    
                                    $1,836Corporate
                                    
                                    
                                    (50
                                    )
                                    
                                    
                                    1,443
                                    
                                    
                                    
                                    (1,150
                                    )
                                    
                                    
                                    5,347
                                    
                                    
                                    
                                    (1,200
                                    )
                                    
                                    
                                    6,790Residential
      mortgage-backed
                                    
                                    
                                    (3
                                    )
                                    
                                    
                                    962
                                    
                                    
                                    
                                    (83
                                    )
                                    
                                    
                                    1,435
                                    
                                    
                                    
                                    (86
                                    )
                                    
                                    
                                    2,397Mutual
      funds
                                    
                                    
                                    (865
                                    )
                                    
                                    
                                    4,314
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    (865
                                    )
                                    
                                    
                                    4,314Common
      stock
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    (5
                                    )
                                    
                                    
                                    23
                                    
                                    
                                    
                                    (5
                                    )
                                    
                                    
                                    23$(949
                                    )
                                    
                                    
                                    $8,555
                                    
                                    
                                    
                                    $(1,238
                                    )
                                    
                                    
                                    $6,805
                                    
                                    
                                    
                                    $(2,187
                                    )
                                    
                                    
                                    $15,360December
      31, 2008Less
      than Twelve Months
                                    
                                    
                                    Twelve
      Months or More
                                    
                                    
                                    TotalUnrealized
                                    
                                    
                                    Fair
                                    
                                    
                                    Unrealized
                                    
                                    
                                    Fair
                                    
                                    
                                    Unrealized
                                    
                                    
                                    Fair(In
      thousands)
                                    
                                    Losses
                                    
                                    
                                    Value
                                    
                                    
                                    Losses
                                    
                                    
                                    Value
                                    
                                    
                                    Losses
                                    
                                    
                                    ValueState
      and political subdivisions
                                    
                                    
                                    $(70
                                    )
                                    
                                    
                                    $2,134
                                    
                                    
                                    
                                    $-
                                    
                                    
                                    
                                    $-
                                    
                                    
                                    
                                    $(70
                                    )
                                    
                                    
                                    $2,134Corporate
                                    
                                    
                                    (327
                                    )
                                    
                                    
                                    5,349
                                    
                                    
                                    
                                    (1,145
                                    )
                                    
                                    
                                    2,805
                                    
                                    
                                    
                                    (1,472
                                    )
                                    
                                    
                                    8,154Residential
      mortgage-backed
                                    
                                    
                                    (150
                                    )
                                    
                                    
                                    7,491
                                    
                                    
                                    
                                    (5
                                    )
                                    
                                    
                                    734
                                    
                                    
                                    
                                    (155
                                    )
                                    
                                    
                                    8,225Mutual
      funds
                                    
                                    
                                    (744
                                    )
                                    
                                    
                                    4,251
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    (744
                                    )
                                    
                                    
                                    4,251Common
      stock
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    (6
                                    )
                                    
                                    
                                    21
                                    
                                    
                                    
                                    (6
                                    )
                                    
                                    
                                    21$(1,291
                                    )
                                    
                                    
                                    $19,225
                                    
                                    
                                    
                                    $(1,156
                                    )
                                    
                                    
                                    $3,560
                                    
                                    
                                    
                                    $(2,447
                                    )
                                    
                                    
                                    $22,785





We
conduct a formal review of investment securities on a quarterly basis for the
presence of OTTI. For the second quarter of 2009, we adopted FSP FAS 115-2 and
FAS 124-2, Recognition and
Presentation of Other-Than-Temporary Impairments, issued by the FASB on
April 9, 2009. We assess whether OTTI is present when the fair value of a debt
security is less than its amortized cost basis at the balance sheet date. Under
these circumstances as required by the new FSP, OTTI is considered to have
occurred (1) if we intend to sell the security; (2) if it is “more likely than
not” we will be required to sell the security before recovery of its amortized
cost basis; or (3) the present value of expected cash flows is not sufficient to
recover the entire amortized cost basis. The “more likely than not” criteria is
a lower threshold than the “probable” criteria used under previous
guidance.  The FSP requires that credit-related OTTI is recognized in
earnings while noncredit-related OTTI on securities not expected to be sold is
recognized in other comprehensive income (“OCI”). Noncredit-related OTTI is
based on other factors, including illiquidity. As required, presentation of OTTI
should be made in the statement of income on a gross basis, including both the
portion recognized in earnings as well as the portion recorded in OCI. Normally,
the gross OTTI would then be offset by the amount of noncredit-related OTTI,
showing the net as the impact on earnings.  OTTI charges have been
credit-related in 2009, and therefore no offset was presented on the June 30
statements.  Additional disclosures are also required by this
FSP.





In
determining whether OTTI has occurred for equity securities, the Company
considers the applicable factors described above and 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.





For debt
security types discussed below where no OTTI is considered necessary at June 30,
2009, we applied the criteria of FSP FAS 115-2 and 124-1. That is, we do not
intend to sell the securities and it is not more likely than not that we will be
required to sell the securities before recovery of their amortized cost
basis.  For equity securities, we have the intent and ability to
retain the investments for a period of time sufficient to recover the amortized
cost basis of these securities.





At June
30, 2009, one taxable municipal revenue bond has been in an unrealized loss
position for 5 months.  The security was issued by Ennis Texas
Economic Development Corp and is currently AAA rated by S&P.  The
security is scheduled to mature in 2024 and the present unrealized loss position
represents only 1.65% of its current book value. Thus, the security is not
deemed to be other-than- temporarily impaired.







-11-
 Table of Contents




At June
30, 2009, nine corporate securities were in unrealized loss
positions.  The two securities in the largest unrealized loss position
represent trust-preferred issuances from large money center financial
institutions.  The JP Morgan Chase floating rate trust-preferred
security has a carrying value of $984,000 and a fair value of $560,000. The Bank
of America floating rate trust-preferred security has a carrying value of
$979,000 and a fair value of $419,000.  The securities are rated A1
and Baa2 by Moody’s.  The securities are both floating rate notes that
adjust quarterly to LIBOR.  These securities reflect net unrealized
losses due to the fact that current similar issuances are being originated at
much higher spreads to LIBOR, as the market currently demands a greater pricing
premium for the associated risk in the current economic
environment.  Management has performed a detailed credit analysis on
the underlying companies and has concluded that each issue is not credit
impaired thus, the securities are not deemed to be other-than-temporarily
impaired. Due to the fact that each security has in excess of 17 years until
final maturity, and management has determined that there is no related credit
impairment, the associated pricing risk is managed similar to long-term, low
yielding, 15 and 30 year fixed rate residential mortgages carried in the
Company’s loan portfolio.  The risk is managed through the Company’s
extensive interest rate risk management procedures.





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





The
remaining two corporate securities have been in unrealized loss positions for
three months or less. The unrealized loss positions principally relate to
changes in interest rates subsequent to the security acquisition date, as well
as a greater amount of credit spread currently being priced into similar
security offerings.  Thus, the securities are not deemed to be
other-than-temporarily impaired.





At June
30, 2009, five private label CMOs and one agency mortgage-backed security are
currently in unrealized loss positions. All six of the above mentioned
securities are currently rated AAA.  These unrealized losses relate
principally to changes in interest rates subsequent to the acquisition of the
specific securities.  None of the securities in this category had an
unrealized loss that exceeded 10%. Management reviewed the underlying mortgage
collateral associated with its holdings in CMOs and agency MBS noting the
underlying credit score information, loan-to-value information, and the
concentration risk associated with the geographic area that the majority of the
underlying mortgage collateral resides in.   Based on the
relatively high composite credit ratings and low average loan-to-value ratios
identified, combined with the low collateral concentrations in the more troubled
states, management deems that no other-than-temporary impairment is
present.





The
Company presently holds in its investment portfolio a $2.8 million investment in
a no-load mutual fund, which invests primarily in mortgage-related
instruments.  The fund holds mortgage-backed bonds and securities
issued by government-sponsored mortgage entities and by private
companies.  The underlying assets are comprised of variable rate,
adjustable rate and fixed-rate residential mortgage and home equity
loans.  As a result of the recent problems in the real estate and
mortgage securities markets, the fair value of the fund has declined and,
accordingly, the Company’s recorded other-than-temporary impairment charges of
18% of the value during 2008.  The value of the investment in the fund
has declined further below its cost basis by approximately $369,000 as of June
30, 2009.  The current fund value is not a compilation of the daily
trading prices of the underlying securities, but rather is derived from matrix
pricing in an illiquid market, thus it is more reflective of liquidation pricing
than of the Fund’s true fair value.  Fund cash flows have been
uninterrupted, as no individual security has experienced a default of
contractual principal or interest payments. The Fund continues to reinvest
excess cash flows into short-term federal agency backed mortgage-backed
securities, thus improving the overall risk profile of the Fund.  The
overall value of the fund has continued to improve during 2009.  As of
July 31st, the unrealized loss associated with the Company’s holdings in the
fund has decreased to approximately $317,000, representing a 14% improvement
since June 30, 2009 and a 17% improvement since the end of the last quarter, at
March 31, 2009.  Management has displayed the intent and ability to
hold this security until its value improves.  Given all these facts,
it is management’s opinion that additional other-than-temporary impairment is
not present at this time.





In
addition to the mutual fund backed by mortgage-related instruments, the Company
also holds a $2.2 million investment in a mutual fund consisting of investment
grade, dividend paying common stocks of large capitalization companies
(companies with market capitalization in excess of $5
billion).  Management recorded an other-than-temporary impairment
charge of 24% of the Fund’s value in 2008.  The value of the
investment in this fund has declined further below its cost basis by
approximately $447,000 as of June 30, 2009. The overall value of the fund has
continued to improve during 2009.  As of July 31st, the unrealized
loss associated with the Company’s holdings in the fund has decreased to
approximately $348,000, representing a 22% improvement since June 30, 2009 and a
47% improvement since the end of the last quarter, at March 31,
2009.  Management believes that the underlying investment grade
securities represent equity positions in well-managed companies with a diverse
cross section of various industries.  Management has performed a
review of each underlying holding comprising the Fund. The review and analysis
indicates that there are no individually impaired holdings and there is no
indication that the profitability of the individual companies is impaired beyond
the current economic cycle.  The Fund value is highly correlated to
the overall stock market performance and management believes that the market
will return to previous valuation levels over the next economic
cycle.  Management has the intent and ability to hold this security
until its value improves.  As such, the recent decline in fair value,
since the September 30, 2008 write-down for impairment, is not considered to be
other-than-temporary.




-12-
 Table of Contents


The
Company also holds an investment with a book value of $183,000 in the Financial
Institutions Fund, LLC, which invests primarily in equity securities issued by
community banks and thrift institutions and holding companies of such banks and
thrifts located principally in the Northeastern United States.  At
June 30, 2009 the fund is in a net unrealized loss position
of  $49,000.  A review of the underlying holdings indicates
that there are no impaired holdings within the portfolio.  However,
the portfolio is made up of the common stock of financial institutions that are
operating in a heightened risk environment. As of July 31, 2009 the fund’s value
had increased $52,000, or, 39%.  As a result of the subsequent
improvement in fund value, management feels no additional impairment change is
necessary at this time.


During
the second quarter of 2009, the Company recorded an other than temporary
impairment charge of $298,000 associated with its holdings in a senior unsecured
note issued by CIT Group, Inc. (“CIT”). As current concerns grew relating to
CIT’s ability to meet its current short-term obligations, combined with the
belief that other government programs were not going to be made available to
CIT, the Company concluded that the liquidation of its current holding at a loss
was prudent, and the security was sold on July 16, 2009.  The
impairment charge recorded in the second quarter was based on the sale proceeds
as compared to the amortized cost basis of the security.





The
following table presents a roll-forward of the amount related to credit losses
recognized in earnings for the period ended June 30, 2009.





(In
      thousands)
                    
                    TotalBeginning
      balance – January 1, 2009
                    
                    
                    $875Initial
      credit impairment
                    
                    
                    298Subsequent
      credit impairments
                    
                    
                    -Reductions
      for amounts recognized in earnings due to intent or requirement to
      sell
                    
                    
                    (298
                    )Ending
      balance - June 30, 2009
                    
                    
                    $875





Gross
realized gains (losses) on sales of securities and other-than-temporary
impairment charges for the six months ended June 30 are detailed
below:





(In
      thousands)
                  
                  2009
                  
                  
                  2008Available-for-sale
      securities:Realized
      gains
                  
                  
                  $96
                  
                  
                  
                  $21Realized
      (losses)
                  
                  
                  (9
                  )
                  
                  
                  (21
                  )Other
      than temporary impairment
                  
                  
                  (298
                  )
                  
                  
                  (342
                  )$(211
                  )
                  
                  
                  $(342
                  )





As of
June 30, 2009 and December 31, 2008, securities with an amortized cost of $36.8
million and $37.8 million, respectively, were pledged to collateralize certain
deposit and borrowing arrangements.





Management
has reviewed 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.





(6)
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 June 30, 2009.  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 June 30,
2009, for guarantees under standby letters of credit issued is not
material.






-13-
 Table of Contents




(7)
Fair Value Measurements





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





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





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





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





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





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





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





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





Foreclosed
real estate:  Properties acquired through foreclosure, or by deed in
lieu of foreclosure, are recorded at their fair value less estimated disposal
costs.  Fair value is 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
following tables summarize assets measured at fair value on a recurring basis as
of June 30, 2009 and December 31, 2008, segregated by the level of valuation
inputs within the hierarchy utilized to measure fair value:




At
      June 30, 2009Total
      Fair(In
      thousands)
                            
                            Level
      1
                            
                            
                            Level
      2
                            
                            
                            Level
      3
                            
                            
                            ValueAssets:Investment
      securities available for sale
                            
                            
                            $1,745
                            
                            
                            
                            $65,478
                            
                            
                            
                            $-
                            
                            
                            
                            $67,223At
      December 31, 2008Total
      Fair(In
      thousands)
                            
                            Level
      1
                            
                            
                            Level
      2
                            
                            
                            Level
      3
                            
                            
                            ValueAssets:Investment
      securities available for sale
                            
                            
                            $1,918
                            
                            
                            
                            $70,220
                            
                            
                            
                            $-
                            
                            
                            
                            $72,138





Certain
financial assets and financial liabilities are measured at fair value on a
nonrecurring basis; that is, the instruments are not measured at fair value on
an ongoing basis but are subject to fair value adjustments in certain
circumstances (for example, when there is evidence of
impairment).  The following tables summarize financial assets measured
at fair value on a nonrecurring basis as of June 30, 2009 and December 31, 2008,
segregated by the level of valuation inputs within the hierarchy utilized to
measure fair value:




-14-
 Table of Contents





At
      June 30, 2009Total
      Fair(In
      thousands)
                        
                        Level
      1
                        
                        
                        Level
      2
                        
                        
                        Level
      3
                        
                        
                        ValueAssets:Impaired
      loans
                        
                        
                        $-
                        
                        
                        
                        $-
                        
                        
                        
                        $466
                        
                        
                        
                        $466Foreclosed
      real estate
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        251
                        
                        
                        
                        251At
      December 31, 2008Total
      Fair(In
      thousands)
                        
                        Level
      1
                        
                        
                        Level
      2
                        
                        
                        Level
      3
                        
                        
                        ValueAssets:Impaired
      loans
                        
                        
                        $-
                        
                        
                        
                        $-
                        
                        
                        
                        $295
                        
                        
                        
                        $295Foreclosed
      real estate
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        335
                        
                        
                        
                        335





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





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





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





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





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





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





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





Mortgage servicing rights -
the carrying amount approximates fair value.





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





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




-15-
 Table of Contents





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





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





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





The
carrying amounts and fair values of the Company’s financial instruments as of
June 30, 2009 and December 31, 2008 are presented in the following
table:




June
      30, 2009
                
                
                December
      31, 2008Carrying
                
                
                Estimated
                
                
                Carrying
                
                
                Estimated(Dollars
      in thousands)
                
                Amounts
                
                
                Fair
      Values
                
                
                Amounts
                
                
                Fair
      ValuesFinancial
      assets:Cash
      and cash equivalents
                
                
                $8,225
                
                
                
                $8,225
                
                
                
                $7,678
                
                
                
                $7,678Investment
      securities
                
                
                67,223
                
                
                
                67,223
                
                
                
                72,138
                
                
                
                72,138Net
      loans
                
                
                247,415
                
                
                
                253,301
                
                
                
                247,400
                
                
                
                250,020Federal
      Home Loan Bank stock
                
                
                1,917
                
                
                
                1,917
                
                
                
                2,549
                
                
                
                2,549Accrued
      interest receivable
                
                
                1,518
                
                
                
                1,518
                
                
                
                1,678
                
                
                
                1,678Mortgage
      servicing rights
                
                
                55
                
                
                
                55
                
                
                
                15
                
                
                
                15Financial
      liabilities:Deposits
                
                
                $280,906
                
                
                
                $283,079
                
                
                
                $269,438
                
                
                
                $272,207Borrowed
      funds
                
                
                36,400
                
                
                
                37,751
                
                
                
                51,975
                
                
                
                53,777Junior
      subordinated debentures
                
                
                5,155
                
                
                
                5,155
                
                
                
                5,155
                
                
                
                5,155Accrued
      interest payable
                
                
                182
                
                
                
                182
                
                
                
                211
                
                
                
                211Off-balance
      sheet instruments:Standby
      letters of credit
                
                
                $-
                
                
                
                $-
                
                
                
                $-
                
                
                
                $-Commitments
      to extend credit
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -





(8)
New Accounting Pronouncements





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





In April
2009, the Financial Accounting Standards Board (FASB) issued FASB Staff
Position (FSP) No. FAS 157-4, Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly(FSP FAS
157-4).  FASB Statement 157, Fair Value Measurements,
defines fair value as the price that would be received to sell the asset or
transfer the liability in an orderly transaction (that is, not a forced
liquidation or distressed sale) between market participants at the measurement
date under current market conditions. FSP FAS 157-4 provides additional guidance
on determining when the volume and level of activity for the asset or liability
has significantly decreased. The FSP also includes guidance on identifying
circumstances when a transaction may not be considered orderly.  FSP
FAS 157-4 provides a list of factors that a reporting entity should evaluate to
determine whether there has been a significant decrease in the volume and level
of activity for the asset or liability in relation to normal market activity for
the asset or liability. When the reporting entity concludes there has been a
significant decrease in the volume and level of activity for the asset or
liability, further analysis of the information from that market is needed and
significant adjustments to the related prices may be necessary to estimate fair
value in accordance with Statement 157.  This FSP clarifies that when
there has been a significant decrease in the volume and level of activity for
the asset or liability, some transactions may not be orderly. In those
situations, the entity must evaluate the weight of the evidence to determine
whether the transaction is orderly. The FSP provides a list of circumstances
that may indicate that a transaction is not orderly. A transaction price that is
not associated with an orderly transaction is given little, if any, weight when
estimating fair value.  This FSP is effective for interim and annual
reporting periods ending after June 15, 2009, with early adoption permitted
for periods ending after March 15, 2009.  An entity early
adopting FSP FAS 157-4 must also early adopt FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of
Other-Than-Temporary Impairments.  We have adopted this
standard on April 1, 2009 without a significant impact on our current financial
position or results of operations.







-16-
 Table of Contents


In April
2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, Recognition and Presentation of
Other-Than-Temporary Impairments(FSP FAS 115-2 and FAS
124-2).   FSP FAS 115-2 and FAS 124-2 clarifies the interaction
of the factors that should be considered when determining whether a debt
security is other-than-temporarily impaired. For debt securities, management
must assess whether (a) it has the intent to sell the security and
(b) it is more likely than not that it will be required to sell the
security prior to its anticipated recovery. These steps are done before
assessing whether the entity will recover the cost basis of the investment.
Previously, this assessment required management to assert it has both the intent
and the ability to hold a security for a period of time sufficient to allow for
an anticipated recovery in fair value to avoid recognizing an
other-than-temporary impairment. This change does not affect the need to
forecast recovery of the value of the security through either cash flows or
market price.  In instances when a determination is made that an
other-than-temporary impairment exists but the investor does not intend to sell
the debt security and it is not more likely than not that it will be required to
sell the debt security prior to its anticipated recovery, FSP FAS 115-2 and FAS
124-2 changes the presentation and amount of the other-than-temporary impairment
recognized in the income statement. The other-than-temporary impairment is
separated into (a) the amount of the total other-than-temporary impairment
related to a decrease in cash flows expected to be collected from the debt
security (the credit loss) and (b) the amount of the total
other-than-temporary impairment related to all other factors. The amount of the
total other-than-temporary impairment related to the credit loss is recognized
in earnings. The amount of the total other-than-temporary impairment related to
all other factors is recognized in other comprehensive income.  This
FSP is effective for interim and annual reporting periods ending after
June 15, 2009, with early adoption permitted for periods ending after
March 15, 2009.  An entity early adopting FSP FAS 115-2 and FAS
124-2 must also early adopt FSP FAS 157-4,Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not
Orderly.  We have adopted this standard on April 1, 2009
without a significant impact on our current financial position or results of
operations.





In April
2009, the FASB issued FSP No. FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value
of Financial Instruments(FSP FAS 107-1 and APB 28-1).  FSP FAS
107-1 and APB 28-1 amends FASB Statement No. 107, Disclosures about Fair Value of
Financial Instruments, to require disclosures about fair value of
financial instruments for interim reporting periods of publicly traded companies
as well as in annual financial statements. This FSP also amends APB Opinion
No. 28, Interim Financial
Reporting, to require those disclosures in summarized financial
information at interim reporting periods.  This FSP is effective for
interim and annual reporting periods ending after June 15, 2009, with early
adoption permitted for periods ending after March 15, 2009.  An
entity early adopting FSP FAS 107-1 and APB 28-1 must also early adopt FSP FAS
157-4,Determining Fair Value
When the Volume and Level of Activity for the Asset or Liability Have
Significantly Decreased and Identifying Transactions That Are Not Orderlyand FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of
Other-Than-Temporary Impairments. The adoption of this
staff position resulted in additional disclosures about fair values of financial
instruments in the Company’s June 30, 2009 quarterly report on Form 10-Q, but
did not result in a change in the reported values of any amounts in the
consolidated financial statements.





In June
2009, the FASB issued SFAS No. 166, Accounting for Transfers of
Financial Assets, an amendment of FASB Statement
No. 140.This statement prescribes the information that a
reporting entity must provide in its financial reports about a transfer of
financial assets; the effects of a transfer on its financial position, financial
performance and cash flows; and a transferor’s continuing involvement in
transferred financial assets.  Specifically, among other aspects,
SFAS 166 amends Statement of Financial Standard No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, or
SFAS 140, by removing the concept of a qualifying special-purpose entity
from SFAS 140 and removes the exception from applying FIN 46(R) to
variable interest entities that are qualifying special-purpose
entities.  It also modifies the financial-components approach used in
SFAS 140. SFAS 166 is effective for fiscal years beginning after
November 15, 2009.  We have not determined the effect that the
adoption of SFAS 166 will have on our financial position or results of
operations.





In June
2009, the FASB issued SFAS No. 168, The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting Principles, a
replacement of FASB Statement No. 162. SFAS 168
replaces SFAS No. 162, The Hierarchy of Generally
Accepted Accounting Principles,to establish the FASB Accounting Standards
Codificationas the source of authoritative accounting principles
recognized by the FASB to be applied by nongovernmental entities in preparation
of financial statements in conformity with generally accepted accounting
principles in the United States.  SFAS 168 is effective for
interim and annual periods ending after September 15, 2009. We do not
expect the adoption of this standard to have an impact on our financial position
or results of operations.
  -17-
 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 II are wholly
owned subsidiaries of Pathfinder Bancorp, Inc., however, Pathfinder Statutory
Trust II is not consolidated for reporting purposes.  Pathfinder
Commercial Bank, Pathfinder REIT, Inc. and Whispering Oaks Development Corp. are
wholly owned subsidiaries of Pathfinder Bank.  At June 30, 2009,
Pathfinder Bancorp, M.H.C, the Company’s mutual holding company parent, whose
activities are not included in the consolidated financial statements or the
MD&A, held 63.7% of the Company’s outstanding common stock and public
shareholders held the remaining 36.3% of the common stock.





The
following discussion reviews the Company's financial condition at June 30, 2009
and the results of operations for the three months and six months ended June 30,
2009 and June 30, 2008.





Statement
Regarding Forward-Looking Statements





When used
in this quarterly report the words or phrases “will likely result”, “are
expected to”, “will continue”, “is anticipated”, “estimate”, ”project” or
similar expression are intended to identify “forward-looking statements” within
the meaning of the Private Securities Litigation Reform Act of
1995.  Such statements are subject to certain risks and uncertainties.
By identifying these forward-looking statements for you in this manner, the
Company is alerting you to the possibility that its actual results and financial
condition may differ, possibly materially, from the anticipated results and
financial condition indicated in these forward-looking statements. 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 various factors could affect the Company’s
financial performance and could cause the Company’s actual results for future
periods to differ materially from any opinions or statements expressed with
respect to future periods in any current statements.  Additionally,
all statements in this document, including forward-looking statements, speak
only as of the date they are made, and the Company undertakes no obligation to
update any statement in light of new information or future events.





Application
of Critical Accounting Policies





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





The most
significant accounting policies followed by the Company are presented in Note 1
to the consolidated financial statements included in the 2008 Annual Report on
Form 10-K ("the Consolidated Financial Statements").





These
policies, along with the disclosures presented in the other financial statement
notes and in this discussion, provide information on how significant assets and
liabilities are valued in the consolidated financial statements and how those
values are determined.  Based on the valuation techniques used and the
sensitivity of financial statement amounts to the methods, assumptions and
estimates underlying those amounts, management has identified the allowance for
loan losses, deferred income taxes, pension obligations, the evaluation of
investment securities for other than temporary impairment and the estimation of
fair values for accounting and disclosure purposes to be the accounting areas
that require the most subjective and complex judgments, and as such, could be
the most subject to revision as new information becomes available.





The
allowance for loan losses represents management's estimate of probable loan
losses inherent in the loan portfolio. Determining the amount of the allowance
for loan losses is considered a critical accounting estimate because it requires
significant judgment and the use of estimates related to the amount and timing
of expected future cash flows on impaired loans, estimated losses on pools of
homogeneous loans based on historical loss experience, and consideration of
current economic trends and conditions, all of which may be susceptible to
significant change.  The loan portfolio also represents the largest
asset type on the consolidated statement of condition.  Note 1 to the
consolidated financial statements describes the methodology used to determine
the allowance for loan losses, and a discussion of the factors driving changes
in the amount of the allowance for loan losses is included in this
report.







-18-
 Table of Contents




Deferred
income tax assets and liabilities are determined using the liability
method.  Under this method, the net deferred tax asset or liability is
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases as well as net operating and capital loss carry
forwards.  Deferred tax assets and liabilities are measured using
enacted tax rates applied to taxable income in the years in which those
temporary differences are expected to be recovered or settled.  The
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income tax expense in the period that includes the enactment
date.  To the extent that current available evidence about the future
raises doubt about the likelihood of a deferred tax asset being realized, a
valuation allowance is established.  The judgment about the level of
future taxable income, including that which is considered capital, is inherently
subjective and is reviewed on a continual basis as regulatory and business
factors change.





Pension
and post-retirement benefit plan liabilities and expenses are based upon
actuarial assumptions of future events, including fair value of plan assets,
interest rates, rate of future compensation increases and the length of time the
Company will have to provide those benefits. The assumptions used by management
are discussed in Note 11 to the consolidated annual financial
statements.





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) if we intend to sell the security; (2) if it is “more likely than
not” we will be required to sell the security before recovery of its amortized
cost basis; or (3) the present value of expected cash flows is not sufficient to
recover the entire amortized cost basis.   Management continually
analyzes the portfolio to determine if further impairment has occurred that may
be deemed as other-than-temporary.  Further charges are possible
depending on future economic conditions.





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





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





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.





Net
income was $31,000, or $0.01 per basic and diluted share, for the three months
ended June 30, 2009, as compared to $300,000, or $0.12 per basic and diluted
share, for the same period in 2008.  For the six months ended June 30,
2009, the Company reported net income of $610,000, or $0.25 per basic and
diluted share as compared to $632,000, or $0.25 per basic and diluted share for
the same period in 2008.  During the second quarter of 2009, the
Company recorded an investment security impairment charge of $197,000, net of
tax benefits of $101,000.  During the second quarter of 2008, the
Company recorded an investment security impairment charge of $205,000, net of
tax benefits of $137,000.







-19-
 Table of Contents


The
Company has continued efforts to expand its lending and deposit relationships
within the small business community.  These efforts have helped the
Company transform its statement of condition from one more concentrated in
residential loans and retail deposits to a more diversified mix of residential,
consumer, and commercial relationships.  On an average balance basis,
total commercial loans comprised 34.0% of the total gross loan portfolio for the
six months ended June 30, 2009 compared to 30.6% for the six months ended June
30, 2008.





The
Company sold approximately $4.5 million in municipal investment portfolio
holdings and $6.4 million of fixed rate residential real estate loans during the
first half of the year.  These efforts, combined with other deposit
gathering efforts, were undertaken to improve the Company’s overall liquidity
position and reduce its reliance on wholesale borrowings. Short-term borrowings
decreased $16.6 million, or 94%, when compared to December 31,
2008.  Long-term borrowings increased $1.0 million, or 3%, when
compared to December 31, 2008.





Results
of Operations





The
return on average assets and return on average shareholders' equity were 0.03%
and 0.61%, respectively, for the three months ended June 30, 2009, compared with
0.35% and 5.41%, respectively, for the three months ended June 30,
2008.  During the second quarter of 2009, when compared to the second
quarter of 2008, net interest income increased $239,000, partially offset by an
increased provision for loan losses of $137,000.   Noninterest
expense increased $395,000, which was primarily the result of increased pension
plan expense to amortize losses recorded in the prior year, and the increase in
FDIC regular assessment and special assessment charges.  The provision
for income tax expense during the second quarter of 2009 included $58,000 to
increase the valuation allowance on deferred tax assets generated by capital
losses in 2008.





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.





Net
interest income, on a tax-equivalent basis increased to $2.8 million for the
three months ended June 30, 2009, from $2.7 million for the three months ended
June 30, 2008.  The Company's net interest margin remained the same,
at 3.41%, for the second quarter of 2009 when compared to the same quarter in
2008.  Reductions in the Company’s current levels of earning asset
yields, due to falling short-term interest rates, have been offset by efforts to
reduce the cost of funds, and have resulted in maintaining the Company’s net
interest margin. The small increase in net interest income is attributable to a
decrease of 52 basis points in the average cost of interest bearing liabilities,
and was offset by a decrease of 48 basis points in the average yield earned on
earning assets.  Average interest-earning assets increased 5% to
$328.2 million for the three months ended June 30, 2009, as compared to $313.3
million for the three months ended June 30, 2008.  The increase in
average earning assets is primarily attributable to a $22.8 million increase in
average loans receivable, and a $1.8 million increase in average interest
earning deposits, offset by a $9.7 million decrease in average investment
securities.  Average interest-bearing liabilities
increased  $13.7 million to $301.3 million from $287.6 million for the
three months ended June 30, 2008. The increase in the average balance of
interest-bearing liabilities resulted primarily from a $15.7 million increase in
average deposits and a $2.0 million decrease in average borrowings.





For the
six months ended June 30, 2009, net interest income, on a tax-equivalent basis,
increased to $5.6 million from $5.1 million for the six months ended June 30,
2008.  Net interest margin increased 10 basis points, to 3.41% for the
six months ended June 30, 2009 from 3.31% for the six months ended June 30,
2008. Average interest-earning assets increased 7% to $330.0 million for the six
months ended June 30, 2009 as compared to $309.5 million for the six months
ended June 30, 2008, and the yield on interest-earning assets decreased 48 basis
points to 5.39% from 5.87% for the comparable period.   The
increase in average interest-earning assets was primarily attributable to a
$23.8 million increase in average loans receivable and a $1.5 million increase
in average interest earning deposits, partially offset by a $4.8 million
decrease in average investment securities.Average interest-bearing
liabilities increased $17.6 million but the cost of funds decreased 60 basis
points to 2.17% for the six months ended June 30, 2009, from 2.77% for the same
period in 2008.  The increase in the average balance of
interest-bearing liabilities resulted primarily from a $16.4 million, or 6.8%,
increase in average deposits and an $1.2 million, or 2.9%, increase in average
borrowings.





Interest
Income





Total
interest income, on a tax-equivalent basis, for the quarter ended June 30, 2009,
decreased $175,000, or 3.9%, to $4.4 million from $4.5 million for the quarter
ended June 30, 2008.





The
average balance of loans increased $22.8 million to $249.1 million, with yields
decreasing 36 basis points to 5.93% for the second quarter of
2009.  Average residential real estate loans increased $4.3 million,
or 3%, and experienced a decrease in the average yield to 5.62% from 5.70% in
the comparable quarter of 2008.   Average commercial real estate
loans






-20-
 Table of Contents


increased
$12 million, while the average yield on those loans decreased to 6.96% from
7.45% from the period a year earlier. Average commercial loans increased $3.8
million and experienced a decrease in the average yield of 94 basis points, to
5.13% for the quarter ended June 30, 2009, from 6.07%, in the quarter ended June
30, 2008. The decrease in the average yield on commercial loans was primarily
the result of new commercial loan origination activity taking place at yields
lower than the average yield on the existing commercial loan portfolio, combined
with the downward repricing of the existing adjustable rate commercial loan
portfolio into the current, historically low, interest rate
environment.  Average consumer loans increased $2.3 million, or 9%,
while the average yield decreased by 121 basis points.





Average
investment securities (taxable and tax-exempt) for the quarter ended June 30,
2009, decreased by $9.7 million, with a decrease in tax-equivalent interest
income from investments of $300,000, or 31%, when compared to the second quarter
of 2008.  The average tax-equivalent yield of the portfolio decreased
101 basis points, to 3.61% from 4.62%.





Total
interest income, on a tax-equivalent basis, for the six months ended June 30,
2009 decreased $178,000, or 2%, when compared to the six months ended June 30,
2008.





Average
loans increased $23.8 million, with average yields decreasing 52 basis points to
5.90% from 6.42% for the six-month period ended June 30, 2009 when compared with
the same period in 2008.  Average residential real estate loans
increased $5.7 million, or 4.5%, and experienced a slight decrease in the
average yield of 16 basis points from the comparable six-month period ended June
30, 2008.   Average commercial real estate loans increased $10.8
million, while the average yield on those loans decreased to 6.87% from 7.52%
from the period a year earlier.  Average commercial loans increased
$4.9 million and experienced a decrease in the average yield of 148 basis
points, to 5.08% for the six months ended June 30, 2009, from 6.56%, for the six
months ended June 30, 2008. The decrease in the average yield on commercial
loans was the result of new commercial loan origination activity taking place at
lower yields and variable rate loans pricing downwards. Average consumer loans
increased $2.2 million, or 8.5%, while the average yield decreased by 133 basis
points.





For the
six months ended June 30, 2009, tax-equivalent interest income from investment
securities decreased $243,000, or 13%, compared to the same period in
2008.   The average tax-equivalent yield of the portfolio
decreased 36 basis points, to 4.21% from 4.57%.   Moreover, there
was a $4.8 million decrease in the average balance of investment securities,
reflecting the sale of municipal investment portfolio holdings in the first
quarter.





Interest
Expense





Total
interest expense decreased $304,000 for the three months ended June 30, 2009,
compared to the same quarter in 2008, as the cost of funds decreased 52 basis
points to 2.08% in 2009 from 2.60% in 2008.  Although average deposits
increased in 2009 over the second quarter of 2008, the associated cost of funds
decreased sufficiently to lower the overall interest expense
incurred.  Average time deposits increased $9.3 million, but were
offset by a 76 basis point reduction in the cost of funds.  The
average balance of money market demand accounts increased to $33.6 million at
June 30, 2009 from $26.8 million at June 30, 2008 and was offset by a decrease
in the cost of funds to 0.69% from 1.75%.  The average balances of
other deposit categories showed small increases or decreases when comparing the
second quarter averages between 2009 and 2008, but all categories had a
reduction in the associated cost of funds.





Interest
expense on borrowings decreased by $45,000, or 10%, when compared to the same
quarter in 2008, as a result of a decrease in average borrowings of $2.1 million
and a 23 basis point decrease in the cost of funds. The decrease in cost is
attributed to the cost of the junior subordinated debenture, down 163 basis
points, which resulted from a reduction in its index rate based on 3-month
LIBOR.





Total
interest expense decreased $675,000 for the six months ended June 30, 2009,
compared to the same period in 2008, as the average cost of funds decreased 60
basis points to 2.17% in 2009 from 2.77% in 2008.Average time deposits
increased $11.8 million, but were offset by a 76 basis point reduction in the
cost of funds.  The six-month average balance of money market demand
accounts increased $4.0 million at June 30, 2009 from the prior year period and
was offset by a decrease in the cost of funds to 0.81% from
2.23%.  The average balances of other deposit categories showed small
increases and decreases when comparing the six-month period results between 2009
and 2008, but all categories had a reduction in the associated interest expense
as the result of a decrease in cost of funds of 59 basis points.





Interest
expense on borrowings decreased by $114,000, or 12%, from the prior six-month
period. The reduction in the average cost of borrowings to 3.78% from 4.43% in
2008, was offset by an increase in average borrowings of $1.2
million.








-21-
 Table of Contents




Provision
for Loan Losses





The
provision for loan losses increased $137,000 and $127,000 for the three-month
and six-month periods ended June 30, 2009, respectively, when compared to the
same periods in 2008.  The Company continues to provide for loan
losses to reflect the growing loan portfolio and to reflect a loan portfolio
composition that is more heavily weighted to commercial term and commercial real
estate, which have higher inherent risk characteristics than a 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 1.11% at June 30, 2009 as compared to 0.99% at
December 31, 2008.  Nonperforming loans to period end loans increased
to 1.03% at June 30, 2009 from 0.93% at December 31, 2008. The increase in
nonperforming loans is primarily the result of deterioration in the delinquency
status of residential real estate loans.  Management believes that the
existing allowances provided on these loans are sufficient to cover anticipated
losses.





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
quarters indicated:




Three
      Months Ended June 30,(in
      thousands)
                          
                          2009
                          
                          
                          2008
                          
                          
                          ChangeService
      charges on deposit accounts
                          
                          
                          $360
                          
                          
                          
                          $355
                          
                          
                          
                          $5
                          
                          
                          
                          1.4
                          %Earnings
      on bank owned life insurance
                          
                          
                          56
                          
                          
                          
                          56
                          
                          
                          
                          -
                          
                          
                          
                          0.0
                          %Loan
      servicing fees
                          
                          
                          55
                          
                          
                          
                          61
                          
                          
                          
                          (6
                          )
                          
                          
                          -9.8
                          %Debit
      card interchange fees
                          
                          
                          73
                          
                          
                          
                          70
                          
                          
                          
                          3
                          
                          
                          
                          4.3
                          %Other
      charges, commissions and fees
                          
                          
                          114
                          
                          
                          
                          111
                          
                          
                          
                          3
                          
                          
                          
                          2.7
                          %Noninterest
      income before gains (losses)
                          
                          
                          658
                          
                          
                          
                          653
                          
                          
                          
                          5
                          
                          
                          
                          0.8
                          %Net
      losses on sales and impairment of investment securities
                          
                          
                          (298
                          )
                          
                          
                          (342
                          )
                          
                          
                          44
                          
                          
                          
                          -12.9
                          %Net
      losses on sales of loans and foreclosed real estate
                          
                          
                          (15
                          )
                          
                          
                          -
                          
                          
                          
                          (15
                          )
                          
                          
                          -100.0
                          %Total
      noninterest income
                          
                          
                          $345
                          
                          
                          
                          $311
                          
                          
                          
                          $34
                          
                          
                          
                          10.9
                          %Six
      Months Ended June 30,(in
      thousands)
                          
                          2009
                          
                          
                          2008
                          
                          
                          ChangeService
      charges on deposit accounts
                          
                          
                          $711
                          
                          
                          
                          $734
                          
                          
                          
                          $(23
                          )
                          
                          
                          -3.1
                          %Earnings
      on bank owned life insurance
                          
                          
                          112
                          
                          
                          
                          123
                          
                          
                          
                          (11
                          )
                          
                          
                          -8.9
                          %Loan
      servicing fees
                          
                          
                          111
                          
                          
                          
                          151
                          
                          
                          
                          (40
                          )
                          
                          
                          -26.5
                          %Debit
      card interchange fees
                          
                          
                          137
                          
                          
                          
                          136
                          
                          
                          
                          1
                          
                          
                          
                          0.7
                          %Other
      charges, commissions and fees
                          
                          
                          219
                          
                          
                          
                          207
                          
                          
                          
                          12
                          
                          
                          
                          5.8
                          %Noninterest
      income before gains (losses)
                          
                          
                          1,290
                          
                          
                          
                          1,351
                          
                          
                          
                          (61
                          )
                          
                          
                          -4.5
                          %Net
      losses on sales and impairment of investment securities
                          
                          
                          (211
                          )
                          
                          
                          (342
                          )
                          
                          
                          131
                          
                          
                          
                          -38.3
                          %Net
      gains on sales of loans and foreclosed real estate
                          
                          
                          65
                          
                          
                          
                          6
                          
                          
                          
                          59
                          
                          
                          
                          983.3
                          %Total
      noninterest income
                          
                          
                          $1,144
                          
                          
                          
                          $1,015
                          
                          
                          
                          $129
                          
                          
                          
                          12.7
                          %





For the
three months ended June 30, 2009, noninterest income before gains (losses)
remained relatively level with only a $5,000 increase, when compared with the
three months ended June 30, 2008. A $6,000 decrease in loan servicing fees was
primarily attributable to non-recurring fees that were collected for commercial
loans in 2008.  This decrease was offset by small increases in service
fees, debit card interchange, and other fees, all associated with increased
activity.  The majority of the increase in noninterest income is the
result of net losses on sales of investment securities being less than that in
the prior year, resulting in a positive impact when comparing the two
periods.  This was offset by losses taken on foreclosed property that
did not occur in the second quarter of 2008.





For the
six months ended June 30, 2009, noninterest income before gains (losses)
decreased $61,000, or 4.5%, when compared with the six months ended June 30,
2008.   The decrease was comprised of a decrease in service
charges on deposit accounts, a decrease in earnings on bank owned life insurance
and a decrease in loan servicing fees.  The decrease in service
charges on deposit accounts was primarily attributable to the decrease in usage
of our extended overdraft product.  The decrease in loan servicing
fees was primarily attributable to non-recurring fees that were collected for
commercial loans in 2008. The decrease in noninterest income before gains
(losses) was offset by an decrease in






-22-
 Table of Contents




net
losses on sales and impairment of investment securities and
loans.  Net losses on sales and impairment charges taken on investment
securities were less than that in the prior
year.  Other-than-temporary impairment charges were less in 2009 and
were offset by gains on the sale of $4.5 million in municipal securities,
resulting in a positive impact when comparing the two periods. The increase in
net gains on sales of loans and foreclosed real estate is due to the gains
recognized on the sale of $6.4 million in 30-year fixed rate residential
mortgages, which were offset by losses on the sale of foreclosed real estate in
the second quarter.





Noninterest
Expense





The
following table sets forth certain information on noninterest expense for the
quarters indicated:




Three
      Months Ended June 30,(In
      thousands)
                    
                    2009
                    
                    
                    2008
                    
                    
                    ChangeSalaries
      and employee benefits
                    
                    
                    $1,377
                    
                    
                    
                    $1,242
                    
                    
                    
                    $135
                    
                    
                    
                    10.9
                    %Building
      occupancy
                    
                    
                    306
                    
                    
                    
                    332
                    
                    
                    
                    (26
                    )
                    
                    
                    -7.8
                    %Data
      processing
                    
                    
                    336
                    
                    
                    
                    330
                    
                    
                    
                    6
                    
                    
                    
                    1.8
                    %Professional
      and other services
                    
                    
                    242
                    
                    
                    
                    203
                    
                    
                    
                    39
                    
                    
                    
                    19.2
                    %Other
      operating
                    
                    
                    555
                    
                    
                    
                    314
                    
                    
                    
                    241
                    
                    
                    
                    76.8
                    %Total
      noninterest expense
                    
                    
                    $2,816
                    
                    
                    
                    $2,421
                    
                    
                    
                    $395
                    
                    
                    
                    16.3
                    %Six
      Months Ended June 30,(In
      thousands)
                    
                    2009
                    
                    
                    2008
                    
                    
                    ChangeSalaries
      and employee benefits
                    
                    
                    $2,749
                    
                    
                    
                    $2,579
                    
                    
                    
                    $170
                    
                    
                    
                    6.6
                    %Building
      occupancy
                    
                    
                    629
                    
                    
                    
                    678
                    
                    
                    
                    (49
                    )
                    
                    
                    -7.2
                    %Data
      processing
                    
                    
                    675
                    
                    
                    
                    639
                    
                    
                    
                    36
                    
                    
                    
                    5.6
                    %Professional
      and other services
                    
                    
                    414
                    
                    
                    
                    422
                    
                    
                    
                    (8
                    )
                    
                    
                    -1.9
                    %Other
      operating
                    
                    
                    922
                    
                    
                    
                    628
                    
                    
                    
                    294
                    
                    
                    
                    46.8
                    %Total
      noninterest expense
                    
                    
                    $5,389
                    
                    
                    
                    $4,946
                    
                    
                    
                    $443
                    
                    
                    
                    9.0
                    %





Total
noninterest expense increased $395,000 for the three months ended June 30, 2009
when compared to the same period for 2008. The increase in salaries and employee
benefits was primarily due to normal merit increases combined with an increased
pension expense as the result of pension plan losses incurred in
2008.   A $241,000, or 76.8%, increase in other expenses was
primarily due to an increase in FDIC assessments on
deposits.  Pathfinder Bank offset 90% of its Deposit Insurance Fund
assessments with available one-time assessment credits during the first two
quarters of 2008 and took the remaining balance of the credit against the third
quarter assessment.  For the first nine months of 2008, credits
utilized to offset amounts assessed for Pathfinder Bank totaled
$76,000.  Assessments for Pathfinder Bank in 2009 were not offset by
credits.





On
December 22, 2008, the FDIC published a final rule that raises the current
deposit insurance assessment rates uniformly for all institutions by 7 basis
points (to a range from 12 to 50 basis points) effective for the first quarter
of 2009.  On February 27, 2009, the FDIC also issued a final rule that
revises the way the FDIC calculates federal deposit insurance assessment rates
beginning in the second quarter of 2009.  Under the new rule, the
total base assessment rate will range from 7 to 77.5 basis points of the
institution’s deposits, depending on the risk category of the institution and
the institution’s levels of unsecured debt, secured liabilities, and brokered
deposits.  On May 22, 2009, the FDIC adopted a final rule imposing a 5
basis point special assessment on each insured depository institution's assets
minus Tier 1 capital as of June 30, 2009. The special assessment will be
collected on September 30, 2009, but must be accrued as of June 30,
2009.  The Company has estimated the impact of the special assessment
to be $165,000.  Both the special and regular assessment changes have
impacted all FDIC insured institutions for the quarter ended June 30,
2009.





Total
noninterest expense increased $443,000 for the six months ended June 30, 2009
when compared to the same period for 2008.  The increase in salaries
and employee benefits was primarily due to normal merit increases and incentive
based compensation costs, combined with an increased pension expense as the
result of pension plan losses incurred in 2008.   Data processing
costs increased $36,000, or 5.6% due to an increase in maintenance fees and
Internet banking charges from greater customer access.   A
$294,000, or 46.8%, increase in other expenses was primarily due to an increase
in FDIC assessments on deposits.  These increases were offset by
decreases of $49,000 and $8,000 in building occupancy and professional and other
services, respectively.  The decreases were the result of
non-recurring charges that were expensed in 2008.








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Income
Tax Expense





Income
taxes increased $10,000 for the quarter ended June 30, 2009, as compared to the
same period in 2008. For the six-month period ended June 30, income taxes
increased $121,000.  The effective tax rate was 34.9% and 24.6% for
the six months ended June 30, 2009 and June 30, 2008,
respectively.  The increase in income tax expense and effective tax
rate in 2009 in comparison to 2008, resulted from pretax income for the
six-month period that was higher by $99,000, combined with a reduction of income
earned on tax-exempt investment securities and additional deferred tax expense
recorded in the second quarter of 2009 to increase the valuation allowance
established against deferred tax assets.  The additional expense in
2009 is partially offset by a reduction of the Company’s tax rate from the
statutory rate through the ownership of tax-exempt investment securities, bank
owned life insurance and other tax saving strategies.





Changes
in Financial Condition





Assets





Total
assets decreased approximately $5.5 million, or 1.6%, to $347.2 million at June
30, 2009, from $352.8 million at December 31, 2008.  The decrease in
total assets was primarily the result of a decrease of $4.9 million, or 6.8%, in
investment securities and a $632,000 decrease in Federal Home Loan Bank
stock.  The reduction of the investment securities portfolio was a
result of the sale of municipal securities.





Liabilities





Total
liabilities decreased $6.2 million, or 1.8%, to $327.1 million at June 30, 2009,
from $333.3 million at December 31, 2008.  Deposits increased $11.5
million, or 4.3%, and long-term borrowings increased $1.0
million.  These increases were offset by a reduction in short-term
borrowings of $16.6 million, or 94.3% and a $2 million reduction in other
liabilities as the result of a $2 million contribution to the Company’s pension
plan.  The increase in deposits was the result of an increase of $6.9
million in municipal customer deposits, with the balance coming from increased
retail deposits.  The municipal deposit increase was driven by the
receipt of tax revenues by our municipal customers.  The decrease in
short-term borrowings is a result of management utilizing liquidity generated
from net deposit growth and the sale of approximately $4.5 million in municipal
investment portfolio holdings during the first quarter, to pay down overnight
borrowings and maturing short-term advances.





Loan
and Asset Quality and Allowance for Loan Losses





The
following table represents information concerning the aggregate amount of
nonperforming assets:




June 30,
                    
                    
                    December
      31,(In
      thousands)
                    
                    2009
                    
                    
                    2008Nonaccrual
      loans:Commercial
      real estate and commercial
                    
                    
                    $1,140
                    
                    
                    
                    $1,455Consumer
                    
                    
                    288
                    
                    
                    
                    254Real
      estate - mortgage
                    
                    
                    1,151
                    
                    
                    
                    614Total
      nonaccrual loans
                    
                    
                    2,579
                    
                    
                    
                    2,323Total
      non-performing loans
                    
                    
                    2,579
                    
                    
                    
                    2,323Foreclosed
      real estate
                    
                    
                    251
                    
                    
                    
                    335Total
      non-performing assets
                    
                    
                    $2,830
                    
                    
                    
                    $2,658Non-performing
      loans to total loans
                    
                    
                    1.03
                    %
                    
                    
                    0.93
                    %Non-performing
      assets to total assets
                    
                    
                    0.82
                    %
                    
                    
                    0.75
                    %




Total
nonperforming loans increased 11% at June 30, 2009, when compared to December
31, 2008.  The increase in nonperforming loans was primarily the
result of the deterioration in the delinquency status of residential real estate
loans.  Management believes that the underlying collateral, combined
with the existing allowances provided, are adequate to cover potential losses
that may occur from the remediation process.





The
allowance for loan losses at June 30, 2009 and December 31, 2008 was $2.8
million and $2.5 million, or 1.11% and 0.99% of period end loans,
respectively.








-24-
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Capital





Shareholders'
equity at June 30, 2009, was $20.1 million as compared to $19.5 million at
December 31, 2008.  The Company added $610,000 to retained earnings
through net income.  The increase to retained earnings was combined
with a decrease of $159,000 in accumulated other comprehensive loss, which
decreased to $3.0 million from $3.1 million at December 31, 2008. Net unrealized
holding gains on securities, net of tax, resulted in a decrease in accumulated
other comprehensive loss of $76,000.  In addition, $83,000 of
amortization of retirement plan losses and transition obligation, net of tax
expense, decreased accumulated other comprehensive loss during
2009.  Two dividends were declared during the second quarter of
2009.  In April of 2009 the Board of Directors announced that the
Company had declared a cash dividend of $.03 per share on the Company’s common
stock relating to the quarter ending March 31, 2009.  This dividend
was paid on May 29, 2009.  The second quarter dividend of $.03 per
share was declared and recorded in June 2009.  The current dividend
level represents an approximately 71% reduction as compared to 2008 dividend
levels.  Dividends reduced capital by $150,000.  The Board
of Directors and Management of the company believe it is in the best interest of
the shareholders to conserve capital at this time.





Risk-based
capital provides the basis for which all banks are evaluated in terms of capital
adequacy.  Capital adequacy is evaluated primarily by the use of
ratios which measure capital against total assets, as well as against total
assets that are weighted based on defined risk characteristics.  The
Company’s goal is to maintain a strong capital position, consistent with the
risk profile of its subsidiary banks that supports growth and expansion
activities while at the same time exceeding regulatory standards.  At
June 30, 2009, Pathfinder Bank exceeded all regulatory required minimum capital
ratios and met the regulatory definition of a “well-capitalized” institution,
i.e. a leverage capital ratio exceeding 5%, a Tier 1 risk-based capital ratio
exceeding 6% and a total risk-based capital ratio exceeding 10%.





The board
of directors and management are 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
Company’s capital ratios is both prudent, given the current climate, and
potentially opportunistic as we move into the next business
cycle.  Additionally, any increase to capital will continue to support
the Company’s lending activities to individuals, families, and businesses in our
community.  In November, Pathfinder Bancorp, MHC the mutual holding
company parent of Pathfinder Bancorp, Inc filed its original application
requesting Capital Purchase Program funds under the Treasury’s Troubled Asset
Relief Program.  Management has received a preliminary approval letter
from the Department of the Treasury relating to the Company’s application
request, and is evaluating its potential participation in the
program.





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.  Total credit available under the existing lines is approximately
$72.5 million.  At June 30, 2009, the Company has $36.4 million
outstanding against the existing lines with $36.1 million
available.





The Asset
Liability Management Committee of the Company is responsible for implementing
the policies and guidelines for the maintenance of prudent levels of
liquidity.  As of June 30, 2009, management reported to the Board of
Directors that the Company is in compliance with its liquidity policy
guidelines.








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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.




-26-
 Table of Contents




PART II - OTHER INFORMATION





Item
1 - Legal Proceedings





None





Item
1A – Risk Factors





Although
a smaller reporting company is not required to comply with this item, in
addition to the other information contained this Quarterly Report on Form 10-Q,
the following risk factors represent material updates and additions to the risks
previously disclosed in our filings with the Securities and Exchange Commission.
Additional risks not presently known to us, or that we currently deem
immaterial, may also adversely affect our business, financial condition or
results of operations. Further, to the extent that any of the information
contained in this Quarterly Report on Form 10-Q constitutes forward-looking
statements, the risk factors set forth below also are cautionary
statements identifying important factors that could cause our actual results to
differ materially from those expressed in any forward-looking statements made by
or on behalf of us.




We
Hold Certain Intangible Assets that Could Be Classified as Impaired in The
Future.  If These Assets Are Considered To Be Either Partially or
Fully Impaired in the Future, Our Earnings and the Book Values of These Assets
Would Decrease




Pursuant
to SFAS No. 142, Goodwill and
Other Intangible Assets, we are required to test our goodwill and core
deposit intangible assets for impairment on a periodic basis.  The
impairment testing process considers a variety of factors, including the current
market price of our common shares, the estimated net present value of our assets
and liabilities and information concerning the terminal valuation of similarly
situated insured depository institutions.  If an impairment
determination is made in a future reporting period, our earnings and the book
value of these intangible assets will be reduced by the amount of the
impairment.  If an impairment loss is recorded, it will have little or
no impact on the tangible book value of our common shares or our regulatory
capital levels.




A
Legislative Proposal Has Been Introduced That Would Require Pathfinder Bancorp,
MHC and the Company to Become Bank Holding Companies.




The U.S.
Treasury Department recently released a legislative proposal that would
implement sweeping changes to the current bank regulatory
structure.  The proposal would create a new federal banking regulator,
the National Bank Supervisor, and merge the Office of Thrift Supervision (the
current primary federal regulator of Pathfinder Bancorp, MHC and the Company) as
well as the Office of the Comptroller of the Currency (the primary federal
regulator for national banks) into this new federal bank regulator.




If this
proposal is implemented, Pathfinder Bancorp, MHC and the Company would become
bank holding companies subject to supervision by the Board of Governors of the
Federal Reserve System (the “Federal Reserve”) as opposed to the Office of
Thrift Supervision.  The Federal Reserve has historically looked to
Office of Thrift Supervision regulations in its regulation of mutual holding
companies and processing of mutual holding company applications; however, it is
not obligated to follow such regulations.  One important Office of
Thrift Supervision regulation that the Federal Reserve does not follow relates
to the ability of mutual holding companies to waive the receipt of dividends
declared on the common stock of their stock holding company or savings bank
subsidiaries.  While Office of Thrift Supervision regulations permit
mutual holding companies to waive the receipt of dividends, subject to filing a
notice with the Office of Thrift Supervision and receiving its non-objection,
the Federal Reserve’s current policy is to prohibit mutual holding companies
from waiving the receipt of dividends so long as the subsidiary savings bank is
well capitalized.  Moreover, Office of Thrift Supervision regulations
provide that it will not take into account the amount of waived dividends in
determining an appropriate exchange ratio for minority shares in the event of
the conversion of a mutual holding company to stock form.  If the
Office of Thrift Supervision is eliminated, the Federal Reserve becomes the
exclusive regulator of mutual holding companies, and the Federal Reserve retains
its current policy regarding dividend waivers by mutual holding companies,
Pathfinder Bancorp, MHC would not be permitted to waive the receipt of dividends
declared by the Company. This could have an adverse impact on our ability to pay
dividends and, consequently, the value of our common stock.




Any
Future FDIC Insurance Premiums Will Adversely Impact Our Earnings.




On May
22, 2009, the FDIC adopted a final rule levying a five basis point special
assessment on each insured depository institution's assets minus Tier 1 capital
as of June 30, 2009.  The special assessment is payable on September
30, 2009.  We recorded an expense of $165,000 during the quarter ended
June 30, 2009, to reflect the special assessment.  The final rule
permits the FDIC’s Board of Directors to levy up to two additional special
assessments of up to five basis points each during 2009 if the FDIC estimates
that the Deposit Insurance Fund reserve ratio will fall to a level that the
FDIC’s Board of Directors believes would adversely affect public confidence or
to a level that will be close to or below zero.  The FDIC has publicly
announced that it is probable that it will levy an additional special assessment
of up to five basis points later in 2009, the amount and timing of which are
currently uncertain.  Any further special assessments that the FDIC
levies will be recorded as an expense during the appropriate
period.  In addition, the FDIC materially increased the general
assessment rate and, therefore, our FDIC general insurance premium expense will
increase substantially compared to prior periods.






-27-
 Table of Contents


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





The
Company's Annual Meeting of Shareholders was held on April 29,
2009.  The following are the items voted on and the results of the
shareholder voting:





1.           The
election of Bruce E. Manwaring, L. William Nelson and Lloyd “Buddy” Stemple to
serve as directors of the Company, each for a term of three years, and George P.
Joyce for a term of two years or until his or her successor has been elected and
qualified.





Name                                                  
 For                              Withheld


Bruce E.
Manwaring                                      2,352,827                          81,538


L. William
Nelson                                           2,352,827                          81,538


Lloyd “Buddy”
Stemple                                2,332,977                        101,388


George P.
Joyce                                              2,332,977                        101,388





Set forth below are the names of the
other directors of the Company and their terms of office.





Name                                           Term
Expires


Janette
Resnick                                                    2010


Corte J.
Spencer                                                   2010


Steven W.
Thomas                                              2010


Thomas W.
Schneider               
                         2011


Chris R.
Burritt                             
                        2011





2.           The
ratification of the appointment of Beard Miller Company LLP as auditors for the
Company for the year ending December 31, 2009.




For          
             
Against                    Abstain


Number of
Votes                                2,425,761                         8,255           
           349





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








-28-
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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.








August 14,
2009                                  /s/ Thomas W.
Schneider


Date                                                      Thomas
W. Schneider


President and Chief
Executive Officer





August 14,
2009                                 /s/ James A.
Dowd


Date                                                      James
A. Dowd


Senior Vice President and Chief Financial Officer









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 Table of Contents




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




Certification
      of Chief Executive Officer
                        
                        Pursuant
      to Section 302 of the Sarbanes-Oxley Act of 2002I,
      Thomas W. Schneider, certify that:1.I
      have reviewed this Quarterly Report on Form 10-Q of Pathfinder Bancorp,
      Inc.;2.Based
      on my knowledge, this report does not contain any untrue statement of a
      material fact or omit to state a material fact necessary to make the
      statements made, in light of the circumstances under which such statements
      were made, not misleading with respect to the period covered by this
      report;3.Based
      on my knowledge, the financial statements, and other financial information
      included in this report, fairly present in all material respects the
      financial condition, results of operations and cash flows of the
      registrant as of, and for, the periods presented in this
      report;4.The
      registrant's other certifying officer and I are responsible for
      establishing and maintaining disclosure controls and procedures (as
      defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
      control over financial reporting (as defined in Exchange Act Rules
      13a-15(f) and 15d-15(f)) for the registrant and have:(a)Designed
      such disclosure controls and procedures, or caused such disclosure
      controls and procedures to be designed under our supervision, to ensure
      that material information relating to the registrant, including its
      consolidated subsidiaries, is made known to us by others within those
      entities, particularly during the period in which this report is being
      prepared;
                        (b)Designed
      such internal control over financial reporting, or caused such internal
      control over financial reporting, to be designed under our supervision, to
      provide reasonable assurance regarding the reliability of financial
      reporting and the preparation of financial statements for external
      purposes in accordance with generally accepted accounting
      principles;(c)Evaluated
      the effectiveness of the registrant's disclosure controls and procedures
      and presented in this report our conclusions about the effectiveness of
      the disclosure controls and procedures, as of the end of the period
      covered by this report based on such evaluation; and(d)Disclosed
      in this report any change in the registrant's internal control over
      financial reporting that occurred during the registrant's most recent
      fiscal quarter (the registrant's fourth fiscal quarter in the case of an
      annual report) that has materially affected, or is reasonably likely to
      materially affect, the registrant's internal control over financial
      reporting; and5.The
      registrant's other certifying officer and I have disclosed, based on our
      most recent evaluation of internal control over financial reporting, to
      the registrant's auditors and the audit committee of the registrant's
      board of directors:(a)All
      significant deficiencies and material weaknesses in the design or
      operation of internal control over financial reporting which are
      reasonably likely to adversely affect the registrant's ability to record,
      process, summarize and report financial information;
and(b)Any
      fraud, whether or not material, that involves management or other
      employees who have a significant role in the registrant's internal control
      over financial reporting.August
      14, 2009
                      /s/
      Thomas W. Schneider
                        Thomas
      W. Schneider
                        President
      and Chief Executive Officer







-30-
 Table of Contents




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





Certification
      of Chief Financial Officer
                
                Pursuant
      to Section 302 of the Sarbanes-Oxley Act of 2002I,  James
      A. Dowd, certify that:1.I
      have reviewed this Quarterly Report on Form 10-Q of Pathfinder Bancorp,
      Inc.;2.Based
      on my knowledge, this report does not contain any untrue statement of a
      material fact or omit to state a   material fact necessary
      to make the statements made, in light of the circumstances under which
      such statements were made, not misleading with respect to the period
      covered by this report;3.Based
      on my knowledge, the financial statements, and other financial information
      included in this report, fairly present in all material respects the
      financial condition, results of operations and cash flows of the
      registrant as of, and for, the periods presented in this
      report;4.The
      registrant's other certifying officer and I are responsible for
      establishing and maintaining disclosure controls and procedures (as
      defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
      control over financial reporting (as defined in Exchange Act Rules
      13a-15(f) and 15d-15(f)) for the registrant and have:(a)Designed
      such disclosure controls and procedures, or caused such disclosure
      controls and procedures to be designed under our supervision, to ensure
      that material information relating to the registrant, including its
      consolidated subsidiaries, is made known to us by others within those
      entities, particularly during the period in which this report is being
      prepared;
                (b)Designed
      such internal control over financial reporting, or caused such internal
      control over financial reporting, to be designed under our supervision, to
      provide reasonable assurance regarding the reliability of financial
      reporting and the preparation of financial statements for external
      purposes in accordance with generally accepted accounting
      principles;(c)Evaluated
      the effectiveness of the registrant's disclosure controls and procedures
      and presented in this report our conclusions about the effectiveness of
      the disclosure controls and procedures, as of the end of the period
      covered by this report based on such evaluation; and(d)Disclosed
      in this report any change in the registrant's internal control over
      financial reporting that occurred during the registrant's most recent
      fiscal quarter (the registrant's fourth fiscal quarter in the case of an
      annual report) that has materially affected, or is reasonably likely to
      materially affect, the registrant's internal control over financial
      reporting; and5.The
      registrant's other certifying officer and I have disclosed, based on our
      most recent evaluation of internal control over financial reporting, to
      the registrant's auditors and the audit committee of the registrant's
      board of directors:(a)All
      significant deficiencies and material weaknesses in the design or
      operation of internal control over financial reporting which are
      reasonably likely to adversely affect the registrant's ability to record,
      process, summarize and report financial information;
and(b)Any
      fraud, whether or not material, that involves management or other
      employees who have a significant role in the registrant's internal control
      over financial reporting.August
      14, 2009
              /s/ James A. Dowd
                James
      A. Dowd
                Senior
      Vice President and Chief Financial Officer







-31-
 Table of Contents




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





Certification
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002Thomas
      W. Schneider, President and Chief Executive Officer, and James A. Dowd,
      Senior Vice President and Chief Financial Officer of Pathfinder Bancorp,
      Inc. (the "Company"), each certify in his capacity as an officer of the
      Company that he has reviewed the Quarterly Report of the Company on Form
      10-Q for the quarter ended June 30, 2009 and that to the best of his
      knowledge:1.the
      report fully complies with the requirements of Section 13(a) of the
      Securities Exchange Act of 1934; and2.the
      information contained in the report fairly presents, in all material
      respects, the financial condition and results of operations of the
      Company.The
      purpose of this statement is solely to comply with Title 18, Chapter 63,
      Section 1350 of the United States Code, as amended by Section 906 of the
      Sarbanes-Oxley Act of 2002.August
      14, 2009
                /s/ Thomas W. Schneider
                  Thomas
      W. Schneider
                  President
      and Chief Executive OfficerAugust
      14, 2009
                /s/ James A. Dowd
                  James
      A. Dowd
                  Senior
      Vice President and Chief Financial
Officer





-32-