Pathfinder Bancorp, Inc. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Comparisons are to the corresponding 2015 periods, except balance-sheet comparisons, which are to December 31, 2015. Amounts are in U.S. dollars.
Business context and financial results
Pathfinder is a bank holding company whose principal business is its investment in Pathfinder Bank. The bank completed the combination of Pathfinder Bank and Pathfinder Commercial Bank on May 31, 2016, operating as a single New York State-chartered commercial bank. Management expects some annual cost savings, with little effect on investments or operations.
- Q2 earnings: Net income attributable to Pathfinder was $832,000 available to common shareholders, up 25.9% from $661,000. Basic and diluted EPS were both $0.20, versus $0.16. Return on average assets was 0.50%, up 4 basis points.
- First-half earnings: Net income available to common shareholders was $1.477 million, up 27.6% from $1.158 million. Basic EPS was $0.36 and diluted EPS $0.35, compared with $0.28 for both measures in 2015. Return on average assets was 0.45%, up 4 basis points.
- Net interest income and margin: Q2 net interest income rose 6.7% to $4.993 million; first-half net interest income rose 7.1% to $9.833 million. Net interest margin declined to 3.16%, from 3.33% in Q2 2015 and 3.31% in the first half of 2015. Growth in average interest-earning assets more than offset margin compression.
- Other income and expenses: Q2 noninterest income increased 7.8% to $1.026 million, including $132,000 in securities gains. First-half noninterest income rose 11.6% to $2.027 million. Noninterest expense increased 12.9% in Q2 to $4.778 million and 12.1% for the first half to $9.481 million, reflecting higher staffing and benefits, data processing, advertising and other costs.
- Credit costs: Provision for loan losses was $150,000 in Q2 versus $401,000, and $360,000 for the first half versus $784,000. Management attributed the reductions primarily to improved credit quality.
Financial condition, cash flow and liquidity
- Assets and lending: Total assets were $671.0 million, up 7.7% from year-end. Gross loans were $450.6 million, up 4.7%; commercial and industrial loans, commercial real estate and first-lien residential mortgages were key growth areas. Investment securities totaled $158.5 million, up 10.7%.
- Funding and debt: Deposits were $526.1 million, up 7.3%, with growth in consumer, business and municipal accounts. Short-term borrowings were $50.0 million, long-term borrowings $13.5 million, and subordinated loans $15.0 million. The subordinated borrowing balance includes a $10.0 million loan issued in October 2015.
- Cash flow, first half: Operating activities provided $3.3 million; investing activities used $37.3 million; financing activities provided $43.9 million. Cash and cash equivalents rose $9.9 million to $25.1 million. Loan growth used $20.5 million of cash; net deposit and short-term borrowing increases contributed to financing cash flow.
- Liquidity: The company reported $160.8 million of available credit facilities and $63.5 million outstanding, leaving $97.3 million available at June 30. It also entered into a $26.0 million standby letter of credit arrangement with the FHLB to help collateralize public deposits; pledged loans reduce available borrowing capacity.
- Capital: The Bank reported a 9.67% Tier 1 leverage ratio, 14.62% Tier 1 risk-based and common equity ratios, and 15.89% total core capital to risk-weighted assets. Management said the Bank exceeded current and projected regulatory minimums, including the fully phased-in capital conservation buffer.
- Equity and dividends: Total equity was $60.1 million, including $59.7 million attributable to Pathfinder. Pathfinder’s equity declined from $70.8 million at year-end, principally due to redeeming $13.0 million of SBLF preferred stock. The company declared common dividends of $0.10 per share in the first half and announced a further $0.05 quarterly dividend payable in August.
Material changes and unusual items
- The company redeemed all $13.0 million of SBLF preferred stock on February 16, 2016. The redemption reduced future preferred dividends; management estimated annual savings of $1.2 million versus the 9% preferred dividend rate that would otherwise have applied from April 2016. The $10.0 million subordinated loan used substantially to finance the redemption carries an effective annual rate of 6.44% and increased annual interest expense by approximately $644,000. Management said the transactions did not affect the Bank’s regulatory capital position.
- Securities gains contributed to noninterest income: $132,000 in Q2 and $212,000 in the first half, versus $49,000 and $101,000, respectively, in 2015. Management said sales and redemptions reflected portfolio adjustments for market conditions and projected cash flows.
- The interest-rate swap on $2.0 million of floating-rate trust preferred debt expired in Q2 and was not renewed.
- Common shareholders’ equity includes the effects of the preferred redemption; excluding it, management said equity would have increased approximately $1.9 million in the first half.
Credit quality, outlook and risks
- Nonperforming assets were $5.7 million, or 0.84% of assets, compared with $5.8 million, or 0.94%, at year-end. Nonperforming loans were 1.14% of loans, down from 1.24%; total delinquent loans were 2.04%, compared with 2.06%.
- The allowance for loan losses was $5.93 million, or 1.32% of gross loans, versus $5.71 million, or 1.33%, at year-end. Potential problem loans declined to $8.3 million from $10.0 million, although loans classified as doubtful increased by $679,000. Management considered the allowance adequate at June 30.
- No new troubled debt restructurings were reported in the first half of 2016. The filing reports $1.9 million of accruing TDRs outside the nonperforming-asset totals. Four foreclosed residential properties had a carrying value of $170,000; $1.1 million of residential loans were in foreclosure.
- Management cited credit quality and allowance adequacy, securities impairment, competition, interest-rate and economic conditions, regulation, and deposit funding as risks. The company’s lending is concentrated in Oswego and Onondaga counties, making borrower repayment dependent in part on local economic conditions.
- The filing gives no earnings or financial guidance. Management cautioned that interim results are not necessarily indicative of full-year results. It is evaluating the impact of the new CECL expected-credit-loss standard, which for SEC filers is effective for fiscal years beginning after December 15, 2019.
- Management reported effective disclosure controls and no material adverse legal proceeding. It stated that there was no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether loan and deposit growth can continue without further deterioration in net interest margin or materially higher funding costs.
- How operating expenses develop after the bank combination, and whether anticipated cost savings are realized.
- The sustainability of earnings excluding securities gains and the effect of subordinated-debt interest following the preferred-stock redemption.
- Credit migration and loss exposure, particularly the increase in doubtful loans, commercial lending, impaired loans and loans in foreclosure; assess the allowance against portfolio growth.
- Municipal deposit concentration, collateral requirements, borrowing availability and the liquidity impact of the standby letter of credit.
- The company’s eventual CECL implementation analysis and any resulting allowance or capital effects.