Pathfinder Bancorp, Inc.: Form 10-Q for the period ended Sep 30, 2024

General

The Company is a Maryland corporation headquartered in Oswego, New York. The Company is 100% owned by public shareholders. The primary business of the Company is its investment in Pathfinder Bank (the "Bank"), a New York State chartered commercial bank, which is 100% owned by the Company. The Bank has two wholly owned operating subsidiaries, Pathfinder Risk Management Company, Inc. (“PRMC”) and Whispering Oaks Development Corp. All significant inter-company accounts and activity have been eliminated in consolidation. Although the Company owned, through its subsidiary PRMC, 51% of the membership interest in FitzGibbons Agency, LLC (“FitzGibbons” or “Agency”), the Company is required to consolidate 100% of FitzGibbons within the consolidated financial statements. The 49% of which the Company does not own, is accounted for separately as a noncontrolling interest within the consolidated financial statements. At September 30, 2024, the Company and subsidiaries had total consolidated assets of $1.48 billion, total consolidated liabilities of $1.36 billion and shareholders' equity of $120.2 million, plus noncontrolling interest of $854,000, which represents the 49% of FitzGibbons not owned by the Company. On October 1, 2024, the Company completed the sale of its interest in FitzGibbons to Marshall & Sterling Enterprises, Inc. Please refer to the “Recent Developments” section below for additional details regarding the sale of FitzGibbons.

The following discussion reviews the Company's financial condition at September 30, 2024 and the results of operations for the three and nine month periods ended September 30, 2024 and 2023. Operating results for the three and nine months ended September 30, 2024 are not necessarily indicative of the results that may be expected for the year ending December 31, 2024 or any other period.

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 included in the 2023 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 22, 2024 (“the consolidated annual financial statements”) as of December 31, 2023 and 2022 and for the two years then ended. Therefore, only material changes in financial condition and results of operations are discussed in the remainder of Item 2.

Statement Regarding Forward-Looking Statements

This report includes forward-looking statements within the meaning of Sections 27A of the Securities Act of 1933, as amended, and 21E of the Securities Exchange Act of 1934, as amended, that involve inherent risks and uncertainties. These forward-looking statements concern the financial condition, results of operations, plans, objectives, future performance and business of Pathfinder Bancorp, Inc. and its subsidiary, including statements preceded by, followed by or that include words or phrases such as “believes,” “expects,” “anticipates,” “plans,” “trend,” “objective,” “continue,” “remain,” “pattern” or similar expressions or future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “can,” “may” or similar expressions. There are a number of important factors that could cause future results to differ materially from historical performance and these forward-looking statements. Factors that might cause such a difference include, but are not limited to: (1) general economic conditions may be less favorable than expected; (2) competitive pressures among depository institutions may increase significantly; (3) changes in the interest rate environment may reduce interest margins; (4) loan origination and sale volumes, charge-offs and credit loss provisions may vary substantially from period to period; (5) the impact of a pandemic or other health crises and the government's

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response to such pandemic or crises on our operations as well as those of our customers and on the economy generally and in our market area specifically; (6) political developments, wars or other hostilities may disrupt or increase volatility in securities markets or other economic conditions; (7) legislative or regulatory changes or actions may adversely affect the businesses in which Pathfinder Bancorp, Inc. is engaged; (8) changes and trends in the securities markets may adversely impact Pathfinder Bancorp, Inc.; (9) difficulties in integrating any businesses that we may acquire, including our recently completed acquisition of the East Syracuse branch of Berkshire Bank, which may increase our expenses and delay the achievement of any benefits that we may expect from such acquisitions; (10) the impact of reputation risk created by the developments discussed above on such matters as business generation and retention, funding and liquidity could be significant; (11) our ability to prevent or mitigate fraudulent activity and cybersecurity threats; and (12) the outcome of any future regulatory and legal investigations and proceedings may not be anticipated.

Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. Except as required by law, we disclaim any obligation to revise or update any forward-looking statements contained in this Quarterly Report on Form 10-Q to reflect future events or developments.

Application of Critical Accounting Estimates

The Company's consolidated quarterly financial statements are prepared in accordance with accounting principles generally accepted in the United States and follow practices within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the consolidated quarterly 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 accounting 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 unaffiliated 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 annual audited 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 quarterly 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 credit losses, deferred income taxes, pension obligations, the evaluation of investment securities for credit losses, the estimation of fair values for accounting and disclosure purposes, and the evaluation of goodwill and intangible assets for impairment to be the accounting areas that require the most subjective and complex judgments. These areas could be the most subject to revision as new information becomes available.

The ACL represents management's estimate of lifetime credit losses inherent in the loan portfolio. Determining the amount of the allowance for credit losses is considered a critical accounting estimate because it requires significant judgment on the use of estimates related to the amount and timing of expected future cash flows on individually evaluated loans, estimated losses on pools of homogeneous loans based on historical loss experience, and environmental factors, all of which may be susceptible to significant change. The Company establishes a specific allowance for all commercial loans in excess of the total related credit threshold of $100,000 and single borrower residential mortgage loans in excess of the total related credit threshold of $300,000 identified as being individually evaluated which are on nonaccrual and have been risk rated under the Company’s risk rating system as substandard, doubtful, or loss. In addition, an accruing substandard loan could be identified as being individually evaluated.

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The measurement of individually evaluated loans is measured by determining the present value of expected future cash flows or, for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expenses as compared to the loan carrying value. For all other loans and leases, the Company uses the general allocation methodology that establishes an allowance to estimate the lifetime incurred loss for each risk-rating category. The measurement of individually evaluated loans is generally based upon the present value of future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans are measured based on the fair value of the collateral, less costs to sell. At September 30, 2024, the Bank’s position in individually evaluated loans consisted of 49 loans totaling $19.6 million. Of these loans, 16 loans, totaling $3.1 million, were valued using the present value of future cash flows method; and 33 loans, totaling $16.5 million, were valued based on a collateral analysis. For all other loans, the Company uses the general allocation methodology that establishes an allowance to estimate the lifetime incurred loss for each risk-rating category.

In estimating the ACL on loans, management considers the sensitivity of the model and significant judgments and assumptions that could result in an amount that is materially different from management’s estimate. At September 30, 2024, the Bank held $534.5 million in commercial real estate and commercial & industrial loans (collectively, commercial loans) representing 57.9% of the Bank’s entire loan portfolio. The Bank allocated $9.8 million to the ACL for these loans, including $3.7 million derived from the use of qualitative factors in the calculation. Given the concentration of ACL allocation to the total commercial loan portfolio and the significant judgments made by management in deriving the qualitative loss factors, management considers the impact that changes in judgments could have on the ACL. The ACL could increase (or decrease) by approximately $936,000, assuming a 25% negative (or positive) change within the group of qualitative factors used to determine the ACL for commercial loans. The sensitivity and related range of impacts for various judgments on the ACL is a hypothetical analysis and is used to determine management’s judgments or assumptions of qualitative loss factors that were utilized at September 30, 2024 in the final recorded estimation of the ACL on loans recognized on the Statements of Financial Condition.

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

The Company’s effective tax rate typically differs from the 21% federal statutory tax rate due primarily to New York State income taxes, partially offset by tax-exempt income from specific types of investment securities and loans, bank owned life insurance, and to a much lesser degree, the utilization of low income housing tax credits. In addition, the tax effects of certain incentive stock option activity may reduce the Company’s effective tax rate on a sporadic basis.

We maintain a noncontributory defined benefit pension plan covering most employees. The plan provides defined benefits based on years of service and final average salary. On May 14, 2012, we informed our employees of our decision to freeze participation and benefit accruals under the plan, primarily to reduce some of the volatility in earnings that can accompany the maintenance of a defined benefit plan. Pension and post-retirement benefit plan liabilities and expenses are based upon actuarial assumptions of future events; including fair value of plan assets, interest rates, and the length of time the Company will have to provide those benefits.

When the fair value of a security categorized as available-for-sale ("AFS") or held-to-maturity ("HTM") is less than its amortized cost basis, an assessment is made as to whether or not credit loss is present. Management makes a quantitative determination of potential credit loss for all HTM securities even if the risk of credit loss is considered remote and uses a best estimate threshold for securities categorized as AFS. The Company considers numerous factors when determining whether a potential credit loss exists. The principal factors considered are (1) the financial condition of the issue and (guarantor, if any) and adverse conditions specifically related to the security, industry or geographic

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area, (2) failure of the issuer of the security to make scheduled interest or principal payments, (3) any changes to the rating of the security by a nationally recognized statistical rating organization (“NRSRO”), and (4) the presence of contractual credit enhancements, if any, including the guarantee of the federal government or any of its agencies.

The Company carries all of its AFS investments at fair value with any unrealized gains or losses reported, net of tax, as an adjustment to shareholders' equity and included in accumulated other comprehensive income (loss), except for the credit-related portion of debt securities’ credit losses securities which are charged to earnings. The Company's ability to fully realize the value of its investments in various securities, including corporate debt securities, is dependent on the underlying creditworthiness of the issuing organization. In evaluating the debt securities portfolio, for both AFS and HTM securities for credit losses, management considers (1) if we intend to sell the security; (2) if it is “more likely than not” we will be required to sell the security before recovery of its amortized cost basis; or (3) if the present value of expected cash flows is insufficient to recover the entire amortized cost basis.

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

Fair values for AFS securities are obtained from unaffiliated third party pricing services. 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 sources. Fair values for marketable equity securities are based on quoted prices on a nationally recognized securities exchange for similar benchmark securities. The fair values of foreclosed real estate and the underlying collateral value of individually evaluated loans are typically determined based on evaluations by third parties, less estimated costs to sell. When necessary, appraisals are updated to reflect changes in market conditions.

Management performs an annual evaluation of our goodwill and intangible assets for possible impairment at each of our reporting units. Based on the results of the December 31, 2023 evaluation, management has determined that the carrying value of goodwill was not impaired as of that date. Management will continuously evaluate all relevant economic and operational factors potentially affecting the Bank or the fair value of its assets, including goodwill. Should future economic consequences require a significant and sustained change in the operations of the Bank, re-evaluations of the Bank’s goodwill valuation will be conducted on a more frequent basis.

Recent Events

On July 19, 2024, the Bank completed the previously announced purchase and assumption of the East Syracuse, NY branch of Berkshire Bank, the banking subsidiary of Berkshire Hills Bancorp, Inc. In connection with the purchase, the Bank assumed $186.0 million in deposit liabilities and acquired $29.9 million in loans. With respect to the purchased loans, the Bank paid an amount equal to the sum of 95% of the aggregate unpaid principal balances, measured as of the closing date, plus any accrued interest related to the loans through the closing date. The Bank also paid a 5.8% premium on the aggregate amount of non-time deposits associated with the branch, measured as of the closing date (the “Core Deposits”), and assumed all non-Core Deposits associated with the branch, measured as of the closing date, at par value. The total deposit premium paid by the Bank therefore equated to approximately 3.8% when applied to the aggregated Core Deposits and non-Core Deposits. The average cost of deposits acquired in the East Syracuse branch acquisition was approximately 1.99% (excluding the effects of future Core Deposit Intangible amortization). The Company utilized the additional liquidity obtained with this acquisition and paid down approximately $150 million of borrowings that had an average cost of approximately 5.33% at June 30, 2024. Finally, the Bank assumed Berkshire Bank’s existing commercial lease for the real property associated with the branch with an annual lease payment of approximately $946,000, excluding property taxes and certain other associated property related obligations that the Bank also assumed, and purchased the personal property and fixtures located within the branch facility for approximately $224,000.

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On September 30, 2024, the Company announced that its Board of Directors declared a cash dividend of $0.10 per share on the Company's voting common and non-voting common stock, and a cash dividend of $0.10 per notional share for the issued warrant relating to the fiscal quarter ended September 30, 2024. The dividends were payable to all shareholders of record on October 18, 2024 and were paid on November 8, 2024.

On October 15, 2024, Pathfinder announced that it sold its interest in the FitzGibbons Agency, which contributed $28,000 to the Company’s net income and 24 basis points to its consolidated efficiency ratio in the third quarter of 2024, to Marshall & Sterling Enterprises, Inc. Reflecting an active insurance brokerage market and the FitzGibbons Agency’s success since initiating its partnership with the Bank 13 years ago, Pathfinder will receive approximately $2.0 million from the sale, which closed on October 1, 2024, and the Company expects to recognize a portion of that amount as a net gain in the fourth quarter of 2024.

Summary of 2024 Third Quarter Results

Net income decreased $6.8 million to a net loss attributable to common shareholders of $4.6 million or $0.75 per share for the third quarter of 2024, compared to net income available to common shareholders of $2.2 million or $0.35 per share for the third quarter of 2023. Third quarter 2024 results included a $9.0 million provision for credit losses due to $8.7 million of net charge offs resulting from a comprehensive loan portfolio review and $1.6 million in transaction-related expenses for the previously announced July 2024 closing of the East Syracuse branch acquisition.

Net interest income for the third quarter of 2024 was $11.7 million, an increase of 16.6% from the third quarter of 2023. An increase in interest and dividend income of $3.5 million was primarily attributed to increases in interest income from loans, taxable investment securities, and federal funds sold and interest-earning deposits of $2.0 million, $1.2 million, and $426,000, respectively. The increase in loan interest income included an $887,000 catch-up interest payment associated with purchased loan pool positions. Increased interest and dividend income was partially offset by an increase in interest expense of $1.9 million. This increase in interest expense was predominantly the result of higher average interest rates and average balances associated with deposits and borrowings, compared to the third quarter of 2023.

Net interest margin was 3.34% in the third quarter of 2024 compared to 3.07% in the third quarter of 2023. The increase of 27 basis points was driven by improvements in interest-earning asset yields, including 25 basis points attributed to the catch-up interest payment received in the third quarter of 2024, partially offset by higher funding costs.

The provision for credit losses was $9.0 million in the third quarter of 2024 compared to a provision for credit losses of $0.8 million in the third quarter of 2023. The provision for credit losses for the third quarter of 2024 was primarily driven by a comprehensive loan portfolio review that the Bank undertook in the third quarter of 2024. Net charge-offs during the recent quarter were $8.7 million, representing 1.29% of average loans on an annualized basis, compared to $3.8 million, or an annualized 0.61% of average loans, in the third quarter of 2023. See the “Provision for Credit Losses” and “Loan and Asset Quality and Allowance for Credit Losses” sections of this Management’s Discussion and Analysis for further discussion.

Noninterest income totaled $1.7 million in the third quarter of 2024, an increase of $514,000 or 43.1% from the third quarter of 2023. The increase in noninterest income for the third quarter of 2024 included increases of $278,000 in interchange fees, $196,000 in earnings and gain on bank owned life insurance ("BOLI") including a net death benefit of $175,000 on BOLI, and $49,000 in service charges on deposit accounts.

Noninterest expense totaled $10.3 million in the third quarter of 2024, increasing $2.6 million from the third quarter of 2023. The increase was primarily due to $1.6 million in transaction-related expenses for the East Syracuse branch acquisition, in addition to third quarter 2024 operating costs of approximately $462,000 associated with operating Pathfinder Bank’s newest location.

For the third quarter of 2024, annualized noninterest expense represented 2.75% of average assets, including 43 basis points from acquisition-related expenses. The efficiency ratio was 75.28%, 1,186 basis points attributed to acquisition-related expenses. The efficiency ratio, which is not a financial metric under GAAP, is a measure that the Company believes is helpful to understanding its level of non-interest expense as a percentage of total revenue. Annualized

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noninterest expense represented 2.20% of average assets and the efficiency ratio was 67.93% in the third quarter of 2023.

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Results of Operations

Net Interest Income

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

The following tables set forth information concerning average interest-earning assets and interest-bearing liabilities and the average yields and rates thereon for the periods indicated. Interest income and resultant yield information in the tables have not been adjusted for tax equivalency. Averages are computed on the daily average balance for each month in the period divided by the number of days in the period. Nonaccrual loans have been included in interest-earning assets for purposes of these calculations.

(Unaudited)

Unaudited

(In thousands)

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Unaudited

(In thousands)

Third quarter 2024 net interest income was $11.7 million, an increase of 16.6% from the third quarter of 2023. An increase in interest and dividend income of $3.5 million was primarily attributed to average yield increases of 74 basis points on loans including 39 basis points from an $887,000 catch-up interest payment associated with purchased loan pool positions, 67 basis points on taxable investment securities, 227 basis points on fed funds sold and interest-earning deposits, and 65 basis points on all earning assets. The corresponding increase in interest income from loans, taxable investment securities, and federal funds sold and interest-earning deposits was $2.0 million, $1.2 million, and $426,000, respectively. Increased interest and dividend income was partially offset by an increase in interest expense of $1.9 million. This increase in interest expense was predominantly the result of higher interest average interest rates and average balances associated with deposits and borrowings, compared to the third quarter of 2023.

Net interest margin was 3.34% in the third quarter of 2024 compared to 3.07% in the third quarter of 2023. The increase of 27 basis points was driven by improvements in earning asset yields and lower average borrowings, partially offset by higher funding costs, as well as 25 basis points attributed to the catch-up interest payment received in the third quarter of 2024.

Net interest income before the provision for credit losses increased $852,000, or 2.9%, to $30.6 million for the nine months ended September 30, 2024, as compared to the same nine month period in 2023. This increase was due to a $9.5 million increase in total interest and dividend income, primarily attributed to average yield increases of 65 basis points on loans, 88 basis points on taxable investment securities, 49 basis points on tax-exempt investment securities, 214 basis points on fed funds sold and interest-earning deposits, and 70 basis points on all interest-earning assets as a result of the higher interest rate environment. The corresponding increase in interest income from taxable investment securities, loans, federal funds sold and interest-earning deposits, and tax-exempt investment securities was $4.7

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million, $4.3 million, $485,000, and $34,000, respectively. Increased interest and dividend income was partially offset by an increase in interest expense of $8.6 million. This increase in interest expense was predominantly the result of higher average interest rates and average balances associated with deposits and borrowings, compared to the same period in 2023.

Net interest margin was 2.97% for the nine months ended September 30, 2024 compared to 3.02% for the nine months ended September 30, 2023. The decrease of 5 basis points was driven primarily by a greater increase in funding costs for the nine months ended September 30, 2024 as compared to the same nine month period in 2023.

Rate/Volume Analysis

Net interest income can also be analyzed in terms of the impact of changing interest rates on interest-earning assets and interest-bearing liabilities and changes in the volume or amount of these assets and liabilities. The following table represents the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Company’s interest income and interest expense during the periods indicated. Information is provided in each category with respect to: (i) changes attributable to changes in volume (change in volume multiplied by prior rate); (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) total increase or decrease. Changes attributable to both rate and volume have been allocated ratably. Tax-exempt securities have not been adjusted for tax equivalency.

Unaudited

(In thousands)

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Deposits

The Company’s deposit base is drawn from eleven full-service branches and one motor bank in its market area. The deposit base consists of demand deposits, money management and money market deposit accounts, savings, and time deposits. Total deposits increased by $76.1 million, or 6.8% from December 31, 2023. The increase in deposits during the nine months ended September 30, 2024 was primarily due to $186.0 million in deposits assumed with the East Syracuse branch acquisition, offset by a reduction of $106.0 million in brokered deposits utilizing lower-cost liquidity provided by the transaction, as well as seasonal fluctuations in municipal deposits. At September 30, 2024, 77.45% of the Company's deposit base of $1.20 billion consisted of core deposits. Core deposits, which exclude certificates of deposit of $250,000 or more, are considered to be more stable and generally provide the Company with a lower cost of funds than time deposits. The Company will continue to emphasize retail and business core deposits in the future by providing depositors with a full range of deposit product offerings and will maintain its recent focus on deposit gathering within the Syracuse market.

A summary of deposits by category at September 30, 2024 and December 31, 2023 is as follows:

(In thousands)

In addition to deposits obtained from its business operations within its target market areas, the Bank also obtains brokered deposits through various programs administered by IntraFi Network and through other unaffiliated third-party financial institutions.

The following table sets forth our nonbrokered and brokered deposit activities at the dates indicated:

(In thousands)

Provision for Credit Losses

We establish a provision for credit losses, which is charged to operations, at a level management believes is appropriate to absorb lifetime credit losses in the loan portfolio. In evaluating the level of the allowance for credit losses, management considers historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as future events change. The provision for credit losses

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represents management’s estimate of the amount necessary to maintain the allowance for credit losses at an adequate level.

The Company recorded $9.0 million in provision for credit losses for the three month period ended September 30, 2024, as compared to $833,000 for the three month period ended September 30, 2023. The provisioning in the third quarter of 2024 and 2023 reflects management’s determination of the appropriate level of additions to reserves, the composition of the loan portfolio, changes in quantifiable econometric data statistically correlated to historical charge-off rates, subjective qualitative assessments of changes in a broad array of factors including changes to underwriting criteria, loan staffing and local market conditions. This represents an $8.1 million increase in provision for credit losses in the third quarter of 2024, as compared to the same period in 2023. This increase can be primarily attributed to a comprehensive loan portfolio review that the Bank elected to undertake as part of its commitment to continuously improve its credit risk management approach. Following its conclusion, the Company recorded net charge offs of $8.7 million in the quarter and reduced nonperforming loans by 34.0% to $16.2 million at period end, or 1.8% of total loans. The allowance for credit losses on September 30, 2024 represented 1.87% and 106.8% of total and nonperforming loans, respectively.

The third quarter 2024 provision for credit losses included an increase in certain qualitative and other factors that resulted in a net increase in the provision for loans of $369,000, offset by a decrease in specific reserves of approximately $13,000. The Bank's credit sensitive portfolios continue to be carefully monitored, and the Bank will consistently apply its loan classification and reserve building methodologies to the analysis of these portfolios. Please refer to the asset quality section below for a further discussion of asset quality as it relates to the allowance for credit losses.

There was an increase in the provision for credit losses in the first nine months of 2024 to $10.0 million, an increase of $7.3 million from $2.7 million for the same nine months in 2023. This increase can also be primarily attributed to the aforementioned net charge offs of $8.7 million during the third quarter that the Bank undertook after a comprehensive loan portfolio review.

The Company measures delinquency based on the amount of past due loans (defined as loans equal to or greater than 30 days past due) as a percentage of total loans. The ratio of delinquent loans to total loans was 4.1% and 3.8% at September 30, 2024 and December 31, 2023, respectively. Delinquent loans (numerator) increased $3.9 million from December 31, 2023 to September 30, 2024. Total loan balances (denominator) increased $25.5 million from December 31, 2023 to September 30, 2024. The increase from December 31, 2023 to September 30, 2024 was driven by an increase of $1.3 million and $3.7 million in loans delinquent 30-59 days and 60-89 days, respectively, slightly offset by a decrease in loans delinquent 90 days and over of $1.1 million.

The Bank continues to diligently monitor credit portfolios, particularly those considered sensitive to prevailing economic stressors, and apply conservative loan classification and reserve building methodologies.

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Noninterest Income

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

The following table sets forth certain information on noninterest income for the periods indicated:

Unaudited

(In thousands)

Noninterest income totaled $1.7 million in the third quarter of 2024, an increase of $514,000 or 43.1% from the third quarter of 2023. The increase in noninterest income for the third quarter of 2024 included increases of $278,000 in interchange volume and rate improvement, $196,000 in earnings and gain on BOLI including a net death benefit of $175,000 on BOLI, and $49,000 in service charges on deposit accounts. Noninterest income growth from the year-ago quarter also reflected increases of $101,000 in net realized gains on sales of marketable equity securities and $49,000 in gains on sales of loans and foreclosed real estate, partially offset by a $175,000 increase in net realized losses on sales and redemptions of investment securities.

Noninterest income totaled $4.7 million in the first nine months of 2024, an increase of $783,000 or 20.2% from the first nine months of 2023. The increase in noninterest income for the first nine months of 2024 included a non-recurring gain of $245,000 related to refunds received from cumulative lessor related pass-through operating expense charges for a single leased branch location. Noninterest income growth during the first nine months of 2024 compared to the same prior year period also reflected a $239,000 gain on marketable equity securities, $219,000 in earnings and gain on BOLI, a $155,000 increase in interchange fees, a $118,000 increase in service charges on deposit accounts, a $41,000 increase in loan servicing fees, and a $23,000 increase in insurance agency revenue, partially offset by a $380,000 increase in net realized losses on sales and redemptions of investment securities. Total noninterest income had an aggregate gain of $123,000 in all other categories.

Third quarter 2024 results reflect the Bank’s strategy to proactively seek out and capitalize on new opportunities to diversify and enhance recurring noninterest income’s contribution to total revenue. As the Bank moves forward with its growth strategy, noninterest income is anticipated to play an increasingly vital role in maintaining a well-balanced and resilient financial profile.

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Noninterest Expense

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

Unaudited

(In thousands)

Noninterest expense totaled $10.3 million in the third quarter of 2024, increasing $2.6 million from the year-ago quarter. The increase was primarily due to $1.6 million in transaction-related expenses for the East Syracuse branch acquisition, in addition to third quarter 2024 operating costs of approximately $462,000 associated with operating Pathfinder Bank’s newest location.

Professional and other services expense was $1.8 million in the third quarter, increasing $1.3 million from the year-ago quarter. The increase was primarily attributed to branch acquisition-related expenses.

Salaries and benefits were $5.0 million in the third quarter of 2024, increasing $805,000 from the year-ago quarter. The increase was primarily due to $141,000 transaction-related bonuses to employees, $115,000 reduced salary cost deferrals (“ASC 310-20”) associated with reduced lending volumes, and $80,000 of ongoing personnel-related costs associated with operating the branch acquired early in the third quarter of 2024. The remaining increase was primarily driven by higher salaries and benefits costs associated with merit increases and wage inflation.

Building and occupancy was $1.1 million in the third quarter of 2024, increasing $266,000 from the year-ago quarter. These increases were mostly due to ongoing facilities-related costs of approximately $322,000 associated with operating the branch acquired early in the third quarter of 2024.

Noninterest expense in the nine months ended September 30, 2024 was $25.9 million, an increase of $3.5 million, or 15.8%, when compared to the nine months ended September 30, 2023. The increase was primarily due to $1.6 million in transaction-related expenses for the East Syracuse branch acquisition, in addition to third quarter 2024 operating costs of approximately $462,000 associated with operating Pathfinder Bank’s newest location.

Professional and other services expense was $3.1 million during the first nine months of 2024, increasing $1.5 million from the year-ago period. Salaries and benefits were $13.7 million in the nine months ended September 30, 2024, increasing $1.4 million, or 11.8%, when compared to the nine months ended September 30, 2023. Building and occupancy was $2.9 million during the first nine months of 2024, increasing $165,000 from the year-ago period. These increases were all primarily attributed to the aforementioned branch acquisition-related expenses.

Income Tax Expense (Benefit)

Income tax expense decreased $1.7 million to a $1.2 million benefit, with an effective tax rate of 20.3%, for the quarter ended September 30, 2024, as compared to $573,000 in expense with an effective tax rate of 20.7% for the same three month period in 2023. The decrease in income tax expense for the quarter ended September 30, 2024, as compared to the same quarter in 2023, was primarily driven by the current quarter net loss. The effective income tax rate decreased 0.4% to 20.3% for the three months ended September 30, 2024 as compared to 20.7% for the same three month period

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in 2023. The decrease in the tax rate in the third quarter of 2024, as compared to the same quarter in 2023, was primarily related to fluctuations in permanent tax differences.

Income tax expense decreased $1.9 million to a $160,000 benefit, with an effective tax rate of 27.1%, for the nine months ended September 30, 2024, as compared to $1.8 million in expense with an effective tax rate of 20.6%, for the same nine month period in 2023. The decrease in income tax expense for the nine months ended September 30, 2024, as compared to the same nine month period in 2023, was primarily driven by the year-over-year decrease in income before taxes coupled with increases in permanent tax differences. The effective income tax rate increased 6.5% to 27.1% for the nine months ended September 30, 2024 as compared to 20.6% for the same nine month period in 2023. The increase in the tax rate in the nine months ended September 30, 2024, as compared to the same period in 2023, was primarily related to fluctuations in permanent tax differences.

The Company’s tax liability is a function of the 21% statutory federal tax rate, the level of pretax income, the varying effects of New York State income taxes, and is partially reduced by tax-exempt income from specific types of investment securities and loans, bank owned life insurance, and, to a much lesser degree, the utilization of historic and low income housing tax credits. In addition, the tax effects of certain incentive stock option activity may reduce the Company’s effective tax rate on a sporadic basis.

Earnings per Share

Basic and diluted earnings per Voting and Series A Non-Voting share were $(0.75) per share for the third quarter of 2024, as compared to $0.35 for the same prior year period. The decrease in earnings per share between these two periods was due to the decrease in net income.

Basic and diluted earnings per Voting and Series A Non-Voting share were $(0.09) for the nine month period ended September 30, 2024, as compared to $1.10 for the same prior year period. The decrease in earnings per share between these two periods was due to the decrease in net income. Further information on earnings per share can be found in Note 3 of the unaudited consolidated financial statements of this Form 10-Q.

Changes in Financial Condition

Assets

Total assets increased $17.3 million, or 1.18%, to $1.48 billion at September 30, 2024 as compared to December 31, 2023. This increase was due primarily to increases in total loans, finance lease right-of-use assets, and intangible assets, net. These increases were partially offset by decreases in total cash and cash equivalents and investment securities.

Loans totaled $921.7 million at September 30, 2024, an increase of $24.5 million, or 2.73%, compared to $897.2 million at December 31, 2023. This increase was driven by $29.9 million in loans acquired from Berkshire Bank and represented increases of $14.8 million in total consumer loans, $10.3 million in total commercial loans, and $353,000 in total residential mortgage loans.

Finance lease right-of-use assets totaled $16.9 million at September 30, 2024, an increase of $12.8 million, which can be attributed to the acquisition of the East Syracuse branch on July 19, 2024. Intangible assets, net, totaled $6.2 million, an increase of $6.1 million, primarily due to the core deposit intangible created through our branch acquisition, also as a result of the purchase of the East Syracuse branch during the third quarter of 2024.

Total cash and cash equivalents totaled $35.3 million at September 30, 2024, a decrease of $13.4 million, or 27.5%, compared to $48.7 million at December 31, 2023. This decline was due to a decrease of $20.0 million in interest-earning deposits, partially offset by an increase in cash and due from banks of $6.6 million.

Investment securities, including investment in FHLBNY stock, decreased by $7.3 million, or 1.63%, to $442.6 million at September 30, 2024. This decrease was due to decreases in HTM securities and FHLBNY stock of $17.9 million and $3.3 million, respectively. The total decrease in investment securities was partially offset by increases in AFS securities and marketable equity securities of $13.3 million and $666,000, respectively

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Liabilities

Total liabilities increased $16.5 million, or 1.23%, to $1.36 billion at September 30, 2024 as compared to $1.35 billion at December 31, 2023. The overall increase was due primarily to increases in total deposits and finance lease liabilities, partially offset by a decrease in total short and long-term borrowings.

Total deposits increased $76.1 million, or 6.80%, from $1.12 billion at December 31, 2023 to $1.20 billion at September 30, 2024. This increase was due to a $39.9 million increase in noninterest-bearing deposits, as well as a $36.2 million increase in interest-bearing deposits. Finance lease liabilities totaled $16.8 million at September 30, 2024, an increase of $12.5 million from December 31, 2023. Increases in total deposits of $186.0 million and finance lease liabilities of $13.0 million can both be attributed to the acquisition of the East Syracuse branch during the third quarter of 2024.

Short-term borrowed funds from FHLBNY decreased $65.4 million, or 52.0%, to $60.3 million at September 30, 2024, while long-term borrowed funds from FHLBNY decreased $10.2 million, or 20.3%, to $39.8 million at September 30, 2024. Both decreases in short-term and long-term borrowed funds are due to the Company utilizing a portion of the low-cost liquidity provided by the acquisition of the East Syracuse branch to pay down these borrowings during the third quarter of 2024.

Shareholders’ Equity

Shareholders' equity increased by $751,000, or 0.6%, from $119.5 million at December 31, 2023, to $120.2 million at September 30, 2024. This increase was primarily due to a $2.9 million decrease in accumulated other comprehensive loss, as well as increases of $135,000 and $117,000 in unearned ESOP shares and additional paid-in-capital, respectively, reduced by a decrease of $2.4 million in retained earnings.

Capital

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 banking operations. This strong capital position serves to support growth and expansion activities while at the same time exceeding regulatory standards. At September 30, 2024, the Bank 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 8%, Tier 1 common equity exceeding 6.5%, and a total risk-based capital ratio exceeding 10%.

In addition to establishing the minimum regulatory capital requirements, the regulations limit capital distributions and certain discretionary bonus payments to management if the institution does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets above the amount necessary to meet its minimum risk-based capital requirements. The buffer is separate from the capital ratios required under the Prompt Corrective Actions (“PCA”) standards. In order to avoid these restrictions, the capital conservation buffer effectively increases the minimum levels of the following capital to risk-weighted assets ratios: (1) Core Capital, (2) Total Capital and (3) Common Equity. At September 30, 2024, the Bank exceeded all regulatory required minimum capital ratios, including the capital buffer requirements.

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Pathfinder Bank’s capital amounts and ratios as of the indicated dates are presented in the following table:

(In thousands)

Non-GAAP Financial Measures

Regulation G, a rule adopted by the Securities and Exchange Commission (SEC), applies to certain SEC filings, including earnings releases, made by registered companies that contain “non-GAAP financial measures.” GAAP is generally accepted accounting principles in the United States of America. Under Regulation G, companies making public disclosures containing non-GAAP financial measures must also disclose, along with each non-GAAP financial measure, certain additional information, including a reconciliation of the non-GAAP financial measure to the closest comparable GAAP financial measure (if a comparable GAAP measure exists) and a statement of the Company’s reasons for utilizing the non-GAAP financial measure as part of its financial disclosures. The SEC has exempted from the definition of “non-GAAP financial measures” certain commonly used financial measures that are not based on GAAP. When these exempted measures are included in public disclosures, supplemental information is not required. Financial institutions like the Company and its subsidiary bank are subject to an array of bank regulatory capital measures that are financial in nature but are not based on GAAP. The Company follows industry practice in disclosing its financial condition under these various regulatory capital measures, including period-end regulatory capital ratios for its subsidiary bank, in its periodic reports filed with the SEC. The Company provides, below, an explanation of the calculations, as supplemental information, for non-GAAP measures included in the consolidated annual financial statements. In addition, the Company provides a reconciliation of its subsidiary bank’s disclosed regulatory capital measures, below.

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(In thousands)

Loan and Asset Quality and Allowance for Credit Losses

The following table represents information concerning the aggregate amount of non-accrual loans at the indicated dates:

(In thousands)

Nonperforming assets include nonaccrual loans and foreclosed real estate (‘‘FRE”).

As indicated in the table above, nonperforming assets at September 30, 2024 were $16.2 million, and were $1.2 million lower than the $17.4 million reported at December 31, 2023 and $192,000 lower than the $16.4 million reported at September 30, 2023. The decrease in the nonperforming loans at September 30, 2024, as compared to December 31, 2023, was driven by charge-offs for loans in two consumer loan pools with a balance of $2.2 million, as well as the downgrade of one commercial real estate loan with a balance of $1.4 million.

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Fair values for commercial FRE are initially recorded based on market value evaluations by third parties, less costs to sell (“initial cost basis”). On a prospective basis, residential FRE assets will be initially recorded at the lower of the net amount of loan receivable or the real estate’s fair value less costs to sell. Any write-downs required when the related loan receivable is exchanged for the underlying real estate collateral at the time of transfer to FRE are charged to the allowance for credit losses. Values are derived from appraisals of underlying collateral or discounted cash flow analysis. Subsequent to foreclosure, valuations are updated periodically and assets are marked to current fair value, not to exceed the initial cost basis for the FRE property.

The allowance for credit losses on loans represents management’s estimate of the lifetime losses inherent in the loan portfolio as of the date of the statement of condition. The allowance for credit losses was $17.3 million and $16.0 million at September 30, 2024 and December 31, 2023, respectively. The ratio of the allowance for credit losses to total loans was 1.87% as of September 30, 2024, as compared to 1.78% at December 31, 2023 and 1.76% at September 30, 2023. Management performs a quarterly evaluation of the allowance for credit losses based on quantitative and qualitative factors and has determined that the current level of the allowance for credit losses is adequate to absorb the losses in the loan portfolio as of September 30, 2024.

Loans purchased outside of the Bank’s general market area are subject to substantial pre-purchase due diligence. Homogenous pools of purchased loans are subject to pre-purchase analyses led by a team of the Bank’s senior executives and credit analysts. In each case, the Bank’s analytical processes consider the types of loans being evaluated, the underwriting criteria employed by the originating entity, the historical performance of such loans, especially in the most recent deeply recessionary period, the offered collateral enhancements and other credit loss mitigation factors offered by the seller and the capabilities and financial stability of the servicing entities involved. From a credit risk perspective, these loan pools also benefit from broad diversification, including wide geographic dispersion, the readily-verifiable historical performance of similar loans issued by the originators, as well as the overall experience and skill of the underwriters and servicing entities involved as counterparties to the Bank in these transactions. The performance of all purchased loan pools are monitored regularly from detailed reports and remittance reconciliations provided at least monthly by the external servicing entities.

The projected credit losses related to purchased loan pools are evaluated prior to purchase and the performance of those loans against expectations are analyzed at least monthly. Over the life of the purchased loan pools, the allowance for credit losses is adjusted, through the provision for credit losses, for expected loss experience, over the projected life of the loans. The expected credit loss experience is determined at the time of purchase and is modified, to the extent necessary, during the life of the purchased loan pools. The Bank does not initially increase the allowance for credit losses on the purchase date of the loan pools.

At September 30, 2024 and December 31, 2023, the Company had $19.6 million and $22.6 million in loans, respectively, which were individually analyzed, having established specific reserves of $2.4 million and $3.7 million, respectively, on these loans. The $3.0 million decrease in specifically identified loans between these two dates was the result of a single relationship charge-off.

Appraisals are obtained at the time a real estate secured loan is originated. For commercial real estate held as collateral, the property is inspected every two years.

Management has identified certain loans with potential credit profiles that may result in the borrowers not being able to comply with the current loan repayment terms and which may result in possible future identified loan reporting. Potential problem loans totaled $37.0 million at September 30, 2024, a decrease of $6.1 million, as compared to $43.1 million at December 31, 2023. These loans have been internally classified as special mention, substandard, or doubtful, yet are not currently considered specifically-identified.

In the normal course of business, the Bank has, from time to time, sold residential mortgage loans and participation interests in commercial loans. As is typical in the industry, the Bank makes certain representations and warranties to the buyer. Pathfinder Bank maintains a quality control program for closed loans and considers the risks and uncertainties associated with potential repurchase requirements to be minimal.

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The future performance of the Company’s loan portfolios with respect to credit losses will be highly dependent upon the course and duration, both nationally and within the Company’s market area, of the concentrations in the Company’s loan portfolio. Concentrations of loans within a portfolio that are made to a single borrower, to a related group of borrowers, or to a limited number of industries, are generally considered to be additional risk factors in estimating future credit losses. Therefore, the Company monitors all of its credit relationships to ensure that the total loan amounts extended to one borrower, or to a related group of borrowers, does not exceed the maximum permissible levels defined by applicable regulation or the Company’s generally more restrictive internal policy limits.

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 composition and 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 ability to borrow from the Federal Home Loan Bank of New York (“FHLBNY”), whose competitive advance programs and lines of credit provide the Company with a safe, reliable, and convenient source of funds. A significant decrease in deposits in the future could result in the Company having to seek other sources of funds for liquidity purposes. Such sources could include, but are not limited to, additional borrowings, 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 and/or losses on the sale of securities or loans.

Through the first nine months of 2024, as indicated in the consolidated statement of cash flows, the Company reported net cash flow from operating activities of $13.9 million and net cash outflows of $26.1 million related to investing activities. The net cash outflows from investing activities was generated principally by an increase of $33.3 million in net loan activity, a $6.3 million increase in gross core deposit intangibles, and a $1.6 million increase in premises and equipment, offset by a $12.0 million decrease in net investment activity, and an increase of $3.0 million in proceeds received from the sale of assets-held-for-sale. The Company reported net cash outflows from financing activities of $1.1 million, primarily due to a $76.1 million increase in net deposit balances from the acquisition of the East Syracuse branch, a $75.5 million decrease in borrowings, and an aggregate decrease of $1.7 million in net cash from all other financing sources, including dividends paid to common voting and non-voting shareholders and warrants of $1.8 million.

The Bank’s management monitors liquidity on a continuous basis through a broad range of internal programs and considers effective liquidity management to be one of its primary objectives. At September 30, 2024 the Bank had deposits of $1.20 billion, of which a portion were nominally uninsured, as they were above the insurance limits established by the Federal Deposit Insurance Corporation (“FDIC”) on that date. Of the nominally uninsured deposits at September 30, 2024, $76.1 million were insured through a long-standing reciprocal deposit program managed by a third-party entity. In addition, $110.5 million in municipal deposits are fully protected against principal loss by a collateral program whereby the Bank places high-quality securities with an independent custodian as collateral. The Bank had $146.9 million in deposits, representing 12.3% of all deposits, that were considered to be uninsured at September 30, 2024.

The Company has a number of existing credit facilities available to it. At September 30, 2024, total credit available under the existing lines of credit was approximately $232.7 million at FHLBNY, the Federal Reserve Bank, and two other correspondent banks. At September 30, 2024, the Company had $100.1 million of the available lines of credit utilized on its existing lines of credit with the remainder of $132.6 million available.

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The Asset Liability Management Committee of the Company is responsible for implementing the policies and guidelines for the maintenance of prudent levels of liquidity. As of September 30, 2024, management reported to the Board of Directors that the Company is in compliance with its liquidity policy guidelines.

Off-Balance Sheet Arrangements

The Company is also a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. At September 30, 2024, the Company had $222.3 million in outstanding commitments to extend credit and standby letters of credit.

The Company's exposure to credit loss in the event of nonperformance related to off-balance sheet arrangements is proportional to the contractual amount of those instruments. Such financial instruments are recorded when they are funded. The Company records an allowance for credit losses on off-balance sheet credit exposures, unless such commitments are unconditionally cancelable, through the provision for credit losses expense. The allowance for credit losses on off-balance sheet credit exposures as of September 30, 2024 was $556,000 and is included in other liabilities on the Company's consolidated Statements of Condition.

Under the supervision and with the participation of our Chief Executive Officer (“CEO”) and our Chief Financial Officer (“CFO”) (the Company’s principal executive officer and principal financial officer), management conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of September 30, 2024. The term “disclosure controls and procedures,” under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Based on the evaluation of our disclosure controls and procedures as of September 30, 2024, our CEO and CFO concluded that our disclosure controls and procedures were effective as of that date.

We did not make any changes in internal control over financial reporting during the quarter ended September 30, 2024 that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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