Pathfinder Bancorp, Inc. annual report, FY2017

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Pathfinder Bancorp, Inc. — 2017 Form 10-K

Business context and reporting period. This annual report covers the fiscal year ended December 31, 2017, with balance-sheet comparisons to December 31, 2016. Pathfinder Bancorp is a bank holding company whose principal subsidiary, Pathfinder Bank, serves customers primarily in Oswego and Onondaga Counties, New York. Its business centers on gathering deposits and making residential, commercial real estate, commercial business and consumer loans.

Financial performance and condition

  • Profitability: Net income attributable to Pathfinder Bancorp was $3.49 million, up 6.7% from $3.27 million in 2016. Basic and diluted EPS were $0.86 and $0.83, respectively, versus $0.79 and $0.78. Return on average assets fell to 0.42% from 0.48%; return on average equity rose to 5.69% from 5.35%.
  • Revenue and margins: Net interest income increased 14.0% to $23.12 million. Net interest margin declined to 2.97% from 3.14%, while the net interest rate spread fell to 2.83% from 3.03%. Noninterest income was essentially unchanged at $4.18 million. Noninterest expense rose 10.9% to $21.19 million; the efficiency ratio improved slightly to 79.13% from 79.90%.
  • Credit costs and asset quality: Provision for loan losses rose to $1.77 million from $953,000. Net charge-offs increased to $890,000 from $412,000, including a $565,000 charge-off of a fully reserved commercial real estate loan. Nonperforming loans were $4.89 million, or 0.84% of loans, compared with $4.81 million, or 0.98%, in 2016. The allowance was $7.13 million, or 1.23% of loans, versus $6.25 million, or 1.27%.
  • Growth and balance sheet: Total assets grew 17.7% to $881.3 million. Net loans increased to $573.7 million from $485.9 million; deposits rose to $723.6 million from $611.0 million. Shareholders’ equity was $61.8 million, and book value per common share was $14.44.
  • Cash flow and liquidity: Operating cash flow was $6.84 million; investing activities used $133.94 million and financing activities provided $126.67 million. Cash and cash equivalents decreased $428,000 to $21.99 million. The Bank reported $82.5 million in unused availability from total credit lines of approximately $182.4 million. Brokered deposits were $145.1 million, about 20.1% of deposits.
  • Debt and capital: Year-end borrowings and subordinated loans totaled approximately $88.95 million, including $73.89 million of FHLB borrowings and $15.06 million of subordinated loans. The Bank was categorized as well-capitalized; its total risk-based capital ratio was 13.97% and Tier 1 leverage ratio was 8.16%.

Material changes versus 2016

  • Net interest income increased with substantial asset growth, but funding costs rose: interest expense increased $2.49 million, and net interest margin narrowed.
  • Loans grew 18.0%; commercial real estate and commercial lending continued to expand. Commercial real estate loans were 33.2% of the loan portfolio, while residential real estate loans were 38.2%.
  • Provision expense and net charge-offs increased. Nonperforming-loan and nonperforming-asset ratios improved, but past-due loans rose to $12.35 million from $9.76 million.
  • Noninterest expense rose by $2.08 million, driven in part by staffing, facilities, business development, risk management and FDIC assessment costs.
  • The Company redeemed its $13 million SBLF preferred stock in 2016; it paid no preferred dividends in 2017. The replacement subordinated borrowing carries an effective funding cost of 6.44%.

Outlook, commentary, risks and unusual items

  • Outlook: No numerical earnings or financial guidance is provided. Management plans to continue growing commercial and commercial real estate lending, expanding business relationships and deposits, developing fee-generating services, and selectively expanding its presence in the Syracuse-area market. A new Syracuse-area branch was planned to open, subject to regulatory approval, in fall 2018.
  • Interest-rate and funding exposure: Management cites sensitivity to changing rates, competition for deposits and loans, and the possibility that maturing certificates of deposit may leave or require higher renewal rates. Certificates of deposit totaling $146.3 million were scheduled to mature within one year. Commercial real estate and business lending carry greater credit risk than residential mortgage lending.
  • Credit and concentration risks: A $1.7 million commercial real estate loan secured by a special-purpose property had a $300,000 specific reserve; management said the balance might not be fully realizable. The loan portfolio is concentrated in the local economy and real estate collateral. The Company also acquired $25.8 million of out-of-market automobile loan pools in 2017; the originating institution services these loans.
  • Unusual items: Short-term Treasury sale-and-repurchase strategies generated $428,000 in 2017 gains, partly offset by $598,000 of related borrowing interest expense; management reported a net after-tax income benefit of $178,000. The Tax Act generated a $155,000 fourth-quarter tax benefit and reduced the federal corporate tax rate to 21% beginning in 2018. The reported 2017 effective tax rate was 20.6%; management said it would have been 24.0% without the Tax Act benefit.
  • Contingencies and controls: Management said pending claims and lawsuits, primarily foreclosures, were not expected to materially affect financial condition or results. Management reported effective internal control over financial reporting and no material weaknesses. The independent auditor issued an unqualified opinion on the financial statements; the filing does not include an auditor attestation on internal controls.

Important facts for investors to verify

  • Whether loan growth and deposit growth can continue without further deterioration in net interest margin or an increase in funding costs.
  • The collectability and collateral values of the $1.7 million special-purpose commercial real estate loan, and the performance of the out-of-market automobile loan pools.
  • The adequacy of the $7.13 million loan-loss allowance given higher charge-offs, rising past-due loans and commercial real estate exposure.
  • The cost, renewal behavior and concentration of brokered deposits and large certificates of deposit, as well as remaining borrowing availability after pledged collateral and letters of credit.
  • The recurring earnings contribution from lending and core fee income compared with gains from the short-term Treasury strategies and tax-related benefits.